Building a Better BailoutTARP does nothing to
patch the hole in the banking system. And it certainly
doesn't do anything to encourage banks to make more loans.
Yes, banks have gotten nearly $300 billion in money from the
government, and that's a lot of dough. But it's not free
dough. In return for federal cash, the government has taken
preferred-stock shares as the firm's markers. Unlike common
stock, which is the kind you or I would buy from a broker,
preferreds have to eventually be paid back, so they are
really loans, not additional capital. (See
which country has the best bailout plans.)
Say a bank has $5 in capital and $100 in loans. Now the
government gives the bank an additional $100 in preferred
shares and says, "Go make more loans." Well, the bank might
then have $200 in loans, but it still has only $5 in common
shareholders' equity. The result: if just 2.5% of its loans
go bad, the bank's shareholders are wiped out. Wisely, the
largest banks in the nation lent less in the fourth quarter
of 2008 than in the previous three months — a strategy that
has drawn some complaints. But that hasn't removed the
pressure on their shares. That's because the banks have had
to continue to take loan losses. And banks don't have the
option to pass those losses off on the new money they got
from the government. They have to write down their common
stockholders' equity first. And as that capital falls, so go
the bank's shares. Some are alarmingly close to zero.
No bank's stock has fallen more in value during the past
four months than Bank of America's. The combined value of
its shares is now $37 billion. That's $123 billion less than
they were worth at the end of September. In the third
quarter, BofA was forced to write down $4.4 billion in
loans, or about 1.8% of its loan portfolio. Compared with
what some of its competitors wrote down, that wasn't a heck
of a lot; Citigroup, for instance, had a $13.2 billion
charge in the same quarter, primarily related to loan
losses. But the relatively small loss took BofA's thin
tangible equity, the type of capital that matters most to
shareholders, down to a ratio of just 2.6% of loans,
according to FBR. By that measure, Bofa was a weaker bank
than any of its rivals, including Citigroup. But since the
market was so focused on bad loans and the charge-offs banks
had to take, no one seemed to notice BofA's faults.
That is, until the fourth quarter. In mid-September 2008,
in a deal pushed by regulators, BofA agreed to buy Merrill
Lynch. The acquisition actually boosted BofA's capital
ratios, but it also added losses to an already fragile
capital structure; Merrill Lynch lost $15 billion in the
fourth quarter alone. Knowledge of the impending losses
forced BofA CEO Ken Lewis to ask the government for an
additional $20 billion in TARP funds — on top of the $25
billion it had already received — as well as about $100
billion in loan guarantees. Without the government
assistance, BofA says, it couldn't have closed the merger.
The Merrill losses, which weren't publicly revealed until
early January, have angered shareholders, some of whom have
sued the company for not informing them sooner. And last
week, the losses also led Lewis to ask Merrill's top
executive,
John Thain, to resign for failing to keep BofA officials
apprised of his firm's bottom-line problems. Thain says
Lewis knew all along. (See
pictures of TIME's Wall Street covers.)
Cleaning Up the Mess
Nouriel Roubini, the New York University economics
professor who was famously early in predicting that
the end of the housing boom would cause a financial
crisis, estimates that continued loan losses will force U.S.
banks to come up with an additional $1.4 trillion just to
stave off bankruptcy. And since the banks aren't likely to
earn much money or attract new investors anytime soon, much
of the money will have to come from the government.
Regulators are split on what to do next. The Federal
Deposit Insurance Corporation is backing a plan to create
what it calls an aggregator bank, which would buy up the
loans of BofA, Citigroup and the rest of our now troubled
system, theoretically putting an end to the escalating
losses eating away at the banks' capital. But if the
government buys those assets at current market rates, banks
would be forced to take immediate losses on the sales, doing
more harm than if the government just left the troubled
loans where they are. Sources say the Federal Reserve would
prefer to let the banks keep the loans and troubled bonds
for now and instead provide the banks with insurance
policies guaranteeing that the government will swallow a
good deal of future credit losses. But a similar deal that
the Fed struck with Citi did little to boost that company's
stock or stave off fears that it may soon go under.
That's why a small but growing number of people are
starting to talk about nationalization. Speaker of the House
Nancy Pelosi recently said nationalization, or something
close to it, is a better solution than just buying bad
assets, because if the government takeovers succeed, then
taxpayers get to keep the profits when they eventually
resell the banks. But if the government doesn't turn a
nationalized bank around, it could be very costly to
taxpayers.
No matter what happens, things have definitely changed
for Lewis and other former titans of the banking business. A
few months ago, BofA's CEO was hailed for running a bank so
prosperous that it was able to swallow mortgage lender
Countrywide Financial and investment bank Merrill Lynch in
the depths of the worst banking crisis in recent history.
The trade magazine American Banker named Lewis Banker
of the Year in December. Now he's fighting to keep his job.
And even if he succeeds, he's got a new partner. The
government already has a large stake in his bank, with its
$45 billion in preferred shares. The government's ownership
could dramatically rise if the Fed starts buying common
shares of BofA, which would mean that Washington would be
calling more of the shots. Increasingly, the only
shareholder that matters to Bank of America and other banks
is Uncle Sam. Without the government, the math of the
banking business these days just doesn't add up.