Banks Say Plan to Guarantee Their Debt is Flawed, Ask For a Better Deal

In the wake of the Treasury Department foisting equity infusions onto nine banks, not all of which wanted or needed them, the industry has decided to get in front of these initiatives. The latest bright idea. of guarantees of bank debt, gets a thumbs down from the intended beneficiaries. But sadly, it isn’t the general concept they object to, but the particular version on the table. Predictably, they want to pay less and get more.

One wonders if the government bond guarantee program was designed with intent so as not to be used, but be ready in sketch form to be sweetened if conditions deteriorated further (note this plan is under the aegis of the FDIC, and Shiela Bair appears to be straightforward, but the concept was likely cooked up at the Treasury and the details negotiated with the FDIC).

From Bloomberg:

JPMorgan Chase & Co., Bank of America Corp. and Goldman Sachs Group Inc. are among banks that told the government its program to back their bonds is flawed because it doesn’t have a strong enough guarantee.

The Federal Deposit Insurance Corp. guarantee for repayments in default needs to be clearer, fees are too high and banks need more freedom on whether to opt in, according to a letter from law firm Sullivan & Cromwell LLP posted on the agency’s Web site on behalf of nine banks….

The comments shed light on why almost a month after the government placed its guarantee behind new bank bonds, no U.S. company has yet tested the market. By contrast, under a similar program in the U.K., banks have issued the equivalent of 13.9 billion pounds ($20.6 billion) of government-guaranteed bonds…..

The letter cited the U.K. program as a model because it offers “an unconditional guarantee” of principal and interest when due. Without a similar guarantee, U.S. banks will be “at a significant disadvantage” to their U.K. and European counterparts because their government-backed debt will be more expensive for borrowers and less attractive to investors, the letter said.

Yves here. This logic helped get the US in trouble in the first place, a regulatory race to the bottom. Now we are getting it on the subsidiy side, as the industry hoovers up everything it can. And by all accounts, banks have excess reserves at the Fed. suggesting that they are in no mood to lend, independent of the government guarantees. The bond issuance argument is a red herring.

Back to the article:

Banks asked the FDIC to reduce the fee they must pay to preserve the option to issue both guaranteed and non-guaranteed debt. The FDIC wants to charge a pre-paid fee of 37.5 basis points on outstanding debt as of Sept. 30, scheduled to mature on or before June 30, 2009, in exchange for the freedom to issue both while participating in the program. The group of banks wants to reduce that to a 75 basis-point fee on 25 percent of the outstanding debt. A basis point is 0.01 percentage point.

The other six banks represented in the Sullivan & Cromwell letter were Bank of New York Mellon Corp., Citigroup Inc., Merrill Lynch & Co., Morgan Stanley, State Street Corp. and Wells Fargo & Co.

Credit Suisse Group AG sent a separate letter to the FDIC on Nov. 4.

Without rules that “fully and irrevocably” guarantee repayment, the size of the program and the number of banks that participate will be “significantly below the expectations of the FDIC, the industry, and all interested parties in the health of the U.S. banking system,” wrote Fred Sherrill, managing director at Credit Suisse Securities USA LLC in New York.

Interim rules for the government program fall short of traditional bond guarantees because they leave the timing of principal and interest payments in the event of a bank default open to changes by bankruptcy courts, Sherrill wrote….

Standard & Poor’s issued a report Nov. 10 supporting the banks’ position on the guarantee…

Last week, the agency extended the deadline for banks to choose whether to participate to Dec. 5, so they could “fully consider” the final rules before making a decision.

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  1. Anonymous

    This is more like a robbery then begging. The banks have been told they are too important to fail so why not grab every penny they can from their governments.

    Greed is God.

  2. Richard Kline

    Only 68 shopping days left; the banksters are playing it close for that final markdown firesale on taxpayer assets. If there was any spectacle less edifying than watching plutocrats steal from the public purse, it would be Dubya getting caught stealing White House silver on his way to the helicopter pad come departure day.

  3. K Ackermann

    You know what? Cut the banks loose.

    If they are not lending money, then what possible use are they?

    I started compiling a report on the number of times Wall Street firms have been fined for wrongdoing, and I had to stop. The task was too overwhelming.

    There is no place on earth that is more crime-ridden than Wall Street. It is a cesspool of lawlessness and corruption.

