Waiting For Geithner, by Tim Duy: Treasury Secretary Timothy Geithner is slated to announce the latest financial stabilization plan Monday. From various press reports and leaks, these are things to be looking for:
1. No bad bank. The plan appears likely to leave toxic assets in the hands of the financial sector, rather than purging them from the system once and for all. The bad bank idea is proving to be prohibitively costly if your fundamental goal is to maintain the status quo - one cannot shower the sector with such financial largess and expect to leave existing shareholders and bondholders unharmed. Instead, there appears to be a move toward guaranteeing losses beyond a certain amount, a "ring fence" approach.
2. More string tied to aid. Institutions receiving aid will be subject to "limits" on executive pay, requirements that they modify troubled mortgages when possible, and requirements that government money stimulate new lending appear to be among the strings. The additional strings will likely discourage willing participation.
3. Triage? From Bloomberg:
The Treasury may increase its stake in lenders that are judged short of capital, the people said on condition of anonymity. Should extra taxpayer funds result in a majority ownership by the government, officials would then decide whether to liquidate the institutions, place them into receivership or retire the companies’ assets over time, they said.
This sounds like Treasury would try to identify those institutions worth saving, and either nationalize or liquidate those with that require federal help on the order of a de facto nationalization. The Wall Street Journal suggests something different:
The rescue is shaping up to include a second round of capital injections with tougher terms. The government is looking to get money into banks by buying preferred shares that convert into common equity within seven years; that avoids diluting current shareholders' stakes while helping banks better withstand losses. The Treasury may also allow banks that already received capital injections to convert the Treasury's preferred shares to common stock over time.
The Journal version sounds like an effort will be made to protect existing shareholders and avoid nationalization.
My suspicion is that Treasury will talk tough, but continue a band-aid approach that dribbles out funds at a rate that both avoids the messy issue of nationalization while providing insufficient funds for adequate capitalization, all while trying to keep toxic assets in the banking system. Clearly, I am not optimistic.
4. Formal acceptance of agency debt. This one circulated the markets Friday; explicit endorsement of agency debt should render it nearly as good as Treasuries, and bring yield spreads, and mortgages, down dramatically.
5. Foreclosure mitigation. Reports suggest a stepped up effort for foreclosure mitigation to the tune of $100 - $200 billion. I don't view this as an effort to prop up prices; it is simply not enough the weigh against the literally trillions of lost value. I also suspect it is very difficult to identify homeowners who can benefit from reasonable modifications that don't require either a substantial and untenable taxpayer contribution or the homeowner becoming a virtual mortgage slave, tied to an unrealistic housing payment.
6. Support for bankruptcy "cramdowns."
7. A greater role for the FDIC. Give the FDIC authority to liquidate non-bank firms in an orderly fashion, and extend guarantees of financing bonds issued by banks. The former would likely require legislation.
8. Expanded role for the Fed. The Wall Street Journal describes the evolution of the new TALF facility. My favorite line:
Some hedge funds, which often use borrowed money to boost returns, are lining up to get in on the Fed program, seeing a chance to make high double-digit-percentage returns with little downside using low-cost loans made on easy terms. Some officials inside the Fed are nervous about relying on unregulated hedge funds. But they see it as a trade-off in order to get capital to consumers.
I can just see how this program evolved. Fed and Treasury officials meet with Wall Street titans looking for methods to unglue the financial system. The answer: Create programs that guarantee risk-free double digit returns for wealthy investors. In the meantime, I am trying to explain to aging Rotarians nearing retirement that they are simply screwed; the risk free rate for them and the other 99.9% of the population is pushing at zero.
These appear to be the highlights; I hope I have not missed anything substantial. We will soon see which leaks were accurate, and what details were not leaked.