"the banks being forced to sell assets that could raise capital and provide some tax relief to taxpayers"

From the FT:

"America’s banks need to hold a yard sale( I THINK THAT SHE MEANS A FIRE SALE )

By Meredith Whitney

Published: January 21 2009 19:33 | Last updated: January 21 2009 19:33

A clear lesson learnt from this credit crisis has been to sell and sell early. However, it appears as if US banks are setting out to make some of the same mistakes of the past 18 months all over again. In many instances, those mistakes determined who survived and who did not.

Throughout 2007 and 2008, when I asked managements why they were not more aggressive in disposing of assets, the common answer I received was that they believed current prices were too distressed and did not reflect the true underlying value. Unfor­tunately, the longer they waited, the less these assets were in fact worth( THEN THEY WERE CORRECT.). Such a strategy cost Merrill Lynch and Citigroup more than half of their per share capital. In the case of Lehman Brothers and Bear Stearns, capital all but vaporised. These are just some examples but in reality this applies to too many financial institutions."

Throughout 2008, hundreds of billions of dollars were raised to recapitalise US financial institutions, but this money simply went to plug holes( PAY CALLINGS ) created by holding on to assets with declining values. Until the fourth quarter, monies were raised from willing investors. However, beginning in the fourth quarter with troubled asset relief programme capital created to recapitalise these institutions, US taxpayers became the default investors.

Now, when the average taxpayer finds him or herself overextended, he or she is forced to backtrack and, in situations of duress, sell stuff (otherwise known as a yard sale). In these cases, selling a set of snow skis for $15 or a prized record collection for $10 is not desirable but is necessary. Why should the US taxpayer be forced to fund behaviour that he or she would never have the luxury of indulging in?

Citigroup provides a prime illustration to support this argument. Last Friday, Vikram Pandit, Citigroup’s chief executive, stated: “We are not in a rush to sell assets( WE ARE WAITING FOR THE GOVERNMENT TO BUY THIS CRAP AT INFLATED PRICES. ).” This comes from a company that has incurred more than $51bn (€39bn, £36bn) in writedowns and has called upon more than $45bn in Tarp money from the taxpayer. At a minimum, this seems like a company currently operating under a different rule book from that used by taxpayers.

What is more, taxpayer dollars will have increasing demands on them. Thirty eight states are underfunded: already California and Arizona have begged for more than $10bn in federal dollars, while at least 36 more states have shortfalls in their 2009 budgets totalling more than $30bn. I believe they will be forced to sell assets such as toll roads and airports( FINE ). It is worth noting that the US is well behind the rest of the world in terms of private ownership of such assets.

The fact is that there is money on the sidelines looking for opportunities to invest( I AGREE ). One constant question I get from investors, who need somewhere to put their money, is: if I had to own something, what would it be? I am not very helpful to them at the moment as my answer is that I would own nothing. I do tell them that I believe that later in the year there will be fabulous opportunities to invest in new combinations of businesses that are currently “off the menu” to individuals. What I mean by this is that the system will eventually force disposals of assets: here I am just arguing that we need to get to it sooner rather than later.( I AGREE )

Funding is the critical challenge to outsiders’ ability to bid more aggressively for assets. Many of these potential investors have clean balance sheets and, if provided with the appropriate funding concession (guarantees( NB ) of long-term, low-cost capital from the government), could also more ably lubricate( USE A DIFFERENT WORD, PLEASE. ) the financial system by making actual loans. These investors could be private-equity firms or existing public companies. The key here is government providing a funding concession and the banks being forced to sell assets that could raise capital( END THE CALLING RUN ) and provide some tax relief to taxpayers.

No one doubts that losses will go higher, so asset sales are certain to be heavily discounted just as initial bids for collateralised debt obligations and retail mortgage-backed securities were. However, in retrospect, those “discounts” were far less than the write­downs companies took just months later. While it is never pleasant to sell one’s “crown jewels”( I WOULDN'T KNOW ), the strain of this credit crisis and the overextension of many bank balance sheets will require that they sell what they can and perhaps not what they would like. After all, that is what the average taxpayer would be forced to do."

I don't believe that they have it in them.

"The introduction of a significant buyer will result, not in price discovery, but in price distortion."

From the FT, George Soros:

"The right and wrong way to bail out the banks

ByGeorge Soros

Published: January 22 2009 20:06 | Last updated: January 22 2009 20:06

According to reports in Washington, the Obama administration may be close to devoting as much as $100bn of the second tranche of the troubled asset relief programme funds to creating an “aggregator bank” that would remove toxic securities from the balance sheets of banks. The plan would be to leverage this amount up 10-fold, using the Federal Reserve’s balance sheet, so that the banking system could be relieved of up to $1,000bn (€770bn, £726bn) worth of bad assets.

