Why is the government so reluctant to hand losses to the bondholders? The standard explanation on both far left and far right is that Treasury and the Fed are in the pocket of the banking industry, and Geithner et. al. are simply bailing out their corporate masters. I don't entirely discount this theory, though I would (and did) put it more nicely: all the information the regulators has comes from the people they are trying to regulate. This naturally biases them towards the regulated. Every time I am tempted to get outraged about this, I think through the alternative: regulators who don't have much interaction with those they oversee. I'll take Tim Geithner over Maxine Waters any day of the week, and twice on Sunday.The guarantees that the US government has already extended to the banks in the last year, and the insufficient (though large) capital injections without government control or adequate conditionality also already given under TARP, closely mimic those given by the Japanese government in the mid-1990s to keep their major banks open without having to recognize specific failures and losses. The result then, and the emerging result now, is that the banks' top management simply burns through that cash, socializing the losses for the taxpayer, grabbing any rare gains for management payouts or shareholder dividends, and ending up still undercapitalized. Pretending that distressed assets are worth more than they actually are today for regulatory purposes persuades no one besides the regulators, and just gives the banks more taxpayer money to spend down, and more time to impose a credit crunch.
These kind of half-measures to keep banks open rather than disciplined are precisely what the Japanese Ministry of Finance engaged in from their bubble's burst in 1992 through to 1998 ...
And in this case, I don't think that's the whole, or even the greatest part, of the explanation. Rather, I think their problem is largely political: avoiding the "n" word, yes, but more importantly, avoiding any more crisis injections of capital into the system.
It's easy to blithely say "Why don't they just make the bondholders take a haircut?" Harder when you think about who those bondholders are: insurers. pension funds. the bond component of your 401(k). Financial debt makes up something like a third of the bond market, and the largest holders are pensions and insurers.
The insurers are the biggest problem, because they're just so heavily regulated. They're not allowed to hold risky assets. Convert their bonds to equity and they will be forced to dump that equity at prices that will trend towards zero. Many insurers will see their capital impaired below the regulatory limits, requiring a government bailout.
Pension funds are the next biggest problem. They're already in big trouble because of stock market declines. The bonds are the "safe" portion of their portfolio, the stuff that's supposed ot be akin to ready cash. Convert their bonds to equity--or worse, default--and suddenly they're illiquid and even further underwater.
Nor is the 401(k) problem small. Bond funds are typically held most heavily by the people closest to retirement; they're for income, not capital gains. What is your mother going to do when a third of her mutual fund income gets converted to equity that produces no cash and can't be sold because the insurers have all had to dump their shares on the market at once? Or simply disappears into the land of bankruptcy lawsuits?
There's also the problem of what it does to the ability of banks to raise capital. Bank bonds are sold on the implicit assumption that the taxpayer, not the lender, will eat capital deficiencies. Changing that understanding risks runs on the bank a la Lehman whenever a financial institution looks the least bit shaky. Banks are inherently highly leveraged institutions even in a good regulatory environment; this might make our banking system much more volatile in the future. It's somewhat akin to what would happen if we simply announced that the FDIC would stop tomorrow.
I think what Geithner et. al. fear is that nationalizing or reorganization will put the government on the hook for massive and immediate losses in both the banking system, and the "safe" entities that lent it money. I fear they may be right. But I think the lesson of Japan is that we have to do it anyway. I don't know what form the fix should take. I don't know how painful the fix will be. But I'm pretty sure any fix that makes us recognize the losses, recapitalize the banks, and move on, will be better than two decades of zombie banks and glacial growth.
This is exactly right. Lost in all the hysteria around blaming Lehman's bankruptcy as the "cause" of the crisis, is why Lehman going bankrupt caused any problems at all. It was because outstanding commercial paper caused losses at the Reserve Fund which led to them breaking the buck, halting redemptions, and triggering a run on money market mutual funds. When people talk about nationalizing Citi and Bank of America, they need to consider who owns the securities that they are suggesting be wiped out or given a haircut. Citi is 3x larger than Lehman was. BAC is even bigger than that. The market won't easily digest hundreds of billions of dollars in bond losses are debt to equity conversions.
Megan,
Exactly! The losses will fall on anyone holding financial assets, which is most people in the US, in one form or another. The political class is utterly terrified by the prospect of this becoming general knowledge. That is why you see so many attempts to construct stealth bailouts, but in the end, reality can't be evaded forever, or even very long since the most productive workers are not far from retirement.
Great post, thanks
Somehow we need a person with a baseball bat standing near any pundit that claims we should let the rich take the hit, it won't happen we will see the true effect of trickle down economy.
Amen, Megan. This is the systemic risk that I was trying to convey to Basic Fact. Is there any chance that the dithering by Geithner is an attempt to give counterparties time to unwind or limit their exposure?
Al makes a request:
I wish Megan would explain this further, because I don't understand.
Why would diluting the common equity shareholders not lead to instability, whereas haircutting the debtholders (and preferred equity holders) would lead to instability?
What is the difference between common equity holders and debtholders (and preferred equity holders) that is relevant to the instability that Gross (and Megan) say we need to avoid?
Now, Megan answers. Thanks Megan!
