Everyone Has a Banking Plan Now

Another day, another banking plan, this one from two senior partners at McKinsey and Company, which may be the most influential company you may never have heard of.

The authors recognize the toxic-asset pricing problem: If the government buys them at market value, the banks become insolvent instantly; if the government pays book value, it is paying a massive subsidy. They also recognize the rough scale of the problem, predicting another $1 trillion in writedowns. And here’s the proposal:

[W]e propose that the government step in and establish a voluntary program to create a real market price and terms for the sale of bad assets. Rather than use modeling for valuation, the program would set discounts from either of the two basic approaches to accounting value [fair value and “hold-to-maturity,” which isn’t quite accurate, but that doesn’t matter], based on some recent past date (for instance, December 31, 2008). A reasonable level might be 10 percent off for securities already marked to fair value and 20 percent off for loans being held to maturity. Upon their sale to the government, existing shareholders would absorb the loss taken on the discount, and that loss of common stock value would be replaced by converting TARP preferred stock to nonvoting common (which would be vested with voting rights if sold to private parties).

I don’t see how this creates a “real market price.” If I’m a bank, I can sell to the government, at 10% or 20% off my book value, any assets I think are worth less than that; and I can keep all the ones I think are worth more than that. That’s not a market, it’s a free put option that rewards banks for having overstated the value of their assets. Even if you make the discount percentages bigger, it doesn’t change the basic dynamic: the banks will unload the worst assets, and keep the less bad ones. (Which might be one way to reduce uncertainty about the banks: “I’m really worried about all those toxic assets they are holding.” “Oh, don’t worry – they already dumped all the really bad ones on the taxpayer.”)

The authors argue that the subsidy is compensated for by the preferred-to-common conversion, which increases the government’s ownership stake. However, there’s a problem with this argument. Preferred stock is already worth something: when you convert it for common, you don’t magically get more value. Ordinarily, the value of the common you get should be the same as the value of the preferred you gave up. However, if you’re the government and you’re dealing with Citigroup, the common you get is worth a good deal less than the preferred you gave up. (At current prices, the government is exchanging $25 billion in preferred shares for about $8 billion in common shares. You could say that the preferred stock wasn’t actually worth $25 billion, but that’s only the case because there was risk that Citi might not buy it back when it had to – and if Citi didn’t buy it back, then its common shares would be worth zero.)

But, the argument goes, if you bail out the banks in this way, the common will regain its lost value, and the taxpayer is better off eventually.

If restoring the ongoing-concern value of banks helped the industry’s valuation to regain its January 2007 level (about 20 percent less than its high), we calculate that the government’s shareholdings would be worth about $560 billion.

The S&P 500 Financial Sector Index spent January 2007 in the 490s. It hit its all-time high of 509 on February 20, 2007. Today, it’s 82. How long do you think it will be before it reaches 490 again?

If the government is going to buy toxic assets, I prefer Lucian Bebchuk’s model.

Separately, Alan Blinder, whom I usually agree with, has an op-ed outlining some of the potential problems with nationalization. Unlike many opponents of nationalization, Blinder has the decency to be clear what he is talking about:

Because “nationalization” can mean many things, let’s first clarify what the current debate is about. Don’t think Hugo Chávez or even Clement Attlee. Imagine instead that the government acquires a majority interest in — or perhaps 100 percent of — a bank, wipes out the existing shareholders and installs new managers. Then, sometime later, a healthy bank is sold back into private hands, and we all live happily ever after. At least that’s the idea.

However, after listing some reasonable concerns about nationalization, he settles on the good bank/bad bank proposal, without mentioning what Krugman points out: there’s no way to remove bad assets from good banks without someone – that is, the government – taking over the liabiilities.

38 responses to “Everyone Has a Banking Plan Now

  1. The current problem, from the perspective of an informed non-economist reader, is not which remedy to try, none are guaranteed solutions, but an inability on the part of the authorities to face the problem. So maybe the argument should turn from economics to politics and psychology.

    At some point every one has had a project that started off on the wrong foot and gradually got worse. But you hold on, clinging to the illusion that the tide is turning because the thought of admitting your mistake a redoing all your work is more unpleasant than continuing to kick the dying idea ahead of you.

    So here we are, waiting for Geithner, Obama and Bernanke to come to terms with what is obvious to everyone on the outside from James Baker to Nouriel Roubini—we need dramatic, decisive, overwhelming action, not incremental modification of the existing system.