Although the details have not yet been decided, this approach harks back to the approach originally taken – but eventually abandoned – by Hank Paulson, the former US Treasury secretary. The proposal suffers from the same shortcomings: the toxic securities are, by definition, hard to value( TRUE ). The introduction of a significant buyer will result, not in price discovery, but in price distortion( THE PRICE WILL GO UP CONSIDERABLY ).

Moreover, the securities are not homogeneous, which means that even an auction process would leave the aggregator bank with inferior assets through adverse selection ( YES. BETTER INVESTORS WILL GET THE BEST DEALS. ). Even with artificially inflated prices, most banks could not afford to mark their remaining portfolios to market so they would have to be given some additional relief. The most likely solution is to “ring-fence” their portfolios, with the Federal Reserve absorbing losses that extend beyond certain limits.( YES )

These measures – if enacted – would provide artificial life support for the banks at considerable expense to the taxpayer, but would not put the banks in a position to resume lending at competitive rates. The banks would need fat margins and steep yield curves for a long time to rebuild their equity.( YES )

In my view, an equity injection scheme based on realistic valuations, followed by a cut in minimum capital requirements for banks, would be much more effective in restarting the economy. The downside is that it would require significantly more than $1,000bn of new capital. It would involve a good bank/bad bank solution, where appropriate. That would heavily dilute existing shareholders and risk putting the majority of bank equity into government hands.

The hard choice facing the Obama administration is between partially nationalising the banks, or leaving them in private hands but nationalising their toxic assets( I WOULD JUST NATIONALIZE ). Choosing the first course would inflict great pain on a broad segment of the population – not only on bank shareholders but also on the beneficiaries of pension funds. However, it would clear the air and restart the economy.( THIS IS THE BETTER OF HIS TWO CHOICES. )

The latter course would avoid recognising and coming to terms with the painful economic realities, but it would put the banking system into the same quandary that proved the undoing of the government sponsored enterprises (GSEs) – Fannie Mae and Freddie Mac. The public interest would dictate that the banks should resume lending on attractive terms. However, this lending would have to be enforced by government diktat because the self-interest of the banks would lead them to focus on preserving and rebuilding their own equity.

Political realities are pushing the Obama administration towards the latter course. It cannot go to Congress and ask for the authorisation to spend an additional $1,000bn on recapitalising the banks because Mr Paulson has poisoned the well in the way he demanded and then spent the money for Tarp. Even the second tranche of Tarp – the remaining $350bn – could only be pried loose by a congressional manoeuvre. That is what is leading the Obama administration to contemplate reserving up to $100bn of that tranche for the “aggregator bank” solution.

The stock market is pressing for an early decision by putting pressure on financial stocks. But the new team should avoid repeating the mistakes of the previous one and announcing a programme before it has been thoroughly thought out. The choice between the two courses is momentous; once made, it will become irreversible. It should be based on a careful evaluation of the alternatives.

President Barack Obama can fulfil his promise of a bold new approach only by establishing a discontinuity with the previous team. Congress and the public are right in feeling that too much has been done for the banks and not enough for beleaguered householders. The government ought to take the GSEs out of limbo and use them more actively to stabilise the housing market. Having done so, it could go back to Congress for authorisation to recapitalise the banking system the right way.

The writer is chairman of Soros Fund Management"

I agree with him about purchasing Toxic Assets, but leaving a hybrid arrangement in place is a recipe for a real disaster, although not as bad a disaster as doing nothing.

"Things may be bad, but I don’t think we are going back there. "

John Plender with a good post in the FT:

"Insight: Opportunities for cheer in this time of adversity

By John Plender

Published: December 23 2008 16:06 | Last updated: December 23 2008 16:06

In a spirit of seasonal goodwill, this column will attempt to cheer shell-shocked investors with a little optimism.

Quixotic, I grant you, after a year in which the lights went out all across the global financial system. But worth a try, even if the caveats have to be set out first.

There is no escape from the fact that the global economy in 2009 will be truly awful. Worse, with surplus( SAVER ) countries such as Japan, Germany and China showing no sign of contributing to a solution to global imbalances( THEY WANT TO KEEP THE CURRENT SYSTEM, AS MUCH AS POSSIBLE ), subtrend growth is on the cards for some years after the recession comes to an end( NO WAY OF KNOWING THAT ).

The return of the state as an important actor in the economies of the developed countries takes us into a far from brave new world in terms of animal spirits( WE'LL GET THEM BACK ).

