Generous Henry's Big Bailout
Okay, we all should be glad that Treasury Secretary Henry Paulson seems to have abandoned, or at least sidelined, his TARP program and instead decided to directly inject capital into the banking system. The problem is under-capitalized banks and that is best solved by giving the banks more capital.
But, there is a big issue about the terms under which they were given capital. Secretary Paulson decided that a 5 percent rate of return on preferred share was good enough for the taxpayers. Warren Buffet got a 10 percent return for his investment.
No one would confuse Henry Paulson for Warren Buffet, but come on -- he could get a 4.0 percent return buying treasury bonds. I can't believe that he had such bad business sense when he was CEO of Goldman Sachs.
The markets gave Paulson's investment strategy a big thumbs down from the taxpayer perspective. Goldman Sachs shares jump 10.7 percent after the details were made public. Shares of Bank of America rose 16.4 percent and Citigroup's stock rose 18.2 percent. Obviously the market thinks that Paulson gave the banks a really good deal.
It also seems unlikely that the executive compensation restrictions will have much effect. I doubt that we will hear about any top executives getting big pay cuts because of the bailout, but I will be very happy to be proven wrong.
In short, it seems that we have a whole new group of welfare dependents. Forget Reagan's mythical "welfare queen" who drove a Cadillac. These folks have private jets and homes on the Hamptons. And, they wreck banks and economies for a living.
--Dean Baker
Problem is that once you buy into the too-big-to-fail (Oops! "systemically significant financial institutions") slogan your criticisms become nothing more than weak, marginal carping.
Paulson had to hide which of the Big 7 were terminally insolvent and that meant he had to convince all seven to take government investments.
I very much expect he couldn't convince some (J.P.Morgan-Chase and Wells Fargo?) to get with the program on a preferred coupon over 5%.
October 14, 2008 10:52 PM | Reply | Permalink
Actually, can you imagine any one of these egomaniacs -- Kenneth D. Lewis, Jamie Dimon, Lloyd C. Blankfein, John J. Mack, Vikram S. Pandit and Robert P. Kelly -- sitting at that meeting with Paulson and admitting that his bank was in trouble.
Paulson probably had a tough time getting anyone to buy into 5% preferred ("C'mon men; I know you don't need it, but the investors don't know that and they're anxious. Do it for the good of the country").
October 14, 2008 11:08 PM | Reply | Permalink
Paulson's original plan was to buy toxic assets at well above market prices. He had to do it that way, because the banks were carrying those assets at above market values and would have impaired their balance sheets if they sold at market values.
Charlie Gasparino thinks (today @ 7:40a.m.) that the capitalization of these big banks implies that Treasury plans to buy the toxic assets at near market value.
In other words Paulson told the bankers that they're not getting the windfall he'd earlier promised and they'd better take the money, now, because it wasn't coming later.
October 15, 2008 8:03 AM | Reply | Permalink
Dr. Baker:
And it's not just the 5% "coupon" (dividend, technically), that marks this as bad relative to the Buffet deal. Buffet received an equivalent amount ($5 billion) of favorably-priced common stock warrants that he can exercise anytime during the next five years. The rough plan for Paulson, as I understand it, is for the Treasury to get warrants equal to just 15% of the preferred stock injection.
Also striking is how different this is than the Treasury-AIG deal. I understand that the AIG bailout was for different purposes -- AIG was going immediately bankrupt whereas the solvency of the banking system over the next, say, 24 hours, is relatively assured (with diminishing levels of confidence the farther one goes out) -- but the Treasury charged AIG for its loan facility a rate of LIBOR + 8.5%. While I understand that there is a difference between a loan and a preferred stock purchase, they are not all that different: preferred stock is like a bond, but with fewer recovery protections, and like a stock for capitalization purposes, but it doesn't share in the broader common stock market gains. The important point with the present Paulson action is, to my eye, that the Treasury picked a very low fixed rate for a LONG time (five years!) without reference to LIBOR.
It's not crazy to assume that interest rates will go up within the next five years. It's also not crazy to assume that there will be few buyers -- probably not $250 billion worth -- in the near future for Treasury's preferred stock for anything under 100-200 bps + LIBOR. So if Treasury wants to unload the preferred shares once the market stabilizes, how do we get out of the position? If the market is going to demand a reasonable rate of return on this asset, then the price of our investment will drop until the interest rate is at the market yield. Even if Treasury sweetens the deal for some buyer by waiving cap gains taxes or whatever, it's still money lost from the fisc. (It's unclear to me whether the Treasury has commitments from the banks to buy out the government stakes for par value.)
The worst part, perhaps, is that the British avoided this almost entirely, taking huge stakes in common stock (with some preferred shares). The NYT and WSJ reported that the big three UK banks saw their stock price fall after the deal was announced because of the dilutive effect of those transactions; to which I say -- isn't that a reflection of the moral hazard inherent in the risks those banks and shareholders took to bring them to this position? What would be irresponsible is to allow the system to fail. What is responsible is to save the system without unduly rewarding risk-taking that has produced failure.
