backing debt with a guarantee does not require an immediate outlay of funds, the federal government could have to cover losses if there are defaults

TO BE NOTED: From the NY Times:

"Localities Want U.S. To Support Muni Bonds

By LESLIE WAYNE

State and local governments are asking Washington to give them something that banks are trying to get rid of: federal bailout money.

California is asking that money from the Treasury’s TARP, the Troubled Asset Relief Program, be used to help back more than $13 billion in short-term borrowings. Members of Congress and several municipalities want bailout money to be used to cover more than $1 billion in losses from investments by municipalities in debt issued by Lehman Brothers, the investment bank that went bust.

And Representative Barney Frank, chairman of the House Financial Services Committee, is drafting legislation that would have the Federal Reserve, and potentially the Treasury’s bailout money as well, stand behind floating-rate municipal bonds — a $400 billion market that provides short-term financing to municipalities, but which has been largely frozen in the current credit crisis.

Another measure drafted by Mr. Frank, Democrat of Massachusetts, would create a public finance office within the Treasury Department to reinsure $50 billion in municipal bonds. This proposal comes as downgrades of municipal bond insurance companies have made it more difficult and costly for state and local governments to issue bonds.

All of the proposals are meant to help struggling state and local governments that are facing a cash-flow squeeze. The economic downturn has eaten into their tax bases as local businesses shut, houses are lost to foreclosure and there is a resistance to raising taxes. The risk to the federal government is that it could lose money if things get worse for municipalities and states. ( NB DON ) Although backing debt with a guarantee( NB DON ) does not require an immediate outlay of funds, the federal government could have to cover losses if there are defaults — which could be substantial if the economy weakens or states and municipalities cannot bring their budget deficits under control. Nonetheless, these overtures by state and local officials reflect a sense — perhaps just a hope — that municipalities suffering from a downturn in revenues and creditworthiness may find some relief in Washington beyond the stimulus money the federal government already is spending.

When the relief program was first conceived of last year, pleas by municipalities for a slice of the money went unheeded by Treasury officials who had earmarked the funds solely for troubled banks and financial institutions. But, in recent days, new conversations have taken place involving Federal Reserve and Treasury officials and state and local representatives that have given rise to cautious optimism.

“The municipal sector has been asking for federal assistance since TARP was just a glimmer in Hank Paulson’s eye,” said Matt Fabian, managing director at Municipal Market Advisors, an independent research firm. “But no one was pursuing it for months. Now, there has been a re-engagement in Washington about using the TARP money.”

Andrew Williams, a Treasury spokesman said, “We’ve had conversations with people from California and with people from around the country about the challenges facing the municipal market. And we continue to study the issue closely.”

In a speech last week at the National Press Club, Treasury Secretary Timothy F. Geithner said that the Treasury is “looking at ways to make sure these markets are working so that states and munis can meet their needs.”

But, according to a Bloomberg News account of the speech, Mr. Geithner cautioned: “I wouldn’t use the word bailout.”

With bailout fatigue setting in, it is unclear how successful the municipalities will be. At a Congressional hearing last Thursday called by Mr. Frank, federal officials remained cool to the idea of tapping into the relief fund, while still expressing concern over a credit squeeze facing many municipal borrowers.

David W. Wilcox, a deputy director at the Federal Reserve, said at the hearing that the Fed is “quite concerned” over any proposal that would extend federal guarantees to municipal debt. But, he allowed that if Congress does take that course, it should “tailor any government intervention in the municipal bond market relatively narrowly” and provide for a quick government exit when market conditions improve.

On the same day, Mr. Geithner told a House Appropriations subcommittee that the relief money cannot be used to resolve local government budget crises, since that money has been reserved for financial companies.

He said, however, that the Treasury would work with Congress to help states like California, which have been struggling to arrange backing for municipal bonds and short-term debt. Mr. Geithner did not provide any specifics.

Clearly, market conditions are not favorable in several corners of the municipal bond market, which consists of more than 50,000 public entities that have issued about $2.7 trillion in debt.

In April, Moody’s Investors Service issued its first-ever blanket report on municipalities and assigned a negative outlook on the creditworthiness of all local governments in the United States. This suggests that Moody’s may downgrade the ratings of many municipal issuers, which would increase their borrowing costs.

The biggest squeeze right now is on variable-rate demand notes, a common form of floating-rate borrowing that is backed by the promise of having sufficient future municipal revenues to repay investors — an increasingly uncertain proposition. The relief money would be used to guarantee these notes.

California, which has been crying the loudest for relief money, is in worse shape than most municipal borrowers. In a May 13 letter to Mr. Geithner, California’s treasurer, Bill Lockyer, said that the state “will be almost out of cash in July.”

Mr. Lockyer added that it is “highly unlikely that the state can access the short-term market ... based on its own credit.”

“We believe that California is not the only state to confront the same short-term cash-flow borrowing needs,” said Tom Dresslar, a spokesman for the California treasurer’s office. “But no one has as great a need as we do in terms of dollars.”

Michael Decker, a co-chief executive for the Regional Bond Dealers Association, concurred.

“All kinds of municipal borrowers are facing revenue shortfalls,” said Mr. Decker. “California is the largest example. Some states are better off than others. But all outstanding debt is backed by tax revenues. And municipalities are facing a greater or lesser level of distress.”

Also clamoring for help is a group of municipalities that purchased Lehman debt, which is now nearly worthless. Legislation authorizing the use of relief money to make these purchases was introduced by two California Democratic representatives, Jackie Speier and Anna Eshoo. If approved, this would be more like a bailout than a guarantee, because the federal government would be paying face value for debt that otherwise has little value.

The price tag on that proposal is around $1.6 billion. The argument promoted by the two congresswomen is that the Treasury and Fed allowed Lehman to fail, causing governmental bodies to lose money.