Capitalism will be( SLIGHTLY ) more heavily regulated( TRUE ) and less entrepreneurial( FALSE ). As for the financial system, a further round of bank recapitalisations will be needed( MAYBE ) and the problem of pricing toxic paper remains unresolved( IT WILL BE SOLVED SOON ).

Note, too, that when the financial system finally does recover and the economy is on the mend, the timing of any return to fiscal and monetary rectitude, after the huge efforts to stave off deflation, poses a horrific policy challenge( FAIR ENOUGH ).

Yet it is clear that the US will leave no policy stone unturned in the attempt to put the economic show back on the road( TRUE ), so there should be no Japanese-style lost decade in North America.

That is a very positive message for the global economy. And in the world of investment, opportunities abound while pessimism rules( I AGREE ).

The most interesting now lie in the corporate bond market( I AGREE ). As Mark Kiesel of the bond fund manager Pimco points out, high quality credit spreads are trading at their widest levels for 75 years, while investors this month have been able to put their money into a diversified basket of investment grade corporate bonds yielding 8 per cent compared with an earnings yield on the S&P 500 of 6 per cent or less.

All across the developed world, corporate bond yields appear to be discounting defaults on a scale that defies common sense( I AGREE ).

Equities likewise look cheap in big markets in terms of the Q ratio, which measures share prices relative to the replacement cost of net assets, and price earnings multiples( TRUE ). Yet the market will probably have to cope with some spectacular bankruptcies in 2009 and in a more muted capitalist environment the earnings prospect in the developed world looks unexciting.

So while the market will find a floor, any bounce may be tame( WE'LL SEE ). The way to make big money in equities will be to identify those companies that will defy the market’s expectation that they will fail( THAT'S TRUE ).

In terms of countries, the UK is now the developed world’s bargain basement after sterling’s slide. International investors will see value in UK equities. Also in property (where, as the chairman of a property company, I have to declare an interest).( GOOD LUCK BRITS )

The first half of 2009 will be bad in commercial property with forced sales pushing up yields against a background of weakening rents. But the market should then stabilise because it offers real value( I AGREE ).

Yields in the UK came down proportionately much less than in the US in the boom, and the level of speculative development has been much less than in previous cycles. With well-let properties available on yields as high as 8 or 9 per cent against 10-year gilts at a little more than 3 per cent, this will be a very tempting prospect for international investors.

The tank traps next year could be in the government bond markets. With no borrowing taking place in the private sector, governments are being crowded in. Hence low yields on fixed interest debt. When credit markets return to health, this will be very dangerous territory( POSSIBLY A BUBBLE ).

If you still feel gloomy, remember that it could be worse. In December 1974 the dividend yield on the FT All-Share index reached 12.7 per cent. Things may be bad, but I don’t think we are going back there."

Just think if it were really like the 1930s.

"His frequent changes of direction are not only embarrassing, they also upset the very markets this program was designed to calm."

Alan Blinder was my choice for Treasury Secretary, which tells you something about me because I'm going to disagree with him here in the NY Times:

"Missing the Target With $700 Billion

By ALAN S. BLINDER

“First you say you do, and then you don’t. And then you say you will, and then you won’t. You’re undecided now, so what are you gonna do?”

— “Undecided,” by Sid Robin and Charlie Shavers

UNFORTUNATELY, Treasury Secretary Henry M. Paulson Jr. has turned this old song into the unofficial theme of the Troubled Assets Relief Program, the $700 billion bailout. His frequent changes of direction are not only embarrassing, they also upset the very markets this program was designed to calm.( VERY TRUE )

It pains me to say this, because I was among the first to call upon Congress to create two institutions to deal with the financial crisis: one to buy and refinance home mortgages, the other to buy what came to be called “troubled assets.” The legislation signed in October empowered the TARP to do both. Sadly and amazingly, it has done neither( I WAS FOR TAKING OVER THE BANKS ).

Regarding mortgages, Mr. Paulson is in a tong war with Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation, who wants to deploy( THAT WORD AGAIN ) a small fraction of the TARP money to refinance millions of mortgages. Her plan may not be perfect — whose is? — but she’s pushing in the right direction. But he, apparently, disagrees and has devoted no money to this purpose( TRUE, BUT THE FED HAS ).

Regarding mortgage-related securities — the “troubled assets” themselves — Mr. Paulson stunned markets on Nov. 12 by announcing that he wouldn’t spend a dime on that purpose, either. Oh? As one of my students asked me the next morning, shouldn’t they at least change the name?

