Bullseye Integration

There has been a lot of talk about getting the banks to disclose what they did with the bailout money. To these people I say: “You don’t get it!” That usually gets a lot of different reactions; from strange funny looks to … well … you can fill in the blank.

Before you lynch me I’ll set the stage. First, let’s deal with lines of credit. Suppose you have a business that is performing reasonably. You are making money, making a living and paying the bills. You have an opportunity that you can say yes or no to. The opportunity will allow you to make more money, but you need to go into debt. Many entrepreneurs will get a line of credit with a bank to take advantage of the opportunity. In my scenario, all is well with the new debt. Now let’s say, out of the blue, with no notice the bank calls the line of credit (tells you must pay it off in full, today). Let’s say there is no history or precedent of this ever happening and no reasonable business person would have anticipated the bank’s action. You as a business person can either sue the bank, default, or contact your customers to pay immediately (and close off their credit terms), or find money elsewhere. There are probably more scenarios, too. The point is that there is a chain of dominoes that ripple from the bank’s action. Your customers might have to take similar actions to comply, if they want to comply.

One more scenario and the stage will be set. I like movies. To me they do a decent job of explaining the way things work (amid a lot of fantasy). Let’s talk about Trading Places (1983). Hopefully you remember this John Landis movie with Eddie Murphy & Dan Aykroyd about A snobbish investor and a wily street con artist who find their positions reversed as part of a bet by two callous millionaires. Do you remember the scene at the end where they seize all of the assets and holdings of Duke & Duke because they did not have cash to settle their positions? They may well have had more than enough assets, but just not enough cash.

Ok, so you say, what do these pretend scenarios have to do with the banks and the bailout? You all know that banks take deposits, cash checks and make loans. Many people have not thought about the transaction rules that allow the banks to clear checks between banks. Virtually all consumers write checks throughout the month, while making deposits one, two or four times per month. Businesses may deposit daily and write checks daily or in a pattern. What it comes down to is that a given bank may have a net inflow or outflow of money into the system on any given day. Like Trading Places, they must settle with the Fed at the time of clearing their items. In order to keep from guessing how much cash they might need, they have lines of credit with other banks. This allows the bank to invest however according to their investment strategy: some banks make business loans, some consumer loans, some real estate loans, some use international transactions, some use derivatives, some use any or all combinations of the above.

Finally, on to the fed’s bailout … what happened that caused the panic was that the major banks fearing that the mortgage crisis was going to make many other banks insolvent, cut off their lines of credit without notice/precedence (as I understand the facts). Unfortunately, this action was sufficiently severe that it became a self fulfilling prophecy. The affected banks could not meet their clearing requirements (they might have been able to arrange it if they had enough notice to reorganize their investment strategy). Keep in mind that the potentially failed banks have customers that would have their lines of credit cut off, too. The Fed did not have the resources to directly bailout the potential failed banks … or want to stretch to that extent. It would have required well over 100 times what was allocated. The politicians do/did not have the stomach for the cascading nature of the damage to the businesses and consumers that bank with the potentially failed banks.

So, the Fed gave the big banks money to ensure the other banks got to keep their lines of credit, thereby avoiding a cascading failure scenario. The Fed wisely held back a decent portion of the money to use for unseen events which gave the major bank’s even more confidence that they will not be left holding the bag. The Fed’s action saved all of us from the total collapse of our financial markets and therefore our economy. It worked!

Now, the original question: How did the banks spend the actual cash?

It doesn’t matter. It served the purpose. It was money well spent.

Bob Stackhouse is a Mergeronomist and the CEO of BullsEye Integration, LLC

BullsEye Integration, LLC is a transformational consulting firm headquartered in Northern California that serves small cap firms. We help companies make informed strategic decisions and assist them in the effective execution of their strategy.