Fed's Kohn: 2nd Round TARP to be Injected into Banks

A: It appears more & more likely that the 2nd tranche of TARP funds will be used similar to that of the 1rst round; injected directly into the banks. This raises the possibility of a TARP II or RTC like vehicle to be created to transfer toxic assets directly off the banks balance sheets to the government. I'm not defending more government rescues here, just looking at the scope of the problem, the trend of deteriorating economic conditions, and what the government already proved they will do to prevent systemic collapse. I wonder if/when in 2009 we find out officially that $700,000,000,000.00 wasn't enough to solve the problems we face.

Via CNN Money's article , "Fed's Kohn: Banks will get more TARP money":

Federal Reserve Governor Donald Kohn is set to tell Congress Tuesday afternoon that the lion's share of the remaining $350 billion from the government's controversial financial rescue plan will once again go towards propping up the nation's banks.

"I would expect the bulk of the remaining...funding to be devoted to strengthening financial institutions," Kohn said, according to a copy of his prepared remarks, which were released Tuesday morning.

The TARP was originally packaged and sold to Congress as a necessary, emergency rescue plan, that would directly buy troubled assets off the balance sheets of distressed banks. Instead, Paulson called an audible, and used the funds to inject capital directly into the banks to shore up capital ratios as more writedowns were forcing the banks to raise more capital. You remember those write-downs don't you?

The first batch of funds lasted about three months. Now they need the second batch. It seems likely that a portion of the 2nd $350Bln will be set aside for smaller banks, other sectors, foreclosure prevention, loan modifications, and who knows what else. But the biggest banks will likely get another communal injection of the same amount at the same time; just like last time. This way no one bank is exposed as more or less distressed than another. No way another $350Bln is enough to keep the banks fully recapitalized if the economy continues to worsen, more loans stop performing, and the distress spreads to higher quality debt classes. Lets not forget we have about $300Bln of ALT-A residential mortgage backed securities (RMBS) still on review for downgrades at S&P. What about Prime? What about HELOC's? What about Credit Cards? What about Auto Loans? What about CMBS? And on and on the debt pyramid goes.

I think the general strategy with these banks right now is to prevent systemic collapse by keeping the banks capitalized as the toxic balance sheet unwind continues. Clearly, the bulk of TARP round 1 was used to recapitalize and it appears TARP round 2 will be used in the same manner. Which leaves us with ridding the balance sheets of the remaining toxic assets that are causing the most problems. I see no reason why government will stop now, given the scope of the problem.

I recall this market exposure chart by T2 Parners, LLC floating around the blogosphere a month or so ago:

Here is the Full 116-page report from T2 Partners found online and issued December 18th, 2008.

Now, if this is close to being accurate and defaults are rising and spreading to higher quality debt classes, how long do you think another $350Bln distributed to hundreds of banks will last? If anyone has an updated chart on the market size of the above debt classes, please post in comments below.

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