Typically, a steep yield curve is a sign of a strong recovery, but there is nothing typical about current monetary policy.

From Antonio Fatas and Ilian Mihov on the Global Economy:

The yield curve and the credibility of central banks

An increase in the yield for 10 year bonds put the yield curve in the US at one of its steepest since the mid-70s raising concerns about the evolution of long-term interest rates and the effect that they might have on the economic recovery. From Bloomberg, you can see that there are two ways to interpret the increase in the yield: Timothy Geithner thinks this is a good sign

Geithner also said that the rise in yields on Treasury securities this year “is a sign that things are improving” and that “there is a little less acute concern about the depth of the recession.”

Others see this as a sign of concern

Gross said in an interview today on Bloomberg Television that

while a U.S. sovereign rating cut is “certainly nothing that’s going to happen overnight,” financial markets are “beginning to anticipate the possibility.”

Typically, a steep yield curve is a sign of a strong recovery, but there is nothing typical about current monetary policy. Here and here are two blog entries that discuss the recent steepness of the yield curve in the US.

One thing that I find interesting is that despite the uncertainty surrounding the current economic situation, the yield curve is almost identical in the Euro area (Germany), the UK and the US (see chart below). This means that not only the perception of a default risk for these three government is similar, which is probably a reasonable guess, but also that inflation expectations are almost identical for the ECB, the Bank of England and the Federal Reserve.

While it is difficult to imagine circumstances where the inflation rates in these three areas deviates by a large amount, it is not that unlikely to build scenarios where inflation differentials are larger than the ones implied by those yield curves. Given the uncertainty and the difficulty predicting which ones of these scenarios will prevail, the yield curve seems to be anchored by the assumption that the three central banks will adopt very similar policies and will deliver an almost identical inflation rate. That's a strong sign of confidence on these three central banks.

Antonio Fatás"

Me:

Don said...

From my point of view, this is how you want QE to work against Debt-Deflation, which is a panic phenomenon.
1) Low Short Term Interest Rates, as a disincentive to buy guaranteed assets, and an incentive to buy stocks and corporate bonds. This attacks the Fear and Aversion to Risk.
2) Rising Longer Term Interest Rates, which signal an end to Deflationary Fears, and are an incentive for Longer Term Investing.As well, as you say, the Spread often ( which is as exact as this gets ) signals a recovery.

Now, what's interesting, is that I take it that this is what Bernanke and Geithner have been arguing, although not necessarily saying it the way I do. And, in fact, it seems to be working, which , again, is about as good as it gets, since none of us know the future.

Yet, as obvious as this is to me, others have been puzzled by this line of reasoning. I, on the other hand, do not understand the point of having interest rates move in tandem, insofar as incentives are concerned.

I understand the idea of rising interest rates being a problem, but the Fed has other means of addressing mortgages, in coordination with other parts of the government. However, I am not for keeping interest rates of mortgages artificially low at all, but certainly feel that this policy should now end. We need to see a plausible bottom on housing prices, without the perception of government still keeping housing prices artificially high.

Don the libertarian Democrat

Of course, Inflation will be the issue going forward, but I prefer that to a Debt-Deflationary Spiral. Call me silly, I guess.

June 1, 2009 2:14 PM

confirming the revival of risk taking and a general acknowledgement that economic life will continue

TO BE NOTED: From Alphaville:

"BarSlap! Posted by Paul Murphy on May 28 17:10.

Tim Bond, the Barclays Capital strategist, is having none of this bearish pessimism that has gripped markets since Bill Gross said the US could lose its triple A status and Marc Faber invoked the Z-word when discussing the prospects for American inflation.

From Bond’s latest Global Speculations - “Upside down bulls”:

In the financial markets, interpretation often counts for more than fact. Indeed, after passing through the qualitative and emotional analytical filter, factual inputs can often emerge from the process as anti-facts. At present, many market participants still appear to be afflicted by the mood of depressive pessimism that became pervasive last year. Under this condition, market developments and economic data-points that an impartial analysis would usually construe as positive are being warped into negative signals. Signs of an economic recovery, somehow, end up being interpreted as signs of impending economic doom.

Nowhere, Bond says, is this truer than with the prevailing fuss about the dollar and US treasury yields.

The fact that both asset classes have been losing their safe haven status is an unambiguously positive development, confirming the revival of risk taking and a general acknowledgement that economic life will continue.

Why, the BarCap man asks, if investors are fleeing the US because of its towering debt burden and the threat of hyperinflation, is sterling going up? Frying pans and fires springs to mind. Similarly, why has the Yen been depreciating against the dollar?

The current rumblings of discontent smack more of the avoidance of cognitive dissonance on the part of inveterate bears, than any dispassionate analysis of the situation.

Full takedown of the bears available here.

This entry was posted by Paul Murphy on Thursday, May 28th, 2009 at 17:10 and is filed under Capital markets. Tagged with barcap, green shoots, recovery, tim bond."

And Clusterstock:

"Analyst Says The Treasury Collapse Is Bullish Sign

Joe Weisenthal|May. 29, 2009, 6:41 AM|5

Print

Tags: Economy, Debt, U.S. Government, Tim Geithner, Interest Rates

You've seen the scary charts showing just how bad the Fed's policy of quantitative easing has failed. Although it would love to push long-term interest rates down to 4%, the market was having none of it. And the general consensus is that the uber-steep yield curve is a big nyet vote on both fiscal and monetary policy.

Tim Bond, an analyst at Barclays, says hogwash, taking the Geithner view that the rally in yields is the predictable response to both a recovering economy and the dissipation of the panic premium in US-denominated assets that built up during the bubble. The full report is embedded below (via FT Alphaville). Here's the introduction:

In the financial markets, interpretation often counts for more than fact. Indeed, after
passing through the qualitative and emotional analytical filter, factual inputs can often
emerge from the process as anti-facts. At present, many market participants still
appear to be afflicted by the mood of depressive pessimism that became pervasive last
year. Under this condition, market developments and economic data-points that an
impartial analysis would usually construe as positive are being warped into negative
signals. Signs of an economic recovery, somehow, end up being interpreted as signs of
impending economic doom.

Nowhere is this truer than of the prevailing fuss about the dollar and US treasury yields.
Both asset classes have been losing the save haven and liquidity premiums established
during the market carnage of last year. This is an unambiguously positive development,
confirming a revival in risk appetites, decreased fears about the financial system and a
general improvement in economic expectations. However, after passing through the
prevailing interpretative filter, these positives become negatives. Rather than indicating
an economic recovery, the lower dollar and higher bond yields apparently reflect a crisis
of confidence in US Inc, investors fleeing the prospect of endless budget deficits, a
towering government debt burden and prospective hyperinflation.

Never mind the rather obvious objection that the violent rally in Cable specifically
contradicts this theory – unless of course one assume s that jumping out of the frying
pan into the fire is a rational approach to securing a safe haven. Equally, never mind the
other rather obvious point that the currency of the largest creditor nation – Japan – has
recently been depreciating against the dollar, a development that is not exactly
indicative of rising concerns about US borrowing. Rather, if one starts from the premise
that nothing good is happening in the global economy, any contrary empirical
indications must inevitably be re-interpreted to fit the premise. The current rumblings
of discontent smack more of the avoidance of cognitive dissonance on the part of
inveterate bears, than any dispassionate analysis of the situation.

Bond Sell Off

Publish at Scribd or explore others:"

Me:

Don the libertarian Democrat (URL) said:

May. 29, 10:20 AM

I agree with him, as does Richard Fisher:

"Meanwhile, Reuters reported, "Federal Reserve Bank of Dallas President Richard Fisher said on Thursday it was not clear if the U.S. Treasury yield curve was steepening because of concerns over supply or a more optimistic economic outlook. "Obviously, there is a lot of supply of debt. Another way to interpret the steepening of the yield curve is ... confidence in economy going forward," he told reporters after a speech, adding that both could be happening at the same time. "I think it is probably a little bit of both, discounting the supply of new debt, but I detect...there is a pick up in confidence about the future," said Fisher."

