Interpreting the "Financial Stability Plan"

Posted on February 11, 2009 by David Laidlaw

Treasury Secretary, Tim Geithner, provided an outline of the Administration’s Financial Stability Plan to protect the financial system. The plan contains three main tenets. The first is to “stress test” all of the banks to determine the banks level of solvency and insolvency. Those banks that can be saved will then be provided additional capital in a transparent manner through Internet postings. The second part of the plan involves creating an entity with private partners that will buy toxic assets from financial institutions. The entity would require $500 billion at the outset and then as much as $1 trillion over time. The final part of the plan calls for consumer lending support. This section involved the expansion of the TALF plan passed in November of last year to buy asset-backed securities such as student loans to support lending in these markets. However, this program has been extended to include a comprehensive plan to address foreclosures in the housing market.Funding for this last section was expected to require $1 trillion.

We believe the market sold off immediately for two justifiable reasons. The first is that the staggering funding requirements involved suggest that the problems within the financial system are even greater than already anticipated. The market understands the weak footing of such behemoths as Citi and Bank of America, but was shocked by the estimate of an additional $1 trillion that is necessary to resolve the problem. The second reason for the negative reaction again involves the lack of specificity regarding how these programs will be implemented. For instance, there was no discussion concerning the role of private capital in the “bad bank” and what will be paid for assets. The speech was also extremely light on how foreclosures would be prevented and what mechanisms would be used.

Markets react negatively to uncertainty. Today’s unsettling message from the Treasury (very similar to previous messages from Paulson during the 4th Quarter of last year) indicated that the problems are enormous and we still have not figured out how to solve them.