But Paulson manages to do just that. The way that Paulson, even when doing an ostensibly better thing by the taxpayers than he previously proposed, manages to slant a good act in the worst possible way is just stunning.
October 14, 2008 11:01 PM | Reply | Permalink
common stock warrants
I bet that Warren's stock, (unlike yours and mine) comes with voting rights, something the mere contemplation of which brings Hank Paulson to the very edge of *panic, causing him to awaken bolt upright in a cold sweat at 4:15 A.M.
*The DSM, Fifth Edition defines "Socialist Panic": (cf, "Gay Panic")
The fear that one has been obliged, in the interest of salvaging some scrap of one's personal wealth, to adopt language and tactics that promote the general welfare.
YAY PREVIEW!!
October 15, 2008 1:55 AM | Reply | Permalink
DEAN, is it possible that the banks know, that the push will come now, for the banks to renegotiate mortgages?
Cutting into their profits, reducing their ability to pay more than the 5%.
October 14, 2008 11:03 PM | Reply | Permalink
Dear Dean
I do agree with you on these issues (as I have in earlier threads) and I think you are correct here. These bailouts are designed for the benefit of the bankers. But they have us all over the barrel. If we do not agree then they will collapse the whole system and it will come down. We have no choice. We must go along with their solutions, or else, we will die.
Do you have a better solution?
October 14, 2008 11:03 PM | Reply | Permalink
Okay, we all should be glad that Treasury Secretary Henry Paulson seems to have abandoned, or at least sidelined, his TARP program and instead decided to directly inject capital into the banking system.
Whys should we be glad? There is no crisis, right?
October 14, 2008 11:21 PM | Reply | Permalink
Right.
There is no crisis that requires the United States to invest government funds in American (or for that matter, foreign) banks.
October 15, 2008 12:03 AM | Reply | Permalink
Dan K,
I take Dean's comment quoted above to mean that since there is no (or not much of) a crisis, the less drastic action is better than the earlier, more drastic proposal.
October 15, 2008 1:43 AM | Reply | Permalink
Erica, why is spending hundreds of billions to buy shares of whole banks any less drastic than spending hundreds of billions to buy troubled securities? If we buy securities, we make a clean cash transaction, and what we bought will still have some value even if the bank we bought it from ultimately fails. If we buy shares, we taxpayers are then on the line as investors in troubled institutions.
My understanding is that the economists who have been advocating the preferred stock alternative to the TARP plan have been doing so because they think there is a crisis, and that the foundering banking system needs a speedy, confidence-building "direct injection" of capital. They tend to argue that the TARP plan, with its drawn-out and yet to be designed auction processes, will take too long.
Economists are also recommending a common US and European approach, given the globalized nature of our financial system. Otherwise the crisis just gets moved around from country to country as depositors and investors flee banks perceived as troubled and move to banks seen as secure. If one country is taking over or taking partial ownership of banks, and guaranteeing deposits and loans like crazy, then all the action is going to flow to those government propped-up banks, perceived now as more stable, and away from banks in which governments have no investments. Once Europe settled on the buy-and-guarantee approach to its troubled banks, the US hand was probably forced.
The VoxEU report from last weekend, in which several prominent economists (including Brad DeLong) offered their opinions, and mostly recommended the purchasing of shares and provision of loan guarantees, certainly didn't argue that there was no crisis. In it's opening joint statement the authors wrote:
We are in the throes of what is almost certainly the most serious economic and financial crisis of our lifetimes. The crisis is no longer a US crisis or even a US and European crisis; it is a global crisis. It has spread from Wall Street to Main Street. It is not just investment portfolios and retirement accounts but jobs that are now at risk. There is a need for urgent action. The policy response needs to be decisive. It needs to be global. The stakes could not be higher.
Dean has been all over the map on this issue, in my view. But insofar as I can understand his position, it seems to be something like this: There is no crisis, but so long as lots of people think there is a crisis and are panicking, we taxpayers might as well take advantage of the situation to gobble up some ownership of the private US financial system at a time when the share prices are low, and the political will to spend the money is high.
October 15, 2008 8:12 AM | Reply | Permalink
"They tend to argue that the TARP plan, with its drawn-out and yet to be designed auction processes, will take too long."
Meaning they can't get it done by Jan 21st? :^)
Dude, I didn't say I agree with Dean's assessment, just was trying to say what I think he meant.
Everybody knows that I believe that the fix lies in addressing the housing crisis by shoring up the payments on upside-down mortgages. Crazy, I know, but let's face it--it's the only idea out there that's trickle-over instead of trickle-down.
October 15, 2008 10:35 AM | Reply | Permalink
This is somewhat off topic. Consider it as a data point about "ordinary" people who due to chance have a pile of cash and believe that it means that they are sophisticated and wise.