In my book, this is how QE is supposed to work,ie, low short term interests rates and rising longer term interest rates. It's working. Now, of course, at some point, higher interest rates will become a problem, but we're a bit away from that now. So, the negative comments are reasonable, and might turn out to be right. We might, possibly, lose control down the road. I simply disagree.

By the way, haven't we all learned that we're all highly fallible in predicting the future yet?

And:

Don the libertarian Democrat May 29 15:24

I agree with him and Richard Fisher:

"Meanwhile, Reuters reported, "Federal Reserve Bank of Dallas President Richard Fisher said on Thursday it was not clear if the U.S. Treasury yield curve was steepening because of concerns over supply or a more optimistic economic outlook. "Obviously, there is a lot of supply of debt. Another way to interpret the steepening of the yield curve is ... confidence in economy going forward," he told reporters after a speech, adding that both could be happening at the same time. "I think it is probably a little bit of both, discounting the supply of new debt, but I detect...there is a pick up in confidence about the future," said Fisher."

I just want to be on record as an idiot.

Don the libertarian Democrat (URL) said:

May. 29, 10:31 AM

Joe,

Thanks a million for making that report available.

Cheers,

Don

Treasury Secretary Tim Geithner outlined where TARP money has been allocated and how much is left

TO BE NOTED:

• May 20, 2009, 9:53 AM ET

Where Is TARP Money Going? How Much Is Left?

In congressional testimony this morning, Treasury Secretary Tim Geithner outlined where TARP money has been allocated and how much is left. Here is Treasury’s estimate:

Projected Use of TARP/Financial Stability Plan Funds by Administration as of May 18, 2009

Programs Announced Under Previous Administration

AIG

$40 billion

Citi/Bank of America (TIP and Guarantees)

$52.5 billion

Autos

$24.9 billion

Capital Purchase Program

$218 billion

TALF 1.0

$20 billion

Subtotal

$355.4 billion

Programs Announced Under Obama Administration

Housing

$50 billion

AIG (Second Investment)

$30 billion

Auto Suppliers

$5 billion

Additional Autos

$10.9 billion

Expansion of Consumer and Business Lending Initiative *

TALF Asset Expansion (New Issuance) **

$35 billion

Unlocking SBA Lending Markets

$15 billion

Public Private Investment Program ***

TALF for Legacy Securities

$25 billion

Other PPIP Programs for Legacy Assets

$75 billion

Subtotal

$245.9 billion

Total Committed (Without Potential Repayments)

$601.3 billion

Total Remaining (Without Potential Repayments)

$98.7 billion

Conservative Estimate of Potential Repayments

$25 billion

Total Committed (Including Potential Repayments)

$576.3 billion

Total Remaining (Including Potential Repayments)

$123.7 billion

Additional Funding

Additional Support for the Auto Industry

Capital Assistance Program

* The Consumer and Business Lending Initiative also includes the $20 billion committed to TALF under the previous administration and the $25 billion committed to TALF for legacy securities under the PPIP, amounting to an overall total of $80 billion under TALF and $95 billion under the CBLI.

** New assets made eligible under the expansion of TALF include commercial mortgage-backed securities, mortgage servicing advances, loans or leases relating to business equipment, leases of vehicle fleets, and floor plan loans.

*** The Public-Private Investment Program was announced at a level of $75 to $100 billion, which includes $75 billion in additional resources for the PPIP program on top of $25 billion devoted to TALF for Legacy Securities."

But fixed-income investors wanted an excuse to invest in riskier stuff that carried slightly higher yields

TO BE NOTED: From Naked Capitalism:

"Guest Post: Geither admits easy money did us in

Submitted by Rolfe Winkler, publisher of OptionARMageddon

In an interview with Charlie Rose on Tuesday, Tim Geithner admitted the bubble was caused by Greenspan's easy money policy. Unfortunately, Charlie didn't ask the obvious follow-up: "why will this time be different? Why will Bernanke's easy money policy lead to different results?" Here was the crucial exchange:

Rose: "Looking back, what are the mistakes and what should you have done more of? Where were your instincts right, but you didn't go far enough?"

...

Geithner: "...I would say there were three types of broad errors of policy and policy both here and around the world. One was that monetary policy around the world was too loose too long. And that created this just huge boom in asset prices, money chasing risk. People trying to get a higher return. That was just overwhelmingly powerful."

Rose: "It was too easy."

Geithner: "It was too easy, yes....

What makes Geithner's admission so frustrating is that the government is engaged in the same disastrous policy today, to fight the same bogeyman: deflation.

As Geithner makes plain, a huge side effect was that investors seeking meaningful returns inflated the bubble taking flyers on overpriced, risky securities. Toxic structured products are the obvious example. Credit rating agencies get lots of blame as enablers, rating trash "AAA." But fixed-income investors wanted an excuse to invest in riskier stuff that carried slightly higher yields; hell, artificially low interest rates meant many needed an excuse.*

Truly low risk securities like Treasurys and money market instruments were yielding so little, they were of no use to portfolio managers trying to match assets with liabilities.

But what happens when low-risk fixed-income securities yield 0% or close to that? Asset managers are more or less forced( NB DON ) to seek higher interest rates through riskier investments.

So what are the results of our latest experiment with rock-bottom rates? Investors are piling back into risky investments across the board. Taking just one example, FT noted this week that high-yield debt is skyrocketing. The "experts" cited in the article claim this is proof that we've come through the worst of the recession. In their brains, markets operate efficiently, so running bulls must reflect improving fundamentals.

First of all, efficient market theory doesn't apply to asset markets the way it applies to goods markets. But even if it did, how can folks pretend that any market with fixed prices is operating efficiently? With their stranglehold on interest rates via open market ops, central banks everywhere are engaged in a massive price fixing scheme that distorts investor incentives across all asset markets.

Geithner admits such a policy was a disaster before, that the "overwhelmingly powerful" force of low rates inflated the bubble. So how can he/Bernanke justify the same approach this time 'round? No doubt they'd argue they've no other choice: a ponzi system "relying on credit" needs credit to flow or else it will collapse. It doesn't occur to these guys that the system itself is flawed, that we need a gut renovation, not just another layer of paint.

No doubt de-leveraging would be quite violent if the Fed left rates higher. But de-leveraging is the only solution to the crisis. God forbid Bernanke's easy money policy actually "works;" God forbid he "rescues" the economy by reflating the credit bubble. De-leveraging is coming, whether we want it to or not. Better to rip the band-aid off quickly...

-----

*Not that CRAs are blameless. They deserve every ounce of criticism they've received. "

Me:

Don said...

"But fixed-income investors wanted an excuse to invest in riskier stuff that carried slightly higher yields; hell, artificially low interest rates meant many needed an excuse.*"

"Asset managers are more or less forced to seek higher interest rates through riskier investments."

I agree with you about the search for higher yields, but there is no such thing as "more or less forced". Actual human beings made decisions and gave advice that was either negligent or criminal, in many cases. Wanting to achieve higher returns with less risk is silly. Lower interest rates cannot "cause" any sentient being to do anything. An incentive is just that. It is not a command or irresistible urge. This is a mechanistic explanation of human behavior.

"to fight the same bogeyman: deflation"

Not only is it not a bogeyman, it is far worse than inflation. A Debt-deflationary Spiral has no natural stopping point. From my view, that's what Fisher's paper showed, and the current crisis validates Fisher's theory.

Nevertheless, I liked your post, because you made plain the assumptions you are working under, which allow me to understand your argument and why you believe it. Many differences come from different assumptions.

Don the libertarian Democrat

use bailout money repaid by large banks to support additional capital infusions for smaller banks

TO BE NOTED: From the NY Times:

"U.S. to Use Bailout Repayments to Aid Small Banks

By THE ASSOCIATED PRESS

WASHINGTON (AP) — The Obama administration said Wednesday that it would use bailout money repaid by large banks to support additional capital infusions for smaller banks.

