Wednesday, February 11, 2009

Geithner's Financial Stability Plan (FSP)

Markets barfed at the announcement of the FSP (-5%) and the $2T number and finished with a funky 7888.88 on the DOW which made me think there was some chinese manipulation of the market since chances this number comes up is 1 in 100,000. My OCD is kicking in big time and I am obsessing on these numbers.

Anyway, I went out and read the coverage and the transcript of the fact sheet. In a nutshell, the plan is somewhat tough on banks and wall street didn't like that. Of course they didn't. Most investors cry wolf when they see pork in politics but would rather see a discreet appropriation of public funds to prop the bad banks, well there is little of the sort in the fact sheet except for the securitization bit.

1/ A stress test for banks
The fact sheet talks about a stress test for banks to see if they can sustain a further deterioration of the economy. A bit vague on the one hand. On the other "sustaining deterioration" is out of the question since the system is largely insolvent, everyone knows it. But what happens if you fail? If the 'stress test' results in TRIAGE resulting in nationalization followed by liquidation for those that fail then sure :)

Of course the plan is vague and avoids talking about nationalization, penalties if you fail the stress test etc. This smacks of lack of political courage but does lay the ground work for a good bank/bad bank approach and triage. This is a very soft way to approach the topic of nationalization for the bad banks, it may be vague on purpose.

2/ Lending facility for Securitization market.
This one makes me scratch my head a bit. They commit a HUGE number ($1T) to getting the securitization market going again. The government will buy AAA tranches of new structured debt. On the one hand, this is too big a gift to the banks. Securitization and the fact that banks did not hold onto the debt they originated is partly to blame for the current mess. It didn't matter that the batch was shit, it was sold off to investors who got the shaft. Securitization needs a complete overhaul, the market has been KILLED and this kind of government intervention by complete over-riding of the securitization market seems dangerous. Of course the banks want this market alive and securities on top of it if there were defaults and free money while you are at it. On the positive side, this is a pragmatic monetary approach that both admits that TARP failed to reactivate credit flow and an implicit ADMITION THE GOVERNMENT DOES NOT CONTROL MONEY LEVELS. This is a longer topic and I will write a separate entry, but Geithner has an interesting sentence in there saying "recycling of money by securitization is what made credit available". Yes, it is. It is also the innovation that got the banks to leverage over the 10x capital ratio (they got the cash back) and allowed them to create debt to capital ratios way beyond what our forefathers legislated in the Great Depression. It was a bonanza and death by debt. 40x is where some investment banks were. So this is a way of saying that 10 is too little 40 is too much but going from 40 to 10 at once will kill the patient. However good debt, car loans, prime real estate, students, what they call "good borrowers" are suffering because the subprime CDOs went to shite can we resuscitate the good market without the bad products? (BTW, naked CDS on CDOs are part of this market and, again, should be banned as they encouraged the market to function on shite).

I must admit that the securitization part is the part that really bothers me. This is a dead horse they are trying to prop up and I don't like it one bit, the part about AAA being bought by the government on which Geithner spends so much time is complete bullshit. It is what triggered the current crisis, AAA rating on absolute crap. AAA is no guarantee these days. It seems they are too afraid of sudden deleveraging and they could be right, I am probably wrong. It is corrupt but it may be what is needed. Both pragmatic and corrupt.

3/ Accountability, Transparency, Dividends, Pay
The 500k cap is there. What most people will not like is the cap on dividends (1c until the govt is paid back). They also limit M&A activity by saying that if you are a recipient of money you cannot use that money to go out and buy healthy banks while you are not healthy. It would distort the market too much. They also say that this is not money to pay salaries. Good for them to put that in basically they are saying this is public money to lend and nothing else.

In retrospect of course the markets would tank at "no dividends" but hey it is better than out-right nationalization. There is some arm-waiving around "no interference by lobbyist and politics" that would be really good but I wonder how well this will work. Politics will always meddle and corruption will always be present. This by far is the part that really kicks the banks in the teeth. I like it.

4/ Support for mortgages
This one I really don't know what to think of. It feels like it is fraught with moral hazard (you overpaid for a house you can't afford, it's ok we will help you) and a big way to defraud the savers to help the spenders. If you were good with your money you will be punished, if you were stupid you will be rewarded. I don't know what kind of message this sends. The flip side of this argument is that defaults on mortgages is what is driving this crisis and anything to avoid it is good and a necessary step to stabilizing the financial markets :) so it is really step zero. There is also the human component to it that must be taken into account. This quickly gets political and I stay out of it.

5/ Public-private partnership for bad asset purchase
Another implicit admission that TARP1 was too little on that front. I don't understand the public-private thing, but if it something like "government gets Buffet style deals" then I am all for it. Commentators are right that this is the fuzzy part. The problem of valuing the bad assets (important for step one) has been the sticky point since the aug 07 panic. No one wants to price this shit and there is no relief from mark-to-market hinted at in the plan. To use "flowery" language, the constipation is strong but when the shit is released, watch out. At least this is trying to say that the government will not be there to give the banks a sweet heart deal.

