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Dunkelberg: Digging Deep Into Those Bank Profits

It is good news that the big banks are reporting profits, though as some observers have noted, it’s not hard to make money with free funds (provided by thousands of smaller banks who cannot continuously roll over Federal Funds as a way to fund assets).

It is also good that they continue to write off huge chunks of toxic assets and bad loans. The question there is whether or not the write-offs are of sufficient size, a question yet to be answered, either by events or government bureaucrats.

Little attention is paid to the fact that a large share of these big bank assets are funded by bank debt, not deposits (as is the case for small banks) and that these debts are guaranteed by the government. It was the withdrawal of short term funding that sealed the fate of Bear Stearns and Lehman and one can only speculate as to how long the mega banks could stand without the guarantee (especially if they repay their TARP loans).

Meantime, the government is suggesting that it might convert its preferred TARP stock into common stock.

This might be helpful based on the way capital adequacy is measured, but that would convey large voting rights to the government. If government officials truly believe that the government can’t run these institutions well and that they don’t wish to, perhaps they would sign a pledge not to vote the shares.

Of course such a conversion would impose an “AIG Dilution” on the shareholders of the bank and perhaps make private investors less interested in providing capital with such a large government stake in the banks and a tendency of Congress to renege on its deals. There are losses to take, and ultimately they are likely to fall on the least well represented constituency in Washington – consumers.

We just have to figure out the least expensive and most honest way to stick it to ‘em and get on with it.

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William Dunkelberg is an Economics Professor at Temple University.