The difference between book value assets swapped by banks at the Federal Reserve and the Treasury Bills obtained (created by 'valuation margin' plus fees) provided the liabilities side of the ledger for purchase of preference shares in the banks and for Quantitative Easing - and the same is exactly true in the UK. How much and from precisely whom what has been pledged and swapped is unclear except in abstract at high level, with details kept off the reported balance sheet of the central banks. As Ben Bernanke said Nov. 18, '08 to the House Financial Services Committee.“Some have asked us to reveal the names of the banks that are borrowing, how much they are borrowing, what collateral they are posting. We think that’s counterproductive.” Similarly, in the UK, the 2009 banking Bill made disclosure entirely a matter of Bank of England and HM Treasury discretion. There has been partial disclosure in both countries.There are four purposes served: one, for Government to replace private sector funding of banks' 'funding gaps' (roughly difference between deposits and loans financed on medium term basis by banks rolling over MTN programs that could not be continued when private sector sources dried up in the credit crunch); two, to replace banks' reserve capital eaten away totally by asset writedowns and credit losses; three, to replace ordinary equity with Government-owned preference shares; four, to take troubled assets off the banks' balance sheets for up to 3 years. All this is facilitated by 'buying' in banks' loan assets in exchange for high interest repayable loans and treasury bills paying almost zero coupon. If the banks fail to be able to repurchase their pledged assets when the 3 years is up then Government buys these outright and retains flexibility to pursue for the loan balance, keep or sell the assets.
All this can be very profitable to Government if it retains the holdings well into economic recovery when the loan assets will have gained in value and over a number of years of bank paying interest and fees. But, with signs of junk bonds recovering in market value and banks share values trending up the banks are keen to pay off and take back what they can to enjoy as much as they can of this profit for themselves, and thereby also avoid direct controls and direction from Government. They are beginning with buying back government shareholdings.
Government is anxious to prove politically that the financial measures to save the banking system are only temporary and remunerative for 'taxpayers' and that the federal budget deficit can be narrowed, even though the support for banks was 'off-budget' and never actually a direct cost to taxpayers, except for one early cost items, TARP. Voters remain dismayed at the disconnect between several $trillions Government aid support for 'Wall Street', which seems to be restored to underlying profitability ahead of 'Main Street' i.e. the rest of the economy, which received it seems much less in loans and deficit investment.
Hence, with mid-term elections in mind in 2010, TARF will close to new deals in March and several repayments of government preference share holdings can be headlined. Citigroup and Wells Fargo this week unveiled a total of $30bn in stock raising to return $45bn to Government. This trades off reducing government supervision (seen as intereference in bonuses and lending levels) at expense of diluted shareholders and short-term profits (hitting shareholders and tax payable to Government). While the values are small in terms of obligations to Government (worth circa $3-5.5 trillion depending on how one looks at it or even up to $8 trillion when insurance guaranees are crudely factored in), but large in terms of shareholders' equity. Arguably, this is another blow to the myth of 'shareholder value' at least in short to medium term, and may be seen as bankers protecting themselves and their bonus culture at the expense of shareholders?
The repayments first by bank of America and now by City and WF are intnded to blunt government restrictions on pay and operations – and herald the beginning of the end of a period of extraordinary federal support for leading banks.
On Dec-02..President Barack Obama told bankers assembled at the White House that they should help boost the economy – particularly by helping finance “creditworthy small and medium-size businesses” – in return for the government assistance. “The way I see it, having recovered with the help of the American government and the American taxpayers, our banks now have a greater obligation to the goal of a wider recovery, a more stable system and more broadly shared prosperity.”
For several reasons it is difficult for banks to comply with this as it means switching off their credit risk systems and even pushing loans when borrowers are deleveraging and small businesses seeking to borrow more are viewed as likely to be heading for failure even if only because they are being squeezed to death in many cases by big business customers.
The Citi offering, which could be the biggest yet by a US bank, is another unexpected and unwished-for test of shareholder medium to long term faith in the company’s future. Under the agreement, US Treasury will sell up to $5bn of the bank’s shares, reducing its 34% stake to below 30%. The authorities have agreed to sell the rest of the government’s stake within the next year! Citi will also terminate an agreement with FDIC to backstop $250bn in toxic assets. As a result, Citi will cancel $1.8bn-worth of preferred securities held by the FDIC, leaving the regulator with $5.4bn of preferred shares. Adding insult to injury, as shareholders are diluted Citi will issue $1.7bn in stock to staff in lieu of bonuses and might sell $3bn in preferred securities in 2010. The measures may result in a $10.1bn pre-tax loss in 4th quarter but save Citi $2.2bn a year in interest and amortisation expenses, much of it to Government!
Citi’s stock issue will be accompanied by selling $3.5bn in convertible bonds to bolster its balance sheet but this dilutes the equity of existing shareholders (private $50bn, government $25bn, roughly) by roughly 5%, causing Citi shares to close down 6.3% on the announcemtn to $3.70. But total shareholder dilution could be far more than this?
Wells, which bought Wachovia last year will sell assets worth $1.5bn and save a further $1.4bn by paying employees in stock not cash. Once Citi repays the Tarp funds, Wells Fargo will be the only major bank still in TARP, which helped bail-out capital reserve equity shortfalls in 700 US banks, after Bank of America recently returned its $45bn bail-out TARP funding. But the banks are still heavily obligated to the Government in other programmes including TARF.
All US banks have received balance sheet support worth more than twice all US banks' reserves including support for mortgage assets via Ginnie, Freddy and Fannie agencies, plus other programmes via FDIC. Banks may not be able to repay more than half i.e. about $1 trillion within 3 years, hence another up to $1 trillion is envisaged being sold to Hedge Funds and similar 'Shadow-banking' investors supported by soft loans from the Federal Reserve - why? because shadow banking's normal leverage source has been the banks via prime brokers but they've dried up their risk appetite.
