Possibly necessary, but…
We have explained that the roots of the current problem in the global banking system go back about 50 years, when funding of bank loans moved away from using a depositor’s checking account to provide the funds and morphed over time into a vast system of banks lending to each other. So when there came a crisis of confidence in interbank lending, a nearly risk-free strategy emerged for knocking off banks one after another, In effect, a Doomsday Machine was created that could devour bank after bank until few were left standing; meanwhile, the rest of us would have a Depression, or worse. So now it comes to pass that the Treasury is considering purchasing equity in banks, which we and others said last week made a lot of sense, at least in theory. NYT:
Treasury officials say the just-passed $700 billion bailout bill gives them the authority to inject cash directly into banks that request it. Such a move would quickly strengthen banks’ balance sheets and, officials hope, persuade them to resume lending. In return, the law gives the Treasury the right to take ownership positions in banks, including healthy ones.
The Treasury plan was still preliminary and it was unclear how the process would work, but it appeared that it would be voluntary for banks.
The proposal resembles one announced on Wednesday in Britain. Under that plan, the British government would offer banks like the Royal Bank of Scotland, Barclays and HSBC Holdings up to $87 billion to shore up their capital in exchange for preference shares. It also would provide a guarantee of about $430 billion to help banks refinance debt.
The American recapitalization plan, officials say, has emerged as one of the most favored new options being discussed in Washington and on Wall Street. The appeal is that it would directly address the worries that banks have about lending to one another and to other customers.
Meanwhile, Bloomberg reported that measure to date have not been sufficient to get banks to lend: “The London interbank offered rate, or Libor, for three-month loans rose to 4.75 percent today, the highest level since Dec. 28. The Libor-OIS spread, a measure of cash scarcity, widened to a record. The overnight rate fell to 5.09 percent, still 359 basis points more than the Fed’s 1.5 percent target rate.” We will not be surprised to see some banks take advantage of equity infusions from the Treasury. They may live to regret it a few years later, if the government decides to become intrusive in matters of corporate governance, but then again they’ll be alive to regret it.