Geithner’s Plan To Save The Banking System: What Does It Mean For Banks?

After watching the destruction of the financial sector over the past 12-18 months, I (like many investors) became a huge bear on many of its components.  I have been a big advocate that in order for the markets to recover, the financial sector needs to stabilize.  Without a strong financial sector in place, the rest of the economy will lag due to the lack of credit availability, and housing prices will continue to decline.  On Monday, Treasury Secretary Geithner released his Toxic-Asset solution to try to help restore confidence in the U.S. banking industry.

This plan has significantly changed my view on the sector and may be the biggest step, other than the TARP program, to revive U.S. banks.

The markets obviously applauded the move by the Treasury as many of the bank stocks surged significantly during trading on Monday.  Today’s leaders in the banking sub-sector included J.P. Morgan (JPM), Citigroup (C), Bank of America (BAC), and Wells Fargo & Co. (WFC), as they surged over 24%, 19%, 26%, and 23%, respectively.  Goldman Sachs (GS) also benefited not only from the Treasury’s news but also from its announcement that it may sell 15-20% of its 4.9% stake in Industrial & Commercial Bank of China Ltd., which could raise more than $1 billion at current market value.

Treasury Secretary Timothy Geithner has been in the hot seat over the past couple of months as many investors and lawmakers have been upset with the speed at which he has acted to shore up the financial system.  This new plan will help the banks clean up their balance sheets, as the federal government will put up as much as $100 billion combined with private capital to generate $500 billion in capital to purchases toxic assets.  According to The Wall Street Journal, this figure could increase to $1 trillion in size over time depending on the private sector.  This will be a huge help to many assets that have plummeted over the past year due to a 20% decline in housing prices, rising delinquencies, and a massive de-leveraging move by financial institutions and hedge funds.  Over the course of this financial crisis, over $1 trillion has been pulled out of the system due to de-leveraging.

What does this plan mean for the banks?  With the exception of maybe Goldman Sachs and Morgan Stanley (MS), most of the banks have not marked these toxic assets to market value.  Both Goldman and Morgan Stanley have acted very aggressively to mark down their assets in order to ease investors’ concerns.  With some of the larger money-center banks, it would be extremely difficult to mark everything down to market value, as a lot of these assets currently have no market to trade in (which would imply that they would be worth nothing).  Ultimately, the Treasury’s goal is to restore confidence in the system to provide a market for these assets.  This will raise the value of some of these assets from their current “market value” of zero and closer to their “true-market worth.”

This is going to be extremely difficult for Geithner to accomplish, but he is on the right track with the process that has been outlaid.  Bill Gross of Pimco told CNBC:  “Four or five managers are going to be selected - we hope to be able to do that on the securities side. On the bank-loan side, we hope to be able to participate as a buyer.”  Among other top candidates for this highly regarded list include Larry Fink’s BlackRock (BLK).  BlackRock is already helping out the Treasury with past financial sector bailout plans.

The future prospects of the financial sector have definitely improved with Geithner’s new plan, but it will take some time to see if this is really what is needed for the sector to recover.  This plan has boosted confidence within the sector, but more will be needed for these banks to return to sustainable positive operating profits.  Problems will likely continue with consumers as they have lost a considerable amount of wealth from their real estate, retirement accounts, and investment portfolios.  With unemployment currently at 8.2% and rising, and over 20% of Americans in fear of losing their jobs, consumers will tighten their wallets further.  This will only put another drag on any form of an economic recovery.

Disclosure: The Fund the author is associated with is long JPM, GS, and BLK.

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