Ready for More Bad News?

In the past week, the stock market reacted erratically to two huge government actions intended to shore up economic confidence. As this five-day chart of the Dow Jones industrial average shows, stocks rallied last Thursday and Friday as a deal over fiscal stimulus crystallized. The mere anticipation of the passage of an $800 billion-plus stimulus package was enough to get people whistling "Happy Days Are Here Again." But on Tuesday, stocks surrendered most of those gains after Treasury Secretary Tim Geithner laid out the latest plan to stabilize the faltering financial industry.

What accounts for bipolar response? These were twin, aggressive efforts to deal with the woes affecting the whole economy and the pathetic financial sector. Why would Geithner's Treasury plan worry Wall Street while the stimulus plan didn't? As a public speaker, Geithner is no Obama. Geithner could learn to be more upbeat, but that wouldn't be useful. Investors have lost faith in the financial system precisely because policymakers and executives engaged in the classic post-bubble reaction of promising a swift return to profitability. (In my forthcoming e-book, Dumb Money, I dub the realization that the titans of finance were a bunch of clueless oafs "The Slow Unmasking.")

Geithner is realistically pessimistic about the economic crisis while the rest of Washington—even President Obama—hasn't caught on to how bad it is yet. From the rhetoric surrounding the stimulus bill, you'd think the American economy is already stabilized, able to breathe on its own, and ready to get up and start walking. The bill itself is called the Economic Recovery and Reinvestment Plan. Its success will be measured, Obama noted in his press conference last night, through positive milestones, most notably the saving or creation of 4 million jobs. That number, which he used six times, was the justification for the size of the package and its urgency: "It's important for us to have a bill of sufficient size and scope that we can save or create 4 million jobs." Obama might want to retire that line, for this reason. The takeaway: Things are tough and might get somewhat worse. But this plan is a plan for recovery and job creation.

Geithner struck a different tone in his speech. The patient he diagnosed is nowhere near ready for ambulatory care or physical therapy. Rather, it's struggling to breathe without life support. Worse, it is still in danger of infecting the whole hospital. The financial sector, pro-cyclical on the way up—easy money begat more easy money—is also pro-cyclical on the way down. "Instead of catalyzing recovery, the financial system is working against recovery," he noted.

For Geithner, the plan is more about stabilization and triage rather than recovery. Look at the language he uses. The initiative's Web site is FinancialStability.gov. "We're going to require banking institutions to go through a carefully designed comprehensive stress test, to use the medical term," Geithner said. Merely stabilizing the patients under his care, Geithner said, would be an expensive and lengthy process. "This strategy will cost money, involve risk, and take time," he said. Even when the course of treatment is complete, a recovery may still be a long way off. "As costly as this effort may be, we know that the cost of a complete collapse of our financial system would be incalculable for families, for businesses and for our nation." (Here's the fact sheet.) The takeaway: The financial sector is still in meltdown. The best we can hope for is that these hundreds of billions of dollars in new spending and support will help stabilize things.

The great challenge for Obama now is that the economy at large is beginning to resemble the financial sector. The latest readings on job losses, auto sales, and overall economic growth show an economy that is spiraling downward. Politicians may be hoping that the economy is like a bungee-cord jumper, who, after experiencing a sickening drop, experiences great relief as he bounces back sharply. But they might want to temper the promises they make about recovery. Many economists believe we need a bigger stimulus package, not a smaller one. Obama's rhetoric about recovery may be reassuring, but, at this point, Geithner's pessimism is more credible.