Big Banks vs. America

Banking bailouts were sold to us as a "necessary evil" because we were told only our existing network of banks could irrigate the economy with cash and so rescue industry. Now we know they can't do that because their legacy absorbs all the resources, it would appear more sensible to let the old banks fail and start a new generation of banks. After all, the best credit risk is the institution that has no debt. So you could say the error wasn't to let Lehman collapse, but not to have allowed all the banks to collapse in order to have a fresh start. And right now the job market has plenty of bankers available to set up and run new institutions. With just a quarter of the $800 billion or so already splashed about you could start a whole new Wall St. It's not a matter of saying "no more banking system" but "no more fatally compromised old banking system burdened with structural insolvency." (Ban)king is dead. long live (ban)king.

-- A reader of The IRA

The term "bad bank" is being tossed around Washington dinner tables this week, a sign that the situation facing the largest banks is reaching a boiling point. It is amazing to us to see how little people understand the choices facing us with the big banks, how narrow those choices truly are and how the numbers in terms of losses are so BIG that they will ultimately force us to do the right thing. A couple of points:

First, IRA's estimate for accumulated bank charge offs for 2009 is in the neighborhood of $1 trillion vs. $1.5 trillion in Tier 1 Risk Based Capital at all US banks today. Good news, though, is that 2/3 to 2/4 of that loss number comes from the top four - Citigroup (C), Bank of America (BAC), JPMorganChase (JPM) and Wells Fargo (WFC), in that order of risk profile.

Since most of the toxicity in the banking system is concentrated among the larger banks, perhaps we can rebuild the industry using the next round of TARP funds to bulk up these relatively smaller banks and thereby end up with 10-15 larger super regionals in the $300-$500 billion asset range. There may even be banks of this size still doing business under the current names of C, JPM, BAC, etc, but these new banks will have new owners and creditors.

Second, the Good Bank/Bad Bank debate is really a political battle between the large banks listed above plus Goldman Sachs (GS) and Morgan Stanley (MS) et al among the Sell Side survivors in NYC vs. the rest of the industry and the US economy. In preparing their plans for review by the White House, we hear that the Fed and OCC are supporting further bailouts for the larger banks, while the rest of the industry is being resolved and recapitalized a la Washington Mutual and Lehman Brothers.

Perhaps we ought to feed the "good bank" parts of the "too big to fail" crowd, a crowd prone to leverage and bad risk management, to the smaller and plain vanilla bankers that comprise the nominal majority of the industry. This would solve many things including reducing the lobbying power that Wall Street has in Washington. Come to think of it, President Obama should think about banning lobbying by any company participating in the TARP.

Remember that the entire banking industry stands in front of the taxpayers in terms of loss absorption at the FDIC, so you can understand why the smaller banks in the industry are SERIOUSLY PISSED OFF at the large banks and their minions in the Obama Administration like Tim Geithner and Robert Rubin. Oh, and don't forget Chairman Ben Bernanke and the entire Fed board of governors. These leading officials are increasingly talking the side of the large banks in the battle over limited financial resources, a fact that is causing the community bankers to rise in anger. Stay tuned.

Third, juxtapose the Fed/OCC position of 'let's bail out the big banks' (equity and debt) which Tim Geithner established in the Bear Stearns and AIG rescues, and reiterated in his confirmation testimony, with the modified "tough love" position of Sheila Bair, where she proposes to buy bad assets from the Big Four Zombies w/o a resolution. It seems clear that both sides of the equation in Washington are prepared to socialize the large bank losses and in particular subsidize the bond holders at public expense, an act of generosity that could cost the industry and taxpayers another $1 trillion before all is said and done.

But at least with the modified tough love proposed by Bair, the US government still would clearly end up as the explicit owner and the existing equity and preferred would be diluted out of existence as the quid pro quo for the bad asset purchases. That is the little detail people in Washington still don't understand. Indeed, if you think about C as perhaps accounting for one third of the $1 trillion IRA charge off estimate, then Washington must impose a haircut on debt or ask the banking industry and the taxpayer to subsidize the loss.

