“Make banking boring again” is a favorite reaction to news that JPMorgan was screwing up its VaR modelling of its attempt to get long gamma with improperly delta-hedged tranches of the CDX.NA.IG.9 and, sure, maybe, but don’t tell Treasury:

The U.S. Treasury may pool stakes in small banks bailed out during the financial crisis to entice potential investors as the Obama administration winds down the Troubled Asset Relief Program.

“Some of the investments are smaller and it may not be possible to auction them individually,” Tim Massad, the Treasury Department’s assistant secretary for financial stability, said in an interview. “So one of the things we’re looking at is pooling those investments together.”

You can see how much TARP money remains outstanding at all the wee banks at pages 240-257 here; on a quick look the smallest seems to be the $1.4mm subordinated debentures at Frontier Bancshares of Austin, TX, and there are plenty of other single-digit-millions remaining slugs of preferred or sub debt.* The notion that it would be impossible to sell something at auction for less than $50mm seems weird to me – it’s done all the time by, um, auction houses – but you get the idea: these are subordinated fixed-income instruments of small banks that have run into trouble in the recent past; the risks are significant and the potential rewards – particularly in absolute dollar numbers – may not justify the investment of time and effort to understand and bid on them.

So financial structuring can be used to increase liquidity and optimize pricing: let investors buy larger sizes of more diversified investments, and let them buy an instrument with other holders so there can be secondary market liquidity. And you can never have too much secondary market liquidity: investors will bid more aggressively in the government’s auction if they know there will be a robust secondary market, and the government’s ability to sell out here helps it support the financial system in the future. To really optimize pricing, Treasury could even carve the pool into tranches, so that more conservative investors can put money to work in these banks at lower risk (perhaps evidenced by AAA ratings) than you’d get from just small-bank preferred stock, while more aggressive investors can take more risk for a higher return.

Ha, sort of kidding. Anyway here’s another Bloomberg article about Fed regulators panicking about how they failed to stop JPMorgan from losing money in its investing-excess-deposits business:

New York-based JPMorgan’s trading loss, announced last week, occurred in its chief investment office, which oversees about $360 billion, the difference between deposits and what the bank lends. The New York Fed is investigating how other banks it regulates are investing deposits that aren’t loaned out, said the person, who wasn’t authorized to discuss the matter publicly and declined to be identified.

Some have wondered about the social utility of this business generally – shouldn’t JPMorgan be using our hard-earned deposits to lend to businesses that are building factories or music … things … on Facebook, rather than just investing them in securities bought in the secondary market? What good has secondary-market liquidity ever done anyone?

Anyway. This just struck me as a weird juxtaposition. I’m hoping that the Fed and Treasury will get together and reconcile these differences. Maybe JPMorgan’s CIO should be buying pools of small bank preferreds? Could be risk, though. How would they hedge?

Update: A reader notes about the pooled bank preferred auctions:

In the last TARP auction, at least two of the banks were bidders for their own securities. They were perfectly happy with paying a higher price than other “market” bidders because they could still take a gain at 97/98px.

By pooling the securities, the smaller banks won’t be able to take advantage of that opportunity. “How come the big banks got to buy their own back at a discount and you didn’t even give us the opportunity!” UST is very aware of this potential and is currently expending much energy trying to figure it out.

Oh please small banks, form your own mutual investment fund and bid for all of UST’s bank preferred CDO! Then dissolve the fund and redeem all your own preferreds. What could possibly etc.

Treasury Weighs Selling TARP Bank Shares in Pools [Bloomberg]
Fed Said to Study How Banks Manage Deposits After JPMorgan Loss [Bloomberg]

* There also seems to be some correlation between teeny size and grandiose-generic naming. So TARP’s got $2.7mm out to United Financial Banking Companies (Vienna, VA), $3.7mm out to First BancTrust Corporation (Paris, IL), and $6.6mm to Citizens First Corporation (Bowling Green, KY).

