Breaking The Bank

My problem with Monday’s expected announcement from Mr Geithner doesn’t have much to do with the details of the public-private partnership.  I doubt this will work, because I don’t see the incentive for banks to sell assets at less than the value currently on their books.  Right now, they have the government right where they want it – look at the body language and words of leading CEOs.

The government feels that it cannot take over large banks, there is no bankruptcy-type procedure that would work, and only deference to the CEOs of major financial institutions can get us out of this mess.  This is a conscious strategy decision from the very highest levels.

I’d like to say: OK, but this is absolutely the last time we will try for a solution to our banking problems involving a private sector-led approach.  Of course this would not be credible and bank CEOs know this.  Instead, I propose the following.

If Secretary Geithner’s scheme works, we draw the lesson that our banks became too big and we aim to make them smaller relative to the economy moving forward.  The regulatory agenda currently in progress – including for discussion at the G20 next week – would do essentially nothing to reduce the political power of big banks.  We need simple caps on bank size, leverage relative to the economy and – this is harder – measures of interconnected tail risk (i.e., is everyone making the same kind of crazy loans?).  Design a system with this in mind: regulators get captured and super-regulators get super-captured.

If the scheme doesn’t work, we draw the exact same lesson.  And, of course, we should expect Chairman Bernanke to move forward with his Plan B (or is it Plan Z?): inflation.

In any case, our top political leadership needs to really sell some version of the following message.  We let the banks get out of control and the cost will be enormous; our debt/GDP ratio will in all likelihood rise from around 40% to over 80%.  We cannot afford to have the same problem again.  We must break the power of banks before they break us all.  And if you don’t think banks can do that much damage to economies, just look around outside the United States – the world is full of countries where growth is slowed or distorted by a financial system that becomes too powerful.  This is not about tweaking the existing U.S. regulatory system; it is about complete change and – in many senses – turning back the clock to a financial system that was simpler, smaller, and much less dangerous.

By Simon Johnson

77 thoughts on “Breaking The Bank

  1. Nationalisation need not involve the government running banks on a day to day basis. Why not set up a sovereign wealth fund (e.g., with an eminent chairman such as Paul Volcker) with a clearly defined mandate to acquire any US bank on condition that (a) the existing board and CEO is replaced within 6 months, and (b) the bank is sold within (say) 10 years. (I understand the Swedish experience was that the banks were re-privatised too early and Swedish taxpayers could have got a better return had there been more time to re-privatise the banks). This approach would meet objections that governments are not good at running banks. It would also satisfy concerns about using taxpayer funds to bail out existing management (thereby aggravating moral hazard). To help ensure that the SWF does not overpay for acquiring banks, the US government could announce that taxpayer funds would only be provided to banks that are acquired by the SWF. I would be grateful if James or Simon could explain what’s wrong with using SWF to nationalise banks. As far as I can tell, no one seems to have given this approach any consideration. Note that Australia has a SWF called the Future Fund, which holds shares in Telstra (the telco incumbent) which the Ausralian government “privatised” last year. Telstra is now operated as a fully privatised company notwithstanding the fact that the government still owns a significant amount of equity through the Future Fund.

  2. We do not need to solve the long term issue this week. There is plenty of time to solve the next banking crisis before it happens on September 9, 2019 or whenever.

    Quite simply the banking system is over-leveraged. Debt has to be converted to equity. This has to be done now before the nation is bankrupted and the dollar is debased. The Bush-Obama approach amounts to just that – putting debt on the taxpayers back and/or inflating debt away, all the while demonizing the bankers as they stuff our money in their pockets. Send in the barbers now and administer the haircuts!

    I am not convinced that it is necessary to break up big banks. Too big to fail means we haven’t thought through how to liquidate or recapitalize the big banks quickly and efficiently when the need arises. Or rather, the real reason to break up the big banks is their political power.

  3. I am not an economist – but from reading discussion at various blogs (naked capitalism, firedoglake – especially J. Galbraith’s posts, krugman’s blog) I find a consensus that the Geithner Plan (basically a reshuffle of the Paulson Plan) WILL work – that is, it is confusing enough to enable the banksters to replenish their losses with money stolen from tomorrow’s taxpayers, and leave the current power structure intact.

    As to why this is being done – perhaps it is simply enough to know that Obama is in Wall St.’s pocket. But another hypothesis is that, unless they get their way, the banksters can break the system completely and have convincingly expressed this threat – leading to the collapse of just about every pension plan, for example.

    And yet all this financial destruction would take place in a world that is, generally speaking, physically intact. The vital organs are OK – it’s the nervous system that has cancer, or epilepsy, or syphilis.

    Is it really impossible to find some other way to coordinate things except through Wall St. and The City? I believe the bankster would like us to think so – they may even believe it themselves – but their readiness to resort to force when a country attempts to withdraw from the dominion of international capitalism suggests that they fear that there may be viable alternatives.

  4. To Kien, keep in mind the venerable Mr. Volcker is over 80 years old. Most people his age are busy sunning in Palm Beach.

