So Now We Know . . .
Counting down to the announcement of the Geithner plan, the New York Times has this account of how it came into being (and why it should be called the "Geithner plan," although maybe Larry Summers is hiding behind him):
In the end, Mr. Geithner largely prevailed in opposing tougher conditions on financial institutions that were sought by presidential aides, including David Axelrod, a senior adviser to the president, according to administration and Congressional officials.Mr. Geithner, who will announce the broad outlines of the plan on Tuesday morning, successfully fought against more severe limits on executive pay for companies receiving government aid.
He resisted those who wanted to dictate how banks would spend their rescue money. And he prevailed over top administration aides who wanted to replace bank executives and wipe out shareholders at institutions receiving aid.
I'm not a huge fan of executive compensation caps, as I think they are something of a sideshow. But I think the general approach of playing nice with banks and their shareholders is a mistake, because it leads to intransparent subsidies like the privately-financed bad bank is sure to be. (If the government is guaranteeing assets bought by private investors, as is widely rumored, it's still a subsidy; it's just not as obvious as writing a check.)
The most important thing in the bank rescue plan should be cleaning up their balance sheets to the point where even in a worst-case scenario we don't need to worry about bank solvency (at least for those banks that are left standing by the rescue). If the government announced, "we will buy any assets you want to sell, at their current book values," this would be a massive subsidy worth hundreds of billions of dollars (and requiring trillions of dollars in initial outlays), but it would at least restore confidence in the banks. If the government announced, "we are taking over Citigroup, Bank of America, and JPMorgan because they are insolvent, and we will write down their questionable assets to nothing, recapitalize them, and later reprivatize them," this would also restore confidence, although it would unleash a flood of litigation and political attacks against the government for engaging in "socialism." But if instead you try to split the difference, avoid too much government involvement, and pretend you are not subsidizing the banks, you end up coming up with these too-clever-by-half subsidies that you are trying to hide from Congress and the public, and no one can be confident that they will work.
It's possible that the "uniform stress test" will be rigorous enough to weed out and either close or recapitalize all those banks that may become insolvent in a severe recession. And it's possible that the government guarantees will be generous enough to bring in enough private capital to buy up enough toxic assets to make bank balance sheets trustworthy enough. So it will take a few months to learn if the plan will work.
It appears from this (and other reports) that Geithner is representing his constituency (the banks and those who own them) quite well and they should be pleased with his plans to coddle them and screw the American taxpayer.
February 10, 2009 11:18 AM | Reply | Permalink
Why are we protecting bank shareholders? Creditors, I can see. There's precedent for that. But shareholders?
February 10, 2009 11:26 AM | Reply | Permalink
Innovation? Corruption?
Big stockholders having had their equity largely but not completely wiped out are probably lobbying like mad to keep some chance of revival. 5% of Citi is owned by one Saudi Prince, I read a while back. Trying something a bit different can be a very good idea, if done "smart" and the idea is sound.
There is a public policy question here: Should public policy now bail out the insurers, investors, and bookies?
February 10, 2009 6:33 PM | Reply | Permalink
"In our financial system, 40 percent of consumer lending has historically been available because people buy loans, put them together and sell them. Because this vital source of lending has frozen up, no plan will be successful unless it helps restart securitization markets for sound loans made to consumers and businesses -- large and small." Timothy Geithner 2/10/2009
He's going to fund this with $1 trillion. Screw that!
Give Us the Money!
February 10, 2009 11:32 AM | Reply | Permalink
I wholeheartedly agree!
It would make a helluva lot more sense to me if the government just gets in the business and starts making the loans. At least that way we wouldn't be borrowing money that will never be repaid. Let "the market" reap the reward of it's profligate irresponsibility and fraud.
February 10, 2009 12:23 PM | Reply | Permalink
It's not the same as government spending. It's a government loan. Apples and oranges...
February 10, 2009 5:15 PM | Reply | Permalink
this comment is about the main page of TPM. when a post is made that says "this was a punt" with out further explaining WHAT the heck the poster is talking about it just alienates people who have not closely been following the news in the past hour.