Instead, taxpayer money has been used mainly to recapitalize ailing banks. To be sure, this use of the TARP is perfectly legal. The legislation gives the secretary broad authority to buy “any other financial instrument” that he deems “necessary to promote financial market stability.” That certainly includes buying bank stock. ( VERY TRUE )

The question is not one of legality, but of judgment. Old-fashioned believers in democracy may recall that a reluctant Congress was sold on the idea of buying troubled assets, not on injecting capital into banks. No wonder members are crying foul. ( I AGREE. )

In fairness, Mr. Paulson was not alone in advocating capital injections. Many economists and financial experts agreed. But I doubt that many of them intended for the government to buy preferred stock with no control rights, at above-market prices and with no public-purpose strings attached( I HOPE NOT ). The automakers are not being treated this way in their $13.4 billion loan ( FUNNY THING ).

Because about half of the $700 billion remains uncommitted, let’s review the arguments supporting the three main uses of the TARP:

MORTGAGES The financial crisis began with falling home prices and fears of rampant mortgage defaults — fears that are now coming true. Those fears depressed the values of securities based on mortgages, making them “troubled.” Foreclosures are painful and costly events that destroy real estate values and force fire sales of homes — which depress prices further. It is hard to see a way out of this mess without seriously reducing foreclosures( THIS IS VERY HARD TO DO ). Understanding that, Congress directed the Treasury secretary to use the TARP to get mortgages refinanced. But he has not.

MORTGAGE-RELATED SECURITIES There were several rationales for buying troubled mortgage-backed securities. First, panic had virtually shut down the markets for these securities — markets that must be restarted to restore our system of mortgage finance. Second, one source of that panic was that nobody knew what the securities were worth. A functioning market would establish objective valuations. Third, many mortgages are buried in complex securities. Buying the securities would let government refinance the underlying mortgages.( I STILL DON'T SEE WHY THE GOVERNMENT NEEDS TO DO THIS. IN FACT, BY HOLDING OUT THE POSSIBILITY THAT THIS MIGHT HAPPEN, IT ENCOURAGED OWNERS OF THESE TROUBLED ASSETS TO BE RECALCITRANT AND HOLD OUT FOR A BETTER DEAL. WHEN IT DIDN'T LOOK LIKE IT WOULD HAPPEN, THESE ASSETS FELL IN PRICE AND SOME OF THEM ARE NOW BEING PRIVATELY BOUGHT. THIS LEADS ME TO BELIEVE THAT MY POINT IS CORRECT )

Mr. Paulson says he changed his mind about buying troubled assets because the facts changed. I’m sure that many facts changed. But what new facts invalidate the rationales above?

Furthermore, there are clear synergies among the main uses: Buying mortgage-backed securities helps the government acquire mortgages to refinance, refinancing mortgages to avert foreclosures enhances the values of these securities, and both policies support the one position that Mr. Paulson has embraced wholeheartedly, bolstering the finances of banks ( IT MIGHT WORK, WITH THE RIGHT PEOPLE RUNNING IT ).

RECAPITALIZING BANKS Granting the secretary catch-all authority to buy “any other financial instrument” was a sensible addendum to the law. It offered much-needed flexibility to respond to unforeseen circumstances — an auto bailout, for example. But whoever imagined that the addendum would consume nearly all the TARP money, leaving nothing for its two stated purposes? ( THE BANKS )

But suppose you believe (though I don’t) that recapitalizing banks was the best use of all the money. Even then, the secretary’s execution leaves much to be desired. Never mind the lack of transparency and the management issues recently cited by the Government Accountability Office. Think about this:

Treasury has bought preferred stock with no control rights. The 5 percent dividend rate that taxpayers will generally receive is half what Warren Buffett got from Goldman Sachs. Banks receiving capital injections through the front door are generally allowed to pay dividends out the back door. And there are no public-purpose quid pro quos, such as a minimal lending requirement. So banks can just sit on the capital, which is what most of them have done, or use it to make acquisitions, as a few have. ( THAT'S IT. HOWEVER, THAT'S THE NATURE OF A HYBRID PLAN, SINCE THE GOVERNMENT AND BANKS DO NOT HAVE THE SAME INTERESTS )

Clearly, Mr. Paulson bent over backward to make the terms attractive to banks. He contended that wide participation was essential in order to avoid stigma. To that end, he even forced money on several bankers who didn’t want it( STIGMA ONE ). Naturally, the strong banks that didn’t want the money made that fact known to the markets immediately ( THE STIGMA EXPLANATION NEVER REALLY PASSED MUSTER ). Throwing taxpayer money where it was not needed wasted a precious resource.

