Whoa! What Happened? The Un-Plan

Stocks are down sharply today following Treasury Secretary Geithner’s speech on the financial bailout. This is our attempt to explain the reaction. We see several possible explanations:

1) First, the market may simply be “selling the news.” Traders had been expecting this financial bailout plan for several weeks now, and the anticipation helped the S&P 500 rally from the yearly closing low of 805 on January 20, 2009, to yesterday’s close of 870 – an increase of over 8% in just three weeks. When an event has been fully anticipated by the market, many times the reaction to the event will work in the opposite direction. We may be seeing some of this today. However, this may be a bit of wishful thinking on our part.

2) We were struck not only by the tone of urgency in President Obama’s speech last night, but also his dire depiction of our current circumstances. The President described our economy as the worst since the Great Depression. We do not disagree. However, we do not believe it is terribly constructive for the President to appear on national television on all the major networks telling the public just how bad things are. The only possible outcome from such a dramatic warning is that consumers tighten their purse strings even more, which obviously is not good for the economy at large. It seems to us that this “paradox of thrift”, as it has been described, is just now beginning to receive the appreciation it deserves. Easy credit and high consumer debt levels are what got us into this crisis, and a return to financial responsibility is the only way out. This process is likely to be long and painful.

3) Geithner’s speech raised more questions than answers. The three components of Treasury’s plan are designed to achieve the following four general objectives: 1) stengthen bank balance sheets and encourage bank lending; 2) deal with the “bad assets” plaguing the balance sheets of all types of financial institutions; 3) jump-start the securitization market, which has been the source of funding for up to 40% of certain consumer and commercial loans in recent years; and 4) stabilize the housing market. However, Geithner’s remarks were surprisingly light on details. Most importantly, we were not told how the government will determine prices for the bad assets going into the new public/private investment fund. Instead, we were simply told that a range of different structures was being evaluated. Secondly, we were told that a new stress test would be implemented to determine whether banks had sufficient capital to withstand expected losses. However, we were not told what factors would be included in this stress test. Unfortunately, many investors had thought that Treasury’s plan would include these most important details. Today’s speech left many people with many questions.

4) There was no mention by Geithner of a possible suspension of mark-to-market accounting. Many people had been expecting that this accounting convention, which has been responsible for so much of the write-downs that are crippling our financial institutions, might be relaxed temporarily until liquidity improves. It is unclear why this idea was not implemented.

Lastly, we would just mentioned that we found Geithner’s relative lack of conviction unprecedented and somewhat troubling. He seemed to be hedging himself an awful lot in describing the expected success of these initiatives. Would the market reaction have been any different if Geithner had expressed complete confidence in his new plan? Probably not, but we think some soothing rhetoric from all our public officials might be a little more constructive right now.