How a Creeping Government Takeover is Destroying the Banks

How a Creeping Government Takeover is Destroying the Banks

By Robert Tracinski - January 20, 2009

The basic pattern of the Stimulus Depression continues: the more the government tries to stimulate it, the more depressed the economy gets.

According to the latest report in the New York Times, after hundreds of billions of dollars in spending, the stimulus is not working. The banks who were supposed to be saved by the first round of bailouts are actually in worse shape and need more federal cash.

The Times notes that the source of the problem is that "Private investors are scarce. For all but a small group of healthy banks, bankers and analysts say, the government may be the only investor left."

But the obvious question is: why are private investors scarce? Maybe it has something to do with the terms of the "stimulus" aimed at them. The Times story contains only one hint at this:

Mr. Obama's economic team is planning a broad overhaul of the program to impose more accountability and more restrictions on executives at companies that receive government money.

"More accountability" means more government management of the banks; more restrictions means more measures designed to reduce the profitability of the banking industry and drive out the best talent.

For an example of what all of this "accountability" means, consider the Wall Street Journal's overview of the government's treatment of the healthiest of the big nationwide banks, Bank of America.

Bank of America CEO Ken Lewis earned kudos last year for stepping into the breach when the mortgage market and Wall Street cratered. BofA's purchase of Countrywide Financial and its September agreement to buy Merrill Lynch offered a welcome dose of optimism and private capital amid the panic.

In December, Mr. Lewis realized that he had been too optimistic.... After BofA shareholders approved the Merrill purchase on December 5, Mr. Lewis saw Merrill's assets plunge in value and began to explore a way out. At least he wanted a better price....

Mr. Lewis's effort to protect his common shareholders was vetoed by his most important shareholder, the feds. In October the US Treasury had insisted on investing $15 billion in his bank. Come December, Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke told him that Merrill had to be saved, and that BofA had to be the savior....

In other words, the feds believe that the way to calm financial markets is to force the nation's largest, and a heretofore healthy, bank to swallow toxic assets it didn't want.

But here's the really awful part: the Treasury's forced investments in Bank of America are held in the form of preferred shares paying an 8% dividend. Yet the bailout agreement forced on the bank "limits quarterly common stock dividends to a penny a share." Oh yes, and Bank of America "will also have to accept new executive compensation limits. And the bank will need to submit for government approval a plan to modify troubled mortgages." The Journal's commentary concludes: "Mr. Lewis doesn't seem thrilled that the government has a larger piece of his business. When asked yesterday when the bank might escape federal ownership, he replied, 'I wish I knew,' and then added, 'clearly as soon as possible.'"

Similarly, Bloomberg's David Pauly describes the incoming administration's attempt to suppress the stock dividends paid by banks, a measure which effectively eliminates the "last reason to own bank shares."

Banks have traditionally paid hefty dividends. In the years before the onset of the subprime mortgage crisis, payouts by Bank of America Corp., for instance, yielded about 3 percent to 4 percent of the company's stock price and grew steadily.

Now President-elect Barack Obama plans to take away even that attraction, Lawrence Summers, who will head the new administration's National Economic Council, informed Congress this week.

Obama...will order the Treasury Department to limit dividends paid by commercial banks and investment banks that receive "exceptional assistance" from the government to "de minimis amounts."

While investors have known that current yields were ballooned by falling share prices and that massive bank losses made some payouts unsustainable, many may have bet that relatively stronger banks would still maintain nice returns....

Now, what dividends, if any, banks can pay may depend on how extraordinary "exceptional" may be interpreted and how trifling "de minimis" may turn out to be....

It seems likely that dividends of all the major bank recipients of Washington rescue money will be restricted.

Again, while private investors may be out of luck, the government will still get its dividend: "Obama's Treasury may want to assure the banks have enough money to pay the dividends they owe US taxpayers. The preferred shares in financial institutions that the government bought in the rescue effort pay 5 percent dividends for the first five years, 9 percent after that."

All of this reminds me of a minor subplot from the 1990 film Goodfellas. The movie is interesting as a relatively un-glamorized portrait of the life of mobsters--though that won't necessarily make for a fun evening's viewing. The subplot involves the hapless owner of an Italian restaurant that becomes a favorite hangout for the mobsters. When they become a bit too rowdy, the owner goes to the godfather and asks him, in the politest possible way, if he can tell his men to keep it down and stop scaring off the regular customers. The godfather immediately demands a part-ownership in the restaurant--and it is clear that this is an offer the owner can't refuse.

What follows is a series of scenes in which the mobsters feel free to show up at the restaurant and steal cases of beer from its coolers, for example, or walk out after a large meal without paying the bill. After all, they're business partners, aren't they? Eventually, having bled the restaurant dry through this kind of petty theft, they set fire to the place in order to collect the insurance money.

That's how the banks must be feeling right now about their own unwanted "business partner," the federal government. Having been coerced into accepting bailout money from the Treasury, they now find that their new partner is draining away every last bit of wealth that used to belong to the bank's real owners, its private shareholders.

No wonder that the LA Times reports that "An index of 24 major bank stocks has fallen every month since September and dived 29% just since year-end, to a 13-year low Friday."

Much more of this mob-style "stimulus," and private shareholders will have been driven completely out of the financial industry--which will then be taken over by the goodfellas at the Treasury and the Federal Reserve.

Robert Tracinski is editor of The Tracinski Letter and a contributor to RealClearMarkets.

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