The Financial Times has a front page article claiming that banks face large writedowns in the toxic asset plan. While the equity markets partied after the unveiling of Tim Geithner's new plan, considerable concerns remain about the enormous bid/ask spreads between what investors might be willing to pay for distressed loans and where the banks are carrying them on their balance sheets. Although the leverage provided by the government is theoretically supposed to raise the bids, credit markets did not rally nearly enough after the announcement to close the yawning divide. Consequently, Mr. Geithner's plan has the same fundamental flaw that it had when it was Mr. Paulson's plan: if banks are forced to sell at these prices, they would have enormous holes in their balance sheets and would need to raise more capital. Some banks are better capitalized than others, and the stress tests have been designed to determine which banks can withstand the writedowns. Although quite frankly, you don't need a stress test to tell you which bank is more distressed. A $1 to $3 stock price is evidence enough.
But if you pair the stress test, with the toxic asset auction plan, what do you get? Some banks that'll make it, and some that won't. What to do with the banks that won't? You can either keep them afloat or you can seize them. Is it any wonder then that Bernanke is finally serious about having methods in place to deal with an orderly unwind of large financial institutions?
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