The Treasury secretary Timothy F. Geithner said in his comments that the repayment proceeds expected from some of the largest banks would be used “to reopen the application window” for banks with assets under $500 million.

In remarks to the annual meeting of the Independent Community Bankers of America, Mr. Geithner said the window for applying or reapplying, and the deadline for small banks to form a holding company to participate in the program would be open for six months."

Fed Chairman Ben Bernanke and his colleagues hated the thought of financing a bank run with government dollars

TO BE NOTED: From the WSJ:

"By KATE KELLY

Bear Stearns Cos., the 85-year-old Wall Street firm known for its tough trading culture, was rescued from impending bankruptcy by a deal with J.P. Morgan Chase & Co. on March 16, 2008 -- making Bear the first major casualty of the financial crisis. The firm spiraled from being healthy to practically insolvent in about 72 hours.

Adapted from "Street Fighters: The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street" by Kate Kelly, to be published by Portfolio, a member of Penguin Group (USA) Inc., on Tuesday. Copyright 2009 by Kate Kelly.

The meltdown began in earnest the evening of Thursday, March 13, 2008, when Bear executives made a shocking discovery: They were nearly out of cash. Faced with a slew of withdrawals from worried clients and a sudden pullback from lenders, the firm had less than $3 billion on hand -- not enough to open for business on Friday.

Bear chief executive Alan Schwartz immediately called J.P. Morgan, which as Bear's clearing agent managed its cash, to ask CEO Jamie Dimon for an overnight loan. Mr. Schwartz knew that if a deep-pocketed creditor like J.P. Morgan didn't come through, Bear's only option was bankruptcy, and he later phoned New York Federal Reserve Bank president Tim Geithner to say so.

Mr. Dimon, a veteran dealmaker, was willing to try to help. But, concerned about making a major financial commitment after just a few hours of research, he prevailed on the Federal Reserve Board for the funding instead.

During the wee hours of March 14, Fed officials relied on legislative powers that hadn't been used since the 1930s to find a temporary solution: a loan to Bear of undetermined size, to be provided through J.P. Morgan. What follows is an account of some of the events that surrounded their move.

Thursday, March 13, around 7:45 p.m.

Tim Geithner wasn't surprised to hear that night from Bear. Early Thursday morning, he had received a call from Alan Schwartz, who had warned him that a cash crisis might be looming.

72 Hours

Government officials and bankers raced the clock through the weekend to sell Bear Stearns.

Corbis

Thursday, March 13, 2008

6:00 p.m.

Chief Executive Alan Schwartz, Chief Financial Officer Sam Molinaro, and other senior Bear executives meet to discuss the firm's cash position. The shocking news: They're down to less than $3 billion, not enough to open for business on Friday.

Bloomberg News

Friday, March 14

4:45 a.m.

Federal Reserve Chairman Ben Bernanke, Tim Geithner, president of the Federal Reserve Bank of New York at the time, left, then-Treasury Secretary Hank Paulson, and other government officials hold a nail-biting conference call. They discuss Bear's precarious position and what a Bear bankruptcy could mean for the broader markets. Fearing disaster, Fed Board members authorize an emergency loan to the troubled investment bank, to be provided through J.P. Morgan.

Bloomberg News

7:30 p.m.

En route home from his worst day on the job ever, Mr. Schwartz gets a call from Messrs. Geithner and Paulson, who tell him he must have a deal to sell Bear by Sunday evening. He calls Mr. Molinaro with the news, and they prepare to meet first thing the next morning at the office.

Saturday, March 15

6:00 p.m.

After a long day of due-diligence meetings with executives from J.P. Morgan, who are interested in buying Bear, Mr. Schwartz receives a tentative bid from the large bank: between $8 and $12 per share. He and his team are grim that the price isn't higher, but relieved to have a potential deal in the works.

Getty Images

Sunday, March 16

9:00 a.m.

J.P. Morgan executives meet to discuss the Bear purchase after a sleepless night of reviewing the smaller firm's books. Hearing of his team's grave concerns about the quality of mortgage assets in Bear's portfolio, J.P Morgan Chase & Co. chairman and CEO Jamie Dimon decides to call off the talks.

Mr. Geithner alerts Messrs. Paulson, right, and Bernanke to the latest development. They discuss whether the government can backstop a J.P. Morgan purchase of Bear by agreeing to absorb potential losses.

Reuters

4:45 p.m.

Bear's investment banker gets a call from J.P. Morgan with the bank's final bid: $2 per share. Despite misgivings among Bear's board members, including chairman Jimmy Cayne, directors reluctantly approve the deal.

7:05 p.m.

The down-to-the-wire purchase is announced to the world. About 10 minutes later, the Fed reveals plans to "open the discount window" and allow investment banks to borrow directly from the government, an unprecedented move designed to aid other struggling firms.

Mr. Geithner had spent much of the day talking to his staff and other regulators about the issues that faced the troubled investment bank, trying to gauge how swiftly it might slide downhill. Unlike some officials at the Securities and Exchange Commission, he had taken cold comfort in knowing that Bear had opened that morning with close to $10 billion. What mattered, he felt, wasn't the hard cash the firm kept on hand, but how long that cash could last under such punitive market conditions. Not long, had been his guess.

The New York Fed president had spoken to Mr. Schwartz earlier in the evening and knew he was contacting J.P. Morgan for a loan. Until he got an update, however, all Mr. Geithner could do was wait. He was eating dinner with his wife and children at their suburban home when Bear's CEO called with terrible news.

"We're down to three or four billion and we feel like we've got no option but to file," Mr. Schwartz said, in a reference to bankruptcy.

Mr. Schwartz had also spoken to Jamie Dimon that evening, interrupting the J.P. Morgan chief's 52nd birthday celebration with his family. "Let's do something," the Bear CEO had told him. It was too short notice for a wholesale purchase of Bear, he knew, but the firm wouldn't open on Friday without a quick cash infusion. He asked Mr. Dimon to consider providing a $25 billion line of credit. Mr. Dimon agreed to look in to it.

After hanging up with Mr. Schwartz, the J.P. Morgan CEO focused on tracking down Steve Black, his point person on a deal of this nature. On vacation with his family in Anguilla, Mr. Black, the co-chief of J.P. Morgan's investment bank and an old ally of Mr. Dimon's from their shared days at Citibank, had left his cellphone back at the hotel while he dined out with his wife. Mr. Dimon needed to figure out where his division head was eating and get the phone number of that restaurant.

Friday, 8:30 a.m.

On the sixth floor of Bear's Madison Avenue headquarters, it was chaos. The elation people had felt at hearing about the Fed's emergency loan soon gave way to a panicked obsession over the language of the press release that would announce it. Naturally, Bear wanted the wording to sound as upbeat as possible, as though they'd be carrying on business as usual. They also wanted to hint that, just in case things didn't go well, J.P. Morgan was keen to buy them. But there was debate over how explicit to be about Bear's merger talks with other parties, which were still at a very early stage.

Another flashpoint was the length of time the Fed money would last. Government officials and J.P. Morgan had proposed suggesting 28 days, a figure that would take Bear well beyond the critical day ahead and give the public the idea that Bear was safe for the moment. Bear lawyers, however, wanted to say "at least 28 days," in order to leave their options open. But the other side held firm. It would be 28 days at the most, Bear was told.

During these debates, Bear Treasurer Bob Upton scurried between executives' offices, collecting opinions on the text. But after 90 minutes going back and forth, Mr. Upton snapped. "We gotta get this thing done!" he told Richie Metrick, one of Bear's senior investment bankers. "Get it into the marketplace."

Full Coverage

• Bear Stearns -- A Year Later
• From Fabled to Forgotten (3/14/09)

But the executives couldn't figure out which version was the final copy. The treasurer made a quick round of checks, grabbed a printout of what he thought was the right draft, and was rushing over to a copier when Mr. Metrick came screaming out of the CFO's corner office, where Mr. Schwartz was waiting. "Give me the f- document already!" Mr. Metrick bellowed at Mr. Upton. "I'm trying to get it f- finished!" the treasurer screamed back. He hurtled toward the copier, draft in hand.