Instead of being a closed loop of the same people commenting to each other, don't you think it would be helpful if there were some labels or references so a reader might have a CLUE what is being talked about? I know it has been amended slightly now, but it still has nothing to indicate that it is related to TARP or Geithner altho that is what I am deducing it is about. Talk about "inside the Beltway thinking" the assumption that if you don't know what we are talking about then do not read our blog, is pretty obnoxious.
February 10, 2009 11:54 AM | Reply | Permalink
Learn about how this country is being taken over by global banking interests and turning the U.S. into a third world operation of the rich over the masses of mostly poor people (a third of that made up from the class formerly known as the Middle Class). If you can't watch the entire video, the better part starts around one hour and 20 minutes into the video where the narrator talks about Lincoln and the Civil War. The video ends with possible solutions including the proposal of eliminating, if not at least limit the powers of fractional interest banking and of the pseudo-government known as the Federal Reserve Bank (this video was produced prior to Geithner becoming Treasure Secretary, (1996)):
http://video.google.com/videoplay?docid=-515319560256183936
or visit their web site: www.themoneymasters.com
From their web site, the Monetary Reform Act - A Summary: This proposed law would require banks to increase their reserves on deposits from the current 10%, to 100%, over a one-year period. This would abolish fractional reserve banking (i.e., money creation by private banks) which depends upon fractional (i.e., partial) reserve lending. To provide the funds for this reserve increase, the US Treasury Department would be authorized to issue new United States Notes (and/or US Note accounts) sufficient in quantity to pay off the entire national debt (and replace all Federal Reserve Notes).
The funds required to pay off the national debt are always closely equivalent to the amount of money the banks have created by engaging in fractional lending because the Fed creates 10% of the money the government needs to finance deficit spending (and uses that newly created money to buy US bonds on the open market), then the banks create the other 90% as loans (as is explained on our FAQ page). Thus the national debt closely tracks the combined total of US Treasury debt held by the Fed (10%) and the amount of money created by private banks (90%). Because this two-part action (increasing bank reserves to 100% and paying off the entire national debt) adds no net increase to the money supply (the two actions cancel each other in net effect on the money supply), it would cause neither inflation nor deflation, but would result in monetary stability and the end of the boom-bust pattern of US economic activity caused by our current, inherently unstable system.
Thus our entire national debt would be extinguished – thereby dramatically reducing or entirely eliminating the US budget deficit and the need for taxes to pay the $400+ billion interest per year on the national debt - and our economic system would be stabilized, while ending the terrible injustice of private banks being allowed to create over 90% of our money as loans on which they charge us interest. Wealth would cease to be concentrated in fewer and fewer hands as a result of private bank money creation. Thereafter, apart from a regular 3% annual increase (roughly matching population growth), only Congress would have the power to authorize changes in the US money supply - for public use -not private banks increasing only private bankers' wealth.
February 10, 2009 11:56 AM | Reply | Permalink
What should be clear to all by now is that banks do not lend their own money - banks lend other peoples' money.
One way that they get money is by attracting deposits, selling bonds, selling stock, etc. These amounts show up as "liabilities" on the balance sheet, since they have to be paid back. The bank can then lend this money to borrowers, and these mortgages, loans, etc., show up as "assets" on the balance sheet, since they will be paid back to the bank in the future.
Typically, a bank's lending via this mechanism is limited, since the liabilities side of the balance sheet is limited to about 10 times the bank's capital. This limits lending to about 11 times bank capital.
This limits the banks income from the intrest spread. However, the bank has another revenue stream, the fees on loan origination and the transactions on deposit accounts, etc.
Banks can expand this fee income if they can make loans that do not become assets on the balance sheet. They do this by bundling loans together, slicing them into tranches of different credit quality, getting insurance companies, etc, to insure them with credit default swaps, and getting the rating agencies to place an attractive credit rating on them. Then they sell this securitized debt to hedge funds, pension funds, endowments, insurance companies, mutual funds, family offices, foreign banks and financial institutions, sovereign wealth funds, etc.
Once sold, the loans disappear from the bank's books -- they neither show up as assets, nor do they require comparable liability entries.
