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Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!

Wednesday, February 25, 2009

Big Bank Nationalization -- No Thanks

First, a contrary view: The conventional wisdom is that the banks
need to be "fixed" to have an economic recovery. I see it the other
way around. We need to see an economic upturn start first to have
a good chance at straightening out the major banks. Recovery
implies an improvement in loan loss experience, an improvement
in bank operations cash flow and stronger investor interest. A
persistent economic decline implies all of the opposite: wider
losses, shrinking cash flows and the coup de grace for bank equities.

Overall, bank loan demand is more of a lagging indicator, since
businesses can cover early recovery working capital needs with
fast rising cash flows. In the meantime, banks can accomodate
early recovery mortgage needs straight out of the pot. Early
economic upturn provides business with a chance to reduce their
loans and for big companies to refinance short term credit with
bonds. Yes, eventually we will need the banks to finance advanced
expansion, but the early upturn comes first.

Banks follow a certain script with troublesome credits. They
increase loan loss reserves, charge off losses against those reserves
and post loan delinquencies to regulators. Banks are now being
stressed tested every day in the weak economy and will now
step up with 2 year estimates of unrecoverable loans and the hits
to capital such might involve. The US Treasury will then have a
projection of external primary capital each of the major banks
might need.

An economic upturn will bring better loan loss experience and lead
to an upward revaluation of toxic, securitized loans. It will also
greatly expand the market for selling these loans as monster bid /
ask spreads narrow.

At this point, banks would be foolish to sell those loans at large
discounts. If it wants, the Treasury can enlist private capital with
guarantees to, in effect, make a market for the junky stuff. But
an economic upturn will underwrite a far better market, as banks
can sell at reduced losses if need be and dilute equity less.

For my part, the most appropriate course for the Gov. is to
recapitalize the big banks as needed in the short run, close out
the smaller stinkers and wait for improving economic conditions.

The guys out there who are calling for an immediate takeover of
Citibank have no idea of what they are asking for. First, the Feds
would be on the hook for hundreds of billions of $ deposits. Then,
figure it will take the new top guys and directors 18 months to
figure well what they have inherited. In the meanwhile, top
divisional people will leave for better money elsewhere, leaving the
bank undermanned at a time when businesses may come a calling
to bank with a "risk free" house. Finally, there's an even darker
side: The guys at the seized bank may simply not prove very
helpful. So, taking on a big guy via a takeover should be an
absolute last resort.

The focus needs to be on re-starting the economy.

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