Some Observations on Where We Stand In the Financial Situation

Similar sentiments have been voiced by others. It is almost as if these people want CEO for breakfast.

Secondly, the financial situation has taken everything else off the agenda. In the early summer it was “Drill Baby Drill” with questions about a government shutdown over the issue of offshore oil drilling as the consummate Republican wedge issue. Earlier today, it was reported in Bloomberg that a 26-year ban on offshore oil drilling will be dropped as part of a year-end spending bill according to House Appropriations Committee Chairman David Obey (D-Wisconsin).

While Obey indicated that the ban would be lifted through March 6, 2009, and that the November election would decide what drilling policy is, the fact is given the Government’s need to raise revenue the ban is gone. In addition, the spending measure on the floor tomorrow will include a $25 billion loan package for the auto industry, $23 billion in disaster assistance, and an additional $2 billion for Pell education grants along with the annual defense, homeland security and veterans' affairs appropriations bills. Most of the rest of the government will remain at current funding levels.

Three, it is very obvious that Hank Paulsen and Ben Bernanke if they get this new asset buying federal agency are going to agree to some very-very tough conditions which they may not think wise but are necessary for members to cough up a tough vote on this. This is now way past executive compensation controls and the other things I wrote about.

Now, it has reached the point that to show how tough they are Paulsen and Bernanke are talking about the Treasury getting equity in the participating companies in the form of exercisable preferred stock warrants. By the time this comes to a vote – if it does – this could become the functional equivalent of Roz Nowick rules by a multiplier of 10 as a condition of participation.

In fact, these types of terms that Barney Frank and Crew want are very-very tough. It makes what was done to AIG appears mild and there AIG investors may trying to derail the Treasury takeover by demanding a shareholder vote on the warrants portion of the agreement.

While the AIG deal was described as an $85 billion loan, it appears to have borrowed “only” borrowed $28 billion as of September 17th from the Federal Reserve said last week, even though full specifics of the accord with the government STILL has not been publicly released.

Bloomberg reports that the investors [whose stock value could go way down] decided at a New York meeting today to ask AIG for data so they can raise money and keep the Treasury from taking the 79.9 percent stake. It’s not just Hank Greenberg who is trying to avoid this, but also Roger Altman, Eli Broad, Shelby Davis of Davis Selected Advisers LP and Bill Miller of Legg Mason Inc. Mickey Kantor apparently is the lawyer for the shareholders.

If Broad and Kantor and others want to take this over and repay the loans IN FULL and avoid the warrants, I am sure that would make everyone happy. This is not simply about private investors. New York Comptroller Tom DiNapoli's office was involved because the New York State held 10.8 million AIG shares in a retirement fund as of Sept. 12.

A lot of people looking at AIG as the model obviously would be discomforted by those terms and would want to avoid it by seeking other suitors – which is why most of Lehman Brothers has been snapped up.
Three, there has been a lot of speculation about whether what is going to happen is inflationary or deflationary. Anyone who says they know is a fool.

Last, but not least, I wanted to discuss what is happening with Goldman Sachs and Morgan Stanley and the potential problem of resultant bank merger mania. Both Morgan and Goldman became with expedited Federal Reserve and US DOJ approval - bank holding companies which has had the effect of the market in effect re-enacting Glass-Steagall.

There will still be investment bankers but it will be a boutique much smaller business. If investment banks operate they will be subsidiaries of real banks and subject to the strict requirements – one would hope – that banks operate under.

Goldman and Morgan becoming defacto regulated banks and the creation of other mega banks has to be closely monitored. In particular I am concerned about Morgan. Both Goldman and Morgan own industrial banks in Utah and they both agreed as a condition to incorporate existing Industrial Banks [per the Utah Department of Financial Regulations IB’s are bank lights] into State chartered traditional banks.

The reason why I am worried about Morgan is that the President of Morgan’s Utah IB is M. Danny Wall who helped create the Savings & Loan fiasco 20 years ago. Morgan Stanley plans to sell as much as a 20 percent stake for $8.4 billion to Mitsubishi UFJ Financial Group Inc., Japan's largest bank, to shore up capital. I think UFH having gone through the Japan fiscal nightmare will have zero tolerance for idiots – we hope.

As to Goldman-Sachs, Berkshire Hathaway aka Warren Buffet agreed late Tuesday to invest at least $5 billion in Goldman Sachs Group. While Warren is not 100% perfect, he is knows how to control management to control Buffoonery. This shows that Goldman Sachs culturally is transforming itself into a stable banking business.

Having said all of this, I am still concerned about the banking business in terms of community investing and concentration of assets. As I noted above, a large number of people (assume 1,000,000 people through out the US at 75K apiece) are moving excess cash above the FDIC limit into other accounts which is at least $75 billion.

As such, we can assume that the size of FDIC insured deposits are increasing which creates issues. That does not mean that there is a run on banks because people who might have money in a Golden 1 move it to First Northern or a Wells and vice-versa so that there are more accounts under the FDIC umbrella.

At the same time, the Federal Reserve by this time next week should be paying interest on overnight reserves which will reduce overnight inter bank lending. Also, a lot of banks getting these cash infusions-transfers will be looking to buy safe securities AKA Treasuries. That means that the Government will have a ready market for its securities if and when a deal comes together and should lower interest rates.

However, because a lot of smaller banks will become cash cows they are on the table. In fact, both Goldman and Morgan Stanley are likely to benefit because as Bank Holding Companies other banks can buy their share offers and infuse capitol into them.