Though this effort has hit stiff opposition, Ms. Eshoo has not given up.

“It’s been said that some banks are too big to fail,” Ms. Eshoo said in testimony at a May 5 hearing held by Mr. Frank on the issue. “It can also be that counties, school districts and cities are too small to be noticed.”

To us, that week, it looked very much like a run on the entire financial system

TO BE NOTED:

Sunday, May 17, 2009

How TARP Began: An Exclusive Inside View

May 14, 2009 04:01 PM ET | Rick Newman | Permanent Link | Print

When it first came into existence last September, TARP—the troubled assets relief program—sounded like just another ungainly government acronym. But since then, it has become an integral—and controversial—part of America's recession economy.

TARP's chief architect was Henry "Hank" Paulson, President Bush's treasury secretary, who led the financial rescue along with Federal Reserve Chairman Ben Bernanke and New York Fed Chairman Tim Geithner, who's now Paulson's replacement at treasury. Their initial plan was to use the $700 billion in TARP funding approved by Congress last October to purge financial firms of their so-called toxic assets.

[See why the banks still aren't fixed.]

But TARP morphed into an über-bailout that included direct cash injections into banks, the auto rescue, the AIG intervention, and other government efforts to revive the economy. If it sounds like a trial-and-error experiment, well, that's how it felt to the policymakers who designed it, too. "When we looked for easy solutions, we kept coming up empty," says David Nason, who was a senior Treasury Department official during the Bush administration. "Hank used to say all the time, 'We're going to have to do this with duct tape and fishing wire.' "

Nason and some of his Treasury colleagues did much of the jury-rigging, running doomsday scenarios, negotiating emergency deals with banks, wooing incredulous members of Congress, and devising ways to deal with problems once considered unthinkable. Frustrated Treasury Department officials, for instance, foresaw much of the carnage but found themselves poorly equipped to stop it. Anxious finance ministers from around the world began calling Treasury last summer to find out what the government planned to do about the developing crisis. The most tense moment may have been the September failure of Lehman Brothers, which occurred with alarming speed after British financial regulators scotched a takeover bid by the British bank Barclays.

[See 6 surprises from the recent bank stress tests.]

Nason and two other former Treasury officials, Philip Swagel and Kevin Fromer, spoke recently at a panel discussion sponsored by the Milken Institute. Their remarks form one of the most thorough accounts to date of how the government struggled to contain the worst financial crisis since the Great Depression. (See a video of the full discussion, which I moderated.) Here's a condensed version of their remarks:

David Nason, former assistant treasury secretary for financial institutions: The first inflection point was March 16, 2008, which was the acquisition date by JPMorgan Chase of Bear Stearns. The sheer time it took for this institution to go from viable to nonviable was breathtaking. Just two days before, the regulator [the Securities and Exchange Commission] had said Bear had adequate liquidity of $8 billion. This is an important inflection point because it was the first time the government had stood up and said we are going to support nonbanking institutions. We knew at that point the times had changed. We knew the policy ramifications were going to be very difficult and far reaching.

[See 5 signs the bailouts are getting better.]

We worried most significantly about the consequences of other similarly situated firms. It was a very trying and stressful time because when we looked for easy solutions, we kept coming up empty. The government did not have a ready-access pool of money to support or manage the resolution of financial institutions. The political climate was very challenging—at the time, people saw this as a bailout for fat cats on Wall Street. And there was some jurisdictional squabbling in Washington.

Philip Swagel, former assistant treasury secretary for economic policy: Right after Bear failed, the economy looked like it was actually in pretty good shape considering the problems in housing and the financial sector. Overall growth was positive, driven especially by exports. In the wake of Bear's failure, we looked at options, including many things that are now familiar: buying assets, insuring assets, buying pieces of pieces of institutions, in other words injecting capital, and a massive bailout from the bottom from refinancing every troubled homeowner. And we said those are all things you could write down, but back then, you had rebate checks that had been enacted but weren't yet going out, and we had positive growth. It would have been hard to imagine getting the authority to do those things or the approval from Congress for a contingency fund in case things got worse.

Nason: The next inflection point was July 2008. The government was worried about the big investment banks, CDS [credit-default-swap] spreads were blowing out, we were also worried about Fannie Mae and Freddie Mac. These were some of the most leveraged institutions on Earth. Together, they had over $5 trillion in exposure if you consider the guarantee obligations that they had. Match that against about $60 billion in capital. We were also concerned that the housing correction was turning out to be significantly worse than the GSEs [government-sponsored enterprises, such as Fannie and Freddie] expected. We were very concerned that the GSEs were being overly optimistic about their ability to manage risk and withstand future losses.

[See the best and worst bailed-out banks.]

The GSE equity prices were getting punished during this time. More important to us, however, was the debt market. It was very clear to us there's no way the U.S. financial system is going to allow a firm the size of Fannie Mae to collapse( NB DON ). We were very worried about the trillions in debt they had outstanding, and what it would do to confidence if we let that debt go.

At this time, the Treasury was getting calls from finance ministers' offices from different parts of the world inquiring, "What is the government's relationship with Fannie Mae and Freddie Mac?" It's odd, but this appeared to be the first time that people were focusing on the fact that these are quasi-governmental institutions.

During this time period, the home loan banks, another GSE with similar exposure to the housing market, decided to postpone an auction. Every auction was something that we focused on and were worried about.

[See the banks most likely to pay back their bailout funds.]

We made the decision based on this set of circumstances that we had to support the GSEs. How were we going to do that? What did we have in our toolbox? Essentially nothing. We had about $2 billion of backup credit support for the GSEs. For $1.4 trillion organizations. This was clearly not enough to support these institutions in any real way. And we had no ability to provide any kind of equity support at all. So we decided we had to go up to Congress, bite the bullet, and ask for authority to backstop these institutions.

