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Government Intervention Probable

From: "Government Intervention Probable But Bank Nationalization Unlikely", Heather Anderson, Credit Union Times, 3/4/2009

Federal Reserve Chairman Ben Bernanke reassured lawmakers he’s not aiming to nationalize big banks during his Feb. 24 appearance before the Senate Committee on Banking, Housing and Urban Affairs.

While the Fed chief said the future of the nation’s $100 billion and up club depends upon the economy, Bernanke told the committee he doesn’t think any major bank is on the verge of failure and said any government money used to buffer banks against capital-eliminating losses would aim to avoid nationalization, not support it.

Despite the encouraging words, a joint effort by the Treasury, the FDIC, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Reserve Board began stress testing banks with more than $100 billion in assets on Feb. 25, during Bernanke’s second day of congressional testimony.

The stress tests will assess whether the banks have enough capital to weather the current recession. Models will assume conditions that are significantly worse than current economic figures for a two-year projection period. Banks that don’t pass muster will receive government capital, whether they want it or not.

“Any government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time,” stated a Feb. 23 Treasury release.

Bernanke repeated those terms to Congress the following day, adding that “only at that time, going forward, if those losses do occur, would the ownership implications become relevant.”

However, he did indicate that the government would probably cut more bailout checks to banks, saying regulators are aiming to restructure banks, remove toxic assets and lure private investment back after banks regain profitability.

Mike Schenk, CUNA vice president of economics and statistics, said he thinks additional government action is likely, saying of major banks, “the status quo appears increasingly untenable.” However, he agreed that any additional implied government guarantees should help reduce market uncertainty and, at least initially, increase confidence in the institutions.

Economic researcher Mike Moebs, principal at Chicago-based Moebs Services, was optimistic with a grain of salt. Moebs said he doesn’t think government nationalization of banks will be as extensive as some are predicting; however, according to his calculations, the largest 117 banks in the country are in financial trouble.

“The stress tests will ask if they have enough capital to withstand their problems with both investments and loans,” Moebs said. “The answer has been very clear ever since the bailout bill: they don’t.”

Why? Moebs gave three primary reasons: the departure from mark-to-market accounting, too many toxic investments and performance problems with whole loans.

Additionally, the concept of too-big-to-fail is its own failure, he said.

“Ultimately, it comes down to this: banks had enough capital, but leveraged it too highly and didn’t watch it closely enough because they bought into this concept of too-big-to-fail,” Moebs said.

Couple the practice of highly leveraging banks with the safety net of a guaranteed government bailout, and the end result is a disaster waiting to happen, he said.

“You’re effectively telling those who run banks, go ahead and take on more risk because the government is there to bail you out. It’s like having your mom hold your hand everywhere you go,” he said. “Pulling in those eight largest banks and ripping them apart as the House Financial Services Committee did was a waste because the banks were just following what they were taught.”

Western Corporate FCU Vice President of Economic and Market Research Dwight Johnston agreed, saying government bailouts haven’t forced any changes in management or strategies.

“Yes, clearly, they’re taking on too much risk,” he said. “It’s almost like they’re swinging for the fences.”

Johnston questioned the lack of defined structure for companies receiving government assistance, using Fannie Mae and Freddie Mac as examples.

“In theory, those are still semiprivate companies, and they’re doing some government mandated things, but the government is letting them grow when they’re supposed to be shrinking and allowing them to charge substantial fees so that their rate really isn’t as advertised,” he said. “All of these companies that are semi-taken over, how are they supposed to operate? What we have now is a strange hybrid of public and private.”

The WesCorp economist was slightly optimistic about the potential of the Obama administration’s financial recovery plans, saying the market wants stability and clarity, and some sort of government support structure for banks could help. However, he was critical of Treasury Secretary Tim Geithner.

“You can’t dangle bank nationalization out there,” Johnston said. “Either say it will happen under certain circumstances or not. It goes back to Geithner; that was just a really bad appointment. He might be a smart guy, but he was with Bernanke and Paulsen every step of the way, a relatively invisible man, but part of that trio. The AIG bailout was his baby and look where we are now.”

Johnston said bailouts and the concept of too-big-to-fail won’t help get America back on the right track. After all, it was a disconnect between cashing out mortgages to purchase things and the end result, a huge debt load, that fueled the banking crisis.

