A New Goal for TARP Funds: Create Mutual Banks

Call this a wild idea, but if the government wants to leverage its efforts in encouraging credit in the US economy, it should consider seeding mutual banks. The US government would contribute money to 435 new banks (say $250 million to each), one for each congressional district, with the provision the government’s stake could be bought out at 1.5x what it put in. The government would have a preferred dividend of 3 month LIBOR plus 5% or so.

The mutual banks would attract deposits, because the institutions would be healthy. WIth the leverage from deposits, these new mutual banks would make loans that many current lenders would shun because their balance sheets are compromised. They would be smaller institutions, not large like Fannie, Freddie and the FHLBs. Depositors would own 2/3rds of the banks, with the government’s preferred stake getting 1/3rd of the votes. These banks would pay dividends to depositors above any interest paid, in proportion to the profit earned on balances deposited. (CDs being a higher cost source of funds would not get much of a dividend.) The dividends would be paid out of profits in excess of what is needed to maintain the bank’s capital levels.

The mutual banks must remain mutual for 10 years, after which they can be demutualized, with shares going to existing depositors in proportion to the cumulative profit earned off of each account for existing depositors.

That allocation system, similar to what is done with mutual insurers ('the contribution principle”) solves a lot of problems: people rushing to deposit when they hear about a demutualization, or, small depositors that think they will get a biggish slug of stock. Sorry. This is yet another area where the insurance industry is a lot brighter than the banking industry, and why? We have actuaries, and you don’t. ;) Actuaries are the best kept secret in business, at least, that is what the Society of Actuaries tells me. ;) This insures fairness in who gets equity, and how much.

Now, this provides a much sweeter deal to depositors than what they currently have at their banks. It is almost as good as a credit union, except these are subject to taxation. (As the credit unions should be.)

This raises the objection: What of our current banks? Will you let them go bust? Why not prop them up?

This is one of the stupidities of how the current TARP was set up. We reward incompetence. Better we should allow the institutions to fail, wipe out the common, preferred, sub debt, etc. After that, transfer the deposits and clean assets to the new mutual banks in the vicinity, and let the FDIC reconcile the crud through a new RTC.

This would set the incentives right. Failure gets punished. Depositors get rewarded for depositing in healthy institutions. The government makes no big promises, but the interests of depositors are protected.

This puts the stick in front of existing banks. No handouts, and more competition. Show that you can delever and deliver, and you will survive. Aside from that, we consolidate the failures into new healthy institutions. With big failures the FDIC kicks additional funds into the affected mutual banks absorbing problems, but with an increased ownership interest to be bought out.

This is my idea of how the government and private industry could cooperate, with low ultimate costs to the taxpayer, while not subsidizing incompetence. Such a deal. Should I send it on to the Obama Administration?

Comments

[Jolly_Rancher:]

Great idea. One problem: this mass reallocation of capital would require a mass reallocation of human resources. That's a fancy way of saying that the same crooks and incompetents who were in conspiracy with the government to bring us the last bubble will simply abandon their current sinking ship to captain another. I say we should keep the insitutions we have and fire the management.

Jan 10 09:23 AM

[kruser53:]

Great article for starting a discussion.

Jolly_Rancher, sounds like a good thought, but I can add one disquieting aspect: Who will replace the fired management? Will the new management come from the employees trained by the fired management? Or will the new management come from the ranks of the untrained?

If an untreatable mold has airborn spores, when some of the fruit gets infected you have to throw out the entire basket.

Jan 10 09:39 AM

[Moon Kil Woong:]

I have a few comments about TARP. 1) How badly written TARP was. Congress rolled over so much that it can be spend without Congressional approval only by a congressional denial of spending it can they prevent more looting of our money (make no mistakes it's the public's money). Congress has given out all semblance of fiscal control. Any President can pass TARP for whatever reason they want and can only be blocked by a over-ridable veto (a 99% impossibility).

Second, why not just abolish all banks and let the Fed and Treasury become god almighty. Pretty much we are doing it already. If they are the lender of last resort, covers all risk in the system, and are the only buyer of mortgages using the wildly mismanaged company puppets Freddie Mac and Fannie Mae then basically there is no need for a bank.

If they use taxpayer money to infuse capital into every bank then why don't they be honest and admit that the banks they give too are government institutions. Barney Frank made it clear. Take government money and you do whatever we want. The defunct banks, financial institutions, and insurance companies are government institutions if the government so says so. And rightly so. Unfortunately they are still being run by the most terrible management in the world who keep paying themselves millions to loose billions upon billions of taxpayers money.

No wonder no one trusts anyone. No wonder there is uncertainty. No wonder the economy is in the dumps. Our economy has shown itself to be a complete fiasco with Trillions in losses hidden off balance sheet thanks to the Bush Jr. administration that allowed banks to hide all their losses off balance sheet using Base I accounting.

Even England couldn't have thought up a more crooked system. All they could think of to screw the Americans was a stamp tax and central bank. We should really think long and hard about what exactly is going wrong here. The Fed can pay interest on deposits, buy bonds, and inflate their balance sheet putting the US taxpayer on the line for trillions without disclosing it on the government's balance sheet. Soon they will ask to issue their own debt making them the same as the Treasury. They instantly have all the powers of the Congress, no accountability, and complete control over the value of your money. Not only are they just trilionaires but they will hold the keys to compete monetary power.

