Wednesday, July 07, 2010
But do you know who really benefits from a bank bailout? Why, after all, do we do it? Where did the notion of a bank bailout come from?
Depositors. Savers. That's who benefits societally from ensuring that financial institutions remain liquid and solvent. In Argentina, for example, depositors were not bailed out. Instead, their dollar denominated deposits - which they had earned and saved - were converted into pesos and then devalued by 70%. By contrast, depositors in the US are protected in order to ensure that the banking system - that is, the blood and oxygen which powers are economic system - does not suffer a liquidation. That, by the way, is a result of the banking system failure we suffered during the Depression. We've seen this movie. It ended badly.
So please, can we stop now with the misplaced concerns about bank bailouts and "too big to fail" and so forth? It was in our interest as citizens and taxpayers to capitalize Citibank, BofA, JP Morgan, Goldman Sachs, Morgan Stanley and every other bank to prevent the bank runs that we were already beginning to experience as a result of the failures of Lehman and WAMU, among others.
It would be nice if some intellectually curious 10 year old of a journalist decided to research and write that story. Instead of the inane 10 millionth ignorant complaint about "bailouts for bankers." Bailouts are for DEPOSITORS. SAVERS. Regular people. Without them, we would be screwed. We would bury our money in the backyard or stash it in the mattress (with our gold, no doubt).
Backing up the banking system with reserve injections, so-called "bank-bailouts", is the classic job of a central bank. It's one of the principal reasons why we even have a central bank and it ensures an active money supply and is a crucial backstop in consumer trust in banks. Get used to these sorts of actions, as I don't think we're done with them during this stressful economic cycle.
But "too big to fail" is a different matter entirely. A Citibank failure, for example, would have had only a minor impact on consumers (if any at all) and not even a great deal of impact on American small business. Citi just has too small a market share. Yet, they were deemed "too big to fail". Why? The Treasury never explained their reasoning, and also never explained why National City Corp., whose failure had a tremendous impact on northeastern Ohio, small business across the midwest and even consumers (where NCC had substantial regional market share), was allowed to fail. Again, why?
Too big to fail is a concept that the Treasury needs to defend. There needs to be a far more active debate on this idea before we all just "stop whining". So, I disagree with you on this one.
Your post is ridiculous. Depositors at all FDIC-backed institutions would have been made whole, if the institution failed, by the FDIC. The TARP bailout monies alone would have made 2.8 million depositors whole (at the max of $250,000/account). The Fed didn’t have to bailout the banks to save individual depositors.
Your posts are usually pro-wallstreet, but this is really over the top.
Shouldn't the bank equity holders and bondholders taken the first hits rather than the taxpayers?
It would have been far cheaper to insure all the deposits, flush the equity and bonds and then move the deposits to stronger institutions, then reduced the insurance back to its original max.
CardinalPark (CP) started this thread ... so I invite his energetic response to what follows ... please others join in too. It goes to fundamental issues about what America will be: Are we South American chrony capitalists or not?
To CP: Work what follows ... or forever hold your manhold cheap. You started it.
CardinalPark is a shill for Goldman, if you didn't already know. Once in, never out. I suspect he gets his talking points directly in "alumni only" memos.
After the lobbyists did their magic to "Financial Reform" ... guess what?... we just created six new GSEs, to add to Fannie and Freddie:
1) Wells Fargo (Wachovia broker network)
2) Bank of America (Merrill Lynch)
3) Citigroup (Salomon, Smith Barney)
4) JP Morgan Chase (JP Morgan, Bear Stearns)
5) Morgan Stanley
This is a rank ordering by how much of their business mix is in capital markets and "exotics." Thus, the likes of US Bancorp, American Express and some other big financials aren't included. We could argue about flipping around # 2, # 3 and # 4. You could drop Wells Fargo from the list, as what they do is your daddy's boring broker-dealer business.
To be complete ... Barclays (which recently beefed up with Lehman carcass), Credit Suisse, Deutsche Bank and USB are the other big players in US capital markets and exotics.
To CP: For openers, you've completely misstated how the FDIC has worked in theory and practice over the last 80 years. It's one of the few FDR programs that's worked as advertised. I can detail this, if you care.
Goldman has no "depositors." Lehman didn't either.
So what you wrote is either misninformed, or disenguous. I suspect the latter, because you're working from Goldman talking points. Tell me if I'm wrong.
So here's my opener: Goldman could be orderly liquidated, who would care? If you shut down Wells Fargo, a lot of people would care. Goldman doesn't "bank" anyone but themselves anymore.
