Treasury Secretary Timothy Geithner ducked the tough questions investors want answered as he rolled out a plan to repair the financial system -- and stock traders made him pay for it.
Driving investor doubts was Geithner’s failure to clearly address three issues at the heart of the crisis: Will banks saddled with toxic debt be forced to fail? How will illiquid assets be removed from bank balance sheets? And what will be done to arrest the decline in house prices that triggered the turmoil?
The risk is that the market reaction sabotages the plan before it gets under way, forcing Geithner to change his approach in response -- a position that his predecessor, Henry Paulson, frequently found himself in. That may mean the plan “may just end being an interim step,” said Kenneth Rogoff, a former chief economist at the International Monetary Fund who’s now a professor at Harvard.
“Tim Geithner did a great job in painting the broad strokes of the problem and laying out general principles, but it was a big disappointment not to have more details,” Rogoff said.
Rogoff also said Geithner missed an opportunity to send a stronger signal distinguishing his approach from Paulson’s: “I would have liked to see President Obama standing behind the Treasury secretary, considering this speech, more than anything else, was supposed to lay out the policies signaling a decisive break from the past.”
Bank Stocks
The Standard & Poor’s 500 stock index tumbled 4.9 percent yesterday as investors dumped bank stocks on skepticism whether the plan will work. Bank of America Corp. plunged 19 percent and Citigroup Inc. dropped 15 percent. Stocks recovered today as investors bought bank shares trading near their lowest valuations on record.
Geithner defended his approach at a Senate Budget Committee hearing today, saying that he wanted to move “carefully” to fashion the financial rescue plan so that he wouldn’t be forced to change the strategy later. “I do not want to do that. I do not think that would be helpful for certainty,” he said.
The program Geithner laid out has three main elements: Injecting fresh government capital into some of the country’s biggest financial institutions; establishing a public-private partnership to buy as much as $1 trillion of banks’ bad assets; and starting a credit facility of up to $1 trillion to promote lending to consumers and businesses.
‘Dangerous Dynamic’
U.S. banks have sustained $756 billion in credit losses since the crisis began and have warned of more to come. “The recession is putting greater pressure on banks,” Geithner, 47, said in unveiling the Obama administration’s plan in Washington. “This is a dangerous dynamic, and we need to arrest it.”
President Barack Obama, speaking at a Feb. 9 press conference, said it was critical that the government restore investor trust in the financial system. “We’ve got to restore confidence so that private capital goes back in,” he said.
The trouble is that investors abhor uncertainty and Geithner only seemed to add to that with a proposal short on specifics.
“He should have waited until he had his ducks in order,” said Ward McCarthy, of Stone & McCarthy Research in Skillman, New Jersey. “The lack of detail leaves too much room for confusion, misinterpretation and speculation.”
Anil Kashyap, a professor of economics and finance at the University of Chicago Booth School of Business, gave Geithner credit for getting regulators to agree to subject the country’s 18 to 20 largest banks to stress tests to determine whether they have enough capital to withstand an even worse economy.
Tests for Banks
Geithner said the tests would be used to determine which banks need more capital from the government. Left up in the air is whether the government will shut down banks that the tests show are all but insolvent, rather than putting more money into them.
That’s a step that experts such as Rogoff advocate. “You don’t want to try to keep zombie banks on life support,” he said.
Until it’s clear which, if any, of the big banks the government may take over, investors will be wary of putting any more money into the sector for fear of being wiped out.
That’s a problem for Geithner because he is counting on investors to provide the bulk of the financing for his program to lift toxic assets from banks’ balance sheets. The illiquid securities, mainly tied to mortgages, have made lenders loath to extend new credit.
Toxic-Asset Fund
The so-called Public-Private Investment Fund that will purchase the securities will have an initial capacity of $500 billion, including some $50 billion backing from the government, and could grow to $1 trillion.
The details of how the fund will work have yet to be decided and Treasury officials suggested it could take months to come up with a final program.
“We are exploring a range of different structures for this program, and will seek input from market participants and the public as we design it,” Geithner said.
Officials said the program will aim to provide potential buyers of the assets, including private equity firms, with longer-term financing that they say they need to carry out deals.
“There is a lot of capital that seems to be waiting on the sidelines to acquire the distressed assets,” said John Lyons, chief executive officer of Savills LLC, a real estate investment banking firm. “The issues are nobody knows what the value of that product is, and we still have the falling knife syndrome,” in which plunging prices make investors reluctant to jump into the market.
More Money Needed
Louis Crandall, chief economist at Jersey City, New Jersey- based Wrightson ICAP LLC, said that the Treasury may ultimately have to ask Congress for more money to finance the purchase of the bad assets. Both Geithner and Obama have left open that possibility.
Behind some of the uncertainty of what the mortgage-related assets are worth is the continued decline in house prices. Home prices in 20 U.S. cities were down 18.2 percent in November from a year earlier, the fastest drop on record, according to the S&P/Case-Shiller index.
The Obama administration has pledged to use at least $50 billion from the bank bailout fund help the housing market by preventing foreclosures. Geithner said the details of the plan will be announced in the next few weeks.
“It would have been helpful to have a little bit more detail on exactly how the package is going to take place, how homeowners can apply, and the impact on financial institutions,” Dino Kos, a former Fed official who is now managing director of Portales Partners in New York, said in an interview yesterday on Bloomberg Television.
Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, praised Geithner for not moving “too quickly without a lot of thought involved in what the implications would be.” Still, he said, “I take this as the first step in the process. We don’t have a lot of time, the window is closing and we’ve got to move.”
General News 