  5. People in the blogosphere claim there are various legal impediments that make a quasi-nationalization solution impossible:
    (1) The government has no authority to seize control of most of (e.g.) Citibank; the only statutory authority is for the part related to deposits.
    (2) Citibank (e.g.) is a large multinational corporation; the government would have either no authority to seize the foreign components, or, if it did, it would be forced to sell them off immediately.

    I don’t really believe this things, but would like someone with more knowledge about this to comment.

  6. I think Occam’s razor favors the “Obama and the Democratic leadership are in the banks’ pockets” theory.

    FWIW, I’m a Democrat myself and donated to Obama’s campaign. However, my (admittedly vague) impression is that, among industrial sectors, FIRE leans less towards the Republicans than others. (Meaning, it’s not necessarily pro-Democrat, but it’s not nearly as pro-Republican as, say, energy.)

    Thus, there’s no partisan angle for an equitable solution because both parties have been corrupted on issues related to the financial sector.

  7. Bank failure is not a bad option.

    Certainly it’s a better option than putting American tax payers on the hook for banking stupidity.

    Maybe, once that happened, American voters and politicians could get down to the real problem at hand – corporate/union/lobbyist influence in policy.

  8. It seems to me that we have lost this “breaking the bank” issue.

    The inflation to come will attempt to goad people into piling on more debt on top of their present over-indebtedness. While job loss remains a real fear, this strategy will not work, but perhaps in a few years the reflation will “work”.

    Team Obama takes a “top-down” bankers’ point of view on the problem. Just let the credit flow and we’ll all be buying replacement flat-screen TVs again. The TVs will have a new set of nifty features, which will allow government bureaucrats to make the hedonic adjustments necessary to demonstrate that inflation is not so bad after all. Nothing will change — until it does.

    Since there will be no basis for a sound economy and therefore a sound recovery, we will fall into the merde again sooner rather than later, even without a housing bubble to propel things along. The next time around, the debt will be so large that we won’t be able to encourage the accumulation of debt to overcome a problem caused by the accumulation of debt, a insane strategy in so far as we are tossing future generations on the scrapheap to pay for our sins.

    And then we will be done for.

  9. The whole system is run by a group of people suffering from delusions of grandeur. To them nothing is really broken. They’ve got these bad debts on the books that they’d love to unload, but since it wasn’t really their faults for putting them on the books they don’t understand why they should suffer for it. It’s the government’s job to save the economy so they should do what’s right and just open the checkbook and take them off their hands. Simple as that.

    Of course, IMHO they should all be fired, the banks should be chopped up and the bond holders should take haircuts (and I don’t care if it takes us 10 years to do it). In the dog-eat-dog world of pure capitalism far worse would succumb to them all so they should be happy with that solution!

  10. I’m not sure if I will be able to understand the details of the Geithner plan nor do I know whether it will work. But one thing that I can put forth as an educated guess is that it will take a LONG time.

    The problem still remains that nobody knows what the appropriate price should be for these “toxic” assets. Is it 20c on the dollar? Is it 40c? How about 80c? Even in a situation where the federal government basically offers a subsidy to enable private money to come in and buy these mortgages and securities, you still have the problem of the two parties working out the appropriate pricing. The banks will say, “Great, now that you have a subsidy, I can sell you my non-performing asset at or near par” to which the buying entities will say, “There is no way I’ll pay you much more than the going price on the market, say 20c on the dollar.” In a sense, they’ll haggle over who is entitled to capture the value generated by the government subsidy/guarantee itself. Even in an environment where a buying entity is shielded from absolutely losses, they will not want their money tied up in an asset that has very little possibility of increasing in value.

    As an real life analogy and perhaps a microcosm of the ZOMBIE bank that is Citigroup, I have been looking at purchasing a home that has been on the market for nearly 2 years. The lien is held by Citi Residential Mortgage and the loan amount according to the tax records is over $900K. The house is a short sale. I’ve watched the asking price on the home go from $850K to $800K to $750K and now to $650K. In the intervening time frame, offers have come and gone (I have inquired) every offer lower than the asking price at the time and rejected by the bank. In addition, one potential buyer in particular had an engineering company brought in that estimated foundational repairs at over $150K. The report, by law, now must be included in the disclosures. I’m no contractor but the house lies of relatively flat land so it seems that the estimate is intentially exaggerated. Why won’t Citi just sell the house? Well, that’s an interesting question. There are two important questions that need to be answered first. The natural first question is: “What is the house worth?” This is a topic that could be debated. But the most important question for Citi is, “What is the value of the mortgage on Citi’s balance sheet and how much of a write-down would Citi be required to take if it sold it for $650K or $550K or $500K?” Expressed in the terms of a single home, it seems like petty cash compared to the figures being thrown around. But multiplied over the multitude of mortgages across Citi’s portolio, how much of a problem will this be? (FYI, I have no idea whether the mortgage is only SERVICED by Citi or if it is actually HELD as a whole mortgage by the bank. Based on the loan amount, I would guess the later.)

