Thursday, April 16, 2009

take insolvent banks into receivership and wipe out the stakeholders – senior creditors included. This would be nationalisation by another name

TO BE NOTED: From the FT:

Stress tests deepen headache for Obama

By Edward Luce in Washington

Published: April 16 2009 18:17 | Last updated: April 16 2009 18:17

Many US presidents – the past two included – begin their terms vowing to focus on domestic problems, but end up obsessed with foreign policy. For Barack Obama, who on Friday travels to Trinidad for the Summit of the Americas, having stopped off to visit Felipe Calderón, his Mexican counterpart, that switch may come unusually quickly.

Mr Obama is feted abroad, even if he is finding it harder than his predecessors to impose Washington’s agenda on the world. But the realities of dealing with an increasingly multi-polar world pale in comparison to the growing migraine he faces at home.

Within the next two weeks the Obama administration is to release some results of the long-awaited “stress tests” of the nation’s 19 largest banks. If truth be told, these tests could have been finished in an afternoon many weeks ago. But the administration pushed back the day of reckoning to buy some breathing space.

The political climate has since only deteriorated, even if the economy has shown one or two “green shoots” of recovery. Those shoots could easily be killed off by the severe frost of a bank recapitalisation exercise gone wrong. Given the weak hand at Mr Obama’s disposal, nobody should count on a successful roll-out.

With only $32bn (€24bn, £21bn) left of the $700bn in Troubled Asset Relief Pogramme (Tarp) funds – or possibly as much as $135bn depending on how you account for the Treasury’s commitments – Mr Obama will almost certainly lack the cash to recapitalise bank balance sheets. And Congress is in no mood to grant him any more.

There are three possible ways round this.

First, the stress tests could show that the banks will survive any further economic decline over the next few months. For this Panglossian approach to succeed, the administration would have to convince the markets that its tests were sufficiently stressful – a tall order should it produce a straight flush of 19 unlikely solvencies.

Second, the tests could reveal significant capital shortfalls. The Treasury would then give viable banks six months to raise the difference from the private markets. Goldman Sachs, probably the most robust of the group, has expressed confidence that it can do this. But the markets are volatile. To declare a shortfall that the Treasury cannot instantly plug may be to risk another meltdown, triggering a crisis of confidence in Mr Obama’s whole approach to the credit crunch.

Third, Mr Obama could take insolvent banks into receivership and wipe out the stakeholders – senior creditors included. This would be nationalisation by another name. But both Tim Geithner, the Treasury secretary, and the president have all but ruled out a step they consider politically almost as toxic as the assets they wish somebody would buy.

Mr Obama always has the option of saying he has changed his mind. The stress tests revealed a far worse picture than imagined, he might say, leaving a temporary takeover of the leading banks as the only viable option. Or he could spend some of his considerable political capital appealing to Congress to authorise more funds to recapitalise the banks.

Neither option is remotely attractive. But hoping that a rising economy will float the banks clear of the rocks would risk an even worse, and more expensive, shipwreck a few months down the line. It is an unenviable quandary so soon into his term of office.

Meanwhile, the mood music is getting steadily uglier. On Wednesday, fringe Republican groups entertained the country with a collection of “tea parties”, protesting at tax increases. The fact that Mr Obama is cutting taxes for the large majority of Americans, albeit by small amounts, did not damp their sense of outrage.

The fact, also, that this “grassroots” protest was heavily sponsored by Fox News, Rupert Murdoch’s “fair and balanced” channel (meaning that it was, in fact, an “Astroturf” rather than a “grassroots” event) should not remove its underlying message. Most Americans – Democrats included – detest bailing out Wall Street. Whose side is Mr Obama on, they wonder: the banks’ or the public’s?

In a private meeting Mr Obama recently warned senior bankers that he was the only thing standing between them and the “pitchforks”. As time goes on, he may be forced by politics, as much as economics, to conclude that nationalisation is the least of all evils.

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