Tuesday, February 10, 2009

Geithner Tanks the Market

You can read the full text of Tim Geithner's speech here.  A quick summary of the salient points:
  • More transparency via the new website FinancialStability.gov.  If you click on the link, it just says "This site is coming soon."  We're not fully operational on the transparency bit yet.
  • Banks will be required to go through a stress test where the various government agencies with authority over our nation's major banks will conduct a forward looking assessment about the risk on balance sheets.  Those institutions that need additional capital will be able to access a new funding mechanism from the Treasury as a bridge to private capital.  The capital will come with conditions to ensure that every dollar of assistance is used towards greater lending.  The assistance will also come with terms that encourage institutions to replace public assistance with private capital as soon as possible.
  • A Public-Private Investment Fund will be established.  The program will provide government capital and financing to help private capital buy crappy loans and assets from our banks.  This program is still a work in progress and the government is seeking input from market participants (i.e. they're on the line with Bill Gross.)
  • In conjunction with the Fed, the government will commit up to $1 trillion dollars to support the Consumer and Business Lending Initiative.  You can read the details of the statement from the Fed about the TALF here.  The program will be extended to include other types of newly issued AAA-rated asset-backed securities such as CMBS, private label MBS in addition to the previously announced auto loans, credit cards, student loans and SBA-guaranteed small business loans.
I suspect that the portion of Geithner's speech that has spooked the market is related to the stress tests being performed on financial institutions.  Any financial institution requiring further injections of public capital will get that capital on much harsher terms, consequently, it's fair to pummel the stocks that will require further government investments.  Certainly if the government finds that a large institution or two cannot survive, then this time perhaps equity holders and preferred equity holders may be entirely wiped out.  Furthermore, setting up a private/public bad bank isn't anywhere near as promising for a potentially insolvent institution as a bad bank that is purely government funded and a waste receptacle for unwanted assets.  If private investors were willing to purchase assets at the prices where banks have the assets marked, we wouldn't have a problem then, would we?  Even with government financing, private investors will still be looking for a bargain.  Nobody is going to raise the bid to par just because they can get 75% of the purchase financed.  In a scary market like this, with so much uncertainty in the economic outlook, is anyone with any money left going to stick out their neck?  No.  It would've been much easier to have the government buy the first trillion before throwing out a bid.  

The TALF, while a good idea in principal, doesn't really address the problem of legacy assets.  It merely creates a financing market for new securitizations.  Since underwriting standards are bound to be better this time around, I'm not terribly concerned about future losses on the TALF.  However, somebody still has to pay for the cleanup of the legacy toxic assets.  It looks as if we're not quite out of the woods yet.  

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