The market needed some details

I previously wrote on this blog that the stock market hates uncertainty.  Conversely, it loves assurance.  The Treasury Secretary’s announcement of the new bank rescue plan addresses the problem of toxic assets and how the government plans to relieve banks and financial service companies of up to $1 trillion of this liability. 

These toxic assets have acted like a figurative anchor locked around the figurative ankles of the banks. As has been discussed on this blog, the banks have reduced lending and sought to preserve capital as they wrestle with tarnished balance sheets.

As you will remember, the Treasury Secretary had the opportunity to make this very announcement weeks ago, but provided only sketchy details. The stock market reacted and we saw a continuous sell-off that has depleted the wealth of retirement accounts everywhere.

Now the government has articulated their plan to help the banks and free up the credit markets by using a combination of government and private intervention.  

Banks need to resume lending

The lingering question in recent months has been, how does the government price and dispose of billions in toxic assets?  With no answer to this question, the DOW fell to a twelve year low in early March.  The announced plan would have the government making use of $75 to $100 billion of TARP funds.  The government would partner with the private sector and hedge funds to buy up billions in toxic assets.

The private sector is the wild card in the equation.  How much participation can the government expect? Will investors go for the risk-reward equation as they see it?   According to a March 23^rd story by the AP, ‘Under a typical transaction, for every $100 in soured mortgages being purchased from banks, the private sector would put up $7 and that would be matched by $7 from the government. The remaining $86 would be covered by a government loan.’

The FDIC will also contribute to the new plan by purchasing up to $500 billion of residential and commercial loans. This was anticipated to help clean up banks balance sheets. Additional bank failures are still anticipated.

Taxpayer funds continue to flow

Then there was the Omnibus spending bill.  This bill includes another $14 billion in earmarks.  Government spending gone ballistic. The bailout takes on yet another face, but in the end, it’s all your money.

The Omnibus spending bill is a whopping $410 billion.  It contains nearly 8,000 earmarks.

I am considering creating an auto-complete function on this blog; whenever a ‘b’ or ‘t’ is entered, the word ‘billion’ or the word ‘trillion’ is automatically spelled out.  The Congress and the president apparently equate these numbers with ‘hundred’ or ‘thousand.’  Unfortunately, there is a significant difference between each of these descriptive terms that impacts generations of taxpayers to come.

In the meantime, more consensus has been voiced in recent days that the most important measures to repair the economy have to be refocused on the banking system.  This was at the heart of the original bailout.

The focus of bailout funds for banks includes freeing up capital to increase lending and stabilizing banks that have large pools of toxic assets on their books.

Take your TARP funds back- please

Ironically, many of the banks that took early bailout funds (TARP) are anxious to give it back. Many more never took the funds, although they were approved to receive it. This information is not largely known by the public.

Many otherwise healthy banks do not want the stigma attached to the bailout funds. Many of the leading recipients of the bailout have brands and reputations that have been tarnished because of their financial difficulties. Healthier banks don’t want to be grouped in with institutions that find bailout funds a necessity.

An LA Times article describes one example of a bank anxious to overnight a check back to the government. Northern Trust Corp. received negative publicity because it took $1.5 billion in TARP funds and later sponsored an annual golf tournament. The bank stated that it actually made a $795 million profit in 2008 and was not deserving of the negative press. The golf tournament has raised $50 million for charity and the bank feels it has been undeservingly maligned.

TARP2- planned, but few details

With the stock market hitting record lows, the ‘stimulus’ package continues to make headlines. In an office tucked away in the Treasury Building, Timothy Geithner works on adding some specific strategies to a vague TARP2.  The original announcement of the TARP2 specifics disappointed Wall Street and has had an adverse effect on the DOW for several sessions.

A Fox Business story reports that the Treasury Department will spend ‘up to $100 billion of the next phase of TARP to help ease tight credit for consumers and businesses.’