On July 30, 2008, the president signed a bill into law to provide equity support to these institutions. And we had the ability to support their debt up to the federal debt limit.

We made the judgment not to request the authority to nationalize the GSEs. It would have muddied the political discussion. I'm not sure we would have gotten the authority, and at this time, there wasn't a pressing need to do so. There's a long, tortured story about how the GSEs and Washington interface. But we wanted to have broad authority to support the GSEs and prevent their collapse.

[See why the auto bailout is a good model for other struggling firms.]

The entire month of September was an inflection point under my definition. But the first inflection point associated with September is Sept. 7, 2008, when the GSEs were forced into conservatorship. That came after regulators determined that they were drastically undercapitalized.

Two days later, AIG's stock fell 19 percent. Lehman's discussions to sell itself to the Korean Development Bank failed. The next day, Lehman put itself on the market for sale, with no clear takers. After some very tense discussions about whether there would be a purchaser, like JPMorgan was for Bear Stearns, we were very distressed to know that there were no takers.

So from the 10th to the 14th, the Federal Reserve, with the Treasury's support, decided to flush the system with liquidity. The Federal Reserve expanded the level of collateral the primary dealer credit facility would take, they increased the collateral that the term securities lending facility could take, and they increased the ability of banks to support nonbanking institutions. The government was putting "foam on the runway" to try to deal with what we were afraid of, which was how the market would react to a Lehman Brothers bankruptcy.

The next day, Lehman Brothers filed for bankruptcy.

The question is: Did we let Lehman Brothers fail? That assumes it was a choice that we made. The simple truth is that the government was presented with an institution with a $600 billion balance sheet, with enormous leverage. Confidence in the institution was virtually nonexistent. The only way to stabilize a firm under these circumstances is to stop a run on the institution, stop counterparties from claiming their debts should immediately come due. That was manageable in the Bear Stearns situation because someone was willing to guarantee all or most of those liabilities.

[See how bailouts can butcher capitalism.]

The public posture was that government support would not be available. But there wasn't a single credible buyer at the table who was turned away by us.

So when people ask, "Why did you let Lehman Brothers fail?" I ask, "What is the deal that the government turned down that would have prevented Lehman's failure?" If there's not someone willing to take on a balance sheet as large as that of Lehman Brothers, what is the government to do? The government has a few options: We have a lending facility at the Fed, you could provide a loan to them secured against collateral, or you could guarantee all their liabilities. That might have been the right decision, but we had no authority to do that before TARP.( NB DON )

Looking back, if we could have plugged some of the holes in our authorities, maybe this could have been done differently. I don't think we would have gotten those authorities if we had asked for them before September.

[See why the feds rescue banks, not homeowners.]

Of course, things continued to be unpredictable. We didn't predict that the U.K. bankruptcy process would essentially destroy all confidence in that funding model and that business model. And we didn't expect that the commercial paper market would essentially shut down because Lehman Brothers' commercial paper was impaired. Those two markets were the transmission vehicles that killed confidence, which we didn't expect.

That same day as Lehman, Bank of America acquired Merrill Lynch. We didn't have a second to catch our breath. The day after the Lehman bankruptcy, AIG got a $50 billion loan from the Federal Reserve. There was no significant discussion over whether the Federal Reserve was going to provide backup facilities to AIG because of two distinguishing characteristics: One, they were huge. They were global. They were bigger than Lehman Brothers. But the more important distinction is that the Fed is in the business of providing loans when it is "secured to its satisfaction." And AIG had the benefit of having solvent, highly regulated, very valuable insurance subsidiaries to which the Federal Reserve felt comfortable extending its loan facilities.

[See more companies likely to fail this year.]

After that we get to Sept. 17 2008, which was essentially the creation of the TARP concept. It was at that point that there was a meeting of the minds between Paulson, Bernanke, and Geithner that enough is enough, we're going to break the back of this crisis, and we're tired of not having the tools to deal with this crisis. And the judgment was made that we were going to ask for broad authority from Congress.

At that point, it was essentially 24-hour duty at the Treasury Department. Some people slept there.

Kevin Fromer, former assistant treasury secretary for legislative a ffairs: For context, this was a program about the size of the entire federal operating budget on an annual basis. Congress usually works through that process for 10 or 15 months, just to keep the lights on. We were asking Congress for $700 billion in basically a week or two. In the context of a national election. An election year is typically not the year to do big things.

We had one week left in the legislative calendar. It was not possible to do it in a week. I wasn't sure it was possible to do it at all. We needed to get somewhere fast, so we sent up the infamous three-page bill, which was draft legislative text the committees needed to start the discussions.

[See why the markets hate the idea of bank nationalization.]

Swagel: It was very difficult to say, if this shock happens, you will get this economic effect. In September, the nation as a whole didn't understand that what was happening in the credit markets would matter to them. There was this sort of Wall Street-Main Street divide. It was hard to explain to people why this mattered.

The week of Lehman and AIG, there was a panicked flight from mutual funds, and that led to a lockup in commercial paper. In our view, that was really the key, the CP market breaking down. That had a direct link to investment. Businesses use that to fund their daily operations. That would lead to a direct plunge in business spending, and that's exactly what we've seen over the last two quarters. A very sharp decline in business investment.

The one-month Libor [London interbank offered rate] spread is a measure of stress in bank lending. It's really, do you trust a bank to hold your money for a month. After that week, the stresses in the bank funding markets were huge. To us, that week, it looked very much like a run on the entire financial system. ( NB DON )

Nason: We were afraid of a complete and utter collapse of the global financial system.( NB DON )

Swagel: Imagine if the Fortune 500, blue-chip companies, can't buy paper clips or meet their payroll. All the things these firms rely on money-market funds and commercial paper for. And it goes downhill from there. It starts with the big firms and then every firm in the nation.