So all in all some details are there, some are missing but the tone is both harsh on the banks and realistic when it comes to securitization.

11 comments:

Andrew Meyer said...

Thanks for the summary. What's interesting about this whole thing, is that as bad as Geithner did, Obama's explanations were savvy and demonstrated that he understood the situation. That is in contrast to the senator who apparently asked about those "default credit swaps."

The most important and powerful aspect of a President is symbolic. Obama's ability to articulate issues and demonstrate that the government is actively doing something is important.

No doubt there are rough times ahead, but nature abhors a vacuum and there is an abhorrent lack of leadership in the world today. Obama provides a reason to hope that that may just be changing.

The fact that the stability and stimulus plans provide some structure where it's possible to do the right things, means there's groundwork and a basis beyond hope.

Marcf said...

Hey andrew,

yes, ironically most of the coverage has been "is the obama presidency already a failure?". Give me a break, the guys have been there 3 weeks and people are pissed off because there are some details missing? methinks there is a lot of partisan gloating at "look! the markets tanked! Obama is done". Excitements for the excitable. Then there is the whole flip side of people accusing O of being just as much of a lapdog to the financial elite as the bushies were. Part of me says "of course" that is the place of politics! but the less cynic part of me hopes the teeth shown in broad strokes in this fact sheet will not be diluted to nothing.

Anonymous said...

Check this out

http://www.newyorkfed.org/newsevents/speeches/2006/gei060516.html

Geithner has been thinking about this for a long time.

Roy Russo said...

On "4/ Support for mortgages", I believe the idea is to stop "preventable foreclosures", by reconstituting wacky loans in to lower interest 30y loans. Morality aside, I think they all know that if you prop-up the housing prices where they are today, you're elongating the problem. Perhaps the goal in this part of the plan is to have controlled slide.

Bruce said...

The Dow is off 18% since Obama was elected. No US president, even Carter, had the market snub his proposals like this. The market is forward looking by nature and doesn't like what it sees here.

Marcf said...

Roy, yes, it is clearly what they are trying to do. Slow down the rate of decay of mortgages, so that you can reflate faster than we are deflating. One argument is, and I used to be of that opinion, that you could revert to almost normal if you stopped the bleeding on mortgage. Problem is I have been reading too much Keen lately that does pure credit money based model gone bad in the minsky instability moment sense, these clearly are bi-stable models, one in positive land, the other in negative land the transition is sudden and hard to reverse, until the banks AND mortgage situation are reversed, this won't get better. Nationalize!

Roy Russo said...

The only sure-way out of this, is to fully nationalize the banking system. *But* I'm afraid that nationalization leads to banks being pilfered by the people or whatever party is in power. I think that sentiment is shared by most people in the U.S.

If Bush lessons are any indication, we're moving toward nationalization. Once the populace is scared enough, they will trade their freedom for security.

Jean-Luc van Hulst said...

Just to get an idea about how much 'deleveraging' is going on in some markets: "Median housing prices in the Fort Myers metropolitan area have plummeted from $322,000 in December 2005 to less than $107,000 in December 2008, the Obama administration notes."

That's a lot of pain in any mortgage from 120K and up in that market.... That's why the bad assets problem is still there I think. And now foreclosures are 'on hold', waiting for a plan. So yes, like you said 'help for the irresponsible'. But will it be enough if your mortgage is underwater 50% or more? Unlikely

(http://www.cnn.com/2009/POLITICS/02/11/henrietta.hughes/index.html )

Marcf said...

On third thought, it kind of woke me up this morning.

If the real problem is lack of demand for debt from the public then there is nothing that can be done. Nationalization of the banking system will not solve the demand problem. At least the keynesian angle in Geithner's plan is that the govt is committing to buying securitized products and stimulate demand in the secondary markets. But if the primary isn't there there isn't much they can securitize. Obviously the flip side of it, and I just don't know the data to formulate an opinion, would be that qualified borrowers cannot borrow because the securitization is gone and banks cannot pass debt through the revolving door. In that case, reviving the securitization market is a way to get the door revolving again without nationalizing the banking system.

Jean Luc, yeah the mortgage situation may be so bad it doesn't matter. I am awaiting the 3rd wave of defaults Pierre Fricke keeps talking about, the one where most people realize they should walk away from their mortgages, take the hit, pay less in rent and rebuy in a few years once prices are really depressed and people will get a blanket pardon from banks for impaired credit scores.

Army No Va said...

"The only sure-way out of this, is to fully nationalize the banking system."

Nope...won't help. Reflating won't too much either. You've got to get money into the hands of people so they can pay their debts. There is too much debt in the system.

Recessions are business cycle events that eliminate overcapacity. Depressions are deleveraging events that eliminate insolvency through bankruptcy and default. Guess which we are in?

The situation is worse. The Baby Boomers just woke up and realized not only can they not spend like before because of their debt but also because they have little retirement savings and diminishing prospects for good jobs due to the economy and their AGE!

So Gen X and the Millenials need to save the ecomony by buying Boomer houses at 300x monthly rent :-) ...

I'd say we are in an 1870s length and depth Depression at least. Maybe go deeper (but longer than) like the 1890s.

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