Toxic Assets Plan to Force US Banks to Take Large Writedowns

The US government's plan to cleanse banks' balance sheets of toxic assets is expected to force large writedowns on loans, requiring banks to raise more capital from taxpayers or investors. Senior bankers warn that the capital shortfall created by the writedowns could make it more difficult for banks to pass the authorities' new "stress test", increasing the pressure on them to raise fresh funds from investors or the government if capital markets remain frozen. The plan aims to restore investor confidence in banks' financial statements by bringing reported capital in line with economic reality and changing incentives for bank executives.

Key Takeaways:

• The US government's plan to buy troubled assets will prompt banks to record losses on those portfolios, forcing them to take large writedowns on their loans.
• The capital shortfall created by the writedowns could make it more difficult for banks to pass the authorities' new "stress test", increasing the pressure on them to raise fresh funds from investors or the government.
• Large banks such as Citigroup, Bank of America, and Wells Fargo will be affected by the plan, with some analysts warning that it may cause them to fail the stress test.
• Accounting rules allow banks to carry loans on their balance sheet at their original value, but the government plan will force institutions to take a writedown equal to the difference between the original value and the sale price.
• Some analysts believe the potential writedowns will deter banks from taking part in the plan, while others warn that the authorities may put pressure on banks to sell toxic assets.
• Policymakers say the plan aims to heal the disconnect between the market and the banks by restoring investor confidence in their financial statements.
• The plan aims to change incentives for bank executives so it no longer makes sense for them to defer actions that investors believe are necessary to restore confidence.

Statistics:

• The US government hopes to raise $1 trillion by selling off toxic assets to private investors and other financial institutions.
• Citigroup is expected to take a 36% stake in the bank as part of the government's plan.
• Bank of America and Wells Fargo have received federal aid and will be affected by the plan.
• The government plans to offer investors generous financing to buy banks' distressed assets, which will force institutions to sell loans at a discount.
• The plan aims to force banks to increase writedowns via additional provisioning or disposal, with some analysts warning that it could cause a bank to fail the new stress test.

Sources:

• Francesco Guerrera in New York and Krishna Guha in Washington, "Warning on more asset writedowns"
• Richard Bove, analyst at Rochdale Research, "Bank capital destruction: Geithner plan could destroy bank capital"
• Sheila Bair, chairman of the Federal Deposit Insurance Corporation, "Stress tests: 'In consultation with regulators'"