Reassuring, But What About the Banks?
I like the general tone - reassuring but conveying the seriousness of our situation. My guess is that the daily consumer spending numbers will be good tomorrow (unlike when George Bush tried to be reassuring on the economy in September 2008; consumption collapsed the morning after.)
But what exactly is the banking strategy? This is the critical piece that we haven't yet seen in meaningful detail.
Here's what the President just said,
"And when we learn that a major bank has serious problems, we will hold accountable those responsible, force the necessary adjustments, provide the support to clean up their balance sheets, and assure the continuity of a strong, viable institution that can serve our people and our economy."
I really don't know where this is going. Are we taking over failed banks (i.e., the usual FDIC process) or just providing them with more (and more) subsidies of various kinds?
The President also just said we'll be tough on bankers. That's fine with me. But who will appoint the boards of directors and on what basis? Unless you know the governance piece, you don't know who will really run these banks and how they will be compensated.
And, honestly, how do you get total credit to go up (or be "re-started") when many creditworthy people and firms don't want to borrow. The crisis of confidence started with credit problems in the fall, but surely now it's much wider - and much more global.
It will take something very bold and probably quite new to get us out of this slump any time soon. Have we seen this yet?
The stimulus plan will reassure some workers in some occupations they have job stability. Other components - energy efficiency measures, etc., will put some people to work after a few months, then the R&D money will come on.
February 24, 2009 9:53 PM | Reply | Permalink
Yeah, when the rah, rah wears off, we are back to the banks, aren't we?
February 24, 2009 10:15 PM | Reply | Permalink
I don't think we're supposed to be worrying our pretty little heads about the banks or Social Security tonight.
February 24, 2009 10:32 PM | Reply | Permalink
Simon, I think it's such a difficult problem that they just don't know the solution yet. And that's pretty scary -- they don't know what to do.
On the other hand, odds are they will figure it out, and I don't think what they do will be based on the political consequences. The public will support them, as long as whatever they do actually works.
It's a game of Jenga. And I agree with Nouriel Roubini -- there's about a 30% chance that they won't be able to find a solution (which leads to Great Depression 2.0).
-- ARG
February 24, 2009 11:28 PM | Reply | Permalink
"The crisis of confidence started with credit problems in the fall"
No, the crisis started years ago. Oct. was the end of the crisis of confidence and the beginning of a chance to rebuild confidence on a sound footing. That process will take work.
Other than that your post is very 'sympatico'. I am not impressed by Geithner or Obama on the economy, so far.
February 25, 2009 12:00 AM | Reply | Permalink
The only solutions Obama has offered on the banks are those that the banks themselves are comfortable with. That's a problem.
February 25, 2009 12:11 AM | Reply | Permalink
Bernanke gave a pretty clear picture of what will happen with the banks during his testimony yesterday.
- There are about 20 banks in the > $100 billion assets class that are of concern.
- The government can exert whatever influence it wishes over these banks without actually owning a majority of their common stock.
- The government can provide them with additional capital as events dictate. The "stress test" is designed to discover what the projected needs will be over 5 years for various economic scenarios.
- There currently exists no process or mechnism which is capable of seizing and closing the largest institutions, including all of their foreign and domestic subsidiaries, without substantial risk of causing a systemic collapse of the global financial system.
I would put C, BAC, JPM, WFC, GS, and MS in the really too big to fail category. Bernanke did express an willingness, even eagerness, to work with Congress to craft legislation setting up a process for closing this level of institution.
The picture for the banks is pretty clear. The picture for the non-bank institutions is far harder to figure out, since they aren't as well regulated. How many more problems like AIG's Financial Products operation in London are there?
February 25, 2009 11:41 AM | Reply | Permalink
"- There currently exists no process or mech[a]nism which is capable of seizing and closing the largest institutions, including all of their foreign and domestic subsidiaries, without substantial risk of causing a systemic collapse of the global financial system."
Really? The only problem I see is that non-banking activities have been lumped in with banking activities, on purpose. That should be treated as criminal activity.
What exactly is the real substantial risk? Are you merely repeating a meme here?
February 25, 2009 3:38 PM | Reply | Permalink
That is my recollection of Bernanke's response to a question from one of the Senators -- Corker perhaps, I couldn't find a transcript.
