Force Banks to Write down Debt Before TARP

originally authored posted yahoo finance

Posted Jan 13, 2009 12:17pm EST by Aaron Task

It's no coincidence President Bush has requested the second $350 billion of TARP funds at the same time Wall Street is grumbling about how Citigroup, and possibly Bank of America and others, may need additional capital.

But before the government puts another dollar of taxpayer money into the banks, they must force these firms to "lift the kimono" and write-down their bad assets, says Joshua Rosner, managing director of Graham Fisher and one of the first analysts to warn of a pending crisis in the mortgage.

"Because the assets continue to get worse, the capital [banks] are given just gets hoarded," Rosner says. "They need to hold capital in order to meet regulatory capital requirements instead of using it to make loans that seek productive economic returns."

Treasury could act as a clearinghouse for bad debt and hold open market auctions to determine the "true price" of those assets. Once those market prices are established, we can determine which banks are still viable and which aren't, Rosner says. "Then the FDIC can come in in a traditional way [to seize troubled banks] or the government could then use TARP money to institutions free of bad assets."

Forcing banks to take write-downs before the government injects capital is how Sweden successfully resolved its banking crisis in the 1990s.

But even if the "Swedish solution" were adapted, Rosner says the structured finance market remains broken, which is preventing all this government money from making its way into the economy in a meaningful way. He compares it to opening a water spigot without having the pipes to take the water where it needs to go.

If this market isn't fixed, the risk of a deflationary spiral intensifies because the "velocity of money" has slowed to a standstill.