I say it again: Goldman had a big role in -- and profited from, at least for awhile -- our financial debacle. This may still come to light. If half what I suspect is true, Goldman should be hung and quartered.
I'll go further, when the "rest of us" figure out that it's a rigged game to the likes of Goldman's and CP's advantage, it'll all come crashing down.
Any takers? Let's go CP ... mano a mano ... you picked the fight.
Let's be clear CP:
1. Bank bailouts are not a "public good" but a "necessary evil."
2. Bank shareholders likely benefited disproportionately.
3. The banks continue to impose G-S and the BHA which were also lessons we learned in the Depression. Much easier to stop a run on the old Chase, or Citicorp, which was a fraction of the size, than the current behemoths.
So complaining that we "had to" bail out banks is completely reasonable. Let's not try to say it was a good thing, if it was by anyone who knows at best a "necessary evil."
Perhaps I am oversimplifying but to me the issue hinges on the problem of defining a "bank" vs. a "trading house". Banks provide a version of a public good that helps an economy/financial system function while trading houses seek profit and shouldn't really be concerned with "larger issues", it's not their deal. Not that banks don't seek to profit but there is also a service connected to the Fed (and cheaper financing), the money supply and all that other macroeconomic lingo, most of which I have forgotten.
In recent years the two are pretty much co-mingled for all these firms mentioned. The government was forced to intervene because the stability of the whole system was jeopardized. So be it; it's another fine mess "someone" has gotten us into. More interesting is what happens next with these issues and idiocies like fannie/freddie.
I am a TigerHawk fan, but your post is way off.
Take Goldman - they got paid 100% on the dollar for $13 billion or so in CDOs (or some form of mortgage-backed security - I can't keep the names straight) insured by AIG, via a taxpayer bailout of AIG, that Treasury knew would be used to pay Goldman.
According to Michael Lewis's book, The Big Short, Goldman knew that the insurance they bought from AIG was radically underpriced relative to the risk.
Goldman should have been allowed to lose every dime. There was no economic or moral justification for bailing them out. Quite the opposite.
ok - good stuff.
1) keep in mind the order of events. Bear Stearns effectively failed, and was foisted on JPM with Fed assistance. No bailout. Then Lehman and WAMU fail. Lehman files for bankruptcy; WAMU depositors begin to line up and withdraw deposits. No bailouts. Lehman creditors get killed; its clearing customers (a form of depositor) become unsecured creditors, esp in Europe); WAMU is seized by the FDIC to stem the depositor run.
That depositor run spreads...it infects Wachovia. Money market funds begin to freeze as Lehman overnight paper "breaks the buck."
Merrill is next in line for bankruptcy.
BofA is at risk; Well Fargo is at risk. Any leveraged financial institution with non-term funding (every one) is now effectively insolvent and unfundable. Creditors, including depositors, are heading for the exits.
At that moment, the US financial system became paralyzed.
Without government providing klast resort capital and providing liquidity to every financial institution and explicitly guaranteeing overnight funding, you the depositor would have lost your dough. You the brokerage client would have become an insecured creditor in bankruptcy. How long would it have taken you to get something less than 100 cents on the dollar back?
Hence, bank bailouts.
I did not, and do not defend how they dealt with AIG - not a bank. I frankly think they didnt understand the risk at AIG because they were talking to the wrong people - Cassano and Greenberg were the people to deal with, not their clown successors. All the govt had to do there was stand behind the contracts, not pay them out. That was just stupid.
I also don't defend FNMA and Freddie.
However, the govt could not let another bank go. They frankly tried to let them go, but the situation was fueled by letting BS and Lehman go and the associated fallout from WAMU and deposit runs.
So while I will simply avoid the Goldman topic - I did work there, never hide that, it really has nothing to do with my post.
Had the government not stepped in to capitalize the banking system in September and October 2008, we would have experienced a far more severe financial crisis, panic and depression. The eventual depositor bailout (by the insolvent FDIC) would have been insufficient. and the loss of confidence in banking alone - in the fractional reserve system - would have been infinitely more costly than the TARP.
Look at all the straw men!
"Depositors at all FDIC-backed institutions would have been made whole, if the institution failed, by the FDIC."
What a pleasant myth. First of all, do you think the FDIC has unlimited funds? Secondly, do you think that those guarantees would be either a) cheaper than the bailouts of the relevant bank or b) worth the requisite destruction of financial institutions? Wouldn't it be better to stave off the need for FDIC re-coupment?