Per Geithner, 40% of consumer loans are packaged and sold into the market for securitized debt this way. However, I believe that the commercial loans, corporate paper, commercial mortgage backed securities, etc., are sold at an even higher percentage. Furthermore, the over 50% of the buyers of securitized debt have in the past been foreign institutions, organizations, and individuals.
Therefore, unless this securitized lending market can be restarted, lending will be constricted by over 1/2, even if the banks are lending to the full amount they can keep on their own balance sheets. Indeed, since the banks have taken losses, they have to curtail their own deposit taking and lending to bring their capital ratios down to what regulators require, which reduces their ability to lend.
Furthermore, restarting the market will require convincing foreigners that US originated securitized debt is a good risk.
February 10, 2009 2:35 PM | Reply | Permalink
60% is not this kind: "Per Geithner, 40% of consumer loans are packaged "
"However, I believe that the commercial loans, corporate paper, commercial mortgage backed securities, etc., are sold at an even higher percentage."
Wild guesses aren't much help. Why would this be so, and is this paper in the same bad shape as residential mortgages and derivatives or synthetics?
February 10, 2009 4:32 PM | Reply | Permalink
"Delinquencies of securitized commercial mortgages may quadruple in the next 18 months to almost 4 percent, said Kenneth Rosen, an economist at University of California, Berkeley, who runs a real estate hedge fund. About 70 percent of commercial mortgages are pooled into commercial mortgage-backed securities that are sold to investors, Rosen said."
From "Bernanke's Easing Thwarted by Surging Commercial Mortgage Rates", January 25, 2008.
http://www.bloomberg.com/apps/news?pid=20601103&sid=aaK_r.bfo7TI&refer=news
February 10, 2009 5:39 PM | Reply | Permalink
Thanks.
Now, what does it mean down the road? If delinquencies are at 4% in 18 months, that suggests that defaults are less, and foreclosures even less.
Are CMBS also messed up in synthetic derivatives?
February 10, 2009 6:26 PM | Reply | Permalink
Defaults on CMBS appear to be less than for RMBS. But CMBS are done for different categories of commercial properties, such as apartment buildings, shopping malls, office buildings, factory buildings, etc. Each may have different default rates.
There can be derivatives related to CMBS.
February 10, 2009 10:49 PM | Reply | Permalink
Kwak comes close on two points:
"split the difference"
I agree that this is the harder path to walk well. But as I understand it, Geithner is not out to pretend he is not subsidizing the banks, rather he's openly subsidizing investors by guaranteeing liabilities of the banks (assets of its creditors). If banks happen to also be investors (hold their own toxic assets themselves) that is different.
There needs to be clear public definition of what is and is not a "toxic asset" in general for this purpose. Some candidates:
Residential First Mortgages
Residential Other Loans (home equity...)
Commercial ... (as above)
Mortgage Backed Securities
Other non-Mortgage Backed Securities
SIVs
CDSes
Other derivatives or CDOs
In my view, the market can be understood as consisting of investors, gamblers, and crooks. Geithner should help "subsidize" at most the first category, if anyone.
"The most important thing in the bank rescue plan should be cleaning up their balance sheets to the point where even in a worst-case scenario we don't need to worry about bank solvency"
I think this isn't quite right as stated, but I cannot put the problem into words just now. Any suggestions?
February 10, 2009 3:58 PM | Reply | Permalink
Toxic assets are not so much related to the categories that you list as they are to risk. Maybe they should be called "hallucinogenic assets" since either you will have a wonderful experience or they will permanently damage you.
For example, a mortgage backed security consisting of a bundle of 30-year fixed-rate first mortgages, with complete documentation from a reputable originator, from a recourse state would be fairly easy to analyse with respect to risk.
A mezzanine tranche of a mortgage backed security consisting of a mix of Alt-A ARMs and conforming first mortgages from California's Central Valley wrapped in a credit default swap from an insurer who's rating will depend on how many other CDS's go sour, would be fairly hard to analyse with respect to risk. This is a toxic asset.
