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

On this, as with repayment, the government is speaking out of both sides of Geithner's mouth.

TO BE NOTED: From ChumpChanger:

"The Two Faces Of The Treasury

So does Timothy Geithner want banks to repay TARP funds or not? It seems to me that in Geithner's latest testimony you can find any answer you prefer. On the one hand, the stress tests are supposed to determine which banks have sufficient capital to return government money. On the other, whether the government will take it back will be determined not only by the tests, but whether it is in the national interest: in other words, Treasury would prefer that banks lent out the money than that they return it. The initial assumption that banks that didn't take money would be at a competitive disadvantage has been replaced by another idea (admittedly already present in Hank Paulson's initial pitch) that dividing banks into government supported, tottering ones and self supported stable ones would put the government supported banks at a disadvantage.

There's another, unspoken, assumption--or maybe hope--here, though, which may be even stranger. It is that adding more capital to the banks will make it feasible for them to increase lending to levels that will jump start the economy. To some extent, of course, that's true. Cheap money will be lent out. However, what's keeping the stronger banks from lending right now is not a lack of capital. It is rising losses on loans they've already made. Loans that were risky before are more so now in the midst of a recession, and there is no magic solution that will both increase lending and reduce risk. This ultimately is Treasuries dilemma: telling banks to lend more and do it more responsibly at the same time. On this, as with repayment, the government is speaking out of both sides of Geithner's mouth.

By Mark"

That's the noise being made to reassure the great unwashed public. But whether there is any real difference in outcome is unknowable.

From Naked Capitalism:

"Bank Stress Tests Now Officially a Garbage In, Garbage Out Exercise

We've had plenty of company in voicing doubts about the Treasury's so-called stress tests of the 19 biggest banks. To quickly recap the main issues:

The bank will run the tests themselves, using the same risk models that caused the mess. With only ten examiners on average per bank, and most of the banks having very diverse businesses (mortgages, complex structured credits, credit cards, consumer loans, commercial real estate, large corporate loans, small business lending, foreign operations, credit default swaps, other derivatives exposures, foreign lending and FX exposures), their ability to probe the results, from a skill and manpower basis, is dubious, particularly in the capital markets exposures

For the simpler products, there will be no verification of the loans versus the underlying files.

The so called "adverse" scenario, at the time the tests were announced, was far more optimistic than the typical trajectory of a financial crisis. As the IMF noted in its newly released economic outlook, the current mess is likely to prove worse, due to it being an international, synchronized credit crisis (past outbreaks have been at worst regional).

As the economy has only deteriorated since the tests were announced, even more optimistic mainstream economists are coming to the view that the supposed downside case is likely to approximate the middle of the road case, meaning the "stress" in the tests is insufficient.

The Administration has acknowledged this problem with one of its typically Orwellian responses, by saying it will interpret the results more harshly. But how can anyone do that in a realistic way given the inadequate knowledge of the operations, resulting from sending in only enough examiners to have pleasant conversations over tea about the numbers as they came out? Without digging into operational level data and seeing how it is adjusted to produce bank wide results, any understanding is woefully superficial. Even among the big banks, you can't apply the same sort of adjustment to a largely retail bank like Wells versus a bank with incredible product and geographic diversity like Citi. or ones with very substantial trading operations and complex derivatives exposures (JP Morgan, Goldman, Morgan Stanley, as well as Ciit). Pray tell, how do they decide what adjustment to make to banks with very distinct business profiles? And even for ones with largely similar profiles (Goldman and Morgan Stanley), there are very important differences between.

Answer: they haven't done the spadework to make these subjective adjustments. So the whole exercise, which was dubious from the start, is now patently a PR stunt, with the Treasury also having indicated that it wants to have the exercise be seen as having teeth. That means the Treasury has decided on a forced curve, that on their relative ranking, the somones on the bottom will need to raise more equity (either from the public or failing that, the TARP).

The one thing that may change (we stress may, to paraphrase T.S. Eliot, this Administration cannot take very much reality), is that the line on the relative ranking of who is deemed to need more equity or not may be pushed higher. That's the noise being made to reassure the great unwashed public. But whether there is any real difference in outcome is unknowable. All that is certain is a show will be made as to how the process was toughened up.

A relative ranking is a "price of everything, value of nothing" process, definitive yet singularly unhelpful. An absolute measure, of who needs dough and who doesn't, is vital. In fact, we have said repeatedly that that should have been the Treasury's and SEC's top priority after Bear failed. But the procedures were never in place to do that adequately.

From the Financial Times:

Rising unemployment is prompting US authorities to consider taking a tougher stance in judging the results of bank stress tests...

When the stress tests were revealed two months ago, the authorities defined the adverse scenario as one in which unemployment rose gradually to peak at 10.4 per cent in late 2010.

But, since the announcement was made, unemployment has risen much more quickly than was expected, even under the “adverse scenario”...

The authorities believe it is too late to revisit the assumptions underpinning the stress tests. However, it is not too late for them to decide to interpret the implications for capital more stringently. The Treasury declined to comment.

Making such an adjustment would help arguments against claims by critics such as Nouriel Roubini, chairman of RGE Monitor, who wrote on his blog: “The stress test results are meaningless as actual data are already running worse than the worst case scenario.”

The authorities have not yet made a final decision on changing the way the tests will be interpreted. Even if officials do lean in this direction, it may never be visible because they did not specify in advance any precise formula relating stress test outcomes to required bank capital. Moreover, signs of economic recovery could persuade policymakers to disregard the rapid recent rise in unemployment on the grounds that it might revert to the less alarming trajectory they originally expected.

Policymakers also believe that other assumptions in the test still reflect a worse-than-expected outcome.

More on this topic (What's this?)

The Commercial Real Estate Sector: As The Other Shoe Drops - Be Wary of Bank Stocks (, 4/17/09)

Too Naive (Financial Armageddon, 4/12/09)

Watch Out for Bank Stress Tests (, 4/16/09)

Read more on Banking at Wikinvest

Posted by Yves Smith "

Me:

Don said...

“Will applications filed by QFIs or the names of applying QFIs be released publicly?
No. Treasury will not release the names of QFIs who apply for the CAP or those which
are not approved. Treasury will publish electronic reports detailing any completed
transactions, including the name of the QFI and the amount of the investment, as required
by the Emergency Economic Stabilization Act of 2008, within 48 hours of the
investment.”

