On Saturday, joined by hundreds of friends, family and colleagues on a snowy December day in Yonkers, NY, we celebrated the life of Mark Pittman. Readers of The IRA who wish to express their thanks to Mark and show support for his family may make contributions to the Pittman Children's College Fund, c/o Dr. William Karesh, 30B Pondview Road, Rye, NY 10580.

Do large banks really need more capital?

The Group of 20 finance ministers have agreed to new, increased capital requirements for banks "that would force many institutions in Europe to raise tens of billions of euros in capital in the coming months," the Financial Times reports. Reading through the recent statements by Treasury Secretary Tim Geithner and former Fed Chairman Alan Greenspan last week, we see a lot of references to demanding more capital be held by banks and that this will somehow make the entire financial system more stable.

First a final clarification about the Q4 2008 data from the FDIC. A reader of The IRA who is part of the regulatory community sends this comment regarding our last missive and our CNBC appearance on Tuesday with Dick Bove and Larry Kudlow.

Says the reader:

What do many corporate buyers of insurance have in common with American International Group? Perhaps more than they would like to admit. Like AIG, many companies in the past few years have bought finite insurance, which transfers a prescribed amount of risk for a particular liability. What regulators now want to know is, how many companies, like AIG, have used finite insurance to artificially inflate their financial results?

"Infinite Risk?"
CFO Magazine
June 1, 2005

In the late winter of 2008, a strong whiff of millenarianism had already crept into American public life. As voters flocked to the primaries in startling numbers, many Democrats became convinced that the Second Coming lay just around the corner. By contrast, sentiment among Republicans was more somber, if equally chiliastic: they quaked at prospects of a dire Last Judgment on the administration of President George W. Bush in the November presidential election. Partisans of both parties also harbored fears of Armageddon in the Middle East, if for very different reasons. Still, on that classical day of reckoning, the Ides of March, when the Four Horsemen of the Apocalypse suddenly appeared over the offices of the giant brokerage firm of Bear Stearns in lower Manhattan, almost everyone was astounded.

"Too Big To Bail: The 'Paulson Put,' Presidential Politics, and the Global Financial Meltdown"; Thomas Ferguson and Robert Johnson, International Journal of Political Economy (spring 2009)

Once upon a time you dressed so fine

You threw the bums a dime in your prime, didn't you?

People'd call, say, "Beware doll, you're bound to fall"

We've been hearing a lot from readers lately, as you might imagine. Many of them thank us for speaking frankly about the issues regarding the growing but soluble solvency problems facing the largest US banks. We appreciate the comments.

Click here to see our discussion yesterday on TechTicker with Henry Blodget regarding the Geithner plan for the banks. We tried to lay out in simple terms how we see the next few weeks and months unfolding regarding the larger banks. We also try to understand and articulate why the Obama Administration seems so reluctant to engage on the large bank solvency issue.

On Monday, February 23, 2009, American Enterprise Institute in Washington is hosting an event entitled "Everything You Wanted to Know about Credit Default Swaps." IRA co-founder Christopher Whalen and Mark Brickell, the former chairman of the International Swaps and Derivatives Association (ISDA) and founder of Blackbird Holdings, will discuss and debate the market for credit default swaps and proposals in the Congress to reform this over-the-counter market.

It is pretty clear from news reports that the OTC derivatives markets is going to see substantial regulation in the coming year. These reforms to reign in the retrograde characteristics of the OTC derivatives markets hopefully will include:

We spend overmuch much time on dead zombie banks. Let's switch gears now and talk about how strong, well-managed banks are helping the FDIC and state regulators create what we've called the Prime Solution, putting troubled assets and deposits in strong hands, and how this ongoing process is the example members of Congress should be taking in developing responses to the crisis.

In the NY Times on Sunday, the saga of Bank of America (BAC) CEO Ken Lewis is documented. All we can say about BAC and Ken Lewis is that this bank has gone from arguably the most stable large money center to one of the most unstable, just behind Citigroup (C). We attribute this remarkable transformation to the ill-advised Countrywide and Merrill Lynch transactions, both of which were done without a receivership to restructure the target companies.

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

"But I'll get back on my feet someday,
The good Lord willin', if He says I may.
I know that the life I'm livin's no good,
I'll get a new start, live the life I should.
I'll get up and fly away, I'll get up and fly away, fly away."

Wharf Rat
The Grateful Dead

Doubtless SA readers who follow financials saw the announcement by the princes of volatility at Goldman Sachs (NYSE:GS) that they were thinking of establishing an internet bank as part of their new business strategy of being a commercial bank. Oh, Nelly.

Hearing the news, we thought for a moment of that day a few months ago when Lehman Brothers publicly advanced the idea of Korea Development Bank as a potential savior. We thought at the time: KDB? Not impressed. And now GS wants us to think positively about their prospects as a going concern because of internet banking. Please. This does not bode well for the investment thesis behind GS.

