Treasury Secretary Tim Geithner seemed to go from zero to hero in one day when the stock market soared on March 23, ostensibly because of his latest plan to help banks unload illiquid securities of uncertain worth. The Wall Street Journal headline shouted, "Toxic-Asset Plan Sends Stocks Soaring."
But homebuilder stocks jumped as much as bank stocks, suggesting the same day's news about a 5.1% jump in existing-home sales deserves much of the credit. Any remaining credit should go to Fed Chairman Ben Bernanke, not Geithner.
The rally in financial stocks began after Ben Bernanke's March 11 speech to the Council on Foreign Relations. He came out strongly against the nationalization of banks and admitted that the bookkeeping problems of many banks are largely an artifact of foolish federal regulations. Bernanke said, "capital standards, accounting rules and other regulations have made the financial sector excessively procyclical."
Together with similar comments from Barney Frank and the Financial Accounting Standards Board (FASB) on March 16, Bernanke's comments hinted that regulators might avoid imposing crippling capital requirements and loan loss write-offs on the basis of dubious mark-to-market accounting for illiquid assets. He also made it clear for the first time that Treasury's stress test for banks "is not pass-fail." Many had assumed the stress test was just that--a way to decide which banks were worth saving and which would be allowed to fail.
The S&P500 index for financial stocks rose 29% from 96.82 on March 10 to 126.01 on March 18. But the index suddenly sunk to 109.71 by Friday, March 20, on worries that Geithner's remarks the following Monday would be poorly received. Despite Monday's rally, financials closed at 120.75 on the following day--4% lower than they had been on March 18.
Until recent headlines gave Geithner undue credit for a one-day rally, the administration officials had correctly insisted such daily moves could be misleading. Weekly stock market moves, however, are not so easy to brush off. The administration must learn to respect sustained market reactions to its policy proposals because the loss of stockholder wealth has had a devastating effect on consumers, banks and businesses.
This table compares the S&P500 index for financial stocks on the day when federal policies were announced to the level of that index one week later.
A 31% drop in the market capital of financial stocks followed nationalization of Fannie Mae and Freddie Mac on Sept. 7, 2008, in just seven days. It suddenly became very dangerous to hold shares in any bank or insurance company large enough to be suddenly expropriated without shareholder approval.
On Oct. 3, 2008, the House reluctantly authorized the $700 billion Paulson-Geithner-Bernanke TARP slush fund. Many votes switched from "no" to "yes" because the S&P 500 stock index had dropped to 1,100 the day before. A week after the law was enacted, however, financial stocks were 23% lower.
On Oct. 14, 2008, Treasury pulled a "bait and switch" trick with its capital purchase plan. Nine banks were compelled to sell preferred shares to the government despite protests from Wells Fargo and Morgan Stanley. The teaser rate was a 5% dividend, later raised to 8%-9%.
Although the new plan was described as "injecting capital," it is a thinly disguised loan. Few noticed this deception except Binyamin Appelbaum of the Washington Post who on explained on Feb. 25, 2009, that, "The Bush administration went so far last year as to rewrite the regulatory definition of capital to include the federal aid, which comes in the form of preferred shares. So far, investors have not been swayed. To them, the government aid doesn't look like reliable capital. It looks a lot like a loan that the government wants back."
Faced with new risks from dilution, warrants and federal caps on dividends, investors fled from TARP-impaired stocks. As a result, those costly "capital injections" probably added zero capital, on balance. They just replaced high-quality equity capital with bogus public capital (i.e., more debt). Financial stocks collapsed after the government began this incremental quasi-nationalization, falling 46% in five weeks.
A few days after the presidential election, FDIC Chairman Sheila Bair began pushing a plan to persuade or compel mortgage lenders to modify loans to slash monthly payments. If regulators or bankruptcy judges could do that, the added risk of devaluation of the assets behind mortgage-backed securities must make those assets more toxic. So, financial stocks fell 24%.
A week before the Inauguration, President-elect Obama asked Congress for the second $350 billion of TARP funds. Financials fell another 25%. The day after the Inauguration, the Wall Street Journal's front page featured this perceptive headline: "Banks Hit by Nationalization Fears: Financials Plunge as U.S. Considers New Rescue Options."
On Feb. 10, 2009, Treasury Secretary Geithner announced his "Plan A," which confirmed those fears of creeping nationalization. Geithner implicitly acknowledged that government preferred stock was not the sort of genuine capital needed to pass his stress test. Yet his new plan to convert such shares into common stock made it even more obvious that private shareholders would be first to be sacrificed. A Feb. 19 Wall Street Journal report by Peter Eavis declared, "Government capital injections sit like ill-disguised Trojan horses in the nation's largest banks."
Although Geithner's Feb. 10 presentation did prompt a sell-off of bank stocks (Citi shares fell 50% by Feb. 20), its impact is difficult to disentangle from the Feb. 13 Congressional agreement on a "stimulus package." That so-called stimulus bill was, of course, a $787 billion deferred tax increase, plus interest. Although investors could not be sure when the tax bill would be presented, Obama warned us that the first installment would come from higher tax rates on dividends, capital gains, stock options and the profits from foreign affiliates of multinational corporations. S&P financials were at 133.13 the day before Geithner spoke and 123.17 the day before Congress hiked future taxes by $787 billion. The index then fell to 96.18 on Feb. 23 and to 81.74 by March 6. If anything was stimulated, it was short-selling.
Since last September, the federal government has justified numerous costly and heavy-handed programs by claiming each new intervention would help the banks and restore confidence to financial markets. The only objective measure of success or failure is the market value of financial stocks. By that standard, government solutions have been the biggest problems.