It probably reflects the fact that a "bank", such as CitiGroup, is not just a domestic bank that can be easily shut down by routine FDIC procedures. Citi is a holding company with hundreds of corporate subsidiaries engaged in a wide variety of financial transactions, both domestically and internationally. The list of subsidiaries is large partly because corporations are established to perform specific services for large customers.
No government regulator(s) have the legal authority or the operational resources to close and unwind a Citigroup in a way that ensures the safety of the global financial system.
February 25, 2009 6:10 PM | Reply | Permalink
"Citi is a holding company with hundreds of corporate subsidiaries engaged in a wide variety of financial transactions"
Fine: Citi is not a bank. Strip out the bank part. Sell off the bank part to someone who can at least act like a banker, and make sure enough assets go with it. Nationalize Citi's other assets and break contracts which violate the public interest. Then sell it or give it to the creditors in whatever size pieces they can handle. Let them deal with it.
Let's be honest about what's going on here. This is not about lending or banking. It's about gambling and theft.
Letting investment firms become commercial banks strikes me as the policy problem which needs to be unwound.
February 25, 2009 8:50 PM | Reply | Permalink
Stripping out the non-bank part and letting it fail doesn't work. Remember that they converted Goldman Sachs and Morgan Stanley to banks, and they married Bear Stearns and Merrill Lynch to banks specifically so they could be kept from failing.
The Bear Stearns marriage to JPM was before the Lehman failure. Unfortunately, they couldn't get Lehman married off and the Fed had no authority to prop it up. Paulson let Lehman fail.
The Lehman failure caused a near collapse of the system, and it forced them to come to AIG's aid to the tune of $150 billion so far. It was bad enough that they later too action to keep ML, GS, and MS from failing.
There may be a couple other insurance companies, hedge funds, and possibly others that are in the "systemically critical" league. These are institutions that have contractual obligations to other institutions such that if the institution fails, it causes other institutions to fail like dominos.
February 25, 2009 11:41 PM | Reply | Permalink
"Remember that "
You apparently didn't read my comment before replying to it. :(
"The Lehman failure caused a near collapse of the system"
Scare talk. Since a near collapse is not a collapse, you just said "the sky did not fall".
"it forced them to come to AIG's aid"
False. It was an option, hardly a forced choice, unless you mean it was extortion, which would be part of my point. This is about theft.
I did not say "let it fail". But that's what you discussed. Please read what I write as being my best shot at writing what I mean.
"Nationalize Citi's other assets and break contracts which violate the public interest. Then sell it or give it to the creditors in whatever size pieces they can handle. Let them deal with it."
February 26, 2009 3:56 AM | Reply | Permalink
Fine: Citi is not a bank. Strip out the bank part. Sell off the bank part to someone who can at least act like a banker, and make sure enough assets go with it.
The FDIC's traditional process has been to seize a failing bank and sell it to a larger, healthy bank. This doesn't work when the failing bank(s) are the biggest banks. Who would be the hypothetical "someone"?
Nationalize Citi's other assets and break contracts which violate the public interest. Then sell it or give it to the creditors in whatever size pieces they can handle. Let them deal with it.
Citi is huge, with hundreds of subsidiaries. Many of these are not in the US. How would this be done? I've seen estimates yesterday that a GM bankruptcy would incurr 1.2 billion in legal and banking fees. You are likely to cause a global shortage of lawyers by breaking up Citi. Also, the default of Citi would trigger covenants in contracts between other parties -- those derivatives again.
Let's be honest about what's going on here. This is not about lending or banking. It's about gambling and theft.
Some derivatives have legitimate business purposes, while others really are gambling. They are all legal. Who has the legal authority to declare them against the public interest in all jurisdictions?
Letting investment firms become commercial banks strikes me as the policy problem which needs to be unwound.
If they had not combined the investment banks with commercial banks, and had not rescued AIG, the global financial system would have melted down. It's not over yet, and there may be a number of non-bank financials that also pose systemic risk.
February 26, 2009 9:15 AM | Reply | Permalink
Merrill, I think we're talking past each other here. Some derivatives, not all; DOJ and courts. Citi is not "all bank", the point is to strip out the bank with the FDIC covered deposits and some assets. The financial system needs restructuring if not total meltdown. $1.2B in costs is small potatoes, and maybe those costs could be contained.