Fromer: This was an extremely difficult communications challenge. It made it enormously difficult to sell the package to Congress and for them to sell it back home. They were angry when they came back from home after the election. They had seen the amount of money they were being asked to put into institutions, getting anecdotal information from small businesses and lending institutions, and the picture was, we've invested significantly in these institutions, and we're not seeing credit flow to consumers and small businesses.

The markets were volatile for quite some time, and people became desensitized to volatility in the markets. What people didn't understand, which was quite reasonable, was the credit markets, how credit is provided in this country. That's not a criticism; it's arcane to anybody without a certain educational background. It's an almost-impossible-to-explain set of circumstances.

Nason: People were getting used to seeing the stock market go up and down. We were trying to explain, "What's happening in the equity market is not really what we're worried about. We're worried about some other market that you've never seen and aren't familiar with," and people look at you like you're insane because you're asking for $700 billion and you can't provide anything besides a chart to show why it's important.

[Here's the chart, which shows how rapidly widening credit spreads reflect a seizure in the credit markets.]

People could appreciate the money-market mutual funds situation. There is $3.3 trillion of money invested in money-market mutual funds. A panic in these funds helped in terms of selling the importance of our message. And the commercial-paper market stress was important in communicating this as well. If that market collapses, you could have huge employers saying, I'm going to start laying people off. I'm going to start shutting plants down, I'm going to start defaulting on my bonds, and that's going to trigger bankruptcy( NB DON ). Those are the kinds of things you had to say, in the doomsday scenario, to convince people that this was critical to the system.

After [the first TARP vote] failed in the House [on September 29], then the equity markets finally responded. [The Dow Jones industrial average plunged 778 points.]

Fromer: It was clearly a response that forced a number of people to say, "OK, we get it now."

Swagel: Even after the legislation passed, stresses in bank funding still got worse. So we got what we needed; we were thinking about buying assets, but we needed to think more broadly.

Nason: There were two purposes at the time. This is a critically important point and something the current administration is suffering under. The dual purposes were financial system stability and provision of credit to the economy. People are not focused at all on the fact that the former is the primary reason we went up and asked for emergency authority. To derail a total breakdown of the financial markets and the global financial system. And we believe and hope that the confluence of programs put into place in a very short period of time actually did that.

The second part of it is, getting credit flowing into the economy. People seem to only focus on, "Why isn't this money being put into the economy?" That's important, of course, but you have to remember a significant portion of this money was there to be a buffer against future losses.

Swagel: To me, the stabilization of the financial markets is the salient accomplishment of the TARP and the actions of the Treasury in the fall. The normal playbook for dealing with a bank crisis is first, winnow out the banking sector so the zombie institutions don't clog up the credit channels and divert resources. As a society, I'm not sure we're going to do that. Next is stabilize, inject capital into the firms that are left so they're still viable. And No. 3 is do something about the balance sheets. Give certainty about the performance of the assets and the viability of the firms. I think we did No. 2, we stabilized the system. No. 3 is still the ongoing challenge.

Nason: The reason the TARP morphed from asset purchases to injecting capital is really quite practical. Asset purchases were taking longer than we had hoped, and it was more complicated with the vendors. Also, we needed to be in lockstep with our brethren around the world. The U.K., France, and Germany were prepared to guarantee the liabilities of the banking sector and were going to deploy capital into their banks.

Fromer: The folks in place right now clearly have the advantage of looking back at what we did and the conditions that existed when we did it. They're benefiting from experience. A number of them were part of the process going back to last summer.

Swagel: The job of the TARP has not been done, but the first step is done. In terms of the larger picture of what matters to families, we're still pretty far away from getting back to normal.

Nason: There are still valuation problems with a lot of the assets on bank balance sheets. Then we still have to deal with inevitable credit contraction.

Fromer: It's not conceivable to me that there's a TARP II. It's going to take time for these programs to stand up and operate and invoke full participation from all quarters. Given dynamics right now, I think it's unlikely there will be another TARP."

Some bankers dismiss it as a half-hearted approach

TO BE NOTED:

SunTrust to Sell Stock and Cut Dividend

Update | 11:13 a.m.

SunTrust, one of the 10 large banks found wanting in the government’s recent stress tests, said Friday that it would take a number of actions to raise and conserve capital, including issuing new stock and slashing its dividend.

Regulators said last week that SunTrust, an Atlanta-based regional bank, needed more capital to absorb future losses in case the economic downturn is worse than expected.

SunTrust said it “plans to adjust the composition of its overall Tier 1 capital resources to increase the common equity portion by $2.2 billion,” which is equal to the amount the government said the bank will need to raise by fall to be in compliance with the capital levels under the federal stress tests’ “more adverse” economic scenario.

Under Suntrust’s plan, which it said was not final or formally approved, more than half of the capital would be raised through the sale of $1.25 billion in new stock, diluting current shareholders. The company said it would sell the stock from time to time through an at-the-market, or A.T.M., offering, in which a company sells stock periodically at various prices instead of all at once. Morgan Stanley would be the sales agent for the offering.

To conserve capital, the company will also cut its quarterly dividend from its current payout of 10 cents per share to 1 cent per share.

SunTrust is the latest bank to announce an A.T.M. stock offering, which allows it to dribble out shares to investors over time. Bank of America began a similar effort last week, following on the heels of smaller lenders like Zions Bancorp and Wilmington Trust.

A.T.M. stock deals are frowned upon on Wall Street for many reasons. For one, bankers collect fewer fees for underwriting the offering. Investors may see it as a sign of weakness, since the banks forgo the opportunity to pitch their business strategy, and a signal they are worried that an ordinary offering could fall short. Some bankers dismiss it as a half-hearted approach.

