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Treasury Exposes Markets to Added Stress Flu

Posted By J.D. Foster, Ph.D. On April 28, 2009 @ 10:56 am In Economics | Comments Disabled

Markets are weighed down by worries over the new swine flu and the ongoing stress flu; the former from Mexico, the latter from the Treasury Department. Recently, Treasury added markedly to market uncertainties by suggesting it would convert federal capital injections from preferred shares of banks to common shares [1]. This makes little sense unless Treasury’s goal is to unsettle markets further and dilute the holdings of existing shareholders.

Treasury’s stress test examinations of the nation’s largest banks to determine if they have the capital to survive a major economic downturn should ultimately provide some assurances to the stock market. Until then, the stress tests are destabilizing markets by injecting extraneous uncertainties regarding the tests themselves, the process, and the implications for banks that are found to be short of capital.

The Treasury then doubled down on market fears through its equity conversion proposal. Treasury currently owns billions in preferred shares of the major banks. These shares plus its supervisory powers mean the most troubled banks have already been effectively nationalized through the backdoor. The banks are still learning what this means in practice, and its not pretty – threatened pay caps, CEO firings, etc. Converting the preferred shares to common shares takes this nationalization one small step further.

What the conversion does not do is make the banks any healthier. Banks that are light on capital remain so. And because it has so little concrete meaning, the conversion to common shares raises serious questions about Treasury’s real intentions. Giving the Obama team the benefit of the doubt that in fact they don’t want to run these banks on a day-to-day basis, this peculiar conversion proposal has left markets wondering what Treasury really is thinking. Consequently, this proposal only adds to the market’s worries. Upsetting them further is no way to restore credit markets to normalcy. It’s time for Treasury to step back and let markets heal.


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URL to article: http://blog.heritage.org/2009/04/28/treasury-exposes-markets-to-added-stress-flu/

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[1] it would convert federal capital injections from preferred shares of banks to common shares: http://www.nytimes.com/2009/04/20/business/20bailout.html

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