US Treasury Secretary Tim Geithner today unveiled the new Financial Stability Plan. His announcement pricked a bubble of excessive expectations, and the markets’ disappointment was clear as stocks fell, bonds rallied, and JPY and USD rose, signalling higher risk aversion. This is particularly unfortunate as Geithner had stressed at the outset that the new Administration was determined to deploy overwhelming force, in contrast to a policy strategy that had so far been reactive and behind the curve, and had therefore failed to restore confidence. The immediate market reaction paradoxically confirmed his assessment: investors and the public at large have lost confidence, and urgently need to see concrete and detailed measures—announcements are not enough anymore, and today’s announcement came too soon. It would probably have been better to wait until more details had been worked out—but that was perhaps politically unfeasible or unwise. Having said this, I think the markets’ disappointment is excessive, and reflects overblown expectations more than weaknesses in the strategy. Geithner’s overall assessment of the gravity of the situation was realistic and candid, the strategy is sound, the government’s determination inspires confidence and the commitment to transparency and direct support to households and firms should ensure public and political support. The new Administration is moving in the right direction, but the markets will need to see more concrete steps before they can believe in this change.
The market’s disappointment should not take away from the fact that the guiding principles and the overall strategy outlined today are sound and should prove effective. Geithner emphasised that, building on the lessons of the present and past crisis, the new strategy would be based on the following key principles:
1. A comprehensive and forceful policy response, formulated in forward looking way and erring on the side of too much action rather than too little.
2. A policy effort to be sustained until the recovery is firmly established, avoiding the risk of hitting the brakes too early.
3. Policies aimed at mobilizing and leveraging private capital, not simply substituting it.
4. A firm and consistent commitment not to allow further failures of financial institutions.
The promise of a comprehensive, forceful and sustained response should restore confidence, while leveraging private capital acknowledges the magnitude of the challenge and represents a commitment to exploit market mechanisms to the extent possible. Main drawback: the commitment not too hit the brakes too early will eventually fuel concerns on the exit strategy, posing a risk to bond yields.