So here we are, looking at an all-too-familiar story. The administration that brought you the Iraq war and the Katrina response is locking in another disaster before it leaves town. What to do?( WAIT FOR THEM TO LEAVE. I ACTUALLY BELIEVE THAT THE PERCEPTION OF THE BUSH ADMINISTRATION IS A CAUSE OF THIS CRISIS. MAYBE THIRD, AFTER GOVERNMENT GUARANTEES AND FRAUD )

Fortunately, the TARP legislation authorized a first tranche of $350 billion but wisely gave Congress a mechanism for blocking release of the second $350 billion. With the first tranche now committed, Mr. Paulson said he would soon request release of the second. Based on his performance to date, Congress should reject that request unless he agrees to spend most of the next installment on TARP’s two stated purposes.( DON'T LET HIM SPEND IT )

Failing that, we can wait a month for the new Treasury secretary, Timothy Geithner. ( LET'S WAIT )

Even Blinder's version of the Hybrid Plan would go sideways in practice.

"If bankers do not start lending of their own accord, governments will force them to."

I was not happy with TARP, once transformed from buying toxic assets, being sold as a credit stimulus plan, and then turning out not to be one. But I never believed that so many people in so many countries would be going through the same thing and feeling the same way. Once having received the money, the banks should be expected to lend. Willem Buiter wants to penalize banks if they don't, and the FT isn't too happy about this problem either:

"Bankers must start lending – or else

Published: November 21 2008 20:00 | Last updated: November 21 2008 20:00

“Neither a borrower nor a lender be” was not intended as advice for bankers. Someone should tell them. The purpose of the recent round of recapitalisations was to strengthen banks so that they could continue lending during a global downturn. But banks are not doing so. They must. They are vital utilities – a modern economy cannot function without credit. If bankers do not start lending of their own accord, governments will force them to.

Banks around the world have been recapitalised. Governments bought shares in them, increasing the banks’ risk-capital buffers. The banks were injected with enough capital not only to make up for the losses they were expected to make in the downturn, but also to allow them to expand their lending without the capital cushion becoming too small relative to the banks’ assets. Newly fortified, banks were supposed to become trustworthy borrowers and confident lenders."

This is my point about TARP being a credit stimulus plan. Only we're talking about Britain, as well. It's like a virus.

"Expecting further losses, however, they have clammed up. They are wary of extending their balance sheets further. This is, in part, because they are still traumatised after a near-death experience. Many banks have also seen their top management decapitated. Finally, investors and banks have become so risk-averse that even government guarantees on lending are not convincing. Despite being underwritten by the US government, perceptions of the risk on Citigroup’s debts have remained stubbornly high".

As Peston showed, this hoarding strategy, cleaning up your books, waiting for sentiment to turn, makes sense from the point of view of the banks. However, they were given the money to lend it. So, as Peston says, there's a conflict. But I predicted this from the first. The banks will lobby and do what they feel they need to in a hybrid plan. That's a major reason that they don't work and cost so much. There's an inherent tension between the banks and the interests of the taxpayers. That's why I favored the Swedish Plan. It wasn't because I wanted the government running banks. But, please, Political Economy is having the knowledge and sense to understand how the real world is functioning. This tension was built in to TARP, and the other hybrids in other countries. I've just showed you Britain, so I'll try and document others.

"Governments can do more to support lending. They can reassure markets that capital ratios are supposed to fall in the downturn and that they stand behind the banks. Finance ministries around the world can recapitalise further. Central banks can expand their lender of last resort functions.

If evidence emerges that banks are not lending because they are hoarding cash to pay off the expensive preference shares taken by governments, the rescue can be restructured. One option would be to give governments more control of the banks; another would be to reduce the short-term costs of the capital.

But even if governments ensure that lenders are solvent and liquid, it could still be rational for each bank not to lend. Banks want safety in numbers when it comes to lending. But a lack of credit would force sound companies under because of a working capital squeeze. Faced with this prospect, governments will have no choice but to step in.

Politicians may attempt to lend directly, taking on credit risk to stimulate certain categories of lending and insurance. But banks, which have always been dependent on the largesse of taxpayers, could be forced to adopt central targets for new lending. This would overcome the problem of no institution wishing to be the first-mover. And banks would have little choice but to obey; if they are unco-operative, they could end up in public ownership."

So, governments can:

1) Explain to creditors that a bank's capital falls during a downturn ( Good luck )

2) Reassure that they stand behind the banks ( Good luck, if this just means jawboning )

3) Give capital to the banks if they need more. Hopefully this means after have loaned a bunch.

4) Make borrowing from Fed cheaper ( Aren't they doing that? )

5) Threaten them with being taken over ( I'm sure they're scared )

I say just take them over and be done with it. Then take them private ASAP.

"Paulson did it quietly and in the background": Then How Did I Know It?

