Published March 25, 2009

Geithner effect pulls up Asian markets

But relief may be short-lived as euphoria wears off; balance sheets still need repairing

By CONRAD TAN

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(SINGAPORE) Stocks in Asia surged yesterday, extending their gains into a second day after the US government unveiled its latest plan to excise the toxic assets that have poisoned confidence in banks from their balance sheets.

Major private-sector investors including US asset manager BlackRock and Pacific Investment Management Co (Pimco), the world's biggest bond fund, said that they would take part in the plan, raising hopes worldwide that it could succeed where previous attempts had failed.

Here, the Straits Times Index finished 42.26 points or 2.5 per cent higher at 1,706.34, after climbing 3.6 per cent earlier in the day, led by bank stocks.

Hong Kong's Hang Seng Index rose 3.4 per cent, powered by HSBC Holdings, whose shares soared 9.8 per cent. In Japan, the Nikkei-225 stock benchmark ended 3.3 per cent higher. But while some analysts feel that the US plan is just what the doctor ordered, dissenting voices are already emerging.

'I suspect that this is not going to solve the problem,' said Kevin Scully, who heads independent equity research firm Net-Research Asia here. He warned that the latest equity rally is unlikely to be sustained. 'It's probably a bear trap,' he said. 'People feel good that there's a plan.'

Even if it is successfully implemented, banks that sell their toxic assets will almost certainly do so at a loss, which will force them to raise more capital through rights issues or share placements, he added. 'What that means is that share prices will collapse because of dilution - you can't run away from that.'

Major stock indices in Europe were down by more than one per cent at midday, erasing some of Monday's gains. In the United States, the Dow Jones Industrial Average fell 1.3 per cent in early trading after its euphoric 6.8 per cent climb a day earlier.

Under the public-private investment programme announced by US Treasury Secretary Timothy Geithner on Monday, the government will pump money into joint-venture investment funds with private investors to buy up to US$500 billion worth of soured mortgage debt and other troubled assets from banks. The special-purpose funds will be privately managed, but subject to close watch by US regulators.

The government is offering to provide half the seed capital for these investment vehicles, drawing US$100 billion from its war chest under the Troubled Assets Relief Program. It expects private-sector investors such as Pimco, BlackRock and hedge funds to provide the other half of the equity capital.

The government will then offer loans to the special-purpose funds or guarantee debt securities that they issue, to finance their purchase of the toxic assets. Through this leverage, the government estimates the programme could be expanded to buy US$1 trillion worth of hard-to-value assets from banks.

Banks holding such assets, which include billions of dollars of debt securities backed by pools of mortgages and other loans, are reluctant to dump them at the distressed prices that private investors would pay without government support, forcing massive writedowns. Meanwhile, fears that the value of the underlying collateral will collapse further as the US economy worsens have put off potential buyers. Equity investors, worried that the banks will ultimately shoulder the losses, have driven the share prices of many banks to record lows.

By sharing the risk of losses through its co-investment, the government hopes that it will be able to attract private capital, especially from pension funds, insurance companies and other long-term investors back into the market.

'It could be just what we need' to start the world's biggest economy on the slow road to recovery, said David Cohen, director of Asian economic forecasting at Action Economics in Singapore. 'After all, what has been the major hurdle to allow the economic recovery to get started was the fear that the banking system was still frozen and would not be able to finance the recovery with the necessary credit flows.'

But the plan also came under fire from other economists, including Nobel laureate Paul Krugman, who argued that the government support is effectively a subsidy to encourage private investors to buy banks' unwanted assets for more than they are worth, using money from the public purse.

The latest proposal, wrote Mr Krugman in The New York Times, 'would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt'.