The US government agrees to bail out Citibank.
The federal government agreed Sunday night to rescue Citigroup
Inc. by helping to absorb potentially hundreds of billions of dollars
in losses on toxic assets on its balance sheet and injecting fresh
capital into the troubled financial giant.
The agreement marks a new phase in government efforts to stabilize U.S.
banks and securities firms. After injecting nearly $300 billion of
capital into financial institutions, federal officials now appear to be
willing to help shoulder bad assets, on a targeted basis, from specific
institutions.
I don't want to be a self-panicker; these things take time. But I'm becoming increasingly convinced that the original theory of the bailout--that it would step in and provide a firewall to prevent future failures--has been proven wrong. I still think it was worth trying, prospectively; there seemed to be at the time, a reasonable prospect that it would save money in the long run by forestalling the need for future bailouts. But in hindsight, it hasn't worked.
(I'm well aware that I am about to be slammed for supporting the bailout by a large number of people with shaky command of the concept of "uncertainty". Hopefully, at least a few of them will pause to consider that confusing getting good results with having a good decision making process
is exactly the cognitive error that brought us to this disaster in the first place.)Where does it leave us, if the firewall has failed? It's worth looking at what sort of seems to have worked during the Great Depression--I say "sort of" because the more histories of the era I reread, the more it becomes clear to me that economists and wonks drew far too firm conclusions from their study of the period, conclusions like "We know what happened, and therefore how to prevent it from happening again." If you read the histories with an eye to gaping holes, there's a distressing amount of "Why the economy experienced [the 1930 consumption contraction/the second banking panic/insert your favorite adverse event here] is something of a mystery", after which the author darts, without further comment, to the part of the Great Depression he thinks he can explain.
But I digress.
What does actually seem to have worked in the Great Depression is not the second banking holiday, which was arguably something of a disaster on many levels, but what the Roosevelt administration did with the second banking panic: sent auditors out to every bank in the country to ascertain whether they were solvent or not.
This process is more difficult now, because it seems to me that the instruments that 1930 banks were dealing with were basically understood. There was supposed to be a steady stream of interest payments; if those payments weren't coming in, then you new the loan was in trouble. Harder to know what the value is of a derivative where the underlying payment streams may or may not be impaired.
Nonetheless, I think it would make sense to take some of those laid-off bankers and put them to work under more experienced regulators, and try to develop some metrics for communicating the creditworthyness of the banks. The ad-hoc nature of the response may have initially meant flexibility, but now it just means panic.
What else are we pretty sure worked? The FDIC, which eased peoples' fears and stopped bank runs from taking down solvent banks. Monetary stimulus seems to have worked somewhat, although less effectively than is usual.
All else is more controversial. Things like work relief programs may have done a good job at alleviating misery--and I find myself annoyed that palliative measures are being sold virtually exclusively as fiscal stimulus. The stimulative virtues of extended unemployment benefits are not particularly exciting, but they are an excellent way to ensure that families hit hard by a recession do not suffer from want. This is important--and so affordable, too!
The things we know, pretty much without a doubt, did not work? Attempts to keep prices high through government fiat. FDR tried just about everything you could imagine to halt the Great Depression, and several things that you couldn't, unless you were a very special sort of lunatic. The attempts at price supports were the worst of the worst. The National Industrial Recovery Act, which it is not too harsh to call quasi-fascist, probably takes first prize: it involved creating gigantic cartels of industry and labor, which were intended to collude to keep prices high. When the Supreme Court said (unanimously!) that the government wasn't allowed to do this, FDR tried to pack it with sympatico cronies like any cheap third-world dictator. Only the intervention of some brave Democratic senators saved us from both a stunning erosion of American democratic institutions, and a barking mad price-fixing scheme that would have further prolonged the crisis.
The nation's farm subsidy scheme comes in a close second; the object was to keep commodity prices high in an era of general deflation. Hence milk poured upon the ground and wheat fields burned when people in the cities were starving. This survived the Supreme Court to turn everyone in my mother's home town into permanent Republicans; they weren't economically sophisticated enough to understand why one should destroy food when needy people could have eaten it.
Probably not terribly harmful, but crazy expensive and awesomely lunatic, was FDR's scheme to buy gold. Some bright boy on his staff had noticed that when the price of gold was high, the price of other commodities was usually also high. Neatly reversing cause and effect, the government embarked upon a series of gold purchases in an attempt to make the economy grow. They might more effectively have written to Santa and asked him for a good economy for Christmas. Thankfully, this was so moronic that eventually even FDR's band of merry tinkerers noticed that it wasn't working, and also, that all the other central bankers were standing behind the privy, pointing and laughing. It was rapidly abandoned, especially by the standards of the New Deal, which tended to pile program upon program until a sort of old-candlewax effect was achieved.
