THE UNDER-CAPITALISED US financial system needs "at least" $1 -$1.2 trillion (€800-€962 billion) to restore confidence and improve liquidity in the credit markets, according to a new report.
The much-revised Troubled Assets Relief Programme (Tarp), which is injecting up to $700 billion of public capital into banks, will not work, according to Friedman Billings Ramsey analyst Paul Miller, because it is not providing "true capital".
The Tarp would boost tier-1 capital, which measures a bank's financial strength from a regulator's point of view, but this would not result in increased bank lending because banks "will not view Tarp capital as something that can be levered".
Instead, "only injections of true tangible common equity will solve the current crisis", Miller said. When a bank loses money or pays a dividend, it comes from so-called "tangible common equity".
Eight of the largest US financial institutions had $12.2 trillion of assets but just $406 billion of tangible common capital, the analyst noted, meaning that firms were leveraged by a ratio of 29:1.
A trillion-dollar injection would bring this ratio down to a more manageable 12:1, rehabilitating bank balance sheets and enabling banks to lend freely once more.
"As realists, we understand that there is not $1 trillion sitting on the sidelines waiting to recapitalise the financial industry," Miller noted, saying only the government could inject such an amount. It needed to be done "as quickly as possible". A "holiday" on dividend payments was also recommended.
The eight institutions listed in the report as particularly vulnerable - AIG, Bank of America, Citigroup, GE Financial Services, Goldman Sachs, JPMorgan, Morgan Stanley and Wells Fargo - form part of a financial sector that has been the victim of enormous selling pressure this week, with market participants seemingly sharing Miller's fear that the $700 billion Tarp would prove insufficient as the global economy contracts rapidly.
Goldman Sachs, long regarded as one of the best-run financial institutions in America, yesterday fell below $55 for the first time since flotation in 1999. Its share price peaked at $248 a year ago.
In Europe, the cost of credit default swaps that protect European debt against default hit an all-time high yesterday, surpassing the panic levels seen in the aftermath of the fall of Lehman Brothers. That lack of capital might cause a large bank to fail has been the source of increased market chatter of late, with particular focus on the perils facing Citigroup. Its shares have lost approximately two-thirds of their value in November alone on fears of snowballing losses from toxic debt and mortgages, with investors unconvinced the firm's plan to slash expenses and offload more than 50,000 workers will be enough to stem the tide. Citigroup employs 352,000 people worldwide, with 2,200 in Dublin and Waterford.
Shares fell by 23 per cent on Wednesday and suffered a similar slide in early trading yesterday, despite the announcement from Saudi billionaire Alwaleed bin Talal that he was planning to up his stake in the company to 5 per cent. Alwaleed, who said shares were "dramatically undervalued", might have to pony up as much as $350 million to do so.
Such a shareholding would have cost a lot more in the past, however. Valued at more than $270 billion two years go, Citigroup shares are now worth less than half the $75 billion the group has raised since the credit crisis began.
The meltdown in Citigroup and the wider financial sector has caused many investors to ask the same question posed by Miller - "how did we get here?"
Simple, the FBR analyst said: "We did not demand enough capital in the financial system given the risk on the balance sheets."
Even if American financials immediately received the capital injections required, he added, it would likely take three to five years for the financial system to fix itself completely.