On Friday, the FDIC closed and facilitated the sale of two CA savings banks, Downey Savings and Loan, the bank unit of Downey Financial Corp (NYSE:DSL) and PFF Bank and Trust, Pomona, CA. All deposit accounts and all loans of both banks have been transferred to U.S. Bank, NA, lead bank unit of US Bancorp (NYSE:USB). All former Downey and PFF Bank branches reopen for business today as branches of U.S. Bank.

Earlier this year we wrote positively about Downey and the funding advantages it had over larger thrifts such as Washington Mutual due to the solid deposit base and strong capital. Indeed, as of Q3 2008, the bank's Tier One leverage ratio was over 7.5%, more than two points over the minimum, and its charge offs had actually fallen compared with the gruesome 400 basis points of default reported in the previous period.

Who would think the day would come where blue chip stocks would have 30-day volatilities in the 180% range? That's a barn door so wide you can throw a pick-up truck through it blindfolded and still come up with a valid price guesstimate. No wonder the entire stock market is having an extended nervous breakdown. The key assumption of market efficiency theory, namely that price equals value, is so eroded that people no longer have a computational basis upon which to base portfolio strategies. The amazing thing is how many people continue to get up every morning and blindly pull the handles on the slot machines. There's something kooky going on when everyday folks set cell phone trading alerts to only make noise if the DJIA moves by at least 200 points.

Read our lips: Price is not presently a valid surrogate for value - maybe never was. Efficient market theory has a place somewhere in the tactical tool kit, but right now it must wait until the 80/20 rule is again satisfied where 80% of stocks represent 20% of market volatility. For now, it's time for everyone to hunker down plugging numbers to compute valuations the hard way. In rough seas, clarity and cash flow wins.

As the first step in promoting the government's new voluntary bank capital injection plan, Secretary Paulson summoned the CEOs of the nation's largest banks to Washington and "made them an offer they couldn't refuse." He told them that as part of the government's "voluntary" capital program, he was going to "invest" $125 billion of the government's money in preferred stock that they would issue. In return for this capital injection, these institutions would also grant the government warrants, and executives would at least nominally subject themselves to limits on executive compensation. It was also "suggested" that they deploy the capital to make new loans, even though many would improve their financial position measurably by redeeming other higher-cost debt, including preferred stock previously issued. Finally, although the preferred stock was to be nonvoting, as would any common equity that the government might acquire through warrants, the "terms of the injection and suggestions" sure had the smell of exercising a controlling influence. (Bob Eisenbeis, Cumberland Advisers)

Last week, the global financial system took a deep breath and began to react positively to the heaping quantities of fresh capital that politicians in the US and EU are shoveling at the latest problem created by the subprime mortgage bust, namely bank solvency. So far, so good, at least for now.

Click here to download  the "Emergency Economic Stabilization Act of 2008" draft released on September 28, 2008 [PDF file].

Click here to download a section by section analysis of the draft legislation[PDF file].

"The creatures outside looked from pig to man, and from man to pig, and from pig to man again; but already it was impossible to say which was which."-- George Orwell, Animal Farm

Watching and listening to the Big Media comment Monday on the press release by the Fed's Board of Governors regarding Morgan Stanley (MS) and Goldman Sachs (GS) becoming bank holding companies, it struck us that very few people outside the risk community really understand the corporate structure of financial firms.

Earlier this week, we sent out a note to our readers regarding the AP story published on Wednesday, September 17, 2008 entitled "Federal bank insurance fund dwindling." Reported by Marcy Gordon of AP's DC bureau, the story quotes IRA's Christopher Whalen on the mounting angst felt by Americans with respect to the safety and soundness of their bank deposits.

Unfortunately, for the reasons we stated in our comment, we believe that AP got the story entirely wrong:

Prior to the announcement I was worried that [the Treasury] would maintain the status quo and continue to throw money at [the GSEs]… Now it appears they are fundamentally changing them, which is good. These companies are now in the process of going away. They even threw in the FHLB (via a secured lending facility) which is also a positive step as they need to go too. The first step is nationalization. Eventually they should sell them off as 10 different private companies with no more ties to the U.S. government. This is going to cost the Treasury A LOT of money, but is necessary to get them out of the mortgage market. Fannie was necessary in 1938 but not in 2008. It is going to strain the Treasuries' finances. It can also mean much higher Treasury interest rates, offsetting any narrowing of mortgage spreads. (Jim Bianco, Bianco Research, September 8, 2008)

We congratulate Treasury Secretary Hank Paulson for finally acting on the advice of many in the market, including The IRA, and imposing a conservatorship on Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE). Moving a week after Labor Day is not bad timing at all and now enables us to focus on the next task, namely providing the financial resources to backstop the FDIC (see our earlier comment, "Memo to the President-Elect; How Much Capital Does a Bank Need?', August 21, 2008").