I don't think we're going to get anything quite that crazy. But we'll undoubtedly get their mildly manic cousins: minimum wage laws, stiffer unionization rules, and heavier corporate taxes, on the theory that if demand for something is falling, the best way to fix the problem is to make it more expensive. There remain a few things that Obama's election has not changed, the tendency of demand curves to slope downward among them. The effects of these efforts will thus be mixed at best.
We may well also get the automobile (or steel, or airline, or whatever) equivalent of the Farm Bill: congress may cave into the notion that any industry which was once successful and lucrative, ought to be so forever. Like the Farm Bill, it will not actually prevent the economy from changing, only make it phenomenally more expensive and less efficient. But if that sort of thing were enough to stop our legislators . . . well, frankly, I'm not able to imagine such a world, so I can't even provide you a punchy example of what it might be like.
We've had a citi credit card for years, and over the last five, I can't remember how many times it's been replaced due to security breaches. If it's an indication of how the company's run, it's no wonder it's in such trouble.
Which makes me wonder why it's any different then GM. There are other American banks that are better run, including the bank that scooped Wachovia out from under Citi's nose, Wells Fargo. And there are many millions of more jobs, and more of the American economy, dependent on the auto industry then on Citi.
But I've never understood top-down economics. Without folks with money in their pockets to spend, their is no economy. And without local business, local farms, local manufacturing, local jobs, there is no economy, so the Wal-mart model of efficiency do not make much sense to me, either. Sure, it may make sense in a business plan, but the current financial collapse seems to be the logical outcome, because it disregards the failing of local economies (starting with individual families) and the compounding impact of their collapse.
But I'm just an ignorant farmer in Maine. And we're doing pretty good compared to folks on Wall Street right now. We didn't have so far to fall, and we can grow our own food, provide our own heat, and we have plenty of clean water. Got lots of folks who know how to fix things and make things. Sometimes, you need to strip away the abstracts to see real meaning.
"The stimulative virtues of extended unemployment benefits are not particularly exciting, but they are an excellent way to ensure that families hit hard by a recession do not suffer from want."
Is THAT what unemployment benefits are for? Ensuring individual "wants" are addressed? I don't think so. I believe they are intended to address an individual's "needs" which are very different from an individual's "wants" (at least, I would hope so....)
The government will try to backstop all the banks. It is only a matter to time before BAC, JPM, and WFC take their turn in insolvency.
I give BAC until the end of December, JPM will fall sometime in February, and WFC will go before the cherry blossoms arrive in April.
The rot is systemic, and I bet almost no one is technically solvent even by loose Fed standards.
jwh, unless you are a non-native speaker of English, you should be ashamed at your ignorance of the language. please refrain from pointing out such "errors" in the future, at the risk of further embarrassing yourself.
If you read the histories with an eye to gaping holes, there's a distressing amount of "Why the economy experienced [the 1930 consumption contraction/the second banking panic/insert your favorite adverse event here] is something of a mystery", after which the author darts, without further comment, to the part of the Great Depression he thinks he can explain.
But not our Megan. She dives right into what she can't explain.
jwh, unless you are a non-native speaker of English, you should be ashamed at your ignorance of the language. please refrain from pointing out such "errors" in the future, at the risk of further embarrassing yourself.
Posted by james
Grammar flaming doesn't add much to this conversation, so (a) consider knocking it off; (b) if you must flame, at least capitalize your flames properly.
"This process is more difficult now, because it seems to me that the instruments that 1930 banks were dealing with were basically understood. There was supposed to be a steady stream of interest payments; if those payments weren't coming in, then you new the loan was in trouble. Harder to know what the value is of a derivative where the underlying payment streams may or may not be impaired."
The is about the eleventieth time Megan has stated that Wall Street didn't, and doesn't, understand those newfangled finacial instrument thingies (but, shucks, no one does, so it's ok!). Yet the Masters of the Universe were happy to leverage the hell out of them, and now that the end result is, uh, kind of messy, Megan feels that it's not only reasonable to get the credit markets rolling again, but to do so by running all that necessary cash through the cretins who f**ked things up in the first place, and all without oversight enough to see to it that the money actually reaches the credit markets, rather than 'shoring up' our necessary, too-big-to-fail financial institutions, so that they can someday (soon, we trust, evn though the initial rationale for the bailout was that we NEED TO DO SOMETHING!!! NOW!!!!) lend again.