Some 15 minutes later, at 9:13, J.P. Morgan's official press release went out on the business wire and was blasted all over computer news feeds and on CNBC. "JP Morgan Chase and Federal Reserve Bank of New York to Provide Financing to Bear Stearns," it read. The release went on to say that the bank and the government would together lend Bear "secured funding," or money backed by collateral, for "an initial period of up to 28 days." Its last sentence was the most intriguing: "JPMorgan Chase is working closely with Bear Stearns on securing permanent financing or other alternatives for the company."

Then, at 9:21, a similarly worded release from Bear was issued. Neither press release contained a statement of support from the Fed, whose full board had not yet met to officially approve the loan.

View Full Image

Associated Press

A few minutes later, the New York Stock Exchange opened for business, and In the 17 minutes between the issuance of the first release and the opening of U.S. stock markets for official trading, Bear shares launched an impressive rally, rising more than 9%. Mortgage traders on the seventh floor were thrilled. "We're alive!" somebody yelled. The cost of purchasing insurance protection against a default by Bear on its debts was dropping to its lowest point in days, and there was gleeful talk about how the so-called "shorts" -- traders hoping to make money on Bear shares' decline -- would get "squeezed," or lose their shirtMr. Black was packing his things in Anguilla when he caught word of the stock activity. J.P. Morgan had located a corporate jet in Miami, and it was on its way to whisk the executive and his family back to New York, where he could advise on whether to purchase Bear -- one of the options now on the table. He shook his head. "People don't understand what just happened here," he told his wife. "I guarantee by the time we land, that stock is going to be in half."

View Full Image

Associated Press

J.P. Morgan CEO Jamie Dimon, left, and Bear Stearns CEO Alan Schwartz, right, testify before the Senate Banking Committee in April 2008. "I just simply have not been able to come up with anything," Mr. Schwartz said, "even with the benefit of hindsight, which would have made a difference."

A few minutes later, the New York Stock Exchange opened for business, and those purchasing Bear shares during the light before-market trading period were replaced by a gusher of sellers. The stock quickly erased its gains and began a swift drop.

In Washington, Treasury Secretary Hank Paulson was just beginning a conference call with industry executives. He wanted to get the tone right, so he had sketched out some potential talking points on a legal pad. He didn't want rapacious trading tactics to further wound a gravely injured Bear, so he decided to put it to the firms straight: I expect you to behave yourselves.

The call began ominously. Technical difficulties made it hard to hear some people. Mr. Schwartz was dialing in from a patchy cellphone, and Mr. Dimon didn't surface until the conversation was 15 or 20 minutes under way.

When things finally settled down, Mr. Paulson was the first to speak. "I want you to deal with Bear Stearns as a responsible counterparty," he told the group. "When you're at a company, you think about protecting yourself at all times," he added. But these were not normal times. He expected firms not to make unreasonable collateral demands, or calls for extra cash or securities to back up loans, and to trade in good faith with Bear.

Meanwhile, in the nation's stock markets, Bear wasn't the only one hurting. Within the first hour of trading, the Dow Jones Industrial Average, the index that tracks blue chip stocks, had fallen more than 300 points, with 29 of its 30 component stocks taking losses. Other financial names, including J.P. Morgan itself, were tumbling.

Having arrived at the airport, Mr. Black found a television. He couldn't believe how fast the stock declines had been. He had expected Bear shares to fall by the time he landed in four or five hours -- not 45 minutes after the opening.

“Paul Friedman liked to joke that Bear people were "not big on titles," but his was chief operating officer of the firm's all-important fixed-income division, which handled the trading of mortgages and other bonds” Read the diary of a Bear Stearns Executive

By then the Federal Reserve Board had gathered in its headquarters in the Foggy Bottom section of Washington and approved the emergency loan. Fed Chairman Ben Bernanke and his colleagues hated the thought of financing a bank run with government dollars, but they believed that helping Bear survive the day would be better than allowing it to collapse.

The vote in favor was unanimous.

Sunday, 8:30 a.m.

Mr. Schwartz stood in the twelfth-floor boardroom, surrounded by more than 100 Bear employees. He spoke to the merits of the potential Bear-J.P. Morgan combination. It was the right thing to do, he told the group, and already the cultures seemed to be meshing well, under stressful circumstances.

"We have a deal," he told the group, "but you're not going to like it."

Adapted from "Street Fighters: The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street" by Kate Kelly, to be published by Portfolio, a member of Penguin Group (USA) Inc., on Tuesday. Copyright 2009 by Kate Kelly."

the government stands behind the banking system and that their deposits are safe

TO BE NOTED: From Bloomberg:

"Geithner Bets U.S. Can Avoid Japan Trap Through Bank Earnings

Share | Email | Print | A A A

By Rich Miller and Matthew Benjamin

May 8 (Bloomberg) -- Treasury Secretary Timothy Geithner is betting that U.S. banks can do something their Japanese counterparts were unable to accomplish in that country’s “lost decade” of the 1990s: earn their way out of trouble.

The stress-test results released yesterday by regulators found that the 19 largest banks face a $74.6 billion capital hole that may be filled mostly by private money. That compares with the hundreds of billions of dollars seen by outside analysts, including the International Monetary Fund, and takes into account banks’ projected earnings over the next two years.

The “stress-test results are an important step forward,” Geithner said in a statement announcing the results. “Americans should know that the government stands behind the banking system and that their deposits are safe.”

Still, the strategy carries risks for Geithner, 47, who served as a Treasury attaché to Japan from 1989 to 1991. If he’s wrong about the banks’ ability to weather the worst recession in at least half a century, the U.S. may just be postponing the day of reckoning when institutions will have to be shut down and taken over by the government.

“This looks like Japan in 1998, when they didn’t spend enough money on the banks,” said Adam Posen, deputy director of the Washington-based Peterson Institute for International Economics. “They then ended up back in crisis in 2001.”

Paying Off

So far, Geithner’s gamble is paying off. Bank stocks have surged in recent weeks as investors bet the stress tests would give the lenders a clean bill of health. The Standard & Poor’s 500 Financials Index reached its highest level in four months on May 6 as the test results leaked out, before slipping 5.8 points yesterday to 162.3.

Geithner said the strategy was designed to ease the uncertainty that drove bank shares down earlier this year. By exposing the lenders to uniform tests and then publicizing the results, he hoped to reassure investors that their worst fears about the future of the banking system were unfounded.

Regulators led by the Federal Reserve found that nine of the 19 biggest banks, including Goldman Sachs Group Inc. and JPMorgan Chase & Co., don’t need more capital. Bank of America Corp. has the biggest hole -- $33.9 billion -- followed by Wells Fargo & Co., with $13.7 billion. Banks that need to bolster capital have until June 8 to develop a plan and until Nov. 9 to implement it.

Potential Losses

Geithner told reporters that regulators took a conservative approach to toting up potential credit losses and calculating the industry’s ability to absorb them through increased earnings. The forecast of future profits was at the “quite low end of analysts’ expectations,” he said.

The results showed that losses at the banks under “more adverse” economic conditions than most economists anticipate could total $599.2 billion over two years. Mortgage losses present the biggest part of the risk, at $185.5 billion.

Jan Hatzius, chief U.S. economist at Goldman Sachs in New York, said banks may be able to rack up enough earnings over the next two years to cover virtually all the remaining credit losses.

The contraction of the financial industry over the last year, including the demise of Bear Stearns Cos. and Lehman Brothers Holdings Inc., has put those that have survived in a better position to post profits, he said.

With the economy showing signs of being close to a bottom, some of the banks may even end up being overcapitalized, added Sung Won Sohn, an economics professor at California State University in Camarillo, California.

Too Easy?

