Monday, April 20, 2009

Bank Bailout Tidbits

The FT reports that strong banks will be allowed to repay bail-out funds they received from the US government, but only if such a move passes a test to determine whether it is in the national economic interest, according to a senior administration official. The FT article doesn’t specify if this test is of the new-fangled variety or is part of the on-going stress tests, the results of which will be released in early May. Present Obama’s top economic advisor, Lawrence Summers told Meet the Press that repayments from stronger recipients of TARP funds could help the government provide further resources to the sector. However, the senior official quoted in the FT article said that even banks that had plenty of capital and had demonstrated the ability to raise fresh capital from the market wouldn’t necessarily be allowed to pay back the TARP unless the government judged such an action to be in the context of the wider economic interest. He pointed to three basic tests (yes, more tests.) The government needed to make sure that the system was stable, that it didn’t create incentives for more deleveraging which would deepen the recession, and that the system had enough capital to provide credit to support the recovery.

Meanwhile, buried on page four of the WSJ is an article stating that the administration is considering advancing a plan to convert the government’s existing preferred stock in banks into common equity, as it has already done with Citigroup. Naturally this has significant consequences for holders of common equity in the 19 largest banks that are currently being evaluated. While equity holders can point to the tripling in Citigroup shares as a result of the massive short squeeze, dilution is never a good thing. One has to wonder if the spectacular rally in bank shares can possibly continue in the face of this news.

Amidst all the hemming and hawing over how to further handle the nation’s ailing banks, the WSJ releases a report that shows bank lending has declined by 23% since October. Administration officials claim that lending would’ve declined far further without the TARP, but the data doesn’t help support the argument that the TARP funds were being used to boost lending to consumers. If that were the true intention of the TARP, neither Goldman nor Morgan would have been included in the TARP. After all, neither of the two investment banks lend to consumers. However, without all of the significant measures taken by the government, they probably would no longer be with us, given the fears that had gripped the interbank lending markets after Lehman’s collapse.

What will the stress tests reveal? Will the results really separate the wheat from the chaff, or will we merely discover that all or most of our banks are technically insolvent? So much is riding on the results of the stress tests that I’m feeling, well, very stressed.


mrbogue said...

stressed? K10, i sincerely hope you're not going long financials right now. I can only think of two major things that would stress me out right now, 1) a home bought at the peak of the boom with a mortgage > 30% of my income, or 2) a good chunk of change long in financials or bull financial ETF

K10 said...

Nah, not long financials. Way too much risk. Just sitting and waiting for good opportunities to buy real estate or stocks or any depreciated asset in the next year. But I worry about the implications to our economy if it turns out that our entire financial system is insolvent. As much as I love volatility and the occassional good bear market when warranted, I don't like the idea of widespread financial devastation. That's not good for anybody.