And:

“What if a QFI needs capital in excess of the investment limit referred to above?
An institution that needs capital in excess of the investment limit referred to above is
deemed as needing “exceptional assistance.” In consultation with the appropriate Federal
banking agency, Treasury will determine whether an institution qualifies for “exceptional
assistance” on a case-by-case basis.
What will be the terms of transactions involving QFIs in need of exceptional
assistance?
QFIs falling under the “exceptional assistance” standard may have bank-specific
negotiated agreements with the Treasury Department.”

That's from CAP. In other words, the whole point was to assure that these banks would be carefully examined for problems, and then made whole or solvent. What we were supposed to hear in public was the amount of assistance, which could vary with the size and particular needs of each bank. The program was meant to instill confidence by assuring the necessary backing for solvency.

Now, just looking at the program as presented, it's asinine to announce who's in what shape. That would negate the point of issuing the blanket guarantee of solvency.

What's happened is that popular perception has latched onto the idea of "stress tests" being a test for who gets seized or something like that. But, think about it: Even if the govt was going to do that, they wouldn't tell us beforehand.

The program was meant to erase a stigma, not produce one. For one thing, we own a lot of Citi, which is trying to sell its assets. It will hardly make selling those assets easier if we announce exactly what they're getting and why.

Now, if you don't want the govt to help these banks, I can understand pissing on this arrangement. But if you do, why would you want to make the banks less able to do business than more?

Finally, unless we seize the banks in an FDIC sort of way, we are going to be left with a hybrid. In other words, if we simply own stock and have someone manage the bank for us until we sell it, that will still be a hybrid plan because the bank will be a private company with certain fiduciary responsibilities to all its shareholders. It's probably a better idea than CAP, but it has lots of risks, such as:
1) It's one thing for a private company to default, another for a govt to default. If we own it, foreign investors and countries expect us to guarantee it. That's why it could lose us a lot of money. We could just screw them, but that will have negative consequences.
2) We will involve ourselves in foreign politics. For example, we needed a retroactive govt law from Mexico to be able to take more than a 10% stake in Citi. That was popular with some people, while not for others. As well, selling Banamex could have currency issues. All of Citi's foreign holdings will involve a similar problem.
3) All other hybrid problems, like conflict of interest, will remain. After all, Geithner is not even from Wall Street, and he's being accused of collusion.

It is true that we can announce every detail of these tests, and that might be what happens. But it could well end up costing us a lot more money if the market and potential investors or buyers hold out for more money. I thought that we were trying to save money.

I'm no fan of this plan, but I'm also not a fan of us shooting ourselves in the foot over and over again. We're in a damnable mess, and there's no clean or easy way out. We've lots of bad choices to choose from. That's it.

Don the libertarian Democrat

April 18, 2009 11:46 AM

a public-private hybrid doesn’t work

TO BE NOTED: From Bloomberg:

"Fannie, Freddie Face Pressure to Revamp as U.S. Aid Increases

Share | Email | Print | A A A

By Dawn Kopecki

April 15 (Bloomberg) -- Fannie Mae and Freddie Mac are under pressure from lawmakers to revamp their operations as the mortgage-finance companies tap more government money to survive.

Among the options under discussion are combining the companies, breaking them up or reshaping their missions.

“It’s highly unlikely that they would return to the way they used to be,” said Ira Jersey, the head of U.S. interest rate strategy at RBC Capital Markets in New York.

Regulators seized Fannie and Freddie in September amid a rise in mortgage delinquencies that led to a combined net loss of $108.8 billion last year at the companies, the largest sources of financing for new U.S. home loans. The Treasury Department has injected $59.8 billion in emergency funds into the companies, including $46 billion issued two weeks ago.

Executives at Washington-based Fannie have discussed internally the possibility of taking over McLean, Virginia-based Freddie’s operations, according to people familiar with the matter. A formal approach isn’t imminent, said the people, who asked not to be named because the discussions are private.

The Treasury has agreed to give the two government- sponsored enterprises, or GSEs, as much as $400 billion through Dec. 31. That agreement probably will need to be extended by Congress before year-end, said Karen Shaw Petrou, a managing partner of Federal Financial Analytics Inc., a Washington-based research firm.

‘New Structure’

“There will be a massive re-write of the GSEs into some new structure,” though probably not this year, Petrou said.

House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, is exploring ways to separate the companies’ private and public missions, said Steve Adamske, a Frank spokesman.

A merger would be the quickest way for regulators to cut costs by reducing Fannie and Freddie’s combined 11,000-person workforce, shedding underperforming mortgage assets and reducing the bureaucracy of running two companies with identical functions, said Christopher Whalen, co-founder of Institutional Risk Analytics in Torrance, California.

Substantial movement toward a merger may not come quickly. James Lockhart, who oversees the companies as director of the Federal Housing Finance Agency, has said they will remain under government control until the housing market recovers, and the Obama administration has ordered Fannie and Freddie to focus on helping homeowners meet their mortgage payments.

Public Mission

“It’s got to happen; we’re not going to put them back the way they were,” Whalen said of a merger. “The only way we’re going to be able to manage them is if we squeeze every last ounce of savings out of the administrative side and just focus on trying to keep the loss number under control.”

Brian Faith, a Fannie spokesman, and Michael Cosgrove, a spokesman for Freddie, declined to comment on the possibility of a merger or other restructuring.

Fannie, created by the government in 1938, and Freddie, formed in 1970 to be a competitor, ensure that banks have cash available to make loans by buying mortgages or guaranteeing securities they help create from the debt. Together they own or guarantee about 56 percent of all U.S. home loans.

Freddie has received $44.6 billion in federal aid, about three times as much as Fannie. Freddie’s tab at the Treasury will cost it at least $4.6 billion in annual interest payments, almost triple what Fannie owes.

“With both of them as wards of the state, do you need two of them?” said Joshua Rosner, an analyst with Graham Fisher & Co. in New York.

Ousted Management

Lockhart’s agency put Fannie and Freddie under its control and forced out executives after examiners said the two may be at risk of failing, threatening further damage to the housing market.

Top management of the companies remains in flux. Freddie Chief Executive Officer David Moffett unexpectedly quit last month. Fannie CEO Herb Allison emerged this week as the leading candidate to run the $700 billion U.S. bank-rescue program, according to a person familiar with the matter.

Under Frank’s plan, a government trust fund would assume the companies’ responsibilities to subsidize rental housing and a remaining company would continue to do business in the private mortgage market, according to Adamske, the lawmaker’s spokesman. He said it’s too soon to say what the final structure would look like.

