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posted by Adam Levitin

Turns out that the Treasury's loan investment in major financial institutions can't count as Tier I capital. That's a big whoops .

I've had trouble identifying the specific problem, but as far as I can tell it might stem from a little footnote in OCC capital requirement regs, that provides that

"Preferred stock issues where the dividend is reset periodically based upon current market conditions and the bank's current credit rating, including but not limited to, auction rate, money market or remarketable preferred stock, are assigned to Tier 2 capital, regardless of whether the dividends are cumulative or noncumulative."

Although this footnote only refers to dividends that reset based on market conditions, perhaps OCC interprets it to cover all stepped dividends (I haven't ventured past the Regs yet). If so, it would mean that the reset on dividend rate on the Treasury's preferred stock from 5% to 9% after 5 years, would make the investment Tier II, not Tier I capital. It's possible that this isn't the problem Reg, but it's the best I've been able to identify from the WaPo story.

All of this points to the problem of trying to jury-rig government support of a banking system that rests on a delicate and very complex regulatory structure. The solution to one problem can cause another. It might have been better, in retrospect, simply to direct the banks to raise more capital and let them first try to do it privately, as BoA was able to do recently.


Can't they just rewrite the regulations to make government investments Tier 1 as an exception to the general rule?

they can rewrite the rules or interpret them as they want, which we have seen all along as this crisis has unfolded. the FRB has stretched section 13.3 of the FR Act in ways many would have never imagined. the TSY has be rewriting the tax code in ways that have not got the attention of members of the hill. also, the bank regulators are now allowing goodwill to be included in the regulatory capital ratios; we all know how well that worked in the 1980s.

another problem with proposed capital infusions is the warrants. according to current rules, a bank must set aside actual shares that would be issued; these shares get counted in the denominator for book value and EPS ratios. hence, the warrants will push these ratios down, which will have some consequences. if a bank does not issue the shares, then the warrants become a liability that must be booked; negating any improvement from the capital infusion. this is a rule they will rewrite this weekend.

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