WSJ: Why Markets Dissed the Geithner Plan

The Wall Street Journal OPINION February 10, 2009, 10:48 P.M. ET

Why Markets Dissed the Geithner Plan Here's how he should handle the banks.

By ANDY KESSLER

One of the cool things about being Treasury Secretary is that you get your signature on dollar bills, giving them authority, defending their honor. 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' skepticism.

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 meager $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.

Mr. Kessler, a former hedge-fund manager, is the author of "How We Got Here" (Collins, 2005).

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The Wall Street Journal FEBRUARY 11, 2009

Market Pans Bank Rescue Plan Treasury Secretary's Announcement Short on Details About Bad Assets, Mortgages

By DEBORAH SOLOMON

WASHINGTON -- Treasury Secretary Timothy Geithner promised forceful action to get credit flowing again in the economy, but the lack of detail in his much-anticipated speech helped drive stocks down nearly

5%, the worst selloff since President Barack Obama assumed office.

Announcing the Obama administration's financial-rescue plan in the Treasury's ornate Cash Room, Mr. Geithner described a mix of efforts that were mostly already known in their outlines. They included a fresh round of capital injections into banks, an expansion of a Federal Reserve lending program and a public-private effort to relieve banks of soured assets. The steps are aimed at getting $1 trillion to $2 trillion in financing flowing through the economy to kick-start both consumer and business lending.

The other prong of the administration's economic program advanced Tuesday as the Senate passed a $838 billion stimulus bill, setting up a conference with the House to reach a final bill, possibly by the end of this week.

Mr. Geithner committed the government to spending $50 billion to stem home foreclosures but said the details remain to be worked out in the next few weeks. Officials also will take the coming weeks to flesh out details, in consultation with the public, of a planned Public-Private Investment Fund to take soured assets off banks' books.

After his speech, Mr. Geithner met with lawmakers. The Treasury could find itself back on Capitol Hill at some point seeking more financial- rescue funds. Officials said they have enough for the time being, but didn't rule out asking for more.

Some observers expressed concern about the plan.

"I am very skeptical that this plan will achieve the desired objectives," said Gerald Ford, a Texas billionaire who has been bidding on failed banks. In particular, Mr. Ford said it was "hard to understand" how the government and private investors will cooperate to set a price for the troubled assets on banks' books that are undermining confidence in the banking system.

Said Ethan Harris, chief U.S. economist at Barclays Capital: "This is the shock and ugh plan."

At a meeting of the American Securitization Forum in Las Vegas, a crowd of about 50 people abandoned their breakfasts to watch Mr. Geithner's speech on TV, some snickering as the stock market began to fall. At the 4 p.m. market close, the Dow Industrials were down 381.99 points, or 4.6%, at 7888.88. The S&P 500 was down 4.9%.

The market hit its lowest level since Nov. 20, when it became clear the Bush administration wasn't going to follow through on plans to buy bad assets from banks. Tuesday was the stock market's worst day since Dec. 1 and left stocks down 10.1% for the year. Treasury bonds, however, rallied.

"We understood that some might be disappointed that we didn't announce a large bailout program," said a Treasury spokeswoman, Stephanie Cutter. "But our focus is on what will be the best comprehensive plan to protect taxpayer dollars, jump-start lending and bring forth a long- term financial recovery, not the hour-by-hour movement of the markets or a particular company's stock on any given day."

The limited number of details of the Obama plan so far underscored the tough problems that lie at the heart of the crisis. The administration has ruled out dramatic approaches such as nationalizing the banking system or throwing gushers of cash at banks without conditions.

'Enormously Complicated' "As you know, this is enormously complicated," Mr. Geithner told CNBC. "We're being exceptionally careful that the taxpayer is being protected, that we're taking risks we understand, and that we're using these resources in a way that's going to give the maximum benefit in getting these markets going again." He called the basic structure of the plan the best way to get markets functioning at least risk to taxpayers.

