Geithner Feeds Zombies

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New Treasury Secretary Timothy Geithner destabilized financial markets Tuesday by unveiling his long-awaited “Financial Stability Plan.” Talk about a disappointment. It could have been so much more.

The problem wasn’t just the lack of details in the multi-pronged scheme for bulking up banks and credit markets. It was also the lack of a tone of authority. There was no sense from Geithner that the new administration is going to take charge of this wretched financial system the way an emergency room doctor would quickly administer harsh medicines and amputate rotten limbs to ensure patients survive. Instead, Geithner conclued one of his presentations saying: “I want to be candid: this strategy will cost money, involve risk and take time.” No wonder stocks plunged nearly 5% and fear tightened its grip on corporate credit markets.

The real shame is that Geithner’s plan includes a good tool, a good tool that he is apparently not willing to say he will use to its potential. The tool is what he called a “stress test” and likened to those that doctors use. He described his test as “comprehensive…assessment” of whether major financial institutions have the capital to absorb losses from “a more severe decline in the economy than projected.” The test will be required of banks with more than $100 billion of assets, he said. It will be given along with “more consistent, realistic and forward looking” assessment of banks’ risks. Banks that take the test “will have access to a Treasury provided ‘capital buffer,’ ” Geithner said.

He could have said that the stress testing would also be used to decide which banks are doomed and should be shut down. But he didn’t. He could have continued with his medical analogies and described the testing as triage—what courageous battlefield doctors do when they decide which casualties to put aside as goners so that they can help those with a chance. But he didn’t. Why not? Maybe it was because Geither has no intention to cull the bad banks. Maybe it was because he did not want to say publicly that more banks will fail.

Regardless, the markets are left to worry. They fear that the land will haunted for years by zombie banks, banks that are too weak to lend, but yet are able still tie up capital and feed on taxpayers.

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