Critics remain unconvinced and charge that the regulators went too easy on the banks in conducting the tests, which were designed to ensure the firms could keep lending even if the economy deteriorated more than most economists expect.

Examiners used an “adverse scenario” of a 3.3 percent contraction in the economy this year, and an average unemployment rate of 8.9 percent in 2009 and 10.3 percent in 2010. Economists see a 2.5 percent drop in output this year, and unemployment rates of 8.9 percent in 2009 and 9.4 percent in 2010, according to a Bloomberg News survey.

“The stress was not much of a stress,” said Joseph Stiglitz, a Nobel Prize winner in economics and professor at Columbia University in New York.

Skeptics of the plan such as Posen said Geithner was trying to make a virtue out of a necessity. With public opposition to bank bailouts high, the Treasury secretary felt constrained from asking Congress for more money to help the industry. Treasury has about $110 billion left in the $700 billion bank-rescue package approved by lawmakers last year.

Ready for More

Geithner said the Treasury had enough money remaining in the Troubled Asset Relief Program to cover the banking industry’s needs. Still, he made clear that President Barack Obama wouldn’t hesitate to ask Congress for more should that prove necessary.

It was public opposition to bank bailouts that prevented Japanese policy makers from taking more forceful action to aid the country’s financial industry in the 1990s.

Like the U.S., Japan at first responded by putting capital into the banks, in 1998 and 1999. The crisis wasn’t fully resolved until 2002, after the government forced the banks to write down or sell off bad loans and effectively nationalized one institution, according to Takeo Hoshi, dean of the School of International Relations and Pacific Studies at the University of California at San Diego.

“I find more and more similarities to Japan as the situation develops here,” he said.

Relying on Partnerships

Geithner is counting on yet-to-be launched public-private partnerships to buy up the impaired assets that remain on bank balance sheets. The partnerships will be financed by low-cost credit via the Fed and the Federal Deposit Insurance Corp.

R. Glenn Hubbard, a former chief White House economist under President George W. Bush, voiced doubts the partnerships would work and argued that more dramatic action -- and taxpayer money -- will be needed to fix the financial system.

“Some more radical solution is going to be in order,” such as dividing troubled institutions into so-called good banks and bad banks, said Hubbard, who is now dean of the Columbia University Graduate School of Business in New York.

Kenneth Rogoff, a former IMF chief economist who’s now at Harvard University in Cambridge, Massachusetts, also said he fears the administration isn’t being forceful enough. Like Japan in the 1990s, Obama has put forward a big fiscal stimulus program to try to get the economy moving again, yet may have been too cautious in acting to repair the financial system.

“If the banking plan still falls short, the fiscal stimulus will have been wasted to some extent,” Rogoff said. “We could end up like Japan, sliding in and out of recession.”

To contact the reporters on this story: Matthew Benjamin in Washington at mbenjamin2@bloomberg.netRich Miller in Washington rmiller28@bloomberg.net"

The cost of protecting against debt defaulting in emerging markets plunged as appetite for risk rose

TO BE NOTED: From Alphaville:

"CDS report: “Mr Geithner has said the world will be fine” Posted by Ed Hammond on May 07 12:39.

The cost of insuring against the possibility of default on Japanese bonds fell dramatically on Thursday, as the market reopened after a three-day holiday to greet a wave of positive sentiment. Tightening in the CDS market was accompanied by sharp gains amongst Japanese equities amid optimism that the country’s economy was beginning to shake off the worst of the global recession.

The iTraxx Japan Series 11, which comprises 50 of the top investment-grade Japanese entities, traded at 225 and 263 basis points, significantly lower than Friday’s level of 320bp and less than half the the 565bp level seen in mid-March.

Meanwhile, the Markit iTraxx Europe, which tracks the continent’s 125 most liquid investment-grade names, maintained this week’s trend for the week by tightening in early trading.

Comments by US Treasury Secretary Timothy Geithner suggesting that no US bank subjected to stress testing, details of which are due to be announced later on Thursday, was facing the risk of insolvency, helped sentiment.

The Markit iTraxx Crossover index, which tracks junk-rated and the lowest investment-grade rated bonds in Europe, was around 728bp, 42bp tighter than the previous evening.

The cost of protecting against debt defaulting in emerging markets plunged as appetite for risk rose, with Russian credit default swaps falling roughly 10 per cent to 271bp from Wednesday’s close of 302.

Mehernosh Engineer, senior credit strategist at BNP Paribas, said, “Mr Geithner has said the world will be fine. We should all get back to partying.”

This entry was posted by Ed Hammond on Thursday, May 7th, 2009 at 12:39 and is filed under Capital markets."

politics wins over economics every time

From Yglesias:

"Someone Needs to Talk to Congress About the Banks

According to Hendrick Hertzberg’s writeup of a recent New Deal 2.0 event, some of the critics of the administration’s approach to the banks are shifting to an interpretation of what’s happening that’s closer to what the administration’s friends are saying:

Stiglitz said he has the impression that while the Administration’s policymakers are familiar with the approach he and Solow advocate and have discussed it among themselves, it hasn’t been given the kind of in-depth consideration that has been extended to the solutions preferred by the big banks. “When push comes to shove,” Solow said, “politics wins over economics every time. It’s the unanswerable objection: ‘You can’t get it through Congress.’”

I totally get this. What I’m not sure I do get is why, if the administration’s had the ability to convince a large swathe of outside analysts that congressional politics are making a highly sub-optimal response necessary, we’re not seeing more signs of an effort to persuade congress that this is a problem."

Me:

1. Don the libertarian Democrat Says:
   April 30th, 2009 at 2:43 pm

   “March 25, 2009
   tg-70

   Treasury Proposes Legislation for Resolution Authority

   Treasury Secretary Timothy Geithner on Monday called for new legislation granting additional tools to address systemically significant financial institutions that fall outside of the existing resolution regime under the FDIC. A draft bill will be sent to Congress this week and several key features are highlighted below.

   The legislative proposal would fill a significant void in the current financial services regulatory structure and is one piece of a comprehensive regulatory reform strategy that will mitigate systemic risk, enhance consumer and investor protection, while eliminating gaps in the regulatory structure.”

   What’s wrong with this legislation?

   I’m for Narrow Banking, can you tell me what this means?

   “They see the lack of a thoroughgoing “reorganization of the financial system” as the “most disappointing” feature of the new dispensation.”

So let me be clear: for sixteen months now I have been a Swedish-model advocate who wants to guarantee bank bondholders

TO BE NOTED: Grasping Reality with Both Hands:

"Tim Geithner and the Swedish Model

James Surowiecki:

The Sweden Example: The Balance Sheet: Ryan Avent beats me to the punch by pointing out the most important part of today’s Times’ story on Tim Geithner, namely that in the summer of 2008, after the collapse of Bear Stearns but before the meltdown of Lehman Brothers, Geithner proposed having the government guarantee the debts of all U.S. banks. The plan was shot down as politically untenable, but, as Ryan points out, had it been put into effect, we would most likely not have seen Lehman go under or had to deal with the incredibly negative consequences of that failure. More important, perhaps, by reducing the threat of panicked runs on bank debt (since those debts would have been guaranteed), such a guarantee would also have made it easier for regulators and banks to deal in a transparent fashion with the toxic-asset problem. That’s why the very first step in Sweden’s much-admired solution to its banking crisis in the early nineteen-nineties, was, yes, a guarantee of all bank debt. As one of the regulators involved in that effort put it, the guarantee “was provided in order to restore confidence and to ease the immediate pressure on banks,” by ensuring “the stability of the payment system and to safeguard the supply of credit.”