Still not buying it, Megan. I've been a big fan for a long time, but I think you have too many friends in the biz whose word you are too happy to accept. The moral hazard issue here just took a monster and made it much bigger and scarier. If you're too big to fail, you're too big to exist. Or, the bets you are making are too big, and do you think the I-banks will come out of this with new regulations that they must limit their bets, uh, their 'risk-hedging investments' to a certain size? Which would probably be the only 'new' regulation that would make any sense.
TJIC, James cared enough about jwh to try to help him out. Flaming has an altogether different goal.
P.S. I'm not flaming you, either.
Given that the initial attempt to limit problems has failed, I fear zombie banks quite a bit. I also fear "looting" -- stories like Mack Whittle, the CEO of South Financial Group taking an $18 million dollar severance package directly before a bailout sound suspicious to me.
So I like the idea of sending a legion of auditors to banks and beginning the process of identifying banks that have failed. I also think that transparency is going to be an asset in the long term. In the short term it was a good tool to reduce panic but as the totals get this large it makes sense to put oversight on the process.
It'll get political and there will be graft but it would make sense to limit the degree of such looting.
Consider that this is the opinion of the majority with what to do with falling house prices, after all, so I'd say that this has strong popular support.
No bank is solvent during a run.
Suppose, however, the Feds sent in auditors who would merely take all of the "off balance sheet" bits that every bank has, and move them briskly right back onto the banks' balance sheets. At that point, we would at least have a transparent look at what condition the banks were each really in. And that removal of uncertainty would go a long way towards making everybody willing to trust them again.
Megan McArdle's default narrative when discussing the current financial crisis is to assault liberals - nothing specific mind you; simply the typical liberal straw-men. This despite the fact that the current crisis was brought about by libertarian conservative Republicans - not labor and/or American manufacturing advocates. Not surprising. Obviously, Republicans only need Joe the Plumber - or a caricature there of - at election time.
As for trashing FDR and derisively second guessing decisions made seventy years ago; without FDR there would be neither capitalism or democracy as we now know it today. Then as now, Republicans made a mess and then went to the sidelines to point fingers at the people following them with a mop.
Maybe seventy years from now, some "blogger" will look back at your article here and get a good laugh at your suggestion that giving a trillion dollars worth of taxpayer money to the same frauds and crooks who wrecked the banks was worth a try. I suppose communism was worth a try too.
Great Post, Thanks
Nathan, nice try, but the current crisis was caused by one thing - a relaxation in the standards for approving home loans. This idea was pushed by Democrats initially through the CRA (ACORN) and then placed on steroids by FANNIE and FREDDIE, who were run by Democratic political hacks (not bankers) (Frank Raines, Jamie Gorelick, heck even Raum Emanuel) who then allowed the ACORN standard to apply to all lenders. Wall Street's role was to take a very very bad idea and figure out a way to more efficiently keep the bad loans hidden and to make money off of the hiding of the risk.
I find a couple of things interesting about the great depression. First, monetary studies show that the money supply shrank about 25%. This was due to Federal Reserve actions. That much deflation was going to be very painful, but it appears to me that the government made it worse by trying to prop up prices. There was insufficient money to support the price levels. When I talk to my parents about that time, they talk about having no money. Much commerce was barter because neither side had money.
In the present problem, the difficult issue appears to me to be that the underlying asset problem is mortgages - no one knows how many will go bad and where housing prices will end up, but while the sub-prime mess is almost over, we have probably another 2 years until we get a good handle on how bad the option arm mortgages will be. Many of them don't start resetting to real rates for another year. Since that is the basis for most of the bad assets, it will just take time to fix this.
lastly, I find that government intervention in the economy rarely makes things better but often makes things worse. An givien the huge debts being run up, I expect interest rates for govenment borrowing to start to rise (also because the Chinese will not longer have these huge surpluses to invest which kept rates low). I can't see any way to pay this (and these economic problems are going to make budget problems with Medicare and SS hit us sooner. I expect the government to try to inflate their way out.
Zic,
I've had the same issue with both Citi debit and credit cards. In Citi's defense, however, Citi is one of the largest, if not the largest issuer of credit cards. Basically, if you used a credit card in a location where a known breach has occurred, they will cancel your card and issue you a new one. But, since Citi is the biggest, there is a higher chance that a person who got ripped off at a location you recently used, had that happen with a Citi card themselves, which is how Citi finds out about it. I don't know how true this is, but my guess is that this is a big reason. Though, after BofA bought MBNA, they became quite big in credit card issuance as well, and I've never had them cancel my cards. Ditto for Chase.
