Debt Settlement Blog

As bad as things have been for U.S. banks over the past year, things could actually be taking a turn for the worse. The Chairman of the Federal Reserve, Ben Bernanke, said Tuesday during a speech at the London School of Economics that the stimulus package now being planned by the Obama administration will not be enough by itself to turn the economy around and that “more capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets.”

It looks like Bernanke has made an economic policy break from the new administration, because he appears to be warning Mr. Obama and Congressional Democrats that most of the remaining $350 billion, or possibly even more, has to go to shoring up banks if they are to resume lending at normal levels.

Here’s the problem; Congress already feels it got “burned” when out-going Treasury Secretary Hank Paulson changed the focus of the TARP from purchasing troubled assets to a recapitalization program. It isn’t likely the Congress will be willing to release the second half of the $700 billion without assurances from the new administration that a large portion of the proceeds will be used to directly support homeowners.

Indeed, according to the New York Times, “Mr. Obama and his economic team have assured Congress that they would use a sizable chunk of the new money from the Troubled Asset Relief Program to help distressed homeowners refinance mortgages and escape foreclosure, “ and that Lawrence Summers, who will head the new administration’s National Economic Council, actually “assured Democratic lawmakers in writing on Monday that the administration would use some of the money to help reduce foreclosures.”

It appears as if Nouriel Roubini’s prediction that credit losses will approach the $2 trillion level is becoming more and more likely. Rising numbers of job losses, which have accelerated sharply in the fourth quarter, show no signs of abating heading into 2009. Together with the expected wave of business failures this year, additional losses in the $500 billion to $700 billion range on bad loans and credit provisions can be expected.

Most agree the TARP was successful in one aspect: the banking system has been stabilized and the risk of systemic failure has been averted. But as more consumers default on mortgages, credit cards and auto loans while business loans, commercial real estate mortgages and leveraged private equity deals go sour, it will become more and more likely to see additional pressures mount on all the big banks.

Acknowledging how unhappy congress is with the way the first part of the TARP money was spent, Mr. Bernanke said he could see why lawmakers would be “understandably concerned” that banks were receiving money when troubled homeowners and other businesses were not. But he justified further cash injections into the banks, saying “this disparate treatment, unappealing as it is, appears unavoidable. Our economic system is critically dependent on the free flow of credit.”

The implied message from Mr. Bernanke is very clear; the banks will be under increasing pressures in 2009 from further loan losses and increased credit provisions, which directly affects their tier 1 ratios. The financial system will become threatened once again as losses mount. Without either further capital injections or a plan to take these troubled assets off bank balance sheets, credit will not return to normal and the economy will continue to decline. A fiscal stimulus by itself will not be enough to return the economy to normal.  Read the original article.