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Busch: Financial Stability And Recovery Plan

US Treasury Secretary Tim Geithner has delayed the release of his Financial Stability and Recovery Plan (FSRP) until Tuesday at 11 AM ET.

Of course, the plan's details are leaking out faster than A-Rods steroid test. The over-arching goal of the program is to stabilize the financial system through a combination of government intervention and private investment. It will involve the US Treasury, the FDIC, and the Federal Reserve with some of the plan a retreads of ideas from former US Treasury Secretary Paulson.

So far, the plan has four components and lots of questions:

First, there will be an injection of TARP funds with all their strings into banks/financial institutions that are so desperate they will agree to the onerous terms. There will be limitations on executive pay along with directives of new lending practices. What will be interesting is if the FSRP tries to force the same conditions on companies that already took TARP injections. The terms will be tougher and will include preferred shares that convert into the common equity within seven years.

In this vein, the FDIC will be given broad, new powers over large financial firms in trouble beyond it's current responsibilities of depository institutions. (This will likely require Congress to act.) In turn, this will likely lead to bank closures/mergers into healthier companies. Last week, the FDIC acted ahead of Geithner's announcement by closing 3 banks. I would expect more to come.

Next, there will likely be a "bad" or "aggregator" bank to buy "toxic" assets from banks. The goal is to provide an avenue for banks to dump these assets and get out of the death spiral of mark-to-market induced capital raising with no lending. According to the leaks, the funding for this entity will come from both the remaining TARP funds and private investors. Geithner will be forced to guarantee the private investment and will be forced to provide a high rate of return to entice investors. Apparently, the US Treasury hasn't worked out all the details on this and may need another month to nail it down. This gets us right back to the original questions from the original TARP program: which assets from what companies at what price?

Then, there will be a foreclosure plank that will attempt to help homeowners who are either in foreclosure or close to going into it. This will initially involve Fannie Mae and Freddie Mac with the hope that other lenders will follow. CNBC reported that officials from the Treasury Department and Department of Housing and Urban Development worked with the GSE companies' regulator to agree on standards for who could get relief and how they might coax other finance companies to follow their lead. Remember, Fannie Mae was created during the Great Depression and helped create a secondary market for mortgages that ignited home ownership. How ironic is it that they are now being asked to help keep those owners in their homes?

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Lastly, the Federal Reserve is going to greatly expand their Term Asset-Backed Securities Loan Facility. As many of you know, I think this will be one of the better programs the Fed is going to run to help restart the ABS (asset backed security) market. This was originally established to buy/swap student-loan, auto-loan, and credit-card debt. According to the CBO, Through the Term Asset-Backed Securities Loan Facility (TALF), the Federal Reserve Bank of New York will lend up to $200 billion to holders of certain AAA-rated asset backed securities (consumer and small business loans), and the Troubled Asset Relief Program will provide $20 billion of credit protection (protection against debtors that do not pay because of insolvency or protracted default) for those loans. The TALF is expected to begin lending this month and its authority expires on December 31, 2009. The key component: both banks and hedge funds are allowed to participate.

Overall, this plan has a lot of moving parts that may or may not work.

I think the aggregator bank could be a way to re-capitalize banks in a stealth way as the Treasury overpays for the assets. They almost have to overpay to get companies to agree to give up the assets. I still think a Brady bond scenario makes more sense for these assets, as it would provide a secondary market to provide pricing and liquidity. The point is that the FSRP is a fresh start with old ideas. Let's see how well Geithner answers all the pricing and structure questions during his press conference tomorrow. Remember, Paulson had a disastrous appearance in front of Congress when they asked him about the original intent of the TARP program.

Let's hope Geithner has learned from it.

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Andrew Busch

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