Financial Rescue: Could It Work? (Morningstar)

Pat Dorsey: Hi, I’m Pat Dorsey, Director of Equity Research at Morningstar. So with Tim Geithner’s Speed plans out on the table of their details were sketchy. We do know the general rout that the government will be going down and its attempt to recapitalize the American banking system. Here with me is Senior Analyst Jaime Peters to talk about the details of the plan that were released on Tuesday Morning. So Jaime, it looks like the plan is going to go down the path of this Public-Private Co-Investment scheme that we discussed yesterday. Jaime Peters: Exactly, it’s going to be called the Public-Private Investment Fund. And what’s going to happen— Pat Dorsey: That was close— Jaime Peters: Very close. And what’s going to happen is the government is going to try to pull in private asset managers and private funds in order to negotiate with the banks to get those toxic assets which include the securities as well as this bad legacy loans off of their balance sheet for a price that the Private Investors will help negotiate. Pat Dorsey: So the idea is that the government is sort of leveraging the expertise and profit motives presumably of private investors with the larger government balance sheet. So putting the Private Managers sort of in the driver seat and setting the asset price in negotiation but in using government capital to expand the size of the program? Jaime Peters: Exactly. We’re looking at about a $500 Billion initial of size up to $1 Trillion, which is large enough for the government to actually make some sort of impact on the banking balance sheet. Because one of the earlier arguments of $350 Billion left in the return funds was not going to be sufficient enough to really make the dent on those Legacy assets. Pat Dorsey: And the second kind of big thing that came out today was talk of the stress test that all banks need to go through in order to get this capital? Give us a little bit of details on that. Jaime Peters: What is the second potential round of capital infusion similar to what was the CPP of the first round of TARP? And this one is going to be for the CAP. And in order for banks to get this CAP fund in there going to have to go to a stress test which basically means the regulators, the government are going to look and see if their balance are just strong enough, what’s on their balance sheet and much more detail as well as potentially a plan for survival as my guess. Pat Dorsey: And we have no details on what this stress test actually is? Jaime Peters: Well, I quite sure. It’s supposed to be comprehensive as really we know. And the top 18 banks looks like about the ones are--$100 Billion more in their assets or more. So I think larger than capital one is going to definitely have to go through this stress test at this point. Pat Dorsey: And a bank that passes the stress test and so then you know presumably went out throwing good money after bad. This is a bank that then could make it through given an additional capital injection does face some restriction, some pretty severe ones if they accept the second round of funding? Jaime Peters: Exactly, it’s the first shift to pass the stress test then you have to accept additional funds from that. And at that point, you then received extra ordinary help from the government. Pat Dorsey: And this is when that executive compensation CAP and other things start to kick out? Jaime Peters: Exactly. Your dividend will have to go to one cent per quarter, it’s similar to what bank from America city when they had their second round of help from the government as well as the government restrictions as well as there’s a lot of tracing of how you were using the money. The government is very concern about showing the public that this money is being use to further lending. They even set a website of FinancialStability.gov in order to try to track it. Pat Dorsey: And this is an interesting question, because obviously, we want too—there’s two goals here. One is stimulate lending just a little hard to do when the people you’re lending to or in rough financial shape. You would want lending to be more prudent and restrain in a recessionary environment. But the other part is you just recapitalize them so they survive I mean, what’s the real motive here? Jaime Peters: Well, the real motive is to get the banking system to work again to lend because without ace of spades, a banking system that people have confidence and you really can’t get the rest of the economy to recover either. So this is actually the full like first half of the Geithner Speed. We’re just trying to sell the reason why you have to support the banking system. Why it’s going to cause attacks. There’s a lot of money but why at the end it’s necessary. Pat Dorsey: So big picture, do we think this is actually going to work because you know one option that was discussed a little bit. There’s the bad bank was basically going in unilaterally getting this toxic assets off the balance sheets that would have caused a lot of write downs but you would had hopefully more trust in what was left on banks balance sheets. In this case, some banks will sell these toxic assets; some may not because they can’t get a good enough price. And it feels like maybe two-piece maker or am I selling it towards? Jaime Peters: Well, the good news is that it looks like of a size that it could potentially work to me. That was the initial problems with $350 Billion not being enough to be able to actually jump-start this. With the private capital, with using the feds balance sheet due to part of this type of activity, we might have enough money to actually get these banks into a better position. The problem is of course that banks really are going to still be concern about themselves for most and not the general economy overall which means that’s some things are going to probably look at the private equity guys and say, I’m not going to sell you my assets for that amount. I can make more money myself if I just hold them. And I think I have plenty of capital. Pat Dorsey: So there’s still a little bit of an incentive to maybe be a bit of a polling on and kind of play chicken with the financial markets and try to get through. Jaime Peters: Pat Dorsey: Especially when you consider that if they don’t--their salaries could be on the line and everything like that. There’s really still going to be a major agency problem associated with the situation. Jaime Peters: Thanks a lot Jaime. We’ll be following this closely with more details I’m sure has the leak out of Washington, DC. I’m Pat Dorsey and thank for watching.