The Next Step?
It looks very much as if the US Treasury is going to adopt the European model in the next stage of the bank bailout. Late tonight the New York Times had this story:U.S. May Take Ownership Stake in Banks
The real novelty here is that the government is prepared to take ownership shares of a US bank in return for injecting capital into that bank. The objective is roughly the same as the previously announced program to buy assets except the focus is now on providing capital rather than liquidity.
The capital issue is this: banks who have lousy assets are having to ‘right down’ the value of those assets. Each right down means a corresponding loss on the banks income statement and consequently a reduction of capital on its balance sheet. That’s the capital part of the problem.
The liquidity issue is this: once banks are nervous of the capital losses other banks may be suffering they hold back from lending to each other. So the market for inter-bank lending freezes up in fear. As a result a bank that need funds to pay off depositors or to make loans cannot rely on one of the major sources of cash. So it stops lending too in order to preserve what cash it has.
And so on.
Buying lousy assets relieves a bank of a potential capital loss and re-assures its trading partners that the bank is ‘safe’ to lend to. The idea is that such a move would unfreeze the interbank lending market.
In contrast this evening’s announcement suggests that the Treasury Department thinks that making direct investments in banks which would bolster capital and cover potential losses will have a quicker and cleaner impact: banks with sound capital ratios will more easily find other banks willing to lend to it.
Of course this is distinctly ‘un-American’! Government investment in the private sector has been taboo here for ever. The current crisis is apparently sufficient to override that taboo.
Is this ‘nationalization’?
No. The government is not taking majority ownership … or at least it doesn’t seem that way … so the US won’t actually own the banks. Instead it will take back ‘preferred’ stock with no voting rights. Although I cannot imagine any deals being done without strings attached. The political environment is so heavily charged that it would not be possible to invest taxpayer money without at least some effort to placate the popular anger at things like executive pay.
The details are yet to come.
But we are definitely in a different era.
