Government Action Falls Short

The Geithner Plan was announced today and caused a major sell-off in the market. I was hoping his speech would cause this type of reaction because I was hoping it would mean the government is announcing a hard-line stance against troubled banks with bold action to eliminate ‘zombie banks’ but that wasn’t exactly the reason for the sell-off. Instead, the sell-off was probably more due to the many unanswered questions in the plan and the uncertainty in its meaning.

It seems that whatever side of the fence you are on about what is best for the financial system depends on your diagnosis of the problem. The Treasury appears to be fighting this problem like it is a liquidity issue that is causing temporarily depressed asset prices. The plan in both its original and current form is to pump enough capital to the banks to keep them afloat until the prices correct and everyone gets their money back (or at least most of it). The other camp is arguing that the banks are insolvent because they are holding permanently impaired assets and the government is artificially keeping them in business even though they are technically bankrupt. Their solution would be to assess the banks needing government intervention, wipe out the current shareholders and management of those banks deemed insolvent, and use some form of bankruptcy proceedings, nationalization, or negotiated private industry sale to start-over with a recapitalized bank.

In the end, maybe Nouriel Roubini is right in his assessment the Treasury seems to be following a course of action based on political reasons. The consensus opinion is that Bank of America and Citi are effectively insolvent while Wells Fargo and JP Morgan are not yet as of today. Instead of taking over BoA and Citi, which risks causing panic for Wells Fargo and JP Morgan, why not delay the decision and hope the economy turns around in the meantime? I actually hope this assessment is more accurate than the more cynical conclusion that the Treasury and Fed are protecting the interests of the big banks at any cost to the taxpayer. I find it ironic that Obama’s speech last night warned if we did not act boldly today that the U.S. could enter a “lost decade” similar to Japan in the 1990’s and the very next day his Treasury Secretary announces a plan that keeps our insolvent banks in business which was one of the major criticisms of Japan during their lost decade. To be more optimistic, at least the groundwork is being laid for the inevitable.

This doesn’t fundamentally change any of my views and I still will wait on the sidelines for better prices in the marketplace. Unfortunately for me, so far, this strategy has not materialized yet as the stocks I am following are almost all up even after today’s fall. Regardless, between the tepid stimulus package and the Treasury plan, I see no reason to expect a strong rebound in the global economy anytime soon and thus see no major catalysts for the U.S. equity markets.