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Toxic Avengers

With anticipation of Geithner's plan buoying the stock market indices, one would expect to see a similar effect in the ABX index, which tracks subprime mortgage-backed securities. But, as the Financial Times reports this morning, there's actually been very little movement on the ABX, a bad sign for Geithner:

But the plan's modest impact on toxic asset prices ... suggests that the liquidity risk premium--the price discount imposed by difficulty obtaining financing--in these markets may not be as big as policymakers hope, implying that prices may not rise very much when government financing comes on stream, leaving banks with still large capital holes.

The bigger these capital holes--and the greater the uncertainty over the value of the remaining assets on bank balance sheets--the less plausible it is that they can be filled with private capital and the more likely it is that the government will have to provide that capital instead.

In other words, the lack of movement is likely the result of a continued pessimism about a) the ability of the market to price the assets correctly, and b) the continued decline in the underlying collateral, i.e. residential and commercial real estate, and the complex terms under which the loans for that real estate were written. Geither et al. seems to believe that bringing liquidity back to the market will quickly lead to a correct price; the market, apparently, so far disagrees.

--Clay Risen