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ANALYSIS
March 2, 2009
Sagging Index no longer reflects what’s going on in the market, some say, Replacements? Google it, to start.
March 2, 2009
Downward price spiral will actually boost the cost of capital for most companies. CFOS, take note.
March 2, 2009
The latest bailout at AIG could be a preview of how the president will deal with Wall Street.
March 2, 2009
No corporate defaults. Big debt offerings. Percolating CP issuance. Things may be looking up in the capital markets.
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March 2, 2009 12:01 AM ET
(Bloomberg)
Some observers contend banks such as Citigroup and Bank of America are already wards of the state, although taxpayers own relatively little of their common stock at present. Granted, on Friday the Treasury Department announced it plans to boost its stake in Citi from 8% to as much as 36%. But AIG has already been nationalized, in the sense that the Treasury controls 80% of the insurer’s common through a warrant. The U.S. picked up that warrant, along with preferred shares, in exchange for the taxpayer equivalent of debtor-in-possession financing. But neither the Treasury nor the Federal Reserve—which is administering AIG’s life support—appear to be acting as if taxpayers are the debtors in possession of anything. As analyst and former investment banker Yves Smith noted on her website, Naked Capitalism, “Power is not simply a function of standing, but also of will, and the powers that be seem to have exercised just about no influence, save the ouster of CEO Robert Willumstad and raising a stink about fancy parties.” Regulators say they don’t expect taxpayers to lose money on the deal because AIG must pay interest on the $153 billion in loans it already has received. Moreover, the assets pledged to Uncle Sam as collateral may eventually be sold at a profit. That, of course, raises questions as to why regulators saw fit to supply AIG with another $30 billion—an amount apparently required because of a $62 billion quarterly loss reported by the insurer today. Regulators also appear ready to provide a backstop for AIG’s credit default swaps, as Bloomberg reported. In fact, the on-going AIG bailout is most likely a way to keep big banks from being burned by credit-default swaps they had bought from the insurer. As the Fed stated in a report to Congress on November 10 when the terms of the initial AIG bailout were eased, the company “is a significant counterparty to a number of major national and international financial institutions.” The report went on to note that $250 billion in swaps that AIG sold to those institutions were designed to provide them with “regulatory capital relief.” Around $30 billion in assets covered by the swaps were put into a Fed-financed vehicle for the purpose of selling them off and thus extinguishing the swap contracts. But those assets were limited to bad mortgages, not corporate loans and European debt. Apparently, those are now going south as well. And as AIG’s capital goes, so goes that of those unidentified counterparties. “Does this mean that the US government is now supporting European Financials in their efforts to minimize regulatory capital?” asks Tim Backshall, chief strategist at Credit Derivatives Research. It seems that way. But if Uncle Sam is simply going to hand AIG another $30 billion—when taxpayers already have the right to liquidate the company’s assets—then banks probably won’t be treated any differently, observers say. Thus, bankers may not have to worry about getting smacked around by the White House. What bankers do fear is “preprivatization.” That’s a term MIT professor Simon Johnson applies to the Bush/Obama approach to financial bailouts, as opposed to the painful restructuring that real nationalization would bring. As Mr. Johnson put it on his website, The Baseline Scenario, “We have state control of finance without, well, much control over banks or anything else. Responsibility without power sounds accurate.” Responsibility with power would likely require AIG and other financial wards of the state to write down their assets so good assets could be separated from bad and sold off to new investors. That’s a prospect that existing shareholders should fear, since their holdings stand to be wiped out in the process. And the managers responsible for the banks’ problems would follow in Willumstad’s footsteps. But such an approach could be good for the financial system and the economy. It’s not as if bailouts without strings are likely to re-inflate the housing bubble. Just ask Japan. Its economy limped along for years because it let its zombie banks carry bad assets at book value after its real estate market collapsed in the early 1990s. As Adam Posen of the Peterson Institute for International Economics testified before the Joint Economic Committee of Congress on Friday, “These kind of half-measures to keep banks open rather than disciplined are precisely what the Japanese Ministry of Finance engaged in.” A decade of post-bubble Japanese-style stagnation would be a disaster but evidently the best regulators think they can do. Yet critics think such a fate can be skirted. “Keeping zombie banks alive is unlikely to restore capital to the system,” Viral Acharya, a finance professor at the New York University’s Stern School of Business, told Financial Week. “We need to separate good assets from bad to cleanse the system and get it back on its feet in 10 to 15 months.” Obama suggested he shared such a goal in his address to Congress last Tuesday, but the terms outlined last week of the Treasury’s new bailout plan stop well short of doing what Arharya recommends. The stress tests to which the Fed has begun subjecting big banks won’t require their restructuring even if they’re found to need more capital and can’t get it from private investors. What’s more, Federal Reserve Chairman Bernanke last week dismissed concerns about moral hazard by likening them to a homeowner’s refusal to call the fire department when his neighbor’s house goes up in flames because he was smoking in bed. By Bernanke’s logic, investors should therefore ignore the financial equivalent of smoking in bed. And indeed, investors seemed to like that logic, and so drove up the value of bank stocks in the wake of the Fed chairman’s statement and news of the Treasury’s terms for further capital infusions. But in light of the actual condition of banks’ assets, the rally may not restore investor confidence for long. Listen again to Mr. Posen before Congress: “Pretending that distressed assets are worth more than they actually are today for regulatory purposes persuades no one besides the regulators, and just gives the banks more taxpayer money to spend down, and more time to impose a credit crunch.” If Obama takes a tough stance with bailouts, however, Bernanke may change his tune, and the Treasury might use the control it obtains through the convertible preferred shares it obtains from banks to restructure them. This will require regulators to bite the bullet by demonstrating as much—if not more—concern for taxpayers than existing shareholders. Some economists say AIG may be the place to start, with the immediate write-down of the insurer’s bad assets and sale of its good ones. Otherwise, said Stern’s Acharya, “management can continue to play a waiting game” in hopes that taxpayer funds will tide AIG over until asset values improve.
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