I think Roubini, Dodd and Greenspan haven't thought this one through. The U.S. isn't Sweden, and not just because our blondes aren't au naturel. Their successful approach revolved around a handful of banks but we have 7,500, as well as many S&Ls and credit unions, which would have to be flushed into government hands. Regulators are overwhelmed as it is, and if you thought Lehman Brothers was a mistake, just standby and see what nationalizing Citi or BofA would do. Our banks remain at the heart of domestic/global financial transactions and daily clearing, while those Scandinavian banks were not. PIMCO would not dispute the need to further capitalize systemically important banks via convertible bonds held by the government, which unfortunately dilute shareholders' interests. To go further, however, and "haircut" senior debt or even existing preferred stock similar to that issued via the TARP would create an instability policymakers should not want to risk. In turn, forcing creditors to take haircuts would undermine other financial sectors such as insurance companies and credit unions. The goal of future policy should be to recapitalize lending institutions while maintaining the basic infrastructure of credit markets. Outright nationalization and haircutting of creditors will do just the opposite.
The problem is that seeing as he's a gigantic manager of bond funds, this is also the policy that will make Bill Gross best off.
This is, writ large, the problem faced by Geithner and Bernanke: the people who know the most are those with the most to lose or gain by their actions. If they do not talk to the experts, they will do something incredibly stupid through not having thought through the possible consequences. If they do talk to the experts, their ears will be filled with advice that is both plausible and self-serving. It needn't even be deliberate deception. Anyone who's ever been moderately successful at sales knows how quickly you internalize the belief in the superior virtues of whatever it is that pays your commissions.
Writ larger, it is the problem faced by regulating a lucrative industry like finance: the bankers always undersand more about what they're doing than the regulators. There are more of them. They are paid lavishly to spend more hours at work. And they will do their best to hire the most talented and experienced employees away from the regulatory agency, while the SEC cannot hope to lure a banker away from a million dollar pot of cash. The brain drain tends to flow one way. Listen to the SEC investigator complain that she couldn't possibly have discovered Madoff's crimes with the resources available to her, and you understand the thankless task we have handed our financial regulators.
I am concerned about the sudden consensus about nationalization--I haven't yet seen a good reason to believe that a tiny bank in a tiny nation like Sweden presents a good model for tackling the problems of the largest financial services company in the world. But the fact that Bill Gross is worried about bondholders taking a loss makes me more inclined to favor the notion. It's perverse, I know.
The game of hot potato continues, but the potato will never cool.
In most ways, Gross is correct- nationalization (liquidation in my mind) will be extremely messy and will have consequences a lot of people advocating it don't fully or even partially understand. On the other hand, zombification of the banking sector will be a complete disaster (and that is what Gross is advocating), but with a bleedout rate that will take a generation before it kills the patient- and it offers no chance of a real recovery.
Why can't the real assets of these banks be broken up and divided among the banks that are actually solvent?
I agree that nationalizing banks or finding ever more expensive and creative ways to keep insolvent banks afloat seems destined for disaster. But, I wonder why anyone cares what Greenspan or Dodd have to say at this point, considering how wrong they've been on everything else.
If it was me, I'd put Roubini in charge of TARP.
"The problem is that seeing as he's a gigantic manager of bond funds, this is also the policy that will make Bill Gross best off."
Ricardo Caballero, the head of MIT's economics department (and not a fund manager as far as I know), seems to share Gross's view:
Yes. Those bankers are so smart. They've been doing a bang-up job lately.
John Hussman (will you start reading him, Megan?), on the other hand, continues to argue that bond holders of insolvent banks should take a haircut:
If I were a prominent blogger for the Atlantic, you know what I would do? I would call Dr. Hussman and ask him what he thinks of Gross's concern about the potential Lehman effects of making bond holders take a hit.
The biggest problem with nationalization is that the political hacks that will wind up running them.
Remember the fraud at Fannie and Fredie?
Imagine BofA and Citi run by an army of Mini-me versions of Rahm Evil, with no transparency or accountability.
Ah, the age-old conundrum with power, problems and problem-solving with power:
The rich and powerful are generally the same people.
This fact of human history shows some consistent occurrences through the centuries.
The astute generally become rich...often by having superior knowledge, connections, information and ability and insight...this insight comes either through be genuinely ahead of the curve or from being in the company of people who are.
This level of wealth leads to empowerment on certain generally benign levels...when viewed over the long haul.
But now this level of empowerment and wealth lead to a REAL power...the power to control law and decision making beyond what sheer private wealth could ever give.
Then you have a ruling elite with wealth and influence amplified by true power: the power to control others and the rules of the game. Being extremely vested financially and legally in what happens makes one selectively knowledgeable and biased in "what the right thing to do is". It is sincere...no doubt...but still myopic in terms of considered sober wisdom and objectivity.
The paradigm of good and bad policy is not really objective anymore and is truly governed partly by what is at stake for those who have a large stake.