A portion of this will go towards foreclosure prevention and the larger portion will go towards ‘new bank capital injections.’  

The TARP ‘stress-test’
More interesting information regarding TARP2 could be found in a column in Forbes.com today.  Author Liz Moyer details how many major banks are stressing out currently anticipating the ‘stress-test’ that is a component of TARP2.  The ‘stress-test’ measures the capital levels of banks.  The test is meant to separate weak banks from strong banks.

Uncertainty about the details of the plan hit banks stocks hard. Major banks were down double-digits in trading today.  The Treasury Secretary has been mute on details and Wall Street hates uncertainty.

The banks fortunate enough to pass the stress-test will get a capital injection from Treasury that will act like a bridge loan. The thinking is that the bank can use this capital as a temporary buffer until they can raise capital in the private markets.

With the failure of four more banks over the Presidents Day holiday, the regulators have their work cut out for them. They need to deal effectively with the troubled banks as soon as possible to restore confidence in the system and get the healthy banks back on a normal lending path again.

In the meantime, the other issue revolving around the TARP program is the need for accountability for the first round of expenditures.  Citigroup and Bank of America are the only two banks that have furnished the government with a detailed accounting of how they used the funds.  More on this in future posts.

Stimulus bill or bailout; which gets your attention?

The stimulus bill is getting all of the press recently.  The bailout, which is still moving ahead, has been moved to the back sections and off of page one.  That doesn’t mean that the bailout has been swept under a rug.  The bailout funds have a specific purpose.  That purpose has changed, but its core purpose is to free up the frozen credit markets and that remains an important goal. The new stimulus bill is loaded with pork and special projects and does not do enough to increase employment, stimulate bank lending or return optimism to the general population.

In the meantime, sources say that the administration is asking Wall Street firms if they would be interested in participating in the bad bank proposal.  At the same time, they are requiring those firms who are getting government money, to cap executive pay. 

According to a Treasury department press release, senior executives are limited to $500,000 a year in total compensation.  Any compensation above that amount has to be in restricted stock. The restricted stock does not allow the executive to claim any value from it until after the firm has repaid the government.  

The bank bailout has not been forgotten

So, with all of the attention on the inflated stimulus bill, is there anything happening with the bailout?
A CNN Money article says that the new administration’s approach to the bank bailout will likely be three-pronged.  The article says that; ‘The plans are likely to include a program that would relieve banks of troubled mortgage assets, and may also feature promises for additional capital infusions or an offer to guarantee the value of some bank holdings.’

This sounds like a return to Paulson’s original plan.  If these approaches are implemented, then the goals of the bailout will be reinforced and live on.

What many taxpayers do not realize is that banks continue to close every week.  Every failed bank is one less source of lending in a community.  One less bank is lost jobs and even more burden on the FDIC. The FDIC’s burden is great today, with 7 bank failures already in 2009. (see my next post for more on this)

TARP funds and the three point solution

Remember that the Obama administration inherited $350 billion in TARP funds to tackle the banking and financial crisis.  One of the first courses of action will be to get the troubled assets off of the balance sheets of distressed banks.  The ‘bad bank’ concept I mentioned in a prior post is still a much-discussed option.  The net effect of this action would be to improve their health and investors concerns and to stimulate lending again.  (stay tuned for more on the other two options)

New oversight for the bailout funds

CNN reports that the new Treasury Secretary and occasional taxpayer, Tim Geithner, will put in place new rules that ‘restrict lobbying related to the $700 billion Troubled Asset Relief Program.’ (TARP) He has also taken some additional steps to strengthen oversight.

The article talked about a poll two business college professors conducted that indicated that only 40% of respondents thought that the former Treasury Secretary was acting in the best interests of the country.
I would take issue with those results. It may be the result of a media campaign that spent more time talking about corporate abuses than the science behind Mr. Paulson’s decisions.

