Tuesday, February 10, 2009

Picking Apart the Geithner Bailout Plan, and A Real Solution

A few words come to mind when trying to understand the Bailout Plan announced by Treasury Secretary Geithner today: incomplete, clueless, odd, potentially devious, lacking in details.

It should not come as any surprise that major stock indexes slumped after Geithner unveiled the plan.

The Dow Jones industrial average dropped 381.99 points points, or 4.6 percent, to close at 7,888.88. The Dow had fallen as much as 420 points in the last half hour of trading.

The broader Standard & Poor’s 500-stock index fell 4.9 percent or 42.73 points, to 827.16.

Every sector of the market was trading lower, with the Standard & Poor’s financials index falling by more than 8 percent,and shares of Bank of America slid 19 percent.

It's clear that we now not only have a man at the Fed that is tone deaf to the markets, but also one at the Treasury.

What Wall Street wanted to see was something along this line:

There are x billions worth of bad paper out there, we are going to do y to take this off the books of banks so that these banks can function again. 

I rush to add that this would not be my proposal in a free market world view without political pressures. However, in the world of realeconomik where political matters are sadly taken into consideration, this is what was needed to be taken care of. Geithner failed.

Let's take Geithner's outline apart piece by piece.

He said:

First, we're going to require banking institutions to go through a carefully designed comprehensive stress test, to use the medical term. We want their balance sheets cleaner, and stronger. And we are going to help this process by providing a new program of capital support for those institutions which need it.
Here's the problem with this. Wall Street and investors see the problem as banks holding bad paper. The banks know what the bad paper is and they want someone to take it off their hands. A stress test sounds too much like politics still trying to kill off some players. Who and how at this point is unknown.

How would a stress test kill off some players? By defining some kind of paper as bad paper that would result in that paper being dumped by banks immediately onto the markets. Who knows who and how such paper would be defined? When the government wanted to kill the junk bond market, it ruled that banks and S&L's couldn't own junk paper even if it was sound paper unlikely to ever go bad. The junk market crash dived, good paper and bad--never too recover.

Banks are not going to hold paper that the government for whatever reason wants to declare a non-passing security in a stress test--it will be gone and muck up the markets as that type of security is sold by banks and other financial institutions across the country.

Thus,the Stress Test is a bad idea, with no real purpose.

Geithner goes on:

...alongside this new Financial Stability Trust, together with the Fed, the FDIC, and the private sector, we will establish a Public-Private Investment Fund. This program will provide government capital and government financing to help leverage private capital to help get private markets working again. This fund will be targeted to the legacy loans and assets that are now burdening many financial institutions.

By providing the financing the private markets cannot now provide, this will help start a market for the real estate related assets that are at the center of this crisis. Our objective is to use private capital and private asset managers to help provide a market mechanism for valuing the assets.

We are exploring a range of different structures for this program, and will seek input from market participants and the public as we design it. We believe this program should ultimately provide up to one trillion in financing capacity, but we plan to start it on a scale of $500 billion, and expand it based on what works.

There's all kinds of problems here. When Geithner says "We are exploring a range of different structures for this program, and will seek input from market participants and the public as we design it." He is telling everyone that he doesn't have a clue as to how he is going to do this. And yet, in his next breath on a clueless program, he says the program will ultimately need a trillion dollars! But since he is clueless about the program he is only going to start spending a half trillion--until, I guess , he gets a clue!!

Do you get why Wall Street might be worried?

Further what's this "private sector" stuff Geithner continues to talk about? It's the Carlyle Group and other insiders, trying to get their piece of the action. How this could possibly work is beyond me. Here's the problem, banks need to get the bad paper off the books at some kind of reasonable price so it doesn't bankrupt them. This is likely a price above market value. The players, like Carlyle Group's co-founder David Rubenstein, don't pay up for anything. Rubenstein is the type that would rather go hungry, than have to pay full price for food off of the McDonald's dollar menu.

All of this, no matter how it plays out will be very inflationary, and,  so now we have  Geithner's final element to his proposal, which is nothng but inflation at the consumer level:

...working jointly with the Federal Reserve, we are prepared to commit up to a trillion dollars to support a Consumer and Business Lending Initiative. This initiative will kickstart the secondary lending markets, to bring down borrowing costs, and to help get credit flowing again.

In our financial system, 40 percent of consumer lending has historically been available because people buy loans, put them together and sell them. Because this vital source of lending has frozen up, no financial recovery plan will be successful unless it helps restart securitization markets for sound loans made to consumers and businesses – large and small.

This lending program will be built on the Federal Reserve's Term Asset Backed Securities Loan Facility, announced last November, with capital from the Treasury and financing from the Federal Reserve.

We have agreed to expand this program to target the markets for small business lending, student loans, consumer and auto finance, and commercial mortgages.
All Wall Street hear's from Geithner here is Federal Reserve, when the Fed is involved you are talking major inflation creation, and for what? Student loans? Auto loans? Let people drive their cars a year or two longer than risk the chance of hyper-inflation.

And there you have it a clueless, inflationary plan, incomplete with plenty of room for monkey business.

Here's how I would handle the situation under realeconomiks, i.e. taking into consideration current day political pressures, rather than the type of proposal that I would recommend in a truly free market world.

I would send an announcement to every bank in America. That would read as follows: The United States Government is forming the Trash Can Bank of America. You hereby have the right to dump any trash loans you have at this bank. Send the loan to us, and as an offsetting entry, you must also send us deposit liabilities equal in dollar value to the trash loans you send us.

In this way, every bank in America would be a sound bank, since the only loans they would keep are performing loans. End of bank crisis.

As for the Trash Bank of America, the FDIC (backed up by the Federal Reserve would guaranty all the deposits). The FDIC would no longer guaranty loans at any other bank after one year. The Trash Can Bank of America would not be allowed to accept any new deposits. When someone withdraws funds, that's it they can't put it bank in that bank. The bank would pay interest equal to the average of the rates paid by the top 25 other banks in the country plus 50 basis points. As for the trash paper the Trash Can Bank of America received, it would be required to held  until maturity. However, bidders would be allowed to bid on any mortgages that are 90 days or more passed due.

1 comment:

  1. I'm thinking about RW's plan of moving equal deposits along with the bad loans. This is sheer genius.

    It would work and eliminate the need for the Treasury to put up any initial money and it would strengthen the entire banking system.

    Does anybody have Geithner's email?