Toxic Trust Company of America
Joe Stiglitz has added his voice to those opposing the idea of an Aggregator (or Bad) Bank.
That amounts to swapping taxpayers' "cash for trash," Stiglitz said yesterday in a panel discussion at the World Economic Forum in Davos, Switzerland. "You shouldn't chase good money after bad. We're talking about a national debt that's very hard to manage."
From the moment Paulson first proposed this idea, I called it the Toxic Trust Company of America . It was a bad idea four months ago and it's still a bad idea. The Times explains that the biggest problem is in valuing the assets to be purchased.
The wild variations on the value of many bad bank assets can be seen by looking at one mortgage-backed bond recently analyzed by a division of Standard & Poor's, the credit rating agency.The financial institution that owns the bond calculates the value at 97 cents on the dollar, or a mere 3 percent loss. But S.& P. estimates it is worth 87 cents, based on the current loan-default rate, and could be worth 53 cents under a bleaker situation that contemplates a doubling of defaults. But even that might be optimistic, because the bond traded recently for just 38 cents on the dollar, reflecting the even gloomier outlook of investors.
If the selling bank was forced to sell the bond at market value to Toxic Trust, it would take an immediate 60% hit to its balance sheet, and need to raise lots of new capital to be in compliance with reserve ratios. If on the other hand we played "Uncle Sucker" and the TTCA bought the bond for the bank's valuation or even S & P's (why are the rating agencies still in business?), we would never recover our principal. Making things even more complicated is my suspicion that many of the synthetic Credit Default Obligation bonds have no underlying value what so ever--are a complete Madoff type fiction.
We have a mechanism to deal with failed banks. It's called the FDIC, a completely funded insurance pool for deposits. Merge the middle tier banks into the strong ones and let the rest be taken over by the FDIC. We have many more systemic issues to face and we should get on with it.
Yep, nationalize anything that can't stand on its own. The only way we can make money by taking on the risks associated with these assets is if we take the bonds rather than pay for them.
February 2, 2009 11:50 AM | Reply | Permalink
I support the idea of a repository for toxic assets [b]under the Swedish system[/b], where the banks are declared insolvent, seized, and then the "good parts" are recapitalized and re-released into the wild, with shareholders and management getting the boot to the rear.
Anything else is just a give away to the banks.
February 2, 2009 12:21 PM | Reply | Permalink
I think I support just forcibly giving all the toxic assets to Sweden and starting over.
February 2, 2009 1:18 PM | Reply | Permalink
I'm with you there. The Feds take the equity -- otherwise we're getting ripped off. Just don't try to run the bank as a government program. If you do, you're going to have to deal with every Congressman complaining that the good citizens of his district can't get the subprime loans that they desperately need, so we're going to have to lower credit standards.
February 3, 2009 7:54 AM | Reply | Permalink
Glad to see your article. One quibble: The FDIC is not fully funded now.
"many of the synthetic Credit Default Obligation bonds have no underlying value what so ever"
Something like this has been on my mind too. How much effect do these synthetics have on the instruments which do at least nominally represent underlying value?
The difference between 38 and 87 (or 97) is huge. That represents panic, not genuine if reduced expectation values.
February 2, 2009 2:10 PM | Reply | Permalink
Would an extra $700 billion have left the FDIC "fully funded"?
I've been thinking about this "bad bank" idea, and I still think it is a bad idea.
I support the notion of letting the FDIC take over the banks that fail. That's the way it's already set up to work; let's allow it to work. We just have to throw extra money into the FDIC (in advance) so that nobody panics.
And while these banks fail, left and right, and while the FDIC manages them, temporarily, let's pass new regulations that limit the size of any one bank.
Don't force (or allow) the one or two "healthy" banks to try to digest the weak ones. Pass new regulations that limit the size and reach of any (new) bank. So we don't have to face this problem again in another 50 years.
When I was growing up in Indiana, back in the '70s, I'm sure I learned that it was against the law for any bank to have branches in more than one county. So all we had were these tiny (and safe) little county banks -- typically two or three in each county (more in some places), lending on very modest leverage, and making a decent living for the bank owners and the people who worked there.
Can anyone explain why that model won't work now? (Or something similar -- maybe we could allow banks to cover an entire state!) I mean, seriously, what is the argument for large banks? What is their advantage -- for me (and for our society)?
