Sunday, September 20, 2009

The TARP game is over, next step is an Uber Big "Bad Bank"

Obama's team came storming into office in the midst of the crisis with all the intent of saving the world financial system. They did it, temporarily at least. As it happened, the crack Obama team handed out cash to failing entities, abandoned accounting scrutiny, and finally provided a little transparency to balance sheets but no accountability for resolution. The markets gained faith in the new system, not because the banks had resolved their problems but because the government was credible and tangible in supporting all major market mechanisms.

This sunlight on the system gave the banks a chance to redeem themselves by opting out of government support by repaying the TARP money. To obtain this freedom, the banks announced their financial health based on increased capital and risk control measures. Was this actually done? No. Now the support programs (agency debt purchases, MBS purchases, T Bond purchases, money market funds(1), home purchase tax credits) are scheduled to lapse. Bloomberg reports "New York Fed President William Dudley, who is vice chairman of the FOMC, has sounded more cautious. "The market expects us to complete these programs,” he said Aug 31. “To contradict that market expectation is a pretty high hurdle.”(2)

What now?

The Obama team remedies addressed the symptoms, but the source was the undercapitalized American consumer and no remedy was found for their plight. As credit cards charge offs, unemployment rates, foreclosure statistics, and many other financial measures all zoom past stress test scenarios, the solvency of the banking system will be in question again by the Spring of 2010. At that point, balance sheets will have to be recapitalized again. Will the banks come back for TARP? No sane bank will risk the public anger of returning to the government as doctor after already claimed to be "cured" and going in for the same penicillin. The credibility of the stress tests will be demolished and the actual health of every bank that took the test will once again be on the table.

What will the government do in that situation? There is no way the Congress will hand out another $750B to the Executive Branch with no strings attached like last time. At least not if they care about holding their jobs come election time. The Executive Branch will have lost their opportunity to single handedly manage the crisis. Instead Congress will take center stage in bringing credibility back to the banking system the only way possible for a government entity. That will require complete nationatization of "bad bank assets" with the taxpayers footing the bill but banks taking a major equity hit in the process.

(1) "Treasury Announces Expiration of Guarantee Program for Money Market Funds" US Treasury Department Press Release, Sept 18, 2009
(2) "Housing Risking Relapse Confronts Bernanke Conundrum"By Kathleen M. Howley, Sept 21, 2009,

The author is long SKF at $25.