Treasury Secretary Geithner unveiled the long awaited plan to shore up the financial system today and it was thinner than a supermodel. The administration has built this up for weeks as their comprehensive plan and while there was bound to be some disappointment, I don’t think anyone thought they would come out with something that was so slim on details.

Basically, there are three elements to the plan. First the banks will undergo a stress test of their balance sheet to determine the health of their balance sheets. Well, that’s nice, but isn’t that something the regulatory agencies are doing all the time? If the banks stress test reveals that the bank is insolvent, what will the response be? Geithner said that banks requiring more capital will have access to a new funding program but he gave no details about how the funding will be provided. Will it be common stock? Preferred stock? 

Second is a public/private partnership to buy up the bad assets on the banks balance sheets. The government will provide financing to private entities to buy the bad assets. There are no details yet about how these loans will be structured, but the rumor is that they will be non-recourse loans with loss protection for the buyers. The lack of detail is appalling but more appalling to me is that this completely misses the point. The banks have these loans marked on their books at 80 or better and the market is willing to pay 25 or less. If the bank sells at 25, regardless of how the buyer finances the purchase, the bank is insolvent. That transaction will not happen as long as the bank can avoid it. The basic problem of how to price the assets had not been resolved.

Third is an expansion of an the existing Fed TALF plan to provide credit to consumer markets such as student loans, auto financing and commercial mortgages. This is not new and merely expands an existing program.

I don’t know how long it will take Geithner and others in the administration to figure this out, but the only answer to the banking problem is to let the weak banks fail. The good parts of these banks can be sold to the remaining good banks and the bad parts can be held by the government and sold off, if they have any value, over time.  The only other “solution” is to nationalize the bad banks and that is a bad idea whose time has not and should not ever come.

Treasury Financial Stability Plan – Overview

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