To be fair, Treasury Secretary Tim Geithner only promised an outline of Team Obama’s plan to rescue and repair the U.S. financial system before his remarks last week. And America got somewhat more than a sketch on a cocktail napkin. But investors gave Geithner’s effort the old heave-ho on February 10 as he added a couple of acronyms to the bestiary of the bailout and told the citizenry that “instead of catalyzing recovery, the financial system is working against recovery,” even as “the recession is putting greater pressure on banks”—a statement confirmed the next day when Morgan Stanley’s John Mack told the chairman of the House Banking Committee he’d work without a bonus. On the other hand, the Treasury secretary statement, fact sheet, and testimony before Congress were far more descriptive than his predecessor’s introduction of TARP. And no one’s saying the solutions to this disaster are clear.
By the end of the week the outline remained an outline, Dr. Roubeni at NYU put total losses faced by the global financial sector at $3.6 trillion and U.S. financial company losses at $1.8 trillion, and investors continued to display their dismay with the disarray.
The poison of asset-backed securities gone bad continues to infect the financial system, and the perception of wobbly money center banking giants shadows all the lifelines Treasury, the Federal Reserve, and governments around the world keep throwing at the strained financial sector. The economic team’s cure for the toxic asset disease drew strong criticism. Quaintly referring to the stew of undesirable securities as legacy assets, Treasury “will initiate a Public-Private Investment Fund that take a new approach” including the Federal Reserve, Treasury, and the Federal Deposit Insurance Corp., according to the fact sheet. The fund’s public-private mix “could involve putting public or private capital side-by-side and using public financing to leverage private capital on an initial scale of up to $500 billion, with the potential to expand up to $1 trillion.”
Bill Mayer, a partner at Goodwin Procter, is dubious. “Unless private equity investors can touch and feel these assets, and are able to do due diligence, they’re backing off,” he says. “And how can you value this stuff?” The banks won’t be happy either because “they’ll increase their hole, unless the assets are priced irrationally,” adds Mayer. “Maybe the pricing will be attractive enough, if there’s enough government support—if there’s enough upside potential and the government completely covers the downside.”
The uncertainty over troubled asset issue continues to threaten the financial sector, observes John Douglas, a partner at Paul Hastings and former general counsel of FDIC. “Deep discounts on these holdings will hit bankers’ balance sheets, exacerbating the very problem the plan is supposed to solve,” says Douglas. “It is clear the banks are going to need more capital, that’s the only way to get put of this. I just don’t see private capital being attracted to the banking system for a while.” So the backing for the investment fund will be largely in the form of government funding. “For the life of me, I don’t see the private sector coming in until those asset can be priced at economic value, and we don’t have that yet.”
As far as other aspects of the plan go, the “extension of TALF will be helpful, but its not going to jumpstart the market—we’re not going to see lending at 2006 levels,” Douglas says.
The prospect of a stress test for major banks is raising industry concerns. Institutions want to know “how the test will be applied under current capital rules,” Mayer explains. “Examiners could well come in with a burn-down analysis, assuming levels of delinquency and value depreciation that would definitely show a larger capital hole than GAAP would require,” he continues. “That would leave banks with a worst case or near-worst case scenario rather than a most likely scenario.”
Those banks with $100 billion-plus in assets will be required to take the stress test and comply with heightened transparency and disclosure requirements. It is unclear whether all banks seeking fresh government capital will stress-tested, too. In any even, such institutions could be told, “Here’s this [capital] hole,” Mayer says. “You have to fill, and we’ll help you fill it, but you’ll have to lend this way, modify loans that way. No dividends. No repurchasing stock. And limit your executive compensation.”