A Recurring TARP Nightmare

Company Research, Market Commentary

While the deployment of the second iteration of TARP is being discussed on Capitol Hill, there were a couple of very distressing pieces of news that I read today.  The first piece from the Wall Street Journal showed that based on banks own reports, 10 of the 13 largest beneficiaries of TARP are lending less now that they have $148 billion in TARP funds (see the WSJ chart).  Amazingly, with more than $90 billion dollars in TARP funding between them, Citi (C) and Bank of America (BAC) are keeping those funds in reserve as they are more risk averse in this environment.  We are not advocating loosening lending standards, but perhaps it is a scary picture of the fact that there isn’t anywhere to put these funds to use.  However, the article quotes a finance professor from Duke University, whose study claims that 59% of U.S. companies surveyed felt constrained by a lack of credit.  Perhaps the risk aversion of banks has swung to far and is now stemming growth.

So, the idea was that the TARP program would recapitalize banks and allow them to lubricate the credit markets and thus help everyone from Wall Street to Main Street continue about their business has not been the case thus far.  We are seeing that the credit markets are still sluggish at best, and the WSJ study shows that they have not put those funds to good use, at least not yet.  There are no easy answers and we can hope that banks become more inclined to lend responsibly soon instead of keeping the funds as reserve for defaults.  There were few strings attached to these funds in the first place, so I guess we will all have to wait for banks management to decide that they are ready to lend again.

The Wall Street Journal study was looking to the short but unimpressive history of TARP, but this week’s newsletter from John Mauldin at Investors Insight looks forward at what could be ahead.  There is significant concern from Mauldin and the now infamous Nouriel Roubini that TARP II will not be sufficient,

Professor Nouriel Roubini and his team at RGE Monitor (www.rgemonitor.com) have been noting in speeches in various venues around the world that they estimate that losses from the financial world could be as high as $3.6 trillion. That is composed of $1.6 trillion in loan losses and another $2 trillion in mark-to-market losses of securitized assets.

“U.S. banks and broker dealers are estimated to incur about half of these losses, or $1.8 trillion ($1-1.1 trillion loan losses and $600-700bn in securities writedowns) as 40% of securitizations are assumed to be held abroad. The $1.8 trillion figure compares to banks and broker dealers capital of $1.4 trillion as of Q3 of 2008, leaving the banking system borderline insolvent even if writedowns on securitizations are excluded.”

Roubini argues that banks will need an additional $1-1.4 trillion dollars in private- and public-sector investments. Then he and colleague Elisa Parisi-Capone lay out in detail how they come up with their numbers. They argue:

“Thus, even the release of TARP 2 (another $350 billion) and its use to recapitalize banks only would not be sufficient to restore the capital of banks and broker dealers to internationally accepted capital ratios. A TARP 3 and 4 of up to $1.05 trillion (assuming generously that all of TARP 2 goes to banks and broker dealers) may be needed to restore capital ratios to adequate levels.”

Everyone knows that Professor Roubini has earned his nickname “Dr. Doom” but he also has also been right more than wrong in the last few quarters.  He presents an incredibly depressing view of where our financial system could be headed.

As we said before, there are no easy answers to this problem, but we wanted to pass along these interesting notes regarding the so far opaque world of TARP.  There is a powerless feeling regarding these funds that have been appropriated so rapidly.  However, it is important to remember that the Treasury (and tax payers) have only loaned this money to the banks, and with any luck we might be able to reclaim some of it, although these reports give me some serious doubts.

Ockham Research Staff @ January 26, 2009

tags: Banks | financial | John Mauldin | Nouriel Roubini | TARP | Wall Street Journal