Monday, November 24, 2008

"The most extreme (and probably effective) solution would be a full guarantee of all sorts of bank debt. "

Bronte Capital gives us some interesting insights into Citi and other matters. You need to follow his whole post, so I'm just going to do what every sensible person does and quote the sections that buttress my own arguments:

"Now the problem is that no matter how many times Pandit says that Citigroup is well capitalised nobody will believe him. In answer to the Brad DeLong question – the company told lies about its mortgage book – which compounded the lies about the dodgy CDO product they sold. The lies about the mortgage book totalled $20 billion on say $43 billion of optimistically valued assets – and those lies reduced the value of Citigroup by $200 billion because they removed the trust in Citigroup.

It is one of those ironic things that when financial institutions lied in 2006 the market seemed to believe them. When they tell the truth now, nobody will listen. "

I find this an important point. Right now, we're in an inverse universe from just a year or so ago, where exuberance has become panic, overly positive credit ratings have become overly conservative, etc. Citi, I contend, didn't really need to be bailed out, but, given the current mood, it became inevitable. After all, as I've said, it was implicitly guaranteed.

"The most extreme (and probably effective) solution would be a full guarantee of all sorts of bank debt. The problem of course is that is hugely risky for the taxpayer. My view – and I think the only way in which such a guarantee is viable – would be that if the taxpayer takes the risk they should also get the upside. That is full nationalisation. The advantage of full nationalisation is that since the system is actually solvent (but illiquid) the government will make a profit out of it. That is fine. Take the risk – make a profit – it’s the capitalist way. Incidentally the Sheila Bair approach of confiscation from the equity holders and subordinate debt holders works fine in this scenario. Indeed the sub-debt holders should wear it – but they will still be willing to lend again because they will be lending again to the government. In a full nationalisation I see no reason for Sheila Bair to resign. (Her tenure in that position would not threaten the financial system.)

I suspect that wholesale nationalisation is the cheapest (and most sure) way to end the financial crisis. But it would be difficult to find a Deputy Secretary of the Treasury for Citigroup (and Bank of America, JPM etc). Still as I think the system is eventually solvent if the government nationalised pretty well the whole system as it failed then the government would make a shocking profit. It would not be the first time – Norway made such a profit.

But I am not sure that the American politic is ready for a wholesale nationalisation of the financial system. Indeed they are determined it seems not to control financial institutions. If you are not convinced of that see the Deal Professor’s wonderful piece on who controls AIG."

This was my position. Paradoxically, but I think that it's becoming obviously more clear, this would have been cheaper, safer, and would have led to the government being removed from this ownership sooner. Why not a free market plan? Because the people with the money don't believe in it, and would have melted into thin air at the thought of not having a government intervention. With all do respect to Casey Mulligan and Gary Becker, your theories are purely Economic in this case, not based on Political Economy and Politics.

"Robert Rubin racks his brain about how he would have done things differently. Well one thing he would have done differently is get Citigroup to remove the culture of obfuscation – the culture that allowed it to be perceived as if it were lying even when it was telling the truth. The problem is that even Robert Rubin doesn’t have enough uncashed integrity to save Citigroup. Even Robert Rubin. In a world where Berkshire credit default swaps are going skyward because people do not believe that Warren Buffett has no collateral requirement Robert Rubin’s reputation ain’t going to count for much. "

This is the final point I want to make. This is Political Economy, where even known wizards cannot overcome fear and aversion to risk, and point people towards the fundamentals. People don't behave like models in the real world in normal times, although it's close enough to make the models useful. In times like these, you're better off listening to philosophers and other odd ducks who specialize in the nature of Human Agency.

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