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February 27th, 2009

Growing Absence of “Middle-Class” Banks



Today Vice President Biden will head the inaugural meeting of the Middle Class Task Force in Philadelphia. The group was formed to help rebuild and strengthen America’s largest class that has been severely weakened by the recession. The White House firmly believes that “a strong middle class equals a strong America.”

While this will focus on rebuilding the mid-tier of society, why has so little focus been directed to rebuilding mid-size or “middle-class” banks?

Beginning back in October when the original nine “too big to fail” institutions were given TARP money, the institutions were urged to become bigger and stronger:

“Treasury doesn’t want to prop up weak banks,” said an official who spoke on condition of anonymity, because of the sensitivity of the matter. “One purpose of this plan is to drive consolidation.”

Just yesterday bank regulators began conducting “stress tests” to the nation’s largest institutions in order to assess their future risk and potential need for additional capital. If capital is needed, the Treasury will provide it in exchange for convertible preferred securities, which can be changed into shares of banks’ common stock. The institutions will have six months to pay the money back. If they cannot, the government will retain its shares of the institution’s stock. In the instance where the capital and conversion results in a greater than 50% share for the government, the institution would be considered “nationalized,” at least temporarily.

Today the government reached a deal with Citi in which they now hold 36% of the bank’s common shares:

The U.S. Treasury agreed to convert up to $25 billion in government-held preferred shares in the bank to common equity, provided private investors contribute an identical sum, in the third major aid package for Citigroup since mid-October.

Over the past perhaps 20 years, the banking landscape has been transformed to a society of small and extremely large, powerful institutions — a lower and upper class of institutions so to speak.

“A middle class of banks could act as a ’shock absorber’ when markets experience difficult times. With a middle tier of institutions, there’s less need to declare an institution ‘too big to fail’ since a failing firm’s functions could more easily be absorbed by other players in the market,” said HSH Vice President Keith Gumbinger.

When nationalization is an emerging strategy in order to control these large institutions — even if it’s only temporary — it may crowd out private industry, only leaving room for small, local banks.

These upper echelon institutions are no longer too big to fail — they’re getting too big to manage. Just as America needs a strong middle class to function according to the principles this country was based on, so does it need “middle-class banks.”

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About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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