Wednesday 11 February 2009
Why Markets Dissed the Geithner Plan
One of the cool things about being Treasury Secretary is that you get your signature on dollar bills, giving them authority, defending their honour. Timothy Geithner’s plan to save the struggling banking system probably does the opposite, throwing good money after bad to a banking system struggling under the weight of its own mistakes. The markets don’t like it. The Dow dropped 382 points while bonds rallied as a port in a continuing storm.
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Why Markets Dissed the Geithner Plan
By ANDY KESSLER, WSJ
11 February 2009
(Editor’s Note: Mr. Kessler, a former hedge-fund manager, is the author of “How We Got Here” (Collins, 2005).)
One of the cool things about being Treasury Secretary is that you get your signature on dollar bills, giving them authority, defending their honour. Timothy Geithner’s plan to save the struggling banking system probably does the opposite, throwing good money after bad to a banking system struggling under the weight of its own mistakes. The markets don’t like it. The Dow dropped 382 points while bonds rallied as a port in a continuing storm.
Mr. Geithner announced a three-point plan yesterday to “clean up and strengthen the nation’s banks,” and made a vague declaration to use “the full resources of the government to help bring down mortgage payments and to help reduce mortgage interest rates.” Unfortunately, those are conflicting plans. Hence the markets’ scepticism.
The Treasury secretary seems stuck on keeping the banks we have in place. But we don’t need zombie banks overstuffed with nonperforming loans -- ask the Japanese.
Mr. Geithner wants to “stress test” banks to see which are worth saving. The market already has. Despite over a trillion in assets, Citigroup is worth a meagre $18 billion, Bank of America only $28 billion. The market has already figured out that the banks and their accountants haven’t fessed up to bad loans and that their shareholders are toast.
Second, Mr. Geithner wants to use up to $1 trillion to back new car loans, home loans and student loans. That’s noble, but incredibly market distorting. Who gets these loans? Will banks be forced to loan to those with bad credit? Who sets loan rates? Doesn’t this just set up another credit squeeze when government guarantees are lifted?
What we need are healthy banks with clean balance sheets and enlightened risk assessment to provide consumer and business loans that will generate returns to shareholders. And to this end, Mr. Geithner wants to create a public-private partnership to buy toxic securities off bank balance sheets. This is a truly worthy goal, but I don’t think his plan for doing so will work. Banks are more than able to sell these toxic loans today. They just don’t like the price.
The first iteration of the Troubled Asset Relief Program (TARP) last year was to buy these bad loans and derivatives. It didn’t work. Nothing was bought when it became clear that paying face value was a taxpayer giveaway to banks, but paying market prices for this stuff would cause huge equity write-downs, wiping out banks which would be left with negative equity and effective insolvency.
The next round of TARP injected money onto bank balance sheets first, boosting their equity so they could absorb the write-downs to come when the toxic junk was bought later. It didn’t work. The $45 billion to Citi and Bank of America wasn’t nearly enough. Instead, $306 billion and $118 billion loan guarantees were extended to cover the bad debt, which unfortunately, the market believes still weighs down banks’ balance sheets.
Now with TARP 2.0, renamed a friendly Financial Stability Plan, the idea is to entice private capital to buy these bad loans and derivatives in an effort to set the “market price.” But Mr. Geithner hasn’t solved the dilemma of banks not wanting to sell and become insolvent. Moreover, no one is going to buy these securities ahead of Mr. Geithner’s action with the “full resources of the government” to bring down mortgage payments and reduce mortgage interest rates. Lower mortgage payments means mortgage-backed securities would be worth even less. Six months to a year from now, big banks may still be weak and the ugly “n” word of nationalization will be back.
Mr. Geithner should instead use his “stress test” and nationalize the dead banks via the FDIC -- but only for a day or so.
First, strip out all the toxic assets and put them into a holding tank inside the Treasury. Then inject $300 billion in fresh equity for both Citi and Bank of America. Create 10 billion new shares of each of the companies to replace the old ones. The book value of each share could be $30. Very quickly, a new board of directors should be created and a new management team hired. Here’s the tricky part: Who owns the shares? Politics will kill a nationalized bank. So spin them out immediately.
Some $6 trillion in income taxes were paid by individuals in 2006, 2007 and 2008. On a pro-forma basis, send out those 10 billion shares of each bank to taxpayers. They paid for the recapitalization.
Each taxpayer would get about $100 worth of stock for each $1,000 of taxes paid. Of course, each taxpayer has the ability to sell these shares on the open market, maybe at $40, maybe $20, maybe $80. It depends on management, their vision, how much additional capital they are willing to raise, the dividend they declare, etc. Meanwhile, the toxic assets sitting inside the Treasury will have residual value and the proceeds from their eventual sale, I believe, will more than offset the capital injected. That would benefit all citizens, not the managements and shareholders who blew up the banking system in the first place.
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