Capital infusions into selected banks and thrifts, from the $250 billion set aside under the $700 billion Troubled Asset Relief Program, create the responsibility for the Treasury and federal bank and thrift regulatory agencies to choose numerous "winners" and "losers" from among the nation's more than 8,300 FDIC-insured institutions.

In addition to burdening the U.S. taxpayer with an enormous expense, the process forces institutions that are already well capitalized and do not want such assistance to carry the stigma of perhaps being deemed unworthy of a government investment.

Bank capital — essentially the difference between an institution's assets and liabilities — works to insulate customers, creditors, investors and ultimately taxpayers against credit risk and interest rate risk.

For reference, as of December U.S. commercial banks held assets of slightly more than $12.3 trillion. Capital of $1.2 trillion at that date produced an equity/assets ratio for the sector of 9.4%, somewhat lower — due to significant deterioration in asset quality and earnings — than the 10.2% computed as of December 2007.

Though 10 of the nation's 19 large "stress-tested" banks have been able to generate capital infusions of approximately $56 billion, the recent failure of Florida's BankUnited strongly suggests that investors may not be willing to take positions in other troubled institutions without federal guarantees against loss.

For banks, strong capitalization provides the basis but not the means for loan growth. For the continuance of normal bank and thrift lending functions, liquidity is essential.

The FDIC, through the self-funded and voluntary Temporary Liquidity Guarantee Program, has substantially bolstered liquidity through unlimited FDIC insurance for no-interest transaction accounts and full debt coverage for certain issues of the senior unsecured debt of eligible institutions. Let's apply the same logic to industry recapitalization efforts!

Bank and thrift regulatory capital, as opposed to GAAP capital, negates certain market-value adjustments for "available-for-sale" securities, required under GAAP, and is a key determinant of safety and soundness. Total regulatory capital remains a component of the FDIC's "well capitalized" assessment.

During the thrift industry crisis of the 1980s and early 1990s, problem institutions were allowed to issue "net worth certificates." These certificates counted toward regulatory capital and were offset by notes receivable from the since-disbanded Federal Savings and Loan Insurance Corp. The program was utilized by a small number of essentially insolvent thrifts, many doomed to fail because of mismanagement and fraud.

If, however, net worth certificates — equal to, say, 3% of risk-weighted assets, with coupons somewhat in excess of those on the offsetting government receivables — could be brought back and applied to all institutions, with the exception of a small number with no chance for survival, we could:



  • Enhance industry capitalization via another self-funding program.
  • Remove any stigma created by the current plan.
  • Provide the basis for increased lending, based upon prudent underwriting.
  • Require appropriate loan modifications (the IndyMac loan modification model).
  • Promote consumer confidence in U.S. financial intermediaries. Determining that small number of institutions not suitable for inclusion could be accomplished by utilizing a combination of factors, including regulatory Camels ratings and risk concentrations.

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