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The U.S. goverment's aid of the banking system is getting a difficult to remove foothold making for a difficult time ahead for the financial services industry.
Some banks want to pay back the government's TARP money, but that's the minority. For smaller banks, especially those with less than $500 million in assets, times are difficult enough that they can't consider the luxury of an early payback.
As a result, there are those in Congress and elsewhere who are starting to worry about the potential for a long-term government participation in the banking system. How deep is the government's stake in the financial services sector? According to The Wall Street Journal, the U.S. government "is on track to pump up to $14.9 trillion into the financial system through more than two-dozen federal initiatives, according to a Deutsche Bank report last month. Of that, only $250 billion, less than 2% of the total, is slated for the Treasury's Capital Purchase Program. The rest is designated for propping up areas including money-market mutual funds and commercial-paper markets, and for purchases of asset-backed securities."
That's a staggering sum. And the fact that it's being spent everywhere is a signal of what could lie ahead for the markets, not just more regulation, but perhaps all out dictating of business plans.
What's more illustrative of the situation is that once the large banks pay back their TARP funds, the government is likely to redeploy the funds to other financial institutions. The New York Times reported this morning that another $7.5 billion is slated to go to GMAC, its second bailout.
So what is this telling us? Well, at face value it means that the financial services sector, and thus the financial system is still severely wounded. Sure, there are likely to be institutions that are in better shape than others. But, the system is still in trouble because it seems to have too many potholes along the highway.
Finance is all about the ability of money to move from one place to another. That requires two parties per transaction that are able to make good on any exchange. If too many parties along the way aren't able to make good on their end, the system eventually falters, which is what happened when Lehman Brothers collapsed, money could not move from one place to another since it was uncertain whether anyone could make good on their end of any deal.
According to the Journal, though, part of the problem is government fear of another meltdown. This fear is making it difficult for the Treasury to fold any of their programs. And at the same time, the banks and other institutions are concerned about having their training wheels taken away.
Chart Courtesy of StockCharts.com
Meanwhile, the rally in the Banking Index (BKX) has stalled, suggesting that investor confidence in the current situation is starting to erode. The really in stocks stalled on 5-20 on the back of the selloff in the bank stocks.
Conclusion
The stock market has had a huge rally since bottoming out in March. Much of it came from the market being very oversold. But a large catalyst was the expectation among traders that the banking mess was on its way to improving.
What is now emerging is a more complex picture. The banking mess is improving for some, and there is more nuance than anyone could have anticipated, as some large banks are still not as healthy as the market had hoped. More troubling is the fact that small community banks, thought to be healthier than the large banks, are not on the whole as healthy as the market thought.
In the small bank sector, there are just as many potential problems as in the large bank sector.
What is now apparent is that a whole new wave of problems may lie ahead. And more important is that the solution, at least for now, could be that the government keeps its hands in the till for a lot longer than anyone thought.
As one commentator noted on CNBC recently, the government is now the uncle that came to visit but won't leave. What's worse is that even though the banks don't like their uncle much, many of them can't seem to function without him.
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