Regulators insist that the big banks are, by and large, well capitalised despite their flurry of write-offs. Just as important, the industry as a whole is still producing fairly strong cash flows: higher in the rocky third quarter of 2008 than in the calm first quarter of 2007, points out Dick Bove of Rochdale Research.
But this masks huge variation. Some regional banks are thriving, especially those that avoided dodgy mortgages and loans to property developers. Hudson City Bancorp, a New Jersey thrift that wrote only high-quality mortgages through the boom and insisted on down-payments of 20 percent, recently announced record profits. According to a survey by Greenwich Associates, such conservative lenders are picking up market share from rivals that rely on government support. But Hudson is in the minority. The number of banks on the Federal Deposit Insurance Corporation’s problem list was expected to rise sharply, from 171, when the FDIC published its quarterly update on February 26th, after The Economist went to press.
Fortunes vary among the giants, too. No one doubts that the sums still needed to put Citi on a sure footing exceed its current market value of about $14 billion. The capital conversion would be its third bail-out in four months. Bank of America is also in poor shape, thanks to its disastrous purchase of Merrill Lynch and its heavy exposure to enfeebled consumers. JPMorgan Chase, the healthiest of the big banks, is nevertheless taking no chances. It cut its dividend this week to save $5 billion in equity. It said this was a precaution, in case conditions worsen dramatically.
What should be done with “systemically important” banks that perform poorly in the stress test? Throwing yet more capital at them risks perpetuating what Paul Krugman, a Nobel prize-winning economist, calls “lemon socialism”, in which banks reap the gains but taxpayers eat the losses. It was handouts without proper workouts that led to Japan’s “lost decade”.
Hence the growing calls for the clean break offered by temporary nationalisation-or “conservatorship”, as some prefer. This involves several steps: ascertain which banks are insolvent, take them over, sever the most toxic assets and sell them over time or hold them to maturity. The good parts would be sold to the public or a strategic buyer as quickly as is feasible. These healthy banks would be fit to lend, benefiting the overall economy. The taxpayer may even avoid losses.
This may present another opportunity: to accelerate the break-up of banks that have become too big to fail. This was a problem before the crisis. Shotgun takeovers of weaklings, such as Bear Stearns, Merrill and Wachovia, have made it worse. Citi is considered particularly unmanageable.
Death and Taxes
This degree of interference would strike some as un-American. But the government’s tentacles are already wrapped around the banking industry, through debt guarantees, loss-sharing agreements, central-bank facilities and capital infusions, not to mention pay caps. It may take up voting rights on its common stock. As Mr. Bernanke pointed out this week, banks cannot do whatever they like with capital they receive from the state. Citi already has to clear strategic decisions with regulators.