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The Dow fell 381.99 points to 7,888.88 on Geitherner’s speech on the Financial Stability Plan. Wow! There is an important lesson here, that markets are only as efficient as the information available and the people who participate in them.

I would give Geithner 5 stars (out of 5) for what he had proposed. Here is why:

1. Outlined the main problem: Instead of catalyzing recovery, the financial system is working against recovery. World trade is contracting. 3.6 million US jobs lost.

2. Outlined what to achieve: Real action. Jumpstart job creation, private investment and credit flows to businesses and families.

3. Outlined a 3 pronged approach:
3.1 Strengthen bank balance sheets. The comprehensive stress test is key here. If you understand all the issues with economic capital modeling, VaR, CVaR and FICO scores, you know 3 things. First most non-risk managers don’t understand the risk methodologies (and I might add many ‘risk’ managers, too). Second it is not going to be easy to implement. I would expect something on the order of 2 to 5 years.

And third, that banks are not willing to admit what the true value of their balance sheets are. The Dow fell 388 points because Geithner is forcing full disclosure, causing the market to come to terms with the real banking problem. That means the market is near its bottom. There may be one more major decline, but the light is at the end of the tunnel, finally. 

My guess is that for inexpensive home loans these toxic assets are probably worth about 10 cents on the dollar in a recession, and increases upward for more expensive homes to about 40 or 50 cents on the dollar. I don’t expect significant house price appreciations until 2011 (earliest) to substantially revise my guesses upwards.

It is important to get some handle on the value of the assets on the balance sheets because only then would future investors have confidence in the banking industry in whatever future shape it takes.

3.2 Establish a Public-Private Investment Fund. Great. The Government does not have to worry/know/ascertain value of toxic assets. It leaves it to the private sector to do that and piggy-back on their valuations. Very neat. Something that can be implemented in a few weeks/months.

3.3 Restart the securitization market. Great. Instead of trying to ‘push’ money through the financial system – and have it clogged up in some loss accrual account – Geithner is proposing to ‘pull’ funds though the system. The resulting ‘vacuum’ will pull credit through the financial system, and get it working again where the demand is. You don’t need to guess ahead of time where the demand is, the ‘vacuum’ will backward allocate funds to where demand is. Something that can be implemented in a few weeks/months.

4. A comprehensive housing program. About time. The origination to securitization process has many fee-taking players and nobody got it right. I do expect adjustments to property values and corresponding reduction in loan payments. Of course the existing investor will take the hit but he should seek recourse from his fee-taking intermediaries, as their fees were priced into his investments.

Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.

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