I wonder how many times that I have to read this. From 124 Monkeys:

"I had completely missed this story by Amit Paley until Michael Scherer put up a blog post about it. Basically, the Treasury Department completely bypassed Congress and the Constitution* to revise Section 382 of the U.S. Tax Code. The why of it is pretty obvious on its face. Paulson believes that we’re on the verge of another Great Depression and he intends to not make the mistakes of letting banks fail and contracting the money supply that caused the first one.

*you know, that pesky document that spells out and specifically states that Congress and only Congress shall have the power to tax the people and pass laws about taxation

Paulson’s original plan was to buy up the bad securities and encourage the credit markets to start trading and lending again. Part of that scenario would definitely involve banks buying up other banks that had tons and tons of losses and bad assets on their books. In order to encourage such behavior, Paulson ordered a roll back of Section 382 to make buying companies with lots of losses - either on their books or waiting to be declared - more attractive.

Paulson did it quietly and in the background because he knew the top down nature of his plan, which essentially was “save Wall Street, let the solvent banks carry the overall economy through the crisis, screw the little guys” would go over very, very badly with Congress who would need votes from all those little guys to get re-elected in a month.

What I don’t understand is why this roll back wasn’t rolled back when the TARP plan changed to bank nationalization. Plus, its like totally unconstitutional and stuff."

Here's my post from, read it carefully:

Saturday, October 4, 2008

Not Really Free Market After All

Paulson's stimulus plan:

"Treasury Secretary Henry Paulson’s plan, which is now law, is fiscal stimulus that will be injected directly into the banking system to supplement almost nonexistent private-sector lending with government cash and determination. Mr. Paulson may be shooting the right weapon at the right time because it will help rescue the banks while restarting corporate and consumer lending.

But Mr. Paulson’s fiscal-stimulus work didn’t end with the bailout bill.

With hardly anyone noticing, on Wednesday he pushed through very technical and obscure changes to tax regulations that provide a “tax subsidy” for acquirers of troubled banks. Just as automakers stimulate car sales through rebate checks, the Treasury is providing a form of tax rebate to acquirers of troubled banks. Everyone can thank Hank Paulson and his stealth tax-driven fiscal stimulus for the astonishing news that Wachovia was being acquired by Wells Fargo and not Citigroup. It was Mr. Paulson’s tax subsidy to Wells Fargo that provided the fiscal grease to make this deal happen. Pundits who point to the deal and proclaim that the “free markets work without government help” don’t understand the motivating effect of several billion dollars of tax benefits to Wells Fargo."

Your government's dollars at work.

And this post:

Saturday, October 4, 2008

Are Regulators Always Wise?

On the Wachovia sale:

"Lawyers not involved in the battle said that Wachovia could defend the Wells Fargo deal by arguing that it is better for its shareholders. Wachovia is likely to claim that its fiduciary obligations — its responsibility to protect the interests of its investors — required it to consider the Wells Fargo bid and, given its higher price, to accept that bid.

The litigation could put regulators in a difficult spot. The Wells Fargo deal may be better for taxpayers, but if it succeeds, in the future other financial institutions may not be willing to help the government, as Citigroup did, because of the risk that they might not reap the anticipated benefit."

You think?

And this post:

Monday, October 20, 2008

“One purpose of this plan is to drive consolidation.”

Score one for Surowiecki. From the NY Times:

"As the Treasury embarks on its unprecedented recapitalization, it is becoming clear that the government wants not only to stabilize the industry, but also to reshape it. Two senior officials said the selection criteria would include banks that need more capital to finance acquisitions.

“Treasury doesn’t want to prop up weak banks,” said an official who spoke on condition of anonymity, because of the sensitivity of the matter. “One purpose of this plan is to drive consolidation.”

I understand this as a temporary move, but don't find consolidation, or creating very large banks, a positive development in the long run.

As well, I don't think that a credit stimulus plan that doesn't stimulate lending to be very useful.


Okay. These three posts explain everything. Citigroup had a deal to buy Wachovia brokered by the government. When the TARP was passed, which included the provisions that I knew about at the time, and that people are claiming were hidden, Wells Fargo took advantage of the new law to put a better bid in to buy Wachovia. This put the government in the odd situation of brokering a deal with Citigroup, only then to pass tax subsidies that led to Wells Fargo making a better deal. A suit by Citigroup then ensued.

Also, the TARP plan was designed to acquire toxic assets from banks, not recapitalize them as happened. So, the original plan for recapitalization was to pass these tax subsidies so that banks could merge, making recapitalization easier, and, hopefully, making the banks more profitable, hence more able to pay us back and survive, since there was less competition.

