One of the central themes of our Atlantic article was that the current crisis in the U.S. is very similar to the crises typically seen in emerging markets, and that resolving the crisis will require (some of) the measures often prescribed for emerging markets. This, Simon said, would be the assessment of IMF veterans who had worked on emerging markets crises.
At the exact same time that we were writing that article, Desmond Lachman – who worked at the IMF for 24 years, and then worked on emerging markets for Salomon Smith Barney for another seven years – was writing an article for the Washington Post saying many of the same things.* Here are the first three paragraphs:
Back in the spring of 1998, when Boris Yeltsin was still at Russia’s helm, I led a group of global investors to Moscow to find out firsthand where the Russian economy was headed. My long career with the International Monetary Fund and on Wall Street had taken me to “emerging markets” throughout Asia, Eastern Europe and Latin America, and I thought I’d seen it all. Yet I still recall the shock I felt at a meeting in Russia’s dingy Ministry of Finance, where I finally realized how a handful of young oligarchs were bringing Russia’s economy to ruin in the pursuit of their own selfish interests, despite the supposed brilliance of Anatoly Chubais, Russia’s economic czar at the time.
As you have no doubt heard by now, the U.S. joined most of Western Europe in announcing a bank recapitalization plan and additional guarantees on bank obligations this morning. The key details are:
- $250 billion of TARP money will go to the program, with about $125 billion already allotted to 8 banks (9 including Merrill) who were given take-it-or-leave-it offers yesterday.
- The government will generally put in between 1% and 3% of assets held by a participating bank.
- Most if not all banks will be eligible; it’s not clear what happens if the $250 billion is oversubscribed.
- The government gets non-voting perpetual preferred shares (no conversion to common), callable after 3 years, with a 5% dividend, increasing to 9% after 5 years.
- The government also gets warrants to buy common shares up to 15% of the preferred investment.
- Although the shares are non-voting, participating companies have to follow Treasury guidelines on executive compensation and corporate governance.
In addition, the government announced a blanket deposit guarantee on non-interest-bearing deposits and a 3-year guarantee of new senior debt issued by banks.
This is definitely at least two steps in the right direction. Nevertheless, some concerns to think about are:
- Is it enough money? 1-3% of assets isn’t much if we are worried about additional writedowns. Besides the writedowns we expect on mortgage-backed securities, a recession will increase losses on all types of loans. Fortunately I don’t see any reason why more of the $700 billion couldn’t go into this program if warranted.
- Couldn’t we have gotten a better deal? Buffett got a 10% dividend and more warrants at a cheaper price on his Goldman investment. However, this plan was structured to protect the interests of existing shareholders to maximize the chances that banks would participate, which may have been the right tradeoff.
- How do we make sure the banks behave sensibly in the future? By getting non-voting shares – as opposed to the UK plan, which will allow the government to appoint bank directors – Treasury has given up one form of control, presumably to avoid charges that the government is meddling in bank operations. This just means that regulation will be especially important.
Although the stock market is moving sideways, the credit market seems to be mildly positive: yields on 3-month T-bills are up 20 basis points (meaning that less money is fleeing to quality) and the TED spread is down 33 basis points (meaning banks are more willing to lend to each other).