U.S. Banks : too big to fail, too complex to manage

Our view:

Legendary investor Warren Buffet says that yet another round of stimulus funds are round the corner as the chances of quick economic recovery seem bleak.With the watered down Obama plan for regulations and reforms still doing rounds of the Congress and unlikely to be cleared this year the Bank lobby is winning both ways.With another round of stimulus and regulation and reforms being pushed back, the Banks are proving the truth in the saying "too big to fail, to complex to manage"

With the bailout and TARP funds loosing steam after an intial promising burst at the Stock exchange, the American economy is once again turning sluggish. The U.S. GDP that dropped by 6.3 % and 5.5 % in the Quarter ending December 2008 and March 2009, fell only marginally by 2.8 in the last Quarter to $ 11,270 Billion.However the reason for this slower decline in GDP was not any miraculuous green shoots or the initial stage of economic recovery, but the increase in transfer income. This transfer income was none other than the effect of bailout funds, the TARP funding and the interbank transfer of funds against toxic assets.

According to U.S. Department of Commerce, the U.S. GDP which was $ 11.73 Trillion in June a year ago has shrunk to 11.27 Trillion Dollars in the month ending June 2009 despite the massive Federal funding. Had it not been for the timely overdose of Government support, the GDP could have shrunk by an additional $500 Billion. The big problem however is that large part of the bailout funds have been exhausted and TARP funds remain unutilised as despite the massive incentive there are no buyers till date for the toxic assets.Since the Banks were able to raise substantial funds from the public they are in no hurry to dispose of the toxic assets and clean up their balance sheets.As a consequence, Banks and their supervisors will take additional time to assess the magnitude the real damage and set the timing of troubled assets sales, as part of their larger efforts to minimise losses to the banking sector.

As a next step, the FDIC will test the funding mechanism contemplated by the LLP in a sale of receivership assets this summer. FDIC Chief Sheila Bair says that this funding mechanism draws upon concepts successfully employed by the Resolution Trust Corp. in the 1990s, which routinely assisted in the financing of asset sales through responsible use of leverage. The FDIC expects to solicit bids for this sale of receivership assets in July. The FDIC will continue its work on the LLP and will be prepared to offer it in the future as an important tool to cleanse bank balance sheets and bolster their ability to support the credit needs of the economy.

Sheila Bair the FDIC Chief is fighting a lonely battle for setting up a multi body systemic risk council whereby each functional regulator takes control of their functions and jointly monitor the Big Banks and Financial Institutions. Setting up a systemic risk council would be in line with the recent EU reforms and would ensure that a slip up or nexus between the single regulator and the Banks do not jeopardise the entire financial system like in the current crisis. The Obama plan drafted by none other than Geithner ( Treasury Secretary ) and Lawrence Summers (White House Economic advisor) however puts all powers in the hands of the Federal reserve, which was one of the few agencies responsible for this current crisis. So while there are no lessons learnt, the Banks are being further bloated as a curious risk management measure.This capital augmentation without getting rid of the toxic assets not only create doubts amongst investors and customers but also the Bank employees about there own fate in the future, when the bailout funds are exhausted.


Thus, with the Banks still in the ICU, they have not started to lend either and credit remains scarce both for the corporate as well as the domestic sector.
Declining consumer confidence, falling stocks and unemployment climbing toward 10 percent has overcome concern that record auctions of government debt will overwhelm demandThe gap between yields on 10-year Treasury notes and 2-year securities narrowed to 2.40 percentage points from a record 2.81 percentage points on June 5 as investors took advantage of relatively cheap longer-term debt

Legendary investor Warren Buffet said recently that the economy could do with a second instalment of stimulus funds as economic recovery seems distant. This is probably the reason why the Treasury yield rates are falling rapidly. This means that the total debt and deficit is due to rise furthur and the GDP is set to decline some more. It is quite likely that the overvalued Dollar now starts plummeting as the U.S. economy moves into the downward spiral requiring additional stimulus especially as global investors like China, Russia, the Saudis and Kuwait are slowly loosing faith and pulling out of investing further both in treasury bonds as well as U.S Dollars