Now, if you followed the Wachovia deal, or tried to understand how TARP could actually work and what it said, these provisions were obvious from the beginning. So, these stories are not news. The only news I can find is that some people claim that it's unconstitutional. But, I believe that is was in the bill that passed, so I'm missing something about this argument. It could be correct, but I need to understand it better.

But, if an amateur blogger like me knew this, how could all these experts not know it?

""The important thing is to get the banks now lending to businesses and to families," he said."

Where have we heard this before? From the FT:

"Alistair Darling, the chancellor, will today unveil details of the arm's-length agency that will manage the £37bn in stakes the government agreed with banks to help them in the credit crisis.

The Treasury said the agency's staff would be tasked with monitoring the lending activities of the banks to ensure that they fulfil the pledge to ensure funding of small businesses and that mortgage borrowers get a fair deal without the banks ramping profit margins at their expense.

As reported in the Financial Times last week, ministers have been in talks with high-street lenders to rewrite their voluntary code on lending to small businesses to ensure that customers are given reasonable notice before loans and overdrafts are axed or made more expensive.

Attempts by the Treasury to strengthen the code, as it has done for mortgage lending, comes amid increasing political concern that the £400bn state bail-out of the sector is not reaping the promised benefits for small companies. Gordon Brown has insisted repeatedly that support for such companies is a condition of the £37bn taxpayer-funded recapitalisation of Royal Bank of Scotland, HBOS and Lloyds TSB.

Yesterday in an interview for the BBC Mr Brown reiterated that his first priority was to get the economy moving. "The important thing is to get the banks now lending to businesses and to families," he said"

Let's see, not lending, keeping money, sounds like TARP. Notice that the British are creating an agency to monitor the lending practices of the banks that received government money. I guess that you can't trust banks anywhere.

Actually, it doesn't sound like the Brits got the banks on paper either. Is insisting like jawboning?

“One purpose of this plan is to drive consolidation.”

Score one for Surowiecki. From the NY Times:

"As the Treasury embarks on its unprecedented recapitalization, it is becoming clear that the government wants not only to stabilize the industry, but also to reshape it. Two senior officials said the selection criteria would include banks that need more capital to finance acquisitions.

“Treasury doesn’t want to prop up weak banks,” said an official who spoke on condition of anonymity, because of the sensitivity of the matter. “One purpose of this plan is to drive consolidation.”

I understand this as a temporary move, but don't find consolidation, or creating very large banks, a positive development in the long run.

As well, I don't think that a credit stimulus plan that doesn't stimulate lending to be very useful.

Better Late Than..."

From the NY Times:

"Two weeks after persuading Congress to let it spend $700 billion to buy distressed mortgage-backed securities, the Bush administration has put that idea on the back burner in favor of a new approach, which would have the government inject capital directly into the nation’s banks — in effect, partially nationalizing the industry."

I believe I've said this should have been the plan from the beginning, precisely because this is where the markets were telling us that we were going to go in the end.

What About Government Guarantees?

Joseph Nocera with a good post, but note this:

"Barely a week after the federal government passed a $700 billion rescue plan that revolved around the sale of toxic assets from financial institutions to the government, the Treasury Department announced it would focus its attention on a new plan to inject capital directly into the banks that most needed it. That is now supposed to be the thing that rescues the banking system.Every financial instrument relied on by investors — with the possible exception of Treasury bills — remains under severe pressure. "

Once again, this is where we were going all along. Nocera misses the part that government guarantees played in this bubble and crash.

The Implicit Assumption I've Been Talking About

Vindication. Check this quote out:

“It is a must for the G-7 countries, especially the U.S., to make a firm commitment to public fund injections for recapitalization of banks in trouble, in order to see the stock market pull out of the doldrums,” Hideyuki Suzuki, an analyst at Morningstar Japan told Reuters. “If the G-7 nations failed to do so, its raison d’être will be called into question for sure.”

As I've been saying, this was the implicit assumption all along.

Against “an amalgam of multiple approaches,”

Soros agrees with me about what I've called compromise/hybrid plans:

"But he criticized both parties for constructing a plan that he believes has become “an amalgam of multiple approaches,” which would do very little to help unfreeze the credit markets.

Mr. Soros proposed a different approach. Instead of the United States government buying bad assets to take out of the market and hoping that banks start lending again, he said it should inject cash directly into troubled banks to replenish their depleted capital reserves."

From my perspective, an amalgam of multiple approaches is a recipe for waste and unending government involvement.

