Friday, October 31, 2008

Government equity stakes in banks already a disaster in the making

The government's $700 billion package to rescue the financial system included, as a Democratic Party prerequisite, the right for the Federal government to take equity stakes in banks in exchange for investments in the banks. These investments could have been super senior debt, but instead gave equity rights. Several posts here in September suggested that this was a bad idea.

Treasury's approach to the infusion of cash into banks has often been to require it, as in the case of JP Morgan Chase which did not need or want the government's money as they could raise money in the private markets if they needed it. Regional banks across the country are being arm twisted into taking the Fed money so that it looks like they are willing participants in the government's mandate to create credit liquidity.

Now the attack on the banking system is already underway, from Barney Frank and Nancy Pelosi, and AG's like Cuomo and Galvin, and countless other irate politicos and pundits, as they call for control of the banking systems dividend policies, merger and acquisition moves, compensation systems, and credit risk management decisions. As Barney Frank said today, banks who accepted these funds must conform their "bonuses, severance payments, dividends, acquisitions, etc." to what is required under the rescue plan. The "etc." is the worst part of that comment. Frank is essentially saying that for a relatively small non-voting, yes they are non-voting, equity stake the Federal government now has substantive managerial oversight of any bank in this plan whether they wanted the money or not.

Certainly banks who receive the money are to a large extent obligated to use it to shore up their balance sheets and therefore the free market will begin to allocate liquidity and funding to the those firms and the industry. From that, lending will begin to flow. That's the point. The point is not that the banks segregate the government infusion money and lend it out on some 19th banking system ledger. Certainly too, if some banks act irresponsibly it's the job of the Federal Reserve or the OCC to regulate them as always. Congressional Democrats are now actually saying that the "American people" are owners of these banks and have a right to hold them accountable for management decisions.

This is all so misguided, stupid, and political that further comment is impossible.

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