To make Frank’s proposal work, regulators may need to put one company into receivership, a process similar to bankruptcy, said Armando Falcon, who was Fannie and Freddie’s government supervisor from 1999 through mid-2005. The fastest way would be for “one to buy all the assets and assume all the liabilities of the other, place the rest of it into receivership and wind it down,” he said.

Home Loan Banks

The solution is to “break them up,” said Representative Spencer Bachus of Alabama, the top Republican on the House Financial Services Committee. “One possibility that I’ve looked at is letting the Federal Home Loan Banks take over some of their obligations and operations.”

The Federal Home Loan Banks are 12 government-chartered cooperatives that lend money for mortgages at below-market rates to their membership of more than 8,100 thrifts, commercial banks, insurance companies and credit unions.

Daniel Mudd, ousted as Fannie’s CEO after the government’s Sept. 6 takeover, said too much is being demanded of the companies, and that lawmakers should rethink the idea of shareholder-owned firms with public missions.

‘Robust’ Debate

“We need to have a robust policy debate,” Mudd, 50, said in an interview. “Do you want large companies to be focused exclusively on housing finance, albeit prone to produce the result -- just like we’ve seen recently -- that when the housing market goes down, there will be blood?”

Falcon, now an industry consultant at Canonbury Advisors in Alexandria, Virginia, said a public-private hybrid doesn’t work. He has advised other nations to avoid following the Fannie and Freddie example in developing their secondary mortgage markets, he said.

“There are just too many inherent risks in following the U.S. model,” he said. “All that has been proven out.”

To contact the reporter on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net."

Brokering the bailout of Long-Term Capital Management in 1998 by invoking the specter of systemic collapse encouraged banks to ignore the risks

TO BE NOTED: From the WSJ:

"You Can't Rush a Recovery

While small business struggles, Goldman Sachs was protected from its AIG mistakes.

By AMAR BHIDé

The U.S. has already committed nearly $3 trillion to rescue the financial system and domestic auto makers, according to a recently released report by a special inspector general.

Treasury alone has announced plans to fork over more than $600 billion in TARP funds, and Treasury Secretary Timothy Geithner seems to announce a scheme a week to jump-start the economy. Unfortunately, just as vigorous thumping won't accelerate -- and can even disrupt -- the rebooting of a computer, unpredictable interventions and improvised initiatives jeopardize rather than hasten robust economic recoveries.

Sustainable recoveries cannot be rushed because individuals and firms can't instantly pick the best possible alternative. We can't immediately auction off our labor to the highest bidder, for instance. Rather we must devote time and effort to finding a suitable job. Once we find a position that satisfies us and learn to do it well, we are loath to leave.

But miscalculations may end presumptively permanent arrangements: We may be laid off from a job we thought was safe because our employer built a new plant to satisfy demand that did not materialize. Then we not only have to search for a new job but also unwind old arrangements -- negotiating severance or selling our home if we have to move to a new city.

Similarly, our employer has to figure out how best to downsize or redeploy excess capacity. And in a recession, searching for new arrangements and the unwinding of old ones -- and anxiety that our turn may be next -- is widespread.

Our government plays an important ameliorative role. Unemployment benefits stop major dislocations from creating the widespread hunger and homelessness experienced in the Great Depression. They also prevent the anxiety of more than 90% of the workforce that remains employed from turning into a panic.

Bankruptcy laws and courts facilitate the orderly unwinding of obligations that individuals and businesses can no longer meet or easily resolve through bilateral negotiations (as is often the case when a troubled business faces many creditors with different kinds of claims). A bankruptcy code that quickly salvages the greatest possible value from failure is crucial for our economic dynamism.

The Federal Deposit Insurance Corporation (FDIC) immediately assumes the liabilities of failed banks and then gradually disposes of their assets -- a process that has ended the bank runs that used to trigger depressions until the 1930s. But beyond amelioration and providing the judicial (or in the case of the FDIC, quasi-judicial) procedures for reorganization, there is little more that the government can do to accelerate the unwinding and renewal necessary to put the economy back on an even keel.

The process involves a sequence of negotiations and experiments that cannot be truncated by throwing in more resources. As Frederick Brooks wrote in his celebrated book on software development, "The Mythical Man-Month: Essays on Software Engineering": "When a task cannot be partitioned because of sequential constraints, the application of more effort has no effect on the schedule. The bearing of a child takes nine months, no matter how many women are assigned." "Brooks's Law" suggests that increasing the size of software teams may delay development.

The wide variety of problems and circumstances in an economic downturn precludes the effective use of a single solution. And the federal government doesn't have the capacity to determine adjustments on a case-by-case basis. The late Nobel Laureate Friedrich Hayek taught that the "man on the spot" with the appropriate local knowledge was much more capable of making good investment decisions than a central planner.

Similarly, the men and women who are closest to the situation have a huge advantage in unwinding the consequences of past miscalculations. The terms of a problem loan are best renegotiated by the borrower and the bank that made the loan. How to cut costs and excess capacity in the automobile industry is best figured out by management, the UAW, bondholders and creditors, under Chapter 11 if necessary.

Ad hoc interventions in the financial markets by the executive branch and Federal Reserve that override private renegotiations and judicial procedures have done serious, long-term harm. Brokering the bailout of Long-Term Capital Management in 1998 by invoking the specter of systemic collapse encouraged banks to ignore the risks of trading with overextended counterparties and laid the groundwork for our current debacle.

The folly was compounded by the bailouts of Bear Stearns and AIG. The bailouts also undermined vital public confidence in the fairness of our system. While small businesses struggle to recoup bills owed by failed customers, the likes of Goldman Sachs, which miscalculated the creditworthiness of AIG, were made whole -- and could thus pay bonuses amounting to many times the incomes of most taxpayers.

Former Treasury Secretary Henry Paulson's Super-SIVs and TARPs eroded rather than helped restore confidence by promoting the belief that things must be really awful for the government to suspend due process and operate in secrecy. The schemes also delayed the actual cleaning up of the balance sheets of large banks. It did so by insulating them from FDIC discipline, and by creating the expectation that the next taxpayer-funded initiative would offer even more cash for their trash.

Mr. Geithner, who was closely involved with the AIG bailout, offers no change we can believe in. His latest scheme is called the Public-Private Partnership Investment Program. But there is actually very little private skin in this game: It gives a handful of wealthy financiers huge nonrecourse loans to enable them to purchase toxic assets that the market supposedly won't buy at a "fair" price. As the housing crisis has shown, providing subsidized nonrecourse loans creates asset bubbles, not true price discovery. And bribing buyers to ramp up prices smacks of market manipulation.