More On Reverse Auctions

Via Greg Mankiw again, a good argument against reverse auctions and TARP by Vernon L. Smith:

"Auction designers should immediately note that we are talking about a market with one buyer and many sellers of a hodge-podge of items. The mechanism that will be used is a "reverse auction" -- with sellers competitively submitting asking prices to sell Treasury a heterogeneous mix of good, some sour, apples and oranges whose content is better known to sellers than the Treasury.

Treasury expertise is in auctioning Treasury securities of a given maturity to multiple competing buyers: say $10 billion worth of six-month bills, or two-year notes. In either case every bill (or note) is identical to every other one. The only uncertainty is the final clearing price and Treasury is assured that it will get the best price.

Treasury has no expertise in this ridiculous new venture. (Auction houses such as Christie's and Sotheby's have no problem with heterogeneous items. They auction them singly or in small assemblies to multiple buyers, who assess the items and make bids that reflect best estimates of true value.)

Treasury action should focus on providing capital to individual banks and mortgage companies in return for debt, convertible bonds and equity and warrants to be negotiated. This is dangerous enough for the taxpayer, but here Mr. Paulson has previous experience. (The model was demonstrated recently when Treasury and the FDIC assisted J.P. Morgan's takeover of Washington Mutual.) Then let companies do any necessary piecemeal paper asset auctions, while Treasury holds managers accountable. This is feasible at least, if hardly risk-free for taxpayers.

This procedure will confront financial systemic risk, and allow prices to emerge competitively that will encourage the all important return of bargain hunting buyers.

Would the procedure work? I don't know. But it does focus on the knowledge that markets are capable of bringing to the table. The bailout does not."

I've never liked this idea and put it on my post about the problems of TARP.

It Becomes Even More Obvious Where We're Going

From the NY Times:

WASHINGTON — The United States and Britain appear to be converging on a similar blueprint for stemming the financial chaos sweeping the world, one day before a crucial meeting of leaders begins in Washington that the White House hopes will result in a more coordinated response.

The British and American plans, though far from identical, have two common elements according to officials: injection of government money into banks in return for ownership stakes and guarantees of repayment for various types of loans...

“As this thing has spread, the opportunities for cooperation have risen,” David H. McCormick, the under secretary of the Treasury for international affairs, said. “We need to promote and highlight these common areas.”

With credit markets still frozen and stock markets around the world in a deep swoon, there is a growing consensus that the crisis is now so fast-moving and harmful to the global economy that it demands an unprecedented degree of worldwide coordination.

The Treasury’s openness to direct infusions of cash is a remarkable change in tone from a few weeks ago, when the Treasury secretary, Henry M. Paulson Jr., and the Federal Reserve chairman, Ben S. Bernanke, discouraged such actions in testimony before Congress. “Putting capital in institutions is about failure,” Mr. Paulson declared on Sept. 23. “This is about success.”...

“At a maximum,” she continued, “you can get general principles — the need for a swift recapitalization of the banks, the need for liquidity — so we don’t get an even bigger credit crunch.”...

The direct injections of cash would be for comparatively healthy banks. If a bank is failing and needs to be rescued or shut down, the Federal Deposit Insurance Corporation would handle it through its own procedures.

The Treasury proposal to recapitalize banks stems from the realization that as the stock market keeps tumbling, and as mortgage-related securities on banks’ balance sheets also plummet, it has become harder for banks to raise fresh capital from investors.

The government concluded it would be able to deliver capital faster and with greater assurance if it did so directly....

Another advantage of the recapitalization plan is more subtle: the Treasury would get more bang for the buck. Because banks have debt-to-equity ratios of 10 to one or higher, a dollar spent buying an equity stake would support 10 times as many assets as a dollar spent buying up individual securities.

Administration officials said the government could acquire stakes in the form of common stock, preferred shares paying a specific dividend or some other form of equity. But officials said the government’s offer of additional capital should be made in a uniform way to all banks...

“Only coordinated action by central banks and governments is able to stop the systemic risk and ensure the financing of economies,” Mr. Sarkozy said. He suggested a special meeting of the leaders of the Group of 8 industrialized nations before year-end."

I posted all of these comments because the themes I've being talking about are all there:

Recapitalization
Nationalization
Coordination
Globalization
Total Government Involvement In Crisis

My reason for saying that we should go there has to do with properties of the proposals which I have argued for earlier, but also because it seemed obvious by the reactions of the markets that investors were counting on this scenario, and aren't getting back in until they see it enacted. It doesn't matter what they say in public, look at how they've been behaving.

I understand and agree with Mankiw, Becker, Flynn, etc., that this trend is worrisome, but I see in as inevitable and leading to an easier path to government eventually getting back out.

In any case, it's obvious where this train is heading, and has been for at least a week, if not longer.