Given all this, Ryan is perplexed that Yves Smith... dismisses Geithner’s proposal... her conviction that any plan to deal with the banking system has to require bank bondholders to take a major hit. In other words, for Smith, the Swedish solution is not the right one. Nationalizing the banks, and wiping out the shareholders, isn’t enough: you have to impose significant pain on the banks’ debtholders, too. Lots of nationalization advocates believe that a debt guarantee is a bad idea. But one of the things that’s made the debate over nationalization confusing is that many of these same people, while arguing that bank debtholders should take a hit, also say that what the U.S. should do is emulate Sweden.... [T]his doesn’t make any sense. At the heart of the Swedish solution was the guarantee of all bank debt, ensuring that bondholders would not take a hit. And the Swedes, at least, thought that guarantee was essential to making their plan work.... [N]ationalization supporters should be clear: if they want to cram down the debtholders, then they don’t want the U.S. to follow the Swedish model. You cannot “Go Swedish” and “wipe out bond holders” at the same time.

There are nationalization advocates who really do want the U.S. to emulate Sweden, including most notably Paul Krugman, who’s said, “Sweden guaranteed all [bank liabilities]. If forced to say, I would go the Swedish route; but of course we can’t do that unless we’re prepared to put all troubled banks in receivership.” But many supporters of nationalization are just invoking Sweden in order to prove that there’s a historical precedent for successful nationalization, while at the same time arguing that the U.S. should reject a crucial part...

So let me be clear: for sixteen months now I have been a Swedish-model advocate who wants to guarantee bank bondholders. I thought and think it is the best practical road out of this mess."

share that worldview, Wall Street’s power and ability to make money will be secure

From The Baseline Scenario:

"Pierre Bourdieu, Tim Geithner, and Cultural Capital

with 64 comments

France in the 1960s and 1970s was the source of a tremendous amount of new philosophical, literary, and critical thinking - Foucault, Derrida, Lévi-Strauss, Baudrillard, Barthes, etc. But in my opinion, the most important member of that intellectual generation was the sociologist Pierre Bourdieu. In Distinction, Bourdieu’s best-known work, he described how economic class is reinforced by cultural capital: economic elites create cultural distinctions, and pass on to their children the ability to make those distinctions, in order to use cultural sophistication as a means of perpetuating class dominance. This may sound abstract, but think about the example that is the subject of Bourdieu’s The Love of Art: museums. Upper-class parents take their children to fine art museums and teach them how to talk about Rembrandt, Monet, and Picasso; later in college, job interviews, and cocktail parties, the ability to talk about Rembrandt, Monet, and Picasso is one of the markers that people use, consciously or unconsciously, to identify people as being from their own tribe. (Note that democratizing museums - making them open to anyone - doesn’t undermine cultural capital, because the key is not looking at paintings, but learning how to talk about them.)

We used the term “cultural capital” in our Atlantic article as a way of describing the influence of Wall Street over Washington. By this, we meant that one of the primary means by which Wall Street got its way in Washington was by creating and propagating the understanding - among sophisticated, educated, cultured people, as opposed to “populists” or the “rabble” that showed up at anti-globalization protests - that what was good for Wall Street was good for the country as a whole. We didn’t mean to say that old-fashioned campaign contributions and lobbying did not play an important role. (We did, however, say that we thought out-and-out corruption of the Jack Abramoff variety was probably a minor factor - not because we have any insider knowledge one way or the other, but simply because such criminal behavior was simply unnecessary given the other levers available.) But I don’t think that implicit quid pro quo bargaining is a sufficient explanation, because I believe it entirely possible that there are honest politicians and civil servants who really, truly believe that they are acting in the public interest when they come to the aid of the largest banks.

Tim Geithner may very well be such a man.

The New York Times ran a long article today about Geithner’s close connections to the New York financial elite during his years as president of the Federal Reserve Bank of New York, a curious public-private entity that plays a crucial role in the operation of the Federal Reserve, yet is governed by a board a majority of which is elected by the private sector banks themselves. The general thrust of the article is that Geithner had close relationships with many of the people whose banks it was his job to supervise, and that many of his proposals and policies have been generally friendly to those banks. But it should be noted that even after reviewing Geithner’s calendar for all of 2007 and 2008, with all its tantalizing mentions of posh meals and get-togethers (the Four Seasons is mentioned seven times), the Times did not find a smoking gun. Geithner was approached as a candidate to be CEO of Citigroup (an offer he quickly rejected), but nowhere is there any evidence that he traded favors for any kind of personal gain.

Instead, what the article portrays is a continuing series of close contacts - breakfast, lunch, dinner, coffee, charity board meetings, etc. - with a set of very rich, very powerful, very impressive people who all believed in the importance of Wall Street, and the importance of lighter regulation of Wall Street, and the importance of making sure that Tim Geithner believed in it too. It’s doubtful that there was anything close to a countervailing influence from people who thought that Wall Street was taking excessive risks and needed to be reined in; the first meeting with Nouriel Roubini was on August 28, 2008. I don’t mean to imply that Geithner was an impressionable youngster when he arrived at the New York Fed. He was 42 (older than I am now), and he had grown up in the Treasury Department in the Clinton administration. But that was a Treasury Department headed by Robert Rubin (former head of Goldman Sachs, later head of the executive committee at Citigroup) and his disciple Larry Summers, both of whom were strong believers - at the time, at least - in the importance of Wall Street and free financial markets.

The Geithner presidency seems to have represented the high point of a long tradition of cozy relationships between the head of the New York Fed and the banks it supervised. The Times article points out that Geithner’s two predecessors ended up as executives at investment banks, and his successor came from Goldman Sachs. But under Geithner, the relationships may have been their coziest:

Other chief financial regulators at the Federal Deposit Insurance Company and the Securities and Exchange Commission say they keep officials from institutions they supervise at arm’s length, to avoid even the appearance of a conflict. While the New York Fed’s rules do not prevent its president from holding such one-on-one meetings, that was not the general practice of Mr. Geithner’s recent predecessors, said Ernest T. Patrikis, a former general counsel and chief operating officer at the New York Fed.

“Typically, there would be senior staff there to protect against disputes in the future as to the nature of the conversations,” he said.

And at the same time, Geithner seems to have been an especially able advocate for Wall Street, both while at the New York Fed and as Secretary of the Treasury. The Times focuses on a few incidents where he took the banks’ side against other regulators, such as the debate over adopting Basel II, which essentially allowed banks to use their own risk models to determine how much capital they needed. And it should be undisputed that since taking over Treasury Geithner has taken positions that are generally friendly to the large banks (Public-Private Investment Program) or reflect a Wall Street-centered worldview that misreads public and political sentiment (AIG bonus fiasco). He has also continued to surround himself with people from Wall Street, including his chief of staff, the law firm that drafted the proposed legislation giving Treasury resolution authority for non-bank institutions, and the asset management firm handling Treasury’s troubled assets. None of this is new, of course; Treasury has been hiring people from Wall Street for years. And that’s precisely the point.

I don’t know Tim Geithner. But I have no reason to believe he is corrupt. Instead, the simplest explanation of the Times article is that he has internalized a worldview in which Wall Street is the central pillar of the American economy, the health of the economy depends on the health of a few major Wall Street banks, the importance of those banks justifies virtually any measures to protect them in their current form, large taxpayer subsidies to banks (and to bankers) are a necessary cost of those measures - and anyone who doesn’t understand these principles is a simple populist who just doesn’t understand the way the world really works.

Returning to my initial theme, he got the cultural education that rich people get, except instead of just going to the Metropolitan Museum of Art and the Museum of Modern Art, he was educated in the culture of Wall Street. Just like an education in art history is a marker of class distinction that is used to perpetuate class distinction, an education in modern finance is a marker of distinction that sets off those who understand the true importance of Wall Street for the American economy. As long the powerful people in Washington, including the regulators who oversee the financial industry, share that worldview, Wall Street’s power and ability to make money will be secure.

That is the importance of cultural capital.

By James Kwak

Written by James Kwak

April 27, 2009 at 11:00 pm"

Me:

I’m disagreeing with people a lot these days. This sociological explanation for people’s views is something I’ve never accepted. I’m a follower of Wittgenstein and Austin, and I remember Ernest Gellner’s Words And Things offering such a critique, in part, on why people were so silly as to accept ordinary language philosophy. Suffice it to say I don’t like that book, but I’m a huge fan of many of his other writings. He was a brilliant man, but his arguments in Words And Things are poor.