The bottom line is that there is a general feeling of suspicion regarding the government bailout and a demand for transparency coming from the Congress and the taxpayers.  That’s fine; it’s taxpayer’s money after all.  It may also prove to be a burden on the next generation.  It has to work as intended and the destination of every dollar has to be known.  If the purpose of the bailout is to reignite lending by banks, then that has to happen.

The remaining $350 billion of the bailout funds will surely find its way to the banks also. The FDIC chief, Sheila Bair has said that the government would create an aggregator bank to purchase the troubled assets of banks. 

Bad bank, good bank, needy bank

The new administration is likely to use the ‘bad bank’ model.  According to an article on CNBC.com, the bad bank idea is gaining momentum.  The bad bank would purchase non-performing or illiquid assets from the banks.  In this scenario, if the government can buy the assets at a bargain price, there is the possibility of repaying the taxpayer.  The government has the capability of holding the assets to maturity.

The CNBC article quotes an economist from Goldman Sachs, who says that banks worldwide have absorbed losses of about $975 billion.  The economist claims that the worst of the global credit crisis is ‘far from over.’  Another industry analyst quoted in the article states that the eight largest financial institutions need ‘up to $1.2 trillion in new common equity and that the government is the only entity that can provide bridge capital to get past the current crisis.’ 

What can we summarize from these opinions?  Much more bailout ahead.  

There is currently no guarantee that the remaining $350 billion of TARP money would be used for the ‘bad bank’ concept.  Watch for further announcements.  As a Citibank shareholder, I’m reluctant to see the banks nationalized.  There are those in influence who would like to move towards this model.  Whatever occurs, more taxpayer money is sure to be expended.

BAILOUT wins a dubious honor

The word ‘bailout’ has been chosen as the Word of the Year for 2008 by the Merriam-Webster Dictionary.   The word received the highest number of look-up’s in the shortest period of time on Merriam-Webster’s on-line dictionary.  (see here)  The word is defined as a rescue from financial distress.

A bailout recap

While the dust settles on the Citibank bailout and the media keeps much of the focus on the auto maker bailout, it may be a good time to review just where we are at with the bigger picture.

GM senior management was reported to have met over this past weekend to hash out their response to congressional requirements for bailout funds.  Of the $25 billion in bailout money for the Big 3, GM is requesting $12 billion. Cost cutting was at the top of the agenda according to sources.

Auto rescue was in the cards

I delayed yesterdays post by a day to see what would happen on Capitol Hill with the second visit of the automaker CEO’s and their ‘plans.’  In so many words, Speaker Nancy Pelosi announced the forgone conclusion that may be a reward for union support to the Democrats.  She made it clear that the automakers in Detroit would not be allowed to fail or declare bankruptcy.  Pelosi suggested a short-term loan as an alternative after hearing the CEO’s from Ford and GM promise to work for a dollar a year.

Some lawmakers were not so impressed, stating that the automaker chiefs should have taken these steps long before now. 

Ford appeared to be in the best condition of the three, only asking Congress for a ‘standby line of credit’ of $9 billion. They believe that there is a chance that they would not even need to tap those funds.  The combined bailout figure could reach $34 billion.

Liquidity is the problem in the states and over the pond

Although the focus has been on the U.S. bailout, the bailout mania has been an international phenom, with similar efforts taking place across the globe.  There is currently a feeling of disconnect in England, where the government bailout of the banks does not seem to be proceeding as hoped for.  The British government’s bailout was a £500 billion bank bailout, meant to stimulate lending. The focus was to help small businesses who employ 13 million people in the UK.

The perceived problem in the UK is much the same as the problem in the U.S.; there has been little improvement in the credit markets and the banks are the common denominator.

 A distracted media

A Google search for new stories on the bailout right now will produce a lengthy list of articles on GM, a number of blog postings and several editorials in newspapers big and small.  Few, if any, articles on mortgages, banks or the credit market.  It would seem that the bailout had lost its focus and reporting on the bailout has gone the same way.

