Thursday, February 12, 2009

Andy Kessler on the Fixing the Banks

From his op/ed column in yesterday's Wall Street Journal, "Why Markets Dissed the Geithner Plan":

Mr. Geithner wants to "stress test" banks to see which are worth saving. The market already has. Despite over a trillion in assets, Citigroup is worth a meager $18 billion, Bank of America only $28 billion. The market has already figured out that the banks and their accountants haven't fessed up to bad loans and that their shareholders are toast.

[...]

Mr. Geithner should instead use his "stress test" and nationalize the dead banks via the FDIC -- but only for a day or so.

First, strip out all the toxic assets and put them into a holding tank inside the Treasury. Then inject $300 billion in fresh equity for both Citi and Bank of America. Create 10 billion new shares of each of the companies to replace the old ones. The book value of each share could be $30. Very quickly, a new board of directors should be created and a new management team hired. Here's the tricky part: Who owns the shares? Politics will kill a nationalized bank. So spin them out immediately.

Some $6 trillion in income taxes were paid by individuals in 2006, 2007 and 2008. On a pro-forma basis, send out those 10 billion shares of each bank to taxpayers. They paid for the recapitalization.

Each taxpayer would get about $100 worth of stock for each $1,000 of taxes paid. Of course, each taxpayer has the ability to sell these shares on the open market, maybe at $40, maybe $20, maybe $80. It depends on management, their vision, how much additional capital they are willing to raise, the dividend they declare, etc. Meanwhile, the toxic assets sitting inside the Treasury will have residual value and the proceeds from their eventual sale, I believe, will more than offset the capital injected. That would benefit all citizens, not the managements and shareholders who blew up the banking system in the first place.

2 comments:

Sivaram Velauthapillai said...

The question, one that the quote doesn't address, is what happens to the bondholders. The equity of these companies are worth very little so that isn't a big problem. Instead, the debtholders, particularly the unsecured bondholders, is the really tricky point. Do you (partially) wipe them out (which will initiate a systematic ripple) or do you let them off (even though they were the ones that financed these banks and enabled them to have high leverage)?

I would argue that if the bondholders aren't punished, it sets a bad precedent. All the leverage in the system comes from the bond investors (that's the definition of leverage after all). If bondholders don't realize that they can have losses, they will recklessly finance future banks as well.

Stockholders have almost been wiped out so the question is what to do with the bondholders.

DaveinHackensack said...

Kessler doesn't address that explicitly, but this would be my approach.

First, let the government scrutinize banks' books, assuming illiquid assets get written down to their current market price (or zero, if there is no current market). Second, determine what is an adequate level of equity. Third, sort the banks into the following categories:

- Banks that are adequately capitalized.

- Banks that are solvent but not adequately capitalized.

- Banks that are insolvent.

For the banks that are adequately capitalized, offer capital injections on generous terms to give them a bigger capital cushion.

For the solvent but not adequately capitalized banks, wipe out the equity holders and swap enough debt for equity to make them adequately capitalized; then give them an extra capital injection as above.

For the insolvent banks, wipe out the equity, and swap as much debt for equity as needed to make them solvent; if there's enough debt to do that, then proceed as above; if there's not, then nationalize the banks and unwind them in an orderly fashion.