Now It’s Official: Treasury Can’t Influence How Banks Use Cash Infusion

Per Bloomberg, Treasury operatives have admitted, despite Henry Paulson’s protestations to the contrary, that the government can only hope for the best in how the nine banks given a collective $125 billion cash infusion early in the week make use of the loot:

Treasury Secretary Henry Paulson persuaded nine major U.S. banks to accept $125 billion in government investment. Getting them to lend it out may prove a tougher sell.

The equity stakes the government is purchasing in Citigroup Inc., Morgan Stanley and seven other big institutions come with no guarantee that the investments will spur lending and unfreeze credit markets. Nor do they give the government board seats or any other leverage to demand that that the firms actually use the money to help the economy.

“The truth of the matter is, they can’t put a gun to their head and say you have to lend this money,” said Charles Horn, a former official at the Office of the Comptroller of the Currency, part of the Treasury Department, and now a partner at the Mayer Brown law firm in Washington.

Treasury officials acknowledge they can’t force banks to get the taxpayer money into the hands of their customers. Instead, officials are betting that the government’s investment will create conditions where banks have a greater incentive to earn profits from lending than to hoard money to shore up their balance sheets.

“It’s in their economic interest,” said David Nason, the Treasury’s assistant secretary for financial institutions, in an interview with Bloomberg Television. “When you give them a stronger capital position and you also provide a certain amount of government backstop to their funding sources, it’s incumbent upon them to go out and continue to lend.”

In the old days, when bankers and corporate executives had some respect for authority, moral suasion, aka “jawboning” could prove effective. Those days now seem to be a distant memory.

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  1. Anonymous

    So essentially they’ll hide this money somewhere to keep themselves going for a few more weeks while the economy tanks then use it to give themselves and their buddies a nice severance?

    Brilliant. Rockefeller 2.0 folks.

  2. Anonymous

    How about “You lend out this money, or we’ll make you lift up your skirt and reveal your balance sheet, Level 3 assets and all”?

  3. CrocodileChuck

    And I thought the Crony Capitalism in Soeharto’s Indonesia was peculiar to that country!



  4. Anonymous

    Banks would never reveal their level 3 asset sheets, that’d be admitting they are lying crooks worth being charged with treason for destroying America overnight. They’d rather set the computers on fire and go ‘whoops’ guess its gone and go hide on some island somewhere.

    Enron was an amateur at book cooking compared to banks.

  5. doc holiday

    The premise of perpetual preferred stock is fairly open ended and each bank will list in its charter what rights are allowed; you go to any bank SEC docs and see how they define shareholder rights regarding preferred shares, i.e, Treasury does not run the mechanics of corpoarate rights.

    Thus, I’m not sure what right Treasury has to dictate terms to corporations, and as you will call, Treasury doesn’t have authority to be in the business of commerce. See Treasury Powers. Think in terms of Treasury telling Buffett how to run Berkshire, it’s the other way around, i.e, Buffett just tells Treasury what it wants.

    Also see: further stupidity and retarded crap:

    Both the role and effects of CDS in the current market turmoil have been greatly exaggerated,” Robert Pickel, chief executive officer of the International Swaps and Derivatives Association, said in testimony before the Senate Committee for Agriculture, Nutrition and Forestry yesterday. “To say that CDS were the cause, or even a large contributor, to that turmoil is inaccurate.”

    Credit-default swap trading expanded 100-fold since 2001 as insurance companies, hedge funds and investors used the derivatives to protect against bond losses and speculate on companies’ ability to repay debt. Lawmakers and regulators have called for more oversight of the $54.6 trillion market after the bankruptcy of Lehman Brothers Holdings Inc., which was among the top 10 backers of the contracts.

    Blaming credit-default swaps for the credit crunch “reflects confusion of the various financial products that have been developed in recent years,” Pickel told lawmakers. The securities have a beneficial role to play in helping financial markets allocate risk, he said.

  6. Anonymous

    It would be delicious irony if Wells Fargo announced that they plan to use their share of the loot to move all their mortgage processing to Bangalore, slash 15,000 jobs, and invest the rest in real estate projects in Dubai.

  7. Max

    I’ve been saying this since they first announced the bailout plan. There’s no way to force the banks to lend, therefore the plan is useless.

    Another few billion wasted.

  8. doc holiday

    A few examples:

    The issuance of Enron preferred stock, while providing desired flexibility in connection with possible acquisitions and other corporate purposes, could adversely affect the voting power of holders of Enron common stock and the likelihood that such holders will receive dividend payments and payments upon liquidation and could have the effect of delaying, deferring or preventing a change in control of Enron.

