US Banking System

With the recent price weakness in Citbank and Bof A, there has been
a flurry of official and unofficial commentary about a bank rescue
package. Today,Treas. sec'y. nominee Geithner suggested an assistance
package of some sort for financials would be soon forthcoming from the
new Obama administration. So, what are the issues?

The private banking system has about $1.4 tril. of equity capital,
including the recently allocated portion of the TARP funds. Loan losses
have been accelerating, and will be around $150 bil. for 2008. The
surge in loan losses wiped out industry profits last year, and we are
now also seeing a rise in losses on securities, although this number is
still small.

At this point, loan losses are too large to allow banks to increase
capital via retained profits, and access to the equities market is
prohibitively expensive for those banks needing to raise equity
capital. Moreover, with the economy very weak, loan losses are
expected to continue rising for the time being.

A very thorny issue carries forward, too. Toxic real estate loan and
securities exposure in the industry continues. The utterly valueless
stuff is being written off, but there is likely substantial exposure to
paper that has no market to mark to, but which has some economic
value nonetheless. Individual bankers are loathe to overbook losses
here, especially since economic value will rise in a recovery.

There is a fear that without some sort of resolution that enables
regulators, economists and investors to pronounce banks "healthy"
again, the banks will not be able to underwrite economic recovery
in the normal fashion.

While on holiday around year's end Congress got an earful about the
weak economy and many members were upbraided for signing off
on TARP. Thus it may be that a grand bailout scheme for the banks
will create an uproar with voters unless there are vast protections
for taxpayers.

When banks are forced to issue high coupon preferreds for the
TARP money, that drains cash flow and dilutes the common
shareholders. More of same will provide a long term cushion to
taxpayers, but will drain earnings enough to substantially inhibit
banks from growing capital internally.

So, IF there indeed has to be a rescue package to restore the
Goodhousekeeping seal of approval to the banks, regulators will
have to look long and hard at ways to protect taxpayers but
reliquify the system at a lower capital cost to the banks. So,
perhaps they will look at convertibles, warrants and sub-class
commons as options.

If a deal is to be done, there must be a depth of transparency that
leaves precious few unanswered questions. Failure to do that will
haunt us all well into the future.