A new Treasury secretary could help shepherd additional relief for the banks through a skeptical Congress.
By Colin Barr, senior writer
NEW YORK (Fortune) -- Betting against bank stocks may soon become much riskier.
The stock market enjoyed a massive snapback rallyfollowing reports that president-elect Barack Obama will make Timothy Geithner, the president of the Federal Reserve Bank of New York, his Treasury secretary.
The Geithner decision is potentially "very helpful" in adding stability to the financial system, said Simon Johnson, an economist at the Peterson Institute for International Economics in Washington, because it suggests the Obama administration is ready to act decisively on the financial crisis.
The U.S. finance sector has been under attack.
Citi (C, Fortune 500) lost nearly two-thirds of its value over the past week, losing 20% Friday alone even as the rest of the market bounced back following a two-day washout.
JPMorgan Chase (JPM, Fortune 500) and Bank of America (BAC, Fortune 500) each lost at least a third of their value, while Goldman Sachs (GS, Fortune 500) traded below its initial public offering price a decade ago.
At the same time, confidence in the current Treasury secretary, Henry Paulson, has been in steep decline. "The plan-a-day stuff has just not worked," said Bianco Research strategist Howard Simons. "The confusion has created paralysis - it's a failure of policy."
The past week's plunge, after all, comes less than a month after the Treasury poured $125 billion into nine big financial institutions to stabilize the banking system.
The selloff started in earnest after Paulson said the Treasury wouldn't buy troubled mortgage assets from financial institutions that are up to their eyeballs in them. In doing so, Paulson abruptly abandoned a sales pitch he made just two months ago to pry $700 billion in spending authority from a reluctant Congress.
That reversal did more than undermine shares of big holders of troubled assets such as Citi, which had been seen as a big beneficiary of the original TARP plan. It also served as perhaps the final strike against Paulson in a credibility battle he has been waging with his critics on Wall Street, in Congress and in the public.
Sen. Kent Conrad, the North Dakota Democrat who chairs the Senate Budget Committee, sent Paulson a letter Thursday in which Conrad says he found it "troubling to learn" that Treasury "may have misled members of Congress, the public, and financial market participants about its intentions with regard to the purchase of troubled assets."
The comment stems from Paulson's assertion in a Nov. 12 speech that by the time the bill enabling the TARP was signed on Oct. 3, it was clear to him that "purchasing troubled assets - our initial focus - would take time to implement and would not be sufficient given the severity of the problem."
Conrad wonders why Paulson didn't share this observation with taxpayers earlier.
"Since the current crisis is due, at least in part, to a crisis in confidence and aversion to making credit and investment decisions in the absence of full and accurate information, it is important for Treasury to signal its intentions clearly," Conrad writes. "Misleading statements and unexplained or poorly explained changes of policy are not helpful to restoring confidence in the credit and equity markets."
Geithner, at the start at least, should have a much better relationship with Congress. That's an important factor with bailouts being deeply unpopular, Johnson said - as shown in the way the executives at the Big Three auto companies were shown the door last week.
Still, the policy questions themselves remain vexing.
While Johnson said there is no easy answer to shoring up the banking sector for a second time in three months, one solution is to repeat the earlier TARP capital plan - inject massive amounts of funds into big institutions at favorable terms for the banks - as a way to show those betting against the banks that it's possible to lose money on those bets.
Big purchases of preferred stock will add to the banks' capital, offsetting the recent erosion in their financial positions as markets have soured.
And because the terms aren't tough on the recipients - banks pay just a 5% dividend on the shares, which is half the market rate in recent transactions at Goldman and GE - stock prices in the sector could actually rise.
Another capital injection alone wouldn't necessarily end the run on the banking system, of course. And it's notable that Citi sat out the rally that boosted the rest of the market late Friday following reports of Geithner's appointment.
But even analysts who have long been skeptical of Citi says its recent trading price understates the firm's true worth. "We believe that there is fundamental value at Citigroup that justifies a $9 price target," Deutsche Bank analyst Mike Mayo wrote Friday.
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