Financial Bailout Remains a Work-in-Progress, Chaos-in-Motion

The Bad Bank model has apparently been shelved. “It will cost too much,” a Fed official told FoxBusiness late Wednesday. But nobody in authority is prepared to reveal whether the assessment of the costs involved in creating a viable Bad Bank (believed to be well in excess of $1 trillion) is simply a best-guess estimate or has foundation in a thorough valuation of the assets currently on the books of financial institutions. By all accounts, Treasury Secretary Timothy Geithner’s bailout plan, due Monday, will be entirely conditioned by the "hope" that underlying economic conditions will improve in late-2009 or early-2010.

The Fed appears ready to expand its consumer lending facility (Term Asset-Backed-Securities Facility, TALF) by $200 billion, or more if necessary, to incorporate securities backed by car loans, credit card debt, student loans and small-business receivables. Another $250 billion is likely to be allocated to the purchase of mortgage-backed paper. And, as far as those now-infamous “toxic” assets are concerned, the current proposal is to provide government guarantees in return for equity stakes. Needless to add, if guarantees are included when calculating the size of Monday’s plan, the cost to the taxpayer will exceed $1 trillion anyway. “This Bad Bank substitute is a Trojan Horse, meant to deflect attention away from the magnitude of the crisis,” concluded a Swiss private banker earlier today.

Secretary Geithner acknowledged that his “agenda is to begin to shape the architecture of a financial recovery plan that will get credit flowing again.” But what inferences can one draw from the fact that the Obama Administration is about to “begin” shaping the future of the financial system after all these months of debate?

Firstly, the size of the problem is not known, at least not by any proven methodology; in fact, lawmakers and regulators alike are extremely reluctant to discuss balance sheet specifics. Secondly, in the absence of proper disclosure relating to the valuation of equity stakes, it is difficult to analyze what kind of returns the government expects on public funds; it is logically impossible to price convertible debt without the availability of comprehensive post-bailout business models. Thirdly, and very obviously, Fed and Treasury officials are relying on the $900 billion stimulus bill (due to be passed today) to jump-start the economy; hopefully, the quick-fix solutions Timothy Geithner will offer on Monday will turn out to be sufficient once credit conditions take a decisive turn for the better.

Since the Obama Administration, and many on Wall Street, are now adhering to Ben Bernanke’s belief that if you keep the financial system alive long enough, it will rectify itself (the “finger-in-the-dyke” strategy), financials (C, BAC, GS, JPM, MS, WFC) may be due to a strong recovery from recent lows during next week’s trading sessions. The challenge today is to determine if the forthcoming rally will represent another short window. Because as the overdue information governing credit and derivative losses comes into the public domain in the months to follow, investors will realize that their common shares have been rendered almost worthless by these ever-evolving bailouts.

In other words, and in brief, private equity has no constructive role in the current environment. In this writer’s view, Monday’s bailout plan will, inevitably, be followed by more bailout schemes, by more dilution for existing shareholders in the face of a rapid deterioration in capacities to generate credible earnings, and by more efforts to “reconstruct” balance sheets by tinkering with mark-to-market and counterparty-risk fundamentals. For all practical purposes, if rigid accounting standards are applied, common shares in most bailout targets are worth zero, with Goldman qualifying as a possible exception at this juncture. So go long banks only (a) if you have faith in the ability of the Obama stimulus plan to revamp and boost the domestic economy in the foreseeable future and (b) if you can predict what genuine shareholder value the stimulus-cum-bailout scenario will bring to the investment equation.

Disclosure: The writer has liquidated his short positions in financials recently, and is looking to re-enter shorts in C, BAC, JPM and MS on next week's rally.

Comments

[David Braun...:]

How can anyone expect anything good to come out of a stimulus package that no one has read, not even the President. How can we imagine that if our lawmakers do not even read the stimulus bill that they could possible look at it critically? Yes, I beleive they have good intentions, but "the road to hell is paved with good intentions." Rakesh, imbedded in your comments is the real solution to our economic problems. Hard work, good intentions and rigorous analysis.

Feb 06 10:59 AM

[Rakesh Saxena:]

Dear David: Yes, you make a key point---nobody appears to have actually read the complete stimulus package, bits and pieces apart; and nobody can offer any cogent analysis of the road map which the stimulus targets. A troubling scenario indeed. Many thanks - Rakesh


On Feb 06 10:59 AM David Braunstein wrote:

> How can anyone expect anything good to come out of a stimulus package
> that no one has read, not even the President. How can we imagine
> that if our lawmakers do not even read the stimulus bill that they
> could possible look at it critically? Yes, I beleive they have good
> intentions, but "the road to hell is paved with good intentions."
> Rakesh, imbedded in your comments is the real solution to our economic
> problems. Hard work, good intentions and rigorous analysis.

Feb 06 12:11 PM

[Fitz919:]

Yesterday and today I've been hearing that 1/3 of the first round of TARP money was wasted. Basically they are saying we paid $1.33 for stock that was only worth $1. Supposedly after several weeks of research that's what an independent group of experts alleges.

Now, I'm not from Missouri, but I have to say, "Show Me!"

They haven't revealed any actual numbers, from actual stock purchases, made with actual TARP money.

This really ticks me off. Where are the facts that prove we overpaid?

Feb 06 03:09 PM

[Fitz919:]

It's time to create new banks. I mean it...brand new banks. Banks that write 4% fixed rate mortgages. Banks that offer auto loans at 5%. Banks that have Credit Cards that are permanently capped at 7%. Banks that don't have toxic assets, and don't create them. Banks that pay interest on savings and checking accounts no matter what the balance.

