“A financial stability plan – $2trn; an economic stimulus – $838bn; watching Wall Street’s reaction – priceless,” said Tracy Alloway on FT’s Alphaville.com. On Tuesday, markets had been expecting the passage of the government’s fiscal stimulus package as well as a promised comprehensive plan for mending the financial system. But the stimulus looks unlikely to have much impact and the Financial Stability Plan (FSP) announced by Treasury Secretary Tim Geithner “offered only a bare-bones outline”, noted Breakingviews.com’s Dwight Cass. Disappointment in the latter wiped almost 5% off the S&P index on the day.
The spending package, about a third of which comprises tax cuts, is likely to merely alleviate the downturn, as Merrill Lynch’s David Rosenberg has pointed out. Now that consumers are retrenching, the drag on GDP could hit around $875bn this year. Paul Krugman, writing in The New York Times, said the package is small beer compared to the estimated $2.9trn “looming hole” in the economy over the next three years.
US spending plan: key questions unanswered
Meanwhile, the FSP foresees a fresh round of capital injections into banks. The authorities will expand their loan programme to investors in the market for securitised debt in an attempt to unfreeze the market and thus stimulate bank lending. This programme will cost up to $1trn. A public-private investment fund will be set up to buy the toxic assets that are clogging balance sheets, causing widespread uncertainty over solvency and hence reducing lending. The fund could buy up to $1trn worth. Among the many gaps in the announcement was the absence of detail on how the public-private plan will work. All we have is “a plan for a plan”, said Kevin Logan at Dresdner Kleinwort.
The central question is how to value the toxic assets. Pricing them too low could make banks insolvent, but overpaying amounts to a subsidy for banks. The hope is that private investors will establish prices by wading into the frozen market, but “they will not want to pay prices that subsidise failed banks”, said the FT. So the government will have to subsidise the investors. Meanwhile, a bank that would be insolvent if its assets were priced at market value is hardly going to sell at a price that is fair to taxpayers or appealing to private investors.
What next?
The fastest way out of this mess, said the FT, is to force banks to write down their losses now. That means some will prove to be insolvent and they will have to be recapitalised by the government – there’s no private capital available – implying temporary state ownership. This will address the pervasive uncertainty over who’s solvent and who isn’t, which has paralysed lending by and between banks. The government is just throwing money at the problem, said Yves Smith on Nakedcapitalism.com, This amounts to “using antibiotics to treat gangrene”.