Tuesday, October 14, 2008 0 comments ++[ CLICK TO COMMENT ]++

Massive Captial Injections and Partial Nationalization Underway

Free market proponents may not like it but governments of the world have taken almost-unprecedented action to inject capital into major banks. Many feel that there is few other alternatives, other than letting the banks collapse. You can get more details at your favourite media source so I'm not going to repeat that story except to provide a summary of the key moves courtesy The New York Times:

There are several elements and they keep changing so it's hard to say what the final situation is. My impression is as follows:

Although the details of the plans differ, we are seeing a global effort. This should increase confidence in the system and was essential. If only America did something while Europe and others did nothing, the impact would may not be significant.

The US government is forcing the leading banks to accept capital injections. Dilution for shareholders amount to around 20% of book value (depending on the bank in question.) The thinking behind the forceful move is the belief that these plans won't work if everyone doesn't participate. If some banks shore up their capital while others don't, there will still be fear of a collapse.

The market, including investors in the affected banks, seem to like the move. The shares of the affected companies are up anywhere from 3% to 13%, even though there is sizeable dilution involved. There is a possibility that the market was pricing in worse scenarios so the dilution may be minor. Short-sellers are still absent from the market--at least new ones--so it's not clear if this is a bogus rally or not.

I'm left-leaning and ok with government intervention when needed but this is basically the end of modern banking. The banking revolution is over. I suppose, like most revolutions, it ends up worse than anyone expects. If what I am saying is true, then investors need to be cognizant of the fact that future investment returns may be nothing like that past 20 years. (Note: I'm just talking about the developed world. The developing world, and banks with exposure there, are still in their infancy.)


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