Citigroup, Wells Fargo and Bank of America are all repaying their TARP loans to the government. They’re selling a lot more of their shares to private investors in order to raise the cash and, in the process, significantly diluting existing shareholders. And that’s not necessarily a bad thing. A year ago banks couldn’t sell shares; there were no buyers. Short term commercial paper markets were frozen. Assets held on bank balance sheets were falling like very large stones because a “market price” couldn’t be determined as no bids could be found. Banks were most distrustful of each other because they feared that the bank across the street might well be laden with the same terrible investments that they had themselves. In fact, they worried that a trade with another bank could leave them with something worse than the problems that were already festering. A year later, this is good news. Markets are open and working again.
I’m surprised by the market’s reaction to these secondary stock offerings by the banks. For example, Citigroup’s offering would be about 23% dilutive to current shareholders, yet share prices declined only 7%. Investors are saying that Citigroup’s share price, which is up about 250% since the March lows, is worth an additional 15% or so on the basis of getting out from under the government’s supervision. Some banks may represent attractive investments right now but need to be evaluated on a case by case basis.
Massive government stimulus and intervention has wrought a really good result: the markets are clearing and banks have been able to raise much-needed capital. However, the crucial point is that this positive environment created by trillions of dollars injected by the government is artificial. Our current sense of stability and resilience has been purchased – and is continuing to be purchased – at an enormous price. The reflexive upswing in markets and economic data is simply that: reflexive. That may change in the future as the real economy recovers, but our current warm breezes are being generated by propane heaters, and the swaying palm trees are plastic.
The government did a good job. Their intervention avoided collapse. In Washington, we find precious few reasons to celebrate and laud government efforts, but this time they deserve credit. Good job, folks! TARP borrowers paid 8% for the loans and are repaying the loans. The program has worked.
While Barack Obama is a charismatic, youthful President, it would be wrong to let schmaltzy sentimentality carry us away to “Letsbehappy Land.” Many of the fundamental problems behind last year’s financial crisis remain. As I write, 25% of residential mortgages in the US are larger than the market values of the homes that secure them. Consumer debt remains very high. Holiday shopping is light. Black Friday weekend saw higher volumes of people spending fewer dollars than were spent last year. In short, 70% of the US Economy (the consumer) continues to struggle and sees further struggling ahead, and 10% of them don’t have jobs. What happens to mortgages and home prices when the government stops making banks facilitate workouts for troubled loans, or removes tax credits for home buyers, or stops buying mortgage-backed securities, which artificially keeps mortgage rates low? The answer is we don’t know. The answer is that at that point we will learn the real market clearing price of those bank assets and for the house for sale down the street. And it may be fine. And it may not. But, Wall Street seems to be screaming against the possibility that maybe just maybe this recovery may be tougher than the headlines want you to believe. There is a universal demand to accept this artificial recovery as both real and everlasting. The success that banks have been having in raising massive amounts of new capital is a testament to the widely held belief that a sustainable economic recovery is indeed at hand.
There is no crystal clear evidence that the stabilization in housing prices and bank credit metrics is anything other than a temporary side effect of the massive government intervention.
Remember that investors rue the decisions they based on belief in the world as it seems and not as it is. This is not a real economic recovery yet. This is what a recovery looks and feels like at its genesis, but a real one is different in that it is fueled by real demand for goods and services.
The government hopes that the current economic recovery based on lots of support will painlessly transition to a real recovery based on increasing demand. We are not there yet. There is money to be made in this type of environment, but we encourage caution. After investors recover from having been swept away by a surge of elation and promises of abundance, they often face the cold porridge of “should have known better.” Be careful. Don’t get caught up in the rip tide. There is no point fighting a rip tide either; it will be over when it is over.
Banks repaying the TARP money is great news. We should enjoy it but recognize it for what it is.