Consider the mortgage bail-out logic:
The consideration of the problem and its solutions does not follow simple, dry economic basics about supply/demand and inflated values. If it did, there would nothing to do except allowing values to fall to adjust on their own according to market forces. But it's not that simple...not because it's REALLY not that simple...but rather because that doesn't work well for those "in the know" with a lot at stake and a slew of sophisticated explanations, contingencies and considerations.
This union of real wealth and REAL Power (read: public influence via government) form of symbiotic relationship and reinforces both apsects: wealth and power. Both are larger than could be otherwise. Wealth without the ability to influence policy to protect and amplify one's wealth is limited in its potential beyond buying stuff for personal consumption.
So, you have the powerful doing things that they truly feel is best for everyone because what they consider best for everyone is heavily influenced by what is best for them. It's natural.
The masses are simply dragged along to deal with the messes, solutions, messes, solutions, crises, bigger solutions, bigger crises and so on of powerful experts trying to resolve problems and cover their own butts at the same time...and that butt-covering is invariably part of the resolution.
I'm still unclear on the difference between "nationalization" and what FDIC and FSLIC do, and what the RTC did. Is it merely a matter of scale and timeframe? That is, if FDIC takes over Chevy Chase Bank they wind it down in a week, but BofA would take a year or two?
Well, Bill Gross is sui generis. He runs the world's largest bond fund, and he seems to get a lot of what he wants. Lehman did hurt PIMCO (and a lot of regular people through PIMCO), and I suspect Gross will get his way now in that the resolution of the Citigroup situation will pretty much spare the bondholders.
Shorter Megan:
Libertarians agree that the free market should be allowed to weed out the winners and losers.
Except for the Big banks cause that would be messy and could cause rich people to lose money.
Then maybe the answer is breaking them apart into smaller, easier to understand chunks.
From the moment I heard "AIG is too big to fail" and the banks are "too big to fail," the answer seems obvious; too big = too big. Make them smaller. Break them into regional banks, separate them into banks and mortgage companies, and investment banks and credit unions and venture funds. Break each one apart based on it's current logical structure. Give shareholders a proportional stake in each of the smaller companies. Some would thrive, some would die, and the market would likely normalize much more rapidly then if the federal government took over.
Most importantly, this would force valuation of the "toxic assets," which seems to be the door nobody wants to open, but the market's need-to-know is ruining us all.
Smaller, regional banks are, i think, more rooted in the health of local economies and neighborhoods, as well.
And please forgive me for repeating myself, because I've suggested this before. But more complexity, instead of removing complexity, seems, well, too complex right now.
To go further, however, and "haircut" senior debt or even existing preferred stock similar to that issued via the TARP would create an instability policymakers should not want to risk.
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?
The obvious solution to Bill Gross's concern that the banks are "just too damn big and too damn complicated" is to have the banks engage in voluntary breakups. And I don't mean selling off the Outer Mongolian bank bought two years ago at great expense - I mean breaking up the retail structure so that, for example, BofA is not trying to get federal waivers because it is hitting the maximum allowed 10% of all US deposits.
Bankruptcy is the answer to this debt spiral. Bad loans don't get repaid...they just sit out there until people face the music. Default has been the solution to bad debts since the beginning of civilization.
We should remove the stigma of default, especially in the case of collateralized obligations like mortgages. A mortgage is a business transaction, not a holy promise. Non-recourse is the effective termination clause of the contract. Noone cries irresponsiblity when a borrower defaults in a rising housing market. Its only when the banks have to honor the out clause in their contract that we now hear the mewling. Defaults on homes that are underwater are not painless, the defauling party would lose any principle paid in, and of course the interest paid in the bank. It is certainly not the homeowner's fault that a property appraised by the bank upon the granting of the mortgage has fallen in value.
Megan: Can you explain the continuing obsession with "preserving shareholder value," for stocks that have lost over 90% of their value in the past year? is this a disguised offensive by "vulture investors" who are buying up these stocks in the hope of some kind of recapitalization-without-nationalization? I don't see who else would care about these stocks going "poof," after they've already gone 90% down that path.
Look, if we're looking for simplicity and trying to avoid complication, there are two easy solutions - 1) Stop giving taxpayer money to banks, or 2) have Tim hand over a couple hundred more billion to each needy bank with no strings attached.
Trouble is, the goal is not simplicity, but rather efficacy and fairness. When banks are in a situation where taxpayers have ponied up more risk capital than equity holders, how do you justify not making taxpayers owners?
The libertarian in me wants to just punt and let the dominoes fall. I know that's reckless, but the truth is, I'm not convinced that, all things considered, we'll end up worse off.
What I know for sure is that when governments usurp power from the people, especially in times of crisis, the people get screwed and the politically connected get a bonanza.
Al,
"Why would diluting the common equity shareholders not lead to instability, whereas haircutting the debtholders (and preferred equity holders) would lead to instability?"
The theory behind that, I think, is that other large financial institutions (insurance companies, etc.) hold bank debt and preferred shares (but not common equity), and a big enough haircut on those assets could threaten those other financial institutions' solvency.