    >> Noncumulative perpetual preferred stock is similar to common stock in its ability to absorblosses. If the Board of Directors does not declare a dividend on noncumulative perpetual preferred stock in any dividend period, the holders ofthe instrument are never entitled to receive that dividend payment. JPMorgan Chase’s outstanding noncumulative preferred stock is a typecommonly referenced as a “FRAP”: a fixed-rate/adjustable preferred stock. However, because the interest rate on FRAPs may increase (up to apredetermined ceiling), the Federal Reserve Board treats the Firm’s noncumulative FRAPs in a manner similar to cumulative perpetualpreferred and trust preferred securities.

  9. Anonymous

    Anon 1:53:

    That’s AFTER the election.

    Embarass the administration before November 5th, and you wake up next to a horse’s head.

  10. doc holiday

    This is chaos, so I don't care what I post, or where, because this has all stopped making sense. I currently don't run a bank, but has anyone seen an example of how this cash injection will be reported for GAAP, or will FASB make up a few new rules, or will this just be a tax write off and IRS will make up new rules? I mean, this is a taxpayer cash being loaned to banks that will then re-loan this back to taxpayers, so is this an asset or liability? I don't even care, I'm just trying to be a smartass, because I know for a fact, nobody has a clue!

    See: In addition, definition of "capital" is clarified. Capital is classified into two categories: "core"or "Tier 1" capital and "supplementary" or "Tier 2" capital. Tier I capital consists of equity capital (common stock and noncumulative perpetual preferred stock) and general reserves from post-tax retained earnings. Tier 2 capital consists of undisclosed reserves, revaluation reserves, general loan loss reserves, hybrid debt capital instruments (such as long term preferred stock and perpetual debtinstruments) and subordinated debt. Total Tier 2 capital is limited to 100 percent of core capital.Loan loss reserves can be included in Tier 2 capital only up to 1.25 percent of risky assets, andsubordinated debt with a minimum maturity of five years may be included up to a limit of 50 percentof core capital.

    >> I guess I need to go back yet again to Chrysler to see how they did the accounting for that bailout… I'm sick of this!

  11. doc holiday

    I’m still looking, so hang tight.

    The United States Congress reluctantly passed the “Chrysler Corporation Loan Guarantee Act of 1979″ (Public Law 96-185) on December 20, 1979 (signed into law by President Jimmy Carter on January 7, 1980)

    Methods of Loan Guarantee Valuation and Accounting Ashoka Mody and Dilip PatroNovember 1996

    A study of loan guarantees used to bail out Chrysler Corporation shows that the U.S.Government’s commitment to alleviate the company’s financial distress made a very significant difference to financing costs (Chen, Chen, and Sears 1986). The method adopted measured returns to the company’s equity and debt following specific government announcements and actions towards implementing the guarantee program. Both the announcements and specificactions resulted in gains to equity and bond holders. An interesting finding is that the gains to equity owners were greater than gains realized by debt holders who were directly guaranteed. The authors suggest that, as residual claim owners, equity holders benefit significantly even when the guarantee is targeted only to debt repayments. Their finding justifies an innovative pricing approach used for the guarantee. In the past, when the government had bailed out corporations in financial distress (such as Lockheed in 1971), the tax payers had, in effect, taken the downside risk but had not gained from the upside when the companies recovered.

    Pricing for Methods of Loan Guarantee Valuation and Accounting the Chrysler loan guarantee corrected this asymmetry and included not only a 1 percent fee on outstanding debt but also warrants on the company’s equity.

  12. Amnon Portugaly

    Treasury Can’t Influence How Banks Use Cash Infusion

    The Paulson’s Bailout Plan to save the U.S. financial system is based on old rules while in this financial meltdown situation thinking outside of the box and new ideas are needed. Thus the plan, based on conventional old rules, most probably won’t work as intended. It also could make things worse as

    By injecting capital and removing troubled ‘toxic’ assets from the balance sheets of the financial institutions, The Paulson Plan will ENABLE the banks to lend again without lingering doubts about their solvency and viability. However, the Paulsen Plan does not ENSURE that those banks and financial institutions that receive bailout aid will increase lending.
    Banks must have BOTH the capability to lend and the willingness to lend. The Paulson plan is aimed at restoring the bank’s ability to lend, at a huge cost to the American taxpayers. However, even with a healthy balance sheet the banks will not lend because of lingering doubts about the solvency of their customers, their ability of paying the loan and the viability of the economy.

