Wednesday, October 15, 2008

No results yet???

Immediately there is skepticism about the government's action to infuse banks with capital. The print and television analysts are already looking for results. As one headline says this morning, "Paulsen has no gun to put at bankers' heads". Hmm, are the bankers at JPM, for example, supposed to go up to the 50th floor and throw $25 billion off the roof down to Park Avenue tomorrow. Would that be quick enough.

The only thing that this plan can do in one day or one week is to begin building some confidence in the banking system such that short term spreads in the interbank markets begin to tighten slightly and liquidity increases on the margin.

This whole process will be really slow even if it works because:
---Securitization markets have been destroyed so the multiplier effect of banks lending and then distributing the risk to global investors, pension funds, mutual funds etc. barely exists. The impact of lending and then being able to immediately reload and keep firing is only available now in the absolute highest credit quality pools of assets with above average returns.
---Equity investors have been blown away, so access to the capital to build corporate balance sheets so that they are more reliably attractive to lenders is going to be a slow slow process. Retail equity investors are gone for a year or two almost certainly. That pulls a foundation out from under the hedge fund and institutional investors, so as they heal their wounds they will see less opportunity to get back in.
---Banks will be wary of keeping all of the risk on their balance sheets for the credit expansion that is needed. They can't possibly do that anymore, and believe it or not they have memories. Remember the 1980's, a time when the concept of bank loan distribution was in its infancy and the bond market was just coming out of its coupon clipping era. The banks ended up with massive amounts of Latin American debt, LBO loans, and commerical real estate loans on their books. When that trifecta of trouble hit because the major banks kept most of it on their balance sheets, that was the last real recession. Major banks had capital ratios of 3% and some like Citibank traded at a hat size. Banks can start lending among themselves and slowly help build the markets back up, but going back to just another bad model ain't gonna happen.
---Setting up these rescue plans with bank equity ownership and heightened regulatory oversight hopefully makes sense, but because of the political season it makes the market very uncertain. With the strong possibility of a Democratic president and Congress in January, the question for investors and managements becomes "how will this be managed?" Could it become more aggressive, and less constructive for an efficient capital market, than Paulsen or Geither said. The markets hate uncertainty and the timing of this is not helpful regardless of what one thinks about the outcome on November 4.

The media needs to agitate us it seems, but a little patience is the only way out.


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