    The trigger that needs to be hit is psychological not logical. Admit error, start over. It would have been easiest when Geithner’s tax problems first came up, every day since then makes it harder.

  2. None of this talks about Feasibility. Citigroup and Bank of America employee about 600000 people the US government approximately 1,8 million people. Some things are beyond the US government including a nationalization of these banks. I would love to see Citigroup and Bank of America nationalized and liquidated. The ability to find a new crew of managers and investors for entities of this size is a daunting if not impossible task. Continential Illinois with a few billion dollars of assets took ten years to liquidate. Where are we going to find investors and new owners who are willing to pay hard cash for the new banks to be created?

    The fact is contrary to the consensus view of the Economics profession the banking industry does not allocate capital wisely or profitably if a long term view is taken. We need a state bank to invest in alternative energy and other things economically useful. Privatge enterprise at least in the US invests poorly from the standpoint of future development.

    The US government could set up a new bank with clean balance sheets and take private deposits to invest in infrastructure … energy, education, … etc. Unlike Private Enterprise it being a state entity would not have to maximize immediate profits as stated by the court decision in 1919 between the Dodge Brothers and Ford Motor co and still in Force.
    This Court Decision needs to be repealed before any alternative proposal to the below becomes viable.

    If the Virtual Parliament of investors are unhappy about loosing their loans after a bankrutcpy at Citi or elsewhere then we can do without them. The Federal Reserve can monetize whatever debt it wants to and hold it should lending be unavailable.

    I have yet to see the proponents of nationalization (myself a former one) explain why they think nationalization is feasible for Banks of this size. To my knowledge the reported asset base of the nationaized banks in the past are roughly 2 orders of magnitude less than what is faced now.

  3. One interesting thing about offering a put option is that it tells us something about what the banks really think of their assets. If the government gave a put option in return for preferred stock, perhaps this would be a step towards nationalizing the banks that are in the worst shape?

  4. Size is not an argument against nationalization: the government employs managers to run the bank just like the board of directors now does. These banks are knee deep in senior and middle management who will remain in place reporting to new executive management. The day to day management activities remain exactly the same. The only difference would be in the Board of Directors, which now represents the government instead of private shareholders, and executive management much, but not all, of which is replaced.

    As for allocation of capital: having a new state bank to invest in long term social projects may, or may not, be desirable. But that has nothing to do with bailing out or solving the current mess. You seem to think that the current system doesn’t allocate capital well, but I don’t know what your criteria are so I can’t comment. If you are arguing that financing a real estate bubble was bad and that we built too many houses, then i would agree.

  5. I don’t want to sidetrack the discussion happening in this thread but, in the interest of covering all bases, I ran in this[1] blog that seems to advocate for an unconventional monetary policy to dig us out of this mess pretty forcefully. For some reason or the other it doesn’t seem to be getting a lot of traction.

    [1] http://blogsandwikis.bentley.edu/themoneyillusion/

  6. Most all of the plans that have been proposed focus on creating “better banks” by springing the less liquid paper into the markets. To my thinking, they all contain substantial risk unless and until we have one good bank….a bank that has capital, deposits and lending power. The one good bank would serve as a backstop to the possibility of another total freeze in the credit system if for some unknown reason the toxic asset conversion program ran afoul of plan. So, I would suggest we take a bunch of TARP money and form a new FDIC insured bank; make its deposits insured to $1 million to attract a large deposit base. While most bank start-ups require branch networks, it certainly could be up and running quickly if it were totally on-line, internet based institution. Short-term, it could invest deposits in the collateralized overnight market or warehousing for current production conforming mortgages. If whichever toxic asset program chosen works as planned, TARP would have a bank to collapse in a couple years, or sell to the private sector. The main idea is that we need a “Plan B” in place to give the system some comfort as it enters uncharted territory.

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  8. If anybody actually wants to sell something, they define it, then they advertise it, something big like a house, they hire an agent to do this for them for a fee of maybe 6%. Nobody wants a toxic asset, but many might wish to own a mortgage obligation. Where’s the list of contracts for sale?

  9. “We need a state bank to invest in alternative energy and other things economically useful.”

    Thank you for making the CNBC crowds argument for them. If you want to do something useful and BU, why don’t you lobby to bring football back.

