So will the $250 billion Hank Paulson plans to inject into banks unfreeze the credit markets? The Treasury Department held a briefing for journalists today to explain why they think the bailout will work. We didn’t go to the meeting but Luke Mullins did.
1. Healthy banks will participate in the program because the terms are favourable. Although participating banks will be forced to accept executive compensation restrictions, government officials said the initial annual dividend rate of 5 per cent makes the capital “attractive.” One official said his agency has received “pretty significant” interest from financial institutions about participating in the program. Another said he expected “a lot of applications.”
2. Banks will then lend out the cash because doing so makes the most economic sense. The officials argued that because banks will be restricted from using the cash to buy back shares or increase dividends, using the capital for lending is the most profitable way to make a return.
3. There are good lending opportunities out there. The tighter underwriting standards and higher down payment practices now being employed by the mortgage industry have created “good lending opportunities” for banks, a government official said. The cash injections will help alleviate the capital constraints that have been working to prevent such activity, the official said.
We hope it works out! But so far, banks don’t seem that interested in ramping up their lending. Libor has come down a bit, but remains at historically astronomic levels. But a look at what’s happened in the mortgage markets suggests that maybe it won’t be so easy. Mortgage rates have remained high despite the ever-cheaper money available from the Fed. Banks remain wary of credit risk, and giving them additional capital won’t cure that wariness.
This is a key point raised by Anna Schwartz in her WSJ interview over the weekend. Paulson’s bailout is preventing the market process from creating transparency about the financial conditions of banks. That lack of transparency keeps fear alive, which holds the banks back from lending.
Earlier: Hank Paulson’s $250 Billion Giveaway.
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