When the stock market surges 7 percent in a single session, I'm going to pay attention. I'm going to think. A few observations on the Geithner Plan to deal with the "toxic assets" problem:
1) Let's keep in mind that there is every chance that the "legacy loan" program isn't going to be up and running until September. Perhaps Treasury can time it with the one-year anniversary of the roll out of the original Paulson Plan. Some nice symmetry there.
2) Will there be a lot of participants? Who knows. There are still lots of details left to be answered, particularly with the "legacy securities" program. As Mike Feroli of JPMorgan notes: "It is unclear how TALF will interact with the Legacy Securities Program. Moreover, the lending rates, haircuts and duration of any TALF loan have yet to be determined. Without this information, the spine of the Legacy Securities Program is no more complete today than it was on February 10th when Geithner first discussed his plan." And while Team Obama has talked down any chance of AIG-like punitive action against participants in the Treasury program, that fear is still hanging out there.
3) What if banks don't want to sell those toxic assets? (Indeed, it now seems as if those stress tests will be used to "twist their arms" to sell.) Let's recall what Warren Buffett had to say about those terrible toxic assets:
Yeah, the interesting thing is that the toxic assets, if they're priced at market, are probably the best assets the banks has, because those toxic assets presently are being priced based on unleveraged buyers buying a fairly speculative asset. So the returns from this market value are probably better than almost anything else, assuming they've got a market-to-market value, you know, they have the best prospects for return going forward of anything the banks own. The problems of the banks are overwhelmingly not toxic assets, you know. They may have been one or two at the top banks, but they are not going to do in--if you take those 20 banks that are subject to the stresses, they're not going to do those banks in. Those banks have the earning power which has never been better on new business going out of this to build capital positions even if they pay low dividends which they're starting to do now.
In fact, Buffett makes the case that all that really needs to happen is a bit of capital, perhaps, and some mark-to-market reform so that the banks don't have to keep taking those big writedowns. Add in the upward sloping yield curve (good for bank profitability) and there's your solution.
4) But to the extent that there is some investor participation in the Geithner Plan, it does perhaps further lower the risk of a depression event. And I think that's what really explains the market's rally of late: some M2M Reform + some better-than-expected economic reports + the Fed's inflation strategy + some clarity on the toxic assets issue + rising commodity prices = no depression. This, of course, does not rule a Lost Decade or a That '70s Show scenario.