Leading line: "Now that the FDIC has effectively admitted they’ve run out of money in the Deposit Insurance Fund, what does that mean to for the banking system in the U.S., and the consumers and businesses using them?"
Lastly, concerning the 'public good' thing; fact: modern economic development began with the invention of banking. The availability of credit and safe places for storing money are absolutely critical to our society. Without them, no checks, no debit cards, no mortgages, no car loans, no letters of credit, et cetera. Commerce as we know it would cease.
But yeah, they're totally worthless to the public and unworthy of salvage when endangered.
What I'm about to say, you already know, but not everyone here does, probably.
Fractional reserve banking is a bit of a hocus pocus move to allow middlemen (what we call bankers) to convert short term loans to the bank (what we call deposits) into long term loans by the bank (i.e. car loans, mortgages, etc.) and the bankers make money off the difference. Bankers are able to make money on the difference because of the yield curve which generally has much lower interest rates for short term loans than long term loans.
People allow banks to do this because the banks promise that they will pay off the short term loans (deposits) at any time and for any reason - thus allowing you to write checks and access your money from an ATM on a 24/7/365 basis. Most of the time, this works fine. In extreme times (Great Depression, 2008) however, some banks can't honor their promise and a run on the bank may occur.
Before deposit insurance (the FDIC) this was more common, but with the advent of deposit insurance, average people are much less likely to begin a run on the bank because they are assured that they will not lose their deposits even if the bank fails. In fact, when the run on Wachovia occured it was NOT a run caused by ordinary customers, but was a run caused by very, very large depositors with deposits well in excess of the FDIC insurance limits.
And so I call bullshit on your statement that "Without government providing klast resort capital and providing liquidity to every financial institution and explicitly guaranteeing overnight funding, you the depositor would have lost your dough."
This is only true if (1) "you the depositor" had over $250,000 in an account at the failing bank or (2) you believe that the government would have refused to "bailout" the FDIC. Given the amount of money the Feds threw at the banks, I find it hard to believe they would let the FDIC default on its deposit insurance obligations. If it did, now THAT would have caused one hell of a panic.
I cannot deny that several banks would have failed, even large banks. However, where do you think those millions that were being withdrawn from Wachovia were going? OTHER BANKS!!!!
More accurately, other banks that were less leveraged and better managed. I'm not sure why you think that badly managed banks should be rescued and allowed to continue to compete with what were/are better managed banks.
Finally, all of that aside, the public furor over this is as follows: 1) banks were in big trouble due to their own actions, 2) government steps in to rescue banks from the bad outcome of their actions, 3) bankers profit (via high earnings, salaries and bonuses) and taxpayers are left with a large bill. You can argue all day long that step #2 was needed, but you aren't going to have people express any sympathy for banks/bankers due to step #3.
The TOTAL amount of money on deposit in banks in the U.S. is roughly $7 trillion. The bailouts will run to at least $3 trillion. We could have easily guaranteed every depositor with that $3 trillion because only a small minority of banks are insolvent... they just happen to be the ones with all the political power.
This "had to do it" argument is bullsh*t. Allowing those 'banks' to go through bankruptcy would certainly have been painful and disruptive--but ultimately the guilty parties would have paid the biggest price and we would be two years into recovery. Instead, we are decades from recovering and the taxpayers, present and future, are the ones who are getting screwed while the bastards who made the mess collect billions in bonuses.
We will all pay the price for the good capital that has been thrown into the pit to cover bank insolvency. Good investments will go unfunded, productivity will lag, debt service will cause government services to be crippled, the U.S. economy will be even less competitive.
Necessary evil, my @$$. Corruption of the worst kind...the kind that drives violent revolt once understood by the screwees.
a couple of responses -
if you think about it, the government in fact let the worst managed institutions fail - and their failure collectively impacted the fundability of the entire system, good and bad. This relates critically to the astute anonymous observer I believe who correctly pointed out that the fundamental flaw in the fractional reserve banking system, from which we derive such tremendous benefit, is the mismatched duration of assets (loans, principally, of long duration) and liabilities (deposits and wholesale funding, principally of shorter duration).
While many would certainly argue that Bear and Lehman were irresponsibly overlevereged, overcmmitted to real estate and therefore illiquid and insolvent (and true as well for WAMU and Wachovia), the same could not be said subsequently of MS, GS and myriad other banks with significant deposits. One of the laughable ironies of the Goldman witchhunt is that they are crucified politically for their success, while former Lehman CEO is publicly villified for his failure. Well, which is it that we want?