The total of bailout commitments to date, to contain the financial crisis, approaches nearly $7 trillion. Please note that these are commitments, and all of the money will not necessarily be used.  Also, as I stated in earlier posts, there is the possibility that the warrants and preferred stock that are part of many deals, may yield a profit.

Are the bailout efforts working?

For 5 sessions, the stock market has been up.  Citibank stock, which was faltering, has seen a significant price improvement (disclosure: I’m a Citibank stockholder).  Has the government’s recent actions restored some confidence to a beleaguered economy?  It would seem so.

The improvement in the stock market has been broad based and has increased the stock prices of even the most beaten down stocks like AIG and Fannie Mae.  As I mentioned in an earlier post, the psychology needed to turn around our economic woes, is just as important as the actual economic stimulus.  With confidence and liquid credit markets, we might begin to climb out of the abyss.

New aid on a case-by-case basis

There will surely be more to come beyond what we are expecting with help for the banks, and a possible bailout of the Big 3. The government has hinted that there could be other Citibank and AIG bailouts, something that will be decided on a case-by-case basis.  A macro-economic view will be taken and the impact on the entire economy will be assessed. 

As Tony Fratto, the deputy White House press secretary stated several days ago;  “We would never foreshadow any specific actions involving private firms, but I think it’s safe to say … that we take threats to our financial system seriously and we stand ready to take any steps necessary to prevent systemic events in our economy.”

President Bush added; “We will safeguard the financial system as the first step necessary for economic recovery.”  “This is a tough situation, but we will recover from it.”

Let’s put things into perspective

I heard Neil Cavuto make a sensible contrast in an interview the other day.  He was passing a store in New York and saw the long line for the new Blackberry Storm.  He pointed out that any comparisons to our current situation and the Great Depression are unfounded.  He reminded people that during the Depression, people stood in long breadlines.  He passed a long line of people waiting to spend big bucks for the newest tech gadget.  This is a good way to put things into perspective.

If the newest incarnation of the bailout is successful putting more money in people’s pockets for student loans, mortgages and car loans, then we are moving in the right direction. Students can continue to matriculate, people will be able to enter the housing market and auto sales will help support that segment of the economy.  There is a method to the madness.

Fed’s new bailout program

Thus far, we have examined the efforts of The Treasury to coordinate a bailout of portions of our financial markets and potentially other sectors. Now, the Fed has stepped in with their own bailout.

$800 billion.

The original Treasury plan was to inject liquidity into the credit markets. Unfortunately, the U.S. is a credit based economy, and everything from student loans to car loans to credit cards relies on credit.  Most loans are re-packaged as securities for sale to investors. 

The Fed has created an asset-backed securities loan facility.  The Fed came to the realization that institutional buyers and sellers had not re-entered the market for key mortgage and lending products.

So let’s review what programs have been instituted up to this point as part of the government bailout. (technically, the Emergency Economic Stabilization Act)

• The Treasury Department’s Capital Purchase Program - $250 billion for banks, $161 billion spent  (Treasury gets preferred stock and/or warrants in return)
• The Treasury Department’s Troubled Asset Relief Program - $700 billion original program
• Systemically Significant Failing Institutions Program – provided the funding to AIG
• Unnamed program -  funded the Citibank bailout- guarantee up to $306 billion in troubled assets.  Purchase of $20 billion in Citibank preferred stock.

A continuing problem

From an article in MarketWatch;

The markets for asset-backed securities “historically have funded a substantial share of consumer credit and SBA-guaranteed small-business loans,” the Fed said in a statement detailing the new loan facility.

The facility is designed to generate increased credit availability and to support economic activity by facilitating renewed issuance of consumer and small-business asset-backed securities at what the Fed called “more normal interest-rate spreads.”

As a side note, the Treasury Department gave an additional $2.9 billion to 23 regional banks this week. And, in a surprising development, there is renewed speculation that an auto industry bailout is imminent. So far, the bailout has totaled more than four and a half trillion dollars.  The government’s balance sheet is in serious disarray.

