Bank Recapitalization plan and North Korea

This post will concern two things: recapitalizing US banks and the recent agitation by NK against their southern cousins.

First, let's start with the banks.

It's important to realize that the current plan supposedly considered consists of the government drawing a fat, black line across the capital structure of every afflicted American bank and saying, "We do not retreat past this point." The mechanics, I suspect, will be a massive investment in convertible preferred stock that will, upon loss milestones, convert into common shares.

For those expecting significant common equity upside in the big banks from this plan, I'm afraid this plan won't bring it: the beneficiary will be senior and sub debt holders, who happen to be other banks. That means the random bank that isn't totally underwater and owns a lot of C and BAC sen/sub debt will get a huge capital gains kick if this plan goes into action.

Think about it: common shareholders are jerks like you and I and crappy funds. Those are all zeros, and we know it. The government must, if it's serious about this plan, protect bondholders at all cost. This inevitable creates massive dilution potential, and so even though TECHNICALLY there isn't another 80% of shares O/S after the government deal, the analysts will realize that given the risk of a seemingly inevitable dilution, common equity shares demand a far lower bid than the currently seek, even now.

HOWEVER, there is some potential for upside: if sen/sub debt is protected, all other banks that own sen/sub debt of other banks will get CAPITAL GAINS on the holdings of other bank debt. To expect these capital gains to countervail portfolio losses and suspended dividends is naive, but that's not the point: the point is to get the banks on life-support.

PROTECT THE DEBT: That's the objective here: forestall further deterioration of the portfolios of those institutions owning bank debt. If we don't backstop bank debt, then we have to recapitalize entirely NEW AND DISTINCT DI's, which means losses in DI's ramifying across the globe. Perhaps it's too odious for us to imagine the pain that would cause, hence .gov's reluctance, or perhaps it's just cronyism as usual... I do not know.

Topic 2: North Korea

North Korea is one thing and one thing only: a release valve for China. Hillary is trying to strong-arm the Chinese into buying more crappy US debt, and so China unleashed the hounds to chase her away. Perhaps the threats are a cover for an otherwise humiliating deal made by the Chinese, but North Korea is definitely in a tough spot, and I would not put anything past them, especially if the US is squeezing the current regime quite hard.

North Korea allows China to, in a true crisis, punish the US severely by attacking South Korea and Japan, which would compel the US to react and further stretch her already straitened resources, especially the US national debt.

It's a dangerous game of chicken. Keep an eye out for North Korea!