“Now comes the realization that wealth is an illusion, but debt is real,” he said.

While the Fed chief said the future of the nation’s $100 billion and up club depends upon the economy, Bernanke told the committee he doesn’t think any major bank is on the verge of failure and said any government money used to buffer banks against capital-eliminating losses would aim to avoid nationalization, not support it.

Despite the encouraging words, a joint effort by the Treasury, the FDIC, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Reserve Board began stress testing banks with more than $100 billion in assets on Feb. 25, during Bernanke’s second day of congressional testimony.

The stress tests will assess whether the banks have enough capital to weather the current recession. Models will assume conditions that are significantly worse than current economic figures for a two-year projection period. Banks that don’t pass muster will receive government capital, whether they want it or not.

“Any government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time,” stated a Feb. 23 Treasury release.

Bernanke repeated those terms to Congress the following day, adding that “only at that time, going forward, if those losses do occur, would the ownership implications become relevant.”

However, he did indicate that the government would probably cut more bailout checks to banks, saying regulators are aiming to restructure banks, remove toxic assets and lure private investment back after banks regain profitability.

Mike Schenk, CUNA vice president of economics and statistics, said he thinks additional government action is likely, saying of major banks, “the status quo appears increasingly untenable.” However, he agreed that any additional implied government guarantees should help reduce market uncertainty and, at least initially, increase confidence in the institutions.

Economic researcher Mike Moebs, principal at Chicago-based Moebs Services, was optimistic with a grain of salt. Moebs said he doesn’t think government nationalization of banks will be as extensive as some are predicting; however, according to his calculations, the largest 117 banks in the country are in financial trouble.

“The stress tests will ask if they have enough capital to withstand their problems with both investments and loans,” Moebs said. “The answer has been very clear ever since the bailout bill: they don’t.”

Why? Moebs gave three primary reasons: the departure from mark-to-market accounting, too many toxic investments and performance problems with whole loans.
Additionally, the concept of too-big-to-fail is its own failure, he said.

“Ultimately, it comes down to this: banks had enough capital, but leveraged it too highly and didn’t watch it closely enough because they bought into this concept of too-big-to-fail,” Moebs said.

Couple the practice of highly leveraging banks with the safety net of a guaranteed government bailout, and the end result is a disaster waiting to happen, he said.

“You’re effectively telling those who run banks, go ahead and take on more risk because the government is there to bail you out. It’s like having your mom hold your hand everywhere you go,” he said. “Pulling in those eight largest banks and ripping them apart as the House Financial Services Committee did was a waste because the banks were just following what they were taught.”

Western Corporate FCU Vice President of Economic and Market Research Dwight Johnston agreed, saying government bailouts haven’t forced any changes in management or strategies.

“Yes, clearly, they’re taking on too much risk,” he said. “It’s almost like they’re swinging for the fences.”

Johnston questioned the lack of defined structure for companies receiving government assistance, using Fannie Mae and Freddie Mac as examples.

“In theory, those are still semiprivate companies, and they’re doing some government mandated things, but the government is letting them grow when they’re supposed to be shrinking and allowing them to charge substantial fees so that their rate really isn’t as advertised,” he said. “All of these companies that are semi-taken over, how are they supposed to operate? What we have now is a strange hybrid of public and private.”
The WesCorp economist was slightly optimistic about the potential of the Obama administration’s financial recovery plans, saying the market wants stability and clarity, and some sort of government support structure for banks could help. However, he was critical of Treasury Secretary Tim Geithner.

“You can’t dangle bank nationalization out there,” Johnston said. “Either say it will happen under certain circumstances or not. It goes back to Geithner; that was just a really bad appointment. He might be a smart guy, but he was with Bernanke and Paulsen every step of the way, a relatively invisible man, but part of that trio. The AIG bailout was his baby and look where we are now.”

Johnston said bailouts and the concept of too-big-to-fail won’t help get America back on the right track. After all, it was a disconnect between cashing out mortgages to purchase things and the end result, a huge debt load, that fueled the banking crisis.

“Now comes the realization that wealth is an illusion, but debt is real,” he said.

—handerson@cutimes.com


Written By: rnybeck
Date Posted: 3/6/2009
Number of Views: 1903

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