For Bank of America, some longtime advisers suggested that the deal was a way for the bank to placate regulators that it was trying to raise equity, even if it was unable to raise the full amount. The hope is that the economy will improve enough that it can avoid selling new shares. That would minimize any dilution to existing investors.

SunTrust may be in an even weaker position, and it will be interesting to see how its offering fares. The bank has been hit hard by the housing crisis, and many analysts expect it to suffer even bigger losses on commercial real estate loans.

As part of its capital plan, SunTrust also said Friday it would sell some securities and other assets that are expected to generate about $300 million in common equity. The company also said it had $3.3 billion of preferred stock and other securities on hand for which it could exchange for common stock, a move that would further dilute existing shareholders.

“We are fortunate to have many ways to address the common buffer required under the government’s More Adverse scenario,” James M. Wells III, SunTrust’s chairman and chief executive officer, said in a statement announcing the plan. “We will be prudent and proactive in evaluating and executing aspects of the plan prior to the November 9th deadline.”

The government found that SunTrust needed the additional capital after the stress test showed it could face losses for 2009 and 2010 of $11.8 billion, or 8.3 percent of its total loans. The company received $4.9 billion under the Treasury’s Troubled Asset Relief Program.

– Cyrus Sanati and Eric Dash"

the government stands behind the banking system and that their deposits are safe

TO BE NOTED: From Bloomberg:

"Geithner Bets U.S. Can Avoid Japan Trap Through Bank Earnings

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By Rich Miller and Matthew Benjamin

May 8 (Bloomberg) -- Treasury Secretary Timothy Geithner is betting that U.S. banks can do something their Japanese counterparts were unable to accomplish in that country’s “lost decade” of the 1990s: earn their way out of trouble.

The stress-test results released yesterday by regulators found that the 19 largest banks face a $74.6 billion capital hole that may be filled mostly by private money. That compares with the hundreds of billions of dollars seen by outside analysts, including the International Monetary Fund, and takes into account banks’ projected earnings over the next two years.

The “stress-test results are an important step forward,” Geithner said in a statement announcing the results. “Americans should know that the government stands behind the banking system and that their deposits are safe.”

Still, the strategy carries risks for Geithner, 47, who served as a Treasury attaché to Japan from 1989 to 1991. If he’s wrong about the banks’ ability to weather the worst recession in at least half a century, the U.S. may just be postponing the day of reckoning when institutions will have to be shut down and taken over by the government.

“This looks like Japan in 1998, when they didn’t spend enough money on the banks,” said Adam Posen, deputy director of the Washington-based Peterson Institute for International Economics. “They then ended up back in crisis in 2001.”

Paying Off

So far, Geithner’s gamble is paying off. Bank stocks have surged in recent weeks as investors bet the stress tests would give the lenders a clean bill of health. The Standard & Poor’s 500 Financials Index reached its highest level in four months on May 6 as the test results leaked out, before slipping 5.8 points yesterday to 162.3.

Geithner said the strategy was designed to ease the uncertainty that drove bank shares down earlier this year. By exposing the lenders to uniform tests and then publicizing the results, he hoped to reassure investors that their worst fears about the future of the banking system were unfounded.

Regulators led by the Federal Reserve found that nine of the 19 biggest banks, including Goldman Sachs Group Inc. and JPMorgan Chase & Co., don’t need more capital. Bank of America Corp. has the biggest hole -- $33.9 billion -- followed by Wells Fargo & Co., with $13.7 billion. Banks that need to bolster capital have until June 8 to develop a plan and until Nov. 9 to implement it.

Potential Losses

Geithner told reporters that regulators took a conservative approach to toting up potential credit losses and calculating the industry’s ability to absorb them through increased earnings. The forecast of future profits was at the “quite low end of analysts’ expectations,” he said.

The results showed that losses at the banks under “more adverse” economic conditions than most economists anticipate could total $599.2 billion over two years. Mortgage losses present the biggest part of the risk, at $185.5 billion.

Jan Hatzius, chief U.S. economist at Goldman Sachs in New York, said banks may be able to rack up enough earnings over the next two years to cover virtually all the remaining credit losses.

The contraction of the financial industry over the last year, including the demise of Bear Stearns Cos. and Lehman Brothers Holdings Inc., has put those that have survived in a better position to post profits, he said.

With the economy showing signs of being close to a bottom, some of the banks may even end up being overcapitalized, added Sung Won Sohn, an economics professor at California State University in Camarillo, California.

Too Easy?

Critics remain unconvinced and charge that the regulators went too easy on the banks in conducting the tests, which were designed to ensure the firms could keep lending even if the economy deteriorated more than most economists expect.

Examiners used an “adverse scenario” of a 3.3 percent contraction in the economy this year, and an average unemployment rate of 8.9 percent in 2009 and 10.3 percent in 2010. Economists see a 2.5 percent drop in output this year, and unemployment rates of 8.9 percent in 2009 and 9.4 percent in 2010, according to a Bloomberg News survey.

“The stress was not much of a stress,” said Joseph Stiglitz, a Nobel Prize winner in economics and professor at Columbia University in New York.

Skeptics of the plan such as Posen said Geithner was trying to make a virtue out of a necessity. With public opposition to bank bailouts high, the Treasury secretary felt constrained from asking Congress for more money to help the industry. Treasury has about $110 billion left in the $700 billion bank-rescue package approved by lawmakers last year.

Ready for More

Geithner said the Treasury had enough money remaining in the Troubled Asset Relief Program to cover the banking industry’s needs. Still, he made clear that President Barack Obama wouldn’t hesitate to ask Congress for more should that prove necessary.

It was public opposition to bank bailouts that prevented Japanese policy makers from taking more forceful action to aid the country’s financial industry in the 1990s.

