Building A $1 Trillion “Bad Bank” (C)(BAC)(WFC)(JPM)

The federal government really does not want to build a "bad bank" to take toxic assets from America’s largest financial institutions. It has taken a number of measures to avoid it.

The Fed has passed tens of billions of dollars of loans to banks and brokerages through its emergency lending window. It has lowered interest rates to zero. Treasury has put $25 billion into each of the money center banks. It is now backing over $300 billion in bad assets held by CItigroup (C) through a loss-sharing agreement. Bank of America (BAC) is getting a similar deal. The programs to back bad assets is almost certainly going to spread.

Over the last several days, the incoming administration has moved toward the idea of creating one federal agency which would have the purpose of taking most of the toxic assets off bank balance sheets. Since the figure at Citi is probably at least as large as the $300 billion pool that the government is guaranteeing, the combination of bad paper from Bank of America, Wells Fargo (WFC), JPMorgan (JPM), and the next tier of large US banks is almost certainly close to $1 trillion.

The sponging up of all these toxic assets takes the discussion back around to what the government gets in return for such colossal aid. The largest American banks had market capitalizations of as much as $300 billion each two years ago. The purchase of bad assets when stock values were at those levels would have kept shareholder dilution at a reasonable level. The government would have gotten shares for taking the junk off bank books and putting it into its new "bad bank" agency.

Those market cap figures are now closer to $40 billion for each of the four largest banks. A one trillion assistance package has to create some value for taxpayers. A stake in the banks would seem to be the only options whether it is through senior debt or equity.

Whatever the solution, the needle come back around to pointing to the a nationalization of the American banking system. There is too little equity left in the banks for them to trade for government assistance.

Douglas A. McIntyre