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Last updated: April 21, 2009 10:06 pm
Tim Geithner, US Treasury secretary, on Tuesday sparked a rally in financial stocks after he said the “vast majority” of the nation’s banks are well-capitalised and damped investor fears that the government will wipe out their holdings.
However, Mr Geithner conceded the massive effort by the US authorities to rescue the banking system from the crisis was showing only “mixed” signs of success.
Appearing before a congressional oversight panel, Mr Geithner said it was hard to know how the financial markets would have operated without such programmes .
Interbank lending, corporate issuance and credit spreads were showing some signs of a thaw in credit, he said, but he added: “To date, frankly, the evidence is mixed.”
Shares in the financial sector – which suffered big losses on Monday – rallied in New York on Tuesday after Mr Geithner said in his testimony that the “vast majority” of banks had sufficient capital.
“There was a reversal in the market after Geithner made his comments,” said Richard Bove, analyst at Rochdale Securities.
The KBW index of bank stocks closed 7.9 per cent higher after a steep fall on Monday, which was partly caused by false rumours about the results of the government’s bank stress tests.
Mr Geithner indicated that the conversion of the government’s preferred equity stakes to common equity – a move that would dilute the holdings of existing shareholders – could prove part of the solution for weaker banks.
Jeb Hensarling, a Republican representative and member of the panel, said he worried that such a move would convert “Uncle Sam into a control shareholder of many of our largest financial institutions”.
“That risk worries me, too,” said Mr Geithner. He said he was concerned at the “potential damage you do to franchise value and expectations across the financial system if you have this expectation of creeping long-term government involvement, government ownership”.
Mr Geithner said the Federal Reserve needed to conclude the stress tests before deciding which banks needed more capital. Some institutions would be likely to raise capital privately, while others could need additional government support.
Separately, a senior Federal Reserve official said that insolvent US financial companies should be allowed to fail, no matter how big they were.
Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, told Congress’s joint economic committee that the design of the $700bn bank bail-out last year had slowed down recovery.
“The United States currently faces economic turmoil related directly to a loss of confidence in our largest financial institutions because policymakers accepted the idea that some firms are just ‘too big to fail’. I do not,” Mr Hoenig said.
“Yes, these institutions are systemically important, but we all know that in a market system insolvent firms must be allowed to fail regardless of their size, market position or the complexity of operations,” he said.
Additional reporting by Sarah O’Connor in Washington
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