Big Banks: What To Do When The Money Runs Out

Ill-timed remarks by Sameer Al Ansari, chief executive of Dubai International Capital hurt Citigroup’s (C) shares yesterday. The man said that Citi would need more capital and that it might not be available from Middle East sovereign funds.

This raised the specter of what happens if a combination of more subprime write-offs, credit card losses, and troubled LBO debt combine to undermine the earnings of the largest banks and brokerage operations as they announce Q1 numbers.

Subprime write-offs could still move up to the tens of billions of dollars again this year. The mortgages that support the derivative paper are still in deep trouble. Mr. Bernanke begged bankers to help out homeowners. He can see the writing on the wall.

The value of LBO debt still on bank balance sheets is still dropping as credit gets tighter and over-leveraged companies face a slow economy.

No matter what market anarchists say, the federal government is not going to allow a huge financial institution fail. While it is not likely that the Treasury or Fed would take direct ownership in a bank, it could open its lending window much wider. Since December, banks have taken over $50 billion from the Fed handing over, in exchange, paper from loans and financial instruments, some of which are clearly worth  only cents on a dollar.

Large banks may not get money from sovereign funds when they need the next draw-down, and that day is coming soon. The Fed is going to put up the money and violate a critical free market tenet. In an open economy, all corporations and financial institutions must stand or fail on their own. The Fed can save the market from a collapse but it will end up, in a perverse and surprisingly direct way, owning a large piece of big banks. It just won’t look that way on paper because paying for something means it is yours

Douglas A. McIntyre