For the record, I'm not convinced at all by the explanation. If, by haircutting bondholders you cause trouble at some insurers or pensions, then you can always bail out the insurers and pensions. I see no reason to bail out 100% of bondholders simply because a minority of those bondholders are systemically important institutions - I'd rather send my limited support to the minority of bondholders we deem important (i.e., insurers and pensions) than to all of the bondholders including Bill Gross.
If we need to bail out the California Teachers pension, fine, but the price for doing so ought not to be bailing out Bill Gross too. Focus narrowly on those important bondholders, and let the rest of the bondholders take the losses on their bets.
And as for the idea that this will impair banks ability to raise capital - so be it. If there really is an "implicit assumption that the taxpayer, not the lender, will eat capital deficiencies" - and I'm not sure there is - then we ought to either get rid of that assumption or make it explicit. Like we saw with Fannie/Freddie, implicit taxpayer guarantees are a very bad idea. If the price of eliminating that assumption is further bailouts, so be it, but we should not continue to have all of the non-sensical implicit guarantees.
I gotta be honest: After reading the title of the post, I was really hoping to read about Locke, Hurley, and the gang.
But didn't Washington Mutual's bondholders get virtually wiped out? No one seem to care in the insurance/money market world when that happened.
"I'd rather send my limited support to the minority of bondholders we deem important (i.e., insurers and pensions) than to all of the bondholders including Bill Gross."
Its not just Bill Gross, its the millions of people invested in his funds via 401k plans, etc.
Every time I am tempted to get outraged about this, I think through the alternative: regulators who don't have much interaction with those they oversee. I'll take Tim Geithner over Maxine Waters any day of the week, and twice on Sunday.
But why would you take Time Geithner over Paul Krugman? Or Felix Salmon? Or any of the many other knowledgeable and intelligent people who think the banks should simply be nationalized? Nobody is proposing Maxine Waters be put in charge of this.
DB Cooper,
Me too!
By the way, what is the date for John Locke now and the passengers of the newly crashed jet? I got the impression that Locke is now separated from the Oceanic survivors by time.
so too big to fail really means too many owners? It's not really about the size of the bank, its about the number of people who take a hit when the bank fails?
Lets see; the bank stocks we owned (sold several weeks ago, now,) would be worth 1/3 to 1/2 of their value a quarter ago. The energy stocks tumble up and down like the barometer. The education stocks are simply down, though people are flooding back to school for retraining. The health care stocks are anemic, even though the boomers get older and sicker by the day. And these are the sectors President Obama promised to focus on, to pour billions of dollars into. We're already taking a haircut, everywhere except the growing foreclosure and bankruptcy industries, as far as I can tell.
Looking at this as a logic problem, I keep coming back to what part of "too big" are we trying to avoid. Because too big is too big is too big. Instead of nationalizing, break them down. Some parts will fail or be nationalized, and the investors and bondholders will take a hit. But some parts will thrive, and they'll start making a profit again.
Or, to make the point succinctly, why would you take Tim Geithner over yourself? Your knowledge comes from interacting with the people you propose to regulate, and yet you've managed to come to a different conclusion.
I think your regulatory-capture thesis is pretty persuasive.
By the way, what is the date for John Locke now and the passengers of the newly crashed jet? I got the impression that Locke is now separated from the Oceanic survivors by time.
Posted by Yancey Ward | February 26, 2009 11:36 AM
Enough! I'm 23 episodes behind, no more spoilers. Please!
Megan nailed it! It's much more complicated than simply protecting the interests of the bankers. I could name a bunch of interest groups that will be harmed (at least in the short term) by nationalization. Yet I can't think of one organized interest group that will be positively impacted. (There must be some - anyone?)
Also, I don't know the numbers off hand, but I bet there's great concern about foreign investment as well. In some ways they're an even more important constituency, since debt financing terms will have a huge impact on our economy for the foreseeable future.
the millions of people invested in his funds via 401k plans
I'm sorry that people invested in things that ended up to be riskier than they had thought. (And that includes me.)
But our support cannot be unlimited. I don't thik we ought to be bailing out Bill Gross and other people who don't need to be bailed out. If we need to bail out pensioners and people expecting life insurance, so be it. And if Megan's mother is so poor that she can't live on her retirement income after some of her bond funds take a hit, then we ought to help her. But if Megan's mom's retirement income goes from $100k/year to $90k/year, that OK by me - there's no reason to be bailing her out too.
Sorry, RG. Mum is now the word.
Greatly appreciated, Yancey. And it's 3 eps behind, not 23. Darn kids and lack of sleep.
Juicy, thsi makes it sound like the WaMu bondholders were not wiped out, JPMorgan assumed the debt.
http://www.fdic.gov/bank/individual/failed/wamu.html#possible_claims
I'm thinking the government is witnessing the lack of market for AIGs assets, and fear the same if they nationalized Citi or BoA.
I don't watch Lost, but don't you think that asking people to avoid discussing episodes from months and months ago is a bit excessive?
It's really very simple. "Hand losses to the bondholders" = Lehman brothers collapse on steroids. It turns out that the consequences of that were horrifyingly bad. So bad, in fact, that a lot of plain awful things start to look good if they can prevent that - even things as bad as the Japanese non-Solution.
Ah, I see the update, RG - 3 episodes is a lot more reasonable than 23.
Anyway, going by your link, it appears to me that only WaMu *secured* debt was acquired by JPM - which makes sense since the assets that provided the security were likelwise acquired. But it appears that unsecured debt was left out.
