Treasury Handouts Focus on Strongest Banks, Forcing Weaker to Fail or Sell

This Bloomberg article treats as a news item the fact that the Treasury is focusing its equity infusion efforts on strong banks, leaving the rest to find their own exit strategy.

But this approach is not surprise; in fact, it is exactly what Treasury said it would do in a conference call to analysts exactly a month ago.

In theory, this might not be a bad idea. The banking industry needs to be rationalized, since excessive leverage permitted the entire industry to grow well beyond sustainable levels. In 1980, financial firms accounted for 8% of S&P 500 earnings. At the industry’s peak, they were 46% of S&P earnings.

However, the way the Treasury is going about this assures that big firms will become even larger. That is not a plus for systemic stability. The only thing worse than firms to big to fail is firms too big to rescue.

From Bloomberg:

The U.S. government’s $160 billion handout to banks from Niagara Falls to Beverly Hills is going mostly to lenders that need it least, putting weaker rivals at risk of being shut down or taken over, analysts say.

“This has the unintended effect of making the strong stronger and the weak weaker,” said Gray Medlin, founder of Carson Medlin Co., a Raleigh, North Carolina, investment bank focused on banking deals. “Banks that are getting bad exams and are under intense pressure from regulators won’t be successful in applying.”

The government buying spree has so far targeted two dozen regional lenders. One, PNC Financial Services Group Inc., immediately bought a competitor, National City Corp. Another, Saigon National Bank, had almost four times the minimum level of capital before selling a $1.2 million stake.

Treasury Secretary Henry Paulson is doling out cash to recapitalize lenders and jump-start takeovers. Besides PNC and Saigon National, regional lenders that have accepted government stakes in exchange for cash include SunTrust Banks Inc., Capital One Financial Corp. and KeyCorp. They also include City National Corp., in Beverly Hills, and First Niagara Financial Group Inc., in upstate New York.

“The goal with this over time is to drive consolidation,” said Ron Farnsworth, chief financial officer of Umpqua Holdings Corp. in Portland, Oregon, which expects to sell a $246 million stake to the government…

“Those struggling the most probably aren’t going to participate,” said Karen Dorway, president of BauerFinancial, a Coral Gables, Florida-based research firm that studies the financial health of banks. She included as examples Downey Financial Corp., BankUnited Financial Corp. and Vineyard National Bancorp….

The government isn’t forthcoming on explaining the purchase program because of concern it may spark bank runs, said Randy Dennis, president of DD&F Consulting, a Little Rock, Arkansas,firm that advises banks. “Banks that are left out will have to deal with the PR effect of not being included,” he said.

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  1. eh

    For a while in some quarters the word has been that this is part of the thinking: a sort of forced collectivisation. To the benefit of the FOH = friends of Hank of course.

  2. Anonymous

    eh, indeed. Although this is happening in other countries, for the benefit of our friendly investment bankers.

  3. Moopheus

    Yes, it’s sort of lose-lose, isn’t it. The banks that are too weak to survive the crisis should be put out of their misery as soon as possible, and the rest need to be cleaned up. But one way or another, that does lead to fewer banks standing at the end, and the big banks having even more concentrated market share. But at this point is there a way out that doesn’t involve weaker banks failing and/or being absorbed into bigger banks?

  4. General Glut

    Perhaps we should call it “industrial policy by stealth”? Picking winners and losers is supposed to be un-American . . . but that is so last year.

  5. FairEconomist

    Recapitalization should follow revaluation; otherwise the money is wasted. Buying preferred in good banks is a bad deal at current prices; buying in bad banks would be just flushing down the toilet. So the policy is good; the effects may or may not be well thought out. Normally I'd assume this was a goof; but with Paulson, diverting fees to M&A fees and greater powers for his buddies is a real possibility.

  6. tompain

    Even with a $20 bil writeoff of bad loans at NCC, PNC is getting a steal in that deal. NCC had the capital to make it through even with writeoffs of that magnitude. Perhaps the government knew something about NCC that the public did not, but otherwise this was a ripoff of NCC holders and a gift to PNC holders. If the government knows something, it should say so. We urgently need some transparency here, both to ensure that government is not improperly exercising its power and to give clarity to the equity markets so that they do not have to maintain a “government wipeout” premium in the cost of equity they assign to banks. Lower cost of equity for banks is in everyone’s interest.

  7. Anonymous

    I suspect that recapitalizations of KEY and FITB were done to improve confidence in these banks. They’re still suspect in my mind.

    If the recapitalizations were targeted to only strong banks, then why has US Bancorp not recieved any investment from Kaskari?

  8. RangerTurtle

    I thought the strategy was to get rid of insolvent banks, recapitalize the remaining banks and hence, confidence would be restored and that all banks are then solvent and can be lent to and lent from.

    Of course it would have been better to put strong contigencies on the TARP money, like paycuts and especially, NO using TARP funds to buy other banks!

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