  10. I have a plan. Implement the damn laws on the books, civil and criminal.

    The above post is correct there is no magic to taking over and running a bank: replace the board. And the toxic paper simply gets liquidated, “fire sale” prices or not. Not one depositor has to lose a penny. We can be done with this in a week.

    The whole game now is for the current crony club to use their inside leverage to turn their inflated paper equity and gains into real assets. To make the taxpayer turn cover their losing bets, and then some.

    They will use every trick in the book, call every favor, and eventually make threats. Billions in personal gains are at stake, folks. This is the issue of why it is taking so long– not because the matter is complicated. There is nothing complicated about it.

    This is where the power of the executive could break up the club. Alas, that appears captured as well.

  11. Johnny dangereaux

    CASH-STARVED STATES NEED TO PLAY THE BANKING GAME:
    NORTH DAKOTA SHOWS HOW

    http://www.webofdebt.com/articles/state_bank_option.php

    Sounds good to me…..

  12. If the government would set up and fund a good bank, why would it be so bad to allow the troubled banks to fail? The American People have felt the whip of these big banks on their backs and have NO sympathy for them. We, the American People will deal with the negative aftermath of failed banks. It is the wealthy who keep attempting to dress a dead pig in new clothes. Economists and the wealthy look like fools. The People will not buy your discredited ideology. Without the People you cannot move forward. If you make the mistake of believing that public relations can get us to accept your further attempts to loot the Public, you are deeply mistaken. If you make the mistake of attempting to take unilateral actions to force People to accept your looting then look for serious trouble. You lost, game over, get out of the way.

  13. donthelibertariandemocrat

    If the government has to buy TAs, I prefer using it for QE. From Nick Rowe:

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2008/12/central-banks-should-bet-on-recovery-literally.html

    “Central Banks should bet on recovery – literally

    Ben Bernanke should publicly bet $1 trillion dollars that the US economy will recover quickly from deflation and recession. He should make that bet on the Fed’s behalf. The Treasury should publicly disavow all responsibility for bailing out the Fed if Bernanke loses the bet. If he loses the bet, it would be paid for by printing money.

    This is how people would react to the bet.

    If they expect deflation and recession to continue, so they expect Bernanke to lose the bet, they will expect the Fed to print an extra $1 trillion, which would be highly inflationary…..which is a contradiction.

    If they expect the economy to recover quickly, so they expect Bernanke to win the bet, they expect the Fed will not print an extra $1 trillion, so they will not expect hyperinflation, just a normal recovery, which confirms their expectation.

    By making such a bet, and making it publicly, the Fed creates the very expectations it wants to create: that deflation and recession will not continue, and that the economy will recover, and return to the normal rate of inflation.

    We need to refine the bet a little. It shouldn’t be an all-or-nothing bet. It needs to vary continuously with the speed and extent of the recovery, so that the quicker GPD and inflation and financial markets recover, the less money the Fed will have to pay on Bernanke’s bet. This creates a benign negative-feedback loop, helping people’s expectations, and the economy, self-equilibrate.

    The bet introduces considerable uncertainty into future money creation. But we are equally uncertain about how much money the Fed will need to create to promote recovery. The bet makes those two things, each uncertain, correlated with each other. That’s good, just as the uncertain payoff of my home insurance policy is good, since it is correlated with the uncertain damage that fire will do to my home.

    One way to implement such a bet would be for the Fed to buy a large amount of risky assets, where those assets would have a very high value if the economy recovers quickly, and a very low value if the economy did not recover.

    Oh, wait…..”

  14. Every single proposal we’ve seen to fix the banks goes something like this:

    1) Government does something which costs a lot of money (a ‘plan’)
    2) Time passes
    3) The economy heals
    4) Presto! Healthy banks!
    5) (optional) Sell them back into private hands at a profit.

    Policymakers – right up to the President – have been spending a disproportionate part of their time (and money) on fixing the banks vs. fixing the rest of the economy.

    Thus, we have lots – dozens – of plans for part 1. (How to fix the banks.) Lots of them sound reasonable. All of them are ludicrously expensive. Many of them are overly complicated, and make strong assumptions about government’s capability to fix problems while at the same time insulting pretty much every other function of government. (So which is it? Competent government, or incompetent government? You can’t spit on the federal government while at the same time insisting it’s the best agency to fix all our problems.)