"The theory behind that, I think, is that other large financial institutions (insurance companies, etc.) hold bank debt and preferred shares (but not common equity), and a big enough haircut on those assets could threaten those other financial institutions' solvency."
Not to mention the CDS' insuring the debt in case of default.
I tried to read this article but got distracted by the naked Swedish blondes in the quote.
it try reading this stuff and i always get tripped up over the hagiography for financial guys.
look if you strangle the goose that lays the golden eggs, you don't get to stand over it trying to administer CPR.
Megan, try this: Wall Street fucked up. Period.
See how easy that was?
The finance guys are simply too smart for anyone's good. We need less smart people running things.
With all due respect to "gigantic" Bill Gross, a business entity with a negative net worth is insolvent. Shareholders and bondholders should get nothing. Not a haircut, a beheading.
Banks should be forced to rationalize assets at current value and prove they have enough assets to stay in business. Those that can't should be nationalized, fixed with taxpayer money, and sold off.
Sure, there will be all sorts of "instability" among shareholders and bondholders. Good. These are the people ultimately to blame for banks that went off the rails. These are the people that hired the CEOs under which so much capital was destroyed. Their capital, not mine. Maybe big funds like PIMCO will start to pay more attention to what their employees the CEOs are doing.
When the history of this economic disaster is written, it will be clear that the single biggest profiteer from all this government largesse is Mr. Gross. Clearly he needs a bailout and this is his indirect way of asking for it. Thus, it is clear that we need to nationalize PIMCO.
Per one guy above, the reason that they don't want to wipe out the bondholders is that it might set off other bombs via the CDS market, or possibly in the CP market (though by now the only holder if Sh*tibank paper has got to be the Fed, so there is noone to wipe out there). Maybe AIG's short alot of CDS on C, that would be like them. Preferred shareholders should just get wiped out, and if they do 'nationalize' they probably will.
It does seem though that if you're not AIG or the Fed, and you're still exposed to C, you deserve to be parted from your money.
Per wiping all this out though, one thing that does seem a bit droll, and I guess good, is just how small all this is compared to when fionance was much more exciting like in the 19th century. If one were willing to do a 19th century liquidiatiom, wiping out all the shareholders and the bondholders and then haircutting the depositors, the depositors of C would probably get away with over 90 cents on the dollar. In the 19th century that would have been a win in a banking panic.
Question: What was the typical percentage of depositor money that was eventually recovered during the banking crisis of the early 1930s?
I'd have to think it was greater than zero. Even in 80% of loans were non-performing and the collateral was sold off at 0.25 on the dollar, you'd still get upwards of 40% of your money back.
"The finance guys are simply too smart for anyone's good. We need less smart people running things."
That comment is tangentially relevant enough to give me an excuse to paste in this revelation Paul Volcker included in a recent speech he gave in Toronto:
We were witnessing something very unusual: banks gone wild. They were wasting their capitals for years by giving money to anybody who asked for it.
I do not understand why the bond holders are untouchable. The banks were lending money to wrong people. The bond holders were lending money to wrong banks. The same bunsiness concept, is not it?
I have a question. These bank problems, do they apply to all banks or only to publically owned banks? A foreign bank I am working for acquired a privately held bank last year. The acquired bank's bad debt provision was only $3M. The bank was in a plain vanilla banking business: borrowing money and lending money. No fancy derivatives, swaps, etc. I started asking around. It looks like privately held banks do not have these problems. They were issuing only convensional mortgages: 20% down with income verification. My understanding is that owners of privately held banks cared not only about today but also about tomorrow. They were risking their own money whereas in publicly held banks the management was risking the shareholders' money.
I think that perception was the reason that Obama was elected, in a sense, Tribune of the United States a la a Gracchus in Rome. But of course, he decides what is in the interests of the 'masses,' e.g. the tax cut which is a welfare check, the $900 million for the terroristic Gaza distributed through the UN (but that will get us into the crony deal like in a tawdry Chicago), the mortgage bail-out which 'gives money not just to the banks but to the people.'
Whenever I hear Gross, El-Arian, et al on talking about what needs to be done I can't help but think there simply advocating for a course of action most amenable to their individual self-interest. Kinda like the CDS, 30:1 leverage, and sub-prime loan.
k1
ryanculver.blogspot.com
In turn, forcing creditors to take haircuts would undermine other financial sectors such as insurance companies and credit unions. The goal of future policy should be to recapitalize lending institutions while maintaining the basic infrastructure of credit markets. Outright nationalization and haircutting of creditors will do just the opposite.