I’m finding the explanations of Geithner’s views strange. He’s limited by the context he’s in. As Burke always held, there’s a difference between politics and political theory. Politics is the art of the possible. His only other real option is more stock for the govt, but that’s hardly a panacea.

As near as I can tell, people are pissed that their pet theories aren’t being trumpeted by Geithner. Mine is Narrow Banking. Yet, I know that moving towards a Narrow Banking system would take time and be contentious. The current bill to seize large financial concerns is a huge step forward. That’s Geithner’s bill, unless I’m mistaken.

Finally, Geithner was for giving a full govt guarantee at the outset of this crisis. I’m with him. At least he understands the harm of Debt-Deflation and how to try and stop it.

I’m in general agreement with you on the problem that we face, but it’s much to soon to count Geithner out. The banks are losing power slowly. As well, I do not agree that the problem of bondholders is the same as the problem with the banks.

wonder why the President and Treasury Secretary have never articulated their strategy as clearly as Jim Surowiecki has.

From:

Tuesday, April 28, 2009 at 2:18 pm

Surowiecki gets bold in defense of Tim Geithner's non-boldness

Posted by Justin Fox | Comments (1) | Permalink | Trackbacks (0) | Email This

Jim Surowiecki, riffing on my post from last week on possible reasons for Treasury's less-than-bold approach to the banking crisis, which was itself a riff on a Ryan Avent riff on a Gary Weiss profile of Tim Geithner (yes, we bloggers are news-gathering dynamoes), writes:

It's true that the administration's approach may not be bold in the sense of being radical, but no one believes that boldness is, in itself, a good thing or that the more radical a solution is, the better it must be. (The Bush Administration's decision to invade Iraq was certainly bold and radical. That didn't make it any less of a mistake.) More important, the boldness issue is really a red herring. Obama's critics' problem with the Administration isn't really that they think it should act more decisively: it's that they think the Administration should act differently.

That's not entirely right. At least some of the criticism of the Administration's approach to the banks comes from people like me who wonder why the President and Treasury Secretary have never articulated their strategy as clearly as Jim Surowiecki has."

Me:

1. donthelibertariandemocrat Says:
   Tuesday, April 28, 2009 at 3:47 pm

   "wonder why the President and Treasury Secretary have never articulated their strategy as clearly as Jim Surowiecki has."

   It's a fair point, but, if I were in the govt, I would assume that only actual improvements are going to do any good at this point. In other words, it's no longer a matter of being convincing in words. Also, if you say, as I do, that the options are limited and ugly, you're likely to be considered a whiner. People will just tell you to shut up and get out then. Besides, Lincoln couldn't convince many people who are disinclined to accept the govt's approach.

   Finally, I've read Geithner make many of the points that people claim that he hasn't. We already have legislation to seize large financial concerns being put forward, and he's admitted plenty of mistakes. I would like Narrow Banking, and that isn't even gaining traction on blogs, but it's hardly only Geithner's fault that I'm not being listened to.

but they have an even larger fiduciary responsibility to their shareholders to raise share prices

From Robert Reich:

"Tuesday, April 28, 2009

Will Ken Lewis Get Canned, and Will Americans Have a Say in the Corporations We Now Own?

I don't know whether Bank of America shareholders will oust Ken Lewis from his chairmanship this week. I don't know if Treasury Secretary Timothy Geithner will eventually do it, either. What really worries me is I don't know who would actually be responsible for doing the deed, or by what criteria.

When it comes to keeping top corporate executives in line we usually entrust the job to shareholders -- or, as a practical matter, boards of directors that are supposed to represent shareholders' interests. When it comes to keeping top public servants in line we generally trust voters -- or, as a practical matter, the elected officials who represent them. But when, as now, the public has committed large amounts of its money to particular companies in the private sector, we're in a quandary.

The $45 billion we've sent to the Bank of America should give the public some say over whether Mr. Lewis remains in his job because he is now accountable to us as well as to his shareholders. But to which group should he be more accountable?

And: Is Mr. Lewis's main job still to make money for his shareholders, or does he now have a higher public responsibility to lend more money to Main Street? Was that public responsibility also paramount last fall when Federal Reserve Chief Ben Bernanke and Treasury Secretary Hank Paulson told Mr. Lewis to proceed with the Merrill-Lynch merger -- and when, according to Mr. Lewis's sworn testimony, he believed they didn't want him to disclose Merrill-Lynch's financial losses to B of A shareholders or anyone else?

It's not even clear who represents us as members of the public. Next month, AIG holds its annual shareholders meeting. Are you attending?

Maybe you should. The $170 billion we've committed to AIG so far amounts to nearly 80% of its shares. Some private shareholders are pushing for a vote to oust an AIG board member and to further restrict executive pay. But these dissident shareholders represent only a slice of the 20% of AIG's private owners.

AIG has three public trustees, each of whom is being paid $100,000 a year. Should they vote with the dissidents? There's no way to know, because the public trustees have no charter or mission statement to guide them, and they don't seem to report to anyone, either.

The question of public representation keeps growing. Now that our loans to Citigroup have been turned into common stock, you and I and other members of the public are poised to become Citigroup's biggest shareholder, holding about 36% of its voting shares. But who represents us, and how should they vote?

The Obama administration apparently wants to do more of these debt-for-equity swaps. They're a means to get more capital to the banks without returning to Congress to ask for more money -- which Congress would be very reluctant to provide. But the swaps also expose the public to more risk. At least loans have to be repaid.

Share prices, as we've seen, sometimes go down. Yet without a means for representing the public's interest in the governance system of these banks, we can only rely on the Treasury secretary to keep a watchful eye over the ongoing decisions of every bank. That's unrealistic.

Even if our public interests were being represented, it's not clear exactly what they are beyond getting repaid or possibly making a bit of a profit. Presumably taxpayer dollars are being committed because of some larger public purpose. Yet companies are designed to make profits, not to fulfill public responsibilities.

Suppose the government, representing the public, instructs the Wall Street banks it now controls to lend more money to Main Street. But top bank executives believe they can better raise share prices by using the money for new investments, bigger dividends, or to lure and retain "talent?" The executives have a duty to do what the government tells them to do, but they have an even larger fiduciary responsibility to their shareholders to raise share prices.

Suppose the government instructs AIG to clean up its balance sheet, but AIG's executives think they can make more money by inventing new off-balance-sheet derivatives? The executives' primary job is to make money for their shareholders. The fact that the public now owns 80% of AIG doesn't change that.

Suppose we tell General Motors Corp. -- about to become partly ours -- to shift its fleet to more fuel-efficient cars. Yet its executives know that as long as gas prices are low, Americans remain infatuated with highly profitable SUVs and pickup trucks? GM executives would have a perfect right, if not a duty, to disregard what we as citizens tell them to do in favor of what shareholders want them to do.

Democratic capitalism entails two systems by which people with significant power are held accountable. One is capitalism, by which companies and their executives are accountable to the market. The other is democracy, by which public agencies and their leaders are accountable to voters. Americans may disagree about how much we want of one or the other, but most people understand we need both systems of accountability. When we confuse the two, we run the danger that people with great power may escape accountability altogether.

That's the problem right now. Bank of America's Ken Lewis is fully accountable to no one. AIG's public trustees have no charter or public mission to guide them. GM is trying to satisfy the Treasury and its shareholders simultaneously, and is doing neither very well. Even as the public takes larger ownership stakes in big Wall Street banks, the public has no systematic means of expressing its growing interest, whatever it is.

Perhaps government had no business meddling in the private sector to begin with. AIG, the big banks and the auto companies should have been forced to work out their problems with their creditors, or else be put into temporary receivership until their profitable units or nonperforming loans could be sold off. Perhaps any company that's judged too big to fail is too big, period. Antitrust laws should have been used to break these giants up before they got so big.