What policy makers should be concerned about is that regional banks which fuel the local economy may be controlled by non local people and who do not know or care about these areas.

Where I think this could become a really major-major issue is in resource dependent areas where because of oil and gas prices the local economy is booming and the royalty checks are flowing in and a lot of local banks are flush. I went to a trade publication which indicated that US Oil production was up for the first time since 1991 beginning in 2007.

Everyone has this image of Texas, Louisiana, Oklahoma and Alaska being the largest energy producing states, but Arkansas, California [because of the Southern Central Valley], Colorado, Kansas [gas], Montana, New Mexico, and North Dakota are now big income wise oil and gas states with people looking to put the money into First Bank of whatever which may have 7 or 8 branches.

The local friendly local banker is a fixture of these communities. He or she may have been a high school athlete or student body president than went to college in the State system, took finance courses, and then came back to the area and is now a fixture of these communities. They or their spouses sit on the School Board or the City Council - they help run the United Way, etc. and are community leaders. There kids go to local schools and do what kids do. I know about this because I dealt with many of these people in my former days. It is not as big an issue in California because of the history of B of A with rural lending but we are the exception.

A massive move on regional branch banks [by Wall Street no less] should – and will - raise a lot of concern. Not only is it something that should be looked at very carefully before any local takeover or merger is approved in any event, if it is not dealt with in whatever Congress passes it could blow up any agreement in the Senate because the disproportionate influence of smaller States. Warren Buffet gets that because he is from Nebraska and still lives there but I am not sure others do.

I looked at the membership of the Dodd Committee in the Senate. There are Democrats and Republicans on this Committee from Colorado, Montana, South Dakota, Utah [Bob Bennett has probably already heard about Goldman and Morgan-Stanley from his locals at the Utah Bankers Association], North Carolina, Tennessee, Alabama, Wyoming, Nebraska, Kentucky and Indiana.

These rural concerns have always permeated the Federal Reserve System. In fact, the bill that President Wilson signed in 1913 to create the Federal Reserve System was a tripartite compromise. People forget that in order to get the Federal Reserve Act passed, Wilson needed his Secretary of State William Jennings Bryan and Justice Louis Brandeis to go make agreements with rural representative to assure that local interests were protected which is why there are 12 Federal Reserve Districts and all these local committees.

These concern are still so great in 2008 in fact that the Conference of State Bank Supervisors which is the trade groups for the State Regulatory agencies – which are dominated by smaller- sent Congress a time out letter in effect. The Conference sent a letter to the House and Senate leaders indicating:

“The CSBS is increasingly concerned about the impact the Treasury’s plan will have on the safety and soundness and long-term competitive posture of community and regional banks. Indeed, investment banks and very large retail banks, which have far greater culpability in the mortgage mess, appear to benefit the most. Community and regional banks, which did not generally participate in high risk lending or the securitization of these loans, have been greatly impacted by the resulting slow down in the economy, sustained significant losses relative to their holdings of Fannie Mae and Freddie Mac preferred stock, and now face the prospect of large bank competitors eliminating their bad assets and investment firms competing directly for funds with federally insured higher yielding money market accounts. In fact, if unaddressed, without offsetting provisions, the Treasury's intervention to address systemic failure will cause collateral damage that could devastate our community banking industry.

Therefore, in an effort to preserve our community and regional banks and the diversity of our nation's banking system, we request Congress to consider the following:

1. All changes should be temporary to allow Congress more time to address the issues directly.

2. Community and regional banks should also be provided with the opportunity to sell problem loans to the government. In many instances, the ability to move a few construction or commercial real estate loans will return community and regional banks to a more stable and profitable condition. To ensure that larger financial institutions do not immediately use all of the proposed appropriation of $700 billion, a certain set aside or specific program should be designated for purchasing the distressed assets of community and regional banks.

3. The inequity of "too big too fail" treatment and the need to protect the payment system should be addressed by providing the FDIC with more flexibility under prompt corrective action, suspending broker deposit rules, and providing full deposit insurance coverage for demand deposits (this will be especially important for small and medium sized businesses).

4. Congress should specifically authorize the insurance of money market mutual funds, ensuring an FDIC like administrative process. Moreover, any coverage should be subject to the same limits and industry funding requirements as required of insured depositories.

5. This is not the appropriate time for regulatory restructuring. Regulatory reform deserves Congress’ thoughtful deliberation outside of a crisis environment.

Community and regional banks have served as a source of strength during this period of economic turmoil. They have provided local market stability, by providing continued access to financial services and meeting the needs of small and medium size businesses. They are also feeling the pressure from a rapidly changing economy and an overall lack of confidence. As Congress moves rapidly to craft a solution of significant magnitude, we must not further exacerbate the economic pressures felt by community and regional banks by only offering avenues of assistance to the large systemic players. Congress can take reasonable and meaningful steps to support community banking. CSBS General Counsel, John ‘Buz’ Gorman, will be available to offer any technical advice on these issues and can provide immediate access to state bank Commissioners with expertise in these complex areas.”

Since the mid 1980's Irwin Nowick has worked for the California State Assembly and State Senate on a plethora of policy issues, most notably firearms legislation. He has been described as "The Assembly's resident genius" by a former Speaker of the Assembly and is seen frequently in the Capitol hallways and offices assisting legislators in drafting and amending pending legislation.