Zic,
Where the losses will happen that will completely blindside people is in those types of assets they view as the same as cash. We are talking trillions of dollars of debt/assets that are going to lose their "moneyness", as Doug Noland likes to describe it. Cash you can hold in your hand is a small fraction of what is treated like money by the population.
Dammit, you title the post something like that and I think you're going to tell us if Desmond is coming back to the island too.
Unless you bought government bonds, you were buying senior debt, that's all. In a sense, the question is which 'promise' or expectation is going to be broken. Peter Lynch, an 'expert' former director of Magellan Mutual Fund, has famously said that if you bought common stocks at the worst time and sold at the worst time (for you) over the long run you would come out ahead. So it depends on what promise you have to break.
It's not just regulatory capture, although I think that's part of it. They are just too scared of the ramifications of letting the losses fall where they will fall. I think Geithner and the rest have concluded that the situation is so grim that a lost decade or two is inevitable anyway. Why go through a paralyzing cascade of sudden losses as well? Bernanke's optimism is feigned, but he's just trying to do his job.
Megan, you've hit the crux of the "problem". But the answer is that the pension funds, 401ks, etc. *should* take losses, since they've taken on the risk. It is much fairer, and cleaner, if the people who put money into risky instruments--even if they thought the instruments were safe--take the losses, rather than the government deciding collectively to spread them amongst everyone.
Yes, it will be massively, widely painful. But that pain/loss already exists, it's just a matter of who, when, and how it's felt.
RG - thanks for the link to the FDIC release for WAMU however JMP assumed only the deposits & secured claims of Washington Mutual Bank. The FDIC states " Any claims by equity, subordinated and senior unsecured debt holders were not acquired (by JP Morgan".
We used the words bonds/deposits/banks interchangeably, but we need to be clear. For Example, Bank America Corporation (the publicly traded entity) is not a bank, it is a bank holding company. The bank it owns is Bank of America N.A. Bank of America N.A is a bank and it is the legal entity that makes your home equity loan, holds the FDIC insured deposits, etc. The only asset that Bank America Corp owns is the stock of the bank, not the banks assets directly (it also owns the stock in Merril Lynch and Countrywide, but lets leave those aside for the time being). There is no FDIC or similar support of the Bank Holding Company it is all at the bank level. If you are a creditor of the holding company, you only have access to the net assets of the bank after the depositors have been paid. Everyone in the bond market knows and understands the difference between buying a bond issued by Bank of America NA and Bank of America Corp.
So, when we are thinking of 'bondholders taking a haircut' we need to make a distinction between the bondholders at the holding company (who knew they were structually subordinated to the bank depositors) and the bondholders at the bank level where they have access to the assets of the bank. For example, as of 12/31/07, there were nearly $135Bn of bonds outstanding issued by Bank of America Corp (this in their 10K filing, the 10K for 12/31/08 hasn't been filed with the SEC yet).
There is a world of difference between the bondholders of a bank and the bondholders of a bank holding company. People who are funding the bank know there is a regulator and I can see the argument for why we want people not to lose money at the bank level, since it is the bank funding the loans for us to buy houses etc. But, at the holding company, you always knew there was a risk that if the equity of the stock of the subsidiary bank is worthless, you are hosed. This has happened. Maybe the bonds are worth 30, 50, or 70 cents on the dollar, I don’t know. But they always know they had this risk which has eventuated.
Yes, Yancey, you're right. But that's why I think breaking the insolvent banks up is crucial; some of the mini-banks that result will fail and go through bankruptcy or be nationalized. And the public will take a hit, a hard hit. But some of the mini-banks that result will thrive, and the public will also take a profit; the cash machine will keep chugging out cash.
Think of it as the good bank/bad bank scenario, but instead of creating a central bad bank, we create good/bad bank twins. Eventually, the bad-bank toxic assets will become valuable as we develop a more satisfactory method for disposing of foreclosed homes. Right now, that system doesn't function well.
More importantly, we return to an era where market forces, including wise management and real risk aversion, control the system; and we return to a system where banks well seek growth but be cautious about too much growth. No individual company should be so big that it threaten the world's economic vitality. (Personally, I feel that way about nations, too, but that's another discussion on American Exceptionalism, and can wait for another day. It is what I heard Jindel reinforcing, however.)
Let failing banks fail. This is what markets are supposed to do.
My favorite episode of Lost was when the aliens were fighting the talking computer and Locke was arguing with Jack while he performed surgery on their leader. Who would have expected that Kate was Hurley's real mother?
I have never watched Lost, but I wanted to start watching it, since people seemed so obsessed with it and it gets such great reviews.
I went to the video store and got the first season on DVD. Took it to the counter. The counter guy--video store geek extraordinaire---looked at me. (following conversation paraphrased, but barely):
"You don't want to rent this."
"Why?"
"Oh, it seems like a good idea. Like when some very pretty girl starts flirting with you, but something's off about her. You think she's mysterious or got deeper meaning due to the mystery, so you keep going on dates with her. The sex is great, but everything's just a bit off besides; her conversations are nonsequitor, her job seems unpalatable, her apartment is just strange, and everything is off kilter.