A casual acquaintance went out of his way to tell me how he had $80,000 sitting around and, because the stock market had dropped drastically, called his broker and told him to buy stocks. That was the extent of his instructions. He has no inside information. He has no background in investing. The money was given to him by his family just like the house he lives in.
I wonder how many people there are like him. He can't be the only one.
October 15, 2008 12:40 AM | Reply | Permalink
Dean, I just want to take a minute to thank you for your engagement on this issue. I've found your posts on this forum, as well as your appearances in media such as Cspan, to be extremely informative. You are the man. Keep it up.
October 15, 2008 12:46 AM | Reply | Permalink
I completely agree with you that taxpayers are getting the shaft on the Paulson bailout for rich guys plan. But the question of the moment for me is why are we not hearing even the slightest peep out of a single Congressional Democrat anywhere about what a bad deal this is for the regular people of the country who will be forced to pay higher taxes to fund this thievery? Where are they? And why is their silence so deafening? Seems to me that the Congressional Democrats may be the most open, shame faced Judas' in history.
October 15, 2008 12:58 AM | Reply | Permalink
Paulson doesn't represent us. He represents Wall Street. I don't see how that could be more clear. That he is still the Treasury Sec is just wrong. Bush and his cronies have screwed this country and taxpayers to no end and it seems like that will persist until the day Bush leaves office. Common sense tells me these people are the cream of the crop white collar criminals.
October 15, 2008 5:07 AM | Reply | Permalink
. . . until the day Bush leaves office.
Is there evidence that Obama or his financial advisers disagree with Paulson & Bernanke's current responses to the "crisis"?
What makes you think January 21st will presage a change in respect to methods employed?
October 15, 2008 7:25 AM | Reply | Permalink
You are spot on here and people are fooling themselves if they think Obama represents anything like a real change of course on this matter. Obama has gotten more money from the financiers of Wall Street than anyone else running for the Presidency this year including McCain or any other Republican! Obama fell right in line on this and is pursuing his predictable "go along/get along" style of corporate, centrist politics. Corporate/centrist politics don't favor regular Americans and don't fight for the interests of the people. Democratic corporate centrists fight for their masters: the wealthy corporate interests.
October 15, 2008 10:19 AM | Reply | Permalink
Indeed, what Obama is going to deliver is the key question of the day. And a scary number won't even acknowledge the indisputable fact that this question will remain unanswered until after Obama is sworn in and proves whether he is just more of the status quo or he is really committed to deliver for all Americans.
I know I would be extremely disappointed if the results from Obama's governance demonstrated that he had been insincere. I wonder though, even if a President Obama did the opposite of what he has said and clearly implied, would hoards of Democrats (much like the irrational hoards of some from the religious right) still prefer denial to addressing reality?
After all, there are still some Dems don't even seem to recognize that the Democratic Congress has done much the opposite of what they had promised would happen once they had the majority. Maybe the day will come when all voters stop gambling on words and start putting their money and time where they see significant results?
It seems a big part of the denial problem is that there are what appear to be some pseudo "liberal" figureheads and commentators who have cleverly positioned themselves on blogs, media and in public life. Such tricksters merely have to talk like bleeding heart liberals on some "bait" issues for their followers to leave their common sense behind and identify them as fellow liberals (kinda like Bush using the pro-life mantra while he's shocking and aweing, or like Congress holding hearings and asking the obvious, hard questions after they've already signed, sealed and delivered a detrimental law)
It seems just a little bleeding heart bait from liberals tricksters can cause large groups groups of uninformed voters to stop thinking for themselves on all issues.
As for Obama, I will give him the benefit of the doubt, take his eloquent words with a grain of salt, and look to his results.
October 15, 2008 3:58 PM | Reply | Permalink
You needen't give Obama the benefit of te doubt. His record and his intentions are quite clear.
Corporate centrism. He's no progressive. Obama is now, and has never claimed anything different, a go with the flow, very mainstream DC Democrat. His popularity has glossed over the fact that he is a centrist and millions of pogressive Democrats who have supported him have done so believing the winks and nods from the campaign that once he's elected Obama will govern more to the left. Sadly, there's not one shred of evidence to support the wink and nod faithful.
He will be better than a Republican but only marginally so unless he actually and finally "gets it" that America is actually in need of substantial, fundamental change. The change Obama has been selling since day one is more tweaking at the margins and the usual DC Democrat run around game of claiming they can only do a little (or nothing) because there is no "bipartisan" consensus. Obama may have just gotten lucky enough with the economic collapse to no longer have that excuse. It may well be that next January the Democrats can run the board at will. And it will be that moment that tells the tale. If the Democrats do have a huge majority but still fail to make the fundamental changes they have claimed they are for over the past 25 or 30 years, then it will be as clear as can be that they too are as much an obstacle to making Aerica the country it ought to be as are the Republicans.
I pray that for once in my lifetime the Democrats will have the moral courage and the balls to actually do what is right for the country instead of what is right for pleasing the wealthy interests they suckle up to once they get elected to Federal office.
October 15, 2008 11:51 PM | Reply | Permalink