Consumers aren’t spending, the GDP is shrinking, and the jobs are dwindling: there’s nothing much good to see in the numbers as they pour in. The economic data is measured in worsts—worst GDP in 26 years, worst January for the DJIA in 113 years, the price tag for detoxifying the banking sector has risen to the trillions. The shy-of-a-trillion-dollar U.S. stimulus package passed through the House with only Democratic support. Now a mix of Democratic and Republican senators complain that the bill needs a.) more jobs creation, b.) more tax cuts, or c.) both of the above.
The Obama administration has not unveiled its much-anticipated rescue plan for financial sector. As of yesterday, some press reports had Treasury Secretary Tim Geithner planning to present a comprehensive solution—including creation of a “bad bank” to drain the poisonous assets from the financial system—next week.
Germany and other EC countries seem to be trying a bank-by-bank approach, while the European Central Bank is reportedly scurrying to come up with pan-European rules.
“I don’t think you’re going to see a single solution,” says Stuart Stein, partner and head of the financial services and corporate governance groups at law firm Hogan & Hartson. “I believe there will be a combination of assets sales, where pools of investors take participation in packages of assets, and some aggregator entities, whether they are banks or LLCs. The problem is too vast and too deep for a single solution. No one is sure what’s going on. There are systemic problems and asset problems.”
The price tag will be numbing: “A couple of trillion dollars for the top ten banks, and another two, three, or four trillion for the rest of the banks,” Stein predicts. Buying these assets at fair value or at-par would be bad approaches. Mark-to-mark prices would be “super low and artificially depressed, and would crush the capital value” of the banks involved, while buying them at-par would translate into “propping up false values,” a tactic that brought Japan its “lost decade.” Instead, the government could package the assets with sweeteners such as “government cleansing, stop-loss guarantees, and other help,” says Stein. “Private equity funds have patient capital. There’s no patience for a bank.” Expect more failures, no matter what—“there will be more changes in the landscape.”
Stein notes that the Federal Deposit Insurance Corp.’s “primary concern is that deposit insurance maintains credibility. If not, we go to the bread lines. Treasury’s priority is to get the economy moving again, but it will take time to rebuild the foundations.” First the toxins need to go.