By Simon Johnson
To fix a broken financial system – and to oversee its proper functioning in the future – you need experts. Finance is complex and the people in charge need to know what they are doing. One common problem, which is also manifest in the United States today, is that many of the leading experts still believe in some version of business-as-usual.
At the height of the Great Depression, Marriner S. Eccles was summoned to Washington from Utah – where he was a regional banker. He helped remodel the Federal Reserve through the Banking Act of 1935 and then became its first independent chairman – the Fed board had previously been chaired by the Treasury Secretary. Eccles was not a fan of big Wall Street firms and their speculative stock market operations; rather he understood and identified with smaller banks that lent to real businesses. Eccles was the right kind of expert for the moment. Who has the expertise to play this kind of role in our immediate future?
Tom Hoenig, formerly president of the Kansas City Fed, has long been a strong voice for financial sector reform along sensible lines. Within the official sector, he has spoken loudest and clearest on the most important defining issue: Too Big To Fail is simply too big. And last week he took a major step towards a more prominent role, when he was announced as the administration’s nominee to become vice-chair at the Federal Deposit Insurance Corporation (FDIC). Continue reading
By Simon Johnson
In the wake of recent equity market declines, the clamor for bailouts of various kinds grows ever louder around the world. Influential voices call for “leadership” from the US and Western Europe, and for policymakers in those countries to “get ahead of the curve”. This is all code for a simple and familiar plea: Do something that will protect investors, particularly creditors who have lent a lot of money to banks and countries that now appear to be in serious difficulty.
But providing another round of unconditional creditor bailouts in this situation would be a mistake. What we need is a combination of transparent losses where bad loans were made, combined with a ring fencing approach that protects sound governments and firms. There is no sign yet that policymakers are willing to make that distinction clear.
The situation around the world is undeniably bad. As Peter Boone and I argued in a Peterson Institute policy paper released a couple of weeks ago, Europe is most definitely “On the Brink” of a serious economic crisis that could involve widespread defaults or significant inflation or both. At the same time, Bank of America shares this week fell to their lowest in 2 years; with other large banks under pressure, there is a legitimate fear of rerunning the parts of the financial crisis of 2008-09. Continue reading
By Simon Johnson. My written testimony to House Financial Services, Subcommittee on Financial Institutions and Consumer Credit is here.
With unemployment back up to 9.2 percent, in the numbers that came out last week, the hunt is on for an explanation of why job creation has been so slow since the financial crisis of 2008. Some House Republicans think they have found a specific culprit: bank examiners.
In the view of Representative Bill Posey (R.) and a number of his colleagues on the House Financial Services Committee, bank examiners are clamping down on otherwise perfectly healthy banks – and forcing them to inappropriately classify some loans as “nonaccrual” (meaning less likely to be paid back). Mr. Posey has therefore introduced a bill that would direct examiners to regard all loans as accrual, as long as payments are still being made – and a hearing was held last Friday to discuss the merits of the matter.
I testified at the hearing and was not supportive of Mr. Posey’s legislation. On the subsequent panel of witnesses, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) testified – as the relevant regulators – and they were even more forcefully against the proposal. Continue reading
The following guest post was contributed by Jennifer S. Taub, a Lecturer and Coordinator of the Business Law Program within the Isenberg School of Management at the University of Massachusetts, Amherst (SSRN page here). Previously, she was an Associate General Counsel for Fidelity Investments in Boston and Assistant Vice President for the Fidelity Fixed Income Funds.
In poetry and politics, metaphor matters. Expect some fighting figures of speech on Thursday, when the conference committee takes up the topic of the Orderly Liquidation Fund or “OLF.” Under the proposed financial reform legislation, the OLF is the facility that would hold the money needed by the FDIC to shut down a systemically important, insolvent financial institution before its failure can contaminate other firms and the broader economy. In other words, one purpose of the resolution authority and OLF is to avoid repeating the disorder and disruption of either the Lehman bankruptcy or the AIG bailout.
To be clear, many question whether regulators will have the courage to invoke this provision and pull the plug on a dying bank. Accordingly, the “prevention” measures under discussion in the legislation are critical — these included the swaps desk spinoff, hard leverage caps on financial firms, regulatory oversight over shadow banks and inclusion of off-balance sheet transactions in capital standards, among others.
One of the hottest debates concerning funding the OLF is over who should pay into the fund and when should they pay. On the question of “who,” the choices have been framed as either industry or taxpayers. And the “when” options are described as in advance of or after a failure. Many, including the House majority in its bill and FDIC Chairman Sheila Bair, support an up-front assessment on industry. Those who oppose an industry pre-fund have tried to damn the OLF as a “bailout fund” and at times the financial reform legislation as a “bailout bill.”
The following guest post was written by Linus Wilson, a finance professor at the University of Louisiana at Lafayette, the media’s go-to guy on calculating the value of transactions between the government and the banks, and an occasional commenter on this blog. Linus also analyzes government-bank transactions at Seeking Alpha.
The U.S. government does few thing better than create debt. After a year of talking about it, the government is going to have the chance to throw their good debt, Treasury bills notes and bonds, after bad, non-performing toxic loans and securities. The Federal Deposit Insurance Corporation (FDIC) and the U.S. Treasury are going their separate ways on their cash for trash schemes at this point. Accountants and investors should be wary of the big prices they see coming from the FDIC’s auctions, but taxpayers should be afraid of the U.S. Treasury’s efforts to re-inflate the securitization bubble.
PPIP finally launches, Mike Konczal lays bare the subsidy, everyone just move along … hey, wait a second!
From the Times article: “[FDIC] officials announced that they had reached a deal to sell $1.3 billion in mortgages from Franklin Bank, a Houston-based lender that failed last November and was taken over by the F.D.I.C.”
Posted in Commentary
Tagged FDIC, PPIP
New York Times:
The Federal Deposit Insurance Corporation indefinitely postponed a central element of the Obama administration’s bank rescue plan on Wednesday, acknowledging that it could not persuade enough banks to sell off their bad assets. . . .
Many banks have refused to sell their loans, in part because doing so would force them to mark down the value of those loans and book big losses. Even though the government was prepared to prop up prices by offering cheap financing to investors, the prices that banks were demanding have remained far higher than the prices that investors were willing to pay.
I don’t think I’ve ever done this before, but . . . Simon and I, March 24:
The problem in the market today is that the prices demanded by the banks are much higher than the prices that private buyers (hedge funds, private equity firms, sovereign wealth funds) are willing to pay. The government has no way to bring down the banks’ minimum sale prices . . .
The subsidy may not be sweet enough to close the deal. According to one analysis, a specific mortgage-backed security was held on a bank’s books at 97 cents, while its market price was about 38 cents. Even if you limit the buyer’s potential loss to the capital he put in, it’s unlikely he will raise his bid from 38 cents to anything near 97 cents. . . .
We have been arguing, here and elsewhere, for a banking approach centered around scaling up FDIC-interventions. Part of the pushback is (1) Congress won’t provide any more money, (2) there is no point in even going to ask, and (3) if you did go ask, that could be destabilizing.
In that context, I’m encouraged by the moves in and around the Senate at the end of last week to increase the resources available to the FDIC (for details, see my assessment on The New Republic’s site this morning). The Administration seems to be taking the lead and key senators are coming on board.
There are still a lot of pieces that can go wrong: the vaunted “stress test” looks weak, the signals on banks from the Fed and Treasury are mixed at best, and the banking lobby is digging in for a long struggle. And the world economy is going to put severe pressure on any approach.
But eventually we will turn a corner and, at that point, the FDIC will likely play a central role.