Like the U.S., Japan at first responded by putting capital into the banks, in 1998 and 1999. The crisis wasn’t fully resolved until 2002, after the government forced the banks to write down or sell off bad loans and effectively nationalized one institution, according to Takeo Hoshi, dean of the School of International Relations and Pacific Studies at the University of California at San Diego.

“I find more and more similarities to Japan as the situation develops here,” he said.

Relying on Partnerships

Geithner is counting on yet-to-be launched public-private partnerships to buy up the impaired assets that remain on bank balance sheets. The partnerships will be financed by low-cost credit via the Fed and the Federal Deposit Insurance Corp.

R. Glenn Hubbard, a former chief White House economist under President George W. Bush, voiced doubts the partnerships would work and argued that more dramatic action -- and taxpayer money -- will be needed to fix the financial system.

“Some more radical solution is going to be in order,” such as dividing troubled institutions into so-called good banks and bad banks, said Hubbard, who is now dean of the Columbia University Graduate School of Business in New York.

Kenneth Rogoff, a former IMF chief economist who’s now at Harvard University in Cambridge, Massachusetts, also said he fears the administration isn’t being forceful enough. Like Japan in the 1990s, Obama has put forward a big fiscal stimulus program to try to get the economy moving again, yet may have been too cautious in acting to repair the financial system.

“If the banking plan still falls short, the fiscal stimulus will have been wasted to some extent,” Rogoff said. “We could end up like Japan, sliding in and out of recession.”

To contact the reporters on this story: Matthew Benjamin in Washington at mbenjamin2@bloomberg.netRich Miller in Washington rmiller28@bloomberg.net"

Healthier banks have complained since Congress attached what the banks consider onerous restrictions to the bailout funds.

TO BE NOTED: From the NY Times:

"U.S. May Set a Debt Test for Banks

By ERIC DASH

The Treasury Department is planning to require banks seeking to free themselves from the government’s grip to show that they can survive without the taxpayer aid that has helped them through the financial crisis, senior government officials said Tuesday.

Banks have been enjoying an indirect subsidy adopted by the government last fall that allows them to issue debt cheaply with the backing of the Federal Deposit Insurance Corporation. The Treasury is expected to announce as early as Wednesday that healthier banks must show that they can issue debt without the guarantees before they are allowed to repay the money they accepted from the Troubled Asset Relief Program, or TARP.

The banks also must demonstrate that they will be able to sell stock to private investors and pass a government stress test to show that they are healthy enough to survive without the taxpayer aid.

The Obama administration plans to publicize the results of stress tests for the nation’s 19 largest banks on Thursday. The results are expected to reveal that a number of them need additional capital.

They are also expected to show that several banks — including Bank of New York Mellon, Goldman Sachs and JPMorgan Chase — are healthy enough to repay TARP funds.

Even before the conditions were formally announced, several banks were trying to raise money in the financial markets without relying on the F.D.I.C. backing.

Banks have grown eager to repay TARP money as quickly as possible, to rid themselves of compensation caps and other restrictions that they complain has hurt their competitiveness.

On Tuesday, Bank of New York Mellon announced it had raised $1.5 billion by selling debt not guaranteed by the F.D.I.C., in a move that positions it to repay the government.

The deal was oversubscribed by investors at a lower cost than previous sales, a sign that analysts said showed how credit was thawing for stronger banks.

JPMorgan Chase raised $3 billion of nonguaranteed debt in April, after a similar offering the month before.

Goldman Sachs sold $2 billion in nonguaranteed debt in late January, and took the additional step of raising $5 billion from private investors after it reported earnings last month.

Healthier banks have complained since Congress attached what the banks consider onerous restrictions to the bailout funds.

At a White House meeting with President Obama in late March, several banks asked the administration to lay out a plan for them to repay the money.

Mr. Obama said he understood their concerns, but did not want to undermine his effort to bolster lending.

The large banks were later told that they would have to wait for the results of the stress tests before they could repay TARP.

So far, only 11 small banks that did not undergo the stress tests have been permitted to repay the bailout money.

But they also must buy back warrants they issued to the Treasury to completely extricate themselves from the government. The warrants are a mechanism that ensure taxpayers will share in any upside for providing aid to the banks.

But banks have been tussling with Treasury over how much they should pay to repurchase the warrants from the government.

It is so difficult to find common ground that just one bank, Centra Financial of West Virginia, has bought back the securities.

That could pose an additional hurdle for bigger institutions like JPMorgan Chase or Goldman Sachs to fully untangle themselves from the government.

On Tuesday, Federal Reserve officials privately delivered the final stress test results to the banks after more than a week of intense negotiations.

Citigroup, Bank of America, Wells Fargo, PNC Financial and several other large regional lenders argued that they were much stronger than the regulators thought, hoping to avoid raising additional capital.

Citigroup, the largest and most deeply troubled of the banks, is expected to need $5 billion to $10 billion of additional capital, according to people briefed on the final results.

Citigroup executives say the bank can easily cover any shortfall, and is considering several options to close that gap.

Among them are efforts to accelerate the sales of several businesses within Citi Holdings, a holding tank for assets it plans to shed, or to expand its common stock conversion plans to a broader base of private investors who hold Citigroup preferred stock.

Both measures would avoid an increase in the government’s expected 36 percent ownership stake."

On this, as with repayment, the government is speaking out of both sides of Geithner's mouth.

TO BE NOTED: From ChumpChanger:

"The Two Faces Of The Treasury

So does Timothy Geithner want banks to repay TARP funds or not? It seems to me that in Geithner's latest testimony you can find any answer you prefer. On the one hand, the stress tests are supposed to determine which banks have sufficient capital to return government money. On the other, whether the government will take it back will be determined not only by the tests, but whether it is in the national interest: in other words, Treasury would prefer that banks lent out the money than that they return it. The initial assumption that banks that didn't take money would be at a competitive disadvantage has been replaced by another idea (admittedly already present in Hank Paulson's initial pitch) that dividing banks into government supported, tottering ones and self supported stable ones would put the government supported banks at a disadvantage.

