U.S. aid to banks seen exceeding $700 billion

NEW YORK (Reuters) - The U.S. government will likely have to pump much more money into banks than the $700 billion it has committed if they are to survive the downturn, even if the cost is a tough pill for taxpayers to swallow.

The government must temporarily support the U.S. banking system, until banks can attract substantial amounts of new money from investors.

To begin operating normally again, banks will have to admit to their bad assets.

But that cannot happen immediately. Banks cannot predict how many of their loans will sour because they do not know how much the economy will shrink, and forecasts of their future losses would only spook investors. Investors will likely shy away from pouring money into banks until they fully understand the extent of their bad assets.

That hesitancy means that in the near term, the government will likely need to pony up more than the $700 billion it agreed to shell out through the Trouble Assets Relief Program, experts said.

"The government is being political and not saying they're putting in a trillion dollars or more, but the commitment has to be open ended," said Dan Alpert, a banker at Westwood Capital.

By the numbers, the outlook for banks is troubling. U.S. commercial banks had about $1 trillion of capital as of the end of the second quarter.

That may sound like a lot, but Alpert estimates that banks globally could have a total of $1.25 trillion to $1.5 trillion of writedowns and losses from mortgages, of which perhaps $600 billion have already been recorded.

Admittedly not all of those will be in the United States, and banks will generate capital in the coming years even as they write down assets and set aside more money for losses. But add in expected losses from commercial real estate, leveraged loans, credit cards, auto loans and a host of other areas as economic growth slows, and even the Treasury's full $700 billion Troubled Assets Relief Program starts to look worryingly small.

But if $700 billion from the government is not enough, don't expect investors to make up the difference -- they aren't interested in pouring money into a banking system that would otherwise be insolvent. That's why pumping in enough money to keep the banking system solvent is key, experts said.

"With honesty on bank balance sheets and enough government bucks, private investors will come back in," said Lawrence J. White, professor of economics at New York University's Stern School of Business, who helped oversee the liquidation of savings & loan assets in the late 1980s and early 1990s.

Government investment should be structured to ensure the government earns a profit if and when the banks' shares rise, White added.

A QUESTION OF SPEED

Investors disagree as to how quickly the government should give capital to banks.

One hedge fund manager who declined to be identified argued that banks should be overcapitalized now, and if banks had been given $500 billion instead of $250 billion, the interbank lending and triparty repo markets, among others, would unfreeze overnight. These markets have been thawing, though they are still not behaving normally.

But other investors said it makes sense to give banks money slowly, to make sure they are using it responsibly. And the government should also leave options open for fixing future problems.

"If you aren't holding anything back, then you've reduced the ammunition for later," said Lee Delaporte, director of research at Dreman Value Management in Jersey City, New Jersey, which has about $14 billion of assets under management.

Giving banks too much capital now might not make sense as the United States heads into a recession. Lending too much to banks creates the risk of more bad lending, which would just intensify the crisis.

"Deploying capital starts with creditworthy borrowers. You need people who can afford to pay you back," said Westwood's Alpert.

But whether government money should be pouring into banks faster or slower, many agree that the taxpayers will be pouring in much more.

"There are a lot of losses that have to be absorbed, so it will be pretty bloody," said NYU's White.

(Editing by Gary Hill)