January 22, 2009

Today's Letter is N for NATIONALIZATION

First thing that caught my attention was this on Wednesday, from the WaPo. Seems some business leaders in DC metro have some questions for President Obama (I'm still getting used to writing that)...

From E. Hunt Burke, president and chief operating officer of Burke & Herbert bank in Alexandria:

· "Is it fair that a strong, well-managed community bank that has consistently operated in full compliance under [Federal Deposit Insurance Corp.] regulations will now have to face a hefty increase in FDIC premiums in the near future to cover the cost of the losses from the mismanagement and poor lending decisions of other banks?"

· "With respect to bankruptcy judges having the authority to cram down first deeds of trust on residential mortgages, is there concern that it will create economic incentives for persons to file bankruptcy who would otherwise not seek to do so?"

· "Related to this, are you concerned that cramdowns on first trust mortgages will make mortgage loans less available to home buyers and more expensive because lenders will not want to incur the risk associated with making the loans and have the terms changes?"

· "Should the largest financial institutions (megabanks) be restricted from acquiring a larger percentage of the nation's deposits than they already possess?"

Cramdowns are going to be a problem. If, at any time and without penalty, a homeowner can get their debt readjusted then they will. Period. It violates the sanctity of contracts and renders the trillions we have outstanding worthless because the assets backing those loans are now subject to measures that can arbitrarily render the terms moot. Adjust unsecured consumer credit? Sure. Extend unemployment benefits? Absolutely. Provide relief to homeowners who need (financial assistance) it? Definitely. Cramdown the notes? No way. You'll see mortgage rates rise 2-3 points as demand for MBS drops precipitously.

As for the last point, it's essential that we do not allow any one bank to exceed the 10% statutory limit.

From Fred Malek, chairman and senior adviser at Thayer/Hidden Creek, a private-equity firm based in Washington:

· "You were one of the architects and supporters of a [bailout/rescue] bill that has not achieved intended results, and credit markets remain largely frozen. What do you intend to do to encourage the flow of credit to support sound investments and growth?"

· "What specific objectives do you have for the $825 billion stimulus package? Why do you think this is a better way to create jobs and reignite economic growth than providing incentives to business?"

· "Other than World War II, which was borne of necessity, can you name any other instance in the United States, or any country for that matter, where government spending and grants have revived an ailing economy?"

Here's the thing... credit markets aren't frozen because TARP failed. They are frozen because the banks are refusing to lend to damn near anyone. You have chickenshits like Jamie Dimon and Ken Lewis who are hoarding cash that the government has given them. Last week, Treasury and the Fed, surreptitiously, started telling the banks to lend. We'll know in the next few weeks if that's happened but in the meantime, they should be preparing to nationalize one or more of the banks.

Trust me, I'm not a fan of nationalization. Government does some things exceedingly well and running a private bank is not one of them. However, we are funding in mountains of cash to stabilize the banks, at attractive terms regarding shareholder dilution, and receiving nothing of benefit for the broader economy. Sure, taxpayers are getting equity and substantially devalued assets. But what we NEED right now is for the banks to start putting all the liquidity back into the system. We need restore confidence to the economy.

There are a ton of people advocating nationlization for various reasons. Krugman is among them, mostly because

he thinks management teams at the banks are just too stupid (I'm paraphrasing) and that the only way to fix is to nationalize. the British are also coming to that conclusion, but here's my thing with all the talking heads bitching and moaning about asset values and the capital infusions...


Take, for example, RBS and the Brit banks...

If the Government is forced to nationalise RBS and perhaps Barclays with their vast exposure in dollars, euros, and yen, it risks being submerged. It is one thing for a sovereign state to let its national debt jump in a crisis -- or a war -- perhaps even to 100pc of GDP. It is another to take on foreign debts on such a scale with no reserves. Yes, the banks have foreign assets as well to match the debts. But how much are these assets really worth?

There it is, boys and girls... no one knows what the assets are worth because the market done broke down. Mark to Market is great when everything is liquid. Supposedly, the evaluation on pricing is based on the collateral and cashflows from the asset. However, the market sometimes over pays and when asset prices are increasing, money chases money. When everything is going down, everyone wants to sit on their hands and Voila! you get a zero bid for an asset that's worth at least 75 cents on the dollar. How do I know?

Because the CBO tells me so... that's the net of the subsidy on the TARP funds disbursed by 12/31/2008. However, even that doesn't tell the whole story because Treasury didn't pay par for these assets. Which means their value could be far higher when all is said and done.

Some are advocating nationalization as a cheaper panacea. I disagree. Nationalization should only be used as billy club to get the banks off their collective asses, not a broad based solution. For one, it opens the door to politicization of banking (bad), full socialization of all losses (even worse), wiping out broad swaths of pension assets which the government will then have to backstop (super awful and expensive) and finally, when you go to reprivatization, you end up giving sweetheart deals to political friends and allies.

In the end, we need a hybrid valuation model for fixed income assets combining M2M with cashflow modeling creating a valuation band that will keep people from having to write down an asset to zero that is still performing.

Posted by mcblogger at January 22, 2009 11:58 AM

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