How to recapitalize the banks October 5, 2011 at 5:20 am
European Union finance ministers are examining ways of co-ordinating recapitalisations of financial institutions after they agreed that additional measures were urgently needed to shore up the region’s banks.
Although the details of the plan are still under discussion, officials said EU ministers meeting in Luxembourg had concluded that they had not done enough to convince financial markets that Europe’s banks could withstand the current debt crisis.
What he should have done, and what the European finance ministers should do, is buy equity. They should buy it at market – unlike the UK recapitalisation of RBS – and they should vote the stock. It is time to get some control in exchange for the cash European taxpayers will be stumping up.
Update. Carter has some good points, and some I disagree with, in the comments. To begin, where he is right:
I wholeheartedly disagree. First, let’s assume right off that you don’t mean buying equity IN the market, as this would just be a bailout of existing shareholders.
Yes, indeed. I did not mean that.
Buying “equity at market” absolutely ignores the dilution of the existing shareholders. Buying equity “at the market” price even if they are newly issued shares is a subsidy to the existing shareholders. It is paying an above-market price.
Yes again. What I was really thinking was ‘not above the market price’, as in the UK’s case. But you are right, the fair price given dilution is well below the current market price for normal market size.
You criticize the US TARP, but essentially the USG backstopped a public issuance by the banks. Banks that could effectively raise funds at a lower cost than the USG proposed did so, and the market provided the funds. Those that could not were going to be funded by the USG, the equity would have been massively diluted, and the USG would have obtained the requisite voting rights.
Um, but the US Government promised not to vote their equity where they had some, and often they took prefs or warrants where they could have taken equity. It seemed to me – and I would be eager to hear counterexamples – that they bent over backwards to be in a position where they did not have to vote stock.
But the government should not arbitrarily take control of an institution that the market is willing to fund and believes is viable.
Hmmm, I disagree. It should not do it often, that is for sure. But in the European case, where the implicit subsidy of ‘we will step in if we have to’ is worth a great deal (Haldane estimated $50B for the UK banking system, so at least $100B for the EU), taxpayers deserve something for that backstop. I would prefer a system where banks explicitly paid for this insurance all the time – similar to the FDIC model – but they should pay a market rate.