Suppose that, when the financial crisis broke two years ago, our leaders had shown a Churchillian steadfastness and allowed the normal realignment to play out under a predictable judicial and regulatory regime. The prices of stocks, bank debt and houses would still have crumbled and unemployment risen. Although recovery wouldn't have been immediate, we'd at least have progress, instead of a sullen paralysis and futile efforts to turn the clock back.

More loans would have been renegotiated and foreclosed properties auctioned off. The FDIC would already be engaged in finding a good home for the loans and deposits of a megabank or two. That agency, now operating with about one-third the staff it had in the 1980s, could also have used some of the bailout money that helped pay for bonuses at AIG and its counterparties to recruit, train and retain more employees.

Best of all, more entrepreneurs and innovators, who capitalize on the opportunities to be found in the midst of turmoil, could have been building the foundations of a prosperous future.

Mr. Bhidé is a professor at Columbia Business School and author of "The Venturesome Economy" (Princeton University Press, 2008)."

but to scoop up secondary market dreck assets to game the public private investment partnership

From Naked Capitalism:

"Has the Gaming of the Public-Private Partnership Begun?

It certainly looks as if Citigroup and Bank of America are using TARP funds, not to lend, which was one of the primary goals of the program, but to scoop up secondary market dreck assets to game the public private investment partnership.

And it fleeces the taxpayer a second way: the public has spent enough money on both banks so that in an economic sense, they ought to have been nationalized. Yet for reasons that are largely ideological and cosmetic (the banks' debt would need to be consolidated were they owned 100% by Uncle Sam), they remain private. So not only are they seeking to extract far more than was intended even with the already generous subsidies embodied in this program, but this activity is also speculating with taxpayer money.

This sort of thing was predicted here and elsewhere. Welcome to yet more looting.

From the New York Post (hat tip reader Hendririx):

As Treasury Secretary Tim Geithner orchestrated a plan to help the nation's largest banks purge themselves of toxic mortgage assets, Citigroup and Bank of America have been aggressively scooping up those same securities in the secondary market, sources told The Post...

But the banks' purchase of so-called AAA-rated mortgage-backed securities, including some that use alt-A and option ARM as collateral, is raising eyebrows among even the most seasoned traders. Alt-A and option ARM loans have widely been seen as the next mortgage type to see increases in defaults.

One Wall Street trader told The Post that what's been most puzzling about the purchases is how aggressive both banks have been in their buying, sometimes paying higher prices than competing bidders are willing to pay.

Recently, securities rated AAA have changed hands for roughly 30 cents on the dollar, and most of the buyers have been hedge funds acting opportunistically on a bet that prices will rise over time. However, sources said Citi and BofA have trumped those bids.

The secondary market represents a key cog in the mortgage market, and serves as a platform where mortgage originators can offload mortgages in bulk that have been converted into bonds.

Yields on such securities can be as high as 22 percent, one trader noted.

BofA said its purchases of secondary-mortgage paper are part of its plans to breathe life back into the moribund securitization market....

While some observers concur that the buying helps revive a frozen market, others argue the banks are gambling away taxpayer funds instead of lending.

Moreover, the MBS market has been so volatile during the economic crisis that a number of investors who already bet a bottom had been reached have gotten whacked as things continued to slide.

Around this same time last year some of the same distressed mortgage paper that Citi and BofA are currently snapping up was trading around 50 cents on the dollar, only to plummet to their current levels.

One source said that the banks' purchases have helped to keep prices of these troubled securities higher than they would be otherwise.

Both banks have launched numerous measures to help stem mortgage foreclosures, and months ago outlined to the government their intention to invest in the secondary market to expand the flow of credit."

Me:

Don said...

I hate to tell everybody this, but we own a large part of Citi, for example. We expect them to make us lots of money. We are shareholders. We want them to make lots of money. If they don't try, they'll be sued, by us.

That's what happened in TARP. It was a hybrid plan. Citi and the government don't have the same interests. On the one hand, we've given Citi a social purpose goal for the money ( namely, lend at all costs ), while, on the other hand, as shareholders, we simply expect them to make us money, and forget about social goals. Which is it?

Don the libertarian Democrat

March 26, 2009 1:55 AM

Dear God, the Administration really thinks the public is full of idiots.

From Naked Capitalism:

"Private Public Partnership Details Emerging

The New York Times seems to have the inside skinny on the emerging private public partnership abortion program. And it appears to be consistent with (low) expectations: a lot of bells and whistles to finesse the fact that the government will wind up paying well above market for crappy paper.

Key points:

The three-pronged approach is perhaps the most central component of President Obama’s plan to rescue the nation’s banking system from the money-losing assets weighing down bank balance sheets, crippling their ability to make new loans and deepening the recession....

The plan to be announced next week involves three separate approaches. In one, the Federal Deposit Insurance Corporation will set up special-purpose investment partnerships and lend about 85 percent of the money that those partnerships will need to buy up troubled assets that banks want to sell.

Yves here. If the money committed to this program is less than the book value of the assets the banks want to unload (or the banks are worried about that possibility), the banks have an incentive to try to ditch their worst dreck first.

In addition, it has been said in comments more than once that the banks own some paper that is truly worthless. This program won't solve that problem. Back to the piece:

In the second, the Treasury will hire four or five investment management firms, matching the private money that each of the firms puts up on a dollar-for-dollar basis with government money.

Yves here. Hiring asset managers to do what? Some investors get 85% support (more as is revealed later), others get dollar for dollar? This makes no sense unless very different roles are envisaged (but how will the price for assets given to the asset managers be determined? Or are these for the off balance sheet entities that should be but are still not yet consolidated, like the trillion dollar problem hanging around at Citi?) Back to the article:

In the third piece, the Treasury plans to expand lending through the Term Asset-Backed Secure Lending Facility, a joint venture with the Federal Reserve.

Yves again. While the first TALF deal got off well, Tyler Durden points out its capacity is 2.7 times pre-credit mania annual issuance levels, which means the $1 trillion considerably overstates its near term impact. And credit demand by all accounts is far from robust. Cheap credit is not enticing in an environment of weak to falling asset prices and job uncertainty. To the Times again:

Although the details of the F.D.I.C. part were still being completed on Friday, it is expected that the government will provide the overwhelming bulk of the money — possibly more than 95 percent — through loans or direct investments of taxpayer money.

The hope is that such a generous taxpayer subsidy will attract private investors into the market and accelerate the recovery of the country’s banks.

The key protection for taxpayers, according to people briefed on the plan, is that the private investors will bid in auctions against each other for the assets. As a result, administration officials contend, the government will be buying the troubled loans of the banks at a deep discount to their original face value.

