Dear Mr. Geithner, What's The Plan?

Make no mistake; all eyes are on Washington this weekend as investors anxiously await Monday’s comprehensive financial bailout plan from Treasury Secretary Timothy Geithner and the final version of the Obamanomics stimulus bill. However, the details of both plans have been sketchy at best and ideas on how best to attack the country’s problems have been bouncing around like a ping pong ball. Thus, no one can be sure as to what exactly the administration has in mind.

Perhaps the best example of this is the issue of whether or not Secretary Geithner will implement a “bad bank” structure into his plan. As you are no doubt aware, the concept of having a government sponsored entity buy up a big slug of the toxic assets out there has received a fair amount of discussion in the press lately. And since the concept has been successful in the past, most believe the implementation of such a plan would be a confidence booster.

However, we learned this week that, in short, this issue is terribly complex and there are questions as to whether anyone can figure out how to make the bad bank plan work. Yet at the same time, any mention that a bad bank is on the way has been good for a pop in stock prices. Thus, the casual observer might conclude that the stock market likes the idea.

Now You See It, Now You Don’t

As of 3:07pm on Friday afternoon, it appeared that the bad bank (aka an “aggregator bank”) was a go. Citing sources close to the Treasury, CNBC reported that the bad bank would be authorized to purchase up to $500 billion in toxic assets and that the plan was expected to be announced on Monday.

However, at 9:37pm on Friday evening, the Wall Street Journal reported that Geithner’s final bailout plan was unlikely to include a bad bank structure to acquire toxic assets. The Journal cites people familiar with the matter and notes that the cost and complexity of the plan appear to be the main reasons for not directly purchasing toxic assets from the banks. (Gee, isn’t this the very same reason why Hank Paulson didn’t go running out and buying toxic assets late last year?)

Then this morning at 10:38am, the Journal reported that Secretary Geithner is indeed “considering a plan to help purge banks of their bad debts.” However, this time around, the idea is to partner up with the private sector. The government would kick in some money from the $700 billion financial-sector bailout fund (aka the TARP – which is likely to be renamed on Monday) and let private firms finance the majority of the program.

Shaking Hands With the Government

If you’ve heard PIMCO’s Bill Gross speak lately, you’ve probably heard him say that his very best investment idea in the bond market right now is to “shake hands with the government.” In short, Mr. Gross suggests that there is big money to be made in the debt market by buying what the government will be buying. Thus, it is safe to say that there are indeed private investors out there chomping at the bit to get in on this game.

We should keep in mind that not every CDO, CMO, etc. is worthless. It’s just that there is virtually no market for these “bad assets” at the present time. Think about it; with the government having been talking about a plan to buy up these securities for months now, would you want to go out and spend a lot of money buying these securities before you knew what the government was going to do? The answer is no. And the reason is that it makes more sense to wait and see what the government is going to do.

But, we’ll bet that once a plan is finalized, there will be investors like Bill Gross out there digging around in the rubble looking for opportunities. This is exactly what happened after the demise of Drexel Burnham Lambert and the junk bond market debacle, and there is no reason to think that savvy bond investors won’t do the same here. It’s just that they are waiting on the Gov’t plan before committing any serious capital.

What We Do Know

While there are many things we don’t know about what Geithner & Co. have up their sleeves with regard to the issue of buying bad assets, we do know that the Treasury does plan on spending a fair amount of TARP money on a mortgage modification or “Mo Mod” platform. The idea is to rewrite up to 500,000 mortgage loans a month and restructure the amount owed so that borrowers would no longer owe more than their home was worth. These restructured loans would then be pooled and sold as securities to the private sector.

We also know that the there is likely to be an expansion of the Fed’s TALF (Term Auction Lending Facility) program to include assets beyond student, credit-card, and auto loans. We know that there is also talk to provide financing for investors to purchase asset-backed securities and to provide government insurance on losses relating to certain assets.

Next, the plan presented on Monday is likely to include another round of capital injections into banks with more strings attached. This time around it sounds like the government will utilize convertible preferred’s as a way to not wipe out current equity owners and avoid the whole nationalization issue. And finally, it looks like the Treasury’s new plan (which, in reality, isn’t all that new) will include an expansion of the responsibilities of the FDIC.

Watching and Waiting

With boatloads of time (24.5 hours to be exact) before the scheduled announcement of Geithner’s comprehensive plan, traders will be watching the wires for any changes that occur. And just so that you are aware, there is a chance that the entire plan will not be revealed tomorrow…

As for how to play things in the stock market, we need to understand a few things. First, short-covering played a major role in last week’s advance. Second, the major indices are now sitting at the top end of their short-term trading ranges and that there is significant resistance overhead should the bulls find a way to break out of the current range. And finally, until the uncertainty surrounding all the political stuff is cleared up, the upside could be limited.

But, as always, we will listen to the message of the market and act accordingly.

Wishing you all the best for a profitable week ahead,

David D. Moenning
Founder TopStockPortfolios.com

Positions in Stocks Mentioned: None

 

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