SIVs are not an asset class, but are entities set up for investors -- From "SIV Accounting" http://www.calculatedriskblog.com/2007/11/siv-accounting.html
"Let's start with the structure of an SIV (Structured Investment Vehicle). First an SIV has investors - like hedge funds or wealthy individuals - who invest say $1 Billion in the SIV (the equity). Then the SIV issues commercial paper (CP) and medium-term notes (MTN) that pay slightly higher rates than similar duration paper. The typical SIV, according to Fitch, uses 14 times leverage, so in our example the SIV would sell CP and MTN for $14 Billion.
Now the SIV invests this $15 Billion ($1 Billion equity and $14 Billion borrowed) in longer term notes. The idea is simple: borrow short, lend long, hedge the interest rate and credit risks - and the profits flow to the investors in the SIV."
February 10, 2009 4:54 PM | Reply | Permalink
I understood SIV's as mainly ways for banks to keep liabilities off balance sheet...?
February 10, 2009 5:13 PM | Reply | Permalink
Correct. The bank would set up the SIV, lend it money or set up a conduit for its commercial paper, and collect fees for running it. But it was not supposed to be on the bank's balance sheet. However, when the SIVs got into trouble, many were put back on the bank's balance sheet. I'm not sure why, but maybe the SIV investors were in the "too big to screw" customer category.
February 10, 2009 5:58 PM | Reply | Permalink
That's too shallow I think. The SIV leaves the balance sheet because the bank no longer has the liability, it's been "sold" to other parties. Merrill's cite makes this pretty clear to me. Am I missing something?
February 10, 2009 7:03 PM | Reply | Permalink
Moi, shallow...?!?
February 10, 2009 8:53 PM | Reply | Permalink
Thanks for the scoop on SIVs (which I only sorta get) but it begs the question of the effect of complexity on toxicity.
"Toxic assets are not so much related to the categories that you list as they are to risk."
I understand that risk uncertainty is problematic to valuation and pricing. Did you mean something more?
What about the "insurance" angles?
1) Insured assets have a different valuation than uninsured, and it depends on the solvency etc. of the insurer and on the contract details.
2) Are the "insurance" policies themselves also assets, and if so, are some of them "toxic"?
February 10, 2009 6:59 PM | Reply | Permalink
I was saying that the toxicity of an asset is more a fuction of the uncertainty of risk, rather than the absolute risk itself. If an asset is high risk, but the risk is well characterized and unlikely to change, it can be marked to an appropriate rate of return. It is not necessarily toxic.
An insured asset has a different value than one without insurance. For example, a mortgage backed security by itself might have a BBB rating. If insured by a credit default swap issued by an insurance company with a AAA rating, the combination may inheirit the higher AAA rating. This both increases the value of the mortgage backed security, and it makes it marketable to more investors, many of whom are restricted by law or regulation to only invest in prime securities.
It was possible to buy a CDS on a security that you do not own. In that case, the CDS itself would be an asset, valued at whatever the current price of a new CDS on the same security would cost. If the rating of the security drops, the CDS appreciates. If the rating of the CDS issuer drops, the CDS depreciates. But in either case, if the moves are extreme, there may be no willing buyers or sellers and the price of your asset becomes unknowable for mark to market accounting.
February 10, 2009 10:33 PM | Reply | Permalink
So if a BBB asset is up for sale, its price depends a lot on whether there is a CDS on it.
"It was possible to buy a CDS on a security that you do not own."
I know. And I call this "gambling". To the extent that institutions have such liabilities (they were counterparties to a CDS which could be called for collateral or payment), taxpayer funds should not flow to the creditor, directly or indirectly. The contract should be nullified or marked down severely (return of premiums paid, maybe). To the extent that institutions have such as assets, I'm a bit more forgiving, but as assets, why would an institutions need to get rid of it?
There is a lot of focus on "toxic assets", but liabilities can be just as problematic. I suspect that's what hit AIG, they were a counterparty to CDS instruments which "paid off" to Goldman Sachs and others, thus making AIG insolvent. The taxpayers paid the bill because Paulson used scare tactics on Congress, and had some extraordinary authority already. It's treason as far as I know.