    This is what is meant by a ZOMBIE bank. Citi can’t sell the house for what the market will pay because it can’t take the multitude of write-downs on its mortgage portfolio for fear of running amok of its capital requirements. But it can’t make any additional loans or investments because it’s cash is tied up in lots of these illiquid real estate assets all over the country. What can it do? Hope. Wait. Beg for a “bailout”. Direct government investment and guarantees can protect their capital ratios and keep them in business. But eventually, it will need to rid itself of these assets (now I’m talking about the specific house in question as well as their overall portfolio of “toxic” assets) and what is the right price? If the government gave ME a guarantee that I would not lose more than $100K on the house, I would likely be willing to offer almost $650K on the property. But my hunch is that Citi would also be thinking along the same lines as increase the price to $750K. And so the dance would go…

    The situation with mortgage backed securities is much worse because of the problem of asymmetric information. At least with this one particular house, I know the bank has any more knowledge about problems with the house than I do. With RMBS however, the fear among potential investors is that the banks know more about individual securities than they would let on and sell the most toxic pieces out first and keep the performing assets on their books. And so if these securities were like the house I was discussing earlier, perhaps Citi will want to ask $750K but potential buyers would only be willing to pay $450K due to fears of assymetric information.

    None of this was a problem when asset prices were rising and all was right with the world. But I’m actually not sure on how a market clearing price can be found (at any level) for these securities unless the government subsidizes nearly 100% of the purchase price at par. At the very least, it will be very, very difficult and take a long, long time. The bankers are not impartial observers with society’s best interest at heart. They are one of many capitalist parties interested in minimizing their losses and maximizing their profit.

    How could Citi be forced to sell the house I want(i.e., their assets) into the market at the appropriate price? They would need to understand that taking a realistic look at the CURRENT values of those assets is what our country and our economy need. Those collective interests outweight the interests of a specific bank or individual. Now THAT is the justification for nationalization. Without nationalization, every bank will try to “hold on” until they can do so no longer, i.e., they become insolvent like Freddie/Fannie, Wamu, Wachovia, AIG, Bear Stearns, and Lehman. And with each subsequent failure the system weakens and drags the next bank down; until all the monkeys have fallen off the bed…

    I’m not an economist nor a fortune teller but it seems inevitable that some banks, in particular Citigroup, will need to be nationalized to deal with the root problem. Throwing money at the banks is both wasteful and ineffective – it just invites a grabfest as to who’s going to get more of it while not providing the solution to the underlying problem of core motivation.

  11. Mistah:

    The common view on the contrary is that the Geithner plan will not work. here is Krugman’s in his last post in the NYT titled Financial Policy Despair “But the real problem with this plan is that it won’t work. Yes, troubled assets may be somewhat undervalued. But the fact is that financial executives literally bet their banks on the belief that there was no housing bubble, and the related belief that unprecedented levels of household debt were no problem. They lost that bet. And no amount of financial hocus-pocus — for that is what the Geithner plan amounts to — will change that fact.”

    Nouriel Roubini, in his RGE monitor states similar views. Roubini as well as Krugman and Johnson with many others explain us that the crisis is not a crisis of liquidity but a crisis of confidence. I crisis of confidence is present when investors doubt the solvency of an institution. The Bush/ Geithner plan addresses the problem as if it were a liquidity problem……

    To go back to Simon’s comment. Can someone recommend me a good book which deals with the world’s recent financial crisis ( something a simple mind like mine could read and understand ).

  12. Simon (and James),

    Thanks for your public use of reason:it is keeping alive my hope that this might eventually become an enlightened century, not just yet another century of enlightenment…:)

    But the obstacles are enormous, and it seems that a truly historic opportunity is being lost, right now.

    For what possible purpose do we (“we” in most generous cosmopolitan sense of the word) need that very dysfunctional and oversized financial system that has imploded? I can see only one reason for existence for it: it was perfectly adapted to amplify asset bubbles to their extreme.

    Trying to revive the imploded system may revive the hopes of the “Masters of Universe”, but it will certainly not serve the ends of global sustainable development. For that purpose we need an entirely different financial architecture. As you say: “We must break the power of banks before they break us all.”

  13. I want to applaud your thoughtful commentary.

    We have 3 major areas to address:

    1. Liquidity – there is a lack of funds due to bank capital reserve requirements and an unwillingness to lend as banks hoarding to shore up their compromised balance sheets.

    2. Confidence – it all comes down to people being willing to take risk or not. Most people are scared and uncertain now – this includes government officials, bank executives, and the public. Until we restore hope…and it will take more than prayers along with some progressive “wins” of freeing up capital and a reversal of foreclosures and unemployment…we’re going to witness and feel more pain. Besides, we are unaccustomed to things taking a long time to progress and our impatience may lead to much more unpleasantness and simply delaying the fundamental restructuring that needs to happen for our economy to recover.

    3. This is a global meltdown. Despite the “sudden” bubble burst last year, the greed-laden frenzy took time to create and it will take years, not months, to cure our sick economy. We need steady hands, fortitude and people who demonstrate both stewardship and leadership to guide the US and other nations back to economic health. This is a time where each of us needs to “take one for the team” because each of us is affected by the mess, whether we like it or not, whether we caused it or not.

  14. I don’t think Unions are a part of the problem here. They have become powerless because of the right wing’s assault on them over the last 40 years. Unions creating problems is something i just don’t see. Whether it is the automotive industry or airline industry…there are businesses doing just fine and treating employees right. If you pay them fairly then the Union thing doesn’t even have to happen but we all know that in this country business wants to pay slave wages whenever possible.

