Wednesday, February 11, 2009

Markets were looking for forebearance

Yesterday markets shunned Tim Geithner's speech. Generally, market participants were disappointed by the lack of detail, Geithner's performance, or the size of the program; take your pick. I like this explanation better, providing a good answer as to why the government's appeal to "do whatever it takes" didn't work. An excerpt from the Wall Street Journal:
Tim Geithner didn't use the words "regulatory forbearance" yesterday in his banking bailout presentation. In fact, no one in Washington uses those words, which are seriously out of fashion. Yet regulatory forbearance is the most important item in the government toolkit, and the giant raspberry Mr. Geithner received from the market yesterday should be his signal that the market understands this and worries he doesn't.

When you hear critics complaining about mark-to-market, they're in effect calling for regulatory forbearance. Banks are required to report holdings of securitized loans at market prices, though market prices are severely depressed right now -- perhaps more so than justified by the performance of the underlying assets.

Let's not kid ourselves, either, that banks haven't already received a few nods to avoid accounting write-downs that would endanger their capital adequacy. Mr. Geithner would have done himself a favor simply to embrace that fact rather than issue the catalog of hand-waving he issued yesterday, which we fear will just extend the government's record of confusing and destabilizing markets.

Regulatory forbearance got a bad name during the drawn-out S&L mess, when it became an excuse for letting institutions gamble on turning themselves around. Equally true, however, is that congressional refusal to recapitalize an insolvent federal deposit insurance agency drove regulators to resort to accounting tricks to prop up failing S&Ls, when they would have preferred to shut them down.

Even so, hundreds of thrifts that benefited from regulatory forbearance didn't end up collapsing at taxpayer expense. By one count, some 40% of the 952 institutions that were given leeway eventually were acquired by stronger banks or recovered on their own.

Regulatory forbearance, curse word though it has become, was also used to good effect in the early 1990s, when many of the nation's biggest banks were dragged down by New England and Texas real estate -- a situation more directly comparable to today's, where so-called toxic assets are concentrated on the balance sheets of a handful of the biggest banks.

Sadly, much of what Mr. Geithner offered yesterday was, in fact, redundant. Banks "too big to fail" already are effectively backed by government and don't need trillion-dollar capital injections or taxpayer-financed toxic asset relief. What markets really could have used was a guiding word about regulatory forbearance and also its corollary: Stepped-up enforcement to make sure bank managements don't take crazy risks while digging out.
Rebecca Wilder

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