    Many people – certainly most taxpayers – are skeptical that if we spend 4 trillion dollars on any plan, we’ll recover 75% of that (in real dollars, at least).

    But before we even get that far, can we regognize the severity of Step 3 (economy magically heals)?

    There is nothing currently in the offing to cause us to believe this will happen soon. Certainly, the forecast on this website does not posit this.

    To the degree that Step 3 does not happen on schedule, ANY bank rescue plan gets vastly more expensive BY THE DAY.

    Moreover, it appears that much of the cost of any bank “plan” is being spent to cover immediate and specific losses. Unlike the S&L crisis, these are not merely assets with depressed market value. Many of them are dead assets – they are not coming back to life. Roubini, for example, now estimates that the financial system could have another 1-2 trillion dollars in write downs (and they’ve already written down a trillion).

    Why are these assets dead, instead of simply depressed? Because people have already gone bankrupt. Forward-looking markdowns to credit-backed assets are based on the _fear_ that those loans will default. As the government has bumbled around spending all its time “fixing the banks”, we’ve seen those fears turn into reality. As fear becomes reality, loses become real and unrecoverable. The longer things go, the more _real_ money all of this will cost.

    So from the taxpayer’s perspective, it seems that ANY plan is more than an “investment” in our financial system. It’s lost money. Gone.

    So let’s be totally, completely honest about the likely cost of all of this mess. It’s not 700 million. It’s closer to 3 or 4 trillion (as stated), and we’re unlikely to get 75% of that back. As each day passes, the percent we could get back diminishes.

    And the reason it’s diminishing is not because we haven’t fixed the banks. It’s because we haven’t fixed the rest of the economy…

    So, compared to that, the taxpayer has to ask this fundamental question:

    Would the world economy be better off if we spent more money on fixing the rest of the economy faster (namely, the source of the problem – the loans themselves) rather than continually pouring money into a sinking ship?

    Most professional economists seem to be dismissing this question as dumb. (They dismiss most people as dumb – the profession as a whole is rather arrogant.)

    And what about this question:

    Why are our academic elite so much more forgiving of risking moral hazard among banks than of risking moral hazard among homebuyers?

    Right now, it’s absolutely clear that we have been lied to – recapitalizing the banks has NOT gotten the economy working. This is a simple fact. We’ve directly injected half a trillion dollars into AIG and the handful of big banks alone, and more is on the way. Yet most of our $789 billion Stimulus package won’t get spent until the end of this year and the beginning of the next.

    In other words, WE ARE FAILING. If we believe in markets, then every stock market around the world is sending us that message loud and clear.

    WE ARE FAILING.

    Focusing the majority of our resources on stabilizing the financial system is NOT working.

    Perhaps it is time for us to consider the possibility that the banks were not the key to fixing the economy, but rather that fixing the economy is the key to fixing the banks.

    If we fix the economy, asset values reflate and those marked-down assets can regain value. As bankruptcies accelerate, however, those marked down assets will become real and permanent losses.

    What this means in real terms is tremendous economic dislocation, lost value, and permanently lost productivity.

    It seems – and I daresay most Americans would agree – that our government (and most of our professional economists) have their priorities misplaced.

  15. BTW, this is a really good explanation of the modern finance system:

    http://www.webofdebt.com/articles/creditcrunch.php

    (found it following Johnny’s link above)

    I find it depressing when lawyers understand more of reality than economists.

  16. Oh, and the McKinsey people are employing a form of “lying with statistics” called deception-through-aggregation.

    From their article:

    “By our rough figures, if the government purchased $1.5 trillion in assets with an average 20 percent discount from accounting value ($300 billion), it would end up acquiring an ownership stake of some 36 percent in the industry as a result of the conversion of preferred stock to common or the injection of new common stock to make up for the equity lost through its discounted purchases. While that is a significant stake in the banking industry, it remains considerably less than what would occur under full-blown nationalization.”

    That’s 36% of the ENTIRE BANKING INDUSTRY. The problem is that the impaired assets are highly concentrated in certain banks, while other banks are generally solvent.

    So that 36% does NOT mean that the govt. will acquire 36% of the stock of most banks, but rather that we’ll likely acquire 75% of the stock of 50% of the banks. That means nationalizing half the banking industry (by total asset size) in the US.