February 26, 2009 4:01 PM | Reply | Permalink
Roubini is now asking openly about:
I think the Fed is over-reacting to Lehman and ignoring/discounting important factors.
There is no "systemic reason", unless we're talking about gambling via derivatives or outright crooked deals which violate the public interest.
Can you either show that derivatives are insignificant and if so just what systemic reasons exist, or if they are significant why they cannot be dealt with "smartly"?
February 26, 2009 6:52 AM | Reply | Permalink
Federal Reserve speeches are at http://www.federalreserve.gov/newsevents/speech/2008speech.htm
See "The Bear Stearns Episode and Its Implications" in Bernanke's speech of July 8, 2008.
Also "Strengthening the Financial Infrastructure" in his speech of August 22, 2008.
In his October 15 speech:
AIG's difficulties and Lehman's failure, along with growing concerns about the U.S. economy and other economies, contributed to extraordinarily turbulent conditions in global financial markets in recent weeks. Equity prices fell sharply. Withdrawals from prime money market mutual funds led them to reduce their holdings of commercial paper--an important source of financing for the nation's nonfinancial businesses as well as for many financial firms. The cost of short-term credit, where such credit has been available, jumped for virtually all firms, and liquidity dried up in many markets. By restricting flows of credit to households, businesses, and state and local governments, the turmoil in financial markets and the funding pressures on financial firms pose a significant threat to economic growth.
Going into the Lehman crisis, I think they were most worried about the money market mutual funds. A run on them would have caused millions of people to loose their money as MMFs "broke the buck", as one of them did. The MMFs have about $1.34 trillion in retail deposits and $2.54 trillion in institutional deposits.
Coming out of the Lehman crisis they realized how pervasive the systemic problems were.
February 26, 2009 9:16 AM | Reply | Permalink
The economy is not a sacred cow, and threats to its growth should not be treated as the sky threatening to fall. Preventing panic is good. Beyond that, it's meddling and churning to no good even if it looks nice at a quick glance.
In fact the economy was over-inflated, everyone agrees on this (or at least nobody disagrees rationally that I've seen). So why doesn't everyone agree that it needed to cool off and contract back to a condition based more on reality than on imagination?? The question is, or should be: How to let it down and how far does it need (or do we want it) to go?
February 26, 2009 4:06 PM | Reply | Permalink
"No government regulator(s) have the legal authority or the operational resources to close and unwind a Citigroup in a way that ensures the safety of the global financial system."
- why not just a debt-for-equity swap, and let creditors deal with it?
February 25, 2009 8:58 PM | Reply | Permalink
The video is at Senate Banking Hearing with Fed. Chair. Bernanke
At 3:10:00 Bernanke references the practicalities of shutting down a large institution. After Shelby's questioning, Corker interjects additional questions about shutting down large institutions beginning at 3:14:30.
February 25, 2009 6:38 PM | Reply | Permalink
Franchise value is the reason to subsidize Citi equity holders to huge $ amounts??
(thanks for the link)
He's afraid of market disruption, but without rational foundation. It's scare talk, again.
Comprehensive Resolution Authority
Why was this not dealt with when Bear Stearns went under, or was it but then forgotten?
TARP was sold as saving banks. It obviously had much less to do with banks than with non-banks. AIG was first bailed out by other than TARP. This just smells of so much bullshit.
February 26, 2009 4:08 AM | Reply | Permalink
Some new data. See Bill Winters - Derivatives at http://investor.shareholder.com/jpmorganchase/presentations.cfm
This would indicate that AIG's losses were primarily related to CDOs and not to CDSs.
February 26, 2009 11:35 AM | Reply | Permalink
Bill Winters - Derivatives
No such terms found on the page. Recent presentation and press release seem irrelevant. ??
February 26, 2009 4:15 PM | Reply | Permalink
Sorry, it is in the menu of today's presentation slides.
Or go to http://files.shareholder.com/downloads/ONE/517048957x0x275126/19682387-d023-4e95-bf23-287d789ff656/Derivatives-BillWinters.pdf
February 26, 2009 5:30 PM | Reply | Permalink
p26 says industry CDS notional is down 50% in 2008.
p28ff are interesting but hard to follow. p29 makes it look like CDS insurance was insignificant in all but the WaMu case, in which the total was pretty low anyway. p30 gives WaMu as a special case example of loan losses rather than derivative losses being dominant somehow related to AIG, as I read it.