    Given the banking system reluctance to provide loans to the real economy, and the collapse of the corporate Commercial Paper market, the only alternative is for DIRECT LENDING to the business sector from the Fed.
    This could include:
    • Fed purchases of commercial paper from corporations and other forms of financing by the Administration to small businesses secured in appropriate ways.
    • Use, say $250 Billion of the Paulson Plan and set up 10 regional banks in the US initially capitalized to the tune of $25 Billion each. Sell shares in these banks worth $25 Billion to private investors with warrants to buy out the government shares at say 5% interest on the original government investment.
    With 10:1 leverage, each of these new banks will have some $500 Billion lending capability or some $5 Trillion in total, ten times the Paulson Plan. These banks having clean balance sheets could easily, along with many sound existing banks, provide the credit the economy needs, even allowing for the failure of other banks with broken balance sheets.

  13. Andrew

    Hi Yves,

    I'm emailing you in regards to an email I sent to you last month about a partnership, have you had a chance to think about it?

    If you would more information about the proposal, please let me know.

    I look forward to hearing from you.

    Kind Regards,
    Andrew Knight.
    Website Manager
    Banking & Finance Division
    Asia-Pacific Region (Australia) Pty Ltd

  14. Glen

    “Let me get this right; You (banks) want me (Fed) to give you $250 billion and have no say in how you use the cash.” Awkward pause “Sure no probs – care for another $250?”

  15. Anonymous

    FYI: In the Chrysler case, Chrysler was saved, along with all the related jobs and
    economic activity. Under the CLGA, Chrysler employees received approximately 15% of the company’s stock, the loan was repaid in full to the government ahead of schedule, and the U.S. government made over $300 million when it sold its stock warrants.

    Bonus Material: The fact that the UAW negotiated the sale of the common
    stock does not change the origin and nature of the costs Chrysler
    paid for the redemption. The provisions of the LGA placed the
    UAW, perhaps anomalously, in the role of representative of the
    largest single block of shareholders in Chrysler. The fact
    remains that although these sellers of Chrysler common stock were
    also employees of Chrysler, they received the cash Chrysler now
    seeks to deduct in their capacities as owners and sellers of corporate stock. Their status as shareholders was not
    “incidental” to the transaction; it was essential.

    The undisputed facts
    show that, although the Government required Chrysler to establish
    the ESOP, it did not require the redemption which gave rise to
    the claimed deduction. Moreover, even if a redemption had been
    required as a condition of the loan guaranty, such a requirement
    would not affect the origin and nature of the redemption as a
    capital expenditure.

  16. Anonymous

    Unless Charles Horn is deliberately playing it close to the vest, his words are rather naive. Of course the government can “put a gun to their head.” The relationship between the regulator and the regulated is a long term marriage in which either side can exert tremendous power by threatening annihilation, through legal or illegal means. Even if it isn’t in the terms of the preferred investment, I assure you that the government has almost infinite tools to “encourage” whatever action it wants. The problem is that the government rarely speaks with one voice, and intelligent coordinated action is difficult to effect. But please, after what we just watched happen with Fannie, Freddie and WaMu, with the government just stepping in and barking out whatever orders it liked, I can’t believe we’re talking about the government’s limitations in this case.

    I was doing a hotel deal in Vietnam recently, and my client wanted assurance from me that as long as we signed the land lease with the government and paid the rent up front, we could build the hotel. I told him, quite gently, that such assurance was impossible. Even if the government agrees today, it can refuse to allow the permits, or drag out a design approval process for years, maybe decades. I told him that he shouldn’t do the deal based on the terms of the lease but rather based on his belief that it was *in the government’s best interest* that the hotel gets built. And he had to keep making sure it was in their best interest, no matter what any documents said.

  17. doc holiday

    The reason this bailout wont work, is because we are bailing out fraud and trying to give value to derivatives that are worthless and then bailout a consortium of crooks with taxpayer cash. Look at Chrysler as a real example of government intervention. Chrysler had crappy cars, but turned around a product and motivated their workforce to be more efficient, and make a profit for the employees and the taxpayers, because of warrants.

    Paulson and Bernanke are suggesting that taxpayers give these financial engineers unlimited shots at supercharging an $800 Billion taxpayer heist, and to roll the dice in a super-casino-bet, intended to wind down their trillion dollar bad bets. Wall street just crashed the global economy and now they wanna try doubling down and going for broke!

    Looking back, bailing out Chrysler, essentially was a simple means to keep several thousand people in the business of building cars that could be sold to people that needed new transportation. If Chrysler would have failed, many of those union employees would have simply been forced to retrain and move on — and the world would have gone on and the business of making cars would have gone on without them. Chrysler was not really that important in a global perspective. Failure was an option then, just as it is now and IMHO, there are crooked banks that need to go under ASAP.