  15. Investers holding 10 percent of Citi (for example), get together and for a hedge fund to buy Citi’s toxic assets.

    If current details are accurate, this fund risk 3 cents for every dollar they spend if they win their bid. At the same time, Citi earns 1 dollar for each dollar bid above their eventual value.

    If the fund pays twice value, the fund holders lose 3 cents times twice the value or 6 cents per value dollar, but gain in Citi one dollar times the value times 10 percent (the group’s stake) or 10 cents. They make 4 cents a dollar risk free; overpay by 3x, means 9 cents earns 20, 4x means 12 cents earns 30 cents… Oh and the other Citi holder get a rich ride.

    The market price for this new auction be a measure of the market’s view for how bold a robbery can be made without public backlash killing this infinitely golden goose.

    Of course, this hedge fund sounds complicated. Now if Citi and B of A happen to each overpay for 100 billion in the other’s assets…

  16. If we can’t, right now, get the banks to go along with a good plan then we aught to right a law and build a process to handle a situation where too big to fail need to fail. I think we’ve got time for that, then just tell the banks, no more money, not more support. When the creditors to the banks come knocking they can prove to them they are fine and these assets are worth lots of money or they can go through this special bankruptcy process designed just for them. Since it would be in print, everyone would know where they stand when the process starts and it could be designed to NOT be a Lehman Bros. like bankruptcy – isn’t that what everyones afraid of when they say too big to fail. Well lets prevent that chaotic scenario from happening, but stop denying that bankruptcy in general is out of the question.

  17. Liberal:

    I couldn’t resist this one.

    If there is strong political will, a central government can do what ever it wishes. It can even enthrone your dog as an absolute monarch……. well maybe not your dog but mine could look good in a flight suit ;-)

  18. Did anyone else read March 21,2009, NYTimes, “Goldman Insists It Would Have Lost Little if A.I.G. Had Failed? “In mid-November, Goldman also sold $5.6 billion in securities related to the swaps at full value to a government-backed vehicle that had been created to help unwind A.I G’s ill-fated trades.” Full value??? A.I.G. ill-fated trades? What about Goldman’s ill-fated underlying MBSecurities? Goldman, definitely, to quote Simon, has the goverment right where Goldman wants it— under its proverbial thumb or should we say jackboot? Maybe we should put Goldman in charge—they, unlike we the taxpayers, “are not in a position to take a loss.” Forget that, Goldman has already been in charge of Treasury—Rubin, Paulson, etc.

  19. To confirm Simon’s view that the banks are taking the piss:

    JPMorgan Chase, who received $25 billion in federal aid, is going ahead with a $138 million plan to buy two new luxury corporate jets. JPMorgan Chase is also building a “premiere corporate aircraft hanger on the eastern seaboard to house them”, ABC News has learned.

  20. Valerie – in saying that the Geithner Plan will “work” – I meant work in the sense that I stated in that sentence:

    “It is confusing enough to enable the banksters to replenish their losses with money stolen from tomorrow’s taxpayers, and leave the current power structure intact.’

    In other words, I regard it as likely to achieve the REAL goal.

    In terms of “working” in the sense of improving the economy, or minimizing the losses to the taxpayers – these may be “stated” goals but they are not REAL goals.

    In general, if you want to know what people’s intentions are, rather than listen to what they say, it is better to watch what they do (and then, of course, try to imagine whether what they got was what they were trying to get – admittedly, this brings inference back in.)

  21. Yes, Nalini, you are right. The stock market behaves like a complex adaptive system (that is, like a city, an ant colony, or the human brain). It displays emergent behaviour: market sentiment is a propery of the whole, like emotion in the human mind.

    When the Baseline Scenario talks of “tipping points”, it implies to this “model” of the economy.

    Because complex adaptive systems have a “life” of their own (they are able to learn in their parts and as a whole), they are not readily coerced. Hence action top-down and from the centre is almost certain to fail and more likely than not to have unintended and generally harmful consequences.

    You “manage” complex adaptive systems by pulling not pushing, by seducing not enforcing. This means building on the knowledge and experience of people at the grassroots.

    This isn’t what politicians and economists want to believe because it marginalizes them.

    Nevertheless, all these government interventions will fail and will compound the problems, as we are seeing. This will leave it to the rest of us to resolve or workaround the mess once the financial system has finally collapsed.

    What can we do about it? Begin by making dialogue (not party-poltical bickering) safe. We won’t solve these problems if we cannot talk about them.

    So three cheers for these guys in Baseline Scenario. Points they daren’t express in the posts are usually made by them(?) or others in the comments.

    Geithner’s latest plan = hugely expensive money laundering of government subsidies to banks. Say no more.

  22. I know ‘inflation’ is not a popular word – particularly on a website run by a former IMF exec – but it may very well be the best shot at long term growth. So here’s my plug for (some) inflation:

    Galbraith, et. al. discuss inflation with regards to WWII. One of the things that pulled the country out of the Depression(s) was inflation of currency that devalued existing & new debt, full employment, and (somewhat forced) savings. This built spending power in the middle class. (others have discussed this on this forum)

    The limit on this is international inflow of goods (in exchange for overvalued US dollars), which has resulted from the US love affair with a strong dollar and cheap imports. And, foreign willingness to finance said imports.

