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Tuesday, February 10, 2009

Assessing Geithner's Bank Bailout

The market's initial assessment is decidedly negative and Dow plunged nearly 400 points upon digesting his plan. The general concensus was that the plan was far too vague and offered little tangible. I would have to concur. This plan can be summed up by "the devil is in the detail" and we got nothing in the way of detail. There are four plans to this plan.

1) The Stress Test

The Treasury will evaluate just how much capital banks have. Treasury will determine if each bank has enough capital to absorb future losses. Those that don't will have access to a revolving line of credit in the form of preferred shares (to the government I assume).

Personally, I have a philosophical problem with this. This rewards those banks that aren't properly leveraged. In other words, if you're a bank that is properly capitalized you have no access to this credit. Beyond this, ultimately what's important is how the Treasury will determine which bank is and isn't properly capitalized. That, Secretary Geithner didn't answer and so the devil here is in the detail.

2) The Private/Public "Bad Bank"

Treasury Secretary Geithner hopes to attract up to $1 Trillion in private money along with $500 billion in Treasury money in this bad bank. This will be a pseudo bank that will buy all of this toxic assets in an attempt to remove these assets from the books of the bank. The hope is that with Treasury backing private investors will be more apt to get involved.

Of course, the Secretary was entirely vague about how all of this will work. Who will buy what? Who will get what? How will these assets be valued? How long will they need to be held? There is a nearly endless stream of questions and none of them were answered by Geithner.

3) $200 billion to drive down rates on everything from mortgages to credit cards to car loans.

This is ludicrous. Not only is this a bad idea but spending $200 billion in every area of credit will drive down rates by about an eighth of one percent for a couple of days. The "distinguished" Economist Journal had this to say.

The third component may be the most promising. Using more seed money from the Treasury, the Federal Reserve will quintuple the size of its $200 billion programme to finance purchases of securities backed by car, credit-card and student loans.

The author should be fired. To say this is promising is simply to be economically brain dead. It's frankly impossible to put a dollar amount on how much this will cost but that Dollar amount will be exponentially higher than $200 billion.

4)$50 billion for loan modifications

Banks will be guaranteed up to $50 billion to provide loan modifications to "avoidable foreclosures? How is that defined no one knows because Secretary Geithner didn't say? Furthermore, here is how the Economist characterized it.

though it is not clear if this will include write-downs of principal, which many economists say are needed to stop the rot as more homeowners slip into negative equity. Banks that receive public money will be required to set up loan-modification schemes that are consistent with guidance from the Treasury. More details of the housing plan are expected over the next week.

So, essentially, the Treausry will create an entire "regulatory framework" for these loan modifications. Yet, not one detail about this framework was available. I have said over and over that loan modifications need serious regulations. That may still happen however if the government is subsidizing them, no one should anticipate any serious discrimination in which loan will be approved/denied.

Overall, the market appears to be right from my perch. This is the sort of plan that four guys sitting in a bar together could come up with. Merely laying out the basic guidelines is not acceptable of the Treasury Secretary. There needs to be significantly more detail. He shouldn't have made an announcement until more details had been laid out. That the Secretary didn't have more detail is not a sign of confidence.

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