Tangible Common Equity

Why is tangible common equity important for banks?

Common Equity is the riskiest of all the sources of funding a company receives from the investors point of view. Investors tend to lose most when a company defaults.

In the case of a bank, tangible common equity serves as a shock absorber. The more tangible common equity a bank has, the greater is the banks ability to withstand from losses.

While Tier 1 Capital ratio is important, Tangible Common Equity constitutes a large part of the Tier 1 Capital. Therefore, Tangible Common Equity is important indicator of the health of a bank.

Converting preferred shares received in return of TARP money to common shares

Conversion of preferred to common seems to be on the table for some banks. The argument for this proposition is that Tangible Common Equity will be boosted by doing so. There are merits and risk for doing so.

Merits:

1. Increase Investor Confidence - If government owns common stock in a company, it would welcome the private investors to invest as well.
2. Decrease Interest Payment - When a company converts preferred to common, company does not have to pay the preferred dividend.

Risks:

1. Diluted shareholder value - This will dilute share holder value.
2. Tax payer stake will be risky as common equity will head to 0 on the event of a bankruptcy
2. Public influence of private business - Private business will be meddled by government.

Lowering principal on mortgage payments

Will lowering principal on mortgage payments alleviate the housing market and economic crisis?

If principal on some mortgages are lowered, market will move towards a home price equilibrium that is lower than the current home prices. The houses for which mortgage principal is not reduced will lose value as an unintended consequence.

Lowering principal impacts households and corporations in the following ways:

1.For many households, home is the only nest egg. Bu reducing principal, their home nest egg will lose value.
2. For corporations holding mortgage backed securities will have to write down the security values due to reduced principal and interest payments.

Therefore, lowering mortgage principal on some houses or all houses is not a solution to current crisis.

Gold and US $ moving in tandem - is this an anomaly?

Gold and US Dollar move in opposite directions. So, why are they gaining in strength in tandem?

US $ is gaining strength against the world currencies. Currencies in the other nations are becoming weaker due to reduced exports and due to less foreign currency remittance. Than is pushing US $ higher relatively while US $ should be falling due to deficit caused and will be caused by stimulus package.

Developing and few developed countries currencies are falling. Investors are flocking to gold as a safe heaven investment. Due to this the demand; hence, the price of gold is rising.

Developing countries currencies will lose strength

Developing countries are exporting less due to demand overseas. Developing countries are receiving less remittances from foreign workers due to retrenchments in the developed nations. These two factors will cause the currencies in the developing countries to fall further. US Dollar and Japanese Yen will gain in strength.

Protectionism

The issues facing countries during this financial crisis is enormous. The steady stream of job losses are weighing on the political strength whether to hold on to the tenants of WTO. Due to the pressure from the population, free trade is in serious question. Is the protectionism the answer to job recovery?

The world has become intertwined. Firms have become global. It would be difficult for companies to operate and generate jobs to alleviate the local job loss if the companies face trade barriers around the world.

Governments should intervene as they have rightly to provide economic package to stimulate the economy. Stimulus interlaced with protectionism will not only hurt the global recovery, but also it would affect the local economy in the long run.

Countries must focus on stimulus sans protectionism.

Spending vs. Savings

Consumer spending is critical for economic recovery.

There are conflicting views as to consumer spending. In Finland, the advertisements are stressing consumers to spend while in United States, bank advertisements stress savings with attractive CD rates. Why such a dichotomy in the world views of consumer spending vs. savings?

Case for savings:

1. Banks need to raise deposit levels
2. Banks can receive cheap funding with attractive CD rates
3. Banks can use the savings to lend money at higher rate
4. Savings is good for the over-leveraged consumer which has been living on borrowed money. So did the companies; banks included.
5. When money is saved in banks, money is not spent in the economy.


1. Case for spending
2. Money spent aids growth
3. Money spent supports employment
4. Money spent replenishes the coffers of state and local governments in terms of sales tax
5. Sales tax in turn helps governments to support government programs

While spending will do good for economy, savings will do good for consumers over leveraged personal balance sheet.

Tax-cut as a means to jump-start economy

When governments reduce tax - both personal and business tax, families and businesses have more money to spend. If they spend money, economic grows. But two important issues arise:

(1) What if the families and businesses do not spend, but rather hoard or pay off debt:

Then, the money not collected in taxes would not circulate to the market to spur growth. This is exactly what happened during 2008 tax rebate program in United Sates.

(2) What do the governments do that rely on tax revenue as source of income?
It does place burden on governments. But, governments happen to gain from sales tax and other fees instead from payroll tax.

If government encounter budget deficit, it can borrow. Deficit will have impact on currency, inflation and interest rate in the long run.