    Most of the McKinsey people I’ve dealt with are smarter than this…

  17. bond trader

    when everyone including isaacs uses continental illinois as a an example against nationalization they do not address the fact bondholders were spared. which make the process more expensive and time consuming. i don’t quite understand this. bondholders use much the same analysis that equity investors use before investing. if they make a bad investment they should lose money. why should geithner, greenspan, isaacs, et al say that senior bondholders must be spared. they must not be spared at taxpayer expense.

  18. Here is a shot in the dark as to why Treasury (last I heard) is keeping us in the dark about the identity of counterparties. Toxic assets may be manageable, but are probably outweighed by toxic liabilities. By this, I mean guarantees against falling asset prices (puts in various forms). It is one thing when the counterparty owns the underlying asset and bought insurance. It is another when the put buyer was speculating on a fall. The put volume of owners is limited by the value of assets, but the speculator put volume is limited only by the put writer’s (former) credibility. The problem for Treasury is similar to housing; does one make all of them whole or only owner/occupiers. In retrospect, initially they optimistically promised to do too much and now, after further asset collapses, have no hope of delivering but can’t say so for fear of making the problem even worse. Am I off base?

  19. While people are trying to figure out what to do with the bad financial assets, is it too much to ask for the government to simply begin providing a service, where people can deposit their omney at 2% interest, and borrow money at 5% interest? I mean, it would be nice to have a financial system. If companies like GE really want to make 22% consumer loans, or play games with hedge funds, they can do what they want. But there is no reason for the entire financial system to be frozen. Since private companies obviously aren’t providing a basic financial system, the government may as well provide one. There are plenty of homeless people who could use a safe place to deposit what little spending money they have, and plenty of families who could use a modest $10,000 loan at 5% so they can stay in their homes while looking for a job. If the government doesn’t provide a financial system soon, I wonder if private enterprise will, in the form of loan sharks, etc. As silly as this sounds, is it really better to wait ANOTHER 6 months while people debate “what do we do about the bad assets?”

  20. The Bentley blog is a good blog – and I also wish they were getting more attention. I have tried to promote it with – as you see here – no results.

    Krugman today said that by the Tayor rule we should now have negative 6% interest rates – i.e. real aggressive inflation. Bernanke has been total and passive disaster – just sitting there and watching this happen. It is beyond sickening. He apologized for the last depression and he is now giving us another one.

  21. Which reinforces the key problem – the underlying asset values.

    The fundamental question is whether it’s cheaper, and better for US taxpayers, to reflate underlying asset values (and thereby help fix the economy) or to watch everything go bankrupt and cover the liabilities of our banks/finance institutions (by issuing public debt).

    The question of derivatives only makes issues worse, and vastly scarier.

    We are now 6 months into “fixing” our financial system, but it looks more broken than when we started.

    The government has embarked on a plan that requires plugging holes as the dam springs leaks. The sheer time and complexity of renegotiating all of these contracts to determine who wins, who loses, how much, how valuable the contract is, etc… Is ridiculous. A single bankruptcy case can take years to fully resolve. Paulson should have read up on transaction costs.

    There is a much more elegant solution. Almost all of these contracts are pegged to _nominal_ asset values. Had we reflated in October, or even January, we might have avoided much of this. Every day that passes, the paper losses become real, and we dig ourselves a deeper hole.

  22. I am glad you found and liked that MoneyIllusion blog. You are known around the web and whatever you can do to promote it would be very helpful.

    As I said above – Bernanke a couple years ago apologized for the last depression and now he is giving us another. This refusal to inflate – to announce and commit to a firm price level target – is simply beyond comprehension.

  23. This has been done before, even in the US, through government postal systems. Japan’s is still alive (and quite large).

    http://www.slate.com/id/2124035/

    There are a lot of “reasons” why the US does not do this. One is that providing banking services is very complex – far too difficult for the government to manage. Much more complex than, say, putting a man on the moon, or fighting a war.

    Only banker-geniuses are sufficiently smart and motivated enough to run an efficient and productive financial system. Private banking is thus vastly more efficient than public banking. Any decent American can see that our private banking industry has been the core to our economic prosperity. By contrast, a public bank would be a disaster!

    Consider, for example, the Bank of North Dakota.

    http://www.banknd.nd.gov/bndhome.jsp

    Oops. I guess that’s a bad example.

