When a Nobel Prize winning economist like Paul Krugman looks at an economic plan and is unsure what it entails, it’s a lesson to the rest of us to be cautious in how strongly we express our own opinions. The immediate question that came to my mind after listening to Tim Geithner (and reading his plan (.pdf) was what order he was going to do things.
He wants the Treasury Department to do a ‘stress-test’ (named for the medical test) of all the banking institutions that have ‘assets’ in excess of $100 billion.
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.
During testimony before the Senate Banking Committee, Geithner expanded on this idea and explained that the Treasury will look at banks’ assets under a variety of different assumptions (from optimistic to pessimistic). Banks that fair poorly under pessimistic assumptions will be eligible for cash infusions.
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.
The way I read this, banks that convert preferred securities into equity would be essentially nationalizing themselves a bit at a time. That seems to be how this plan could be interpreted as a stalking horse towards nationalization. On the other hand, Geithner proposes another program to help scoop out all the toxic assets (now called ‘legacy assets’) that are sitting on these banks’ books.
2. Public-Private Investment Fund: One aspect of a full arsenal approach is the need to provide greater means for financial institutions to cleanse their balance sheets of what are often referred to as “legacy” assets. Many proposals designed to achieve this are complicated both by their sole reliance on public purchasing and the difficulties in pricing assets. Working together in partnership with the FDIC and the Federal Reserve, the Treasury Department will initiate a Public-Private Investment Fund that takes a new approach.
• Public-Private Capital: This new program will be designed with a public-private financing component, which 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.
• Private Sector Pricing of Assets: Because the new program is designed to bring private sector equity contributions to make large-scale asset purchases, it not only minimizes public capital and maximizes private capital: it allows private sector buyers to determine the price for current troubled and previously illiquid assets