Because the government can hold those mortgages as long as it wants, officials are betting the government will be repaid and that taxpayers may even earn a profit if the market value of the loans climbs in the years to come.

To entice private investors like hedge funds and private equity firms to take part, the F.D.I.C. will provide nonrecourse loans — that is, loans that are secured only by the value of the mortgage assets being bought — worth up to 85 percent of the value of a portfolio of troubled assets.

The remaining 15 percent will come from the government and the private investors. The Treasury would put up as much as 80 percent of that, while private investors would put up as little as 20 percent of the money, according to industry officials. Private investors, then, would be contributing as little as 3 percent of the equity, and the government as much as 97 percent.

Yves here, If this isn't Newspeak, I don't know what is. Since when is someone who puts 3% of total funds and gets 20% of the equity a "partner"?

And notice the hint of skepticism from the Times regarding the Administration's supposition that the bidding will result in fair prices. Huh? First, the banks, as in normal auctions, will presumably set a reserve price equal to the value of the assets on their books. If the price does not meet the reserve (and the level of the reserve is not disclosed to the bidders), there is no sale; in this case, the bank would keep the toxic instruments.

Having the banks realize a price at least equal to the value they hold it at on their books is a boundary condition. If the banks sell the assets as a lower level, it will result in a loss, which is a direct hit to equity. The whole point of this exercise is to get rid of the bad paper without further impairing the banks.

So presumably, the point of a competitive process (assuming enough parties show up to produce that result at any particular auction) is to elicit a high enough price that it might reach the bank's reserve, which would be the value on the bank's books now.

And notice the utter dishonesty: a competitive bidding process will protect taxpayers. Huh? A competitive bidding process will elicit a higher price which is BAD for taxpayers!

Dear God, the Administration really thinks the public is full of idiots. But there are so many components to the program, and a lot of moving parts in each, they no doubt expect everyone's eyes to glaze over.

Later in the article, there is language that intimates that the banks will put up assets and take what they get. However, the failure to mention a reserve (a standard feature in auctions) does not mean one does not exist. Or the alternative may be, since bidding will almost certainly be anonymous, is to let the banks submit a bid, which would serve as a reserve. That is the common procedure. when at foreclosure auctions, the bank puts in a bid equal to the mortgage value (so either a foreclosure buyer takes the bank out or the bank winds up owning the property).

Regardless, the equity comes from TARP, and Elizabeth Warren of the Congressional Oversight Panel is no slouch. What will happen when she asks for reports of how the actions have gone (for instance, how many failed because the reserve was not met?) The mechanics will become more apparent to the public over time and may yet come back to haunt Team Obama.

More on this topic (What's this?)

Two Largest Corporate Credit Unions Seized (Option ARMageddon, 3/20/09)

FDIC Closes Three More Banks (Zero Hedge, 3/20/09)

$1 Trillion "Run On Britain" Disclosed (Zero Hedge, 3/9/09)

Read more on Banking at Wikinvest

Posted by Yves Smith at 2:25 AM"

Me:

Don said...

Paul Krugman says this:

"Why was I so quick to condemn the Geithner plan? Because it’s not new; it’s just another version of an idea that keeps coming up and keeps being refuted. It’s basically a thinly disguised version of the same plan Henry Paulson announced way back in September. To understand the issue, let me offer some background."

Here's the first I remember about this plan. It's William Gross in the WaPo on Sept. 27th:

"And so, instead of mild medication and rest, it became apparent that quadruple bypass surgery is necessary. The extreme measures are extended government guarantees and the formation of an RTC-like holding company housed within the Treasury. Critics call this a bailout of Wall Street; in fact, it is anything but. I estimate the average price of distressed mortgages that pass from "troubled financial institutions" to the Treasury at auction will be 65 cents on the dollar, representing a loss of one-third of the original purchase price to the seller, and a prospective yield of 10 to 15 percent to the Treasury. Financed at 3 to 4 percent via the sale of Treasury bonds, the Treasury will therefore be in a position to earn a positive carry or yield spread of at least 7 to 8 percent. Calls for appropriate oversight of this auction process are more than justified. There are disinterested firms, some not even based on Wall Street, with the expertise to evaluate these complicated pools of mortgages and other assets to assure taxpayers that their money is being wisely invested. My estimate of double-digit returns assumes lengthy ownership of the assets and is in turn dependent on the level of home foreclosures, but this program is, in fact, directed to prevent just that.

In effect, the Treasury will have the fate of the American taxpayer in its hands. The Resolution Trust Corp., created in the late 1980s to deal with the savings and loan crisis, dealt with previously purchased real estate, which was flushed into government hands with a "best efforts" future liquidation. Today, the purchase of junk mortgages, securitized credit card receivables and even student loans will be bought at prices significantly below "par" or cost, and prospectively at levels allowing for capital gains. This is a Wall Street-friendly package only to the extent that it frees up funds for future loans and economic growth. Politicians afraid of parallels to legislation that enabled the Iraq war are raising concerns about a rush to judgment, but the need for speed is clear. In this case, there really are weapons of mass destruction -- financial derivatives -- that threaten to destroy our system from within. Move quickly, Washington, with appropriate safeguards.

The Treasury proposal will not be a bailout of Wall Street but a rescue of Main Street, as lending capacity and confidence is restored to our banks and the delicate balance between production and finance is given a chance to work its magic. Democratic Party earmarks mandating forbearance on home mortgage foreclosures will be critical as well. If this program is successful, however, it is obvious that the free market and Wild West capitalism of recent decades will be forever changed. Future economic textbooks are likely to teach that while capitalism is the most dynamic and productive system ever conceived, it is most efficient over the long term when there is another delicate balance -- between private incentive and government oversight."

Interestingly, even the price of the TAs is the same. The overall plan is to have someone buy the TAs at a discount, borrow cheaply from the government, and sell the TAs down the line for a profit.

There were various schemes offered for the government to do this. Why didn't anything come of them? This is harsh, but I believe it's because there's a widespread belief that the government is either incompetent or a sucker, and would vastly overpay for these TAs no matter the plan. Every other reason boils down to this in my view.

I suggested that the only way for the government to do this was to lie, hire Gross and John Paulson secretly, and have them buy up the TAs under their own names for the government. Needless to say, this is not politically feasible.

So, in my view, the government is meant to be played in many investor's minds, and history has reinforced that view to them. That's why the Swedish Plan was the only way to go. The government needed to show that it would be ruthless in protecting the taxpayer's interests in winding down this crisis. Once this ruthlessness was not shown, we were bound to end up in a mess, with hybrids in which the government and investors danced a costly tango.

