ANOTHER ONE POINT TWO TRILLION DOLLARS?

U.S. Needs to Pump $1.2 Trillion Into Banks, FBR Says (Update3)
By Dawn Kopecki

Nov. 20 (Bloomberg) -- The U.S. may need to spend another $1.2 trillion to recapitalize the eight largest financial institutions and stabilize the markets because private investors won't take the risk, an FBR Capital Markets analyst said.

``The sheer size of the capital deficiency, coupled with the opaque nature of credit risk, will keep private capital sidelined,'' Paul Miller said in a research note yesterday.

Treasury Secretary Henry Paulson has committed $290 billion of the $700 billion Troubled Asset Relief Program to buying stakes in banks and in insurer American International Group Inc. to stabilize markets. Paulson said he wants to use the rest of the money to bolster lending for student loans, credit cards and auto loans. Miller, who's based in Arlington, Virginia, said Treasury's preferred equity investments aren't ``real capital'' and won't ensure the firms will survive.

Though Treasury's cash injections so far have bolstered bank capital, they give Treasury a senior repayment position that leaves common equity holders to absorb the majority of the losses, Miller said.

``Only injections of true tangible common equity will solve the current crisis,'' Miller said. Treasury spokeswoman Brookly McLaughlin declined to comment on Miller's report.

Losses Loom

The eight largest U.S. financial companies, including Bank of America Corp. and JPMorgan Chase & Co., have a combined cushion of roughly $405.7 billion in ``tangible common equity,'' FBR estimates. They also have as many losses, $408.3 billion, on their balance sheets that will eventually hit earnings and wipe out that equity.

``If losses are large enough to affect book value and stock price significantly, a company's probability of failure increases, regardless of the level of preferred or regulatory capital,'' he said. Miller is the world's most accurate bearish equity analyst, according to a Bloomberg survey of stock picks of 3,000 analysts at 432 research and investment firms worldwide for the 12 months ended March 31.

The U.S. needs to temporarily inject at least $1 trillion to $1.2 trillion in common equity to restore investor confidence and weather losses stemming from the worst housing market since the Great Depression, Miller said. He said it will likely take three to five years for the financial system to fully recover. The industry is still ``over-levered,'' he said, estimating the amount of tangible equity at the eight firms at 3.4 percent of total assets and the leverage ratio at 29 to 1.

First Responder

``Eventually, capital levels will be strengthened by both private capital raises and internal capital generation, but the federal government will have to be the primary first responder to the crisis,'' Miller said.

The other companies in Miller's analysis are Citigroup Inc., Wells Fargo & Co., Morgan Stanley, AIG, Goldman Sachs Group Inc. and GE Capital Corp. The companies, which include GE Capital parent company General Electric Co., have a total stock market value of about $475 billion.
Recapitalizing those eight largest firms would help stabilize the rest of the U.S. financial system, he said. Other mid-sized and small financial firms aren't as heavily leveraged and should rebound once credit starts to loosen up.

``Once the system is running smoothly and private capital begins to return, we can debate the best way for the government to extract itself,'' he said.

Dilution Concern

Though the investments would dilute current shareholders, Miller said that should not be a primary concern.
``To get the credit markets functioning now, the government must'' suspend dividend payments for all banks, convert TARP funding into common stock, force banks to raise more capital above current requirements and create a central clearinghouse for credit default swaps, Miller said.

``The quicker the government acts, the sooner the financial system can work through its current problems and begin to supply credit again to the economy,'' he said.

U.S. foreclosure filings increased 71 percent in the third quarter from a year earlier to the highest on record as home prices fell and stricter mortgage standards made it harder for homeowners to sell or refinance, RealtyTrac, a provider of real estate data based in Irvine, California, said on Oct. 23.

Lower property values will keep eroding home equity. The S&P/Case-Shiller home-price index of values in 20 U.S. cities dropped 16.6 percent in August from a year earlier, the fastest pace on record. The index has been lower every month since January 2007.

To contact the reporter on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net.