Geithner at the Improv

Amid more public uncertainty, private capital flees.

By the hissing in financial markets, Treasury Secretary Timothy Geithner's opening act as Rescuer in Chief yesterday was a bomb. What everyone saw was Geithner at the Improv, a routine with a few good lines but a lot of material that needs more, well, practice.
[Review & Outlook] AP Rather than focusing on banks alone or proposing a single bailout architecture, Mr. Geithner offered something for everyone with a financial problem, albeit with most of the details left to be filled in later. Investors naturally took this to mean that, much like former Secretary Hank Paulson, Mr. Geithner will be making things up as he goes along. If the goal was to reduce uncertainty, it didn't work. (By the way, the Senate also passed the "stimulus" yesterday; stocks fell nearly 5%.)

That said, Mr. Geithner's proposal is correct in its tacit acknowledgment that there is no grand, miracle cure. The problem of the capital hole in the financial system is too big to fill in any single way, or with public or private capital alone. The bad assets need to be worked off one by one, institution by institution, until balance sheets are cleaned up and normal lending can start again. It's three yards and a cloud of toxic securities.

On that score, Mr. Geithner said the feds will subject all major U.S. banks to what he called a "stress test" to assess their financial health. We had thought this is what the FDIC, the Federal Reserve and other regulators were supposed to be doing all along, but that's last year's failure. A fresh and thorough scrubdown should be useful in forcing banks to be realistic about their businesses, especially the value of their bad assets.

The feds can then sort the banks that have enough capital and are worth saving from those that are insolvent but don't want to admit it. The latter can be liquidated, their depositors protected by the FDIC and their assets sold immediately to a healthier institution or worked off and sold over time. In Mr. Geithner's calculation, the banks that survive will emerge with a clean bill of health that will make them eligible for more public capital, which in turn will help the banks attract more private capital as well.

We were glad to hear Mr. Geithner say in his speech yesterday that "We believe our policies must be designed to mobilize and leverage private capital, not to supplant or discourage private capital." But one problem is that Mr. Geithner's proposal puts a higher priority on adding more public capital first as a source of financial stability. More public capital also comes with the risk of more public interference or control, especially with Congress looking for heads. (See today's House Financial Services spectacle with Wall Street CEOs as the pinatas.) And especially as the share of public ownership rises, so does the larger risk of government nationalizing many of our largest banks. This is a deterrent to more private investment, to put it mildly.

We think there's a strong case for the feds moving more aggressively to resolve Citigroup, a three-time loser whose bad paper taxpayers have already guaranteed to the tune of some $300 billion. Regulators could force more aggressive asset sales by Citi, which should have to shrink until it is no longer too big to require a taxpayer rescue. Refusing to bail out Citi's bond and equity holders would also send a message that the government is not going to save every big bank that takes bad risks merely because it is big.

But in making such a move, the Geithner Treasury should be clear that it has no intention of larger public ownership and control throughout the financial system. The bulk of toxic mortgage assets are on the books of 60 or so of our largest banks, so there's a real danger that under Mr. Geithner's plan taxpayers could end up being substantial owners in most of them. The risk is that deposits would then flow to these "national champion" banks because of their perceived safety, to the detriment of smaller competitors and new private investment in the banking system.

It's also unclear what Mr. Geithner has in mind for his other innovation, a new "Public-Private Investment Fund." He explained the concept as a way for Treasury to leverage up to $500 billion, and eventually perhaps $1 trillion, in private capital to buy toxic assets from banks. This would seem to echo Mr. Paulson's original concept for TARP money, which ran afoul of the difficulty of fairly pricing those illiquid assets. But the Treasury offered no other details.

Mr. Geithner told us in an interview that he doesn't intend this to be a resolution agency for failed assets, and acknowledged that "we're trying to do something that hasn't been done before." So this devil is all in the details, especially if it becomes a back-door attempt to recapitalize banks by overpaying for bad paper. Mr. Geithner would be wise to put someone strong and independent in charge of this fund -- someone who can say no to Congress and has no ties to Citigroup, Robert Rubin or Wall Street.

Like President Obama's, Mr. Geithner's rhetoric tends too much toward doom and gloom for our tastes, or to help public confidence. Americans know this mess is going to take time to work out. But there is a great deal of private capital ready to take risks again if the Obama Treasury lays out transparent, consistent rules -- and if it makes clear that its goal is to restore at the earliest possible date a healthy, privately run banking system.