There are lots of unemployed people who have the skills and integrity to run these new banks, and with the old banks dropping like flies, there will be lots of accounts which will need a new home.

Feb 06 03:40 PM

[SeekingTruth:]

This seems a lot like war, where everyone fights for what they have in it to fight for, whether it be great or small, and I suspect there were very few bankers on the beaches at Normandy.

Listened to Mohammed El- Erian give a very plausible and intelligent appeal for massive bailouts across the board, and I couldn't help but be impressed by his appeal and well crafted and modulated delivery. But this doesn't , however, make it the right thing to do. He clearly has a vested interest in keeping the status quo well established by all possible means and has the ability and foresight to make any adjustments necessary along the way to preserve his and his corporations wealth.

So where does that leave the rest of us? In the rumble seat of course, where we can be along for the ride but are clearly not doing the driving, and if the driver is an idiot and takes it
over a cliff, we're going along with him. Buckle your seat belt, or maybe bail out over the side if you dare.

Feb 06 04:55 PM

[Rakesh Saxena:]

Dear Seeking Truth: The problem is that since too many analysts, fund managers and traders have a vested interest in keeping the system alive, nobody is asking (demanding) for transparency. As far as "buckling your seat belt" is concerned, yes, you are entering a new era of socialism and state capitalism--you can't bail out over the side. Many thanks - Rakesh


On Feb 06 04:55 PM SeekingTruth wrote:

> This seems a lot like war, where everyone fights for what they have
> in it to fight for, whether it be great or small, and I suspect there
> were very few bankers on the beaches at Normandy.
>
> Listened to Mohammed El- Erian give a very plausible and intelligent
> appeal for massive bailouts across the board, and I couldn't help
> but be impressed by his appeal and well crafted and modulated delivery.
> But this doesn't , however, make it the right thing to do. He clearly
> has a vested interest in keeping the status quo well established
> by all possible means and has the ability and foresight to make any
> adjustments necessary along the way to preserve his and his corporations
> wealth.
>
> So where does that leave the rest of us? In the rumble seat of course,
> where we can be along for the ride but are clearly not doing the
> driving, and if the driver is an idiot and takes it
> over a cliff, we're going along with him. Buckle your seat belt,
> or maybe bail out over the side if you dare.

Feb 07 12:26 AM

[Rakesh Saxena:]

Yes Fitz919: What you are speaking to is a "de-leveraged" scenario where a rational approach is taken to the real business of banking in society. I'm afraid, both of us are simply being left on the sidelines (helpless observers) as the government starts on a dangerous trial-and-error exercise. Many thanks for your comments. - Rakesh


On Feb 06 03:40 PM Fitz919 wrote:

> It's time to create new banks. I mean it...brand new banks. Banks
> that write 4% fixed rate mortgages. Banks that offer auto loans at
> 5%. Banks that have Credit Cards that are permanently capped at 7%.
> Banks that don't have toxic assets, and don't create them. Banks
> that pay interest on savings and checking accounts no matter what
> the balance.
>
> There are lots of unemployed people who have the skills and integrity
> to run these new banks, and with the old banks dropping like flies,
> there will be lots of accounts which will need a new home.

Feb 07 12:29 AM

[Reverse Mer...:]

It appears that a new era of common sense banking should be ushered in along with the bailouts or we will never climb out of this hole. Transparency, quality and adherence to rules and structure should be the rule of the day.

Feb 07 02:11 AM

[SeekingTruth:]

Rakesh, Your term "State Capitalism" strikes me as most apropos in describing our current direction. A term I have used for years is "Quasi Capitalism-Socialism" but I think your term is more succinct and "telling".

Thanks again for a job well done and for a new highly descriptive and appropriate term.

Feb 07 10:19 AM

[PROXIMO:]

Rakesh--If you happen to see this post--a question for you---Could you at some point comment on your impression of the endgame for shareholder equity in any of the major banks , if they are nationalized? Total wipeout of the equity or something less? Or does it simply depend on multiple variables? Thanks much for your articles.

Feb 07 11:39 PM

[Rakesh Saxena:]

Dear Proximo: In theory, and if rigid accounting standards are applied, the value of private equity in the banks is almost zero. A blanket nationalization is the only logical answer. However, it is apparent that the government will continue developing a trial-and-error policy, in the hope that the stimulus packages will cause an economic turnaround in late 2009. That is the reason why I see a good trading situation, as long as you maintain a bearish bias. Many thanks - Rakesh


On Feb 07 11:39 PM PROXIMO wrote:

> Rakesh--If you happen to see this post--a question for you---Could
> you at some point comment on your impression of the endgame for shareholder
> equity in any of the major banks , if they are nationalized? Total
> wipeout of the equity or something less? Or does it simply depend
> on multiple variables? Thanks much for your articles.

Feb 08 04:06 AM

[Rakesh Saxena:]

Dear SeekingTruth: FYI, the reason for the term "state capitalism" is that it means big government and strong alliances with big capital (i.e. via the infamous lobbysts). The "socialism" component is irrelevant, since the system does nothing sustainable for workers; we should not confuse the government's alliance with trade unions with real rights and welfare for the poor and underpriviliged. This term, state capitalism, has its roots in pre-War Italy and Germany, and in the Soviet Union under Stalin. I have sent in an article today putting state capitalism in perspective. Many thanks - Rakesh


On Feb 07 10:19 AM SeekingTruth wrote:

> Rakesh, Your term "State Capitalism" strikes me as most apropos in
> describing our current direction. A term I have used for years is
> "Quasi Capitalism-Socialism" but I think your term is more succinct
> and "telling".
>
> Thanks again for a job well done and for a new highly descriptive
> and appropriate term.

Feb 08 04:13 AM