Wednesday, September 24, 2008

Where Did All The Capital Go?

On Monday, the American Bankers Association released a survey of banks to see what the government bailout of gse's (government sponsored enterprises) Fannie Mae and Freddie Mac will cost the banking industry. ABA found that 27 percent of banks surveyed hold preferred shares of Fannie and Freddie stock. Another 3.4 percent hold auction-rate securities backed by the GSE preferred stock.

What does this mean? ABA President Edward Yingling told the Treasury Department that the total loss to the banking industry is between $10 billion and $15 billion." Treasury's takeover and capital funding plan for Fannie and Freddie added an express government guarantee of GSE debt and mortgage backed securities. It left common and preferred GSE shareholders holding a bag of shares worth nearly nothing. In short, banks holding GSE preferred shares don't feel the least bit bailed out.

Federal regulators have described the GSE takeover plan as having only a minimal impact in the banking and thrift sector. Not so says the ABA. The survey reveals that 85 % of banks with GSE equity securities in their portfolios are community banks with less than $1 billion in assets,with the largest concentrations of affected banks in Massachusetts, Illinois, Connecticut, South Carolina, and Virginia. (The Independent Community Bankers of America has accused bank regulators of essentially marking little banks in a con to promote GSE stocks as safe investments.) Banks stuck with worthless GSE securities must offset their losses by reducing their loan portfolios. Yingling said: "The credit crunch will be immediate: with capital difficult to raise in the market today, banks will have no choice but to shrink in order to restore their capital-to-assets ratio to previous levels," he wrote.

Where did all the capital go? The ABA figures it this way. These days the average ratio of bank capital to loans is about $1 in capital to support $7.60 in loans. Doing the math, with every $ 1 million loss in capital value, banks will reduce the amount they are willing (and able) to lend to customers by about $7.6 million. Yingling said GSE losses will "restrain even the best banks in this country from making new loans."


Kelly J. Bozanic said...

I certainly see the negative ripple caused by the resulting increase in the cost of capital, but it seems to me (admittedly a novice at financial analysis) there was no other choice. Because the GSE's attracted so many foreign investors wanting dollar-based securities with higher rates of return than treasury bills, the Fed & Treasury had to intervene to keep from risking those vital investments. Our regulators are in a tough situation and the end may not be around the corner just yet.

In Time magazine, in an article called How We Became the United States of France, the author wrote, "In bailing out mortgage lenders Fannie Mae and Freddie Mac, our government has basically turned America into the largest subsidized housing project in the world." My question is, all considering, is that so bad right now?

Alison M. Kilmartin said...

It may not be so bad right now, but what are we setting in motion today that will affect our generations to come? We talk now about the effects of Roosevelt's New Deal and Johnson's Great Society. What will be the effects of such a major bailout? We can't even begin to imagine.

Don't get me wrong, I don't want the market to crash, my goodness that would be terrible. However, I also don't want to create a new set of problems by throwing money at these problems. Bailouts by the government which causes the government to in turn own major banking and lending institutions in the private sector just can't be a good thing.