It's looking like the White House is floating the idea of using tax dollars to increase bank capital -- as the UK did yesterday. If it does not get significant political objections to the idea, this will probably happen. I think it is a great plan if they do it in the right way.
In order for this idea -- about which I posted -- to work, the Feds should not apply a peanut butter approach to capital injection. Rather, they should cull the herd and put enormous amounts of capital into a smaller number of strong banks.
The White House's original plan -- to buy up toxic waste -- is a great WPA program for Wall Street, but it won't solve the problem. That's because the price that Washington will set for the toxic waste will either be so high that it puts taxpayer money at risk, or so low that it slashes the banks' capital accounts -- making them unable to lend.
The basic problem is that banks are not comfortable lending to each other because they don't know whether the borrower will be around when it comes time to pay back the loan.
That's where the cull and capitalize plan comes in. Washington needs to decide which banks will get the combination of private and public money injected into their capital accounts. But it also needs to decide which banks must merge or close. Here's the important thing: if the money gets spread evenly among survivors and the rest, it won't do any good. The money needs to go to a handful of extremely well-capitalized and profitable banks -- otherwise confidence will not be restored.
However, if the Feds create a smaller herd of banks with ratios of assets to capital of 8:1, this will go a long way to curing the deep woes that ail our banking system. Those strong banks will feel confident that their peers are also survivors so they can freely lend to each other and to businesses. Taxpayers would win from such a plan since it would revive the economy and since the equity stakes in the banks would rise in value and could later be sold to private investors to recoup our costs.
I am hoping that this is what Washington ultimately does -- because I think it will work.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.
Closing Bell: When We All Love the PIIGS (NBG, SQNM, PG, ERTS, KO)
Serious Money: Cheapest Stocks List Shrinks from 26 to 21
Chasing Value: Hasbro Earnings Makes My Point
Reader Comments (Page 1 of 1)
10-15-2008 @ 9:34PM
cocco said...
I agree whith peter's article, however, the gov. should make sure that banks will merge with other banks so we don't have a monopoly.
10-16-2008 @ 9:38AM
cocco said...
I'm totally shoked that the market is taken such a beating. I oersolly think that the security exchange should force the short selling to stop until the market has some stabelization. I could be dead wrong about this. But, whath else is there to do?