Still you chalk it up to her artistic nature and think that just by getting to know her, it'll all make sense. After all, she's pretty and sometimes nice to you and the sex is still good. but months go by, and instead of her personality and life getting explained, it gets weirder. She starts calling you at 3am. She wears neon orange and 1980s clothes on regular days. She talks abotu Phillipino goth bands and African lesbian punk bands one day, country fried singers the next. It's like her life is in a blender, and you've just been added as an ingredient, and slowly, she's turning up the processing speed.
Then one day you come home and find her buck naked, lying face up on the floor, trying to have a conversation with the ceiling fan.
That's when you realize: there was no greater explanation to her mystery or life. There was nothing deep about her, and she wasn't just a quirky girl.
There was no point; the chick was just fucking insane. And the whole time you spent with her was meaningless and a complete waste. "
I left the video on the counter.
It's true, when we do the right thing by nationalizing these zombie banks and wiping out stock and bond holders, it will hurt a good many pension funds, 401Ks, etc.
This is a strong argument for increasing the benefits paid with social security, so that we are not so reliant on the vagaries of the financial markets enabling people to have a dignified retirement.
I look forward to the day that our social safety net expands to match other developed countries - it looks like this whole mess is bringing positive steps in that direction!
Please, people!!!! I just ordered the first DVD of lost. NO SPOILERS!!!!
We now return to your regularly scheduled complaining about Timothy Geithner.
Matt, I'm not sure I get your criticism. I also get my information from these folks, and am aware that that information is therefore biased. My point is only that there's no way to really get around regulatory capture--you can try to control for it, but you can't eliminate it from your analysis, except by deciding that you're going to ignore everything those dastardly bankers say (like Waters), or not having any regulation.
With all respect to Krugman, both he and I have a lot less information than Timothy Geithner. I've been pretty harshly critical of Geithner, and so far I think he deserves it, for dithering unconscionably. But I'm also aware that he knows things I don't, that those things may be very, very scary, and it's a lot easier to criticize or propose never-never plans than to actually put your ass on the line and make a bet.
Of course, insurance companies are very often just another conduit by which retirees access income, be it in annuities, life insurance payouts, long term care policies, etc. In contrast to social security benefits, this income was not supposed to be dependent on an IOU being satisifed by people, often not yet born, who never agreed to provide an IOU, but rather from an insurance company which willingly accepted cash, and then lent the money to supposedly creditworthy entities owned by people who were owners by choice.
I don't know any way out of this mess without a lot of people getting it good and hard, the only question is who gets it worst, and contrary to what The One said or implied the other night, there ain't enough people making more than 250k annually to load it up on them. So, then, who?
So much of our economic and political activity in this country seems devoted to the purpose of keeping retired people warm and comfortable, and for good reason; it's nice to be warm and comfortable, and there are a lot of retired people. Of course, retirement is now quite frequently a multi-decade period, whereas
in the recent past that was far more rare. It seems to me that the paradigm of a large number of people spending the last 20-25 years of their life, many of those years in relative good health, not being economically productive, is not and never has been tenable.
Thus, as someone under the age of fifty, I'd mnake this contributiion; go ahead and tell me right now that I can't draw nondisability governnment retirement benefits until I'm 75 or older. Also increase the age of eligibility for those youngwer than 60, although not all the way out to 75. Start some form of means testing for social security benefits immediately. Use some of the current Social Security revenues to lessen the haircut of the bondholders of insolvent banks. Stop pretending as if these banks are not insolvent.
Nor is the 401(k) problem small. Bond funds are typically held most heavily by the people closest to retirement; they're for income, not capital gains. What is your mother going to do when a third of her mutual fund income gets converted to equity that produces no cash and can't be sold because the insurers have all had to dump their shares on the market at once? Or simply disappears into the land of bankruptcy lawsuits?
Wait a minute. What percentage of a typical bond fund's holding consists of BofA and Citi bonds? Did anyone's bond fund get wiped out when Enron and MCI went down? You can't just say, hey, bond funds own these companies' debt, so if you nationalize them mom (or pension funds or insurers) is going to get smacked. You can't just assume that because a few corporations get nationalized that means 1/3 of the 401k is wiped out. You can't just make a conclusory statement and that's it, you win the point because it sounds good. Data and facts matter. You're doing the same thing as with your mortgage cramdown arguments: you're just making conclusory statements that sound intuitive or logical (you know, like the sun orbits the earth) without providing any data to prove it. But this argument doesn't even sound intuitive and logical. Just how much would most bond funds get hit because of a few companies getting nationalized? I don't know, but at least intuitively, my guess is Citi and BofA and the top 10 or 20 banks alone are in the single digits in terms of percentage of most bond fund holdings.
Megan, I'm no member of the Geithner Fan Club, but I also think that it is more likely that he has information which would rapidly alter dear Prof. Krugman's high regard for dear Prof. Krugman's expertise, if Krugman knew what Geithner knows, than it is likely that Krugman is a lot smarter than Geithner.
I think everyone is underestimating the scale of the financial system reboot that is needed. Zombie Banks are only part of the problem.
The US gov needs to repudiate the national debt, repeal legal tender laws and start over. Crank the printing presses so that FDIC insured depositors get at least some fraction of their money back.
This bank nationalization is analogous to the GM bail-out. It's too little too late. Propping up these banks is just throwing good money after bad.
There is no painless solution. Japan's lost decade(s) will be a walk in the park compared to what is in store for us.
