Some readers and fellow bloggers have been anticipating an over-the-weekend resolution of some sort for Citigroup and/or Bank of America, given the impressive fall (admittedly from already distressed levels) in their stock prices over the last ten days.
I could well be proven wrong, but I didn’t expect it this weekend, and I don’t see it happening…..yet. It will take another trigger, which could very well come shortly.
The reason that stock price falls in the past have provided the impetus for nailbiting and sometimes precipitous government action has been that the bank (and the same dynamic applies to the monolines) were under pressure to bolster capital levels somehow to avoid downgrades. Given that accomplishing that via retained earnings seemed unlikely to impossible, with continued writedowns likely, the only hope was new capital raising. A certain amount of that could be accomplished via the issuance of preferred stock, but the ratings agencies had limits on the ratio of common to preferred, and most affected institutions would need in pretty short order to issue stock. So a tanking share price would greatly lower the odds of shoring up capital levels (it would be massively dilutive, assuming it could even be carried off).
With the TARP, for better or worse, that pressure is in abeyance. The Treasury has given money to banks on non-market terms; there is no reason to think that won’t continue.
I see no desire of Geithner and Summers to move forward on pre-emptively-take-zomibe-banks-out front. Geithner announced his plan to have a plan; Obama is making an announcement of some sort next week (apparently an effort to soothe rattled nerves; presumably some elements of the Geithner work in progress will be released to shore up confidence).
Team Obama is still on Plan A, which is “we can patch this up with the duct tape and bailing wire we have on hand” and they really want to play that out if at all possible. I’m sure they believe that when, for instance, the trillion dollar consumer credit facility is out buying credit card, student loan, and auto receivables, that that will lead to more commercial bank lending (ie fee generation on their part) and we will see some halting progress towards normalcy.
Now what could force their hand is a run on either bank, either depositors (replay of WaMu, on a bigger scale) or counterparties refusing to extend credit or moving accounts out (the Bear scenario). The possible perps of a deposit run would be those whose balances exceed FDIC guarantees (most likely businesses, since if you have payroll of any size, it is impractical operationally to divide your payroll processing among a lot of banks, and you need to have enough cash in the till to make the payments) and foreign depositors. As Felix Salmon noted earlier, Citi has a LOT of foreign deposits. as in….over half a trillion (this relative to a balance sheet of $1,9 trillion).
I haven’t (yet) seen any indication of counterparties headed for the exits. Again, with the government apparently at ready to throw cash at institutions deemed systemically important, there is far less cause for anxiety. Everyone seems to have gotten the memo that there won’t be a second Lehman.
Now let us go to part two. Let us say the stock markets are right, and something happens to push one of these two a lot closer to the edge.
As much as the drumbeat for nationalization/receivership is increasing, I don’t see that happening either (and I would really prefer to be wrong here, see related post). First is the fact that (as I am told by those more expert than me in these matters) that neither bank could be taken out involuntarily over a weekend. Part of the reason apparently is that the FDIC is too short-staffed; it had 20,000 employees during the S&L crisis, it is now down to about 5,000, and the cuts in the staff that handle receivership were deeper. It would take more planning and lead time. Maybe the stress tests are a Trojan horse for this course of action. They seem to be far too superficial to be useful (Stiglitz among others, as reader Dwight pointed out, has made this observation), but the banks may be so deeply under water that a cursory exam will show that.
But the other issue is that these banks (Citi in particular) have operations way way outside the FDIC’s normal ken: big overseas offices, and large capital markets operations. Does the FDIC have the foggiest idea of what to do with a CDS book, CDOs, foreign currencies (some of the exotics and long dated forwards can create headaches, particularly in volatile markets like the ones we have today), proprietary trading operations, prime brokerage? And forget the SEC, they’ve never taken interest in these areas.
So we have two constraints, albeit both operational: a receivership for banks of this size would take longer to put into place than another cobbled together bailout package of some sort. And the power that be almost certainly do not have any sort of blueprint for how to put a major capital markets operation into some form of receivership, either mechanically or legally.
The latter problem is an appalling, criminal lapse. When Bear went under, it illustrated vividly how quickly securities firms go down (Drexel Burnham also went poof). Securities firms collapse into liquidation. Counterparties will not trade with a bankrupted entity. They have to extend credit in order to trade (repos and reverse repos are the lifeblood of trading), and no one is going to extend new credit to an entity in receivership.
It was also VERY well known at the time of the Bear collapse that other securities firms were at risk. Lehman was top of the list, but other names were bandied about: UBS, Morgan Stanley, Merrill. But Paulson & Co. were in kick the can down the road,. There is no evidence they made any effort to determine whether some change in procedures, regulations, or even bankruptcy law, might allow for a more orderly resolution of a failing large investment bank. But no, instead the officialdom decided to redefine the problem. Lehman was deemed to be systemically unimportant since the powers that be had never bothered to develop a Plan B, and Plan A, fobbing it off on the industry, turned out to be a non-starter.
Now it may have been there was no tidy solution, or any “tidy” solution would have required legislative changes that might have been awkward to impossible to get through. For instance, it may have been possible to segregate certain operations and put them in receivership of some sort to reduce the scale of the damage. Regardless, the failure to even consider the issue is an unforgivable failure of foresight.