-- ARG
February 2, 2009 4:45 PM | Reply | Permalink
And I'll just add that the FDIC, after nursing failed banks back to health (or whatever they do) would re-privatize them as small regional banks -- split them up, basically. That's my idea, anyway. Willing to hear arguments as to why this wouldn't work.
-- ARG
February 2, 2009 4:47 PM | Reply | Permalink
Your right Arg, but it amazes me to no end as to just how brain dead most Americans are when it comes to their own financial system. Then again perhaps that's what government planned on.
The creation of a bad bank isn't worth the breath one requires to sound those two words. Lincoln said it best and Jefferson hit the nail on the head.
"The government should create, issue, and circulate all the currency and credit needed to satisfy the spending power of the government and the buying power of consumers. The privilege of creating and issuing money is not only the supreme prerogative of government, but it is the government’s greatest creative opportunity. The financing of all public enterprise, and the conduct of the treasury will become matters of practical administration. Money will cease to be master and will then become servant of humanity." ~ Abraham Lincoln
Jefferson....I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.
In his own Words president Wilson stated that the biggest mistake of his career was allowing the creation of the Federal Reserve. Show some guts Obama and do the right thing. The 100 year experiment is a failure and has brought the country to the abyss. Shutter the Federal Reserve now and return the power of money to the people through US Treasury dollars backed by gold and silver.
February 2, 2009 5:54 PM | Reply | Permalink
I think FDIC was pretty well funded until the coverage limits were blown away. It used to be up to $100K per institution, now I think they upped it to $500K.
Granted that some banks have merged, I suspect they don't have 5x the "collateral" that they used to have. But the main point is letting stockholders and managers and bondholders take a larger or smaller loss. I'm in favor of "larger", that is, liquidate, let the government take the choice assets, and then portion out the remaining assets.
The problem is that CDO and CDS instruments cloud the picture of asset value and quality, since they are like insurance policies of dubious value.
February 2, 2009 9:55 PM | Reply | Permalink
A bad bank is a very bad idea
By Rolfe Winkler
Updated Monday, February 2nd 2009, 9:48 AM
When rumors surfaced on Wednesday that the Obama administration may create a "bad bank" to buy toxic assets, financial stocks soared. Of course bank shareholders were happy; the plan is likely to be a titanic taxpayer hand-out. It has to be to achieve the administration’s goal of keeping banks in private hands.
To understand the banking crisis, and Obama’s emerging solution, all you need to know is one equation: Assets = Liabilities + Equity. This equation explains why banks are dropping like flies.
A bank’s assets are the loans it makes to borrowers. Its liabilities are the dollars it borrows from lenders and depositors to fund those loans. Shareholder equity is what’s left over.
During the bubble, banks made loans for houses at vastly inflated prices. Say, for instance, a bank lent $1 million to a borrower buying a Miami condo in 2006. The borrower promised to repay $1 million over the life of the loan, so the bank valued this asset at $1 million.
Flash forward to 2009, and the condo is now worth $500,000. The borrower defaults because he’d rather lose the condo than pay a million-dollar mortgage on a property now worth half that.
The bank forecloses on the condo and sells it for what it can get, the current market value of $500,000. The bank’s asset, the loan, has fallen from $1 million, which the borrower owed, to $500,000, the amount recovered. A 50% loss.
February 2, 2009 5:41 PM | Reply | Permalink
It is not that simple. Assets have to be priced in order to be entered on the books. If other people are in a panic and selling off bonds at 38% of nominal price, does the bank have to mark down its assets to 38% even though it doesn't intend to hold them?
Also, synthetic instruments like CDO and CDS totally mess up the balance sheet calculation.
February 2, 2009 9:59 PM | Reply | Permalink
sorry, ... even though it doesn't intend to SELL them?
February 2, 2009 10:01 PM | Reply | Permalink
eds is absolutely right. The supreme fallacy in the arguments about market price being the Holy Grail is that there is realistically no market! There is a vacuum where once stood an active market. There is an agora to which no one comes!Once important trading desks at Bear, Lehman -all of the investment banks - and their traders have disappeared.
Everyone including Nobel prize winners Krugman and Stieglitz talk as if there was market normalcy. but in the present, the Federal Government must act as the market and must set the price that will satisfy a lot of uninformed and angry people and a voracious media!
Current mark-to-market rules are invalid!
February 3, 2009 7:26 AM | Reply | Permalink