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The Great Bank Fallacy: CEOs Peddle False Optimism


Plans to repay TARP now are extremely premature.

Minyan Peter answers questions from the 'Ville.

Interviewer: In January, you offered a pretty blunt series of recommendations to then-incoming Treasury Secretary Timothy Geithner. With this past week's stress-test results, and with banks once again able to issue common stock, do you think your recommendations were too extreme?

Minyan Peter: No. My sole aim in recommending what I recommended was to try to get ahead of the crisis, not just respond to it. And in that regard, even with the stress-test results, I still feel like we're taking baby steps.

Interviewer: But the stress test suggests banks need to raise only $75 billion in additional common equity. That's a whole lot less than what you suggested when you recommended that the government convert its preferred shares to common.

MP: Yes, but I think there are 2 pieces you're missing. The first is that the $75 billion in additional common shares is based on something new called a Tier 1 Common Ratio, roughly Tangible Common Equity divided by Risk Weighted Assets. Not Tangible Common Equity divided by total assets.

And while I have high regard for many of our regulators, the difference is significant, especially for "non-traditional" banks, like Goldman Sachs (GS) and State Street (STT), where more than half their balance sheets effectively come out of the denominator when you use Risk Weighted Assets.

But there was more to my recommendation that the government convert its stake than just the need for common equity - and by the way, I also recommended that all of the existing other preferred be converted as well (which is just now happening at Citigroup (C)).

Anyway, my recommendation on the government's conversion was to eliminate the ambiguity regarding control. Right now, we have the entire banking industry doing this very odd dance with the government. The reality is that the industry cannot survive without many of the liquidity programs offered by the government.

So out of one side of their mouths, bank executives talk about how supportive the government has been; out of the other side, however, they talk about how much they hate the restrictions imposed by TARP.

The fallacy here is that, even if the big banks repaid their TARP preferred tomorrow, the level of government intervention in banks' day-to-day operations isn't going away anytime soon.

So it pains me to see bank executive after bank executive make this come-on to investors -- that the world will be all roses and sunshine if they can just get rid of TARP -- I just don't think that will be the case.
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