The bailout and Detroit

It’s hard to grow up in Detroit and speak out against the auto industry.  Half the families in my neighborhood depended on the Big 3 to put food on the table.  The problem started in the ‘70’s though.  People in Detroit blamed Japan for making things more difficult in the auto market.  They could not see that the folks on the line, who would often drink their lunches, were hurting quality and consumers were simply getting smart about this.

I remember working at a benefits fair inside one of the auto plants.  It was dinner time and no one was around for the fair.  I asked one gentleman, who happened to be walking around looking at the vendors tables, where everyone was at?  “Just go to any of the local bars,” he responded, “and you will find everyone there.”

The industry has no doubt changed in recent years. What I recall happened in the late eighties.  The competition with the Japanese automakers, and a strong retooling of minds and machines, has brought Detroit to a position of building better quality vehicles.  Adapting to the current market still presents a challenge to the American automakers.  When gas prices spiked, who was building the biggest SUV’s?

The truth about Detroit and the automakers

While some of this will tick off my old friends back in the Detroit area, the truth is that the high union wages, over-the-top benefits and lifelong pensions have made Detroit uncompetitive with its slimmer competitors.  It would be a shame to see Michigan’s unemployment rate rise above its current 10%, but something has to change.

This is the perspective of many in Congress right now.   The writing is on the wall, and members of Congress can see that there are problems that have gone unaddressed.    There are fundamentals that need change.  The bailout has to be connected with ideas that will improve America.  There can be no backroom deals; the terms of loans have to be available to everyone.

There could be some opportunity for the bailout and its noble purpose.  If the government can generate a profit from loans or investments or improve a faltering industry, then something has been achieved.

Paulson needs to restore confidence

The controversy heats up and keeps the bailout in the headlines.  The Congressional view of Henry Paulson, which had been fairly benign in the past, is changing to one of suspicion and contempt.  Paulson’s friends on Wall Street are not the role models that most people would want to be associated with.

I was in the business for 26 years, so I understand that there are some very smart people leading financial service firms.  The business has always provided enormous paydays to its senior executive suite, and that rankles a lot of people. Paulson can’t get that smell off of himself.

Bernanke and Paulson appear before Congress

To counter this growing suspicion, Paulson and Bernanke appeared before the House Financial Services Committee to provide an update and explanation of the change in course of the bailout. They were met by a number of skeptical committee members voicing the same questions as members of the public. From a purely political perspective, this is all very interesting because there sat both Republicans and Democrats, all on the same page with the same concerns about the plan.

According to an AP story, Paulson explained his change in course by stating; “There is no playbook for responding to turmoil we have never faced. We adjusted our strategy to reflect the facts of a severe market crisis.” 

Concerns of members of both parties sounded surprisingly similar.  From Republican Spencer Bachus of Alabama; “We all understand that when conditions on the ground change, policymakers must be agile enough to adjust to those changed circumstances, but changing too quickly, without adequately explaining why you’ve changed or what you’re going to do next, risks sending mixed signals to a marketplace that is in dire need of certainty and a sense of direction.”

Democrat Paul Kanjorski of Pennsylvania let the Fed Chairman and Treasury Secretary know that they had made a; “180 degree change in policy, and… do we have a plan? Where are we going?” 

Bernanke, who has garnered respect and support from both sides of the aisle in the past stated;   “Going forward, the ability of Treasury to use the bailout program for capital injections and to take other steps to stabilize the financial system, including any actions needed to prevent the disorderly failure of a major financial institution, will be critical for restoring confidence and promoting the return of credit markets to more normal functioning.”

According to AP, the current focus of the bailout is to roll out a ‘capital injection program to pour $250 billion into banks in return for partial ownership stakes in them.’  The first $350 billion that Congress approved will be spent before the inauguration on Jan. 20, and the remaining amount will be in the hands of President-elect Obama.