TARP's Barney Blagojevichs

WSJ, Jan. 22 & 24th:

"Political Interference Seen in Bank Bailout Decisions"

and

"Politicians Asked Feds to Prop Up Ailing Bank " ‏

Some of this is legitimate constituent servicing but much or most of it is,and eventually all will become, a "blagojeviching" of banking. How are 535+ Barney Fifes and/or Barney Blagojevichs, and Treasury, going to better allocate capital among thousands of banks and tens of thousands of corporations on a part-time basis than would full-time capital markets? Kashkari isn't that smart; no one person is.

Why these capital injections have failed, and will continue to fail, is very simple. While $1 of capital can leveraged-up into $10 of loans it can only be leveraged-down into $1 of assets. In other words, when assets fall by $1 it consumes $1 of capital; dollar for dollar erosion. Therefore capital injections are futile until the asset spiral stops; something the feds have made no serious effort to do.

The spiral has gone beyond residential mortgages and "shadow banks" (although 'collateral is still a contagion'). The problem has gone mainstream & global and thus has becomemuch harder to stop. It's being compounded by govts' missteps: banking nationalization, direct (e.g., FDIC gtys) & indirect crowding out, a larger uncertainty premium as govts have arbitrarily rewritten, abandoned, or broken all the rules. For example, their mishandling of the GSEs resulting in small- & middle-sized banks losing billions of assets, and capital, when Fannie & Freddie's preferred & common shares were wiped out by Treasury (yet another self-inflicted wound). So now they too are in line for bailout money.

But, thank you Mr. Paulson for proving correct my analysis that "notching"credit ratings for capital structure rank was woefully inaccurate -- standard practice was to rate an issuer's subordinated debt one notch lower than senior, for example from Aa2 to Aa3, and another notch for preferred shares (e.g., Aa3 to A1). Historically, recoveries or loss-given-default(LGD) are dictated by rank, not rating. Recoveries in GSEs and other financials were far less than even my historical capital structure analysis would have estimated (although financials never recover as much as non-fin'ls).

JRB

1/26/09