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Home Price Declines: How Much Further Do We Have to Go?

Are There Limits to Bank Arrogance?

* Dirk van Dijk, CFA
* On Wednesday May 27, 2009, 3:35 pm EDT

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Buzz up!
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Related:

* Bank of America Corporation
* , Citigroup, Inc.
* , JPMorgan Chase & Co.

Highlights include JP Morgan Chase & Co. (NYSE: JPM - News), Citigroup Inc. (NYSE: C - News) and Bank of America Corp. (NYSE: BAC - News).
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BAC 10.91 -0.07
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JPM 34.66 -1.88
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{"s" : "bac,c,jpm","k" : "c10,l10,p20,t10","o" : "","j" : ""}

Apparently there is no limit to the arrogance and sense of entitlement at the nation's largest banks. From today's Wall Street Journal we get this:

'Some banks are prodding the government to let them use public money to help buy troubled assets from the banks themselves. Banking trade groups are lobbying the Federal Deposit Insurance Corp. (FDIC) for permission to bid on the same assets that the banks would put up for sale as part of the government's Public Private Investment Program (PPIP). PPIP was hatched by the Obama Administration as a way for banks to sell hard-to-value loans and securities to private investors, who would get financial aid as an enticement to help them unclog bank balance sheets.'

Let's recap a bit. Banks make a ton of bad loans and come to the brink of insolvency. The government has to guarantee their debt and injects billions and billions of dollars to shore up their capital base on extremely generous terms. Then the banks all whine and complain that the government might want some say about how much of that capital goes out the back door in the form of mega-sized bonuses to the very same people who lead the world to the edge of the economic abyss.

The ever-powerful Bank Lobby leans on Congress so that it will lean on the Financial Accounting Standards Board (FASB) to substantially ease the mark-to-market accounting rules, so they do not have to reflect the market value of the toxic assets on the balance sheet. The claim was that the bids in the market did not represent 'true value,' but were a fire-sale price.

It is true that there was not a lot of activity going on in the mortgage-backed securities market, especially the non-GSE backed paper that was created by the investment banks that held the worst loans. In an attempt to revive this market, Treasury Secretary Geithner came up with the PPIP program, where the government would invest side-by-side with private investors to buy up this bad paper.

Then, another arm of the government -- the FDIC -- would guarantee loans so the private/public investment partnership could leverage things way up. If the deal goes south, the private investor can then simply walk away from the deal.

The underlying assumption was that the reason there was no market for this stuff was that there were no buyers -- not that the sellers could not afford to sell at the 'true value' of the assets. The latter is far more likely to be the case. They have the real motive to try to pretend that the assets are worth more than they actually are.

Buyers, on the other hand, would be inclined to bid against each other until a rational price level was found. In any case, the idea was to get this paper off the books of the banks.

Now the banks want to be able to buy the stuff themselves, with the government (FDIC) backing. This is insane. Any bank that is selling this stuff should be absolutely prohibited from buying it -- not only the assets on their own books, but from any other institution as well. A shell game where J.P. Morgan (NYSE: JPM - News) buys the toxic assets from Citigroup (NYSE: C - News), which then buys the assets of Bank of America (NYSE: BAC - News), which in turn buys the assets of J.P. Morgan is not significantly different from the banks buying their own bad paper.

The PPIP program, if properly carried out, does have some advantages over the original ex-Secretary Paulson 'Cash for Trash' plan that was at the heart of TARP when it was first passed. On any individual deal, if the private investor makes money, then the government will also make money. However, given the leverage and the non-recourse nature of the debt, the private side will make out like a bandit and the government will make a modest return.

On an individual deal that goes south, the private side will lose what they put in, but that is a small fraction of the total loss, so the government will get kicked in the teeth. This structure does give an incentive to the private investor (who will make the investment decisions) to bid as low as possible on each asset to maximize their potential return. If the banks are allowed to bid on their own assets, or engage in wash-sale transactions with other banks, then there is no such incentive. Indeed the incentive is for them to overpay as much as possible. They get the cash up front from selling the asset, and then when the paper goes bad, the government takes most of the loss.

Incidentally, if the government were to truly follow the rule of law, they are required to fight this idea. The money for the public side of the public private partnership comes from the TARP program. The authorizing legislation for the TARP states:

(e) Preventing unjust enrichment. In making purchases under the authority of this Act, the Secretary shall take such steps as may be necessary to prevent unjust enrichment of financial institutions participating in a program established under this section, including by preventing the sale of a troubled asset to the Secretary at a higher price than what the seller paid to purchase the asset. 12 USCS § 5211(e).

This would seem to be a clear-cut case of unjust enrichment that Congress was trying to prevent when it put this language into the law. I know that the rule of law has become 'quaint' when it comes to the bailing out of the banks, but there has to be a limit somewhere. After all, if the banks participated in kidnapping for ransom, would we allow that to happen simply because the proceeds would help out their balance sheets?

FDIC Chair Shelia Bair needs to tell the bank lobbyists a resounding NO to this proposal, if not call security and have them thrown out of her office for being so arrogant as to suggest such a thing. Adding to the amount of toxic sludge on the balance sheet is not the way to unclog the balance sheets of the banks.

If the banks get their way, it will turn the potentially promising PPIP program into yet another rape of the American taxpayer by the banks. Enough with the Welfare Queens of Wall Street. It is time for someone in Washington to stand up against the bankers. That would be change we could believe in.

Zacks Investment Research
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