The point was, once confidence was lost and the fear of the bank run was prevalent, it became a risk of a run on the system, not any given bank, regardless of the quality of mgmt and the intelligence of their choices and risk management. No bank can avoid the challenge of mismatched duration and daily funding requirements when the market is closed. Not even the strongest (arguably JPM).
There was a very explicit and publicized debate at Paulsen's Treasury about whether they should provide capital only to the weak, or to everybody. They decided ultimately that suppoort had to go to everybody (i.e. the system) because if they were selective, those who didn't receive government support would become unfundable the next day.
There is a certain bitter naivete about this notion that the government provision of capital support in financial panics is avoidable. It's not. Private sources attempted to do so but were devastated by events. TPG and partners invested several billion dollars in WAMU only to see it seized by the FDIC following a run on deposits.
In fact, the Treasury structured their bank investments in most cases wisely and earned exceptional returns on those investments. That is in the end what we should demand of the Treasury - an analysis of the performance of their structured bank investments ("bailouts"). Investment by Investment. Company by Company. Then let's evalute the merits.
At the same time, we should do the same for the non-bank "bailouts". Let's assess FNMA and Freddie and GM and Chrysler and AIG and GE etc.
Let's really look at it and learn from it, rather than indiscriminately criticize and thus invariably derive the wrong lessons and regulate or vote haphazardly and poorly, based upon incorrect or incomplete information.
If what you say in your 11:00a.m. comment is true CP, how is it that the US economy not only survived, but grew bigger and stronger after every single economic downturn prior to 1929?
Prior to 1929, business was left to recover on it's own and it always did.
Why is it naive to assume that would not happen again?
Well, to ignore the Depression and everything that stemmed from it - the economic cataclysm, the market collapse, the truly massive unemployment, the utter collapse of the banking system, it strikes me again as a quaint notion but no longer feasible.
We had increasingly severe economic crises which always gave way ato additional measures to try to minimize those crises. Private sector solutions were devised, for instance, under JP Morgan to prevent or mitigate bank runs. The Depression was the first time that the country's economy and banking system was really too big for a private mitigant to a banking collapse.
So perhaps we would recover, but from a far lower and uch more devastated level. And perhaps only after we had suffered an unfortunate loss of economic freedom and destruction of the middle class.
I wouldn't argue against reserve injections to backstop the credit of the banking system. But you included "Too big to fail" on your rant list, and I disagree with you. The Treasury never has explained it, nor has the Fed, and no policy maker defense exists of the concept. We need a debate.
1. The government is utterly incompetent to regulate financial institutions.
2. The ONLY reason government seeks to micro-manage is to gain leverage for political advantage. Specifically, when regulators have power, they can sell out to regulatory capture. And when politicos have power, they can extort subsidies for contributions.
3. The ONLY good thing government can do is to enforce the premises of free markets, viz. (a) many small independent agents, (b) free flow of information, (c) no subsidies or tariffs, (d) no monopolies. After 2008 we learned there is an (e), "no too big to fail."
IF government enforces these premises, including (e), THEN the free markets will handle the rest.
Afraid of a bank failure? Open 5 accounts of $20k each. That effort costs less than the gross taxation of protecting $100k.
Welcome challenges for refutation.
"The government is utterly incompetent to regulate financial institutions."
Financials have to be regulated -- they have the King's license to create money. Thus, they're more of a "utility" than your local gas & electric. If they're not well regulated, we invite disaster.
"Good regulation" is as much about the cops on the beat as it is about the rules that are being enforced.
What follows -- a few examples of Financial Institution Regulation 101 -- will circle back to "bank bailouts" ultimately.
Here's the first: Derivatives.
Credit Default Swaps Etc. should have been (and could have been) regulated as insurance. That means requiring 100% capital charges (see "Guarantees" below) and requiring that the buyer have an "insurable interest."
If they were so regulated, there'd be hardly any market for them. That's because they hardly ever make economic sense. They're just a tool for speculation, including because they invite arbitrage over timing (e.g, "who cares if it's mispriced, my bonus gets paid this year") and rule avoidance (e.g., gaming Basel capital rules, e.g. Greece gaming the EU rules).
