It might be that the Treasury is lurching slowly in the direction of doing the right thing to fix our financial system. My cull and capitalize plan would pick the surviving few banks and close or merge the others with the winners -- it would then pump a combination of private and public capital into the winners. I think this is a good idea because the surviving banks would be healthy enough to borrow and lend to each other without undue fear of losing their money. This would go a long way to unfreezing the financial pipelines of our economy.
So far, the Treasury has invested $125 billion in nine banks which I am guessing it thinks are among the winners. Now, the Treasury is suggesting that it will dole out more capital to so-called super-regional banks -- such as KeyCorp (NYSE: KEY), Fifth Third (NYSE: FITB), BB&T (NYSE: BBT), and SunTrust Banks (NYSE: STI) -- if they use the money to acquire weaker players. These super-regional banks might be a good investment opportunity now.
Unfortunately, the Treasury is approaching the problem in a haphazard manner. For example, it already gave capital to banks that are losing enormous sums -- Citigroup (NYSE: C) which got $25 billion comes to mind. And of these four super-regionals -- two (KeyCorp and Fifth Third) are losing big bucks and two -- BB&T which posted third quarter profit of $358 million and SunTrust which earned $540 million in the second quarter -- are earning money. Why would Treasury invest in money-losing banks?
The Treasury needs to be much more explicit and systematic about who gets capital, who doesn't and why. It will have to be far more detailed than simply analyzing a bank's strengths and weaknesses. Furthermore, when it gives out capital to banks, it does not force them to lend it out. In the absence of any guarantee to the contrary, they'll probably use taxpayer money to pay themselves big bonuses.
In the meantime, it appears that banks are backing away from the brink. At least the risks in short-term lending appear to be declining. For instance, the TED Spread -- the difference between the three-month London Interbank Offered Rate (LIBOR) and the three-month Treasury bill rate -- has declined from a peak of 4.65% last week to 2.97% yesterday. This is a big improvement but still far higher than the 0.30% TED Spread in August 2007.
I would not be surprised if the market reacted favorably to a plan to encourage mergers in the banking industry -- and the acquirers receiving capital would enjoy a boost in their stock prices (as might the acquired banks if the purchase price was sufficiently high).
Unless we clear out the banking deadwood, however, the financial system could still go up in flames.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He owns Citi stock and has no financial interest in the other securities mentioned
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