Financial Reform Watch

U.S. Treasury Secretary Tim Geithner today announced the administration’s new “Financial Stability Plan” but revealed few details beyond the plan’s overarching principles. The new plan aims to provide more capital for banks while holding them to higher lending and accountability standards, establish a public-private investment fund to deal with “troubled” assets, provide more assistance to homeowners and small businesses, and increase the transparency of the program in order to protect taxpayers.

After an unusual introduction by Senate Banking Committee Chairman Chris Dodd—presumably intended to underscore the administration’s dual commitment to the economic stimulus legislation intended to jump start the economy and fixing the financial system—Geithner described the current situation. He said credit markets are not working, which has led to serious business cut backs and resulted in a financial system “working against recovery.” Geithner criticized the government’s efforts thus far as “absolutely essential, but they were inadequate.”

Following the Treasury announcement, the stock market nose-dived all afternoon, with the Dow Jones industrial average dropping 4.6 percent and the Standard and Poor’s 500-stock index slipping 4.9 percent. Several financial analysts directly linked the market’s poor performance to the plan’s lack of detail, especially regarding the Public Private Investment Fund intended to leverage private capital with government financing. Some analysts contend that today’s announcement exacerbated the uncertainty plaguing the markets. When reporters questioned Geithner about filling in the blanks around the public private partnership, he responded that the administration does not want to release details until they are fully confident they have the right structure. He said they are very committed to bringing in private capital.

Here is a brief overview of the Financial Stability Plan:

1. Financial Stability Trust—A separate entity that will manage the government’s investments in U.S. financial institutions. It also includes requirements for banks to undergo a “comprehensive stress test” conducted in coordination with the major banking regulators—Federal Reserve, FDIC, Office of Comptroller of the Currency, and the Office of Thrift Supervision; and a Capital Assistance Program described as a “capital buffer that will operate as a form of contingent equity to ensure firms the capital strength to preserve or increase lending” in a downturn.
2. Public-Private Investment Fund ($500 billion to $1 trillion)—Treasury will work with the Fed and the FDIC to use public financing to leverage private capital to cleanse financial institutions’ balance sheets of their “legacy” assets. The intent is to have private sector purchasers determine the price for troubled assets.
3. Consumer and Business Lending Initiative (up to $1 trillion)—In order to get secondary markets and securitization (bundling and selling of loans) functioning properly, this plan will expand the Fed’s Term Asset Back Securities Loan Facility (TALF) by providing “financing to private investors to help unfreeze and lower interest rates for auto, small business, credit card, and other consumer and business credit.” What’s new: Treasury increases its participation to $100 billion (from $20 billion); purchases will be limited to “newly packaged AAA loans;” and the reach of TALF is expanded to include commercial mortgage backed securities. Geithner said they may later expand TALF “to include other asset classes,” such as assets collateralized by corporate debt.
4. Transparency and Accountability Agenda—Recipients will have to submit with their applications detailed plans about how they would use the federal money (which will become public upon receipt of funds) and how the federal money would enable them to preserve or generate new lending, including what would have been possible without the federal assistance. Recipients will also be subject to new mortgage foreclosure mitigation programs (guidelines forthcoming), stock and dividend restrictions, executive compensation limits, political interference prohibitions, and public (Internet) disclosure of contracts.
5. Affordable Housing Support and Foreclosure Prevention Plan—The Fed will work to drive down mortgage rates by purchasing up to $6 billion worth of GSE mortgage-backed securities and debt. Treasury will commit $50 billion to prevent “avoidable foreclosures of owner-occupied middle class homes by helping to reduce monthly payments.” Treasury will also establish loan modification guidelines and standards in order to achieve consistency among various government and private programs and increase flexibility in the Hope for Homeowners program and the Federal Housing Authority to expand loan modifications to more distressed borrowers.
6. Small Business and Community Lending Initiative—In the next several days, the president, Treasury, and the Small Business Administration (SBA) will launch this new initiative to increase SBA lending. They support stimulus legislation provisions to increase the guarantee of SBA loans from 75 percent to 90 percent. The administration also plans to reduce fees for SBA 7 (a) and 504 loan programs and streamline loan application processing.