Is this really what the founding fathers envisioned? A Congress completely unaware of their power or responsibility. Compete delegation of fiscal policy. A population who doesn't care about the destitution of their children. Why not just sell 50% of our kids as slaves while we are at it? Because that is essentially what we are doing when our government deficit is 70% of GDP and we are trying to grow it to 125-150% in the next decade (the government expects it to be 100% without any extraordinary items like wars, stimulus, and Congressional stupidity).

I'll stop because to go on would make us all sick.

Jan 10 02:19 PM

[phaf:]

I love this idea (excellent comments above, as well).

Your plan serves a number of positive purposes:
1. It gets the money out in the open. I'm no fan of HUNDREDS OF BILLIONS getting piped into some black box, to do what? Fund the latest acquisition projects of megabanks? Maybe LIBOR is down a bit due to the TARP efforts so far; I dunno, does anyone else, really? Given that the banks won't say what they've done w/ the funds?

2. The plan has built-in political expediency. Funding a start-up in every congressional district should get across-the-board popular support, and therefore have no trouble in congress. Doesn't this also fit right into the Obama populist ideal as well?

3. Distribution of the financial sector. I don't know what it will take to ease the lending fear of the megabanks, but it's not on the horizon. The whole of the economy is hamstrung w/o said credit. Distributing lending services would be a way around the current impasse. In an economy as large and complex as ours, my feeling is that a more distributed net of financing entities rather than a more consolidated bloc of financial firms would impart a more robust underpinning to the economy. Given the shaky nature of all remaining players in the financial realm, greater consolidation toward the strongest among those left standing is inevitable.

If my (future) tax dollars (and kid's, too) will be spent for something, this plan would be it. By all means, forward the plan along!

Jan 10 03:44 PM

[hoover:]

I would say, yes, send it to Obama. It makes far more sense than throwing hundreds of billions at technically bankrupt large financial institutions. The several hundred smaller banks would almost surely be better run, better financed, and probably would create a lot of economic activity. What to do with the behemoth organizarions with the imaginary balance sheets, unknown amounts of off-balance sheet liabilities, and government "food stamp" handouts that they can't even account for? Liquidation. And disappearance from the banking scene.

Jan 10 07:54 PM

[2bz:]

I mentioned creating new banks over 3 months ago in this post: seekingalpha.com/user/...

Jan 10 08:27 PM

[Tradememe:]

This is a great post. The creation of many new healthy banks with no baggage (toxic assets) is a much better solution to kick start the economy.

Jan 11 01:22 AM

[Anthony Alfidi:]

I agree that it's a terrific idea. We can solve the HR problem by having the new RTC screen the mutual banks' employees to weed out those involved in assembling the MBS and CDO intruments that helped cause the credit crunch.


On Jan 10 09:23 AM Jolly_Rancher wrote:

> Great idea. One problem: this mass reallocation of capital would
> require a mass reallocation of human resources. That's a fancy way
> of saying that the same crooks and incompetents who were in conspiracy
> with the government to bring us the last bubble will simply abandon
> their current sinking ship to captain another. I say we should keep
> the insitutions we have and fire the management.

Jan 11 01:35 AM

[Wildhawk:]

Three words: send it, David. Please, send it to every congressman as well as the president.

And I couldn't agree more about the actuary comment. Still, that didn't stop companies like AIG and The Hartford getting into deep water. Apparently either the actuaries at Travelers and Chubb are better than those at AIG and HIG, or management at TRV and CB actually listen to their actuaries!

Jan 11 11:20 PM

[Obvious Adam:]

David send it, not just to Obama and Congress. Send it along to all the financial news channels and magazines as well. Start a groundswell. Right now we need fresh, bold ideas. Presently Congress is only listening to the same people who got us into this mess.

Jan 11 11:39 PM

[District Ba...:]

I applaud your creative thinking. Here is the main flaw I saw, though:

"The mutual banks would attract deposits, because the institutions would be healthy. WIth the leverage from deposits, these new mutual banks would make loans that many current lenders would shun because their balance sheets are compromised."

1. Mutual banks fight for deposits just like everyone else. The vast majority of banks' deposits are insured by the FDIC, and consumers will continue to be rate-sensitive, as long as their money is insured. In almost every market, it is the bigger players - as well as those who are in the greatest liquidity need (many times the same names) - that set the market rates. If you don't believe me, call up a big mutual, such as Eastern Bank in Boston, MA. I'll wager they tell you it is BAC and RBS (Citizens) that set the rates, most of the time.

2. Remember, mutuals do not have shareholders to answer to, but they do still have Directors, and management's pay is still largely performance based. What makes you think that a mutual in Georgia is any better off than a public company in the same market? Both entities are leveraged to their markets, and should see similar credit losses. With all banks, public and private, when credit losses begin to spring up - attention is focused inward. Those mutuals that are not seeing the credit losses are the same ones that shut off (or severly curtailed) lending in 2006, and were conservative underwriters prior to that. (thus, even with extra $ from the gov't, they are unlikely to race out and lend.)

3. Finally, if you run a screen on mutuals across the US, you'll find that:

a) there are few of meaningful size (most are <$500mm assets)
b) they are geographically concentrated in the northeast (I believe something like 30% of mutuals with $1b+ in assets are located in MA alone).

All that said, this was a fun post to read - and a good conversation piece.

Jan 12 05:02 PM

[Iconoclast421:]

It would kill off a million financial sector jobs, and probably make Obama fear being JFK'd, and it would ensure a depression. But other than that it is a good idea. lol. It's a much better idea in terms of long-term thinking. If this was done, the country would likely survive.

Jan 13 11:03 AM