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In a previous article (The Banker's Dilemma), I discussed how the dilemma of the banking community regarding the TARP has been whether to expand their loan portfolios to increase income or retain the equity infusion to shore up reserves against further degradation of previous debt issued. My conclusion was that increasing reserves to retain solvency would trump the desire for profitability in the short term. A bank can survive low or negative operating earnings for several quarters, but will be closed if insolvent for as short a time as a month.
So the banker will choose loss of profitability for a time rather than risk insolvency. The next question is what choice will the banker make for the investment of the increased reserves? The traditional choice is to make heavy use of U.S. Treasury notes and bonds. To counteract this, the Fed has embarked on a program of quantitative easing, buying up treasuries and other debt securities in quantities sufficient to reinforce the rising price and lowering the interest paid by these securities. The logic is that if the interest becomes low enough, the banker will increase loans to obtain the higher interest. If the banker’s primary fear is still insolvency, he will look for a way to increase earnings with lower risk than would be incurred by placing new loans.
It appears that one use of the TARP infusions is merger and acquisition. Some examples are shown in the following table (click to enlarge):
Details on some of the investment and acquisition deals have been described by William Patalon.
The Washington Post reported as much as $140 billion in tax write-offs may be achieved by acquiring banks for the earnings losses on the books of the acquired banks. The liabilities assumed by the acquirer can and have been limited through deals with the FDIC, and, in high profile mergers like the JPMorgan (JPM) acquisition of Bear Stearns instead of BS facing insolvency and the Bank of America (BAC) acquisition of Wachovia, concessions from the Fed and the Treasury Dept.
So let’s get to the bottom line. The U.S. taxpayer has generously granted $250 billion so far to the banking world with the expectation that this would ease the credit crunch and make increased loan availability. The Fed has embarked on a strategy to drive interest rates near zero to make holding traditional assets in reserve unattractive to banks. The Treasury has issued a tax ruling to enable easier take-over of failed banks. Put all this together and a picture is emerging of the solvent banks going down a road to leverage some part of the $250 billion of taxpayer money to acquire assets with liabilities limited by government supported agencies and obtain tax concessions sheltering up to another $140 billion of current and future income. WOW!
How many members of Congress envisioned this specific outcome when they voted for the TARP? I’ll wager none. How helpful will this be to shortening or lessening the recession? It remains to be seen. How does this outcome impact commercial activity outside of the financial system? I see little immediate impact. How does this impact the deficit outlook for the Federal government? I would suggest the cost will be greater than the estimated totals for TARP, all other rescues (AIG, Bear Stearns, Washington Mutual, etc.) and the other exposures most have identified to date, at the very least by the amount of loss of future tax revenue.
Disclosure: No positions in personal or client accounts for any mentioned securities.
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This article has 18 comments:
We can argue all we want about what to do once we figure out where the buck stops. Right now the buck stops with Paulson, (former Goldman CDS pawnbroker and great crasher of the mortgage market and AIG) and Bernake (wormtongue who condescends the Congress every day and says he's stimulating the market when in fact he is encouraging deflation with a 0% rate policy, giving interest to get banks to park money at the Fed, and raising cash to backstop his banker pal's losses which are essentially his board of directors and clients.
I'm sure out founding fathers would be proud...
Everytime Congress acts I feel like one of the passengers on the Titanic watching the last lifeboat leave the ship.
On Dec 29 03:20 AM constructe wrote:
> You would think that Congress would learn how to draft a bill that
> stipulates exactly how it's will and assets are to be handled by
> now. They have had over 200 years to learn. The sad fact is, apparently
> none of them want the responsibility given them. They prefer to give
> it to others. I suppose that blows a lot of holes in representational
> democracy and checks and balances. In fact, I'd wager to say, that
> is probably the greatest root of what is eating away at the foundations
> of economic stability, prosperity, and civil liberties.
>
> We can argue all we want about what to do once we figure out where
> the buck stops. Right now the buck stops with Paulson, (former Goldman
> CDS pawnbroker and great crasher of the mortgage market and AIG)
> and Bernake (wormtongue who condescends the Congress every day and
> says he's stimulating the market when in fact he is encouraging deflation
> with a 0% rate policy, giving interest to get banks to park money
> at the Fed, and raising cash to backstop his banker pal's losses
> which are essentially his board of directors and clients.
>
> I'm sure out founding fathers would be proud...
