Tuesday, January 27, 2009

Common Sense on Banks

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.

The term "bad bank" is being tossed around Washington dinner tables this week, a sign that the situation facing the largest banks is reaching a boiling point. It is amazing to us to see how little people understand the choices facing us with the big banks, how narrow those choices truly are and how the numbers in terms of losses are so BIG that they will ultimately force us to do the right thing. A couple of points:

First, IRA's estimate for accumulated bank charge offs for 2009 is in the neighborhood of $1 trillion vs. $1.5 trillion in Tier 1 Risk Based Capital at all US banks today. Good news, though, is that 2/3 to 2/4 of that loss number comes from the top four - Citigroup (C), Bank of America (BAC), JPMorganChase (JPM) and Wells Fargo (WFC), in that order of risk profile.

Since most of the toxicity in the banking system is concentrated among the larger banks, perhaps we can rebuild the industry using the next round of TARP funds to bulk up these relatively smaller banks and thereby end up with 10-15 larger super regionals in the $300-$500 billion asset range. There may even be banks of this size still doing business under the current names of C, JPM, BAC, etc, but these new banks will have new owners and creditors.

Second, the Good Bank/Bad Bank debate is really a political battle between the large banks listed above plus Goldman Sachs (GS) and Morgan Stanley (MS) et al among the Sell Side survivors in NYC vs. the rest of the industry and the US economy. In preparing their plans for review by the White House, we hear that the Fed and OCC are supporting further bailouts for the larger banks, while the rest of the industry is being resolved and recapitalized a la Washington Mutual and Lehman Brothers.

Perhaps we ought to feed the "good bank" parts of the "too big to fail" crowd, a crowd prone to leverage and bad risk management, to the smaller and plain vanilla bankers that comprise the nominal majority of the industry. This would solve many things including reducing the lobbying power that Wall Street has in Washington. Come to think of it, President Obama should think about banning lobbying by any company participating in the TARP.

Remember that the entire banking industry stands in front of the taxpayers in terms of loss absorption at the FDIC, so you can understand why the smaller banks in the industry are SERIOUSLY PISSED OFF at the large banks and their minions in the Obama Administration like Tim Geithner and Robert Rubin. Oh, and don't forget Chairman Ben Bernanke and the entire Fed board of governors. These leading officials are increasingly talking the side of the large banks in the battle over limited financial resources, a fact that is causing the community bankers to rise in anger. Stay tuned.

The better course for the economy outside NYC is to resolve these large institutions over the course of 2009 and beyond, first by diluting the equity (common and preferred) and effecting a conservatorship a la Fannie/Freddie. This eliminates the issue for the markets. A formal open bank assistance might be a default under the ISDA contract template, something the Fed's conflicted Mandarins would not initially accept, but when the charge-offs at C rise above total risk based capital and keep rising, perhaps minds in DC will begin to change. Then we can haircut the Big Four Bank debt in a negotiated deal pre-receivership, and sell the non M2M bank assets and liabilities to stronger hands. This is the traditional American way of dealing with insolvency in the absence of political meddling by the Fed and the Congress. Let Sheila Bair and the FDIC do the job and we can make the economy rebound with surprising speed. It only takes political courage. We have the money.


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