In theory, some of these TAs could be profitably purchased. But no one really believes that the government would make the hard choices necessary to do this. We're paying more precisely because the market expects us to.

Don the libertarian Democrat

By the way, thanks to Yves for allowing us to post our thoughts, giving it our best shot. Krugman's blog rejects many comments.

March 21, 2009 2:15 PM

"this is a systemic crisis to be solved through hands-on remedies such as the partial nationalisation of the sector. "

From the FT:

"On Wall St: The battle to save the banks

By Francesco Guerrera

Published: January 23 2009 17:31 | Last updated: January 23 2009 17:31

“You can’t win them all”.

The much-abused phrase has long been a safe haven for losers. Defeated politicians, beaten sportspeople and fired chief executives have all found solace in its convenient blend of fatalism and statistical truth.

I always preferred the adage’s flip, sunnier, side: the reassuring concept that you can’t lose them all either.

But the US government’s response to the financial crisis is challenging that belief. Far too many of the actions taken by the authorities in aid of the financial system have run into trouble( TRUE ).

From the collapse of Lehman Brothers and the nationalisation of AIG, Fannie Mae and Freddie Mac, to the double-dip bail-outs of Citigroup and Bank of America/Merrill Lynch, Washington’s decisions have had an uncanny knack for backfiring.( YES )

The result is that we are still grappling with the same problems as when the crisis started 18 months ago: frozen capital markets, financial institutions in poor health and banks’ unwillingness to help the economy with new loans.( YES )

The fact that the latest “cure” – the creation of a “bad bank” to buy toxic assets – looks suspiciously like the “super-SIV” that bombed in November 2007 is testament to the lack of a cogent plan. ( IT'S CRAP )

Before quick-witted readers wheel out cliches about hindsight, 20/20 vision and, for the US contingent, “Monday morning quarterbacking”, I will let bygones be bygones.

Former Treasury Secretary Hank Paulson, the hitherto New York Federal Reserve president Tim Geithner, now ensconced at Treasury, and Fed chairman Ben Bernarke had to take rapid decisions during a once-in-a-generation turmoil.

They did their best in incredibly challenging circumstances( TRUE ). But it was not good enough, at least judging by the devastated share prices, battered balance sheets and broke consumers that currently make up the “financial landscape” of the world’s largest economy.( I AGREE )

As the Obama administration takes charge, it should learn from past mishaps.

Here is my personal, hindsight-enhanced list.

1) If you can’t stand the heat get out of the kitchen. The government’s decision to buy stakes in dozens of banks without demanding board seats and management influence has been counter-productive. It blurred the lines of accountability and left taxpayers and share- holders in doubt as to who runs the companies.( THIS IS CALLED A HYBRID. IT'S ESSENCE IS TO BE MESSY AND COSTLY. )

2) No strings attached is not cool. Without a formal requirement to report to the government, banks have all but ignored pleas to lend more. Instead, they used the federal money for a variety of self-serving purposes, ranging from buying their own debt to boost profits (Morgan Stanley) to paying billions of dollars in bonuses (Merrill Lynch).( A HYBRID )

3) Bigger is not always better. True to his past as a Goldman Sachs banker, Mr Paulson took a deal-making approach to saving troubled institutions. A flurry of takeovers (JPMorgan/Bear Stearns, BofA/Merrill, Wells Fargo/Wachovia) ensued. The result was much larger banks with an even higher concentration of risk. Wouldn’t a break-up of some institutions into more easily digestible pieces, have been worth a try?( YES )

4) Inconsistency is not a virtue( IT'S A CURSE ). Each ailing institution got a bespoke bail-out and share- holders and debtholders received widely- diverging treatments. In some cases, chief executives of bailed-out companies were fired (AIG, Fannie), but spared in others (Citi, BofA).

The confusion has unnerved investors and prompted them to hammer companies’ share and debt at the first signs of trouble. But perhaps the biggest flaw in the authorities’ response to the crisis has been the refusal to treat the problems as system-wide.( I AGREE. BAGEHOT. )

Their preference for ad-hoc measures, their hope that one more deal would do the trick of restoring confidence to the markets, had the opposite effect. As Bear Stearns snowballed into Lehman, AIG, Merrill and Citi, investors came to abhor piecemeal solutions.(THEY WANT AND EXPECT A TOTAL GUARANTEE. HOW HARD IS THIS? )

The Obama era should begin with the admission that this is a systemic crisis to be solved through hands-on remedies such as the partial nationalisation of the sector.( HEAR HEAR )

The authorities were never going to win all the battles during such a drawn-out campaign but they should ensure they do not lose the remaining ones.( VERY GOOD POST )

francesco.guerrera@ft.com"

Of course, it isn't going to be easy no matter what we do.

"Firms That Got Bailout Money Keep Lobbying "

Just as I've been saying, from the NY Times:

"Firms That Got Bailout Money Keep Lobbying

By DAVID D. KIRKPATRICK and CHARLIE SAVAGE

WASHINGTON — The financial giant Bank of America says it is no longer lobbying the federal government about its unfolding bank bailout. After receiving $45 billion in bailout money, lobbying was just too unseemly.

“We are very sensitive to the fact that we have taxpayer money,” said Shirley Norton, a spokeswoman for the company.

Citigroup, recipient of another $45 billion, made the opposite call. While trying to keep a low profile, the company is still fielding an army of Washington lobbyists working on a host of issues, including the bailout. In the fourth quarter, it spent $1.77 million on lobbying fees, according to its lobbyists’ filings. ( YES )

The different approaches from the two banks that have received the most money underscores the growing quandary facing private companies, which increasingly deal with the federal government not only as rule-maker but also as shareholder, lender and trading partner.

Pressing federal policy makers risks the appearance of recycling public money to advance a private agenda, while staying on the sidelines could put a company at a comparative disadvantage.( A HYBRID DILEMMA )

Citigroup and Bank of America are hardly the only two financial firms to confront the issue. During the last three months of 2008, at least seven other firms receiving bailout funds — American Express, Capital One, Goldman Sachs, KeyCorp, Morgan Stanley, PNC and Bank of New York Mellon — all lobbied the government about the bailout, according to a review of their most recent disclosure reports. ( GEE )

The automakers that received billions under the same program lobbied as well( WOW. WHO KNEW? ): including General Motors; its financing arm, GMAC; and Cerberus Capital Management, the private equity firm that controls Chrysler. Other recipients of federal financing also lobbied Congress, the Treasury or both about other matters.( WHAT A SURPRISE )

The American International Group, taken over by the government during an injection of more than $40 billion last fall to prevent the company’s collapse, has discontinued all its federal lobbying; it is now in effect government-owned. But its former executives continue to lobby.( YEP )

Its former chief executive, Maurice R. Greenberg, ousted a few years ago amid allegations of securities fraud, is leading a group of shareholders lobbying for a chance to renegotiate the terms of the government takeover or buy back a bigger stake in the company.

