Treasury to Rework Bailout Plan So Future Bank Profits Will Not Be Impaired

The amount of capital that it will require to repair the system as it is today will most likely be in excess of $4 Trillion.

We will all know more when the fresh losses start coming out of the closet and from under the bed and off the balance sheet. You might be amazed at the shamelessness.

The Wall Street banks are like an illness that will consume us, change us, preoccupy the best part of our lives and our thoughts, for many years to come.

Unless we insist on serious reform of the financial system and the fiscal management of our country.

Our choice.

American Banker
Recapitalization Plan Getting Revamp
By Steven Sloan and Stacy Kaper
Friday, October 17, 2008

WASHINGTON — Regulators and the Bush administration were working Friday to fix technical problems with their plan to recapitalize the banking industry.

Chief among them was a fear that the government's plan to take warrants in banks could pose accounting problems, sources said. At issue is a determination by many bank executives that the warrants, which would be issued in return for a capital injection, are treated as liabilities under generally accepted accounting principles. That would have earnings implications for banks and could dent regulatory capital - the exact opposite of what the administration is hoping to accomplish.

It appeared that at least two options were on the table Friday afternoon. The Securities and Exchange Commission could waive GAAP rules on the warrants. Treasury could also rewrite the provisions of the existing contracts over the weekend to address the concern.

Separately, banking regulators were expected to release a clarification soon saying banks can include Treasury equity stakes in Tier 1 capital. The Federal Reserve Board issued an interim final rule on the issue late Thursday to "immediately provide guidance to bank holding companies concerning the regulatory treatment of the stock."

Banking regulators have said a new rule for individual institutions is not necessary, though they are moving to clarify the situation to avoid any confusion.

Treasury officials were also working to solidify how banks would apply to receive the remaining $125 billion in capital injections available to institutions. An initial infusion of $125 billion has already been granted to the top nine institutions.

In a round of conference calls with the banking industry on Friday afternoon, Neel Kashkari, the interim assistant secretary of financial stability in charge of running Treasury's emergency rescue program, released a few new details.

He said banks would apply for capital through their primary regulator, who would conduct a review and make a recommendation to Treasury to decide, according to those briefed on the plan. Details on how to apply are expected to come out next week.

Foreign banks and insurance companies are excluded from the capital program, but the criteria for large and small banks will be the same, according to sources.

Under the terms, banks could apply for a capital injection equal to a maximum of 3% of risk-based assets. The total $250 billion being dispensed in capital is based on providing enough capital to cover 3% of all banks risk-based assets, Mr. Kashkari told industry representatives. (How much did Goldman and Morgan receive - 3%? - Jesse)

"That means there won't be any rationing," said Wayne Abernathy, assistant secretary for financial institutions at the American Bankers Association. "There will be enough for any bank that wants to participate. There's not going to be a need for any kind of Oklahoma land rush."

Capital will be made available to healthy institutions only — though that has yet to be defined — but healthy institutions could use the government's capital to buy a weak bank. (Will they be as healthy as Goldman and Morgan Stanley? - Jesse)

Treasury has said the capital is meant to provide opportunities for new lending, not to fill in holes caused by losses.

"They see it as a stimulus. If it works that way it could dwarf any of the stimulus projects that are being contemplated on Capitol Hill," said Mr. Abernathy. "We are talking about capital and every dollar of capital usually results in about $10 of lending, so if they can get all $250 billion placed that's about $2.5 trillion of new financial activity." (Trying to reflate this bubble without structural changes is like trying to reload Pandora's box - Jesse)

Charts in the Babson Style for the Week Ending 17 October

Bear Raids and Economic Warfare on a Global Scale

The lawmakers and regulators may wish to look into the quiet but devastating run on the hedge funds that is occurring right now, that is going to cut that industry in half, and distort the markets until the end of the year.

This will affect key commodities in addition to certain industries, and may temporarily impair some national economies.

The Prime Brokers have a rough idea where the hedge funds, their clients, have their major holdings, and are leading bear raids on them as the funds have to raise liquidity because of redemptions. They are publicly identifying those positions to other players in the industry. A conflict of interest of the first order it appears at first blush. Perhaps not illegal, but certainly destructive and 'feeding the fire.'

These bear raids on key positions generate more panic and losses for the hedge funds, which in turn generates more forced selling and losses.

The irony of course is that the Prime Brokers are also the biggest banks, and are being bankrolled by the US Treasury and the Fed by about 400 billions per day in rolling capital. They appear to be at a loss so to speak with regard to productive investment opportunities. Thus they turn to speculation.

In addition to the hedge funds, many banks with their own small trading desks are being caught in the cross fire.

We do not think of this as a conspiracy but clearly the unintended consequence of poorly thought out but well intentioned actions taken in haste.

The lawmakers and regulators must create a firebeak to stop the cycle of destruction. They could require any bank accepting Federal funds to adhere to some simple guidelines about the potentially predatory use of those funds, especially banks that are more like large hedge funds themselves in their composition.

This cycle of destruction of assets is exactly why the Congress enacted Glass-Steagall in the 1930's. Some of the Washington and Fed whiz kids might wish to go back and revisit the raison d'etre for that legislation.

Some likely measures would be an immediate limit on the expansion of short positions in all commodities, with limits based on market size, and the enforcement of laws against naked short selling on all equities immediately.

There should also be disclosure from all recipients of taxpayer money of all net positions to the SEC on a daily and weekly basis. We would also approve of a ban against short selling over certain limits of the size of a market or the shares outstanding by players over a certain size, and all those receiving Fed subsidies.

But this will probably not happen, which is why we may have a political crisis next year.

To put a very fine point on this so no one can miss it, it is not the hedge funds themselves that we care about, or the 'qualified investors' that put money into them. What concerns us are the unintended consequences, the malinvestment, the market distortions, the polarization of wealth, and the political blowback that come from interfering with markets and other people's business for a protracted period of time, and in a big way. The actions being taking by our banks, our 'national champions,' is ours because we are funding them and regulating them. And in this world, if you break it, you bought it, whether it was intended or not.

This is starting to look like economic warfare from some perspectives. The blowback may not be attractive.