    Hence, when we look at the current argument of financial collapse and global systemic failure, we seem to have a system that has failed, versus a single entity. However, that is the fallacy of this ploy, i.e, to believe that if a few wall street derivative shops close, that the world will fall apart and that your local grocery store will not be able to use currency hedging and swaps and CDS and CDOs and SIVs and to bet the farm on bread futures and hamburger futures and soup derivatives and halloween candy that is linked to shorting toothpaste that uses LIBOR as a reset mechanism for hedging cornflakes.

    The argument of the world crashing is bullshit and IMHO, the only thing that might crash — hopefully will crash, will be the option grant compensation and synthetic careers of a shitload of wall street crooks that hopefully will spend the rest of their lives in nasty prison cells — where the devil will be in the details!

    Life will go on, without the crooks and the crooked banks and life will be better without them!

  18. john bougearel


    The Cash injections comes “with no guarantee the investments will spur lending and unfreeze credit markets.”

    perhaps what the taxpayer really needs to do is buy an insurance policy that the cash injection is properly used for its intended purpose :-)

    Could be a nice little cottage insurance industry of sorts for this bank rescue plan Paulson has cooked up. Just sit back, collect the premiums, and hope the banks don’t misallocate or redirect the funds.

  19. Richard Kline

    Practically speaking, the Guvmint is now a limited partner of these firms, putting up funds but unable to influence operations or policy; a sap, in short. And that seems clearly the way Paulson wants it, which suggests to me what I meant yesterday in comments, that these deals are being done mostly for their value as visuals to the credit markets, not because Paulson wants them to work. Remember, Paulson didn’t _want_ the option of taking equity, so he’s sabotaged the process rather than choosing to get value for the public and the government in this. That’s how I see it.

    Paulson’s process is fascinatingly loathsome; his ‘mock execution’ meeting with the Nine Platinum Members was twisted, and not in a good way. To me, Paulson continues to be a major obstacle to actual effective government intervention in the financial crisis. He appears psychologically incapable of doing anything on the level or for the public good. For _that_ condition, Ehrlichman is a remarkably close comparable. When the country needs a prince, we’re stuck with this toad.

  20. Anonymous

    if the government agrees today, it can refuse to allow the permits, or drag out a design approval process for years, maybe decades…he had to keep making sure it was in their best interest, no matter what any documents said.

    This thought starts to get at the root of the problem. The sovereign is sovereign and can rewrite the Law at a moment’s notice. And in this situation the sovereign is guaranteed to change in a few months, and no one knows what the new king’s policies will be. The sovereign can’t even be sued in his own courts unless he agrees to it. And in the case of TARP the sovereign has specifically barred that.

    Credit markets are structured to abhor risk and uncertainty. Truth is, we now have a total risk inversion. The organized options and futures exchanges have become the most predictable, reliable and functional markets. The debt markets are now the least predictable. How this state of affairs came to be will fuel many a Ph.d dissertation in coming decades.

    Meanwhile Paulson has a new plan every day. Over in euroland Sarkozy announces “Two trillion euros!” one day and the next day says it probably won’t be necessary to really commit that much.

    So is it really there or is it just more jaw boning?

    And meawhile credit markets specialist Yves searches for and fails to find solid ground in quicksand. She can say here that it’s essential to unfreeze lending. What advice would she give in her day job today to a paying customer? Commit now or wait?

  21. Matt Dubuque

    Matt Dubuque

    The taxpayers deserve VOTING seats on the board of every bank receiving funds.

    This of course is heresy among those who pray at the altar of the free markets.

    How can we possibly go against the divine wisdom of the invisible hand?

    It was the free market jihadis that crashed the system.

    They are now HOARDING cash.

    The central banks have done their part. The sovereigns have done their part.

    The banks continue to HOARD their cash and this can EASILY provoke an immediate depression.

    We need VOTING members on the Boards of Directors, representing the people, to get the money flowing to the communities.

    This will be derided as an “outlier” post today.

    Six months from now it will seem FAR more reasonable.

    Matt Dubuque

  22. Bendal

    That does it; every Congressman who voted for this Taxpayer Money Giveaway Bill is NOT getting my vote in November. I’m no economist (an engineer by trade), but I didn’t want this bill passed in the original form because Paulson had no oversight, but it appears that the bill as passed doesn’t limit his power in any reasonable manner anyway.

