Reaction to the Obama-Geithner Bank Plan

One interesting way to think about the government's injections of capital is to compare these injections to an M&A transaction between two private companies. Often, the acquiror pays an amount for the target that is significantly greater than the target's perceived value as a standalone institution. This is justified by the synergies that exist between the two companies; ie, the combination creates value that would not be afforded to either company by itself.

So the question becomes: what is the franchise value of the various banks and does the government's injection of capital create synergy-like value?

Without a crystal ball, its impossible to know, but there are viable arguments on both sides and worth exploring.

- Without government injection of equity, it is likely that credit markets will remain frozen and franchise value will be destroyed. With an injection of enough equity, the credit markets will open and more than enough value will be created to show a significant ROE to taxpayers. The value created by the opening of the credit markets is analagous to synergies in a private merger.

- Even if it does produce these said synergies, the government's injection of equity can still be damaging if it does the following: 1) increases bad bank value, but franchise value remains negative, 2) allows bad banks to survive extracting value from good banks, and/or 3) crowds out potential new banks from forming and competing in the market place.