The U.S. Treasury's plan to buy into troubled banks has investors asking 'when, how, and which'?
After a weekend in which European leaders promised to make billions of euros available in a bid to revive bank-to-bank lending, investors are sure to shift their attention back to the U.S. Bush Administration officials have already made clear that their emphasis has shifted from liquidity—buying up problem assets—to shoring up capital at banks and other financial institutions. The U.S. Treasury has made clear it plans to provide capital by taking stakes in financial companies.
But the market wants details: when, how, and which institutions, to start. "The experiences of the past several weeks have conditioned the market to be skeptical of vague or ambiguous solutions," Morgan Stanley analyst Ned Rumpeltin said after the Group of Seven industrialized nations issued a broadly worded "plan of action" on Friday.
Conditions Remain Fluid
In prepared remarks he delivered Monday morning, Oct. 13, Neel Kashkari, the Treasury official heading the agency's financial rescue efforts, outlined some of the steps the agency is taking to get the rescue program up and running. A critical ingredient, he told the financiers gathered at the Four Seasons Hotel in Washington for a meeting of the Institute of International Bankers, is the flexibility Congress gave Treasury in deciding how to set up and implement the rescue programs—flexibility is necessary, Kashkari added, "because the one constant throughout the credit crisis has been its unpredictability."
While Treasury officials remained vague on timing, there are suggestions that significant moves may come soon: Kashkari said the agency expects to name "the prime contractor" to help Treasury buy troubled assets and stakes in banks within 24 hours; the agency will name companies to manage whole mortgages and asset-backed securities within the "next few days." And The Wall Street Journal reported late Monday morning that Treasury Secretary Henry Paulson would meet with top banking chiefs at 3 p.m., likely to discuss details of the agency's plan to take equity stakes in banks and other financial institutions.
Kashkari made it clear the agency is taking a broad approach to resolving the crisis. And speed, he acknowledged, is of the essence. Treasury officials are continuing to work around the clock to get the program set up. "A program as large and complex as this would normally take months—or even years—to establish. We don't have months or years," he said.
Weekend events underscored just how fluid conditions remain. European leaders said they will buy stakes in financial institutions and guarantee loans among them. Each country will act independently under the joint framework; Germany and France were said to have plans to unveil their programs Monday. New Zealand guaranteed bank deposits; Australia did so as well and also said it will provide guarantees for interbank lending. There was talk that the London exchange could suspend trading to allow investors to absorb rescue-plan details and that U.S. authorities might halt short-selling of stocks that see a 20% or greater decline in a day.
Renegotiating with Mitsubishi
Also on Monday morning, Morgan Stanley (MS) said that Mitsubishi UFJ Financial Group has completed its $9 billion investment in the firm, giving it a much-needed capital infusion. Morgan Stanley had brought Treasury and Federal Reserve officials in to help it renegotiate a $9 billion investment from Mitsubishi, which was seeking better terms for the investment amid a sharp slide in Morgan Stanley's stock price; both sides sought reassurances from the Treasury that any government investment in Morgan Stanley won't wipe out Mitsubishi's. According to the Associated Press, as part of the revised deal, Mitsubishi will receive $7.8 billion in convertible preferred stock that carries a 10% dividend and is convertible at a price of $25.25 per share. The Japanese bank will also receive $1.2 billion in non-convertible preferred stock, which also carries a 10% dividend.
That shows why the details are critically important when the government takes its equity positions: Concern that a subsequent government investment would seriously dilute existing shareholders' stakes could give potential private sector investors another excuse to remain on the sidelines. "One view of the Great Depression is that what delayed the recovery was that companies held back investment until they became confident that the rules were not going to change abruptly," wrote Strategas Research Partners in a note to investors on Sunday.
Kashkari tried to reassure the bankers that Treasury is working as quickly as possible to set up the rules under which it will operate—and that it is working "in close cooperation with both domestic and international regulators to understand how best to design tools that will be most effective in dealing with the challenges in our financial system." Financial market participants also say Treasury officials have stepped up efforts in recent days to solicit their advice on how to proceed in ways that would be least disruptive to markets and bring about the largest response.
The agency has set up seven teams to oversee the program in each of the critical areas. The first two will oversee the purchase of mortgage-backed securities and whole loans. Others include a program to insure troubled assets, a standardized program to purchase equity in a broad array of financial institutions, and another to focus on keeping struggling homeowners in their homes after the Treasury purchases mortgages and mortgage-backed securities. "We will look for every opportunity possible to help homeowners," Kashkari said.
Preventing Conflicts of Interest
Finally, two other teams will oversee executive compensation and oversight. The executive comp team, he said, is already working hard to define the requirements for financial institutions to participate in three possible scenarios. "One, an auction purchase of troubled assets; two, a broad equity or direct purchase program; and three, a case of an intervention to prevent the impending failure of a systemically significant institution"
Federal Reserve Board Chairman Ben Bernanke will head the oversight board, which will be in charge of preventing conflicts of interest. "Taking aggressive steps to manage potential conflicts of interest is essential because firms with the relevant financial expertise may also hold assets that become eligible for sale into the TARP," Kashkari said.
Kashkari also said Treasury is moving quickly to hire the executives necessary to begin running the program. Tom Bloom, the CFO of the Office of the Comptroller of the Currency and former CFO of the Commerce Dept., will serve as the program's interim chief financial officer. Jonathan Fiechter, Deputy Director of the IMF Monetary and Capital Markets Department in charge of financial supervision and crisis management and a former board member of the Resolution Trust Corporation and the FDIC, will serve as interim chief risk officer.
Still, little is know about which companies the government will invest in. Treasury has said its capital-injection program will be voluntary—banks must apply to sell the government a stake. But how will the Treasury determine which to help and which to say no to?
Pressure to Help Regionals, Too
Officials have said they don't intend to pump taxpayer dollars into institutions that are likely to fail even after receiving government help. That entails accurately predicting which companies will live and which will die, which is notoriously tricky to do: Over time, only about 13% of banks that make the Federal Deposit Insurance Corp.'s list of troubled institutions go on to fail. Expect big "systemically important" institutions to get help first. There is also political pressure to include the regional banks that serve small businesses and local economies.
There is some fear that banks will prove reluctant to seek government capital—that doing so makes them appear shaky. That could spur the government to act first, swooping in to provide capital to key banks before being asked in order to head off collapse.
For firms that don't meet Treasury's survival test, expect to see government-brokered takeovers like the acquisition of a Washington Mutual by JPMorgan Chase immediately after WaMu was seized by the FDIC in late September. Such tie-ups would forestall the risk of another Lehman Brothers, where the investment bank's collapse had widespread repercussions, contributing to American International Group's near-collapse and subsequent government rescue.