    At the least he should insist that the banks begin relaxing their constipated lending practices as a prerequisite to getting taxpayer money; it appears, however, that he thinks that just throwing piles of cash at them will cause them to start throwing it back at us.

  23. tompain

    The problem is not lack of control over the banks. The problem is the mixed message that the banks are receiving from the government. On the one hand, Paulson is telling them they’d better lend and it’s good for them to lend. But the banks have already seen that shareholders of institutions that get in too much trouble with their balance sheet will be arbitrarily and summarily wiped out by the government. FNM, FRE, WM, WB all have been the subject of coerced action or confiscation by the government, to the great detriment of shareholders, even though they were not in immediate danger of collapse at the time.

    Recall that the CEOs of FNM and FRE were summoned to a conference room at Treasury on a Friday afternoon and told, to their great surprise, that they were going to hand over their companies and “voluntarily” accept the government’s “bailout”.

    Now the big 9 are summoned to a meeting at Treasury just over a month later, last Friday afternoon, and they are told, to their great surprise, that they are going to “voluntarily” accept a government bailout. Some of them don’t think they need it, like FNM and FRE thought. Some of them don’t understand why those among them who have behaved more responsibly are being treated the same as those who are in deeper trouble, like FNM was surprised to get the same treatment as FRE. But the government tells them to take the assistance OR ELSE. Or else what? The implication seems to be that if you don’t take the assistance now, and you get in trouble later, you will be wiped out the way others have been wiped out. So you take the assistance, recognizing that the government is still very much in the business of wiping out shareholders even though it has been a whole 2 weeks or so since they last did so.

    But now you go back to HQ and ask yourself, what should I do with this new capital in this uncertain environment? The government wants me to lend. But I have seen what happens to those who lend and get themselves in trouble – they are wiped out by Paulson. Why should I risk that, when instead I can hang onto the capital as an extra margin of safety? Paulson might be unhappy about that, too, but I will worry about that later, he’s only going to be here another few months anyway.

    The government would not be needing to put this capital into the banks in the first place if it had not already scared away almost all the private capital. As soon as they send a credible signal that private capital can rely on clearly stated policies the government will follow in its future actions, private capital will begin to flow into the banking sector again.

    Confiscatory government behavior will always drive capital away.

  24. Steve

    As I’ve said from the beginning: no bailouts, no rescue plans for anybody. Let the whole system crash. Let the World see the greed obsessed rotten underbelly of Capitalism as it really is.

    This whole “bailout” is nothing but Capitalists bailing out other Capitalists using Socialistic concepts – buying up and taking control of banks, for instance – so why not let the whole thing crash, if it’s going to?

    Then, maybe, we could build a true Socialist society that would work for the benefit of all.

  25. Anonymous

    Treasury Secretary Paulson, Fed Chairman Bernanke and Federal Reserve Bank of NY president Timothy Geithner are all tools of the banking industry who use taxpayers’ money to do Wall Street’s bidding. Regardless of the economic outcome, which is dubious at best, bankers will be stuffed to the gills with $700 billion dollars of bailout money and will live in style during the coming recession. To think that the free-market crooks on Wall Street will do anything but bend the rules as much as possible and use taxpayers’ money for their own advantage is Pollyannaish.

  26. Anonymous

    If you give it to working families, they will spend it, pay down debt, and save. GM will sell cars, banks will accumulate saving, and, personal debt will fall.

    Most of all, the innocent families on Main Street, won’t suffer for the greed of a few.

    I know, I know…I am a dreamer. I marginalize myself just by putting these words to the comments.

  27. Anonymous

    Anonymous October 15, 2008 3:07 AM said”
    “FYI: In the Chrysler case, Chrysler was saved, along with all the related jobs and
    economic activity. Under the CLGA, Chrysler employees received approximately 15% of the company’s stock, the loan was repaid in full to the government ahead of schedule, and the U.S. government made over $300 million when it sold its stock warrants.”

    Oh and how is that working for Detroit now…Chrysler was saved and the auto industry still collapsed.

  28. Anonymous

    “Per Bloomberg, Treasury operatives have admitted, despite Henry Paulson’s protestations to the contrary, that the government can only hope for the best in how the nine banks given a collective $125 billion cash infusion early in the week make use of the loot”

    Please, take note of THIS:

    (maybe the Masters of the Universe of the one and only superpower could learn something…)

  29. Dave Raithel

    After reading through this and the preceding post and comments re Paulson v. the Bankers, what comes to my mind is this: In an effort to satisfy irreconcilable demands to let the market do what it will while also directing an outcome other than what it would do, the Treaury policy manages to encourage none of the virtues but all of the vices of laissez-faire and central planning…

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