No country, no genius, no miracle worker has ever found a reasonably quick way out of a financial crisis that did not entail recognising the losses. It is also the universal experience that the longer the recognition of losses is put off, the greater are the losses. Dithering about who takes what share of them will end in everyone, and especially the taxpayers, taking more of them.
The limit for Mr Geithner's conscionable time a-dithering expired a month ago.
It is also true, but no defence for Mt Geithner, that the Bush Administration's conscionable time for dithering ended on about July 31 2008.
No, mlarsen2e3, it's a good argument for telling people that they aren't entitled to anything, and the expectation that people, in good enough health to work, can live off younger taxpayers for many, many, years is not how a responsible person treats his fellow citizens. But my personal experiences have biased me; I knew two of my grandparents, who died in their mid-nineties, after working until their late 80s. I hope to do the same.
Will Allen,
I guess all we have to do is figure out when everyone is going to die, and give them social security only for those 6 or 7 years before death, since that seems to be the amount of time you feel comfortable with old folks being parasites.
No, mlarsen23, all we have to do is tell people that if they are in good enough health to work, and there is work available, then they don't get a check from the government. Doing things that other people value, in order to have them willingly give you things that you value; what a concept!!!
"Nor is the 401(k) problem small. Bond funds are typically held most heavily by the people closest to retirement; they're for income, not capital gains. What is your mother going to do when a third of her mutual fund income gets converted to equity that produces no cash and can't be sold because the insurers have all had to dump their shares on the market at once? Or simply disappears into the land of bankruptcy lawsuits?"
Remember a phrase from a movie "Other people's money"? "I've got only two words for it: who cares". Somebody brilliant has invented a great marketing tool for investments in stock and bond markets: this person called these investments "savings". They are not savings, they are gambling. Do not you know that bond funds also might lose value? If you want to save, put money on a CD.
You don't have to rent or buy Lost on DVD, unless you just want to. Every episode is available on-line at ABC.com I watched the first 4 seasons there.
Will Allen,
Who decides if there is work available for these folks, and how does this decision get made? Sounds like we'll end up with some kind of workfare for the elderly with what you have in mind. We can have grandma picking strawberries or greeting at Walmart until she drops dead I suppose.
It seems to me you want the US to be more like Nicaragua. I'd like it to be more like Denmark (the happiest country in the world, according to surveys).
No, mlarsen23, all we have to do is tell people that if they are in good enough health to work, and there is work available, then they don't get a check from the government. Doing things that other people value, in order to have them willingly give you things that you value; what a concept!!!
I agree with the sentiment, but I don't think we want to create incentives to not be in good health. I'd just have a sliding scale means test for SS benefits and be done with it.
We can have grandma picking strawberries or greeting at Walmart until she drops dead I suppose.
Or we can do something wacky like actually save for our own retirements.
mlarsen23, Denmark is weaslthy. Nicaragua is very poor. Wealthier people tend to be happier than very poor people, although happiness has a lot of factors. You seem to believe that Denmark became wealthier by having peoople not work. You are incorrect.
You are also living in the past, when a perfect storm of favorable demographics in the first countries to industrialize made it quite easy to provide long, long, retirements to a small segment of the population from everyone else's labor.
Well, mlarsen23, we're on our way.
If we lose about 20% of our GDP, and more than double our national debt, we'll be just like Denmark in per capita terms.
Stats from nationmaster.com, Economy Statistics > Debt > External (per capita) .
@Brian2:
One of SoV's great moderate statements is that it isn't your JOB to be responsible for your own economic well being. Other people should make those decisions FOR you without any of that pesky personal responsibility.
Ahh, I think 'Lost' is getting focused now they only have this season and the next season left.
Loose-end-pickup is outrunning loose-end-creation by at least 2:1 at this point.
Ah, John, so eagerly ready to be totally shamelessly manipulated by Ben, by Widmore, by whoever.
Things I am living for:
(1) Ben somehow convincing John that, never mind that strangulation, I was working with you all along, you special man.
(2) John sucking it up, and then
(3) Ben screwing him over again anyway.
I think the disconnect here is many are arguing for bondholder haircuts on the grounds of fairness and justice (even if it reminds me a lot of Airplane - "they knew what they were getting into. I say, let 'em crash"). From that perspective it would seem like policymakers are bending over backwards to protect creditors, perhaps due to regulatory capture. In reality, policymakers recognize that, as in the Lehman episode, when you make bondholders take big losses then unsecured lending in the financial system ceases. This is entirely rational - why should i make a short term loan to a financial institution in these precarious times when i run the risk of massive losses (I believe Lehman recovery was around 15 cents on the dollar). When short term unsecured lending ceases, the economy grinds to a halt and everyone is worse off. I know as a taxpayer you may feel like you are getting screwed by having to make whole a Citibank bondholer but I think the evidence is very strong that you are much better off, even if it seems unfair.
That's true JB, but it is also true that the chance of making substantial economic progress prior to reconciling the balance sheets of these banks is approximately zero, and doing so without requiring the bondholders to shoulder some losses also approximates zero.
Choosing the preferred spot on the spectrum ain't much fun, I suspect.
And for those who would welcome a Japan-like outcome, I would point you in the direction of Japan today.
Fraggle Rock,
According to nationmaster, Denmark's public debt is 26% of GDP, vs. the US at 61%. That doesn't seem so bad to me.
