Preview of the Bank Buy-In

As we said a few weeks ago, eventually the U.S. would have to choose winners and losers - the plainest form of socialist government. "Eventually" came much earlier than anticipated but better now then after more pain - this was a path we were on one way or the other as the entire U.S. system is undercapitalized. We now find out tonight who the "Chosen 9" are - aka the future masters of the universe. After this era of consolidations expect an era of higher fees for the ones (i.e. you) bailing out these banks - less competition after all.

As for these banks, we will want to see how much dilution is taken and if there is any punitive action (i.e. in return for saving your rear you have to give something up at the top levels of the executive suite) like the UK plan. From the WSJ article (emphasis mine; my comments in italics):

• The Bush administration is expected to take stakes in the nation's top financial institutions as part of a wide-ranging effort to restore confidence to the battered banking system, following similar moves by European governments that sent global stock markets soaring.
• As part of its new plan, the government is set to buy preferred equity stakes in nine top financial institutions, according to people familiar with the situation. It's unclear how much would be invested in each institution. The move is designed to remove any stigma that might come with a government investment.
• Banks receiving government funds include Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp., Citigroup Inc., Wells Fargo & Co. and Bank of New York Mellon. Not all of the banks involved are happy with the move, but agreed under pressure from the government.
• The new plan is designed to bolster bank balance sheets by providing new capital, removing rotten assets and taking new steps to make sure they have access to the funds they use to operate. All told, the moves are designed to get money flowing through the system so that banks will lend to companies, consumers and each other. The initiatives, which will likely supersede many of the government's previous efforts, ensure that the U.S. banking sector will be tied to the federal government for years to come.
• One central plank of these new efforts is a plan for the Treasury to take approximately $250 billion in equity stakes in potentially thousands of banks, according to people familiar with the matter, using funds approved by Congress through the $700 billion bailout bill.
• In addition, the FDIC is expected to temporarily extend its guarantee of bank deposits to include certain new funds raised by banks and thrifts for three years. That would be an aid to lenders that have had a hard time raising capital without government assistance.
• Other moves could include temporary loan guarantees aimed at helping banks borrow the money they need to do business.
• All told, the program would put the guarantee of the government behind much of the plumbing of American financial markets, a step that would have appeared inconceivable a few months ago.
• While the Treasury wants to put money into banks, its main goal is to attract private capital. To make sure private investors aren't scared away, the Treasury is expected to structure its investment on terms favorable to the banks and will inject capital in exchange for preferred shares or warrants, these people said, a move that is designed to not hurt existing shareholders.
• The government's new focus is already raising questions about why it didn't adopt such an approach sooner. Mr. Paulson actively opposed the idea that the government should directly invest in banks because he worried about picking winners and losers. He was also concerned banks wouldn't participate because of the perceived stigma and the potential for the government to meddle in their affairs, according to people familiar with the matter.
• This "was not the original proposal but clearly there seems to be a consensus that is essentially what is necessary," said House of Representatives Majority Leader Steny Hoyer.
• House Democratic leaders, including Speaker Nancy Pelosi (D., Calif.) and House Financial Services Committee Chairman Barney Frank, held a closed-door session Monday with 11 economists and other advisers, including Nobel laureate Joseph Stiglitz, to discuss the financial crisis. The group threw its weight behind Treasury's decision to inject capital into the banking system, in exchange for equity stakes. "The consensus was so strong towards direct equity injections that there was literally no dissension on the point," said one of the invited economists, Jared Bernstein of the liberal Economic Policy Institute. "The only head-scratching is why did it take us so long to get here?" (Because as Americans we only fight the fire directly under our rear end.)
• There are costs associated with the new approach. The price of insuring against debt defaults rose for a number of European countries, reflecting rising concerns about how their plans will affect governments' finances. The cost of insuring against a default on £10 million in U.K. government debt for five years, for example, rose Monday to £47,000 annually, from £41,000 Friday. That in turn translates into higher borrowing costs for governments.
• Moreover, blanket guarantees might inspire banks to take unnecessary risks, warned Frederic Mishkin, a Columbia University economist who stepped down as Fed governor in August. "You don't want to give a guarantee to banks that are in trouble" that might try to gamble their way out of problems, he said.
• One sticking point could come from Congress, which wrote into the original bailout bill a requirement that Treasury tamp down executive pay at companies in which it invests. Rep. Frank (D., Mass.) said Monday he wants the government to set conditions for any company that receives a capital injection. (I'll keep an eye on this one - do you think Lloyd Blankfein at Goldman Sachs is going to give up any of his $70M a year? haha - how would Goldman Sachs exist if the CEO gets less than $50M - it would probably file immediate bankruptcy.)

There are going to be so many books written and documentaries filmed about this era - truly living history. Epic.

Comments

[1worldcurrency:]

If they don't dilute existing shareholders, Pelosi will have to move to Paraguay with Bush.

2008 Oct 14 12:39 AM

[who:]

Good or bad, US is playing catch up with Europe.

JPM probably don't want to take part since it claims to be the prudent banker.

Some form of control, similar to UK, is required for injection.

2008 Oct 14 01:02 AM

[IanB:]

This could be even worse for the taxpayer than the original plan. We'll probably end up getting some noncumulative perpetual preferred with no voting rights and no exits, with a dividend that Warren Buffett would laugh at. Why in God's name shouldn't we dilute the shareholders? The shareholders (including myself) enjoyed the benefits of excess leverage on the upside, we should deal with it on the downside.

2008 Oct 14 08:30 AM

[dixie:]

Now would be a good time to give Washington Mutual shareholders there just due.

The FDIC literally gave WM to JPM for peanuts and now taxpayers will loan even more to JPM. What a deal!

2008 Oct 14 09:12 AM

[Smarty_Pants:]

"Not all of the banks involved are happy with the move, but agreed under pressure from the government."

Yep. The Land of the Free, where you are free to do what the government tells you to do, or else.

We have sold our birthright for a mess of potage.

2008 Oct 14 09:20 AM

[Yes Man:]

Read the stiches on the fast ball. Goldman Sachs transforms itself into a bank holding company during talks with the treasury. The treasury convinces Congress to give it $700 billion to buy bad assets from banks. The treasury decides not to buy bad assets but preferred stock in banks. Goldman Sachs, Henry Paulson's former employer, just happens to be a bank now. After the stock jumps by 87%, the treasury decides it is time to buy. The tax payers are on the line to bailout Henry Paulson's buddies.

2008 Oct 14 09:52 AM

[Lymon:]

If my money as a taxpayer is going to buy assets in these banks. Who can I contact to insure my dividend payments get sent to the correct place??

2008 Oct 15 07:52 AM