THE GEITHNER BANK STABILIZATION PLAN

I see allot of barbs being shot at Treasury Secretary Geithner and his plan to stabilize banks. Most come from financial leaders who favor forcing banks to devalue their balance sheets to the point where many go out of business for lack of sufficient reserves. Then the survivors will be able to buy up the assets cheap and extend their mini-empires. Of course collateral damage will be the US economy itself. And this is what worries the President and Geithner.

I have read Geithner's statement about the new "Financial Stability Plan." It works because the Feds continue to understand a basic point, the so-called "toxic assets" have a real value which I call the "maturity value," which means the balances due on the mortgages times the interest rate times the length of the payoff period (term) minus the loss due to defaults and foreclosures. Since the actual default rate on mortgages is 6% and foreclosures rate is 3% the loss is relatively minor. This stands in stark contrast to the current holder of these assets "marking them to the market" which means losses of up to 90%.

The key to each part of Geithner's plan is that the Feds will hold their asset purchases in "trust funds" instead of "investment portfolios." To explain let me use my pet analogy. You have a trust fund set up by your late Uncle Harry from which you receive $50,000 per year. You may not sell or take more from the fund. What is its value? The "mark-to-market" crowd say it would be zero since it may not be sold. But the value is actually $50,000 per year over your lifetime. The Feds look at acquiring "toxic" assets, investing more funds in banks, and other infusions of Fed funds as part of a trust fund, not an investment held to be sold.

Whatever infusions of Fed funds that occur, they will stay the course. And these funds will rebuild balance sheets thus allowing the lenders to provide credit once more.

With these understandings in mind let's look at the Geithner Plan.

FINANCIAL STABILITY PLAN.

This is essentially a continuation of the first use of the "TARP" funds, i.e. capitalize banks by buying shares in them or lending to the banks. It strengthens the balance sheets.

PUBLIC-PRIVATE INVESTMENT FUND.

This is a plan to combine public and private funds to buy up the so-called "toxic assets," or as I call them, "mortgage based assets," and the plan now calls, "legacy" loans and assets. The plan is looking at spending up to $1 trillion.

CONSUMER AND BUSINESS LENDING INITIATIVE.

This is a plan to inject as much as $1 trillion into lending for consumers and businesses. The vehicle will be the "Federal Reserve's Term Asset Backed Securities Loan Facility." Well would you believe, the Feds want to provide lending by "bundling" the loans into assets. Sound familiar, yes, the same thing as "mortgage based assets" or as the market valuation slaves insist on calling, "toxic assets."

Remember my litany, no credit, no buying, no buying, no production, no production, no jobs. Uncle Sam, now in the guise of Secretary Geithner, means to revive the economy by opening the credit lines again. He will do this by rebuilding the balance sheets of the lenders and by injecting massive amounts of funds into the system.

Of course I cannot conclude any piece without reminding you of the tectonic shift in the US economy - Uncle Sam is now the largest single investor in the economy. Added to his role as the largest single consumer, the central banker, and rules maker, Uncle Sam's control over the economy is at a new high. No wonder the Wall Street crowd worries about the nexus of the US economy moving from New York City to Washington DC. Being a native Washingtonian I welcome the move.

Leo Cecchini
February, 2009