    Anyway, there’s another reason the US doesn’t offer public banking. Private banking is a source of _immense_ profits. The ability of private banks to essentially print their own money is one that private industry would kill to hold onto. Private industry simply does not want competition.

    Finally, there are also very long term political economic reasons – just how much power do you want the federal government to have? How would we conduct oversight on such a huge, vastly powerful public bank?

    Japan is currently wrestling with that problem.

  24. Jeeez !

    “If only !”

    Obama inherited the sludge and sleaze of Wall Street, but they were also his largest campaign contributors, thus, it seems, we have “Turbo Tim” and no solution – of any kind – in sight, except for TP’s to “pay up”.

    But what does a solution look like ? Since these Stygian Wall stables need a thorough clorox rinse and dry, why not Ch 11 for the lot ? Depositors would need to do nothing. Those investors and employees who made mistakes would (strange idea, indeed) bear responsibility for them. No more bonuses, and then life goes on.

    The ROW would go about it’s business and the reason for the lending freeze would be resolved at their origins – for example between asset holders and issuers.

    AIG would die. So what ?

    And BTW, Ming, please combine your idea with mine. Please. We can run the world together.

  25. The answer was already stated on another post on this blog a couple of days ago: banking is an industry that is unique in that it’s “product” basically is confidence, or trust. Other industries make things that people buy, which creates value. Banking is just about trust, trust that they will give you more money than you give them, or at least return to you the money that you lent. Without that trust, banks have no product, and to try to save them is a complete waste of time. We have now spent a year trying to save them, and the evidence supports this argument. The trust in these businesses is gone, and as such they have no product and need to be allowed to fail. If people won’t buy GM’s cars, GM goes belly up. If people won’t buy Citibank’s or AIG’s “deals”, they go belly up. It’s remarkably simple, really. Does anyone honestly see a way that Geithner and all can convince anyone at this point to trust the current management at Citibank, BoA, or AIG? If not, then every dollar spent to “save” these institutions with current management in place might as well be burned. Sadly, right now this is an awful lot of dollars…

  26. robby started this string of responses by concluding that: “The trigger that needs to be hit is psychological not logical. Admit error, start over.”

    Obama et al know the score and daren’t talk about it. The banks are bust, the global economy has tanked. We are facing generations of mass unemployment, homelessness, food shortages and poverty. Houses, stocks, pensions, insurance values have plummeted. If our “leaders” came out and said this, there would be riots, lynching, heads on pikes, looting, massive civil unrest and disobedience.

    It’s all going to happen of course. But acting dumb gives the smart banksters time to cut and run.

    Which may be a small consolation for Boris (above) who concludes: “every dollar spent to “save” these institutions with current management in place might as well be burned”. The management of Citibank, BoA, or AIG – with any brains and who value their liberty – will jump before they are pushed.

    Remember the parable of the “Russian Sugar Queue”…

    It’s rumoured that sugar may be available for sale tomorrow, so the lines start to form the day before. Soon there are hundreds of hopeful people queuing in the the freezing cold, and at 11 pm someone comes down the line to explain that there certainly won’t be enough sugar for all these people, so would the Jews leave the line.

    Nevertheless by 3 am the line is longer than ever, and another apparatchik instructs that suger will only be made available to communists so all others must leave the line. Yet by 7am the communists in the queue are now more than ever, and a further official walks down the line explaining that sugar is for Party Members only, non=Party Members must leave the line.

    Finally, at 11 am, after a long, hard night waiting in the freezing cold, the doors open… to reveal that it was only a rumour, there is no sugar after all. Leaving the Party Members to ask “Why do the Jews always get the best deal?”.

  27. Actually size is all more the reason to do it. If we can all agree that too big to fail is too big to exist then the institutions can not be allowed to exist as they are. Go in clean up the banks and mandate that they be divested. It’s not like that hasn’t happened before – think Standard Oil and all the monoploies of the early 1900’s. Who cares if it takes 10 years as long as this isn’t allowed to happen again.

  28. I was in a sugar queue in Moscow in 1992 which leads me to observe that, if we were under Communism, the rulers would be ecstatic. The wars aside, there are more houses than households, food and clothing stores are abundantly stocked, lots are full of cars waiting for drivers, gas is available without rationing, and there is a cornucopia of consumer goods of all manner. The only thing missing from this Utopia is that doctors don’t make house calls and higher education requires money. What we have is a financial problem, but financial systems are entirely artificial. While governments can’t do much about droughts, they can certainly change the rules of the financial game.

