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Tuesday, October 14, 2008

Treasury investing in bank stocks, FDIC insuring damn near everything

The government, in their efforts to save our flawed banking system and spur lending activities, has opted to perpetuate existing conditions by injecting more capital into major banks. The bailout plan continues to disproportionately benefit a select few companies chosen by administration preference behind closed doors. The assumption in place must be that the banks are more market savvy than the Treasury and will put the capital to better use than the TARP fund would.

It seems a bit underhanded that the Treasury just two weeks ago was in front of congress saying they needed to create this fund to buy securities. Paulson and Bernanke were grilled about the culpability of the banks. Democrats raged about executive compensation caps. They told congress if the package wasn't approved immediately we would fail. What seemed like an afterthought attachment that they might buy shares in banks has now become the centerpiece of their strategy.

That said, this is probably a better plan than burying the securities. It would be very hard for the TARP to determine what they owned and how to deal with it – thus far the banks have not been able to do that and they bought the stuff in the first place.

The troubling aspect of this strategy is that it does nothing to correct the conditions that got these banks into dire straits. In fact, it seems to validate their over-levered balance sheets. If the plan comes with stipulations that the banks should not have risky investments, what are they to do with the risky investments already on the balance sheet? Those investments are no less risky and now probably fail an acid test for new investment. How will the dangerous paper go away if they're only allowed to own good paper?

The FDIC has decided to insure everything in sight, raising insurance on accounts to infinity and protecting new preferred securities for banks to pass between one another that will be issued in conjunction with this plan. They will also be offering counter-party insurance.

I understand the plan but I don't understand how it fixes the infrastructure problems. Once again, it prolongs any kind of true realization of the issues. The hangover is extended.

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