Thursday, October 09, 2008

Deja vu: Treasury investment in major banks

It was interesting to read last night and this morning that the U.S. Treasury is very seriously considering direct investment in banks. I read about it in an article in The New York Times by Edmund Andrews and Mark Landler entitled "U.S. May Take Ownership Stake in Banks" and on Bloomberg by Robert Schmidt and Rebecca Christie entitled "U.S. Treasury May Buy Stakes in Banks Within Weeks." It is a great idea, but it is not a new idea either. In fact, I even recommended it back on Saturday in a post entitled "Treasury investment in major banks." My recommendation:

Although The Big Bailout will definitely be a boost for the big banks, it by itself will not raise substantial amounts of capital for the big banks since the values of the "toxic" assets have declined so steeply from their face value. What I think is also needed is for the U.S. Treasury to make direct investments in a number of major banks, preferably in return for an equity stake that could be sold for a profit some number of years down the road. The amount of investment should be in the $1 billion to $20 billion range depending on the size and importance of the bank. Maybe the total amount would be on the order of $100 billion for the top 20 banks in the U.S. Private equity would probably be willing to invest in the next tier of regional banks if the rules for investment are relaxed sufficiently. This is in addition to Treasury recapitalizing Fannie Mae and Freddie Mac on the order of another $100 billion. At that point, the U.S. banking system should be back on its feet, with credit flowing relatively freely, albeit not at the torrid pace we saw during the housing boom.

Separately, the "credit" arms of the car companies and GE need to be divested and regenerated into a form that the banks are willing to take on, even if some Treasury subsidy is necessary. I believe that having industrial corporations compete with banks for loans was one of the seeds that lead to banks to reach too far beyond their core business model to compensate for a lack of decent returns on traditional lines of business. The day of the 0% car loan definitely should be numbered.

The actual details of the Treasury plan are unknown and remain to be worked out, but the main point is simply to provide big piles of cash to banks so that they actually have capital to freely lend ASAP. Buying up their "toxic" assets is the most important aspect of "turning the page" on the banking crisis, but that may take longer than expected and hoped, so a prompt, direct infusion of cash is a good adjunct for the bailout.

According to the Bloomberg article:

The government is planning to buy stakes in a wide range of banks within weeks as the credit freeze increasingly threatens to tip the U.S. economy into a deep recession.

Treasury Secretary Henry Paulson and top aides are still considering options on how the purchases would work, including having the government acquire preferred stock, two officials informed of the matter said.

The move would be a shift in emphasis in Paulson's original intention for the $700 billion bailout package passed by Congress last week. While the Treasury still aims to buy troubled mortgage-backed securities from financial institutions, a direct capital injection would offer more immediate relief.

I still think a joint public/private approach would be best, with Treasury going after the biggest and most worrisome banks and private equity investing in the rest. My understanding is that there are already private equity firms that have raised piles of cash expressly for the purpose of investing in regional banks.

I also think it makes sense to encourage banks to pay a special premium on money market accounts so that even us folks on Main Street can supply capital to help out and actually know where our money is going and that we will be getting a decent return for our assistance. A number of banks are quietly already starting to offer decent rates, but what is needed is a more widespread effort and a government-encouraged publicity campaign to call attention to it.

-- Jack Krupansky


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