And despite missing that GDP, the country seems pretty nice and folks don't have to worry about health care or retirement. Since in the US 20% of the benefits of that GDP probably goes to a very small slice of our population, maybe we wouldn't miss it if we did things the same way as Denmark.
I think this is wrong JB. There are solvent banks. And they will continue to get funds even if necessary from the government temporarily. That's the legitimate job of the government - saving solvent banks in a crisis, but not insolvent ones. As the largest bank failure in history, WAMU, shows another bank can get the assets and obligations to depositors and be in "good" shape not having to deal with the liabilities to bondholders.
mlarsen23:
You wouldn't miss other people having less money. How generous of you.
mlarsen23:
Comparing the US to Denmark is like comparing the state of Michigan to the Upper East Side of Manhattan. The problem domains are not really comparable.
Fraggle Rock,
No, I'm saying I wouldn't miss a very small portion of our population that has much, much, much more money. But you are right, I am not generous where these folks are concerned - I'd like us to tax them much more, like they do in Denmark today and did in the US in the 50s.
And Snob I think it's often very useful to compare all of these locations and many more. I'd like to know in which of these locations are people happier, have better health, more dignified retirements, better education. Of course they are different and have different issues, but I think we have a lot to learn from other countries. I don't understand why we don't compare our cities, states and countries to Europe much more. Mainly it seems to be the reflexive distrust that Joe the Plumber types seem to have for other countries.
What exactly is dignified about living off another person's labor when you have the ability to support yourself? My grandparents defined dignity in exactly opposite terms. Boy, were they saps, huh?
Will Allen,
I'm happy that your grandparents were able to keep working into their old age. Unfortunately, not everyone is able to keep their jobs after a certain age. People break down physically and mentally to varying degrees as they age, and although they may be fit enough to keep some kind of job, they are often poorly equipped to learn a new job. The opportunities they have for employment often decline. The notion of elderly people who are basically healthy but of declining mental and/or physical acuity doing last resort jobs because we are unwilling as a society to provide social security seems just mean. It also doesn't seem wise to me to try to set up some kind of government body that tries to sort the fit and unfit as they age.
It may make sense to means test or raise the retirement age, but to force the aged who have been unable to save or who lost their savings to work until they are physically or mentally unable to work seems to me to be cruel.
I see no reason to bail out 100% of bondholders simply because a minority of those bondholders are systemically important institutions - I'd rather send my limited support to the minority of bondholders we deem important (i.e., insurers and pensions) than to all of the bondholders including Bill Gross.
So the person who saved for retirement outside of a IRA/401K and just bought the bonds you'd let lose?
There would be a lot of effort put into gaming your system of who gets bailed out...
Nationalization in the financial world now means one thing. That is the letting C and BOA fail and taking every bit of their stock and bond holders paper down to zero. In one of the most successful propaganda exercises of all time, letting the bankrupt go bankrupt is now nationalization.
Adding to the hilarity every self styled populist conservative worth their salt is now dreaming of armed insurrection to stop the nightmare of socialism that 'nationalization' would mean. You can't make this stuff up.
You've got the CEO of BAC issuing press releases that sound like what Hitler would have issued from his bunker, if he had been really nuts, boasting about the how the Volkssturm was the crown jewel of Germany's military. That proposition is surely just as reasonable as calling Merill and Countryfried gleaming crown jewels.
Everything Bernanke, Paulson, now Gethner and the rest have done for the banks is pure welfare. There is absolutely no indication that the welfare will end. They are not even asking for a promise from the welfare queens that they won't get pregnant again.
if you believe that the "credit crisis" is to a significant degree panic driven and that bond prices more than reflect the likelihood of defaults, then needlessly imposing bankruptcy and "haircuts" on bond holders is really the dumbest thing you could possibly do
"Adding to the hilarity every self styled populist conservative worth their salt is now dreaming of armed insurrection to stop the nightmare of socialism that 'nationalization' would mean. You can't make this stuff up."
Quotes? Otherwise, yes, you might well be making this stuff up.
Megan,
Please repair to the back-of-the-envelope calculations (based on Standard & Poor's data on the composition of insurance company portfolios) I offered on the previous thread. The following are salient:
1. Insurance companies have some $6.3 tn in assets.
2. Property and casualty companies have 39% of their portfolios in instruments other than bonds.
3. Health and life companies have 63% of their portfolios in instruments other than bonds issued by commercial companies (which is what is under discussion).
4. Let us posit the following:
a. the four banks in question have issued $2 tn in corporate bonds and securitized debt;
b. that their instruments are as likely as any other bond to be found in the portfolios of insurance companies.
c. that a debt-for-equity swap reduces the value of the what can be redeemed by 60%.
The resultant would be a reduction in the value of insurance company portfolios by about 3%.
5. The law can be modified to allow insurance companies to hold more equity for an interim period.
6. The government could set up a fund to invest in distressed insurers.
7. On Lehman effects:
a. The government has issued guarantees on deposits in money market funds
b. It can be written into the legislation that debt-for-equity swaps of this nature cannot be considered 'credit events' which would trigger the default swaps.
