Corporate borrowers counting on the trickle-down effect of the federal government’s injection of capital into banks are in for a long wait. So said bankers and regulators at a securities industry conference in New York today that focused on the Treasury Department’s $700 billion program to purchase senior preferred shares of U.S. banks and buy their troubled mortgage loans and other assets.
“People often ask when we will see banks making new loans,” said Neel Kashkari, who, as the Treasury Department’s interim assistant secretary for financial stability, runs its Troubled Asset Relief Program. Without actually answering his own question, he said in a speech at a conference on the program today at Securities Industry and Financial Markets Association conference on TARP that it would take a few months to finish buying up bank equity. Even considering that, banks must regain confidence in the capital markets before lending again.
To be sure, Treasury is in “deep execution mode” on the share-purchase part of the Troubled Asset Relief Program, which will provide up to $250 billion of equity, said Kashkari. But less than half the money has been invested so far, in nine large institutions.
Other banks have until Nov. 14 to apply for funds. Indeed, Kashkari announced that the deadline had been extended for privately held banks. “Given the complexity of executing these transactions, it will take a few months to fully execute and fund these transactions,” he said.
Kashkari credited the capital-purchase program and actions by the Federal Reserve and the Federal Deposit Insurance Corporation with “numerous signs of improvement in our markets and in the confidence in our financial institutions.” Among the improvements, he said, has been a nearly 245 basis-point drop in the average credit-default-swap spread for the eight largest U.S. banks since before President Bush signed the Emergency Economic Stabilization Act on Oct. 3. Further, the interbank bank lending rates have declined, with one-month LIBOR dropping 243 basis points and three-month LIBOR decreasing 192 basis points, he noted.
Nevertheless, said Kashkari, “our capital markets remain fragile and confidence is still shaky.” While the Treasury Department is confident that banks will ultimately use the capital to extend loans to creditworthy businesses and consumers, “the last thing we want,” he added, “is to encourage banks to resume the poor lending practices that are the cause of the current economic problems.”
Off to an even slower start than the capital-purchase effort is the part of the TARP designed to buy distressed mortgage-backed securities and whole loans. In a survey conducted by the Securities Industry and Financial Markets Association and four other advocacy groups, 53 percent of 445 banks said they were likely to participate in the troubled asset-purchase program.
But Kashkari barely mentioned what was once the cornerstone of Treasury’s stabilization plan, and only then when an audience member asked when asset purchases would start. “Ultimately Secretary Paulson will make the decision on when to roll that out,” Kashkari said. “I can’t give you a date.”
Treasury’s purchase of distressed assets is a critical element of TARP because of the need for price discovery on troubled assets by financial institutions. “It’s more complex to roll out the [asset] purchase program, plus there are concerns about doing more harm than good” by forcing banks to mark down assets, said Randall Guynn, a partner at Davis Polk & Wardwell.
Financiers think it may take more than $700 billion–from private and public sources–to stem the hemorrhaging by banks and restore confidence enough to open doors for borrowers. “The capital injections [from Treasury] will not be an anchor of confidence [in banks],” said Randal Quarles, a managing director of The Carlyle Group. “The only thing that can do that is due diligence from an informed investor, a private capital provider.” Many early investments in distressed financial institutions weren’t structured to provide confidence to other stakeholders, he argued, because they gave the new investors unique protections.
“It may take a lot more capital to put banks into a position where they are willing and able to extend fresh credit on a net basis,” said Jan Hatzius, chief U.S. economist at Goldman Sachs. Since 1998, Hatzius pointed out, businesses have outspent their cash flow, and a reversal of that trend would be a large drag on the economy. He said the economy was in need of a fiscal stimulus of at least $300 billion and maybe as much as $500 billion. “Now is not the time to worry about the U.S. budget deficit,” Hatzius said.
Quarles agreed, contending that the U.S. government is underleveraged at 36 percent of GDP (compared with 100 percent for households). “You can ramp up [U.S.] debt very substantially to ameliorate the shrinking of real economic activity,” he said. “Thirty-six percent leaves a great amount of headroom on the government’s balance sheet.”