If I am not mistaken, about 35% of the liabilities cum net worth of Citigroup, JP Morgan, and Bank of America consists of deposits. For Wells Fargo, the proportion is higher, perhaps 52%. The sum of financial commercial paper in the system amounts to about $750 bn. Even if these four companies issued all of it, it would still amount to
Credit unions, per their federal regulator, maintain about 20.4% of their portfolio in 'investments'. Out there are $3 tn in securities Treasuries, $1.8 tn in municipal bonds, $2 tn in municipal paper, $1.5 in commercial paper, $9 tn in equities, $5 tn in asset backed securities issued by Fannie and Freddie, $2.5 tn in same issued by miscellaneous parties, and $4 tn in corporate bonds. The sum of the last two amount to 22% of the total. Let's say half the total are issued by these four banks and the stakeholders have to take a 50% haircut. The math is as follows: .204 x .22 x .5 x .5, or 1.1% of their assets. Yes, that be an injury, but a hit they cannot take?
I would not trust Mr. Gross in a bingo game.
"I have a question. These bank problems, do they apply to all banks or only to publically owned banks?"
These problems don't even apply to all publicly traded banks. The banks that stuck to the "copybook headings" of banking stayed out of trouble. Unfortunately, the problems apply to some of the largest publicly traded banks.
I appreciate your openness in this post.
But look at the facts
a. Every week, we have banks that are failed, brought into bankruptcy, with the good assets sold off to a good bank, spun off to a "clean" balance sheet. Every week. The proposal is to do what we already do, but with the BIG banks.
b. Sweden - contrary to your notion of the banks being "small" - were, for Sweden, very large, I believe. Now perhaps you meant small in comparison to American banks. In that case, this is true. This would be another case of bringing the banks into receiverships, then spinning them off.
c. Savings and Loan scandal of the 80's. This again, is a 3rd example of financial companies being brought into receivership, then spinning off the positive assets into a clean entity, bought by private investors.
So to make clear - there are multiple successful examples, of doing what we normally do.
Now - the risk, as Bill Gross makes clear, and you have sympathy with - is that there are various bondholders and counterparties that would make a bringing into bankruptcy too "unstable" - i.e. - have Lehman like effects on the financial system.
Is this knowable? How would this be knowable? How would this be falsifiable?
Because clearly the STANDARD way to deal with an insolvent bank, is the above - bring BofA or Citi into receivership, have the various hedge funds absorb their losses - that they play the market for, that's the risk, right? - and do what we always do.
So - it seems to me, that unless you have some high standard of PROOF - regarding the bad effects of taking BofA and Citi into receivership is dangerous - we simply do this the normal way, right?
Because, as many sites have pointed out - there are LOTS of bad debts that aren't even visible at this point. On some site - either Calculated Risk or Big Picture - there was a story of this billion dollar investment into some Pacific Island Condos, for retirement/vacation homes.
This was COMPLETELY underwritten by Citibank - and had stopped production, after being 80% done, with no hope of continuance. That one project alone, is a billion dollar loss, but one that won't show AS a loss, for at least one more year.
And there are hundreds more projects like that.
This is why, most people are VERY confident that Citi/BofA are insolvent, and will show as more and more insolvent, over the next year.
So the only other thing to do - is to pour hundredes of billions more of hard earned american taxpayer money - to what? - keep theses zombie banks around, so that in five years, the bonds commercial paper (that they risk losing) will be worth something?
That is socialism - of the banks and bondholders.
So - the real question is, those who say it is too risky - you need to point out why.
Because the incentives -
a. standard practice,
b. moral hazard,
c. good business sense for the U.S.,
d. clean balance sheet,
e. Get the banks out of the poeple who failed hands
f. resolving uncertainty sooner, rather than later -
all point to taking the banks into receivership, breaking these banks up so there is g. no more "too big to fail", and then spinning the assets off into new private banks, with clean balance sheets.
And the hedge funds and shareholders who took the risk, in the capitalist system, eat the risk.
Of course, all of the above could and did apply to Lehman as well - but I haven't seen the proof why Citi and BofA will do the same.
And if it's true - you still have to clean out the guys who created the mess, which means removing the executive teams, en masse.
Errata
"Even if these four companies issued all of it [commercial paper], it would still amount to
"e.g. the tax cut which is a welfare check"
As opposed to the massive welfare check from the Bush Admin cuts 7 years ago.
Why can't we just let bondholders take it on the chin?
Well, in theory, that sounds great. Except that in reality, these bondholders aren't just rich obnoxious white men investing monopoly money.
Consider the following:
As of year-end 2007, here is a list of financials as a list of top-ten credit exposures at a variety of major insurance companies:
Genworth: 80%
Nationwide: 75%
AIG: 69%
AXA: 66%
Allstate: 63%
MetLife: 62%
Aegon: 59%
Northwestern: 55%
TIAA-CREF: 49%
MassMutual: 49%
ING: 48%
Lincoln: 47%
John Hancock: 39%
Yes, maybe the credit exposures to financials should have been lower at each of these firms, looking in hindsight. But NorthWestern and TIAA-CREF and MassMutual aren't exactly whacko-shops. They are all quite conservative (and a number of other portfolio metrics bear that out.)