According to a recent filing, A.I.G. shareholders paid $90,000 in the fourth quarter to a lobbying team at Ogilvy Government Relations that includes the Republican lobbying powerhouse Wayne L. Berman, a former assistant secretary of commerce under the first President George Bush and a major fund-raiser for the second.

The group also includes three Democrats who had been top aides to the House speaker, Nancy Pelosi; Senator Edward M. Kennedy; and the former House majority leader, Richard A. Gephardt. (Mickey Kantor, secretary of commerce under President Bill Clinton, has advised the group as a lawyer as well.)

Lawmakers, troubled by the prospect of taxpayer-subsidized influence-peddling, are threatening to crack down. Senator Dianne Feinstein, a California Democrat, and Senator Olympia J. Snowe, a Maine Republican, are pushing legislation that would explicitly bar companies from using bailout funds for lobbying or campaign contributions. ( YOU THINK? )

Although hard to enforce, the measure would put banks on notice that aggressive lobbying could set off a negative reaction from Congress.( NOT LIKELY )

“That taxpayer dollars intended to stabilize the economy could find their way into the bank accounts of lobbying firms” is “completely unacceptable,” Ms. Feinstein said in a speech supporting the measure.

On Friday, President Obama issued his own call for more oversight and transparency, citing “companies that have received taxpayer assistance then going out and renovating bathrooms or offices, or in other ways not managing those dollars appropriately.” This was an apparent allusion to reports of office renovations by the former chief executive at Merrill Lynch, a recent acquisition by Bank of America whose heavy losses led to an expanded bailout for the bank.

Bankers, though, defend their right to a voice in public policy debates about the industry’s future. “Nobody mentioned that you are giving up your Constitutional right to petition the government” when accepting federal money, said Edward L. Yingling, president of the American Bankers Association.( HE'S GOT A POINT )

He acknowledged, however, that Citigroup and Bank of America were in a more ambiguous position than the rest of the roughly 200 banks that accepted money from the Treasury and agreed to pay it interest as part of the bailout program. While most banks are required to demonstrate financial health to qualify for the deal, the two giants received $90 billion in emergency measures to prop them up and agreed to give the government a larger say in management.

The two banking behemoths had entered a “middle ground( THEY'RE ALL HYBRIDS. THIS IS BS ),” Mr. Yingling said, between the other private banks accepting federal investments and the three financial firms under full federal control: A.I.G. and the failed mortgage giants Fannie Mae and Freddie Mac. “I would expect that institutions in that middle ground would be well aware that they need to be careful about the tone and manner in which they lobby,” he said.

Citigroup and Bank of America say internal policies prohibit the use of any bailout money for lobbying. Neither, however, has stopped pressing its interests in Washington, albeit more quietly. ( YES )

Though Bank of America says it has stopped lobbying about the bailout legislation — the Troubled Asset Relief Program, or TARP — it continues to lobby on other matters. The bank spent about $1 million on federal lobbying in last year’s fourth quarter, including $820,000 for its own lobbyists, according to filings.

Ms. Norton, the spokeswoman, declined to comment on whether Bank of America was lobbying on other financial crisis proposals, such as creation of a government-controlled “bad bank”( I SAID THAT THIS WOULD HAPPEN ) to take over toxic securities.( WHY NOT? )

Nicholas Calio, Citigroup’s top lobbyist, handled Congressional relations for both the first and second President George Bush. Its team of outside lobbyists has also included a former Congressional liaison for President Clinton, a former chairman of the Federal Deposit Insurance Corporation, a former deputy assistant Treasury secretary and the veteran Democratic strategist Steve Elmendorf.

The two banks’ problem is an increasing one for the industry, said Scott Talbott, top lobbyist for the Financial Services Roundtable. “There is a TARP blowback problem,” he said. "

This was all predictable. I predicted it in the beginning of October. This is our system. This is what happens with a Hybrid Plan, and why Nationalization, while not perfect, is preferable to Hybrid Plans like TARP or a Bad Bank.

But I’ll just echo Kevin Drum’s words on nationalization: “No stampedes, please.”

James Surowiecki is trying to make it real compared to what?:

"Nationalization Will Not Be Easy( HAS HE ACTUALLY LOOKED AT THE COMPLEXITY OF THE BAD BANK? NO ONE HAS EVEN ADVANCED ONE IDEA ON HOW TO VALUE THE TOXIC ASSETS YET. )

Like Kevin Drum, I think that as the “nationalize now” meme has taken hold in the blogosphere, people are talking about nationalization “awfully casually( FOR FOUR MONTHS. ).” One way this manifests itself is in the argument that the only reason people are skeptical of nationalization is because it’s “un-American,” when, in fact, I think people are skeptical of it for two big reasons:

1) Two years of financial crisis does not invalidate the general principle that private enterprise is typically better at efficiently allocating resources than government( SO WHAT? NOR DID IT VALIDATE THE IDEA THAT PRIVATE ENTERPRISE IS INFALLIBLE. ); and

2) the idea of the state literally determining which companies and individuals do or don’t get credit is( WHAT WAS TARP? A LOTTERY ? ), even to a non-libertarian, at least a little troubling.

The other way the pro-nationalization forces are making their case casually, I think, is that they’re not just skipping over the details of how the process would work (and the devil here really is in the details)( AND THE BAD BANK PEOPLE AREN'T ? PLEASE. ), but they’re also downplaying the magnitude of what they’re advocating, and of how long it’s likely to last( JUST THE OPPOSITE IS THE CASE. THE PEOPLE ADVOCATING THE HYBRID PLANS ARE DOWNPLAYING HOW LONG THESE PLANS ALWAYS LAST. ). In Paul Krugman’s Op-Ed on Monday, for instance, he suggested that nationalization would be like what the Resolution Trust Corporation did with the savings and loans at the end of the nineteen-eighties: seizing the banks, hiving off their bad assets, paying off debts to make them solvent, and then selling the banks to new owners. But when you nationalize the entire banking system( WHO'S ADVOCATING THIS? ), who, exactly, are these “new owners” who are buying the cleaned-up banks supposed to be? And what investor is going to be interested in putting up money to acquire a bank that has to compete with nationalized, and therefore subsidized( HOW? ), banks (since the government presumably won’t be able to privatize all at once). Krugman also adds that any government takeover will be “temporary.” But does that mean eighteen months, or does it mean a decade( THE SAME QUESTION APPLIES TO THE BAD BANK IDEA. )?

