Fixing America's Banks: Geithner Doesn't Have the Right Answer

Timothy Geithner's policy to fix the banks is destroying private equity and is simply inadequate.

Outstanding mortgages total $11 trillion plus. Half were financed through Fannie Mae (FNM) and other government banks. The balance were written by commercial banks, held as straight mortgages or bundled into collateralized-debt-obligations (CDOs) held by banks and fixed-income investors.

As housing prices fall, mortgage losses mount and will likely reach another $1 trillion. Banks take charges against capital to cover losses and could deplete capital and become insolvent.

Through TARP, Treasury is boosting bank capital by buying dividend paying preferred shares, and is financing these purchases by selling $750 billion in bonds. As housing prices fall, loan defaults and losses rise, and the CDOs held by banks fall in value.

Housing prices are down 27 percent since August 2006, and could fall another 15 or 25 percent. About $400 billion in TARP funds are committed, and with housing prices dropping faster than Galileo's rock, the remaining $350 billion will not be enough.

The Treasury is performing stress tests on the 19 largest banks to determine whether their common share equity could cover prospective losses. Citigroup (C) and others will come up short if Treasury is honest about how much housing prices could fall.

Bankers usually include preferred shares and other assets when measuring capital adequacy to cover prospective losses, and by those measures, Citigroup and others remain well capitalized for now. Treasury has offered banks the option of converting its preferred shares to common stock.

At Citigroup, Treasury is offering to convert $25 billion of preferred shares to common stock, if Citigroup suspends dividends to most private preferred shareholders and significant numbers convert to common shares. Choosing between preferred shares paying nothing and high risk common shares worth just a bit, most will likely take the plunge.

These tactics essentially confiscate private equity — a government taking. Washington's stress tests and sacking of Citigroup motivate general fear among investors and are driving down most bank common stock prices.

No solution to preserve private banking can be found without halting the free fall in housing prices. That will require an aggregator or bad bank to purchase about $2 trillion in mortgage-backed securities from banks. Leaving alone mortgages that will be repaid, reworking those that could be repaid with some adjustments in principal and interest, and foreclosing on the rest, the aggregator banks could fix the number of foreclosures and limit the fall in housing prices.

As many mortgages would be saved, and the aggregator bank, like the savings and loan crisis Resolution Trust Corp., would likely earn a profit. Hence, it could be financed with TARP funds and private investments.

The banks, though not free of other problems would be strong enough to raise new capital, buy back the government's preferred shares, and contribute to economic recovery.

Secretary Geithner has other plans whose motivations only the gods above Mount Olympus can divine.

Comments

[raytayzmd:]

...so many posters' make me think of an analogy -- hundreds of people on a big boat and everyone's making money and partying hearty; no one's thinking that it's possible that the boat might hit an iceberg -- doesn't matter anyway since the boat unsinkable; but -- oops! -- guess what happens...now some of the people recognize the crisis and attempt to deal with it by lowering the lifeboats, bailing water, etc...but then there are those utterly useless individuals whose only contributions are whining, bitching and moaning about how they're not having fun anymore...or proclaiming how they knew all along that the boat was going to sink sooner or later...or screaming for the heads of those who built the boat...or ranting that they're way of rescuing passengers is infinitely superior...one may only hope that after the boat sank, these individuals all drowned -- thus making the world a far, far better place.

Mar 10 10:29 AM

[User 68127:]

Rather than the aggregator bank, run by the government, why not just get rid of mark to market? Then the banks could keep, modify, or foreclose their own pool of loans without having to start the death spiral of writedowns, capital raising...

I hate to say it, but I think even the banks are better equipped than the government to work out these loans. If only the govt would get out of the way with their misguided regulations. But then they would not be able to control the world and use their policies and threat of policies to buy votes and impose a utopian socialist world view...

Mar 10 11:28 AM

[CautiousInv...:]

I do not believe the focus of government policy should be to preserve shareholder wealth and shareholders are fortunate that more draconian measures, such as nationalization, are not being implemented.

Nationalization, of course, would wipe out shareholders completely.

Separately, Citi has been declining since October, 2007 and in a nosedive since October, 2008. Unless Citi shareholders have been riding this storm out beneath a rock, they have had more than enough time to either increase or decrease their holdings to suit their appetite for risk and their view of the future.

Mar 10 12:24 PM

[monday1929:]

Many of us who saw this coming tried very hard to warn you, and even change the system. Wanting those who commited crimes to face justice is something I have a feeling you were very enthusiastic about when your 401k was at delusional levels and the ones being punished and held accountable were the poor.


On Mar 10 10:29 AM raytayzmd wrote:

> ...so many posters' make me think of an analogy -- hundreds of people
> on a big boat and everyone's making money and partying hearty; no
> one's thinking that it's possible that the boat might hit an iceberg
> -- doesn't matter anyway since the boat unsinkable; but -- oops!
> -- guess what happens...now some of the people recognize the crisis
> and attempt to deal with it by lowering the lifeboats, bailing water,
> etc...but then there are those utterly useless individuals whose
> only contributions are whining, bitching and moaning about how they're
> not having fun anymore...or proclaiming how they knew all along that
> the boat was going to sink sooner or later...or screaming for the
> heads of those who built the boat...or ranting that they're way of
> rescuing passengers is infinitely superior...one may only hope that
> after the boat sank, these individuals all drowned -- thus making
> the world a far, far better place.

Mar 11 09:09 AM

[whisperonth...:]

The Titanic relation isn't quite accurate, since no one else caused the iceberg, whereas the badly written loans and the scammers wanting to make a profit by flipping houses on money they couldn't afford to repay were intentionally caused. Another poor reference but one we should take note of: There was great wealth on that ship. It went down with it. We have the power to save Citigroup, which has tremendous wealth. Shall we jump ship now? I say no.

Mar 11 11:35 AM