18 comments (hidden to protect delicate sensibilities)
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Comments (18)

  1. Posted by Matt's Pre-K Teacher | May 17, 2012 at 3:23 PM

    Did the dog eat the rest of the article, and the charts?

  2. Posted by tarpy | May 17, 2012 at 3:25 PM

    Ok, Matt, kind of stretch, but we'll grant you that.
    I think the bigger sort of juxtaposition, is that SIGTARP report says like on page 1, "a common misconception about TARP is that it made money. In fact, TARP is in the red by $3 bajillion."
    Then you look at the Treasury's recent TARP update presentation, and that one says, more or less, "not only did TARP save the financial system, it also made money!"

  3. Posted by Long Gamma | May 17, 2012 at 3:32 PM

    I understand everything up to the word "VaR".

  4. Posted by UBS MD | May 17, 2012 at 3:35 PM

    I believe Var was an old old wooden ship. Used in the cival war era.

  5. Posted by Bros Always Wins | May 17, 2012 at 3:57 PM

    I think you meant Civar Wal era.

  6. Posted by trojan_ | May 17, 2012 at 4:10 PM

    Thumbs are ready… now I just need the cornholes to jam.
    -Timmy

  7. Posted by Guestivus | May 17, 2012 at 4:14 PM

    "JPMorgan was screwing up its VaR modelling of its attempt to get long gamma with improperly delta-hedged tranches of the CDX.NA.IG.9"

    Yeah, I can see how that would be way too wild and crazy for some people.

  8. Posted by guest 3 | May 17, 2012 at 4:30 PM

    Just another manic Monday Matt?

  9. Posted by Guest | May 17, 2012 at 4:40 PM

    "The U.S. Treasury may pool stakes in small banks bailed out during the financial crisis to entice potential investors as the Obama administration winds down the Troubled Asset Relief Program."

    Because TruPs performed so well through the last cycle?

  10. Posted by Observer of Dumbass | May 17, 2012 at 4:44 PM

    The JPM braintrust correctly got "long gamma" but the problem was it was "negative gamma".

  11. Posted by Too Easy | May 17, 2012 at 4:46 PM

    Actually it turned out to be "DUM.BA.SS.9"

  12. Posted by PermaGuestII | May 17, 2012 at 5:16 PM

    Wonder how many of the small banks had to be bailed b/c their capital got vaporized when the Feds zero'ed the Fan/Fred preferreds?

  13. Posted by Guest | May 17, 2012 at 5:18 PM

    The pools could be managed instead of statiic

  14. Posted by FKApmco | May 17, 2012 at 5:40 PM

    Dear Matty: may I congratulate you on the improvement in your writing style recently. The total disappearance of the word "like," the shorter articles etc. is much appreciated and the tale of a whale of a fail was fucking epic…in a good way.

  15. Posted by 1801Observer | May 17, 2012 at 6:31 PM

    Massad said that they were going to consider pools a while ago on a Treasury blog….they dont have to create a CDO, Trust or special purpose vehicle of any kind….they can jst put 50-100 preferred position together worth 500 million to 900 million or so and sell it winner take all….they can even pre qualify the bidders to make sure that at least initially the preferred are in the hands of approved investors…Some of the bigger ones like Synovus you take care of individually …you could be done in a year to 18 months.

  16. Posted by guest | May 18, 2012 at 12:37 PM

    Timmy is brushing up on rock, paper, scissors just in case Europe needs his help again.

  17. Posted by sohbet | May 12, 2013 at 8:20 PM

    Relative game comment sounds like pr straight from ir talking points to me written by an underpaid res associate rather than an honest opinion of what matters: will financing costs for banks rise and will corporates that have stronger ratings than the banks wake up and disintermediation

  18. Posted by reseller tanpa modal | August 18, 2013 at 2:13 AM

    boring is something really not bad.. reseller tanpa modal