Banks Need Bailouts, But Where's The Money?

At the G7 meeting Paulson says market turmoil is 'serious, persisting'.

The current turbulence in the world's financial markets is both 'serious' and 'persisting,' and it will take time to work through, US Treasury Secretary Henry Paulson told his counterparts from the world's seven richest nations.

'As the financial markets recover from this period of stress, as of course they will, we should expect continued volatility as risk is repriced,' Paulson told reporters in a prepared statement after meeting with finance chiefs from the Group of Seven.

My Comment: "Repricing of risk" is synonymous with "more capital needed".

'While financial markets are improving, it will take time to work through the current financial turmoil,' he said.

The Treasury chief expressed confidence in the world's largest economy, telling his counterparts that the United States would 'continue to grow' this year.

My Comment: You can't "continue" to grow if you're not growing. The US is in recession and it is going to be a deep one.

The former Goldman Sachs (GS) executive urged financial institutions to come clean about weak balance sheets.

'Past episodes of financial turmoil have demonstrated that recognizing losses and restoring capital are two of the very most important steps toward restoring financial normalcy,' he said.

Banks Need To Raise Capital Quickly

Reuters is reporting Paulson:Banks need to raise capital quickly.

U.S. financial institutions have to realise losses and raise capital quickly to stave off a credit crunch, U.S. Treasury Secretary Henry Paulson told the Nikkei business daily.

"The worst thing is if they don't raise capital, if they shrink their balance sheet, and then restrain their lending," Paulson said in an interview with the Nikkei published on Saturday.

Paulson also said financial institutions, including monoline bond insurers, must look to the private sector, not the government, to strengthen their capital, denying using public funds to support the banking system.

Paulson also said he welcomes investments from sovereign wealth funds, saying he has had many conversations with them and they all assured him that they are driven by the desire to maximise their returns.

Heart Of The Matter

Let's get to the heart of the matter. Paulson is saying that US banks are capital impaired. With a continual repricing of risk, walk aways and rising credit card defaults, banks are becoming more capital impaired with each passing day.

Paulson's statements are in stark contrast to those made by the Jim Glassman, senior U.S. economist at JPMorgan Chase & Co.

"There is no such thing as a banking system short of reserves. The Fed has absolute control over the supply. ... In a world where the Fed can print money, there is no shortage. The banks get the reserves they want."

My rebuttal to Glassman and the origin of those statements can be found in Borrowed Reserves And Tin-Foil Hats.

Obviously Paulson agrees that reserves cannot be printed into existence. Furthermore, and this is critical, Paulson recognizes there is insufficient means within the US to raise those reserves. The question is not one of liquidity but one of solvency.

Federal Reserve Emergency Powers

In the Panel on Government Sponsored Enterprises, Poole spoke on the Emergency Powers of the Fed.

In the interest of a full understanding of the Federal Reserve’s powers in the event of a crisis in the market for GSE obligations, I’ll outline the Fed’s powers as provided by the Federal Reserve Act.
....
The Federal Reserve has ample power to deal with a liquidity problem, by making collateralized loans as authorized by the Federal Reserve Act.

The Fed does not have power to deal with a solvency problem. Should a solvency problem arise with any of the GSEs, the solution will have to be found elsewhere than through the Federal Reserve.

The Fed can print easily enough. A string of coupon passes would do it (at the risk of sinking the US dollar of course). However, that would not put reserves into capital impaired banks, nor would it spur lending in a world awash in over capacity.

Where's The Money?

Right before he left Washington for Tokyo to meet Group of Seven (G7) financial leaders Paulson said: "If there's any doubt that they [banks] will not have enough capital, they should go out and get capital where it is available." Good luck!

Bank Of America Is Paying 3.7% On CDs in an attempt to raise money. Countrywide is bordering on desperation given the yield on short term treasuries and the Fed Funds Rate.

Here is a Countrywide Financial ad effective Saturday, February 9, 2008.



Does anyone see a hint of a problem here?

If not, here it is: 15 year mortgages are currently at 5.04% as stated by Bloomberg and cost of funds for Countrywide are 4.75%. That may look like a positive rate of return but it's not close, all things considered.

From Bad To Worse

Please consider the Fortune article Countrywide: From bad to worse.

The troubled lender posted a $422 million loss and revealed that a third of its subprime loans are delinquent.

The loss threw cold water on Countrywide chief operating officer Steve Sambol's confident assurances to investors in October that, "We view the third quarter of 2007 as an earnings trough, and anticipate that the company will be profitable in the fourth quarter and in 2008." Seen in this light, Countrywide's fourth-quarter loss, compared to a $621 million profit a year ago, is what the numerous class action attorneys circling Countrywide (CFC) will surely call "an unfavorable fact." Countywide finished 2007 with a loss of $704 million.

The numbers didn't appear to faze Bank of America CEO Ken Lewis's determination to acquire Countrywide, however. In a conference Tuesday, Bloomberg quoted him as telling investors. "Everything is a 'go' to complete this transaction.

Banks Compete For Capital

Here's a partial list of 6 month high yield CDs from Bankrate.Com.



click on chart for sharper image

Banks are competing for capital at unattractive rates. Countrywide is competing for capital at panic rates.

So where is the money? It's not in the US. Paulson has resorted to begging sovereign wealth funds to bail out capital impaired US banks.

Key Questions

• Is a massive sovereign wealth fund bailout of the US coming?
• When?
• How much is needed?
  
• At what price?
• Will it save the economy?

The answers to the first two questions are unknown. The answer to the third question goes up every day. The answer to the fourth question is: If there is a bailout, it will be at a very steep price. For proof, consider Cost of Capital "Ratchets Up" at Citigroup and Merrill.

For now, let's assume the bailout comes, on time, and as much as needed. The critical question then becomes "Will It Save The Economy?" The correct answer to that question is "How Can It?

Paulson and Bulls Clinging To Misguided Hopes of what sovereign wealth funds can do will have their hopes dashed yet again.

The party is over even though hope lingers on.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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