Should a blanket decision to allow the bondholders - really these companies, and a number of pension funds with similar responsibilities - to get zeroed out, and it resulted in the collapse of one or two or three of these companies, the economic consequences to their clients -- annuity income slashed or eliminated, carriers exiting the insurance market (leaving uninsurable clients and their families high and dry, since they rely on guarantees of insurability and other riders to function), and premium increases on universal life and term policies that effectively render needed insurance coverage unaffordable for families -- would be devastating.
There is no way you could avoid a large bailout of insurers. We're already doing it with AIG. The Pension Benefit Guaranty Corp. would ahve to do it with pension funds.
Who loses?
Not fat cats who can recover. It's going to be workers who CAN'T recover who will take it on the chin.
It's not a matter of zeroing out bondholders and shareholders in financial institutions, and forgetting about it, leaving market forces to recover.
The Administration and Congress and the Fed have a very thin line to walk, with few options at hand, and they all suck.
It
"Even if these four companies issued all of it [commercial paper], it would still amount to
Bernanke all but admitted to following Gross's recommendations.
I may be naive, but I don't understand why anyone has confidence in Volker, Bernanke, Geithner, Greenspan....they were all participants in creating this financial catastrophe...
Isn't this a bit like appointing a known arsenist as fire chief?
I think there is some room to treat the *institutions* with some deference because of their macroeconomic importance, while treating the *individuals* associated with their past bad decisions in a harshly punitive way. There are many thousands of people, given the scope of what's happened, who deserve to be barred from employment in the financial sector in any capacity. I'm not sure what the legalities are, i.e. to what extent it's possible without the individual's agreement to be barred, and certainly we wouldn't want the government to give up the right of criminal prosecution if that possibility is out there. But I think that both morally, politically, and in terms of actual sound governance of these failing entities, boatloads of people need to be permanently separated from any role in their operation.
"Volker, Bernanke, Geithner, Greenspan"
One of these names is not like the other....
Should a blanket decision to allow the bondholders - really these companies, and a number of pension funds with similar responsibilities - to get zeroed out, and it resulted in the collapse of one or two or three of these companies, the economic consequences to their clients -- annuity income slashed or eliminated,
Is that a trick question? Yes, of course. Government charity should go to people who don't have money.
Should a blanket decision to allow the bondholders - really these companies, and a number of pension funds with similar responsibilities - to get zeroed out
What Dr. Zingales has proposed is that people who bought corporate bonds and asset backed securities from these four institutions (or six institutions if you include Goldman Sachs and Morgan Stanley) and sundries among the nation's distressed banks lose part of par value of their investment through a debt-for-equity swap. Other proposals have suggested this for those who bought bonds from Fannie Mae and Freddie Mac. No one has suggested that the the obligations that adhere to corporate bonds from banks (much less non-financial corporate bonds) be annulled in toto. BTW, anyone who was heavy in equities has lost half their investment in the last year. The notion that the government should be pumping money indefinitely (and risking a sovereign default??) into the megabanks so their bondholders can earn market-rates-ca. 2006 is just too much.
All in all, I suspect we are getting close to the key to understanding the principle behind the behavior of Dr. Bernanke and Messrs. Paulson and Gainther these last six months: don't screw with the bondholders. A driver of the dispositions of Congress has been 'don't screw with the United Auto Workers'. What is distressing is that the country is in a grave crisis and vested interests still find ways through both elected officials and bureaucratic elites to advance themselves against the whole.
Should a blanket decision to allow the bondholders - really these companies, and a number of pension funds with similar responsibilities - to get zeroed out, and it resulted in the collapse of one or two or three of these companies, the economic consequences to their clients -- annuity income slashed or eliminated, carriers exiting the insurance market...and premium increases on universal life and term policies that effectively render needed insurance coverage unaffordable for families -- would be devastating.
Oh. Good heavens. Pass the smelling salts! You mean affluent households might have to -- gulp -- face higher prices for cash value policies? Gimme a break. Tell 'em to buy term.
Should a blanket decision to allow the bondholders - really these companies, and a number of pension funds with similar responsibilities - to get zeroed out, and it resulted in the collapse of one or two or three of these companies, the economic consequences to their clients -- annuity income slashed or eliminated, carriers exiting the insurance market...and premium increases on universal life and term policies that effectively render needed insurance coverage unaffordable for families -- would be devastating.
So, let me get this straight. We're supposed to submit to a disastrous, wealth-destroying, Japanese-style zombification of our banking sector in order to prop up the living standards of upper income households?
The theory behind that, I think, is that other large financial institutions (insurance companies, etc.) hold bank debt and preferred shares (but not common equity), and a big enough haircut on those assets could threaten those other financial institutions' solvency.
I appreciate that. And Jason van Steenwyk adds some additional information above that further supports the point.
I guess my question is - how true is that theory? Jason van Steenwyk adds some information as to the exposure, but who knows which bonds would get haircuts and how much?
And if other financial institutions' solvency comes into question, why couldn't we haircut the boldholders of those institutions too?
