Regional bank rescue?

Monday August 18

Well-capitalised foreign banks are beginning to pick up the choicest parts of the distressed US banking sector.  However, following several recent regional bank seizures -- including the collapse last month of regional thrift IndyMac -- a widespread federal rescue package may still be necessary. While talk of a banking-sector bailout remains politically unacceptable, increasing distress among regional banks means that direct or indirect bailout measures remain a strong possibility, particularly next year.

• No new regulatory structures. Any bailout is unlikely to produce significant new institutional structures. Instead, the Federal Deposit Insurance Corporation (FDIC) might require expanded regulatory authority, and an increase in direct federal funding to protect deposits (rather than continued reliance on a levy on bank deposits to fund deposit insurance).
• Low-key options.If property prices begin to stabilise, a low-key bailout could involve the FDIC quietly restructuring weak institutions or encouraging mergers with sound banks.
• Good bank, bad bank. Similarly, allowing banks greater leeway to pursue a 'good bank, bad bank' strategy may gain greater traction. Under this scenario, a bank spins off problem loans into a separate subsidiary (financed by 'high-yield' bonds), allowing the parent bank to strengthen its capital structure, and the subsidiary to hold the problem loans in a portfolio that may ultimately recover in value once property prices rebound.
• No universal solution. However, the good bank, bad bank option is not a panacea, because only relatively strong banks can pursue it, and it would be unsuitable for many regional banks currently highly exposed to regional property markets.

Other indirect options. If the overall situation continues to worsen, other indirect forms of banking bailout are on the cards, particularly if Democrats gain the presidency and strong congressional majorities in the November elections. These could include more direct measures to prevent foreclosures by providing federal subsidies beyond those created by the recent housing bill; enabling borrowers to continue to meet mortgage payments would have the indirect effect of bailing out banks. However, the cost of such measures could provoke political fallout, as they might be resented by homeowners who have not overextended themselves.