Sunday, March 22, 2009

The Audacity of Incoherent Banking Policy

In October, the Treasury Department strongly encouraged sound banks to take government TARP funds, along with the troubled firms. Predictably, the government is now is forcing banks to focus on the priorities of the relevant politicians rather than those of the financial system. Even though many banks did not even want to accept government capital, there are now being forced to comply with the same rules placed on the banks that needed the money. Naturally this is ingenuous, but it is also harmful to the economy. The New York Times reports: take note

Financial institutions that are getting government bailout funds have been told to put off evictions and modify mortgages for distressed homeowners. They must let shareholders vote on executive pay packages. They must slash dividends, cancel employee training and morale-building exercises, and withdraw job offers to foreign citizens.

Now, the banks that took government funds and can afford to pay them bank are attempting to do so. This signals to the market which are the stable banks. Perhaps this is useful, but when the Treasury persuaded the nine biggest banks to accept capital investments in October, it signaled that the whole banking sector was weak. Chairman of Wells Fargo (One of the strongest banks) Richard Kovacevich asked Monday at Stanford “Is this America? When you do what your government asks you to do and then retroactively you also have additional conditions? …If we were not forced to take the TARP money, we would have been able to raise private capital at that time”* Kovacevich also argued that requiring Wells to take the TARP money made it impossible to raise funds from the private capital market. As a result, Wells was forced to cut its dividend 88% to build up capital so that it will be able to repay TARP. Wells is representative – JPMorgan Chase, US Bank, Goldman Sachs, & SunTrust have also cut dividends and decided to repay TARP funds. Cutting dividends is probably a good business decision for most banks, but it would be nice if they decided to do so in order to expand their businesses – not to avoid giving the government it’s pound of flesh.

Thus far in the financial crisis, the government has signaled an intention to become heavily involved in the financial sector. However, it will not do so with a coherent/stated plan. Many of banks are showing slight signs of recovery (dead cat bounce?), but without much help from the government. The financial sector is extraordinarily complicated, so what would my plan be to fix the high level of instability. Well, it’s pretty simple: 1.) The government needs to organize an orderly bankruptcy of the zombie banks – probably Bank of America, Citigroup, and some regionals. 2.) The government should then take some of the bad loans off the books, creating a “Bad Bank” 3.) Finally, the Feds should sell off the good parts to those banks still existing – A nice reward to them for running responsible institutions. 4.) Withdraw from involvement in the financial sector as quickly as possible.

Let me know if I’m missing something.

* Couldn’t leave this Kovacevich quote out: "We do stress tests all the time on all of our portfolios. We share those stress tests with our regulators. It is absolutely asinine that somebody would announce we're going to do stress tests for banks and we'll give you the answer in 12 weeks."

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