I guess, to me, it all comes down to the same issue - which nobody has an answer for: how do you value the assets held by these shaky institutions? Because if you can't value them, I suppose you don't know how much of a haircut to give the bondholders. And if you don't know what kind of haircut would be needed, you don't know what the effect might be on other financial institutions.
I guess my question is - how true is that theory? Jason van Steenwyk adds some information as to the exposure, but who knows which bonds would get haircuts and how much?
About 57% of the assets of depository institutions are to be found in the big four banks (Citigroup, Bank of America, J.P. Morgan Chase, and Wells Fargo). As a rule, the ratio of deposits to assets among our banks, thrifts, credit unions is about 0.6. For these institutions, it is a great deal lower, and the proportion of their obligations to be found in bond issues a great deal higher. Consider Citigroup: if you add up the corporate bonds, preferred stock, securitized credit card debt, and sundries, it amounts to $367 bn. If you add mortgage-backed securities issued by Citigroup, I would wager you could add another 11 figure sum to that. So, these bonds, and the bonds of several other large banks. It is a pity the $700bn in TARP money was not poured into the FDIC. We would have had plenty of ammunition to digest the smaller banks' uncollectible mortgage debt an the effects of the recession on their loan portfolio's.
Would offer some skepticism about the Lehman analogy. Lehman commercial paper and Lehman bonds were distressed assets. The former was initially valued at nil and the latter (after the subsequent CDS auction) at 9 cents on the dollar. I wouldn't imagine (but what do I know?) that a debt-for-equity swap of Citigroup bonds would vitiate their value nearly that much. Please recall that there was no disaster after the Lehman CDS auction (and recall that Nouriel Roubini's outfit continued to insist that and 11 figure sum would have to change hands even after the Depository Trust and Clearing Corporation announced that $6 bn would have to change hands). Also, a government guarantee of money market funds has been put into effect. One might even write into law that debt-for-equity swaps do not trigger CDS contracts. Would there really be the same anxiety level that there was after Lehman went under?
Seems to me that the bondholders should be paying big time for their errors.
I don't get why this is not more widely agreed upon because:
1. Market-oriented people want proper incentives in place. Investment risks must be risky.
2.Lefties can enjoy watching the rich punished for their greed.
Seems to me this should have bipartisan support.
"One of these names is not like the other...."
It's probably just a coincidence that, in addition to being to only one not contribute to this mess, Volker's the only gentile.
I wonder what Rothbard and von Mises would think about that.
Whenever I discuss this with fellow accountants we all end up agreeing that any half-way decent auditor could have found this fraud while blindfolded. Qualified and experienced auditors were available at the SEC. Indeed, there were people at the SEC (at the Boston office) who felt that Madoff should have been investigated sooner. After seven investigations the SEC still couldn't find this out? I smell a coverup. There were too many people in high places who had too much at stake. The amount of work needed to pull this massive fraud off would require more hours than any single man would be capable of working. Bernie had lots of help. The facts of the story read like a thriller novel made for the movies. The SEC investigator who had an affair with Madoff's niece, the two man CPA firm that couldn't have done a real audit and even listed itself as inactive. The cleverly prepared phony statements, the fake trades that didn't take place, the time Bernie spent going to parties and traveling to his mansions all over the world when he was supposedly working alone day and night making this fraud work all by himself. I really get a kick out of his two lawyer sons who sat in that big office doing who knows what and having no idea what was going on. How did they ever manage to finish law school? I have never seen so many high IQ, well educated people act so dumb. When the right people decide to do a real investigation, Bernie will go down and he will take lots of others with him. And his old lady too!
"I guess, to me, it all comes down to the same issue - which nobody has an answer for: how do you value the assets held by these shaky institutions?"
The accounting would be pretty clear if we were talking about an inventory of widgets, I think: they'd be valued at the lower of cost or market. If it were up to me, I'd apply the same valuation to the banks' inventory of securities. If no one is willing to buy them, mark them down to zero; if someone is willing to pay 30 cents on the dollar for them, mark them down to that, etc.
Market doesn't exist, so that doesn't work. Which is the problem with all of this.
"Oh. Good heavens. Pass the smelling salts! You mean affluent households might have to -- gulp -- face higher prices for cash value policies? Gimme a break. Tell 'em to buy term."
Dude. Do you know a damn thing about insurance? Term insurance (and mortality costs within universal policies) is prohibitively expensive as you get older. Duh. That's why it's TERM insurance. If ir weren't, it wouldn't BE "Term" insurance.
And look... in the post you responded to, I even SAID the premiums on term insurance would become prohibitively high. So high their cumulative total quickly outstrips death benefits.
Term doesn't work well for those in or near retirement.
At any rate, since when do only the affluent buy life insurance? You really need to get out more.
Jasper:
"So, let me get this straight. We're supposed to submit to a disastrous, wealth-destroying, Japanese-style zombification of our banking sector in order to prop up the living standards of upper income households?"
Look, dude. I don't know what kind of class warfare kick you're on, but the people you are going to kicking aren't the people you think they are. "Upper income people?"