So what would it look like for the government to start running out of money? How many trillions can we borrow, after all?
Do you think we'd see a gradual rise in interest rates, along with some rumbling from foreign governments like China? Or would sentiment suddenly change, leaving us surprised (yet again) that there are consequences to our spending?
And does anything in this bailout even remotely resemble investment -- activity that will produce a return so you can pay off the loan? Or is it all consumption, that just leaves us deeper in the hole?
How can you call the bailout a failure when Treasury hasn't spent all the money? All Paulson did before now, for the most part, was to inject some equity into certain banks to shore up investor confidence in their balance sheets. He knew that some of the banks in the worst shape (read: Citi) might well need more money. It did, it got the money, and thus has not failed. And half the TARP money is left. You're calling the game at halftime.
What TARP has clearly failed to do thus far is reassure investors that NONE of the subject banks will fail. The market clearly believed that Citi had a lot more balance sheet pain to endure and thus punished its stock. (But there was no depositor run.) Of course the punishment stopped today, but sho knows, maybe it's only temporary. In this market, there's not a whole lot of rational analysis, but loads of fear-based selling.
MichaelG, your question will be answered soon enough. We can't go on borrowing forever, yet there is no political support for ending our steady diet of debt. The result of TARP -- not to mention the trillions we will surely try to borrow to pay for Medicare, Medicaid and SS -- will eventually be huge inflation, which will send foreign investors running from the dollar.
Has anyone considered the possibility that the firms in question might start actually generating real profits in the next couple of years and will be able to buy out federal stakes? I mean, even under the original equity injection, I recall that the feds gave the banks something like 5 years to pay them back or else their warrants become converted into preferreds with huge dividends (am I recalling this correctly?). Presumably, a) banks have no interest in this happening since their shareholders will revolt and b) even if this does happen, the government will sit on nice dividend payments for all of eternity. Now, if the banks don't recover well enough to be in this position, well, we're screwed either way, TARP or no TARP. Look, I don't even know what I think about the bailout and whether it was necessary and whether it was structured correctly or not, but I'm not entirely certain that all this money just went into a giant sink hole never to be seen. If that's the case, we have worse problems than runaway inflation. Even before that happens, we'll have to start taking shifts with junior standing outside the ranch with a shotgun keeping the roving gangs at bay.
Nice list of what good and bad ideas. A handy dandy summary for your next soiree:
Bad
---
Equity investment in banks to make a firewall
Bank holidays
Price supports (no milk dumping)
Cartelization
Court-packing
Buying gold
Minimum wage laws
Unionization
Increased corporate taxes
Industry bailouts
Industry micromanagement (e.g., forcing customers to take the "next" regardless of its condition item rather than letting them choose from those in stock - yes, NIRA did stuff like that)
Good
----
Deposit insurance
Bank solvency audits (albeit tough to do with today's financial menagerie)
Monetary stimulus (easing)
Work relief
Extended unemployment benefits
But it needs a few more entries:
Bad
---
Excess leverage (margin-based investing then, subprime mortgages and MBS now)
Budget balancing (increasing taxes to pay for increased spending which FDR did until the war began)
Increasing reserve requirements
Policy uncertainty (will they go off the gold standard? will they refinance my mortgage?)
Coupling (across finance and across countries)
Good
----
Social Security
Civilian Conservation Corps
Lindsay's voluntary 30 yr/4% full recourse assumable mortgage refi plan (if you ask me...check it out)
Basil:
Nice try in blaming all this on ACORN, Fannie and Freddie and the Democrats, but you are totally off base. When the total mortgage debt in the country is approximately $15 trillion (only a small percentage of which involved Freddie and Fannie), and the total dollar amount of swaps is approximately $55 trillion, you get the idea that the problem is pure greed by Wall Street. Read Michael Lewis' take on what gave us the current situation and you'll quickly see the CRA was an extremely minor part of this problem.
The problem goes back at least to LBJ and Nixon. Point-scoring about the relative responsibility of those two uberduds W and Slick Willie is feeble stuff. The sucker, as W so sagely put it, may be going down. Conceivably it might even provide the answer to Mr Lincoln's enquiry about endurance.
It's worth noting that 3% mortgages imply 33:1 leverage - just the ratio that brought down the investment banks...3% mortgages and so on is exactly how you get underwater borrowers, and now, meltdown.
Jim, I didn't blame it ALL on FANNIE and FREDDIE and the Democrats. I only stated the obvious truth, that it STARTED with them. It was their idea. they thought, and probably still think, that it was a good idea. Have you ever met a Democrat who has ever admitted to having a bad idea?