The one person who’s really acknowledged the consequences of nationalizing the banks is the economist John Quiggin, who writes:

Once the big banks are nationalized, the government can take its time( AS OPPOSED TO A FIRE SALE THAT WILL DEFINITELY COST THE TAXPAYERS A BUNDLE. ) salvaging whatever assets are still worthwhile and preparing for the reconstruction of a private banking system under a completely new system of regulation, a task that is likely to take several years( THE SAME FOR THE ALTERNATIVE PLANS. ).

Now, Quiggin’s a Social Democrat( POISONING THE WELL ), so this prospect is not a problem for him. But to me, the idea that most of Barack Obama’s Presidency will be spent presiding over a government-run banking system is a daunting thought( THEN KEEP THE HYBRID. ). To be sure, none of these objections are insurmountable( THEY'RE NOT EVEN DISTINGUISHABLE FROM OBJECTIONS TO THE OTHER PLANS. ), and of course the myriad programs the Fed has embarked on to jumpstart the credit markets mean that the government is already intimately involved in controlling the flow of credit( YOU NOTICED. ). And the original idea behind the TARP—which I, unlike just about everyone else in the blogosphere, thought then, and still think, was a good idea when combined with capital injections—has its own set of problems( CAN YOU GIVE ONE REALISTIC IDEA ABOUT HOW TO VALUE THE TOXIC ASSETS? ). But I’ll just echo Kevin Drum’s words on nationalization: “No stampedes, please.”( SURE. LET'S SQUANDER BILLIONS MORE BECAUSE YOU CAN'T SEE THE FOREST FOR THE TREES. GOOD WORK.)

It is true the Swedish model is not a pain-free panacea. It would just mean the beginning of an orderly workout

From the FT:

"Insight: Swedish model for western banks

By Christopher Wood

Published: January 19 2009 16:28 | Last updated: January 19 2009 16:28

As newspaper headlines are full of stories about more forced capital injections by governments into leading American and British banks, it has surely become time to end the present ad hoc( I AGREE ) approach to the intensifying banking crisis.

In the US and Britain most of the big banks have now become a weird hybrid( A HYBRID. YES. ) of public and private sector, given growing government equity stakes in these banks. This raises the issue of the deeply flawed policy response to the crisis. This is that if the authorities are not prepared to let insolvent financial institutions go bust, which would be the quickest, most effective way to correct excesses, as the Lehman precedent demonstrates, the next best way is to nationalise the, in effect bust, banks outright( I AGREE ). This remains the opposite of what is happening in the US and the other country most vulnerable to an imploding financial services sector, namely Britain. Rather, what is happening is nationalisation by stealth( TRUE ).

This approach reached its ludicrous extreme( I AGREE ) in the November bail-out of Citigroup, where the US government put more money in than the entire market capitalisation of the company on the day the deal was announced. But the taxpayer ended up with only a 7.8 per cent equity stake while incumbent management was left in place! Yet now, just two months later, still more taxpayer money looks as if it is about to be poured into Citigroup, while a similar sweetheart deal has been done with Bank of America( ALL TRUE ).

This approach is a recipe for gross conflicts of interest( AS I'VE SAID ). It means the institutions receiving taxpayer money are encouraged to continue to avoid ultimately necessary writedowns because of the hope( I'VE BEEN SAYING THIS ) of yet more bail-outs( TRUE ). Yet the reality is that there is an established template for what to do in banking crises if governments remain determined, as they do, not to allow bank failures. That is the Swedish model of the early 1990s( YES ).

Under this model banks were nationalised, fully aligning the interests of the institution with that of the taxpayer, while the depositor was fully protected. In the process shareholders were in effect wiped out, as they should be, and incumbent management was replaced, as it should be( I AGREE ). This left none of the massive conflicts of interest, as well as perverse unintended consequences, caused by the present anomalous situation in the west where too many banks are being rewarded for failure – leading, incidentally, to a massive competitive disadvantage for those banks that managed their affairs more prudently( I AGREE ).

A crucial principle of the Swedish model is that banks were forced to write down their assets to market and take the hit to their equity before the recapitalisation began. This is of course precisely what has not happened in either the US or Britain, where too many policy measures seek to delay asset price clearing and only add public sector debt on top of existing private sector debt. This is why the current approach in the west to the banking crisis can be compared more accurately with Japanese policy in the 1990s, and that clearly did not work. The outcome, as then, is increasingly zombie-like banks.

The ultimate endgame in countries such as the US and Britain is still likely to be full-scale nationalisation of most of the banking system, as the logic of such action finally becomes overwhelming. But it would be much better if this were done proactively rather than reactively, since it would accelerate resolution of the financial crisis( YES ). This is why nationalising the banks would also be bullish for stock markets, if not for the specific bank stocks themselves ( I AGREE )– although, obviously, there are powerful vested interests wanting to prevent such an ultimate course of action( THE BANKING LOBBY ).

Another point about nationalisation, as in the Swedish model, is that it allows the government to separate the bad assets from banks’ balance sheets and place them in one big “bad bank”. This should enable whatever is left of the smaller “good” bank, which should be managed by old-fashioned commercial bankers, to become a viable private sector operator again more quickly. Another more technical, albeit important, point is that, given that many of the bad assets in this cycle will be derivative- related in some form or other, where two nationalised banks have been counterparties to the same transaction the derivative deal could be in effect terminated or cancelled because the government would be the owner of both entities. In this respect the limited number of counterparties in the $55,000bn* credit default swap market could suddenly become a positive and not, as now, a systemic negative( YES ).

It is true the Swedish model is not a pain-free panacea( TRUE ). It would just mean the beginning of an orderly workout( TRUE ). Unfortunately, the deflationary pain is inevitable because of the scale of the credit boom of recent years, the excesses of which were ignored for so long by the relevant central bankers.( I STILL CLAIM THAT PEOPLE WHO WANT THE GOVERNMENT OUT OF BANKING SOONER RATHER THAN LATER SHOULD WANT THIS PLAN. )

Christopher Wood, equity strategist for CLSA Ltd, in Hong Kong, is the author of “The Bubble Economy” (first published by Atlantic Monthly Press, 1992)."