Wednesday, March 25, 2009

Why Is Treasury Seeking Power to Seize Financial Institutions?

The seizing of insolvent banks is Sheila Bair's job.  After all, the FDIC is tasked with seizing insolvent banking institutions and protecting depositors.  So why is Treasury looking for new powers?  In their appearance before Congress yesterday, Tim Geithner and Ben Bernanke asked for new regulatory powers over financial services institutions, including non-banks, that would allow them to seize ailing institutions if necessary.  The timing of this action is interesting, to say the least.  Why Mr. Bernanke wasn't in front of Congress a year ago, after Bear Stearns nearly collapsed, or six months ago, after Lehman's failure, is a bit of a mystery.  It seems like the Fed has been talking about the need for a systemic regulator and an orderly method for unwinding complex financial institutions for some time.  Yet nothing appears to have happened so far, despite our financial institutions teetering on the brink several times within the past year.  Why is Mr. Bernanke finally getting his act together?  I suspect it is because the ability to seize large financial institutions and Tim Geithner's toxic asset plan are closely linked.

The Financial Times has a front page article claiming that banks face large writedowns in the toxic asset plan.  While the equity markets partied after the unveiling of Tim Geithner's new plan, considerable concerns remain about the enormous bid/ask spreads between what investors might be willing to pay for distressed loans and where the banks are carrying them on their balance sheets.  Although the leverage provided by the government is theoretically supposed to raise the bids, credit markets did not rally nearly enough after the announcement to close the yawning divide.  Consequently, Mr. Geithner's plan has the same fundamental flaw that it had when it was Mr. Paulson's plan: if banks are forced to sell at these prices, they would have enormous holes in their balance sheets and would need to raise more capital.  Some banks are better capitalized than others, and the stress tests have been designed to determine which banks can withstand the writedowns.  Although quite frankly, you don't need a stress test to tell you which bank is more distressed.  A $1 to $3 stock price is evidence enough.  

But if you pair the stress test, with the toxic asset auction plan, what do you get?  Some banks that'll make it, and some that won't.  What to do with the banks that won't?  You can either keep them afloat or you can seize them.  Is it any wonder then that Bernanke is finally serious about having methods in place to deal with an orderly unwind of large financial institutions? 

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