8. On what Mr. Geinther knows, and what he does not:
a. Prof. Zingales in his account of his discussions with Treasury officials said they referred to time constraints and the need to recall Congress. Insurance companies and pension funds were not mentioned.
b. Mr. Geinther knows there is quite possibly $2.5 tn in mortgage debt that is likely uncollectible. We know that too. The question is who eats the cost. Foreclosed homeowners will eat some, the banks and their equity holders will eat some, the Treasury will eat some. The dispute here is whether the bondholders will be asked to eat anything. Bondholders are not depositors or purchasers of commercial paper. They cannot empty a bank's coffers in a matter of hours.
c. The three principals (Geinther, Paulson, and Bernanke) have not wished to be too transparent with the public. (Witness Mr. Paulson's conflicting accounts of what they did do and did not do vis-a-vis Lehman, and why).
d. Someone sold the President on the erroneous idea that Sweden in 1992 had only five banks, and did not educate him that the share of the banking sector occupied by the troubled banks was similar to that of Citigroup and the Bank of America.
e. They first insist they need immediate authority to purchase troubled assets, then they don't purchase any troubled assets. They have had 19 months to develop contingency plans, and they have nada. It is not like banking crises are unprecedented or that there is not a history of policy responses and effects (as Nouriel Roubini has noted). Maybe Mr. Geinther et al. are just the wrong men for their time and place. Been known to happen.
I think what Geithner et. al. fear is that nationalizing or reorganization will put the government on the hook for massive and immediate losses in both the banking system, and the "safe" entities that lent it money.
The government is on the hook right now for the deposits. The ratio of deposits to stated assets for Wells Fargo is about 0.55. For the other three banks, it is about 0.35. Interbank lending amounts to about 4% of bank liabilities. The sum of all financial commercial paper (of which that of these four companies is but a subset) is less than one tenth the value of the nation's bank deposits. Their asset portfolios would have to be mighty awful to put the government on the hook unless you presume we have to guarantee-in-full all bank liabilities, not just those to depositors & money market funds.
Art Deco is quite dishonest:
"b. Mr. Geinther knows there is quite possibly $2.5 tn in mortgage debt that is likely uncollectible. We know that too. The question is who eats the cost. Foreclosed homeowners will eat some, the banks and their equity holders will eat some, the Treasury will eat some. The dispute here is whether the bondholders will be asked to eat anything"
Holders of low rated mortgage bonds have lost hundreds of billions of dollars. If you own, say, a BBB or BB bond that was backed by 2006 vintage mortgage loans in California, chances are the bond is short of principal and been downgraded to CCC-. You have lost due to "default". This is an irreversible loss of principal. CDOs that were backed by lower rated mortgage bonds and asset-backed (backed by credit card receivables and home equity loans, for example) have also largely been wiped out.
What the hell do people think banks have been losing money on?
Prices of higher-rated bonds have been driven into the sewer by the losses so far on low rated tranches of mortgage bonds, probably been driven down too low. But for this idiot here to pretend that bondholders have yet to lose principal from this credit crisis is preposterous.
There have been banks that have failed entirely because they owned Fannie Mae and Fredie Mac preferred stock, which was heretofore a AAA asset that bank regulators treated as a riskless asset (up until the day the US government abrogated these contracts). One of the banks that Barney Frank was accused of lobbying for TARP money for in his district was in that situation: driven into bankruptcy because they bought too many "safe" assets from a government agency. Say what you will about Barney, he could at least see this stupidity of that government action.
I have no idea who Professor Zingales is but if he is anything like Paul Krugman and Art Deco he is another creep!
P.S. the notion that $2.5 trillion of mortgage debt is "uncollectable" is also preposterous
Most mortgages go bad and the banks lose 25 to 50 cents on the dollar. Not all mortgages go bad. In subprimeland, maybe 20% of loans go bad, so on a trillion of subprime, losses are $50 billion to $100 billion. (obviously loans besides subprime are going bad)
as I described it above, these losses are borne by the most subordinated holder of the credit risk - the bank that securitized the loans; fannie & freddie; holders of lower rated mortgage bonds. The distribution of the losses does not follow the distribution of the debt
Where does Art Deco think that $2.5 TRILLION of mortgage debt is "uncollectable" -
One of the reasons that there is a financial panic is there have been real enough losses so far, but investors know that if charlatans and government lunatics are now given free reign, ideologues will certainly try to impose losses on credits (as in confiscate wealth) losses that never would have otherwise occurred
what we are seeing now is the left (or some more extreme elements) using a panic as a pretext to nationalized the largest banks in the country
This has been going on sine when, October? We have not even had 6 months for monetary policy to begin to work and already lunatics are trying to force a nationalization of the banking system.
Basic Fact,
Your video store story was absolutely perfect. I watched season one and was intrigued. Watched season 2 and began to get that "this girl is psycho" feeling. After watching the opening episode for this season, my wife and I looked at each other and said, "That's it."
Jozef,
Repair to the previous thread to see the context of my remarks, which concerned the utility and justice of converting corporate bonds and securitized debt issued by the four megabanks into equity stakes as a means of recapitalizing them. The referent of the discussion was commentary by an official of PIMCO that bondholders of these banks must be held absolutely harmless in a state-administered pre-packaged bankruptcy. One other participant in the discussion was insisting that such an act would 'devastate the middle class en masse'. The current sale prices in the open market for mortgage backed securities was not an aspect of the discussion and I was not giving it any thought in making my own remarks.
