I have spent the past week trying to make sense out of Timothy Geithner's speech and I admit I have been having trouble. Given the financial talent in the Obama Administration, I know they understand that the key to our current economic woes is the banking sector. This is why Geithner's performance is so puzzling to me. I hope we are not hearing a reprise of the same mournful tune sung by the discredited Bush Administration.
For the past 18 months it has been abundantly clear that the banks need to get rid of the toxic assets poisoning their balance sheets. In October 2007, Citigroup, Bank of America and JP Morgan announced they were going to set up an $80 billion fund to buy troubled asset from entities called Structured Investment Vehicles or SIV's. These SIV's were set up by banks to allow them to buy liquid but high yielding assets in a way that would keep them from clogging up their balance sheets. Many of these assets turned out to be toxic. It was a financial slight of hand that raised serious corporate governance problems. The October 29, 2007 edition of Businessweek reported that these SIV's had assets of $325 billion.
For a number of reasons, the SIV rescue plan was abandoned, but I think it is interesting to note that if all the SIV assets would have been purchased at that point in time, it would have only cost $325 billion. There would have been other problems for sure, but a large part of the problem would have been cleaned up.
In October of last year, Congress approved $700 billion - more than twice the amount of SIV assets - to fund the Troubled Asset Relief Program with the intent that it would be used to buy troubled assets off the banks' balance sheets. Instead, in an abrupt about-face, it was used to make direct equity investments into the banks. There was little accountability and accusations of political abuse of the fund have continued to undermine its credibility. The worst part is that it did nothing to address the root cause of the problem.
Now, Geithner says we need another $1 trillion to get these troubled assets off the balance sheets of banks. Yet, again, he is balking at taking decisive action to make this happen. Instead, he is proposing an ill-defined "public/private partnership" in which the government would lend up to $1 trillion directly to private entities (aka "hedge funds") to go and buy these assets from the banks. This is a ridiculous notion.
To put it in perspective, at the end of the last reported fiscal quarter, there were about 744 banks operating in the US with total assets of $8.4 trillion. Geithner's $1 trillion therefore represents 12% of the total assets in the banking sector. There is simply no way that 12% of the entire banking system's total assets are bad. $1 trillion is a stupid number. It is a "shock & awe" number. It is an attempt to draw a line in the sand.
Unfortunately, as we all found out last week, the market and economy are beyond rhetoric. It is time to actually do something. Now, that would be shock and awe.