Dan Greenhaus is at the Equity Strategy Group at Miller Tabak + Co. where he covers markets and portfolio theory. He has contributed several chapters to Investing From the Top Down: A Macro Approach to Capital Markets (by Anthony Crescenzi).
This is his most recent commentary:
Leaning on Fed, U.S. Bank Plan Can Work
Details missing but failed speech will hasten arrival of a better plan
Dan Greenhaus, Anthony Crescenzi
FEBRUARY 11, 2009
U.S. Treasury Secretary Timothy Geithner recently announced a plan to stabilize the U.S. financial system. Investors said it was short on details, sending share prices lower in the U.S. and throughout the world. Despite the reaction, many feel that the framework is good, particularly the scale of the plan, put at as much as $2 trillion or more. This means that when the details arrive, there is a good chance that financial conditions will improve and share prices will recover.
One of the most important aspects of the U.S. bank stabilization plan is its use of the Federal Reserve’s
balance sheet. Without it, the efforts would fall flat because the amount of money needed to stabilize
the banks and the credit system in general far exceeds the amount available in the so-called TARP, the
Troubled Asset Relief Program, and what could be generated through any authorization of new funding
for the TARP. The fact is, actions taken by the Federal Reserve have thus far been the most potent and
effective weapon against the financial crisis, with successes that have been far-reaching and much
greater than those of the U.S. Congress and the U.S. Treasury Department.
The Fed’s Successes
Examples of the Federal Reserve’s effectiveness are numerous, with the dollar amounts stretching well
beyond those available in the TARP. In each case, the Fed stabilized either a market or an entity
simply by creating new money, money that the Treasury would otherwise have to borrow. Importantly,
most of the money created can be destroyed just as quickly and leave no legacy costs, the opposite of
what is likely to happen with some of the economic stimulus deployed by the federal government.
One example of the Fed’s effective use of its balance sheet is the success it had in stabilizing the U.S.
commercial paper market. The Fed in October created its Commercial Paper Funding Facility, a
facility that purchases commercial paper directly from issuers. The facility grew to as large as $350
billion, the same size as the first portion of the TARP. Its current size is $259 billion. The decline
reflects stabilization in the commercial paper market, with U.S. companies able to raise money in the
capital markets and not having to borrow from the Fed.
Another program, the Fed’s Term Auction Facility, has supplied lots of cash to banks. The facility can
grow to as large as $600 billion, and has seen loans swell to as large as $450 billion. Its current level is
There are of course other programs, including the Primary Dealer Credit Facility, the facility that lends
money to brokerage firms. It grew to as large as $148 billion last October; stabilization in the financial
markets has reduced it to $30.2 billion. Loans have been disbursed to Bear Stearns ($29 billion), AIG
($82 billion), and credit lines have been extended to Citibank ($234 billion) and B of A ($87 billion) as
a safety net against their assets. The Fed has also purchased about $75 billion of agency and agency-
backed mortgage-backed securities, committing itself to purchase as much as $600 billion of these
securities ($100 billion of agencies and $500 billion of agency-MBS).
The Fed Expands U.S. Money Tenfold
Treasury Secretary Geithner proposed programs that depend upon the Fed’s balance sheet for success.
In all cases the Treasury will supply seed money that the Fed expands by a multiple of 10. The
programs would mirror the much-awaited Term Asset-Backed Securities Loan Facility (TALF), which
was announced by the Fed way back in November. In the TALF, the Fed will make available $200
billion of loans for the private sector to purchase asset-backed securities. The Treasury is supplying
$20 billion of seed money. It is expected that there will be an expansion of the TALF, to as much as $1
trillion. A separate facility, or investment fund, is expected to be launched to facilitate lending of up to
$1 trillion billion of Fed credit for the purchase of troubled assets. The Treasury would supply up to
$100 billion of seed money.
To repeat, the main upside to this blend of policy actions is the ability to do far more than could be
done using public money. In addition, programs that the Fed deploys can be removed far more quickly
than those deployed by the Treasury and the Congress. There is also far less interference from
politicians when the Fed is involved instead of the Congress. A downside is of course the massive
creation of money. It is akin to walking a dog with a long leash, it being difficult to predict the dog’s
next move and when best to move the leash to keep the dog under control.
In revealing his Financial Stability Plan, Treasury Secretary Timothy Geithner spoke in plain terms,
catering more to Main Street than to Wall Street, clearly showing the fear that exists within
Washington over the use of taxpayer money. Didn’t President Obama speak to Main Street when he
addressed the nation in primetime the previous day? The problem is that Geithner needed to speak
more to Wall Street, where the problems lie, rather than stay at a distance as he did, and leave Wall
Street with too few details with no roadmap by how it might find its way out of current difficulties.
This is not to say that the framework isn’t good–it is, largely because it relies upon the Federal
Reserve’s balance sheet and will eventually help to corral bad assets, it’s just that there is a major
difference between providing a framework and a final destination than the details that are needed to
reach the final destination.
What is missing? Let’s start with the TALF, or should we say the elusive-TALF. The Fed in
November announced the program and it remains at the launch pad awaiting takeoff. The Fed on
Tuesday said that it would announce the date at which the TALF would commence. In other words,
whereas expectations previously were that the TALF would be implemented in February, the Fed
would only say that it would announce the date it would commence. Missing also from the TALF
announcement is the details of it, with market participants still unsure of how it will work. If the
market was unsure about how the $200 billion facility would function, its uncertainties regarding how
the proposed $1 trillion facility will function surely must be higher.
What else is missing? How about the oldest question of all: How will the Treasury and the financial
markets price bad assets? It remains extremely uncertain how this will be done and how it is the
Treasury will entice investors to do something they have been avoiding since the start of the crisis.
The response from Wall Street in response to Treasury Secretary Geithner’s plan was resoundingly
negative. Absent details and “meat on the bones,” the plan was more an outline of a plan than anything
resembling how to execute it. In light of the missing “details,” we must ask ourselves what else we
want to see from the secretary in order to view the plan more bullishly. Here are a few thoughts:
• There need be clarity on how the government plans to encourage the private sector to get involved in an area of the market in which they have already chosen to avoid. This is perhaps the shortfall of the government’s plan and one that is essential to avoid total failure in the plan. The pricing of assets is the thorniest issue here.
• Regarding the stress testing of banks, clarity is needed on what will happen when institutions fail the test and are subsequently deemed insolvent. Administration officials have taken great pains to say that nationalization is not a course they wish to pursue, but as the financial rescue progresses, nationalization of some banks will be necessary if they are proven insolvent. How the government handles this situation will be crucial.
• Building on the above point, we must ask whether the government is prepared to let some financial institutions fail and if so, what criteria will be used to determine which are viable and which are not. Simply turning U.S. banks into so-called “zombies,” which will then be used to increase consumer lending to companies that otherwise could not receive such funding, can have detrimental effects in then longer-term.
• What role will the financial industry have in crafting the plan? While the Administration will surely stop short of letting Wall Street write the plan, its involvement is imperative to making it work. Wall Street made this known in its reaction to the plan. Geithner must balance his need to be Obama’s voice to Main Street, a negotiator with Congress, and an architect for Wall Street on the structure of the financial system and economic policy.