Raw Finance

On January 5, 2009, the U.S. Treasury Department released the details of a $15 billion investment in 7 banks made on December 31, 2008, through a part of the Troubled Asset Relief Program known as the Capital Purchase Program.  This brings the total investment in banks to $177.5 billion of the $250 billion allocated under TARP to the Capital Purchase Program.

The seven banks and the respective TARP investments may be viewed here.

Recapitalization of banks, regarded in some economic circles as a necessary action to recover from the financial crisis, thus curing the recession by restoring a fully-functioning financial market, is now coming under some criticism.  The critique of the Capital Purchase Program does not attack whether the program should be implemented, but rather, it is concerned with how the program has been and will be implemented.  The crux of the concern is that because no one has yet ascertained the full value of the so-called “toxic” assets held by banks (mortgage loans, securitized mortgage loans, credit default swaps, etc.), it is very likely that some, most, or all of the banks included in the Capital Purchase Program are “zombie” banks.  “Zombie” banks are those that have no ability to sustain an ongoing operation, but give the appearance of being able to do so.  The obvious danger in giving money to “zombie” banks is that the investment will be lost.  But the more immediate impact is that “zombie” banks do not lend.  The purpose behind recapitalizing banks is to allow them the balance sheet breathing room to resume lending.  Because “zombie” banks do not lend, the investment (taxpayer dollars – or more likely now printed money) in them is wasted.

Recapitalizing banks is the right idea to bring stability and liquidity back to the financial markets.  The problem is that not every bank deserves to be recapitalized, but no one in Washington wants to make the hard decisions of which banks are sustainable and which are zombies.  Part of the reason why such decisions cannot be made is that we still do not have a full accounting of banks’ balance sheets.

The continued suspicion toward and among banks is what drove up money and credit spreads, making borrowing prohibitively expensive.  According to RGEMonitor, current money and credit spreads are as follows:

• Jan 5: – O/N LIBOR down to 11bp despite interest on reserves due to GSE exception that makes agencies willing to lend overnight at less than policy rate;
  - TED spread (3m LIBOR – T-bill): down to 134bp upon ‘Fed to issue bonds’ idea–> extreme flight to quality is causing record repo failures;
  - 3m USD LIBOR – OIS: down to 125bp;
  - 3m EUR LIBOR – OIS: down to 107bp; 
  - U.S. CDX IG spread: 198bp
  - U.S. CDX HY spread: 1147bp;
  - EU iTraxx IG spread: 180bp;
  - EU iTraxx HY spread: 1035bp;
  - ABS benchmark spreads stay around highs despite $200bn TALF announcement. On the other hand, A2/P2 commercial paper rates fell sharply on the last day of
  2008–> the spread between top Fed eligible paper and lower rated paper climbed to almost 6%. 

Although those spreads have eased recently, banks are still borrowing directly from the Fed.  The Term Auction Facility, which began in December 2007, has tripled in size and continues to hold auctions twice per month.  In the most recent auction, held December 30, 2008, the Fed accepted more than $100 billion in bids on 83-day credit.  Moreover, the $200 billion Term Asset-Backed Securities Loan Facility (TALF) was recently revised to extend the loan maturity from 1 to 3 years.  A Q&A on operational aspects of the TALF may be read here.  Under the TALF, the Fed will lend up to $200 billion on a non-recourse basis to holders of AAA-rated asset-backed securities backed by “newly and recently originated” loans, such as those for education, automobiles, credit cards and loans guaranteed by the Small Business Administration.
 
The longer credit markets remain illiquid, the longer the recession will be – and it is already more than 12 months old.