Geithner Unveils Financial Stability Plan
Treasury Secretary Geithner unveiled a comprehensive Financial Stability Plan (FSP) this morning. The plan has a wide reach which includes bank capitalization, consumer and business lending, a public/private bank, transparency and accountability issues, foreclosure prevention, and small business lending initiative, but details are sketchy still. These are the highlights of the FSP.
(1). It is mandatory for all banking institutions with assets in excess of $100 billion to undergo a stress test before they are eligible for financial aid. In addition, banks receiving aid will be required to disclose how the money is being used. In other words, banks will need to provide information about how many new loans are extended and how many new assets are purchased. Banks may also avail of a “capital buffer” to “help absorb losses and serve as a bridge to receiving increased private capital.” The Treasury’s participation is in the form of preferred shares that can be converted into common equity “if needed to preserve lending in a worse-than-expected economic environment.” A Financial Stability Trust will be set up to manage the government’s investment in financial institutions. Details about the nature of the stress test are not available. We can infer that the stress test will establish which banks need to be capitalized or shut down.
(2). Public/Private Bank – This part of the plan addresses “legacy assets” of banks that are toxic. The early idea of the “Aggregator Bank” that was seen as an entirely public institution is now replaced with a blend of public and private components. The proposed agency will start as a $500 billion institution with the potential to expand up to $1 trillion with public and private capital. Rather than the public sector pricing the troubled assets, the proposal now allows the private sector to determine the price of the illiquid assets. Once again, operational details are not available. In fact, the structure of this agency is open for public comment. Therefore, it is not a fully developed plan as yet.
(3). The FSP expands the Term Asset-Backed Securities Loan Facility (TALF) of the Fed which was announced in December 2008 but is not implemented as yet. The original TALF was a $200 billion program which has been now raised to $1 trillion. The Treasury’s share of the burden is raised to $100 billion from $20 billion. The objective of this program is to unfreeze credit markets and lower interest rates for autos, credit cards, small business, consumer loans, and business credit. The program was conceived as a result of the sharp increase in interest rate spreads of AAA-rated asset-backed securities (ABS) in late-2008. The ABS market has funded a large share of consumer credit and Small Business Administration guaranteed loans. A disruption of this market manifests as lower credit availability to households and small businesses and in turn leads to a further weakening of economic activity. Therefore, TALF is designed to increase the amount of credit available at normal interest rate spreads.
(4). Other aspects of the FSP - All banks receiving capital assistance will be required to participate in mortgage foreclosure mitigation programs. The FSP includes many reporting procedures to enhance accountability and transparency and also to ensure that tax payer dollars are used to generate new lending and preserve capital. In addition, recipients of assistance can only pay quarterly dividend of 1 cent. The FSP contains various other regulations to ensure legitimate and prudent use of funds.
The second-half of $350 billion TARP funds are seen to be adequate to address all the issues Geithner lists, for now. The initial market reaction has not been favorable, with the S&P 500 most likely to close down 5.0% for the day. In other related news, the fiscal stimulus package has now passed the Senate and House and what remains is a compromise bill that President Obama will sign shortly.