I'm not sure the distinction between CDO and CDS is important here. Didn't AIG in effect write "bad" insurance either way?
February 26, 2009 10:09 PM | Reply | Permalink
CDOs and CDSs are quite different. CDOs are synthetic debt instruments that are "manufactured" by setting up a Special Purpose Entity which buys asset-backed instruments and then sells tranches of bonds with different risk levels. These bonds are the CDOs. See http://en.wikipedia.org/wiki/Collateralized_debt_obligation
A CDS is an insurance policy referencing a credit event on a security. You could buy a CDS on a CDO. See http://en.wikipedia.org/wiki/Credit_default_swap
What page 31 indicates is that AIG did not take much loss on CDS. Its losses were due to the mark to market writedown of its CDOs. This impaired its financial position and AIG had to put up more collateral to back its other positions with counterparties, probably CDS counterparties, but it doesn't say.
February 27, 2009 9:07 AM | Reply | Permalink
Well, I remain very curious to know who paid off Paulson, Eisman et al.
I think you're saying that p31 says that AIG made some very bad investments in sliced and diced ABS instruments (maybe mostly MBS). Most defective ABS have been lower tranches like second mortgages which are basically worthless when defaults occur.
If so, this strikes me as incredible. AIG as an insurance company is basically in the practical/applied actuarial field, one would think they would be the experts on risk analysis and management. Was AIG knowingly gambling (engaging in risky speculations) over the past 2-4 years? Was it deceived or just reckless? Did it let some small problem grow until it went out of control? Was it relying internally on the same kinds of math models which evidently allowed Bear Stearns and Lehman to grossly overleverage (and if so, are the model makers complicit)? And again, cui bono, the government monies (Fed, TARP, whatever) -- how much flowed/flows to whom? Did AIG have no significant CDS protection on its CDOs (that is, did it get anyone else to insure its CDOs), or were its huge losses softened by some CDS protection?
Lots of questions there... I would think 5 months would have been more than enough for a report from the 80% owner to give clear answers to most all of them. Allowing for Bush-thinking (foot dragging) as a partial excuse for delays in the fall, Treasury needs to show some transparency ASAP here. I hear that Geithner has far to few subordinates in place. Obama needs to move quickly on getting his deputies installed.
February 27, 2009 3:39 PM | Reply | Permalink
eds - I meant to reply to you - see below.
February 27, 2009 4:08 PM | Reply | Permalink
AIG trail leads to London 'casino' is the best story I've seen on the AIG problem. It indicated that the problem was with CDS, rather than CDOs as described by JPMorgan Chase. But maybe its the difference between AIG the parent company and the AIG FP "casino in London".
The Daily Telegraph article also references a NY Times article by
Gretchen Morgenstern
In the case of A.I.G., the virus exploded from a freewheeling little 377-person unit in London, and flourished in a climate of opulent pay, lax oversight and blind faith in financial risk models. It nearly decimated one of the world’s most admired companies, a seemingly sturdy insurer with a trillion-dollar balance sheet, 116,000 employees and operations in 130 countries.
“It is beyond shocking that this small operation could blow up the holding company,” said Robert Arvanitis, chief executive of Risk Finance Advisors in Westport, Conn. “They found a quick way to make a fast buck on derivatives based on A.I.G.’s solid credit rating and strong balance sheet. But it all got out of control.”
The London derivatives operation was run by Joseph Cassano, formerly of Drexel, Burnham, Lambert.
February 27, 2009 4:06 PM | Reply | Permalink
Thanks, I will look at it later tonight.
Meanwhile, Stiglitz from Democracy now, talking my "book":
... The question is, why did we bail out AIG? What they said is, the reason we bailed it out is if we didn’t bail it out, there would be consequences somewhere else. They didn’t tell us where.
It would make much more sense if we looked at where the consequences were and deal with the problems as they turn out. Just for instance, some of the, quote, “insurance policy derivatives” were not in the United States. The people that would have problems may be gamblers, may be other institutions abroad.
February 27, 2009 7:57 PM | Reply | Permalink
London and New York are joined at the hip, going back to Thatcher and Reagan.