" and the Bank of America (BAC) acquisition of Wachovia--"
You could say you can't fault the players you have to fault the system. But the system should be that Congress has the responsibility to grant funding, allocate the budget, and coin money. Well obviously they don't want to control the money supply (too much work). And obviously, they have a hard time managing any budget at all, even a deficit one. So slap a funding bill infront of them and they can feel proud every time that they got to actually do some good by giving away something to someone like Santa Claus.
To them Christmas is never over.
(Think of it this way: what's worse than the Big Three management? Washington management.)
Some Banks Don’t Know, Others
Won’t Tell What They’ve Done
With Bailout
But bank officers observed laughing all the way to the bank.
Maybe what banks are doing today mirrors what telcos went through after the deregulation disaster 5-10 years ago. Ma Bell is nearly whole again, and the result is 1) less competition, and 2) lower costs of doing business, due to the squeeze on equipment vendors. Things changed for the telcos, and they reacted quickly to adapt. Banks would as well, but their heavy regulation and capital structures make them different from most businesses in how they can react to change.
My guess for the consolidation would be 1) less competition, of course, and 2) lower costs of doing business, due to the closure of branches and white-collar infrastructure. The TARP allows for the banks to make the massive write-offs required for 2) without raising even more private capital in this dismal environment. I think in the long run, it will play out as a positive. I suppose the counterpoint to my argument would be "What does bank consolidation have to do with troubled asset relief?" Well, nothing's perfect.
Remember that the TARP has nothing to do with preventing the leveraged excesses of the past 5 years...only legislation can do that. It was designed for one purpose - an emergency fund to save the financial system, or as Paulson put it, "breaking the glass" in the case of a fire. In that sense, the TARP is all about saving the system, regardless if it's through asset sales, capitalization projects, or consolidation.
Maybe all this means is that the downturn still has very far to go.
Sorry for the foggy substitution of Bank of America. Wells Fargo is the acquirer of Wachovia.
Thanks for the heads up, GD.
jegan
Executive bonuses of course. Mustn't forget those bonuses. Is this not the most productive use of the money (as seen by executives)?
On another note, I have not seen much in the way of commentary on the fact that all the acquisitions being carried out with TARP money are concentrating larger and larger chunks of the banking industry under the control of the people who made the biggest mess of banking in history.
Can such a grand exercise in moral hazard be a prudent move?
Just wondering ...
Step 2 is helping out the consumer. Pouring more cash into the already overflowing banks isn't going to put people to work so they can buy houses, cars, products, and services. It will take a massive amount of work to update our infrastructure, reinforce our defenses against natural disaster, decrease our dependence on unreliable fossil fuels, and rebuild our inner cities. It's time to put all those unemployed people to work on projects that will pay dividends for years.
Oops, I am replying in the wrong place to a different one of your comments.
You mentioned the congress' responsibility to coin money. At the time
the Constitution was written, the framers had just gone through some
pretty bad experiences with a money substitute, the "continental",
wich was pretty worthless paper. To the framers, "money" was gold or silver,
and the responsibility of the Congress to coin money would be to operate
a mint to coin gold and silver brought to the mint by private owners,
and to coin it for a price (coinage charge). This isn't "making" money,
it is taking real money (gold, silver) and coining it. For Congress to "regulate
the value" of money, it would standardize the size and purity of the coins.
An argument can be made that in granting the power to Congress to
coin money, the framers did not intend to grant a monopoly on minting.
Actually, people who USE (real) money in exchange objectify its value
(to them) by the terms of their exchange.
On Dec 29 03:20 AM Moon Kil Woong wrote:
> You would think that Congress would learn how to draft a bill that
> stipulates exactly how it's will and assets are to be handled by
> now. They have had over 200 years to learn. The sad fact is, apparently
> none of them want the responsibility given them. They prefer to give
> it to others. I suppose that blows a lot of holes in representational
> democracy and checks and balances. In fact, I'd wager to say, that
> is probably the greatest root of what is eating away at the foundations
> of economic stability, prosperity, and civil liberties.
>
> We can argue all we want about what to do once we figure out where
> the buck stops. Right now the buck stops with Paulson, (former Goldman
> CDS pawnbroker and great crasher of the mortgage market and AIG)
> and Bernake (wormtongue who condescends the Congress every day and
> says he's stimulating the market when in fact he is encouraging deflation
> with a 0% rate policy, giving interest to get banks to park money
> at the Fed, and raising cash to backstop his banker pal's losses
> which are essentially his board of directors and clients.
>
> I'm sure out founding fathers would be proud...