Wednesday, January 28, 2009 0 comments ++[ CLICK TO COMMENT ]++

Government slowly gaining control over banks

The question on the mind of many is whether huge swaths of the Western banking system is going to end up being nationalized. The huge outlays, ranging from purchasing preferred shares to offering credit insurance, sometimes in quantities seemingly larger than the market cap of such banks, seems to imply that the government owns the banks. Well, it's becoming clear slowly that the government is taking over control.

Perhaps the most symbolic is the cancellation of an airplane order by Citigroup after the Obama administration made a call:

On Monday an official of the Treasury Department called an official of Citigroup, recipient of $45 billion in TARP funds, and complained about the company's new $50 million dollar,12-seater corporate jet from a French company.

The official "told them to fix it," a source with knowledge about the call tells ABC News.

Citigroup this morning released the following statement: "We have no intent to take delivery of any new aircraft."

There is no way such a thing would have happened under "normal circumstances." Politicians often criticize but executives generally ignore them. But not this time.

Whether this is a good or bad is a lengthy debate. Some, such as one of my regular readers, ContrarianDutch, is concerned with the rise of nationalization. I can see his concern. After all, it won't be too long before the government calls on these banks, if the economy deteriorates much further, to continue lending to consumers and corporations even if the risk increases. Fannie Mae and Freddie Mac have, recently, started expanding their mortgage operations after policymakers called for them to do so. The shares are still publicly traded but the orders are coming from the government. Similarly, Citigroup and others may end up with the same fate.

I think I know what the next controversial thing the government will tackle: compensation. It would not surprise me if Citigroup brass, not to mention the other banks, receive another phone call from the Treasury discussing government dissatisfaction with the seemingly large bonuses paid while the banks are posting losses or very small profits.

Most of the readers here probably won't agree with me but I don't necessarily see anything wrong with what is happening. First, though, make no mistake: I don't like what is happening! The fact that the government is taking over these megabanks means that the banks will be inefficient and will crowd out the private sector somewhat. But, the reason I'm more toleranat is because, if governments are spending, not just a few million here and there, but tens to hundreads of billions propping up these banks--nearly all of them would be bankrupt otherwise, at least on our "friendly" mark to market basis--why shouldn't taxpayers own them?

Regardless of whether you agree with my view or take the opposite position, I think we should all prepare for a market environment where huge swaths of the banking establishment is owned by the government (or at least is heavily influenced by it.) Investing in banks would be, in my opinion, somewhat akin to investing in some industrial companies in the 40's when they were essentially controlled by the government for the war effort. Perhaps we are facing a war, of the economic kind, and governments are forced to control the banking system.

I have painted a somewhat gloomy picture, at least if you are a free market type--I hope all of us are, even if the degree differs amongst us--and does not want the government dictating the financial matters; but it will only manifest itself if the economies of the world deteriorate significantly. The consensus right now is for the economy to recover by the second half of this year. If that's true, no need to worry much. Not only will asset prices, especially real estate and bonds, stop declining, banks will start posting strong profits off the positive sloping yield curve. John Hampton at Bronte Capital blog speculates that American banks will earn around $400 billion pre-tax so things can stabilize... but if the economy deteriorates much further, that's when the government will try to use all its tools to get lending going.


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