Obama officials called the minimal details given Tuesday intentional and said they will work with both Congress and the public to fully develop their plans. In part, the Treasury was trying to avoid a repeat of the experience of former Treasury Secretary Henry Paulson, who was faulted last fall for shifting gears and not consulting Congress about changes to his rescue plan. At the same time, the administration was under pressure to get something out quickly, despite limited manpower less than a month after the inauguration.

There were also political calculations, including a decision made early to not consult heavily with Mr. Paulson's team, according to people familiar with the situation. The Obama team spent weeks wrestling with many of the same issues that bedeviled Mr. Paulson's efforts, including how to deal with bad assets.

For a time, the Obama team considered setting up a "bad bank," where the U.S. would buy distressed assets directly from financial institutions. It discarded that idea after realizing it would be too costly and difficult -- as Mr. Paulson also had concluded.

The Obama team also steered clear of consulting Wall Street about its plan in an effort to avoid being seen as joining with a much-maligned industry, officials say. Top bank executives have been complaining in recent days of being frozen out as the administration crafted its plan.

Two senior executives at a large New York bank said Tuesday that Treasury officials recently told them that they wouldn't be consulted on the bailout until after Mr. Geithner had unveiled its broad outlines. After Tuesday's announcement, the executives said they were hoping to wield some influence.

Among the biggest unanswered questions is how the plan to buy troubled assets, such as certain mortgage securities, will work. Many economists agree that removing bad loans and other soured assets from bank balance sheets is vital to the recovery of the financial system.

Mr. Geithner said the administration wants to help banks clean up their balance sheets by becoming a partner with the private sector to buy $500 billion to $1 trillion of bad loans and other distressed assets.

Treasury officials said the government may commit some portion of bailout funds to the program, with the rest of the money coming from private investors and through other "public financing." The Fed could provide bridge loans, but given its substantial other long-term commitments, officials there are reluctant to finance the program. The program could also sell government-backed debt.

It hasn't yet been determined how the so-called investment fund will be structured, including whether the government will be an equal investor and whether there will be one fund or multiple funds established to buy different assets.

That the administration settled on such a complicated idea is a testament to how hard it's been to find a way to relieve banks of their bad bets. The Obama team has been wrestling with the question of how to value the assets, many of which are illiquid and don't trade. To help banks, the government must pay a high enough price so banks don't have to suffer additional losses from selling or writing down such assets. But Congress, facing bailout fatigue, has already warned against overpaying, on taxpayers' dime.

A senior Treasury official said the administration explored "quite a few alternatives" but concluded it was a "challenge" to have the government set a price for the bad assets. Instead, they believe their structure will allow the private sector to value them.

A senior Treasury official said the government "can't simply put capital into banks, we can't simply restart the securitization market and we can't simply take assets off the balance sheets." The market's recovery will depend on the government combining those efforts, the official said.

In addition to buying assets, Treasury plans to inject as much as $200 billion into banks and expand a Federal Reserve facility aimed at jump- starting the consumer-loan market. The existing Term Asset-Backed Liquidity Facility, or TALF, will be expanded to provide as much as $1 trillion in financing to investors who buy assets backed by student loans, credit cards, auto loans and commercial real estate.

In seeking to sell his plan, Mr. Geithner warned that it will cost money and take time to work, and that policymakers may not always get it right. "We will make mistakes. We will go through periods in which things get worse and progress is uneven or interrupted," he said. He said the response to the crisis so far has been "late and inadequate. Policy was always behind the curve, always chasing the escalating crisis."

Moorhead Vermilye, CEO of Shore Bancshares Inc. in Easton, Md., which got $25 million in bailout funds, wondered, "Will another large infusion do any good? I wish I knew. I don't think anyone has got a clue as to how deep this problem will go."

?Robin Sidel, Dan Fitzpatrick, Jon Hilsenrath, Sudeep Reddy and Liz Rappaport contributed to this article.

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