While Tim Geithner provided more questions than answers yesterday in his presentation of the latest version of the "Finance System Bailout Plan", it makes sense to analyze the data that was in fact given to the general public.
The facts: the administration's newly and no-so aptly named "Financial Stability Plan" focuses on three core axes that the government deems critical to making sure there are no future market collapses which can roughly be stated as bank stability and capital sufficiency, private sector co-investment and rebooting securitization. These formal categories as presented by the Treasury are:
i) a Coordinated Supervisory Review ("Stress Test") focusing on the stability of institutions with over $100 billion of assets;
ii) a Public-Private Investment Bank, a combined public-private asset pool to purchase toxic assets, initially sized to $500 billion with the potential to grow to $1 trillion;
iii) a modification of the Term Asset-Backed Securities Loan Facility (TALF) being increased to $1 trillion, and adjusted to include a wider variety of assets.
Coordinated Supervisory Review
All financial institutions with more than $100 billion in assets will be required to participate in a coordinated supervisory review process involving the Federal Reserve, FDIC, Office of the Comptroller of the Currency, and Office of Thrift Supervision. A core part of this review will be a "comprehensive stress test that requires an assessment of whether major financial institutions have the capital necessary to continue lending and to absorb the potential losses that could result from a more severe decline in the economy than projected." Financial institutions that perform this test will have access to a "capital buffer" provided by the U.S. Treasury (i.e., contingent capital that will be provided in the form of a convertible preferred security investment from Treasury that the companies can convert into common equity if needed to preserve lending in a worse-than-expected economic environment. Many large U.S. financial institutions currently have depleted common equity bases, with hybrid capital issues in different forms comprising a disproportionate amount of their total Tier 1 capital.)
Main question on this axis are:
- Will small banks be allowed to participate and under what conditions?
- What defines a stress-test and how is it administered?
- What happens to companies that do not meet standards?
- What are the terms of the contingent capital to be provided?
Companies with more than $100 billion in assets:
Public-Private Investment Fund
The Treasury, in combination with the FDIC and the Federal Reserve, is initiating a "Public-Private Investment Fund" which will combine private and public capital to purchase toxic assets of financial companies, and has an initial size of $500 billion, which can grow to $1 trillion
- How will capital be attracted, on what terms, and how will it be structured?
- How will asset-prices be established, and what are the conflicts of interest?
- What are any residual contingencies that would not be assumed by the buyers?
Term Asset-Backed Securities Loan Facility
The Term Asset-Backed Securities Loan Facility, or TALF, is being brought back with a bigger role this time, in order to attempt a resurrection of the securitization market. The assets that can be included are broader, and the total size has also grown to $1 trillion.
Concerns here include:
- Under what underwriting standards will TALF securities be sold to investors?
- Is TALF attractive enough to stimulate new lending?
- What is the incremental leverage used and is there a downside protection case: To investors, to taxpayers?
Despite the structural soundness of the plan, the biggest problem is that it is again more of an exercise in philosophy than practical finance, while the market is expecting clear cut action and and understanding of which assets it is now safe to buy and for what reasons. Until that happens the market will keep on drifting lower.
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