Nationalizing banks: Why this will Work?

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The Treasury announcement to inject capital (money) into banks, under terms created under the bailout bill.  This article will try to walk through, in English, what this all means.

As part of the bailout bill (or TARP: troubled asset recovery plan), one provision that was mostly overlooked during the congressional hearings and rollout was the feature that permitted the Treasury to inject capital directly into selected banks.

A general understanding that most people had of the bailout bill, was that "troubled assets" would, essentially be "traded" to the Treasury for treasury bills.  That feature still is in the bailout package, but is mired in the developmental stages.  Working out the details of which assets (and from which banks) to trade may take a long time to figure out.

And time is the one precious commodity that no one has.

So the Treasury is proposing to take an "ownership stake" in some banks.  They will "buy" part of some banks in return for preferred stock.  They will receive dividend income and be able to make money by selling those shares in the future.  Probably right back to the banks themselves.

What do the banks get?  Well, when you sell stock, you get cash.

Now...here's where the plan works: When a bank receives equity (cash) it can turn around and lend that money, practically overnight.  However, banks don't lend money on a dollar for dollar basis, it's always leveraged.  Not that 30:1 or 40:1 leverage like what sunk the fat cats. So, for illustrative purposes only, think in these terms: $700 billion could turn into $7 trillion worth of loans and financing.  If that doesn't get banks moving again, we are all dead.  For perspective, consider that the entire mortgage market in the United States is approximately $14 trillion.

This feature was widely overlooked by most folks when the bill was introduced and signed into legislation by President Bush.  But this feature may indeed be the "master stroke" (or "magic bullet") that gets the wheels turning again.  It's a dangerous precedent, and it IS risky (if it doesn't work, it is game OVER).

But understand THIS as well: getting the banks to lend money again, is not the end of a recession.  But it will certainly re-ignite the flame, and can very likely accelerate the economy.  So, while I'm not an economist by profession (but I am an optimist), in my humble opinion I feel this will be a short, but very severe recession... followed by recovery.

You truly are living in interesting times.  I don't believe we will see this kind of action again for years and years.  Maybe generations.  And this is a "magic bullet" (or atom bomb) that we need to insure we will never need to employ again.  Seriously...never again.

I've read many different reports about the mortgage mess.  No one really seems to have accurate data.  But if 80 or 90% of all mortgages are current, I have to believe the federal government has made a good investment with this bailout bill.  I believe the government will make money on these mortgages.  And now that they are injecting capital into selected banks, they will have "preferred stock" in these banks.  Meaning, as the banks get back on their feet, the government will make money on these investments as well.  They are negotiating great terms and getting in near the ground floor.

The immediate impact will be the re-opening of the banks, and the credit markets.   We'll see that right away in our local economy.  But the entire process may take several years to completely unwind.  But the Treasury has the deepest pockets in town.  Whoever is President of the United States in five or six years will certainly try to take credit for the "economic miracle" that occurred on "their watch."

You can count on that.

Thomas Mullooly  is the owner of Mullooly Asset Management, LLC, NJ Fee Only Investment Advisor, providing guidance for your 401k account. Mullooly Asset is a fee-only alternative to stockbrokers and financial planners.

Tom's popular email alerts help folks to reduce the risks in their portfolios. To learn how to stop making investing mistakes or if you would like a free look at your 401k account at work - or your 403b annuity, or section 457 deferred compensation plan at work, visit www.mullooly.net today!

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