Richard Vague: Recapitalize the Banks. . .NOW


dollars pic.jpgThis is a guest post by regular TWN contributor Richard Vague. Vague is the Founding Chairman and former CEO of First USA Bank. He is also the former CEO of Barclays US/Juniper Financial Services. He publishes the eclectic blog,
Delaying the bank recapitalization is delaying the recovery
Are bondholders standing in the way?
Completion. On a date certain. Soon.
As regards the recapitalization of banks, that’s what is needed before a recovery can ever start to gain traction, and before the stock market can truly stabilize.
There are three primary things that need to occur to turn the U.S. economy around: 1) appropriate easing of the money supply; 2) recapitalization of the banks; and 3) productive stimulus–and we further need to coordinate these activities internationally and resist the temptation to impede business activity with either rhetoric or items reminiscent of the Depression-era Smoot-Hawley Act.
The first of these three is being done–a widely under-reported fact and a lesson learned indelibly from the Great Depression when the nascent Fed disastrously contracted the money supply by 25%. And a stimulus package has been enacted, albeit a messy and clumsy one. But the Treasury continues to dither on the subject of recapitalization, with no clear and comprehensive plan, and no date certain for its completion. And this is the biggest sin committed in these early days of the new administration, its consequence stares at us from the financial pages every day, and we have too many so-called ‘zombie banks’ instead of banks with the muscle to aide in our nation’s economic recovery.
The reason recapitalization is so pivotal is that banks scrambling to regain capital adequacy are not able to provide proper credit support to thousands upon thousands of their business customers, forcing many of these businesses–including the creditworthy among them–to contract or fail. Bank recapitalization, therefore, can be seen as the greatest job preservation and creation tool we have.
And as the nine thousand bank failures of the Great Depression demonstrated, an anemic banking system exacerbates the depth and duration of an economic crisis.
There are a several plans out there that would work well enough and can achieve recapitalization without nationalization, including the ones articulated by George Soros in the forthcoming The Crash of 2008 and What it Means, or Max Holmes in his New York Times Op-Ed “Good Bank, Bad Bank; Good Plan, Better Plan,” to name just two of many.
While they have differences, these plans have in common that they effectively take all bad loans off the banks’ primary balance sheet, force the stockholders to take the losses in line ahead of the government, include the bank’s bondholders in the equation, enable banks to take in new private capital, and result in banks that are private, “investable,” and ready to help their customers.
These plans do not require that existing management or the boards remain wholly intact. These plans keep the ‘moral hazard’ safeguard intact.
Instead of pursuing any plan of this type, the Treasury has been doing a little of this and a little of that, with its primary tactic being to put a few tens of billions of dollars into banks that have hundreds of billions of dollars of problems, a strategy has no hope of delivering a healed banking system anytime soon.
And thus the recovery is delayed. Banks where the problem is not fully addressed cannot meaningfully expand their customer lending support–even if Congress tries to require it of them.
Why has the Treasury avoided this type of plan when so many are calling for it? Some have speculated that it is the magnitude of the problem that has prevented Geithner, et. al., from this type of solution–that a full recapitalization would require trillions of dollars beyond what has already been spent, would frighten both the markets and the politicians, and would be politically unachievable.
(As an aside–we question all the extra time being spent on so-called bank “stress tests.” Ensuring bank capital adequacy under stress is the raison d’etre of our bank regulators. If there are not models already in place to quickly assess a bank’s capital adequacy under a variety of stress scenarios–especially after last September–what have our regulators been doing?)
Yet others have pointed out that if losses go against not just existing shareholders, but bondholders as well, the remaining problem will be manageable even with greater-than-expected stress, and the recapitalization could proceed quickly.
These observers speculate that it is the community of bondholders that have undue influence with Geithner and Summers, and are the reason a Soros-type solution is not being pursued. And the government’s existing preferred stock investments complicate this further still.
If so, it’s a tragedy–and an impediment to the economic turnaround we so desperately need.
In the type of plan we would prefer, a date is set, a valuation process (however imperfect) is established, banks have until that date to put their bad loans into a bad bank (or ‘side pocket’ in Soros’s case) guaranteed by the government, and new private capital is raised coincident with that activity (or as soon as feasible thereafter with the government either bridging the interim in some manner). The banks are then ready to be part of the solution rather than part of the problem.
— Richard Vague


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