There have been reports that Rep. Paul Kanjorski said that he was told of a massive outflow of funds from U.S. banks to others overseas on September 18 that the Federal Reserve could not control. There is no way to verify that absent a statement from the Fed. However, we do know that during mid-September, there was a clear movement of funds from U.S. banks to European and other banks where their governments had either already guaranteed their deposits or had made substantial contributions to bank capital. That was one major reason why the TARP plan was suddenly shifted from the purchase of bad housing-related assets to a bank capital infusion plan that was similar to what other governments were doing. Those deposits that left U.S. banks were the proverbial “hot money” that moves quickly to higher interest rates and safer environments. There was no indication that the money movement was caused by any nefarious plot.

However, this report reinforces the fact that financial markets operate on confidence. When that is lost, funds either flow elsewhere or get locked up in safe investments such as government debt. And this is the major hurdle that Treasury Secretary Geithner faces in trying to sell the TARP II plan that he announced yesterday.

Because the plan is mostly composed of bad policy and talking points, it has had little or no effect on financial markets. Rather than making his case for why such his proposal would work or is even necessary, Geithner made his work even harder by providing no details on the most important parts of the plan. For instance, a “bad bank” is poor policy to start with and has many serious operational challenges to overcome before it could have any effect. Geithner’s couple of general talking points raised far more worries than it resolved. Rather than releasing a half-formed plan, the secretary should have waited until he had something meaningful to say. One thing that we have learned over the past months is that speeches are no substitute for sound policy.

– David C. John is a senior research fellow at The Heritage Foundation.