Bankruptcy

Whoops!

By Adam Levitin

Turns out that the Treasury's loan investment in major financial institutions can't count as Tier I capital. That's a big whoops .

I've had trouble identifying the specific problem, but as far as I can tell it might stem from a little footnote in OCC capital requirement regs, that provides that

"Preferred stock issues where the dividend is reset periodically based upon current market conditions and the bank's current credit rating, including but not limited to, auction rate, money market or remarketable preferred stock, are assigned to Tier 2 capital, regardless of whether the dividends are cumulative or noncumulative."

Although this footnote only refers to dividends that reset based on market conditions, perhaps OCC interprets it to cover all stepped dividends (I haven't ventured past the Regs yet). If so, it would mean that the reset on dividend rate on the Treasury's preferred stock from 5% to 9% after 5 years, would make the investment Tier II, not Tier I capital. It's possible that this isn't the problem Reg, but it's the best I've been able to identify from the WaPo story.

All of this points to the problem of trying to jury-rig government support of a banking system that rests on a delicate and very complex regulatory structure. The solution to one problem can cause another. It might have been better, in retrospect, simply to direct the banks to raise more capital and let them first try to do it privately, as BoA was able to do recently.

Full post as published by Credit Slips on October 17, 2008 (boomark / email).