The Proud Few, a Stress Test with Teeth

Location: New York
Author: Ira Artman
Date: Friday, February 27, 2009
 

Tomorrow morning, before the New York Stock Exchange opens, the President could ride Amtrak’s Acela train to Manhattan. He could stand at the steps of the Federal Hall Memorial at the corner of Nassau and Wall.

There, beneath the gaze of George Washington, he could announce that he will immediately suspend or terminate all Federal Reserve and Treasury special facilities, programs, and plans:
Facilities
  • Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility;
  • Commercial Paper Funding Facility;
  • Consumer Lending Facility;
  • Money Market Investor Funding Facility;
  • Primary Dealer Credit Facility;
  • Term Asset-Backed Securities Loan Facility;
  • Term Auction Facility;  and
  • Term Securities Lending Facility.
Programs
  • Automotive Industry Financing Program;
  • Capital Assistance Program;
  • Capital Purchase Program;
  • Targeted Investment Program;
  • Temporary Money Market Fund Guarantee Program;
  • Term Securities Lending Options Program; and
  • Troubled Asset Relief Program.
Plan
  • Homeowner Affordability and Stability Plan.

As of today, with all of these initiatives in place, the most distressed mega banks trade at price/book ratios that do not exceed 20 cents on the dollar. 

If the above facilities, programs, and plans were all eliminated, the price/book ratios of the weakest institutions would drop to no more than 5 or 10 cents on the dollar – tops.

The total assets of the 114 largest US banks – those with assets in excess of  $10 billion each - stand at about $10 trillion.  If the Federal government acquired these for a nickel or dime, it would spend no more than $500 billion to $1 trillion.

A handful of relatively well-capitalized large banks would remain as independent entities, outside the grasp of our elected representatives. 

After the assets of the failed institutions were parceled out to the survivors, the US banking system would look not that different from the Canadian system recently praised by the Chairman of the President’s Economic Recovery Advisory Board - Paul Volcker:

  • What [should] we … be aiming for when we get out of the mess? …
  • We are going to need a financial system that is not going to be so prone to [severe] … crisis…
  • [It]  … ought to be a strong, traditional, commercial banking-type system…
  • We ought to have some very large institutions …whose primary purpose is … to service consumers, individuals, businesses and governments by providing outlets for their money and by providing credit. They ought to be the core of the … financial system…
  • Those institutions should not engage in highly risky entrepreneurial activity. That's not their job because it brings into question the stability of the institution. They may make a lot of money and they may have a lot of fun, in the short run. It may encourage pursuit of a profit in the short run. But it is not consistent with the stability that those institutions should be about. It's not consistent at all with avoiding conflict of interest.
  • These institutions that have arisen [outside of Canada] … that combine hedge funds, equity funds,  [and] large proprietary trading with commercial banks, have enormous conflicts of interest. And I think the conflicts of interest contribute to their instability. So I would say let's get rid of that. Let's have big and small commercial banks and protect them – it's the service part of the financial system.

Source: Paul Volcker – US Economic Crisis, Toronto, Feb 2009.

Are you listening Mr. President?  We need you at that corner of Nassau and Wall.

 

 

REFERENCES

FDIC - Quarterly Banking Profile, 2008Q3.

Paul Volcker – US Economic Crisis, Toronto, Feb 2009; available at John Mauldin’s Outside The Box, 23 Feb 2009.

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