Wednesday, October 15, 2008

Not quite so momentuous

Did not even come as close as I had hoped.

Summaries by Felix Salmon:
1. What Treasury is doing:
A 5% cost of tier-1 capital is incredibly low, especially when there's an embedded call option. And the common-equity kicker, at 15%, is small: that makes it a maximum of $3.75 billion, for firms getting the full $25 billion. (Citi, JPM, BofA, Wells Fargo.) There's not much dilution for equityholders here, and their companies are getting lots of cheap money: no wonder shares in Citi and Bank of America are up again today, even as the broader market is down. ... There's no doubt that TARP II, in its present incarnation, is a vast improvement on TARP I. But it's still not nearly as good as the UK scheme, which was put together to inject money exactly where it would do the most good, rather than trying to set up "standardized terms" which treat each bank equally. That seems like a waste of government money to me.

2.The potential downside:
If you're running an insolvent bank, and you get a slug of equity from Treasury, your shareholders will thank you if you use that equity to take some very large risks. If they pay off and you make lots of money, then their shares are really worth something; if they fail and you lose even more money, well, there was never really any money for them to begin with anyway. ... There's no sure way to prevent such risk-taking altogether. But if you go the UK route and insist on board seats and the ouster of failed executives, it helps. That's what Treasury did with AIG, and they should do the same with the banks they're rescuing. If they don't, they're basically getting all of the downside of nationalization with none of the upside.
I'm quite sure that Paulson hates the fact that he's semi-nationalizing the banking system. But he needs to get real and accept it, rather than trying to brush it under the carpet. Otherwise he's putting hundreds of billions of taxpayer dollars at unnecessary risk.

3. Will it work?
America's banks -- and the world's, for that matter -- have had de facto unlimited access to very cheap Fed liquidity for many months now. That hasn't induced them to lend. Will this latest recapitalization do the trick? I'm far from convinced. And what's more, the demand for loans is drying up fast: do you really feel like buying a bigger house right now, or taking out a car loan? Well, businesses are in the same boat. In a recession, their ROI falls, so they borrow less.

The main reason is the Fed and Treasury huffed and puffed for too long which resulted in so much uncertainty that it has started to affect the real side of the economy.

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