Patrick M. Parkinson, Deputy Director, Division of Research and Statistics
Over-the-counter derivatives
Markets in Which Credit Derivatives Are Traded
"Although credit derivatives have been listed on exchanges, to date the vast majority of credit derivatives have been executed bilaterally with derivatives dealers in OTC markets. The dealers include 15 to 20 large, globally active commercial and investment banks. The principal centers for trading are London and New York. Trades typically are executed over the telephone or through voice brokers. Use of various electronic trading platforms to facilitate bilateral execution of CDS has been growing, especially in Europe, but remains fairly limited. More than half of trading in CDS is trading between dealers. Other than dealers, the most active participants in CDS markets are asset managers, including both hedge fund managers and managers of regulated investment companies."
February 27, 2009 11:03 PM | Reply | Permalink
I may be reaching personal overload on this, but will try to continue later.
February 28, 2009 4:23 AM | Reply | Permalink
Not all losses are CDS only.
Minor segue from gamblers to crooks here (I recommend the rest of the article too):
This looks like a source of CDO failure beyond any naive statistical norm.
February 28, 2009 6:39 AM | Reply | Permalink
In non-recourse states, such as CA, AZ and FL, the first mortgage is secured only by the value of the property. Generally the first mortgage lender will not pursue the mortgage holder for a deficiency judgement.
Therefore, the fraud that weakens the creditworthiness of the mortgage most is the inflated appraisal. Fraud regarding the borrower's income, FICO score, etc. is less important, since the borrower can just walk away from the first mortgage when the house value sinks below the mortgage balance.
In sites such as ml-implode.com there have been many stories about fradulently inflated appraisals. Note that JPM, BAC and WFC did not do much business through independent mortgage agents, mortgage brokers and wholesalers. They got out of this business early. Most of the option ARM and subprime on their books comes from WaMu, CountryWide, and Golden West.
On page 22 of http://files.shareholder.com/downloads/ONE/517048957x0x275120/88b5c365-fb20-4be0-9809-6c353efde0a0/HomeLending-CharlieScharf.pdf JPM is stating that they require FICO > 700, CLTV
Second mortgages taken out as part of home purchase are also non-recourse in these states. However, HELOCs taken out after home purchase are a personal obligation of the borrower, and the HELOC lender can pursue a judgment.
February 28, 2009 12:16 PM | Reply | Permalink
It's getting complicated.
Interesting about HELOC. But that doesn't dispute my working premise about the economic fundamentals, and of course bankruptcy often has the same effect (as walking away from a first mortgage in a non-recourse state). Homeowners still in effect ripped off investors for on the order of a trillion per year via equity loans (not to mention sales). If "in effect ripped off" is too strong, "took spending cash from" is clearly too weak.
I think my main concern in re the fraud angle is that the FDIC, TARP, et al not merely roll over and pay off investors/creditors who got stung by loan frauds as if it were automatic. They need to be tough, whether as "tough love" or as in "putting the screws to".
February 28, 2009 7:52 PM | Reply | Permalink
"Then at the end of 2007 Cassano’s fortunes changed. The company’s accountants changed the basis on which they valued much of the collateral held by its units. Some half a trillion dollars worth of credit default swaps written by AIG Financial Products were marked down. "
"By the end of last year AIG held $562bn of CDS contracts on its books, and in their October 7 testimony before the House Oversight Committee company executives acknowledged that a cockpit for this business was 1 Curzon Street.
In contrast to standard practice, however, AIG Financial Products did not hedge its exposure to a possible fall in the CDS market."
Would that be $562B notional value or "market value"? The former would be a pittance, the latter large, with $3T industry reported overall. The failure to hedge is interesting. That would be a bookie not laying off bets with long odds (like Paulson's 45 to 1 payoff). And does "marked down" mean written off or just slightly devalued? I found it interesting that an accounting change "caused" this to some extent.
February 28, 2009 4:37 AM | Reply | Permalink
I think that it would be market or model value.
As an insurance company, they were doing one way bets -- similar to betting that a house won't catch on fire. But in this case the whole city burned down.
The banks functioning primarily as traders try to keep everything balanced so that their income is not from risk premiums, but only from trading fees.
February 28, 2009 12:19 PM | Reply | Permalink
Yes, trading fees and risk premiums are fairly orthogonal basis, but of course our current "banks" don't seem to have functioned that way. Or are you suggesting that the banks are hurting not because of loan or CDS etc. losses, but fundamentally because their margins and fees are too squeezed?
February 28, 2009 8:37 PM | Reply | Permalink