    The medicine for these problems is a weaker dollar (yes, heresy, but it’s time to suck up the truth instead of living the strong-dollar lie).

    The risk is international capital outflows as investors shift out of the dollar (which would be exacerbated by the EU and Japan holding to deflationary currency practices – such as they appear to be doing).

    Part of the deep problem – addressed frontally by Krugman and laterally by Roubini and others (in discussions of the private debt load) – is that middle class purchasing power has been eroded over the last 30 years such that there’s just not much left. You can argue bitterly over the cause, but the facts are the facts, and if we want long term growth the situation needs to be dealt with.

    Unfortunately, this entire thing is rapidly being recast into a class-warfare argument. Here’s my take on the primary positions:

    Moneyed Classes: “It’s those lazy lower/middle class peons who wanted to have nice houses like us and borrowed more than they could pay! If they hadn’t gotten uppity, this whole system would still be running. (And if you’re a hard-working middle class american who didn’t take on debt, you should be on our side!) And it’s the government’s fault for forcing us to make loans to those poor brown people in California and Florida – we didn’t _want_ to make those loans. Really.

    Oh, and even though we are anti-government intervention, we need the government to bail our banks out because the financial system is the most important part of the economy. That’s unfortunate, but what can you do?”

    Lower/Middle Classes: “You guys rewrote the laws, cheated, and took our money to line your pockets. What do you even make? What do you contribute in exchange for those fat bonuses? You’re a bunch of leeches. Now, when it comes time to pay the piper, we’re losing our houses and jobs, but YOUR jobs/houses are being protected by the bank bailouts? I’d rather see the whole system burn, so the elites can see what it’s like to live like us. I’d like some revenge for the last 30 years of horsepucky you’ve piled onto us. And by the way, if wages hadn’t been declining for 20 years due to outsourcing and health care costs and rising income inequality, we wouldn’t have been in debt!

    And don’t blame us for voting for politicians who promised us lower taxes while piling debt onto our kids. They lied to us, and we can’t be blamed for believing those loies. We’re just pro-American and anti-government. Except when the government is giving money to us.”

    It’s easy to poke holes in both arguments – both are self-serving. But the fact remains that middle class purchasing power will need to be rebuilt to sustain a long term recovery. The dollar will need to devalue to constrain international purchases that we cannot afford (unless we want tariffs…). Americans will have to save more (and consume less – particularly from abroad). Debt will need to be spent down by printing money. While household balance sheets are being rebuilt, someone needs to sustain economic activity so that private companies continue to make investments even without immediate private consumption – and that is government. And govt. can’t do this _entirely_ through taxation of work and borrowing from abroad – it’s going to need to print money also (a tax on currency denominated assets).

    ‘Fortunately’, the US has a huge backload of neglected infrastructure to invest in… So at least the govt. sponsored economic activity should be (moderately) productive for the next 5-10 years, and hopefully stimulating as well.

    Then the pendulum can swing back and we can all go back to the good-ole American tradition of hating our government.

  23. Nice link – blodget has a nicely laid out chart on Total Debt vs. GDP, which rather easily makes some key points:

    ALL of the massive increase in debt from the stable 1970s levels was accumulated between 1984-1992 and 2000-2008.

    All of it.

    Now, here’s something great – someone else previously pointed a link to THIS chart:

    This is a chart of the money multiplier for M1 – essentially a measure of velocity.

    It seems ALMOST a truism, but if the economy continues to grow at 3%, while M1 is shrinking, doesn’t that mean that the difference _has_ to be made up with debt? And that debt is essentially credit that is manufactured by banks (e.g., money created and put to use by banks, instead of the government)?

    I’ll call this the “Strong Dollar Sucker Punch Hypothesis”.

  24. Obama used Volcker leading up to the election and is now apparently ignoring him. It is shameful.

  25. Bravo Simon. Please don’t give up the good fight. When Bernake spoke to community bank leaders last week, he said it was high priority to have a system in place to “unwind” the toobigtofail institutions. Today’s announcement is probably the holding space for that job—

    What did you think about Obama trying to tell the world that it should do exactly as we are doing, in the announcement this morning? I personally hope that advice won’t be taken.

  26. Dear Simon,

    You are absolutely right. There is no “incentive for banks to sell assets at less than the value currently on their books”.

    Assuming that you (i.e., the government) can make the banks sell all the toxic assets at the value currently on their books, do it, under the following terms:

    1. Instead of paying cash, give the banks a three-year guarantee on an amount equal to the value of the purchased assets (presumably, no guarantee will be issued without strings attached re management).

    2. The existing and/or appointed banks’ managers will sell, as trustees, these assets during the three-year period, subject to the government’s guidelines and supervision (and, possibly, under economic recovery conditions).
    The amount of guarantee will be reduced as the proceeds come in.

    3. At the end of the period, or after the completion of the sale (whichever comes first) the ownership issue will be settled according to an agreed formula, the core of which is the size of the residual amount of guarantee – the higher the amount, the higher the government’s share and vice versa (unsold assets will be valued, for that purpose, at zero).

