Wednesday, April 29, 2009

The Geithner Gambit

From Bloomberg:

At least six of the 19 largest U.S. banks require additional capital, according to preliminary results of government stress tests, people briefed on the matter said.

While some of the lenders may need extra cash injections from the government, most of the capital is likely to come from converting preferred shares to common equity, the people said. The Federal Reserve is now hearing appeals from banks, including Citigroup Inc. and Bank of America Corp., that regulators have determined need more of a cushion against losses, they added.

By pushing conversions, rather than federal assistance, the government would allow banks to shore themselves up without the political taint that has soured both Wall Street and Congress on the bailouts. The risk is that, along with diluting existing shareholders, the government action won’t seem strong enough.

“The challenge that policy makers will confront is that more will be needed and it’s not clear they have the resources currently in place or the political capability to deliver more,” said David Greenlaw, the chief financial economist at Morgan Stanley, one of the 19 banks that are being tested, in New York.

From Bloomberg:

Bank of America Corp. needs $60 billion to $70 billion of capital, according to Freidman, Billings, Ramsey Group Inc. analyst Paul Miller, who cited stress tests performed by his firm.

Bank of America should consider converting its preferred shares to common stock, including $27 billion in private hands “as soon as possible,” Miller wrote in a note to clients today. Miller said his firm’s versions of the stress tests were “somewhat tougher” than those performed by U.S. regulators.

Bank of America is among 19 lenders evaluating results of the formal U.S. stress tests. The Charlotte, North Carolina-based lender sold $45 billion of preferred stock to the Treasury’s bank rescue fund. Chief Executive Officer Kenneth Lewis and directors face opposition from shareholders to their reelection at tomorrow’s annual meeting after a 78 percent drop in the share price in 12 months.

“Most major banks will find it very difficult to raise that kind of capital in today’s environment, and we believe the first line of defense would be to convert both private and TARP preferred to common equity,” Miller said. FBR’s stress test included a 12 percent jobless rate, compared with about 10 percent used by the government test, Miller wrote.

I've been trying to get my head around a few different issues lately.

1.) I voted for Obama and therefore have a personal stake in his success.

2.) Should I be supporting the Treasury's plan based on number 1?

The primary issue dividing Geitner's supporters and detractors is the issue of nationalization of the banks. Those that are calling for an immediate nationalization of the largest banks are essentially arguing nationalization is the only method of dealing with the problem. I have come out against nationalization largely because no one has adequately explained how to prevent the process from becoming overtly political. If we can find someone to lead the charge who will do his job based on financial not political reasons I have no problem with nationalization. But considering we recently saw a movement to force JP Morgan to convert secured lending into equity because the bank took TARP money, my fears are still out there and unanswered. I should also add that I supported the idea of using the remaining TARP money to make one giant fund that buys all the good assets from the troubled banks and leave the bad assets to either return to higher values or die. At least then we would only have one institution to monitor. Basically my problem is that I don't trust anyone - Democrat, Republican, Martian -- to do anything for the right reasons.

That being said -- what the hell is the Treasury trying to do?

Here's my read. I think the stress tests were performed to figure out where money needs to go. In addition I think the subtext of the tests was to figure out who needs to be sold and what a fair price for those assets is. Part of Geitner's standard operating rules is to use the government to goad private action. He did this with Bear's sale and probably had an invisible hand in other deals that have happened over the last year or so. So I think it makes sense for him to try and do this again.

That being said -- it's one hell of a gambit. Do I personally support it? About as much as I would support any "solution" right now. But that does not mean I'm thrilled by the option.