Economy Out of the Woods? - Analyst Blog

After almost a year of initiating the $700 billion Troubled Asset Relief Program (TARP), a lot has improved with respect to the economic crisis.

Though the economy is in far better shape now than a year ago, there are persistent problems which need to be addressed by the government before shifting the strategy to growth. We believe that the U.S. economy will regain the growth momentum once these issues are resolved.

On Thursday, U.S. Treasury Secretary Timothy Geithner said that the government won’t provide additional funds to stabilize the financial markets and the government’s economic team has removed a $750 billion line item from the federal budget projections, since it is unlikely to be necessary.

The TARP panel members, however, are not happy as most of the taxpayer-provided money was provided to financial institutions. But this is what was required as financial institutions are the backbone of the economy and they were the primary victims of the recession. However, we continue to see bank failures, with the tally reaching 89 so far this year.

Out of the $240 billion given to banks, $70 billion has come back as the healthiest banks have started repaying TARP funds. The Treasury Secretary estimates that the banks will repay another $50 billion over the next 12 to 18 months. Also, taxpayers have received decent returns on many of its financial-sector investments. TARP repayments have generated a 17% annualized return from stock-warrant repurchases and $12 billion in dividend payments from dozens of banks.

Many of the financial institutions that have already repaid bailout money include JPMorgan Chase (JPM), American Express (AXP), Goldman Sachs (GS), Morgan Stanley (MS), Capital One (COF), BB&T (BBT) and US Bancorp (USB). Also, banks like Bank of America (BAC), Wells Fargo (WFC) and Citigroup (C) are expected to exit from TARP over the next 12 to 18 months.

Earlier on Thursday, The Federal Deposit Insurance Corporation (FDIC) said that it may offer a six-month emergency extension to its debt-guarantee component of the Temporary Liquidity Guarantee Program (TLGP) that guarantees more than $270 billion of debt sold by U.S. banks.

The FDIC is considering two alternatives. Under the first, as planned, the program would expire Oct. 31 with the FDIC’s guarantee for such debt issued through the program expiring before Dec 31, 2012. According to the second alternative, the debt guarantee program will end Oct. 31, but for an emergency the FDIC would extend the guarantee facility by six months. The proposed extension is intended to address emergency circumstances for insured depository institutions and some other entities participating in the program.

In our view, though the domestic credit and liquidity markets appear to be normalizing, an extension of the debt guarantee facility will be helpful to speed up the complete recovery process.

However, there are lingering concerns related to the banking industry as well as the economy. In its latest banking industry update Moody’s Investor Service (MCO) repeated Thursday that the U.S. banking system will continue to suffer at least through the end of next year.

The ratings agency maintains a negative outlook for the banking industry. The agency cited that asset-quality troubles will force many banks to record substantial additional provisions for the remainder of 2009 and all of 2010, which will be a drag on the profitability of many banks for extended periods. This will further add stress to their capital levels.

Economy Out of the Woods? – Analyst Blog

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