I mentioned TIAA-CREF above. Who do you think represents a typical TIAA-CREF annuitant?
Hint: The "T" stands for "Teachers."
Two simple rules:
1) PIMCO is ALWAYS, ALWAYS talking book. No exceptions. Doesn't mean they can't be right.
2) "We have met the bondholder and he is us." Bank bonds are in funds and pensions all over the place. Vanguard's core bond fund is 36% financial. Finance is 20% of the broad bond universe and nearly 65% of the 1-5 year corporate world. If you had to pick an asset that is *under*represented in wealthy individual portfolios, bank bonds would be a good start.
"Market doesn't exist, so that doesn't work."
There should be a market for them this quarter, a SecondMarket.
Unlike Sweden, and unlike most other countries, the USA has a set of experienced and competent experts at dealing with bust banks.Why nationalise when you have the FDIC?
Why nationalize when you have the FDIC?
Here's why: http://iraqnow.blogspot.com/2009/02/megan-depositors-ought-to-get-their.html
Jason, I clicked your link, but the FDIC reserve isn't the limit of its resources.
The FDIC is backed by the full faith and credit of the US government (read a TLGP bond indenture)and has the ability to borrow from it. They have all the govt's resources - our resources. Underappreciated by many.
Look, dude. I don't know what kind of class warfare kick you're on, but the people you are going to kicking aren't the people you think they are. "Upper income people?"...I mentioned TIAA-CREF above. Who do you think represents a typical TIAA-CREF annuitant?...Hint: The "T" stands for "Teachers."
Jason: Surely you're not arguing that most bank debt isn't owned by people who are wealthier than average, are you? I mean, take your example of teachers. While I'm aware some teachers in some areas (mostly down south) aren pretty poorly paid, in general they're not. Plenty of public school teachers make $60-$100k a year with excellent health benefits and lots of vacation. Like most liberals, I don't begrudge public sector employees their remuneration. But let's not kid ourselves who is most going to benefit from using tax money to minimize the size of bank creditor haircuts: it's people whose wealth and earnings are above average. I'm not arguing, mind you, that tax payer money shouldn't be used to recapitalize the banking sector. I think the spending we've engaged in thus far has been unavoidable and necessary, and there's more unavoidable and necessary spending to follow. I'm just worried that A) it will be done in a style emulating 1990s Japan; and B) it will be overly generous to wealthier-than-average people, and insufficiently generous to taxpayers in the aggregate.
2) "We have met the bondholder and he is us." Bank bonds are in funds and pensions all over the place. Vanguard's core bond fund is 36% financial. Finance is 20% of the broad bond universe and nearly 65% of the 1-5 year corporate world. If you had to pick an asset that is *under*represented in wealthy individual portfolios, bank bonds would be a good start.
"Mindles",
I appreciate that. I also appreciate the following:
1. The pool of individuals who bought a house in the last eight years will likely lose a mean of ~20% of their investment and (per Martin Feldstein) ~40% will be underwater when the market hits bottom.
2. People trying to ride it out in equities are down to 50 c on the dollar.
To say that people who bought bonds from one of four or six financial corporations (intermediated through a pension fund or no) cannot lose one cent of their investment (as B. Gross suggests) is difficult to justify unless you posit some sort of knock on effect similar to that of the depositor runs which occurred in 1930-33.
They have all the govt's resources - our resources. Underappreciated by many.
That I did not know. It is a good education reading you.
What I cannot figure is if the FDIC has this authority, why we needed the TARP money for anything but the non-depository institutions.
Exactly. The taxpayer is ultimately on the hook for FDIC coverage. That is precisely why the taxpayer does NOT want to simply have FDIC buy out the depositors.
Another reason is hundreds of thousands of little old ladies who rely on CDs for retirement income, over and above the FDIC limit.
Further, if you haven't noticed, the "full faith and credit" thing is all well and good. But resources are not infinite, and the government is currently undergoing a bit of a fiscal problem.
Obviously, thus far, Treasury thinks it's cheaper in the long run for the taxpayer to take an equity stake in banks than to pay off depositors via FDIC. And so that's why they don't. Question answered. Revealed preference revealed at work.
"Jason: Surely you're not arguing that most bank debt isn't owned by people who are wealthier than average, are you?"
No. And don't call me "Shirley."
I wouldn't argue that, because ALL financial assets are owned by people who are wealthier than average, by definition. (The others we call "net debtors."
I am arguing simply what I stated above: The people who rely most on the continued solvency of insurers, annuity companies, and pension funds (owned by corporations, but with a fiduciary duty to serve beneficiaries - a distinction which seems wholly lost on you so far) are not obnoxious white men playing with Monopoly money, trust fund babies (although so what if they are?), and the Michael Milkens of the world.
I am arguing that the majority of these people you would like to screw are not the ultra-wealthy (though what if they are?), but are teachers, auto workers, cops, firemen, small business owners, widows, orphans, factory hands, farmers and middle class people from all walks of life.
