Site for Free Markets and Free People

Saturday, February 14, 2009

Does Obama Want Financial Stocks to Go to Zero?

A key element to Obama's magical utopia is to force banks (or allow judges on their behalf, but that is a very sketchy idea even to Obama) to rewrite mortgages so that everyone can continue to have a home. It obviously makes no difference whether or not people can afford it because, according to Washington, home ownership is now a right as important as that of free speech (assuming you're not a leading radio talk show host).

Obama rightfully understands that the easiest way to do this is to either persuade banks or to force them. Since banks are private companies, the government can't exactly force all of them to do so. Instead, it can create conditions associated with government TARP financing, ie. if you received any capital, you are now required to renegotiate defaulted loans. The only way banks are going to voluntarily going to accept TARP money with the new harsh conditions is if the FDIC tells them that they are soon going to be undercapitalized and they must either take the equity or sell itself. The FDIC has already been doing this for the past year.

What seems to be happening in the financial sector is a self fulfilling prophecy. Investors have no confidence in the sector because of the rumblings from Washington and the potential impact of new mortgage foreclosure rules, so financial stock prices are in a freefall. Soon, the stocks trade at prices under $1, at which point depositors, customers and the FDIC get worried that the bank may soon go under. The ultimatum then comes - find equity, take our equity, or sell yourself. The first option is not possible given the lack of investor confidence, nor is the third option because Boards are now risk averse. So the bank takes the government forced equity and the TARP rules are in effect, one of which will soon be that if you accept money, you must restructure foreclosures.

In fact, if they wish to do so, the government could just decree that the equity is worthless (heck, it's already only at $1) and the new TARP money will own 100% of the equity. Regardless, the government now controls the bank and can do as it wishes. This isn't 1959 Cuba yet, where the government boldly takes over private companies, but the strategy currently underway seems to be a back door maneouver to achieve the same result. After all, the companies "chose" to accept the TARP funds.

Let's face it - the success of financial stocks is entirely dependent on market confidence. All that's needed is a continuation of the wishy-washy, incoherent and negative jaw-boning and there soon will be no private ownership left of the financial industry. After enough statements from the president that "we're headed for a catastrophe," the government can now do as it wishes related to foreclosure rules. And it can say that it was the result of the banks' own decisions.