Dashed Expectations

Tim Geithner hopes to restore stability to the banking system by luring in private investors. The devil will be in the missing detail.

“We’re going to have to hold out a Band-Aid a little bit…and just be clear about some of the losses,” Barack Obama said of America’s sickly banks this week. As much as $2.5 trillion buys more than a little bit of sticking plaster, one would hope. That is the sum of fresh money that Tim Geithner, Mr. Obama’s treasury secretary, hopes to channel into the financial system through his overhaul of the Troubled Asset Relief Programme (TARP), in large part by using public funds to coax private investment.

Across the world, there is agreement on the need for a more comprehensive response to the crisis. European ministers this week discussed setting up “bad banks” to buy illiquid assets. Mr. Geithner, meanwhile, is keen to distance himself from the ad hoc approach of his predecessor, though his implicit swipes at Hank Paulson, with whom he worked closely on bail-outs, will strike some as unbecoming.

A pity, then, that his plan was more a statement of intent than a concrete proposal, lacking crucial details when, as he himself acknowledged, public distrust and anger over previous government efforts is running high. Markets reacted badly, with shares down (particularly in big banks) and safe assets, such as gold, rallying. Economists, even those supportive of Mr. Obama, were underwhelmed. “Maybe it’s a Trojan horse that smuggles the right policy into place,” mused Paul Krugman, grimly, at Princeton.

Most disappointment was directed at the sketchy plan to tackle banks’ toxic assets, such as mortgage-backed securities and leveraged loans. At a late stage Mr. Geithner rejected the idea of a government-run bad bank (as well as blanket guarantees for noxious assets), put off by the high upfront cost and the problems it would have valuing the debt. He now hopes to amass $1 trillion of buying power by drawing in investors, such as private-equity groups, whose inclusion would stretch the government’s money further and bring more discipline to pricing.

Fine, but Mr. Geithner still has a yawning gap to bridge between banks, which do not want to sell at depressed prices because of losses they would have to recognise, and potential buyers, who need to be sure of healthy returns. It was this that put paid to both the original TARP and Mr. Paulson’s efforts to rescue structured-investment vehicles. Distressed-debt investors, such as Blackstone and BlackRock, are interested but want more information. To be sure of attracting them, the government might need to provide a combination of cheap loans and a guaranteed floor on losses. But even then, the mooted public-private partnership may not be big enough. Barclays Capital counts $2 trillion-3 trillion of troubled assets in America, excluding prime mortgages, which are souring fast.

The plan also falls short in its treatment of the root cause of the crisis: housing. The $50 billion programme to curb foreclosures is modest and short on detail. It is not clear, for instance, if it will include incentives for mortgage lenders and servicers to write down borrowers’ principal, which may be the only way to stop the rot-though more details are expected in coming weeks. Mr Paulson fought to keep foreclosure mitigation out of the TARP, preferring to focus on strengthening financial firms. That is no longer an option. Mortgage relief is “the pound of flesh demanded by an angry public” for the cost of the bank bail-out, says Stephen Stanley of RBS Greenwich Capital.


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