Mr. Geithner’s Plan

The Lehmann Letter ®

Today the stock market reacted with enthusiasm when Treasury Secretary Timothy Geithner revealed his plan to relieve the nation’s banks of their heavily-depreciated mortgage-backed securities.

Many feared that some of the biggest banks were insolvent (their liabilities exceeded their assets, so that they had negative net worth) because they could not sell the mortgage-related securities in their portfolios (and this reduced the value of their assets). The securities had become worthless without a market on which to dispose of them. That market had vanished when home prices plunged and homeowners began to default on their mortgages.

Secretary Geithner proposed to resuscitate the market by offering to team-up with private purchasers of mortgage-backed securities. The government would provide most of the capital so that its private partners could bid on the securities. That would establish a market and market price for the securities and permit the banks to sell them. The government’s partners could afford to bid robustly for these securities and hold them until home values recover because the government provided most of the purchase price.

Here’s the hope: (1) The securities’ value swells as they are purchased, (2) the banks’ assets grow as the banks sell the securities at good prices or hold them as their prices rise. As asset values increase, so does net worth and the banks are solvent once more.

© 2009 Michael B. Lehmann