    I want to know what is going to happen to all the bad assets on the books now. What gives? Will they change the accounting rules for them, or are they going to write them down?

  4. Don

    “The letter cited the U.K. program as a model because it offers “an unconditional guarantee” of principal and interest when due. Without a similar guarantee, U.S. banks will be “at a significant disadvantage” to their U.K. and European counterparts because their government-backed debt will be more expensive for borrowers and less attractive to investors, the letter said.”

    Hello. We’ve seen this argument go back and forth over the water. European banks and investors claimed the same thing when our FDIC insurance went up.

    What about Ireland? I thought that they were getting hurt by unconditional guarantees? What am I missing?

    By the way, what happened to all that talk about beggaring your neighbor.

    Oh, by the way, that reminds me of the problem people in the EU were complaining about, which is that they didn’t have a bank like the Fed, and so all the member banks needed to guarantee everything together to match the Fed’s guarantees.

    Hey, what happens in all this if we have to save UBS?

    Don the libertarian Democrat

  5. dryfly

    China considers building gold reserve:

    November 13, 2008 7:21 PM

    The ultimate deflation killer – create money & dump on the market while pulling down the supply of a 'useless commodity'. The higher the price of gold goes the more efficient a money creator they have.

    I've been waiting for that one for a while – surprised BB & Hank haven't gone that route (or threatened to).

    FD – I don't own gold.

  6. Matt Dubuque


    Competent analysis. Thanks.

    As part of ITS dealings with banks, the British government is ALSO getting Board of Director seats on the banks that take the money. I’m not sure whether they vote.

    We should insist on this stateside as well. That will help to compel the banks to prudently lend.

    Matt Dubuque

  7. doc holiday

    TARP never was a contract or had terms or conditions — it was an attempt to patch together a bailout that would depend on non-accountability. It is thus no shock that a conceptual framework would morph and twist into various illusions (for various people).

  8. Stuart

    The banks want a better deal do they…. How about this. Sit down, shut up and be humble and all the Sr. Executives might stay out of jail.

  9. Stuart

    RE: China and gold reserves. Brother, if I had 1 gold oz for every time I’ve heard this “boy who cried wolf” story over the past 3 years…. I’d have a tonne by now. I’ll believe this when I see it.

  10. simpson

    I guess I am not agreeing with you Yves or any of the other commenters today.

    Why isn’t better for the USG to have a contingent liability by guarantee bond issuances than to have direct full liability for the borrowings at the discount window?

    Yes, you mention that the banks don’t want to lend. That’s right because they need to raise capital to de-leverage. Bond issuances in the market would allow them to raise cash from someone other than the USG for a change, but this only works if there is an effective guarantee.

    An ineffective guarantee is simply useless for both the USG and the banks. The banks don’t benefit at all from an ineffective guarantee. I don’t get it. Why support an ineffective policy?

  11. Anonymous

    There are a number of arguments here. The first is that the guarantee is too expensive compared to other countries. I doubt that argument really holds water if you consider the repayment terms for bailout money that European banks pay.
    The second argument is that the guarantee is not water tight and is next to useless. The difference between European and US guarantees being that timeliness in the event of bankruptcy with bankruptcy judges being able to modify payments.
    The result is that US banks are not trading normally with no major debt being issued since early september. The credit markets remain closed in the US as elsewhere the first blooms of recovery show.
    Its probably just a matter of perspect with European banks knowing full well that if they don’t try to jump start the economy even if they fail then they will be staring into the abyss, whereas US banks are still thinking that individually they can use the situation to their advantage.

  12. bondinvestor

    what is going on here is pretty straightforward. the politicians are desperate to jump start the economy, the banks can sense this, and therefore are taking full advantage of the situation to get the best deal they can.

    issuing US guaranteed debt, even with the fee, is a no brainer. you can issue the debt and use the proceeds to buy back your own senior and subordinate bonds at anywhere from 50-80 cents on the dollar, depending on the institution.

    every institutional bond investor in the world is begging the banks to make this trade. and the banks are smart. to the extent they can pull of the swap without impacting their liquidity position, they will do it.

    but why not wait, allow the economy to deteriorate, see your bonds to drop further, and try to goad the government into reducing the guarantee fee.

    the folks in washington are some of the least commercially savvy people in the entire US economy. it’s sad to watch them get taken to school by the sharks who run the big money center banks.

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