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."