Like I said, financial equity is the hottest ticket in town.  As the shape of the Obama administration’s bank bailout plan becomes known, the zombie banks are crawling out of their graves and up the charts.

First, Swedish-style bank nationalization is looking less like the way out of a crisis and more like a ticket to a prolonged depression. Even Citigroup’s beleaguered CEO Vikrim Pandit had the temerity yesterday to warn that nationalization was a terrible idea. The Swedish solution looked like the consensus a week ago — not anymore. Barclay’s surprise announcement that higher revenues would allow it to post a profit during 2008 demonstrated that banks can make money in this environment, with nearly zero-cost funding from governments, lending guarantees, and ring-fencing of part of their asset books. As I argued in a long Asia Times essay last Friday, subprime and other mortgage assets (among others) have fallen to levels that offer unlevered returns in the mid to high teens. As hedge funds lose their grip on these assets and their ability to raise money, banks will be the last source of leverage with which to acquire distressed assets.

Extremely important, also, is the fact that the Obama administration left mortgage “cramdown” (effectively unsecuring previously secured household lending in the event of bankruptcy) out of the stimulus package, to the utter consternation of left-wing “consumer advocates” and populist Congressmen such as DIck Durbin of Illinois. His supporters are howling, not least because President Obama reportedly told the House leadership personally that cramdown had to scram out of the stimulus package. That is an important test of the new administration. Bank analysts (and pretty much everyone who understands the first thing about banking) have echoed my Jan. 13 warning that cramdown could throw a monkey wrench into the banks’ gears.

It wasn’t a minor matter. As I reported in the linked post, the rally in the top of the subprime capital structure collapsed as soon as CItibank unwisely endorsed cramdown, apparently armtwisted by the federal officials. The fall in asset prices contributed to the run on bank equity that ensued during the third week in January.

The template for dealing with the crisis remains the one proposed by Paul Volcker chairing the Committee of Thirty in early January: stop the banks from writing down the decline in the value of their securities’ holdings against their capital, and let them focus on boosting cash-on-cash returns. A minor variation on this theme was offered this week by Deutsche Bank’s analyst covering banks, Mike Mayo.

What convinced the Obama administration not to play Dr. Frankenstein with the banking system? The collapse of the British pound and the soaring cost of insuring against a British default must have gotten someone’s attention. The sharp backup in US Treasury term yields despite an equally sharp fall in US equity market, moreover, must have alerted some in Washington that the credit of the US Treasury was not impregnable. The worst thing about bank nationalization is NOT that the government will do a bad job of banking. Everyone does a bad job at banking. The worst thing is that it places untold trillions of dollars of new liabilities on the shoulders of a federal government that already is borrowing well over $1 trillion a year.

This entry was posted on Wednesday, January 28th, 2009 at 7:34 am and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.