Sunday, October 5, 2008

Agony Aunt

A CEO of a bank wrote in to ask me "Do you think the approved plan by congress is appropriate. It does recapitalise banks through high priced purchases of non performing debt?"
My instant reply was:
"As a bank CEO, you would have to be in respect of remuneration and reputation (after taking account of the moot balance of legal risks) suicidally desperate to go to TARP - your $millions in bonus-pay are docked or capped for both you and your star performers, plus the US Treasury (probably FDIC) can appoint an oversight board (will your board vote for that?) and the market then sees you as foolish or desperate or both and marks you down even before S&P, Moody's & Fitch drop your grade below AA- (the minimum for unsecured borrowing on the interbank money markets). You will get US treasuries (to put in your discredited capital reserve) as a swap for your toxic collateral - although at a few 100bp above current fire-sale prices - and now (on your trading and banking books) you also have to turn what had been a temporary discount for turbulence and internal mark-to-model fair value valuations into an economic loss i.e. you have advertised your bank to be an all-round basket case in intensive care (like Fortis or HypoReal or Wachovia), sucking at the teats of the Fed. And your stars and their teams, the high flying swinging rats, leave your sinking ship - now an M&A target for sure!
The Fed & UST only have full discretion over the first $250bn and I do not expect them to actually spend more than that. All this means that TARP may not operate as advertised on the packet. But, this is not to say the package won't work. It will. It is only required that TARP as lender of desperate last resort sets a new higher fire-sale price and because of the confidence injected into the equity and other markets. The Fed can use TARP to get back the $85bn loaned to AIG and can practise setting higher prices for toxic exposures on Freddie Mac and Fannie Mae balance sheets. The value of the benefits immediately redeemed thereby by the Fed, including shared riisk commitments with JPM/Bear Stearns and others (e.g. Citi if it has any chance in legally overturning the Wells Fargo/Wachovia deal), amounts to something north of $500bn. And I crudely estimate the benefits to banks' balance sheets generally of something north of $600bn.
It remains to be seen whether the European response of guaranteeing all major bank deposits (and bondholders) by Ireland, Greece and Germany (plus others in the coming days) and France's porposal of a €300bn EU-wide mini-TARP, turns out to be just as successful? On top of this is the conservative money markets swap windows operated by all central banks (mainly the Fed and BoE, but also ECB and Japan) worth over $1 trillion. If all these together do not right the sinking ship, and improve buoyancy, of the global financial system, then we have to conceive more elaborate detailed ideas, urgently, and these may this time include more sticks than carrots?"

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