In testimony before the Congressional oversight panel, U.S. Treasury Secretary Timothy Geithner said that the "vast majority" of our banks are well capitalized. These words were music to the ears of Wall Street traders who drove the Dow up 127.83 points yesterday.
His words were also soothing to bank shareholders, who feared there might be government intervention to take over certain banks or a move to convert government holdings of bank shares from preferred shares into common stock. This would add to the asset base of the banks, but would at the same time dilute shareholder equity.
Shelving these two possibilities removed a great deal of fear in the markets and was a key factor in yesterday's rally. The KBW index of bank stocks jumped up 7.9% after a sharp drop on Monday.
Geithner did sound a cautious note by stating that the efforts of the U.S. authorities to rescue the banking system has led to "mixed" results. He stated that interbank lending, corporate issuance and credit spreads were showing signs of improvement.
When the "stress tests" are complete, the Federal Reserve will decide which banks need time to raise extra capital and which ones need additional government support.
Separately, Thomas Hoenig, President of the Kansas City Federal Reserve Bank, said that he opposed the bailouts, claiming that they created uncertainty in the markets, and that banks should be allowed to fail, no matter how big they are.
Should banks be allowed to fail?