Hank Gets Tough on Banks (albeit too late)

It seems that Hank Paulson thinks (correctly) that some of the banks needing the cash from preferred share purchase should die or merge with another bank. This makes perfect sense because America had way too many banks to begin with (8,000 FDIC members) and many were poorly capitalized from the start. These banks began to pop up all over the country due to lax formation rules and convoluted regulatory procedures that catered to people with the right connections. Typically former bank executives would secure a few investors and strike out on his own hoping to steal customers from his former employer and make a profit for himself in the process. The problem was the FDIC approval gave consumers a false sense that the bank management was competent and genuinely had the customers’ best interests in heart. Too often the banks made loans to fellow good ol’ boys and similar demographics to create private bank feel and boost their egos.

Fast forward to 2007: As business slowed and companies laid off workers, the “good” loans began to run later and later. Mr. Bank CEO does not want to call his friend about the $50k credit line or foreclose on his friend’s $500k home so he gives his friend time to make up the difference. In early 2008 too much time passes and the loans begin to default. In the meantime the Bank CEO’s friend has purchased a $250k condo downtown and abandoned the half-million dollar home which is now only worth $350k. He does this because he is afraid that he will get fired from his job so he wants to stack as much cash as possible before the other shoe drops. Meanwhile, the Bank CEO has to freeze the overdrawn credit line and foreclose on the home which leaves the bank holding onto at least $500k in bad debt. Repeat this process about 20-30 times per bank and you begin to see why the $700B bail out was invented.

English Philosopher Herbert Spencer coined the phrase “survival of the fittest” after reading Darwin’s On the Origin of Species. This is exactly how the Treasury should see the remaining banks in its system. There should be no money given to banks that are on the verge of collapse or are too small to compete on a regional level. Merge or die. What Paulson did not want to do was for banks to use the Treasury cash to fund these acquisitions. He should have placed stronger stipulations during negotiations with these banks. Be careful what you wish for Hank, you just might get it.


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