ALL IS NOT AS IT SEEMS….

On April 10th, in “Why Treasury Is Delaying The Stress Tests” I wrote this:

My guess: the banks will try to raise capital in the coming weeks.  This way the banks can attempt to recapitalize without Treasury’s help, but based on the independent “strength” of their balance sheets.  Surely Wells Fargo can find a few suckers to sell equity to now that everything in the world of banking has been fixed….My translation: treasury is worried they won’t be able to get the toxic assets off the bank balance sheets based on preliminary supply/demand results of the PPIP and that means the banks will need to raise capital from the public (since the taxpayer is almost guaranteed not to fork anymore over via Congress).  This is just a hunch, but it’s the most logical one I can think of.  Treasury knows a lot of the banks are technically insolvent once they mark their books properly and they’re terrified of the fact that they might not be able to recapitalize them before the credit card, CRE and Alt-A tidal waves hit in the coming 12 months.

Just three days later Goldman announced their “excellent” quarter and a capital raise.  Tonight we learn that Wells is announcing a $6B stock offering despite being one of the healthier banks according to the government.  I am calling the Fed’s bluff.  They know the PPIP, M2M and TALF cannot solve the banks’ problems.   As the non-performing loans continue to eat away at bank balance sheets (as they did in Japan) and destroy cash flow the banks will keep coming back to the market for capital and the government will gladly slip them cash under the table as needed.  We’ve chosen our path and that path is the Japanese path.  We are going to avoid taking over the failed banks and pray that they can earn their way out of this mess.  Rather than forcing banks and their bondholders to take their medicine we are going to allow them to finish their zombie walk and while they do they’ll continue to tighten lending standards and keep a lid on any chance of a sharp economic rebound.   And let’s all hope the housing, credit card, and commercial real esate  situations don’t continue to deteriorate.  I fear they will.

Cullen Roche

Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.

He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.