If a major insurer.. pick anyone on the list above.. goes bust because of your class warfare instincts, who gets hurt most?
Answer: It won't be the ultra wealthy. They'll just become merely wealthy. But middle class net savers ... the people who've done the right thing by saving and sticking in jobs and contributing to retirement plans and insuring their own futures ... would be devastated en masse.
I am arguing that the majority of these people you would like to screw are not the ultra-wealthy...
I don't think a modicum of moderation and slow-going in our rush to socialize financial losses constitutes "screwing" anybody, even if it does mean some of them might lose money.
If a major insurer.. pick anyone on the list above.. goes bust...
An individual insurance firm can be saved without taking the Bill Gross approach. And anyway, I'm highly skeptical turning bond holders into equity holders (the approach I favor) is alone going to cause a major insurer to go bust.
Jasper, I presume you are aware that most insurers are not allowed to hold much in the way of risky equity investments, and would therefore have to liquidate any such holdings immediately in order to comply with regulatory requirements. They would be doing so while every other insurer and a not-insignificant number of pension funds were also dumping their holdings for the same reason, with the predictible effect on prices.
"One of these names is not like the other...."
It's probably just a coincidence that, in addition to being to only one not contribute to this mess, Volker's the only gentile.
I wonder what Rothbard and von Mises would think about that.
Posted by Bearded Spock | February 24, 2009 9:49 PM
Actually, Greenspan is the only non-gentile in the list. Spock, bearded or no, isn't a gentile either.
Exactly. The taxpayer is ultimately on the hook for FDIC coverage. That is precisely why the taxpayer does NOT want to simply have FDIC buy out the depositors.
"What I did not know", Jason, was that the FDIC resources are not limited to its appropriated reserves.
The taxpayers' expenditure is limited to the sum by which guaranteed liabilities exceed properly valued assets. The ratio of deposits to assets in commercial banks is about 0.58 at this time. IIRC, there is a temporary extension of guarantees beyond the 250,000 limit per depositor. Ordinarily, only about 62% of deposits by value are under the limit. There is also a temporary guarantee of money market funds and interbank lending, so the commercial paper and interbank loans you leave alone. Still, there is a considerable margin that would have to be consumed by illiquid securities and sour loans 'ere the FDIC has to tap its reserves (though IndyMac managed it). The ratio of deposits to nominal assets for Citigroup, JP Morgan, and the Bank of America is, again, about 0.35.
Revealed preference revealed at work.
What is under discussion is just what the preferences and motives of Mr. Gross (and Mr. Geinther) are.
A back of the envelope calculation to take a rought reading of the scale of the problem to which you refer.
Standard & Poor's Industry Surveys reports that property and casualty insurers hold about 82% of their assets in securities and 61% of these in bonds, NOS. It also reports that life and health insurers hold 82% of their assets in securities of which 37% are in "industrial bonds" and "other bonds". The former have $1.62 tn in assets and the latter $4.7 tn. That would amount to $800 bn in bonds (NOS) and $1.45 tn in "industrial and other bonds". Last time I researched the question, there were $16.5 tn in bonds (NOS) in circulation of which a subset of $11.5 tn were corporate bonds or securitized debt. If the four banks in question have issued $2 tn in corporate bonds and securitized debt (my extrapolation from Citigroup's figures), that amounts to 12% of bonds (NOS) or 18% of the subset. .12 x 800 bn + .18 x 1,450 bn = $360 bn. If a debt-for-equity swap reduced the value of their holdings of issues from Citigroup et al by 60%, they would be out about $215 bn. Again, the insurance industry has (or had as of last May) about $6.3 tn in assets, so $215 bn would amount to about 3% of their assets. I think that a passable educated guess as to the scale of the problem.
Please note, insurers hold some of their assets in equities as well. I would wager they lost more than 3% of their portfolio last October due to this.
Standard & Poor's also reported the source of the income streams of these two sorts of insurers. For one of the two (I forget which), 60% comes from premium payments and 20% from investment income.
I would be very skeptical a debt-for-equity swap for Citigroup bonds will toast any insurance companies. To be sure, that is not my trade.
Jasper, I presume you are aware that most insurers are not allowed to hold much in the way of risky equity investments, and would therefore have to liquidate any such holdings immediately in order to comply with regulatory requirements.
The insurance companies can be given a temporary dispensation in the legislation as regards the composition of their portfolios. That aside, per Standard & Poor's, they have a good deal in their basket right now other than bonds (though the precise share in equities eludes my memory).
But middle class net savers ... the people who've done the right thing by saving and sticking in jobs and contributing to retirement plans and insuring their own futures ... would be devastated en masse.
At worst, some people will have their retirement income cut in bankruptcy court (depending on what sort of pension plan they had). This happened to employees of United Airlines a few years back. This was disagreeable for those employees. The middle-class remained undevastated. An economic meltdown a-la Indonesia in 1998 brought on by depositor runs or by a sovereign debt default really would devastate the middle class.