    4. Cash transfers to the banks will be made during the period only in cases of liquidity problems (subject to the terms of the guarantee), and will be taken into account in arriving at the final ownership apportionment.

    The principle is quite simple. Instead of valuating the ‘un-valuable’, the banks will have three years to get rid, on behalf of the government, of those assets. The higher the price they get, the better for them and for taxpayers.

    If uninsured creditors are meant to emerge unscathed from this crisis, then all the losses will be borne by stockholders and taxpayers. Any plan must make sure that taxpayers are the last to pay.

  27. The Sound and the Fury, signifying nothing?

    All of this high fallutin’ BS is allowing us to miss the point completely. The so-called toxic assets are actually buried in bundles of loans which have been syndicated and sold to investors worldwide. The credit default swaps are an insurance policy sold against default of the whole bundle. The simple solution is for the government to guarantee the debt instruments for a limited time but require any guaranteed bundle to be unbundled and the non-performing debt to be stripped out. This prevents the credit default swaps from having to be paid off on the total packages and allows the non-performing loans to be dealt with. No one wants to break apart their bundles because? Too much work? The true extent of the fraud would be revealed? I can’t tell you the answer to that one, but until the non-performing debt can be separated from the performing debt without triggering compensation through the credit default swaps, I don’t see how this problem ever gets solved.

  28. Its kind of like requiring the financial world to take a time out, go stand in the corner while the grownups sort out the mess. The only question,are there actually any grownups in charge? That may be the crux of the problem.

  29. Its too late.Obama said we were being held hostage by the banks no?He described them as terrorists with a bomb strpped to their chests and a finger on the button{see his town hall meeting}.What do you think that means?
    If the banks are already TOO BIG to fail why are they being allowed to use the TARP to buy up more banks?
    Geithner,Summmers and Bernake ARE the banks.Geithner cams from the fed,Summers the world bank And Bernake is the head of THE bank to the banks.
    Just ask yourself why Lehmans was allowed to fail. Then see who was at the meeting when that decision was made.Then see who is benefiting from that failure.THESE SAME BANKS.
    Then remember David X LI designed the Gaussian copula models for the pricing of collateralized debt obligations{ the mathmatical model that helped bring down wallstreet.}. Who was he working for?J P morgan.
    Who is benefiting from this crisis?J P Morgan etc..
    This crisis is no accident and its international.The banks are bankrupting the world no?And putting us in debt to them for trillions{and whats the derivatives market worth?500 trillion?}
    The bigger question is why.

  30. If what has happened to the economy since last year isn’t enough to convince you that the banks are too large, nothing will.

    By now, the answer to the question “Should a entity with the power to to take down an entire economy be allowed to exist?” should be an obvious NO. Through their repeal of the Glass-Steagall Act, their failure to regulate derivatives, their rescue of Long-Term Capital Management, etc, our government said yes–and opened the door to what we’re experiencing now.

    Any steps other than re-imposing modern versions of Depression-era laws just paves the way for an expensive re-run of our current circumstance. The economic well-being of our country should be reason enough to break these banks up.

  31. “We let the banks get out of control and the cost will be enormous; our debt/GDP ratio will in all likelihood rise from around 40% to over 80%.”

    No Simon, that rise in debt is thanks to the spending that you progressives would like to do over the next 3+ years. Have you bothered to consult CBO on this issue? The financial industry is drop in the bucket compared to your insane health care program.

    Also, you might want to ask yourself whether its a good idea to get rid of institutions like Citi or even AIG in a globalized world. At least with those two institutions, you could count on them to adhere to US global interests (i.e. not screwing over US companies when it came to loans or credit or insurance). Do you really think that the foreign institutions that will replace them will have our best interests at heart?

    What happens when the next Latin America meltdown (or Mexican meltdown) comes? Is Deutchebank, at the behest of the Federal Government, going to make the necessary loans to ensure that we don’t have a failed state on the other side of our border?

    You guys really understand nothing when it comes to the national interest, or, for that matter, the financial industry…and the long history that our government has had working with it.

  32. China”s central bank on Monday proposed replacing the US dollar as the international reserve currency with a new global system controlled by the International Monetary Fund.”

    While the stock market seems to like the Geithner plan, our main creditor has decided the policy will lead the treasury to insolvency.

    and they had fun fun fun till daddy took the T-Bird away. Once again, America reacts to a moment of crisis with a solipsist struggle for political control- and in so doing, loses all of it’s real power. First in foreign policy, now in economic policy.

    it’s over. Dollars to donuts none of these financial types will even reside in the U.S. in 5 years. Just watch.

    P.S.where was David Li born? china
    Where is he now?China

  33. What did bush do about it?Nothing!
    You do know he comes from a banking family?
    Thay his family has interests in china AND saudi arabia?
    He holds hands with saudi princes after all no?
    And who is the carlyle group?There is no national interest when it comes to the banks.They dont care who is the president or dictator.And they now own us.

  34. Perhaps we should be just a tad cautious about predicting they will fail. (Or at least, be precise about what we mean by fail.) There’s a good chance they will fail, but they might just succeed (if they can give away enough money fast enough).

