Ladies and Gentlemen of the Jury

The markets, especially bank shares, preferreds and bonds, rallied following Fed Chairman Ben Bernanke's testimony today. Mr. Bernanke indicated that he does not believe the banks would have to be nationalized, that they had sufficient capital. At worst, Mr. Bernanke believes that banks may have to be dealt with on an individual basis, based on the results of the Treasury's forthcoming "stress test". A stress test which Mr. Bernanke states will not be a pass / fail test, but a measure of how much more funding specific banks may need. In other words, the entire bank rescue plan is jury-rigged.

First, I do not know one credible person who believed that the entire banking system would be nationalized. The believe that only demonstrates ignorance. Even the nationalization of one large bank is a gargantuan undertaking fraught with unintended consequences. A more realistic plan would be to take large equity investments in troubled banks and force their restructuring. Although the government may take equity stakes in certain banks, it appears as though forced (and necessary) restructurings are not on the table.


No large bank will be restructured. No large bank will have to face the realized losses it incurred. The worse off a bank the more money it receives. I am wondering if it truly matters in what class of securities one invests. According to Mr. Bernanke, large banks will be rescued come hell or high water. The secret to business success in America no longer consists of creating an efficient, well-run business model. The new secret to business success is to grow large enough to where a corporation can hold the nation hostage.


President Obama said strings will indeed be attached to further bank rescues (more inconsistencies from the government. I agree with the President. Not only to I agree with the President, but I will go one better. I think shareholders (who are owners of the banks after all) should share in the losses. I say this as an owner of a fair amount of unvested shares of a large troubled bank.

Some will argue that if shareholders, common or preferred, are wiped out, investors will not come bank to those areas of the market. The aftermath of Freddie and Fannie preferreds proves this can happen. However, the result will be that investors will look at the individual business models and results of a company, not just their size or systemic importance (or in the case of the GSEs, government reassurance). Institutions seeking capital from investors will have to be transparent and efficient. If shareholders are forced to share in the pain with taxpayers now, they will be make more prudent investment decisions for years to come and force institutions to better run their operations, lest they cut themselves off from the capital markets. In other words, if institutions want investor capital, it will have to earn investor trust!


Although it appears as the government will act as an economic nanny, I still believe it makes sense to go up the capital structure, just in case the government decides to do the right thing and unwind so-called zombie banks. Just because the government may not act appropriately does not mean that we should take undo risk by counting on the government to act irresponsibly and permit banks to pay dividends, etc. out of TARP money. One of these days it is going to surprise us.