  29. Blinder does say, “So, again, someone must fill the hole. And, realistically, given the mess we’re in, much of that new capital would likely come from the taxpayers.”

    I’d appreciate a fuller response to Blinder here.

  30. Blinder is right. There are just three issues:
    1. You can’t get to the good bank/bad bank split without some form of takeover, unless you are saying the taxpayer should pay book value for the assets.
    2. It’s an open issue whether the creditors should be made whole. If you don’t make them whole, that reduces the size of “the hole.” But if you want to keep the banks standing in current form, like the present Treasury plan, you do have to make creditors whole.
    3. The longer we go without a definitive solution, the bigger “the hole” gets.

  31. I am glad to read Prof. Stiglitz: The Good Bank proposal has the advantage of avoiding the N-word: nationalization. Some believe a more polite term, “conservatorship” as it was called in the case of Fannie Mae, may be more palatable. It should be clear, though, that whatever it is called, the Good Bank proposal entails little more than playing by longstanding rules, a variant of standard practices to deal with firms whose liabilities exceed their assets . This is definitely consistent with what I had been writing for some time and recently here. Let’s set up some good banks via the “bridge banks” in conservatorship.

  32. The McKinsey approach is laughably superficial. It isn’t a solution, it’s a subsidy. It is a formalized put option for the banks, in that they’ll exercise the option on all assets that have a fair market value below the put price. This of course means that through adverse selection, the taxpayer will own the very worst assets from each bank, up to whatever limit is placed on the bank to exercise such a put option.

    What makes the McKinsey solution superficial isn’t the implicit put option, however. What makes it superficial is that it doesn’t even attempt to model “fair value” of the assets being sold to the taxpayer. If the US Treasury instead used a valuation formula for each security, at least the taxpayers would get something closer to a “fair value”, instead of paying dear for toxic sludge. Needless to say, Wall Street would likely test and reverse engineer such a formula, but that shouldn’t be too great a problem if the formula is grounded in reality, and subject to evolutionary changes based on security performance experience.

    In my opinion, we’ll see the asset purchase scenario revisited repeatedly in the future as a matter of policy. Many non-US banks and pension funds are also holding toxic CMOs, Those institutional investors purchase dollar-denominated assets and US Treasury securities. The federal government may not wish to see those customers left dangling in the wind, as they’ll be more reluctant to invest with us in the future. In other words, a direct equity-based bailout of a non-US bank would raise the eyebrows of the public; asset purchases from foreign-based entities wouldn’t invite much scrutiny.

  33. Hedge funds and private money get bailed out
    when our money is given to AIG.
    They do not “need” it. It was their risk, not ours.
    They chose AIG, not us.

    But we pay.

    This is called theft.

    I call it time to bring to accounts.
    Obama, is the “FIX” in ?
    FBI, where are you ?

  34. recessionnews

    My new banking plan? First Bank Of Sealy (as in “posture-pedic”)

  35. Robert Lind

    Thomas Hoening, head of the Kansas City Federal Reserve has written a straightforward explanation and solution of the current banking crisis. It is a 10 minute read and is understandable by someone with no economic background.

    http://www.kc.frb.org/speechbio/hoenigPDF/Omaha.03.06.09.pdf

  36. Lindsay Kellock

    Everybody has a banking plan …

    Would welcome comment on Mr. Bernanke’s four-point plan, as outlined in a speech to the Council on Foreign Relations … NPR March 10: – quote extrapolated:
    “We must have a strategy that regulates the financial system as a whole, in a holistic way, not just its individual components,” Bernanke said

  37. At this stage: Is it really important that we do everything we can to do the right thing? Is it really important that we discuss all the pros and cons?

    Are we talking ourselves to death while the markets are still in free fall at exceptionally fast rate and may further accellerate to a destination we will never be able to even open our mouth to discuss what was happening while we discuss those pros and cons?

    These pros and cons will prove to be moot and academic by the time we finished discussing them.

    We need concrete action. An unfinished plan is better than a perfect plan when applied at the right time and at the correct place. We don’t need to be technocrats and bureaucrats in order to be able to get out of this hell hole.

    We need collective positive actions since as of yesterday.

  38. Pingback: Economic Blog, Everything Economic » Toxic Car Follow-Up: Pricing Toxic Assets