Thursday, January 13, 2011

Tim Geithner's Policies Meet the FDR Framework

If you listen to his words, Tim Geithner understands FDR's framework for the role of government in the financial markets.

For example, in a June 2010 article in the Telegraph, [emphasis added]
Speaking ahead of the meeting Mr Geithner said disclosure, particularly in relation to the financial health of the European banking system, was one of the key areas of focus.
"There's a very good case for trying to bring more transparency and disclosure to these markets and the major institutions," he said
"I think there is broad support in Europe for doing that, again because it reflects a basic reality, which is that uncertainty has a price, and you can reduce uncertainty if you increase transparency and disclosure."
Based on his comments, there is reason to be hopeful that he realizes that the role of government is to make sure that usable, relevant information it made available in a timely manner.

However, his actions suggest that he does not understand or is ignoring on purpose the part of the framework that says that governments should not endorse specific investments.

For example, from the press release announcing the results of the US bank stress tests:
... we have worked to restore confidence in the banking system. The assessment announced today will help strengthen the lending capacity of banks, with greater transparency and actions to reinforce the amount of capital banks hold against the risk of future losses.... 
Greater disclosure will help improve confidence. Today’s results should make it easier for investors to evaluate risk and to differentiate across institutions. The stress test will help replace the cloud of uncertainty hanging over our banking system with an unprecedented level of transparency and clarity. This is important, as markets work best when they have full access to the information on which to make informed investment decisions. With better disclosure, private capital is more likely to flow into the financial system, which will accelerate the point at which banks can replace the government’s investments.
So, did the investors ever receive the underlying asset-level data that was used in the stress tests so they could run their own stress tests?  We all the know that answer is no.

What information did the stress tests convey to the market?  The market learned which banks regulators endorsed (all large banks).  Further, they learned that under Mr. Geithner's leadership the regulators were willing to put the US Treasury's 'money' behind the endorsement.
Going forward, in the event that financial institutions need significant government assistance in terms of the quantity or composition of capital, then in consultation with supervisors, Treasury will evaluate whether existing board and management are strong enough to restore the firm to viability without government assistance. Where Treasury does take common equity, we will seek to return the company to purely private ownership as quickly as possible, and will be guided by the basic principle that the best way to serve the interest of shareholders and taxpayers is to exert our influence only on core governance issues and not on day-by-day operations.
 Is there any hope that Mr. Geithner will come to understand the wisdom of FDR's advice to not endorse specific investments?

There is always hope.  Perhaps, Mr. Geithner will use the new round of large bank stress tests to

  • Release the asset-level data to the markets so that credit and equity market analysts can determine the capital adequacy and dividend paying capacity of the large banks.
  • End the era of the US Treasury endorsing specific investments and standing by as an investor in case a large bank runs into financial difficulty.

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