Home > INVESTMENT PUBLICATIONS
The Bail-Out
What is it?
- A $700 billion fund to buy illiquid loan portfolios from banks
Putting it into place
- Still has to be passed into law, but it will be after the political capital games are played out
- Still to be determined which assets are bought and at what price. Expect the US Treasury to drive a hard bargain
- The US Government will print the money to do it, supported by foreign central banks
- Presumably the assets will be sold on at some stage (remember Hank Paulson’s background) and the US Treasury could make a tidy profit as the current crisis is arguably more about valuation than quality
Effect upon banks
- Depends upon the values at which the loans are currently held on balance sheets relative to the prices that will be achieved
- Loan to capital ratios should improve within banks which have already written down their loan books substantially, but these will be a small minority. The rest will be crystallising the losses on their portfolios and thus we should expect large numbers of announcements about write-downs
- But the real price for banks of this bail-out will come in the form of: tighter regulation / inspection; accounting of off balance sheet items; capital ratios (BIS). Banks will need to raise more equity capital
- I imagine that there will be significant political pressure upon shareholders to get rid of managements which have risked the house and failed
Likely impact upon the wider economy
- Even those banks whose capital position is enhanced by the bail-out will find that new rules will tighten lending disciplines
- The Anglo-Saxon economies remain highly leveraged; the bail-out does nothing to alter this fundamental position. The US and UK housing markets continue to require further corrections
- The bail-out reduces the probability of a deflationary spiral. Inflation becomes a risk only if the increase in money supply is accompanied by an acceleration in monetary velocity, which seems improbable given the fact that the economies remain highly leveraged, and that banking rules will become tougher
- Interest rates will be used for demand management, not to bail out the banks; there is a separation in policy of demand-linked cash flow (interest rates) from bank liquidity (money supply)
- Commodities should fall back after a rally, as should bank shares
- Corporate earnings remain under significant pressure
22nd September 2008