    Geithner may just be a little smarter than we give him credit for: The plan is _intended_ to be a giveaway. However, the gamble is that if the giveaway is sufficiently broad based, then everyone buys up the assets at the same time. This reflates asset values, and potentially feeds back through the economy as a positive wealth shock (if they can keep it going long enough). It also reduces bankruptcies by potentially stabilizing house prices. In the context of their larger plan (stimulus, fed actions, other TARP initiatives), maybe it will work.

    Certainly recent actions make it (slightly) more dangerous to bet on further deterioration in asset prices (and the restoration of mark-to-market and the uptick rule are in line with that).

    The market seems to think it has a shot (or at least, the market is expressing satisfaction that _someone_ won and the long standoff is over).

    At the very least, the market seems increasingly relieved that someone appears to be steering the ship. Finally. Even if it isn’t exactly in the right direction.

  35. The truth comes out from unexpected sources:

    Hey the solution is simple. Vote with your dollars. Put your money in New Zealand dollars, one of the few societies whose banks are uncontaminated by this mess. Become richer as the US$ goes down the tubes. I guarantee you that that will be what the big boys will be doing. That will wake up the politicians. Think of it as economic disobedience.

  36. No truthynesslover, the government owns us. After 10 years we’re going to owe 80% of our GDP to God know who. That’s not the previous moron’s fault…That’s the current moron’s fault.

  37. Sorry Ed, but history isn’t with you on this in terms of progressives driving the private debt/gdp ratios. Politik’s link above has a pretty graph:

    ALL of the increase is in the Reagan/Bush years. ALL of it. Not just most of it. ALL of it. The Clinton years were the island of fiscal responsibility (much of which might be attributed to the 1994 Republican Congress).

    Whatever you might say, the current problem with Debt is not a “progressive” problem.

    Your point on having “American” banks is interesting, to the extent that CITI (which is substantially owned by Saudi Arabian sovereign wealth) is really American.

    At the very least, it’s an interesting point to add to the Big-Bank-Small-Bank debate.

  38. 2 questions:

    – I agree that all the focus is on beefed-up regulation (expanded scope and powers for the Fed, etc.), but no one seems to be remembering that stronger regulators can get captured just as much as weak ones can (indeed, perhaps even moreso, as the incentives for capturing them will be stronger)? How, indeed, does one solve this problem and design a system where the incentives maximize the chances of compliance (both the incentives of the regulated and the incentives of the regulators)? In some ways this is the traditional principal-agent problem, but who has done the best work on this?

    – Has anyone done any credible thinking about not only whether financial institutions must shrink (which is obvious) but even whether and how finance itself must be completely re-thought – i.e., is it efficient to have whole populations spending their time and best human resources gambling in an after-market of pieces of paper called “stocks”? does all of this activity serve any useful purpose that can somehow justify the resources devoted to it? if not, how would a society try to reign in “non-productive” financial activity and focus resources on the true allocation of capital, without unduly impinging on the liberty to trade? is there also a cultural negative impact, that of bestowing respect on the concept of wealth and success without helping to produce real goods and services? – we will never (and should never) completely eliminate speculation, but it is society’s right to try to focus resources on productive activities. Has anyone done serious thinking in these directions, or does everyone accept that the basic structure of financial and capital markets is sound (even if it needs to be smaller and better regulated)?

  39. to Ed,
    What govt?were bankrupt no?
    who owns us?China!
    The current “moron” has no choice but to try to spend our way out and hope to jump start a Zombie economy.The jobs we lost arent comming back and there is NOONE left to start new compnies BUT the govt.
    Thanks to Bush.
    This is the culmination of a 30 year plan by consrvatives to drown the govt in the bathtub.
    Obama inherited this mess.So he was setup.

  40. We can break up all the banks we want but if we dont deal with the federal reserve THE private bank to banks its all just an exercise in futility.
    The FED is the problem!

  41. See the utube Zeitgeist movie-
    Read Creature at Jekle Island (endorsed by Ron Paul)

  42. I think Ron Paul is is living in a different generational and historical pattern but hes right on the money about the fed!

  43. Jay Leno asked the President ‘Shouldn’t someone go to jail?’ Obama shrugged and said ‘The trouble is it is all perfectly legal.’ Frank Rich had a beef about this as well. I’m guessing that if they did start pressing for fraud indictments it would be revealed there is no there…there. How insolvent all of these ‘legacy instrument’ holders are. Securities leveraged by thirty times and guaranteed as AAA…Something isn’t true…where did the money go? Yes, there several who should go to the slammer, starting mr. cassano from AIG.

  44. I can see only one reason to assume that Geitner’s new plan will produce results.

    Gibbs, the White House press secretary, alluded to it today: “the alternative to sharing the burden is to take on the whole thing.”

    As in nationalization.

    Further he said: “This is the result of extensive discussions with both Capitol Hill and Wall Street.

    Who has a gun to whose head? Who is issuing the ransom note this time?

    If Geitner told the banks that they will put up the assets for sale and told the money people that they will put up the money to buy or else… they will nationalize. Then the whole thing begins to make some sense.

    Am I just a conspiracy theorist?

