Wed Feb 11th, 2009 at 04:14:45 AM EST
I guess I'll be a lone voice in the wilderness and defend US Treasury Secretary Geithner and his Financial Stability Plan. It's not all that bad.
First of all, let's look at what Geithner said introducing the plan on February 10th:
I am going to outline the key elements of this program today. But before I do that, I want to explain how we got here. The causes of the crisis are many and complex. They accumulated over time, and will take time to resolve.
Governments and central banks around the world pursued policies that, with the benefit of hindsight, caused a huge global boom in credit, pushing up housing prices and financial markets to levels that defied gravity.
Investors and banks took risks they did not understand. Individuals, businesses, and governments borrowed beyond their means. The rewards that went to financial executives departed from any realistic appreciation of risk.
Haven't we been heaping praise on bloggers for saying these things for a few years? Shouldn't we be happy to hear it from the mouth of the US Treasury Secretary?
frontpaged by Jerome
There were systematic failures in the checks and balances in the system, by Boards of Directors, by credit rating agencies, and by government regulators. Our financial system operated with large gaps in meaningful oversight, and without sufficient constraints to limit risk. Even institutions that were overseen by our complicated, overlapping system of multiple regulators put themselves in a position of extreme vulnerability.
I mean, really...
At the bottom of that "spin sheet" from the US Treasury there's a link to a fact sheet (PDF). The first line is funny...
The Financial Stability Plan: Deploying our Full Arsenal to Attack the Credit Crisis on All Fronts.
reminiscent of the USA PATRIOT act: "U
niting and S
merica...". I guess the US government will always be the US government. Anyway...
To ensure that we are responding to this crisis as one government, Secretary Timothy Geithner -- working in collaboration and joined by Federal Reserve Chairman Ben Bernanke, FDIC Chair Sheila Bair, Office of Thrift Supervision Director John Reich and Comptroller of the Currency John Dugan - is bringing the full force and full range of financial tools available to cleaning up lingering problems in our banking system, opening up credit and beginning the process of financial recovery.
Financial Stability Plan
1. Financial Stability Trust
- A Comprehensive Stress Test for Major Banks
- Increased Balance Sheet Transparency and Disclosure
- Capital Assistance Program
What on Earth is "a comprehensive stress test"? An Audit by another name. First of all, it's not optional. Banks will not be able to say that they don't want to take part in the exercise because they don't need help. Also, participating in the exercise cannot be interpreted as a sign of weakness in and of itself. This is one of the reasons a lot of earlier interventions have not worked: banks that took aid were punished by markets, creditors and rating agencies for showing weakness.
Requirement for $100 Billion-Plus Banks: All banking institutions with assets in excess of $100 billion will be required to participate in the coordinated supervisory review process and comprehensive stress test.
This "supervisory review process" is not a valuation of bad assets to find a "fair price": it is an estimation of risk exposures and
of whether the banks have the necessary capital provision to face possible losses:
Forward Looking Assessment - Stress Test: A key component of the Capital Assistance Program is a forward looking comprehensive "stress test" that requires an assessment of whether major financial institutions have the capital necessary to continue lending and to absorb the potential losses that could result from a more severe decline in the economy than projected.
Since the whole point is that the banks put these assets off their balance sheets to avoid capitalizing their exposures, they clearly cannot have enough capital and so they will, of necessity, be found insolvent or at least inadequately capitalised under current banking regulations. Anyway, just in case it needs repeating, this is not about finding a price for assets that have no market price: it is about exposures
Coordinated, Accurate, and Realistic Assessment: All relevant financial regulators -- the Federal Reserve, FDIC, OCC, and OTS -- will work together in a coordinated way to bring more consistent, realistic and forward looking assessment of exposures on the balance sheet of financial institutions..
Assessing the exposures on the balance sheet is not, I repeat, finding a price for the assets on it. And, finally, transparency and accountability:
Increased Transparency and Disclosure: Increased transparency will facilitate a more effective use of market discipline in financial markets. The Treasury Department will work with bank supervisors and the Securities and Exchange Commission and accounting standard setters in their efforts to improve public disclosure by banks. This effort will include measures to improve the disclosure of the exposures on bank balance sheets. In conducting these exercises, supervisors recognize the need not to adopt an overly conservative posture or take steps that could inappropriately constrain lending.
It may not live to its potential, but potentially this is a 21st century version of Roosevelt's Emergency Banking Act
On March 5, 1933, the day after Roosevelt's inauguration, he called a special session of Congress which instituted a mandatory four-day bank holiday. This act provided for the reopening of banks after federal inspectors had declared them to be financially secure.
Within 300 days of the act's passage, 5,000 banks had passed inspection and were reopened. Roughly two-thirds of U.S. banks quickly reopened under this act, and faith in banking institutions was somewhat restored.
This act was a temporary solution to a major problem. The 1933 Banking Act passed later that year presented elements of a more permanent solution, including formation of the Federal Deposit Insurance Corporation (FDIC).
Anyway, back to Geithner. Just like this is a Mandatory Audit under the name of Stress Testing, it is quite likely a Nationalisation by another name:
Capital Assistance Program: While banks will be encouraged to access private markets to raise any additional capital needed to establish this buffer, a financial institution that has undergone a comprehensive "stress test" will have access to a Treasury provided "capital buffer" to help absorb losses and serve as a bridge to receiving increased private capital. While most banks have strong capital positions, the Financial Stability Trust will provide a capital buffer that will: Operate as a form of "contingent equity" to ensure firms the capital strength to preserve or increase lending in a worse than expected economic downturn. Firms will receive a preferred security investment from Treasury in convertible securities that they can convert into common equity if needed to preserve lending in a worse-than-expected economic environment. This convertible preferred security will carry a dividend to be specified later and a conversion price set at a modest discount from the prevailing level of the institution's stock price as of February 9, 2009. Banking institutions with consolidated assets below $100 billion will also be eligible to obtain capital from the CAP after a supervisory review.
Banks that are found to be lacking in regulatory capital (most likely, all banks :-) will be "encouraged" to seek private capital but they are not likely to find it. Then, they'll get capital from the Treasury in the form of "convertible preferred equity", that is, a sort of bond with a divident rate to be set by the Treasury itself, and convertible into common stock at a price based on the February 9 market price and thus unaffected by the sell-off triggered by today's announcement (isn't that brilliant?).
I think the only flaw in this scheme is that for small banks, the audit is not mandatory but optional. I think it should be extended to them in successive waves, but also in a mandatory way.