As for what the banks have been losing money on, depository institutions have of late had 6.6% of their assets in mortgage backed securities. They have three times as much in mortgage loans they service. A great many of these people are underwater or will be 'ere long. Time bomb.
BTW, with a severe recession ongoing, all kinds of loans will begin to sour at an accellerated rate. Federal Reserve data indicate that charge-off rates have been near previous peaks recorded over the last thirty years, though delinquencies are still lower. We got problems.
Megan's analysis of why the treasury is taking the side of the banks is way off. The reason we are not nationalizing right now has everything to do with the power and influence they hold. Regulators are given extremely broad powers. Bankers are required to provide it by law, if not they go to jail. They don't need to ask nicely.
A figure of $2 tn in credit write-downs has been offered by Prof. Kenneth Rogoff, though I think his figures are not limited to mortgage debt.
Last I heard, the annual attrition of sub-prime and Alt-A loans was running at 8 or 9 % per annum. I think that is consistent with an eventual failure rate north of 40%. The failure rate has been enhanced by the interest-rate resets which have subsided for subprime loans but will continue for Alt-A loans for another three years. However, we were not in a recession until six months ago, and nobody knows how severely the economy will contract and the resultant effects on income and employment. When the residential real estate market bottoms out, 40% of homeowners (prime and subprime) are going to be underwater. Let's hope most ride it out best they can rather than send the keys back and rent an apartment like homo oeconomicus. Prof. Martin Feldstein has been very worried about this phenomenon, which is why he has been pushing loan-modification schemes.
This has been going on sine when, October? We have not even had 6 months for monetary policy to begin to work and already lunatics are trying to force a nationalization of the banking system.
I think the most recent figures indicate that quantitative easing and innovations like buying instuments other than Treasuries may be containing the deflation.
I thought I was suggesting we put the megabanks under a temporary conservatorship and transfer ownership to their longer-term creditors, perhaps with contrivances like affiliated distressed assets funds ('bad banks') appended to clean-up their balance sheets. Perhaps I am not one of the lunatics to which you were referring.
The problem is there's 2 versions of Nationalization.
1) There's the Hugo Chavez version where the State says "This is mine now, thank you very much."
2) There's the American FDIC version where the state says "You're insolvent. We'll help you liquidate and repay your depositors up to the statutory limit and as a special bonus we're going freeze your assets just so what little you have left goes to the depositors and doesn't accidentally disappear into someone's yearly bonus."
I think we could really use more of the 2nd version in this crises. The anti-nationalization sentiment is usually bankers and stockholders using public hatred of option 1 to also avoid option 2, which most of the public (imo) would support.
i'm a young american with a high paying job. why should my tax dollars be given to an elderly generation of morons. i don't care about peoples 401ks. i work hard, they don't. end of story.
why are my tax dollars being burned??? why not spend the money educating poverty.
Bankruptcy has a very specific meaning. It means bankruptcy.
It means sell off the assets and pay off the depositors. Now the depositors losses are socialized by the FDIC. That happened 70 years ago. (Yes they want to kill Obama for it now. To wit. When asked by an audience member whether the policies of the Obama administration would lead to an armed revolution in the United States, Bolton said that he only wanted "a revolution at the ballot box." via TPM) All the deposits are not insured. Too bad suckers. Why in the hell do you still have money in that stinking hole called C? Idiots.
Why is this stuff so hard. Bankruptcy is the market acting through long settled law. Socialism is the FDIC. The GOP had plenty of chances to kill the FDIC since 1980 and didn't. Damn socialists. Hah. Libertarians never had the chance because they can't even get elected dog killer in Podunk.
mlarsen23, perhaps you can further explain what is "cruel" about expecting people to see for themselves as best they are able. Yes, people inevitably break down as they age. When they do, they should be assisted.
Yes, it likely would be difficult to evaluate cases in large numbers, which is why I stated above that I'd prefer to simply raise the retirement age significantly, and ask those who have their health fail beofre they get there to file for disability. Just like they do now.
"[T]he theory of output as a whole, which is what the following book purports to provide, is much more easily adapted to the conditions of a totalitarian state, than is the theory of production and distribution of a given output produced under the conditions of free competition and a large measure of laissez-faire."
-John Maynard Keynes, in the preface to the German edition of The General Theory of Employment, Interest, and Money.
Why is this stuff so hard. Bankruptcy is the market acting through long settled law. Socialism is the FDIC. The GOP had plenty of chances to kill the FDIC since 1980 and didn't. Damn socialists. Hah. Libertarians never had the chance because they can't even get elected dog killer in Podunk.
Posted by rapier | February 27, 2009 12:55 AM
You realise ofcourse that without FDIC coverage of the little people's deposits, America would now be having the 1930s style bank runs with riots and long line ups. See recent Argentina events.
Maybe this is a feature for you? Or is there another aspect of FDIC that grates?
"You realise ofcourse that without FDIC coverage of the little people's deposits, America would now be having the 1930s style bank runs with riots and long line ups."
You realize of course that the FDIC has less than 19 billion dollars in the insurance funs, making the ration to covered deposits about 0.3%.
That's not going to make too many people whole in the event of a multi-bank run.
FDIC just gives people a false sense of security.
It's hard to believe that the government would let FDIC fail rather than bail it out, given all that has happened.
I agree with Al.