Banking Law

An article by Cheyenne Hopkins in today's American Banker (paid subscription required) nicely outlines the immediate reactions of many banking lawyers and consultants to the toxic asset and loan purchase plans announced yesterday by the Treasury Department.

"My concern is that the willing buyer and the willing seller may still be too far apart to create a trade," said Douglas Elliott, a fellow at the Brookings Institution.

FDIC Chairman Sheila Bair conceded that possibility, acknowledging nothing could guarantee the process would produce a good deal for the investor, the bank and the government.

"There is always that risk," she said in a conference call with reporters. "Markets will do what markets will do, but I think this structure has a better chance than any that I've seen to provide that magic price where buyer and seller are willing to meet. But we won't find out until we get it running and see what happens."

The first reaction many of us had to the plan was: "what's the incentive for the bank holding the 'toxic assets' to unload them at prices at which private investors would want to purchase them?" That's been the problem from Day One, when Paulson announced this program last fall. If a bank's written them down to a level that nears a current "fair market value" price, so that no further "haircut" (and no further hit to capital) is taken, then why sell them to a third party who'll benefit from all of the upside as prices recover? Why not hold onto them and let the other chumps establish a market price, get the business moving again, and reap all of the eventual upside for itself?

If the bank hasn't written the assets down, or has, but not enough to make them attractive to buyers, then why would the bank sell them now and take the hit to capital? Let the other chumps sell, reinvigorate the market, and wait until the haircut is much less.

Sheila Bair and others give us a clue as to what might "induce" an unwilling bank to sell.

When asked if regulators might push bankers to accept a price offered through the auction process, Bair responded that it would be a "consultative process with supervisors."

Industry observers argued that the banking agencies would penalize banks that did not take the opportunity to shed their most troublesome assets.

"If the banks refuse to sell, I think you'll see an increased pressure on the part of the regulators and an increased Camels rating going on to the watch list," said Thoma Barrack Jr., the founder, chairman and chief executive of Colony Capital LLC. "The regulators will have no other alternative to start shutting down more banks."

Mark Zandi, chief economist and co-founder of Moody's Economy.com, Inc., said pressure from the Treasury Department and the results of "stress tests" on the banks could force many to participate.

"The stress tests might push the banks to lower their price, and given the very lucrative financing for investors, that will get them to raise their price, and we'll find a nice middle ground here," he said. "So I'm hopeful that the Treasury is pushing both the buyer and the seller to some middle ground, and that will get the auction to work reasonably well."

My guess is that if the regulators start pressuring banks to sell even though they take a hit to capital that impairs their ability to survive, then the quid-pro-quo will need to be additional capital, open bank assistance, or forbearance from the regulators. No bank board will willingly permit a sale at a price that impairs the bank's ability to survive. They'd just as soon let the regulators take punitive action against the institution, even if that results in failure, because they'll at least have a better defense to any action shareholders or the regulators might take against them later that their negligence or malfeasance caused the bank to fail. They can say that the regulators punished them for not doing an unsafe and unsound thing: selling at a price that would have caused the bank to fail.

I can also foresee that if some banks start participating in the program, then the sales prices for assets will be used by the regulators to benchmark values for assets held by recalcitrant banks. If those asset prices would cause a hit to capital, the regulators might "suggest" to the bank that it might as well sell and take the hit, because the next examination team in the bank is going to write down the value of those securities to at least that "market" value and, who knows, maybe even lower. Again, unless the regulators want more banks to fail, I assume they've got a plan in place to replace that capital. Either that, or the FDIC better start taking steroids.

I've seen a lot of complaints on blogs and elsewhere that this is a giant conspiracy to set the price of assets too high and to screw the taxpayer. Banks should be so lucky. The private investors we and others have talked to are salivating at the prospect of offering a nickel on the dollar and making oodles and oodles of serious money by buying assets on the cheap. Those profits will be shared with the US government. Folks like Wilbur Ross, who announced that he's onboard with the program, aren't going to give away profit for the public good. The financing may be so cheap, and the leverage so good, that above-distressed market prices will be offered, but I simply don't think that it's the taxpayers and private investors who will take it on the chin by "overpaying."

No, I think Ms. Bair's comments are very instructive. "Consultations" will be held. Arms will be twisted. Fingers will be broken.

Or, perhaps, the entire cumbersome structure will grind to a halt and collapse under its gross bureaucratic weight.

Wait a minute, I forgot: failure is not an option! As Tim Geithner said in today's House hearing, when asked if he had a backup plan in case this one failed, competence is not a consideration in the success or failure of this program.

Geithner: "This plan will work...it just requires will, not ability."

How very Neitzchean of Secretary Geithner. "Competence? We don't need no stinkin' competence! We have the Force, and the Force is with us!"

Man, this year is going to be a barrel of fun.