There's another, unspoken, assumption--or maybe hope--here, though, which may be even stranger. It is that adding more capital to the banks will make it feasible for them to increase lending to levels that will jump start the economy. To some extent, of course, that's true. Cheap money will be lent out. However, what's keeping the stronger banks from lending right now is not a lack of capital. It is rising losses on loans they've already made. Loans that were risky before are more so now in the midst of a recession, and there is no magic solution that will both increase lending and reduce risk. This ultimately is Treasuries dilemma: telling banks to lend more and do it more responsibly at the same time. On this, as with repayment, the government is speaking out of both sides of Geithner's mouth.

By Mark"

So does it help if your mother converts her loan into a share of the business?

From the NY Times:

---

April 20, 2009, 2:39 pm

Preferred shares to common equity: an analogy

A followup to my previous post. Here’s how I think about it: you started a business with a bunch of borrowed money, but of course had to put some of your own money in. Now, actually some of the money you put in was borrowed from your mother, but the original lenders don’t care about that, since they have prior claim.

Eventually you run into some business difficulties, and your creditworthiness is in doubt — which in turn is making it hard for you to do business. What you need is evidence of ability to repay the money you already owe.

So does it help if your mother converts her loan into a share of the business? Not really, because she won’t get repaid anyway unless all your other creditors get paid first. So the terms of her agreement with you don’t affect their prospects of payment.

And in this case, the TARP is your mother."

Me:

Your comment is awaiting moderation.

“So does it help if your mother converts her loan into a share of the business? ”

It does if she wants to run the business. Some people, well, beings, would rather rule in Hell than serve in Heaven. Go figure.

— Don the libertarian Democrat

shareholders of the banks are wiped out and the bondholders become the shareholders, using taxpayer money to keep the institutions functioning

TO BE NOTED: From Bloomberg:

Stiglitz Says White House Ties to Wall Street Doom Bank Rescue

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By Michael McKee and Matthew Benjamin

April 17 (Bloomberg) -- The Obama administration’s bank- rescue efforts will probably fail because the programs have been designed to help Wall Street rather than create a viable financial system, Nobel Prize-winning economist Joseph Stiglitz said.

“All the ingredients they have so far are weak, and there are several missing ingredients,” Stiglitz said in an interview yesterday. The people who designed the plans are “either in the pocket of the banks or they’re incompetent.”

The Troubled Asset Relief Program, or TARP, isn’t large enough to recapitalize the banking system, and the administration hasn’t been direct in addressing that shortfall, he said. Stiglitz said there are conflicts of interest at the White House because some of Obama’s advisers have close ties to Wall Street.

“We don’t have enough money, they don’t want to go back to Congress, and they don’t want to do it in an open way and they don’t want to get control” of the banks, a set of constraints that will guarantee failure, Stiglitz said.

The return to taxpayers from the TARP is as low as 25 cents on the dollar, he said. “The bank restructuring has been an absolute mess.”

Rather than continually buying small stakes in banks, weaker banks should be put through a receivership where the shareholders of the banks are wiped out and the bondholders become the shareholders, using taxpayer money to keep the institutions functioning, he said.

Nobel Prize

Stiglitz, 66, won the Nobel in 2001 for showing that markets are inefficient when all parties in a transaction don’t have equal access to critical information, which is most of the time. His work is cited in more economic papers than that of any of his peers, according to a February ranking by Research Papers in Economics, an international database.

The Public-Private Investment Program, PPIP, designed to buy bad assets from banks, “is a really bad program,” Stiglitz said. It won’t accomplish the administration’s goal of establishing a price for illiquid assets clogging banks’ balance sheets, and instead will enrich investors while sticking taxpayers with huge losses.

“You’re really bailing out the shareholders and the bondholders,” he said. “Some of the people likely to be involved in this, like Pimco, are big bondholders,” he said, referring to Pacific Investment Management Co., a bond investment firm in Newport Beach, California.

Bigger Losses

Stiglitz said taxpayer losses are likely to be much larger than bank profits from the PPIP program even though Federal Deposit Insurance Corp. Chairman Sheila Bair has said the agency expects no losses.

“The statement from Sheila Bair that there’s no risk is absurd,” he said, because losses from the PPIP will be borne by the FDIC, which is funded by member banks.

“We’re going to be asking all the banks, including presumably some healthy banks, to pay for the losses of the bad banks( NB DON ),” Stiglitz said. “It’s a real redistribution and a tax on all American savers.”

Stiglitz was also concerned about the links between White House advisers and Wall Street. Hedge fund D.E. Shaw & Co. paid National Economic Council Director Lawrence Summers, a managing director of the firm, more than $5 million in salary and other compensation in the 16 months before he joined the administration. Treasury Secretary Timothy Geithner was president of the New York Federal Reserve Bank.

‘Revolving Door’

“America has had a revolving door. People go from Wall Street to Treasury and back to Wall Street,” he said. “Even if there is no quid pro quo, that is not the issue. The issue is the mindset.”

Stiglitz was head of the White House’s Council of Economic Advisers under President Bill Clinton before serving from 1997 to 2000 as chief economist at the World Bank. He resigned from that post in 2000 after repeatedly clashing with the White House over economic policies it supported at the International Monetary Fund. He is now a professor at Columbia University.

Stiglitz was also critical of Obama’s other economic rescue programs.

He called the $787 billion stimulus program necessary but “flawed” because too much spending comes after 2009, and because it devotes too much of the money to tax cuts “which aren’t likely to work very effectively.”

“It’s really a peculiar policy, I think,” he said.

