We hold LightPath Technologies (LPTH) starting at $1.40-$1.60 in January 2017 and suggest long-term ...
America's Banks On the Brink?
10/08/2008 12:01 am EST
On Wednesday, Financial News commentators were heralding the global synchronous rate cut and Paulson's new policy remarks as "the bottom" of the worst financial crises since America's Great Depression. Charles Githler caught up with former FDIC Chairman William Isaac to probe the concern, among a growing number of Americans, that their cash in banks could become inaccessible for a period of weeks in the event of widespread bank closures or a national "Bank Holiday"-as experienced in the 1930s. "No Bank Holiday" said Isaac. Isaac then added his guarded satisfaction with today's remarks by Treasury Secretary, Henry Paulson, "The US Government finally recognizes that confidence and capital are the real problems." As another step, all general creditors of the banking system could be guaranteed. "For the first time, I believe that Washington understands the problem..."
Political leaders told us last week that if the Wall Street bailout bill did not pass, the stock market would drop by 1,000 points and millions of people would lose their homes, jobs, and credit cards. Congress passed the bill, yet the markets have gotten worse.
I believe the problem is that the bailout package does not deal with any of the four fundamental issues that must be addressed immediately: Fear, Bank Capital, and Fiscal Stimulus and Help for Homeowners.
Fear. The financial markets are frozen throughout the world. Banks will not lend to other banks, and to the extent they do, the cost is exorbitant. There is a lot of liquidity, but it is being hoarded.
Which banks will fail, and how will their creditors be treated? Will the government protect just the insured depositors or will it protect the uninsured depositors, bondholders, and other general creditors? The government has handled these claims in different ways in the failures to date, so there is considerable anxiety in the markets.
There is a way to get money flowing through the banking system and financial markets almost instantaneously. The Federal Deposit Insurance Corporation has the authority to declare an emergency in the financial markets if requested by the Secretary of the Treasury. If an emergency is declared, the FDIC could announce that until the crisis abates, all depositors and other general creditors will be protected if an FDIC-insured bank fails.
What would this cost taxpayers? In my view, nothing-indeed, it should save taxpayers a lot. It will get the financial markets working, help put the economy back on track, and reduce the bank failure rate.
We already have an implicit guarantee in place for the largest banks, which control the bulk of our banking assets. Making the guarantee official during this crisis and extending it to the rest of the banks is essential and reasonable.
As I write this article, Ireland has guaranteed its banking system and Denmark and several other European countries appear to be headed in that direction. If enough follow, the US will have no choice but to act.
Bank Capital. The Securities Exchange Commission adopted fair value accounting in the 1990s. This rule required financial institutions to mark their securities to market. I have argued against fair value accounting for more than two decades because I know that we could not have contained the severe banking problems of the 1980s if we had to deal with fair value accounting rules.
A bad idea became highly destructive when the SEC decided to continue fair value accounting after the market for mortgage securities evaporated last year. In the absence of a market, the SEC forced banks to mark these assets to an arbitrary index.
Mortgage securities were marked to a fraction of their true economic value, which destroyed $500 billion of capital in our financial system. Since banks lend about $10 for each dollar of capital, the SEC's rule diminished bank-lending capacity by $5 trillion. Is it any wonder we have a severe credit contraction?
Even now, the SEC continues to fiddle while the financial system and the economy burn. The SEC needs to suspend fair value accounting-act NOW, study it later. This will begin the process of restoring bank capital so banks can start lending again. Instead of the Treasury and Federal Reserve taking over our lending markets, we need to help our private banks do the job.
Another readily available tool to restore bank capital is one that the FDIC used in the banking crisis of the 1980s to give capital-short, but otherwise viable, banks injections of capital to help them get through difficult economic times. The program was a big help in the FDIC's resolution of the $100-billion market insolvency in the savings bank industry at a total cost of less than $2 billion. A precursor of the 1980s program was the Reconstruction Finance Corporation, created to provide capital to banks during the Great Depression.
The FDIC should resurrect this program immediately. It will limit the failures of community banks and put them back into the lending business more quickly.
Fiscal Stimulus and Help for Homeowners. The bailout bill will not solve our banking crisis because it is not attacking the right problems. Instead, we should direct a good portion of the bailout money to providing permanent stimulus to the economy and to helping families who are in danger of losing their homes.
I believe Congress should get off the campaign trail and get back to Washington to get the bill right this time. The world is looking to us for leadership.
Related Articles on STOCKS
The best corporate managers are always one step ahead. Salesforce is the second coming of Amazon.com...
Now about new highs being celebrated, amidst deterioration of a slew of internals: This suggests nei...
Our daily breakout stock ideas are most suitable for aggressive investors seeking ideal entry points...