These arguments may be relevant to the recent past and possibly to the future, but they're beside the point right now. The immediate challenge is to sort out public from private responsibilities and to create clearer lines of accountability.

At the least, when government takes an ownership stake in a company, the pubic should be represented on that companies' board of directors in direct proportion to the size of its stake. Those public directors should be appointed by the president. In exercising their oversight function, they should seek guidance from the president and his top economic officials. And their votes on critical issues before the board -- such as whether to fire Ken Lewis -- should be made public.

posted by Robert Reich"

Me:

Don said...

"But the swaps also expose the public to more risk. At least loans have to be repaid."

That could happen. Also, we're creditors, not owners. If we're owners, we have more control. We also have more responsibility. If we own it, even by being a major shareholder, investors will believe that they're now implicitly guaranteed. Foreign investors have been making this point since Fannie/Freddie was taken over. They expect the guarantees to be honored.

"The executives have a duty to do what the government tells them to do, but they have an even larger fiduciary responsibility to their shareholders to raise share prices."

That's true. It's a strange business in which you're told, as a minority investor, that your business needs to lose money, as is happening with Citi trying to get money from GM. That makes sense. I'm not sure that it's legal to do that.

"Those public directors should be appointed by the president."

Anybody who gets appointed will immediately be examined for any conflict of interest, collusion, friendship, etc. God knows how the AIG trustees are avoiding such scrutiny, but I predict that it will end.

Right now, we're stuck with hybrid plans, all of which have the same problems to varying extents, and are extremely messy. That's why I don't find the criticism of Geithner warranted. He has no good choices.

Don the libertarian Democrat

Tuesday, 28 April, 2009

by ensuring “the stability of the payment system and to safeguard the supply of credit.”

TO BE NOTED: From The New Yorker:

"The Sweden Example

Ryan Avent beats me to the punch by pointing out the most important part of today’s Times’ story on Tim Geithner, namely that in the summer of 2008, after the collapse of Bear Stearns but before the meltdown of Lehman Brothers, Geithner proposed having the government guarantee the debts of all U.S. banks. The plan was shot down as politically untenable, but, as Ryan points out, had it been put into effect, we would most likely not have seen Lehman go under or had to deal with the incredibly negative consequences of that failure. More important, perhaps, by reducing the threat of panicked runs on bank debt (since those debts would have been guaranteed), such a guarantee would also have made it easier for regulators and banks to deal in a transparent fashion with the toxic-asset problem. That’s why the very first step in Sweden’s much-admired solution to its banking crisis in the early nineteen-nineties, was, yes, a guarantee of all bank debt. As one of the regulators involved in that effort put it, the guarantee “was provided in order to restore confidence and to ease the immediate pressure on banks,” by ensuring “the stability of the payment system and to safeguard the supply of credit.”

Given all this, Ryan is perplexed that Yves Smith, in her post today on the Times article, dismisses Geithner’s proposal as just another attempt to give Wall Street a handout. In part, this could be because Smith thinks that, in the absence of a systematic plan to deal with toxic assets (which we don’t know if Geithner had), guaranteeing all bank debt would have allowed banks to engage in more risky behavior, knowing that taxpayers would foot the bill. But I think what’s really driving Smith’s attack on Geithner’s proposal is her conviction that any plan to deal with the banking system has to require bank bondholders to take a major hit. In other words, for Smith, the Swedish solution is not the right one. Nationalizing the banks, and wiping out the shareholders, isn’t enough: you have to impose significant pain on the banks’ debtholders, too.

Lots of nationalization advocates believe that a debt guarantee is a bad idea. But one of the things that’s made the debate over nationalization confusing is that many of these same people, while arguing that bank debtholders should take a hit, also say that what the U.S. should do is emulate Sweden. Henry Blodget, for instance, has argued that that we should follow “a tried and true way of fixing banks: The Swedish Model,” and yet he also insists that we should stop bailing out bank bondholders. And Barry Ritholtz has written that when it comes to dealing with the banks we should “Go Swedish. Wipe out shareholders, bond holders, and all the bad debt and junk paper these firms hold.”

Needless to say, this doesn’t make any sense. At the heart of the Swedish solution was the guarantee of all bank debt, ensuring that bondholders would not take a hit. And the Swedes, at least, thought that guarantee was essential to making their plan work. In the U.S. context, maybe we should follow a different approach, but nationalization supporters should be clear: if they want to cram down the debtholders, then they don’t want the U.S. to follow the Swedish model. You cannot “Go Swedish” and “wipe out bond holders” at the same time.

There are nationalization advocates who really do want the U.S. to emulate Sweden, including most notably Paul Krugman, who’s said, “Sweden guaranteed all [bank liabilities]. If forced to say, I would go the Swedish route; but of course we can’t do that unless we’re prepared to put all troubled banks in receivership.” But many supporters of nationalization are just invoking Sweden in order to prove that there’s a historical precedent for successful nationalization, while at the same time arguing that the U.S. should reject a crucial part of what made that precedent work. So the news that Geithner wanted the U.S. to take a first step on the Swedish path is unlikely to change their view of him. If anything, it’ll just confirm their assumption that he’s not willing to do what’s necessary.

Posted by James Surowiecki"

And:

April 27, 2009

The Fetishization of Boldness

Justin Fox has a nice post laying out a range of possible explanations for the Obama Administration’s decision not to nationalize some of the country’s biggest banks. Sensibly, the very first explanation Fox offers (and one he says he’s finding more plausible) is that the Administration is following its current strategy for dealing with the banks (a mix of regulatory forbearance and government subsidy in the form of debt guarantees and capital injections) because it believes “it’s the proper course of action, because most banks will be able to earn their way out of their problems if given some time and forbearance by regulators.” Oddly, this simple explanation—that Barack Obama, Tim Geithner, and Ben Bernanke have adopted their strategy because they think it has the best chance of getting the economy back on track while taking the least systemic risk, rather than because they’re stupid, or corrupt, or “cognitively captured”—is one you rarely hear floated these days, even though it is, I think, almost certainly true.

At the same time, Fox echoes one of the most common, but least convincing, criticisms of the Administration’s approach in general, and of Tim Geithner in particular, namely that they’re handling the crisis in a “tentative way” and not being bold enough. This critique has become a commonplace—it’s at the heart of Gary Weiss’s piece on Geithner in the new issue of Portfolio, where Geithner is described as “tentative,” “lacking in boldness and imagination,” and lacking “fresh ideas.”

I don’t buy it. Geithner did flub his first big speech, when he gave markets only a tentative sketch of what the Administration’s bank plan would look like. But from a policy perspective, the Administration has not been tentative at all: in fact, it’s been unwavering in its insistence that, given current market and economic conditions, the risks and costs of nationalization outweigh the benefits. And its alternative strategy may be wrong, but that doesn't mean it’s ill-considered, or halfhearted.

It's true that the administration's approach may not be bold in the sense of being radical, but no one believes that boldness is, in itself, a good thing or that the more radical a solution is, the better it must be. (The Bush Administration’s decision to invade Iraq was certainly bold and radical. That didn’t make it any less of a mistake.) More important, the boldness issue is really a red herring. Obama’s critics’ problem with the Administration isn’t really that they think it should act more decisively: it’s that they think the Administration should act differently. In that context, the personal attacks on Geithner for being weak and hesitant (like the persistent references to him as “Timmy,” as if he were somehow a child) are really just rhetorical gambits designed to make the Administration’s strategy seem weak and hesitant as well. The myriad criticisms of Geithner’s style and connections and the Administration’s lack of imagination all really boil down to the same unvarying argument: the government should nationalize the banks. And as long as the Administration refrains from doing this, nothing it does on the banking front—either stylistically or in terms of policy—will satisfy its critics.

Keywords

• Justin Fox;
• Obama administration;
• Tim Geithner;
• Treasury;
• banking crisis;
• banking system

Posted by James Surowiecki"