Commentaries

Wishing away toxic assets

It wasn’t too long ago that there were worries on Wall Street, and presumably in Washington, about the rising tide of so-called Level 3 assets on bank balance sheets. That’s all those hard-to-trade and impossible-to-value securities that many like to call “toxic assets,” but that U.S. Treasury officials euphemistically refer to as “legacy assets”.

These days, however, Washington policymakers seem to have forgotten all about those concerns. How else can you explain the Treasury’s decision to allow 10 banks to repay $68 billion in TARP funds, even though the trash heap of ailing real estate-related securities and other troubled assets at many of these institutions has only grown since last summer.

That’s right. The percentage of assets that can’t be traded or valued on the open market is up at 6 of the 10 banks repaying money to the Treasury. And at some banks, the increase in the percentage of Level 3 assets from last summer is substantial, according to an analysis conducted by the Los Angeles-based research firm Audit Integrity.

Now there are a number of factors that could be contributing to the rise in the percentage of Level 3 assets at institutions like State Street and US Bancorp – none particularly good.

One is that as balance sheets shrink, banks are having an easier time finding buyers for more of their liquid assets, meaning the percentage of untradeable, illiquid assets is getting proportionally bigger.

Or, as Audit Integrity’s Jim Kaplan suspects, some financial institutions may be reclassifying some assets as Level 3, simply to avoid valuing them at depressed market prices and incurring additional write-downs.

Either way, this is bad news because for as long as a bank’s balance sheet is jammed-up with toxic or untradeable assets, it will be reluctant to get back into any serious lending to consumers or small businesses. Banks will be reluctant to expand their balance sheets as long as they still have a mountain of assets they can’t unload or properly value.

Regulators are opaque, too

So much for more transparency in the financial system.

It’s hard for regulators to demand greater transparency from Wall Street banks when they can’t even live up to their own standard of greater disclosure. A case in point is the Treasury Department’s press release touting its decision to permit “10 of the largest U.S. financial institutions” to begin repaying $68 billion in federal bailout money. The only trouble is Treasury doesn’t name any of the banks that can begin repaying money to the Troubled Asset Relief Program.

Treasury, it appears, has left it up to each of the “10 of the largest U.S. financial institutions” to make their own announcements about their intentions to repay the TARP. And some, like Morgan Stanley, didn’t waste anytime putting out a PR trumpeting its plan to repay $10 billion in TARP money.

Now it’s not like this list of banks is any big secret. For weeks now, it’s been well-known that Goldman Sachs, JPMorgan Chase, American Express, Bank of New York Mellon–to name a few–were itching to repay the bailout money.

But this is a question of government accountability. If Treasury has made a decision to allow banks to repay TARP, it should tell us which banks it has given the all clear to. Why should it be left up to the banks to tell us? After all, isn’t it the taxpayers’ money that’s being passed around here.

Nor should Treasury officials pass on the names of the banks in so-called “background” sessions with favorite reporters. The best government is one that is run in the open–not in some closed-door Washington, D.C. conference room.

This refusal on Treasury to do something as simple as print the names of the “10 of the largest U.S. financial institutions” is similar to the same kind of arrogance the NY Fed displayed during the early days of the goverment’s bailout of American International Group. The NY Fed, if you recall, refused to provide a list of the banks it was buying rotting CDOs from, in order to retire some $70 billion in credit default swaps that AIG had written on those securities backed by subprime mortgages.

from Matthew Goldstein:

Bank Investors Get that Sinking Feeling

Once again, bank investors are getting a reminder that share dilution is an issue they'll have to live with for quite some time.

Shares of most financial institutions were falling Tuesday after federal regulators issued a new edict that requires banks to raise capital by selling shares before they can begin repaying any of the government bailout money they've received. The new mandate applies even to the nine banks that last month passed the government's so-called "stress test,'' and were believed not to need to any more capital. It really makes you wonder what passing the stress test was all about.

Two of the hardest hit bank stocks are JPMorgnChase and American Express, which quickly responded to the new regulatory edict by announcing plans to collectively raise $5.5 billion from selling new shares.  Predictably, the share offerings were priced at a discount to Monday's closing prices for both stocks, meaning instant dilution for existing stockholders. 

And investors should expect more dilution in the weeks and months ahead as other banks sell discounted shares to raise capital to either get out from under the Treasury Department's Troubled Asset Relief Program, or simply make up for new holes that emerge in their balance sheets. Indeed, despite all the talk these days about the recession coming to an end and green shoots of economic revival, the signs of new trouble for the banks still abound. Think commercial real estate exposure, for starters.

Just today, Moody's Investors Service reiterated its negative view for the US banking system, saying that many banks will be unprofitable this year. Moody's says continuing losses on ailing assets and bad loans will put "stress on capital levels.'' And that means additional stock sales to fill in some of those new holes.

It's looking more and more like the bank rally of the past few months is running out of steam.