The Wall Street guys (btw, a majority of whom are liberal Democrats - look at the political fundraising numbers) made it much worse.
When you try to substitute political will (we must, after all be FAIR) for markets you get the mortgage meltdown (and the Soviet economy).
I hope a 9/11 Commission type investigation will be done. The facts are there to be discovered.
Thanks to Basil for providing us with a pretty crisp summary of Wingnut Unified Theory (WUT?). I will have to deduct several points, however, for failing to tie in the undeniable fact that John Kerry shot himself just so he could run for president. This of course, is proven by certain facts of the Vince Foster homicide.
Are you by chance a producer for Sean Hannity?
You are a disgraceful rightwinger and I love it.
"When the total mortgage debt in the country is approximately $15 trillion (only a small percentage of which involved Freddie and Fannie)"
and yet, only a small percentage of those mortgages were sub-prime, but they sure did some damage, eh?
I would agree that the CRA was only part of the problem. I would agree that the FM/FM with their leverage and buying of mortgages worsened the problem. I would agree that greed (not just Wal Street) got people to do many things that led to the crisis (borrow too much, lend too poorly, flip too many houses)
But Democrats are too eager to say this was all done by Republicans somehow...come on. Complex issues have complex causes.
One question is when did we start to switch from 20$% down payment mortgages? That was a big change.
Nathan, nice try, but the current crisis was caused by one thing - a relaxation in the standards for approving home loans. This idea was pushed by Democrats initially through the CRA...
A nice theory. Unsupported by facts.
From http://www.traigerlaw.com/publications/traiger_hinckley_llp_cra_foreclosure_study_1-7-08.pdf
Our study concludes that CRA Banks were substantially less likely than other lenders
to make the kinds of risky home purchase loans that helped fuel the foreclosure crisis.
[Emphasis added]
Oh yes, Well Fargo is completely safe. They don't own at or more than half of all the check cashing places in America, practically. They haven't been a Burger King of predatory lending to Citibank's McDonald's.
There comes a point where you have to say 'this is just wrong'. I dont' care if the country slides into depression if Citigroup isn't bailed out. The message here seems to be that if you get big enough, you can get away with anything. I was against bailing out detroit too, but hell, at least they MAKE something.
Break up Citigroup and sell the pieces. Let them go out of business. We aren't going to get out of this without some pain so lets bring it on and get it over with.
I have always been careful with credit. I never borrowed more than I could make payments on. I put 25+% down on my house, all my cards are paid off. My wife and I have foregone vacations, new cars, furniture, etc... in order to save. I am sick and tired of companies like GM and Citigroup holding us hostage.
I say 'no more' - come whatever.
For those bickering, to "suffer from want" is an idiomatic phrase in English which roughly means to be unable to satisfy basic human needs including but not limited to safe/warm housing, food, water, and other very basic necessity. In FDR's four freedoms, one of them was "freedom from want" and was used in the same respect as Megan uses it here.
What do you mean "It hasn't worked." Of course it's worked otherwise we'd now have experienced a complete seize up of the US economy and indeed much of the world economy. This is a typical piece of journalistic sound bite reasoning applied to an issue of enormous complexity. Maybe it hasn't produced that instant gratification without which Americans don't seem to be able to get by but there is no doubt it has headed off a catastrophe. All surgeries don't work out perfectly, at the least the patient has to spend time in intensive care, and if a new crisis blows up it has to be dealt with. For sheer inanity it's sometimes hard to beat the prognostications of so called pundits.
Hi Basil,
I suppose the CRA _required_ Lehman Brothers to run a 70:1 ratio? I guess the CRA _required_ the rating agencies to take BBB junk debt and rate it AAA? I'm waiting for the argument that explains how CRA built those mountains of empty condos in Ft Lauderdale and Miami. LOTS of low income vagrants there just soaking up billions and billions of money. Oh, and CRA paid for those infomercials on "how to ride real estate to easy street." [?]
Clowns, wingnuts, and crazies are all that is left of the GOP. The gods have fallen, but long live the GODS of Wall Street. But believe your opposition on this one, Basil - when taxes do go up to pay for these bailouts the fault will be assessed where it belongs, with Greenspan, Bush, Rove, and Paulson. Eight years won't be washed away by labels of "liberal." The word "Hoover" has a definite meaning in the mainstream culture. "Bush" will be as notorious.
The word "Hoover" has a definite meaning in the mainstream culture. "Bush" will be as notorious.
Bush is starting a vacuum company?
@Rob Lyman,
I'm struggling mightily to avoid making a remark about the future ex-President's great suction power. Must resist...