The Guest Blog

Busch: A Simple Choice


As we prepare for US Treasury nominee Tim Geithner's confirmation hearings before the Senate Finance committee, we have already got a taste of what is to come.

Top ranking Republican Senator Charles Grassley said that the hearing will focus on Geithner's tax issue, TARP implementation, and his role in the Bear Stearnsand AIG bailouts. Grassley said he's undecided on how he'll vote, but that the vote could come as early as tomorrow. This should be fun. (That was my comment, not Grassley's.)

Bloomberg reports that Geithner today will call for TARP reform and ask for Congress to pass a robust stimulus plan to revive the economy. "The ultimate costs of this crisis will be greater if we do not act with sufficient strength now.....In a crisis of this magnitude, the most prudent course is the most forceful course." Geithner also says in his opening statement that, if confirmed, he would refocus TARP to help small businesses and families that are losing their homes and jobs, according to the agency according to the report.

Over the last 72 hours, the global financial structure groaned under the weight of disappointing reports from US and UK companies.

Yesterday, the US bore the brunt of the selling as State Street reported a $9 billion unrealized loss and Regions Financial Corp. said it lost $6.2 billion due to swelling defaults and a large impairment charge. State Street's stock fell 59% and it's stock fell 18%.

Here's the disturbing aspect: PNC Financial fell 41% on Tuesday and they didn't even make an announcement. Overall, the Dow Jones Wilshire U.S. Bank Index has lost over 40% since the beginning of the year with Citigroup (-61%), Bank of America (-64%) , and JP Morgan Chase (-41%) leading the way. All three received government injections. This is a pattern.

Circling this back to Geithner, there is a fundamental choice facing the US government and today we'll see how the designee responds. The choice is over whether the government should nationalize the banks or not. It is a choice over skill sets and profit incentives. As supported by the takeover of Fannie Mae and Freddie Mac , the US struggles with how to manage these entities. To take over a bank and make decisions on how to lend or how to dispose of assets or how to manage a "for-profit" entity, the US Treasury or FDIC or Federal Reserve would be out of their depth.

This takes us back to the central question of how to resolve the banking crisis in the United States. So far, the US government has addressed the symptoms of the disease and not the disease itself. The symptoms include credit, liquidity, and toxic assets. The cures have been acronyms, backstops, and discussions of forming a "bad bank". The disease remains housing and home prices.

This is why I expect new TARP money to flow towards the housing market and to reduce the supply of foreclosures. Here's an idea: why not declare that as of January 1st 2009, all homes in foreclosure will be purchased by TARP? This attacks the supply or inventory problem forcing prices down. It would take away a major negative driver of bank assets. Yes, but it still means the government has to do something with those homes. The best solution would be to follow the RTC model by putting the properties together and then holding a fire sale to clear the market. The government would take the loss between what they pay for the homes and what they sell them for to the market.

It's this loss that no one wants to take or absorb.

While the US taxpayer is on the hook for it, this solution attacks the central problem. More importantly unlike an acronym or a "bad bank", it will stabilize home prices. Taxpayers can live with nationalizing or socializing home owner losses from the real estate market much easier than they can live with taxpayer losses from the banking industry.

Let's see which political party picks up on this first......


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Andrew Busch

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Andrew B. Busch Global FX Strategist atBMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. here