But a dearth of facts bedevils my analysis...
February 11, 2009 12:46 AM | Reply | Permalink
While I would tend to agree that CDS and other derivatives that are disassociated from the ownership of the underlying security tend to be "gambling", this is not always so. The derivative may be used to offset some other instrument with similar characteristics.
Generally, it would be good to standardize, restrict and regulate the types of derivative contracts, instead of allowing almost any contract that any two partys' creative legal staffs can draft.
An authoritive book on derivatives seems to be The Swaps & Financial Derivatives Library: Products, Pricing, Applications and Risk Management, 3rd Edition Revised by Satyajit Das, which comes as a 4700 page, 4 volume, boxed set. It's $315 from Amazon, a little pricy for casual interest.
February 11, 2009 12:27 PM | Reply | Permalink
I agree. The question is again whether all CDS's or just some should be "rescued", and just how much do derivatives affect "toxic asset" valuations for the current purposes?
Since I don't see any banks failing today, I'm inclined to say Geithner is right to hold off publicly on further plans for dealing with failed banks. Markets are fast to react so that G. becomes the driving force in the short term, as market players try to outfox him.
February 11, 2009 3:20 PM | Reply | Permalink
I agree. The question is again whether all CDS's or just some should be "rescued", and just how much do derivatives affect "toxic asset" valuations for the current purposes?
Since I don't see any banks failing today, I'm inclined to say Geithner is right to hold off publicly on further plans for dealing with failed banks. Markets are fast to react so that G. becomes the driving force in the short term, as market players try to outfox him.
February 11, 2009 3:23 PM | Reply | Permalink
""The most important thing in the bank rescue plan should be cleaning up their balance sheets to the point where even in a worst-case scenario we don't need to worry about bank solvency"
I think this isn't quite right as stated, but I cannot put the problem into words just now. Any suggestions?"
It isn't quite right for all kinds of reasons. Mainly because it is wrong.
- 1. we want to reach the point where we don't need to worry about bank solvency, sure, but cleaning up balance sheets is the least important thing. You want a decent liquidation mechanism in place, you want transparency about balance sheets, you want to avoid creating/maintaining to worry about too-big-to-fail entities.
2. calling it a 'bank rescue plan', shows you've misunderstood everything that is important about it.
February 10, 2009 5:56 PM | Reply | Permalink
I think you're close to my intuition, thanks. And I think you're saying that Kwak doesn't understand what he's talking about ("misunderstood everything that is important").
February 10, 2009 6:43 PM | Reply | Permalink
I was under the impression that JP Morgan Chase was okay. It's Citi and BoA that are insolvent.
Of course, I guess we don't really know until Treasury does its "stress test" to determine their health.
This is the better way to go, IMHO. Call a spade a spade, have the government (FDIC) step in to do what they do, and let's get on with it. Screw the shareholders -- they bought shares in an insolvent bank. (Boo hoo for them.)
-- ARG
February 10, 2009 4:22 PM | Reply | Permalink
According to Roubini, the ordering from most risky to least is: Citi, BofA, JPM, WFC.
I was surprised to see Wells in better shape than JPM, personally. Don't know what these impressions are based on. Is it Diamond's hair, or something, that inspires confidence?
February 10, 2009 6:17 PM | Reply | Permalink
Roubini thinks WFC did good damage control in CA where much of its lending occurred, if I recall correctly. I don't know what unknown weaknesses JPM still has, but it has swallowed a lot of stuff in the past year or so and the government covered some pretty big losses when it did.
I've lost track momentarily of who owns whom but
Bear Stearns
Chase
Wachovia
World Savings
WaMu
are big names which went somewhere in the past year or two.
February 10, 2009 7:10 PM | Reply | Permalink
Go that one, two, or three steps further and discover who (individuals) are the majority owners of the corporations that own these banks.
February 10, 2009 7:55 PM | Reply | Permalink
That sounds like more work than I know how to do. Besides insider ownership data, how does one find out who owns stock in a company?
If you have a point to make about something like "incest", or something else for that matter, please spell it out.
February 10, 2009 8:05 PM | Reply | Permalink