Admistration Talks Tough on Banks, Sort of, Maybe

The Financial Times headline reads "US Prepared to Oust Bank Chiefs." Tim Geithner warned on Sunday that the US government would consider ousting board members at banks as a condition for giving the institutions "exceptional" assistance in the future. He neglected to define "exceptional," but given the size of the bailouts we've seen so far with nary a banking executive ousting, I'm going to assume it as greater than $150 billion.

Meanwhile, the administration's PPIP (aka "Pay a Premium for Investment Pukeage," I'll be accepting suggestions for better definitons that fit the acronym) gave a much needed boost to the equity markets in the past few weeks, as many theorized that this would dramatically alleviate the toxic asset problem that our banks face. In contrast to the tough talk that the Financial Times highlighted in its article, the PPIP is a huge gift to the banks and private investors. Sort of. The government will subsidize higher bids for toxic assets because it is assuming all the risk, while private investors participate principally on the upside as they are required to put up very little capital. The PPIP is similar to the zero down payment, no-doc mortgage loan with a teaser rate. Why would a home owner not overpay for a house if the bank takes all the downside when housing prices decline? The government is attempting to solve one problem by making exactly the same mistake. Again. Except this time with taxpayer funds.

On the other hand, FASB relaxed mark to market rules for banks allowing them significant discretion in valuing their portfolios. As many an astute commentator has pointed out already, allowing banks to make up their own valuations for assets "solves" alot of their problems. For one thing, earnings miraculously improve. For another, banks don't have to sell any assets at the market price if they can just mark them at higher prices and "improve" capital positions that way. The FASB accounting change actually discourages banks from participating in PPIP. Maybe FASB and the Treasury should've gotten together and coordinated on this issue? Mr. Geither has continued to dodge the crucial questions as to whether banks will be forced to participate in the PPIP, or even be required to use the market prices that the PPIP produces.

The $1 (or $3?) trillion question, despite the administrations efforts to goose lending , remains the same; will default rates rise to equal the catastrophic levels currently reflected in the market prices of toxic assets? Mike Mayo, a noted analyst, released a report this morning claiming that default rates will exceed depression era levels. If he is right, no amount of government guarantees or accounting chicanery can help the banking sector.