Plan Deficient

The $75 billion mortgage relief program, meanwhile, doesn’t do enough to help Americans who can’t afford to make their monthly payments, he said. It doesn’t reduce principal, doesn’t make changes in bankruptcy law that would help people work out debts, and doesn’t change the incentive to simply stop making payments once a mortgage is greater than the value of a house.

Stiglitz said the Fed, while it’s done almost all it can to bring the country back from the worst recession since 1982, can’t revive the economy on its own.

Relying on low interest rates to help put a floor under housing prices is a variation on the policies that created the housing bubble in the first place, Stiglitz said.

“This is a strategy trying to recreate that bubble,” he said. “That’s not likely to provide a long run solution. It’s a solution that says let’s kick the can down the road a little bit.”

While the strategy might put a floor under housing prices, it won’t do anything to speed the recovery, he said. “It’s a recipe for Japanese-style malaise.”

Goldman Sachs recorded a gain “over time” on the value of the hedges it bought to guard against a default on AIG

TO BE NOTED: From Bloomberg:

"Goldman Sachs’s Viniar ‘Mystified’ by Interest in AIG (Update1)

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By Christine Harper

April 14 (Bloomberg) -- David Viniar, Goldman Sachs Group Inc.’s chief financial officer, said he’s “mystified” by the interest investors and government officials have shown in the bank’s trading relationship with American International Group Inc.

“They’re one of thousands and thousands and thousands of counterparties and the results of any trading with AIG are completely immaterial to what we do,” Viniar said today in an interview. “I am mystified by this fascination with AIG.”

Goldman Sachs, the most-profitable securities firm before converting to a bank last year, received more cash from AIG after the Federal Reserve rescued it last year than any other counterparty. The company has said it was insured against any losses from AIG and it didn’t benefit from the government’s rescue of the New York-based insurer. The Treasury Department’s chief watchdog for the financial rescue program is investigating whether AIG paid more than necessary to banks.

Viniar told analysts today that any profits related to AIG in the January-to-March quarter “rounded to zero,” as most of the transactions were unwound before the end of the year. In an interview, he also said profits in December weren’t significant.

‘Rounded to Zero’

“I would never tell you that we didn’t book any profit, I don’t even know,” he said. “I couldn’t tell you with any counterparty that we booked zero, but I could tell you it rounded to zero.”

After AIG was rescued by the U.S. from collapse last year, banks that bought credit-default swaps got $22.4 billion in collateral and $27.1 billion in payments to retire contracts, the insurer said last month.

Neil Barofsky, special inspector general for the government’s Troubled Asset Relief Program, began an audit two weeks ago into whether there were attempts by AIG or the government to reduce the payments, according to an April 3 letter to Representative Elijah Cummings. The Maryland Democrat requested the probe last month along with 26 other members of Congress.

Lawmakers, frustrated with the cost of an AIG bailout that has expanded three times, have asked why about $50 billion was paid after the initial September rescue to banks that bought credit-default swaps from the firm. The audit will reveal who made “critical decisions” regarding the payments and provide an explanation for the actions, Barofsky said.

‘Misperceptions’

Viniar held a conference call on March 20 to answer questions about the firm’s trading relationship with AIG and to “clarify certain misperceptions.”

When AIG was rescued, Goldman Sachs had $10 billion of exposure to the insurance company that was offset with $7.5 billion of collateral as well as credit-default swaps that would have paid off in the event of an AIG bankruptcy, Viniar said on the March 20 call.

He also said on the call that Goldman Sachs recorded a gain “over time” on the value of the hedges it bought to guard against a default on AIG, even though the government enabled the insurer to honor its obligations. In today’s interview, he said those gains were booked “from 2006 to now” and that any gains booked in the first quarter “would have been very, very small.”

Goldman Sachs reported late yesterday that it earned $1.81 billion, or $3.39 per share, in the first quarter on record revenue from trading fixed-income, currencies and commodities. The firm also raised $5 billion by selling stock at $123 per share, a 5.5 percent discount from yesterday’s closing price.

To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net."

protecting insurers -- who are among the big holders of bank debt -- is one of the reasons that we've protected bank bondholders

TO BE NOTED: From Clusterstock:

"Treasury Will Expand TARP To Bail Out Insurers (HIG, LNC, PRU)

Joe Weisenthal|Apr. 7, 2009, 9:41 PM|

Print

Tags: Wall Street, Treasury, Bailout, TARP, Financial Services, Insurance, Financial Crisis, Tim Geithner

HIG Apr 7 2009, 07:38 PM EDT

8.45	Change	% Change
	-0.96	-10.20%

LNC Apr 7 2009, 07:41 PM EDT

6.89	Change	% Change
	+0.51	+7.99%

PRU Apr 7 2009, 06:41 PM EDT

22.10	Change	% Change
	-0.71	-3.11%

Life insurance companies are facing many of the same solvency challenges as banks, and have been trying desperately to get under the TARP. Some, like Hartford Insurance (HIG), have announced acquisitions of thrifts banks in hopes of garnering eligibility.

In fact, Hartford has been nursing its potential acquisition to the tune of $20 million in loans while it finds out whether the move will make it eligible.

Well it looks like they're in luck.

WSJ says the move to allow insurer participation will be announced in the next few days:

How much money would be available to the insurers remains unclear. The Treasury says it has about $130 billion remaining in TARP funds. Life insurers that are bank holding companies have been eligible for TARP for some time, but the Treasury had not yet given the green-light to approve their applications.

Several have applied, including Prudential Financial Inc. (PRU), Hartford Financial Services Group Inc. (HIG) and Lincoln National (LNC) Corp. No decisions have been made yet about which applications will be approved, these people said.

Bear in mind that protecting insurers -- who are among the big holders of bank debt -- is one of the reasons that we've protected bank bondholders so far. Obviously, that alone isn't enough.

Just $130 billion left though. Might take some creativity to stretch it out, since the prospects of getting more from Congress are daunting."