When Geithner speaks – stock market reaction

Did anyone notice the big drop (more than 3.5%) in the stock market as of Monday’s close? As the financial stocks seem to have been the hardest hit, the better question, however, is “why”?  Well, it seems that this weekend, the latest administration news “leak” landed with a thud, causing an even louder thud on Wall Street.

Here’s the “plan”.  Treasury is worried that some of the TARP banks will not pass Treasury’s “stress test”, and it knows that it can’t go back to Congress for more TARP money. So, it is proposing to swap the preferred shares of stock it now has in those banks for common shares. How will that help the banks, you ask? Well, it won’t.

They propose a preferred-for-common swap, which can conjure up an extra $100 billion in bank tangible common equity, a core measure of bank capital. Not that this really adds any new capital; it merely shifts the deck chairs on bank balance sheets. Why Treasury thinks anyone would find this reassuring is a mystery. The opposite is the more likely result…

But, to a Martian landing here today, without benefit of any history, it would look like the bank has an enormous amount of “common equity”…a key statistic in evaluating bank capital, and, presumably a piece of the “stress test”.

Why the concern? As explained quite clearly in the above quoted April 21 editorial from the Wall Street Journal, it looks like the first step (or perhaps, the second) in nationalizing banks. With each share of common stock comes a vote. The government, by means of those votes, would be able to select the bank’s Board of Directors, who, in turn, set the bank’s policies. As an example, loans to “Group A” (whether sound or not) will be granted, and loans to Group B (no matter how sound) will not be granted. Some banks, most notably, J.P Morgan Chase, have indicated that they will not participate in Geithner’s “toxic assets” buy out plan. With control of the common share vote, they will. Most banks are opposed (for good reason) to the bill allowing the Bankruptcy courts to reduce the principal amount of home loans for those in bankruptcy. With control of the common share vote, the opposition will disappear.

And, guess who gets to control the votes that come along with the government’s ownership of banks’ common stock? If you guessed Barney Frank, chairman of the House Financial Services Committee, and Chris Dodd, chairman of the Senate Banking Committee, go to the head of the class. No wonder Wall Street is concerned.

And, now you also know why, even though some financial institutions are ready, willing and able to repay the TARP “loans” the Obama administration has said “no”.

Perhaps of greater concern to Wall Street is what happens when the government tires of playing with banks, and decides to dump millions of shares of bank common stock on the market? The “thuds” just keep getting louder.