Regulators (and legislators) haven't done so because they've been co-opted. (Tim Geithner and former heads of the New York State Insurance Department -- among others -- will be very well taken care of for what they've accomplished). Banks and others make too much money on these things "95% of the time." The other 5% of the time, they blow up. In practice, it's higher than 5% because of moral hazard. (I suspect there's a lot of moral hazard in how these things have been used by the sharks.) Given just a few players in the middle, they create systemic risk.
Bringing these onto central exchanges doesn't address these fundamental issues.
I'd love to create IGNORAMUS RE and sell insurance on hurricanes, capitalized with my current net worth. I'd make lots of money nine years out of ten -- but go horrendously broke at some point -- after I paid myself handsome bonuses. What's the difference?
Next up: Guarantees
Historic experience has led many regulators to ban banks providing guarantees for a fee. Often this is right in the enabling statute. (Nerdish example: "standby letters of credit" are a legal sleight of hand to get around this prohibition).
This is because guarantees -- because they don't require cash upfront and are often off-balance sheet -- aren't charged with appropriate capital, and are often mispriced for the risk. The monoline financial guaranty industry just blew up -- should we be surprised? Several foreign financials got modest seven figure fees upfront for guaranteeing what turned out to be nine or ten figure liabilities.
"Guaranteeing" derivatives is what brought AIG down.
It's a sucker's bet to not require collateral up-front for guarantees, but only require it later when there's deterioration -- but that's the industry standard for these things.
The rating agencies added to this by ignoring counter-party risk and moral hazard when they modeled these things. You don't have to be a genius to see a lot of correlation in the risks being created -- but the rating agencies ignored it.
..... More to come
Concerns over fractional reserve banking are so early 20th Century. That's why we came up with the Federal Reserve, and later the FDIC.
We want banks to go long. No one is going long right now, which is why we're in an economic funk. Hope and change, indeed.
Re fractional reserve banking: If a bank's loans aren't bad, access to the Fed discount window solves liquidity issues. If the loans are bad, FDIC insurance prevents runs. Most times the FDIC arranges a shotgun marriage for a failing bank, using the failing bank's franchise value as a dowry. When the FDIC does this, the failing bank's shareholders ... and its non-depositor creditors! ... get wiped out. The FDIC uses this method 99 times out of 100, and so only rarely actually pays out insurance to depositors. Smaller banks always get this treatment. WaMu did too.
What's a bank? Bear and Lehman weren't considered banks for these purposes, and so were vulnerable to runs. But today, Goldman and Morgan Stanley are bank holding companies with privileged access to the Fed discount window. I still can't get my head around that.
Shareholders at Bear, Lehman, WaMu and Wachovia suffered ... Goldman and Morgan Stanley not. Lloyd personally made over $300 million in GS appreciation in the months after bailout. It's nice to have the Treasury Secretary on speed dial.
TARP gets a lot of attention, but various arms of government -- including the FDIC -- provided guarantees that let the likes of Goldman and GE borrow billions at rates like 2%.
CardinalPark obfuscates by blurring distinctions between entities and how they were resolved. He's as bad as the Great Dissembler.
Back to guarantees for a moment, implicit and otherwise. Experience shows that parent companies aren't insulated when supposedly independent financial subsidiaries get into trouble -- witness Citigroup and its SIVs, Bear Stearns and its subprime hedge funds, AIG and its CDS business, GE and its CP-funded financial business -- just to cite some recent examples. So the notion that we'll solve the problem by having the likes of Goldman only doing risky stuff in insulated affiliates is false.
Can you say moral hazard?
The moral hazard we've created is not just with big bank shareholders, but with their ordinary debt. Big bank debtholders now expect to be covered 100%, so there's no market discipline on their leverage. For years, buying Fannie and Freddie debt was a way to get 50 bps over Treasuries, with an implied US guarantee -- this got handled just as aggressive debtholders expected. This same premise now holds for our biggest banks.
Can you say GSE?
That's because the federal government is an implicit guarantor for our biggest banks.
This is bad enough, but when these banks are doing business with no redeeming social purpose (e.g., derivatives. proprietary trading) ... WTF??
Just like my IGNORAMUS RE, Goldman will make a lot of money most of the time ... but at the risk of fucking up big time and leaving us with the tab. "Financial Reform" is nothing but. We've written "Too Big to Fail" into legislative stone.
Bienvenidos a Argentina!
Where am I wrong?
ps, thinking on all these federal guarantees got me thinking: How bad would the federal balance sheet look if we used GAAP? Imagine taking those financials -- divide everything by either a million or a billion -- and then take it down to your local bank and try to get a loan.