It has taken three rescue programmes and the promise of more than $3 trillion of taxpayers' cash, yet despite all the US government’s efforts capital markets remain largely closed.
TARP, TALF and PPIP were all designed to ease the pressure on troubled financial institutions by injecting vast amounts of capital into their balance sheets. The belief was that the programmes – and therefore the government – could help jump start lending activity and thereby provide a direct liquidity transfusion to the US economy.
By receiving government capital and guarantees, financial institutions have been able to shore up their balance sheets, reassuring shareholders and the markets and thereby solving their most immediate liquidity concerns. Ten of the largest banks in the US, after initial injections of cash under TARP, have even been able to repay $68 billion to the Treasury.
What the programmes have failed to do though is force banks to actually deal with their underlying problems – specifically their troubled real estate investments. They are refusing to liquidate problem assets, because establishing a market-clearing price for a pool of assets now would set a benchmark for the rest of their real estate portfolios. This could trigger disastrous write-downs. Many banks could in fact end up insolvent.
What’s happening instead is a clogging of the system, which is going to have major repercussions. By sitting on assets, banks are preventing the US real estate markets from finding a natural bottom. As a result, investors are fearing an era of Japanese-style stagnation, with significantly fewer lenders willing to deploy fresh money today than even in 2008.
Those that are willing to lend are concentrated firmly on established relationships, with most origination being extensions of existing loans. It’s a case of lend to extend – or, as any conference delegate will have heard it described as recently: “Extend and pretend” – pretend there is no problem.
What is needed instead, they argue, is an entity that will force financial institutions to sort out their toxic assets once and for all: a bad bank that will clean up a bank’s balance sheet to enable it to focus once again on the job of lending capital to investors. What the investors are calling for is, in essence, another Resolution Trust Corporation.
Of course, the idea was originally floated when the credit crisis struck hard last September but rejected in favour of TARP, then TALF and finally PPIP.
But the need for a bad bank is as great as ever, and it is not too late to create now. Investors must hope that the US government is listening this time round.