Bank Vigilantes

Those of us who were in the business remember the term "Bond Vigilante". The Bond Vigilantes were participants in the U.S Treasury market who put the kibosh on President Bill Clinton's spending plans by pushing the yield of long dated treasuries higher. This forced the President to scale bank spending and instead attack the budget deficit. This prompted presidential adviser James Carville to state:

"I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.''

The Vigilante's, or their descendents are back, but U.S. treasuries are not their targets. It's the banks. Bond Vigilantes are now Bank Vigilantes.


James Carville was not joking when he described the power of the bond market. More than any other area of the capital markets, the fixed income arena exerts the most influence over the economy, the President, Congress and corporations. The bond market is making itself heard loud and clear that it wants toxic asset exposure by banks revealed and it wants those toxic assets of bank balance sheets or it will take its capital elsewhere. Until the Bank Vigilantes feel comfortable, banks will have to go to the government for capital. This is all very frustrating for our new President and his treasury secretary, Tim Geithner.

The government has chosen to engage in a game of chicken with the Bank Vigilantes. The new players in D.C. had best use caution when attempting to stare down the bond market because it does not blink. The man who knows this is Fed Chairman Ben Bernanke. He has stated at several venues that there needs to be a mechanism to deal with an orderly dissolution of a large, systemically-important institution. Mr. Bernanke knows that the bond market (including preferred securities) will withhold investing capital in banks which it believes may not be viable. Why take the risk. Unlike some pundits, the Bank Vigilantes do not take comfort investing along side the government in the preferred market. They do not want to risk a GSE preferred share wipe out. The first bank which comes clean by clearing out its toxic assets and throws off its TARP yoke will attract capital.

If it is that simple, why don't banks just bite the bullet and pay back TARP and become more transparent? Some are. J.P. Morgan, Goldman Sachs and Morgan Stanley are said to be considering paying back their TARP preferred investments. Why don't other large institutions do the same? If one thinks about it, the answer becomes very apparent. They cannot. This is what has prevented both former treasury secretary, Hank Paulson and current treasury secretary, Hank Paulson from enacting a workable rescue. Thus far, the government has thrown money at the problem hoping to pacify the Bank Vigilantes. The Vigilantes will have none of it. One bank CEO suggested amortizing the losses over time. This may not work because the Bank Vigilantes do not want to worry about unknown, but continuing losses. They abhor the unknown. What is frightening is that the Treasury probably has a fairly good idea what these toxic assets will be worth down the road (versus their very low current market prices), but cannot purchase toxic assets, even at their so-called "hold-to-maturity" values because values are likely sufficiently low to cripple or collapse a bank.

What happens next? Unless the Bank Vigilantes have a change of heart or the government can find a way of pacifying them without forcing a bank to acknowledge losses (neither are likely) troubled banks are going to have to face the music. Hopefully Mr. Bernanke's mechanism will be in place by then.