Friday, January 16, 2009

Summers and President Elect Obama Crater The Financial Sector

The S&P 500 Index financial sector is down 21.04% year to date through January 15, 2009. Admittedly, a vast majority of the banks and insurance companies are struggling with the fall out from the mortgage crisis. The upcoming administration's approach to dealing with firms that take TARP money seems to be one of micro managing these firms.

Some of the conditions the Obama administration is proposing is essentially telegraphing to the market that equity holders in TARP funded institutions that they are going to shoulder all the risk in turning around the firms and the economy. Some of the conditions, like forcing banks to lend, are similar to requirements that banks underwrite mortgage loans to less qualified first time home buyers. We know where that got us.

Following are some requirements from Mr. Summers' letter (Full Letter Text (pdf)):
  • Banks receiving support under the Emergency Economic Stabilization Act will be required to implement mortgage foreclosure mitigation programs. In addition to this action, the Federal Reserve has announced a $500B program of support, which is already having a significant beneficial impact in reducing the cost of new conforming mortgages.
  • As a condition of federal assistance, healthy banks without major capital shortfalls will increase lending above baseline levels (emphasis added). The Treasury will require detailed and timely information from recipients of government investments on their lending patterns broken down by category. Public companies will report this information quarterly in conjunction with the release of their 10Q reports. The Treasury will report quarterly on overall lending activity and on the terms and availability of credit in the economy. (more bad loans?)
  • Payment of dividends by firms receiving support must be approved by their primary federal regulator. For firms receiving exceptional assistance, quarterly dividend payments will be restricted to $0.01 until the government has been repaid.
I will say firms taking TARP funds should review their company dividend practice and maybe restrict payouts so long as the TARP funds are outstanding. However, there needs to be a balance between these policies so that the policy does not force out free market investors.

Under the proposed terms noted above, the government is essentially making it unattractive for investors to invest in the common equity of the TARP recipient firms/banks. Given the level of outstanding government debt and the current budget deficit, private sector equity investments are needed to assist in the funding as we work through this difficult economic environment.

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