The better course for the economy outside NYC is to resolve these large institutions over the course of 2009 and beyond, first by diluting the equity (common and preferred) and effecting a conservatorship a la Fannie/Freddie. This eliminates the issue for the markets. A formal open bank assistance might be a default under the ISDA contract template, something the Fed's conflicted Mandarins would not initially accept, but when the charge-offs at C rise above total risk based capital and keep rising, perhaps minds in DC will begin to change. Then we can haircut the Big Four Bank debt in a negotiated deal pre-receivership, and sell the non M2M bank assets and liabilities to stronger hands. This is the traditional American way of dealing with insolvency in the absence of political meddling by the Fed and the Congress. Let Sheila Bair and the FDIC do the job and we can make the economy rebound with surprising speed. It only takes political courage. We have the money.

To read the interview with David Kotok and Josh Rosner, click here.

Stock position: None.

Comments

[James Wilson:]

DID YOU BOTHER TO EVEN SEE WHO ARE THE MAJOR STOCK HOLDERS OF EACH OF THE COMPANYS YOU MENTIONED.

BCS IS THE MAJOR HOLDER IN ALL OF THEM !!!!!!!!!!!

Jan 26 02:44 PM

[Christopher...:]

No, actually BCS is the custodian, the holder in
"street name." The beneficial holders are the millions of BCS custodial customers. ;)

Jan 26 04:57 PM

[Bot:]

If the government was actually interested in doing what is right for the country instead of doing what is right for the control and pocketbooks of a handful on Wall Street and in Washington then what you say makes absolute sense.

The problem is that that no one believes that Obama has the desire, will or ability to affect that kind of change and so he, like many of his predecessors will be the willing slaves of Wall Street money and a net detriment to the American people.

I do not think that Obama will pass this test.

Jan 27 09:55 AM

[Jubilee Year:]

Absolutely brilliant common sense. Bravo, and thank you. I particularly liked this gem: "Come to think of it, President Obama should think about banning lobbying by any company participating in the TARP."

Starting over, resetting the broken financial system, is exactly what we need. I could not agree more, but few people are willing to face what that fully means.

Jan 27 02:26 PM

[ebenezer:]

C'mon everyone...the rules should have been as follows: Your company takes bailout funds, and the following rules apply...

(1) All employee salaries are frozen; (2) No bonus payments for 2008, period; (3) We` are sending an audit team in to see if 2007 and 2006 "clawbacks" on incentive compensation are appropriate; (4) no salary increases or incentive pay until the government money is paid back, with interest; (5) No dividends paid out until the government money is paid back; (6) If you don't like it, you are on your own, or we close you down and distribute your assets to another entity to manage. In addition, clean up your expense side of the business, your balance sheets and prepare a plan for more equitable distribution of profits to your shareholders, your employees and management.

If your employees don't like it, let them quit and see where else they can find a job and make any more money than they already do. A few might, but I'd bet not many. We have a leadership crisis, first, the financial mess is a secondary issue resulting from the leadership void.

Jan 27 11:46 PM

[monday1929:]

And let's add: NO "retention bonuses" to that list. The "claw-backs" should go back at least SEVEN years to reclaim what is now obviously fraudulent bonuses for vanished/negative value. And Jail-time where deserved.


On Jan 27 11:46 PM Ebenezer wrote:

> C'mon everyone...the rules should have been as follows: Your company
> takes bailout funds, and the following rules apply...
>
> (1) All employee salaries are frozen; (2) No bonus payments for 2008,
> period; (3) We` are sending an audit team in to see if 2007 and 2006
> "clawbacks" on incentive compensation are appropriate; (4) no salary
> increases or incentive pay until the government money is paid back,
> with interest; (5) No dividends paid out until the government money
> is paid back; (6) If you don't like it, you are on your own, or we
> close you down and distribute your assets to another entity to manage.
> In addition, clean up your expense side of the business, your balance
> sheets and prepare a plan for more equitable distribution of profits
> to your shareholders, your employees and management.
>
> If your employees don't like it, let them quit and see where else
> they can find a job and make any more money than they already do.
> A few might, but I'd bet not many. We have a leadership crisis, first,
> the financial mess is a secondary issue resulting from the leadership
> void.

Jan 28 08:47 AM