  45. Dear My Shadow,

    It may be true that alot of the mess makers stayed within “most” laws, but, the heads of any organizations that actually signed the financial statements of their company without knowing or understanding what was there, truly could not verify the truth of the financial statement and as such, they violated Sarbanes-oxley–so, if only anyone cared to pursuit this, we could stimulate the economy by building a prison or two, to hold the some of the culprits! Fraud is fraud, and certainly people putting false income on mortgages is fraud, whether it is the signer or the mortgage maker—I FIND IT COMPLETELY FLIPPANT AND ASTONISHING THAT PRESIDENT OBAMA SAID THAT TO LENO–it makes me more sure that he, like all other presidents, has becoome a puppet to the BANKSTER CARTEL.

  46. you must be a new reader here. The fair and right thing (closing insolvent institutions) until every scam to suck money out of taxpayers currency is drawn and our system is bankrupt) With some saying that we are at the 13-15TRILLION dollar point for this scam, i think the BANKSTERS have almost reached the point where the gig is up….establishing this public/private partnership also is handy when the point is reached that the right thing must be done–but by that time, the fraudsters have bought their singapore currency, land in new zealand, lots of gold, and they are sitting back laughing at the suckers that we are!

  47. Davos afforded a unique opportunity for Russian self-styled leader Vladimir Putin to storm the forum stage and to steal the show. Putin presented a basic Blueprint for what should be called “The Post-US World’ as the United States and United Kingdom have lost the mantle of leadership and control. They lost it from failed economic policy, wrecked banking systems, fraud-ridden bond markets, corrupted debt ratings agencies, abuse of IMF & World Bank, and the severe backfire of economies that depended upon housing bubbles. Inflation turned on its haughty financial engineers! Nations with insolvent banks, insolvent households, corporations in liquidation, economies in near collapse, they tend not to be good owners and custodians of the global reserve currency!!!

    Davos provided a flashpoint for a profound change in global leadership. The whimpering US-UK-EU bankers have been shamed. Then after the finger pointing, insults, hand wringing, and gut wrenching, Putin rode in on a white horse carrying a banner. Chinese Premier Wen Jiabao provided the confirmation to what Putin laid out, like a second of a formal motion. Wen Jiabao proceeded from the Davos stage to four European capitals to seal the new path and its legitimacy. The barter system has been launched in quiet, while the Western press continues not to comprehend a ruptured status quo limping along. It cannot; it will not; the transition is on.

    Get ready for the new world order.

  48. cont.
    There is a brand new system being designed that will borrow from the past and apply 21st century tools for barter / counter trade / excess capacity etc. An Exchange Platform will cut out the banks altogether � [Chinese Premier] Wen delivered his speech in Davos and went straight to Berlin where they put the final touch on the new world currency basket , sponsored by Berlin-Moscow-Beijing-Tokyo-Riyadh. Moscow and Berlin already have a massive counter trade / barter trade agreement in place, and Beijing was eager to joint that platform as well.” The new global currencies are planned for launch in January 2010. They will be launched amidst growing chaos. Events up to that time will be tumultuous.

  49. I recently listened to 2 senior financial executives blame mark to market for destroying the financial institutions….not the excessive risks, not the excessive leverage, not the excessive and misaligned incentives, but rather the accounting. Remarkable.

  50. Geithner’s plan is siphoning plan

    Geithner’s plan is worse than Pualson’s plan because the plan will definitely cause over-pricing assets purchase and also cause the siphoning from taxpayers’ money into banks and Wall street investors, definitely worse than Madoff ponzi scheme. Why? We are allowed the assets sellers-Wall street investors (Banks, Hedge funds and all kinds of funds) can join in the program to buy assets. They can be both buyers and sellers and they can set up groups of buyers to bid the assets at the over-price and the loss will come to taxpayers’ money. For example, the intrinsic value of asset at 100 dollars but the sellers and buyers are the same Wall Street investors such as CITIGROUP, JP Morgan of BofA. They definitely want to buy like 150 dollars meaning they will gain 43 dollars (gain from assets sales at 50 dollars but loss from private capital investment at 7 dollars) but the tax payers’ money will lose 43 dollars from the public capital at 7 dollars and the FDIC guaranteed bonds at 36 dollars. Therefore, Geithner’s plan is siphoning plan from taxpayers’ money into the banks and Wall Street investors. If the total plan is 1 trillion dollars, we could expect the loss up to 300-400 billion dollars if they allow Wall street investors to join buying at 40-50 % over intrinsic value. Therefore, we should reduce conflict of interest by not allowing the sellers or the investors who are holding the assets to join buying assets in the program.

    Why depression occur from government’s reckless intervention

    Another point I would like to explain why the economic situation is getting worse to depression if the policy makers transfer the loss from the private investors to taxpayers or we call it as the severe cost of intervention. We have to understand that the private investors/speculators hold the risky assets under risk management plan that they can get loss from investing; however, the taxpayers do not have the plan or risk management for the loss on investment. Therefore, when the government intervene the market and get loss (we are definitely facing the increasing loss of FED and FDIC and we could expect to see more under reckless Geithner’s plan), it is like money transfer from private investors into taxpayers and taxpayers will have to compensate the loss by higher taxes and higher cost of living such as the higher inflation or higher cost of fund such as the higher long-term government bond yield. I think the worst case scenario is not recession with deflated price but the depression with hyperinflation because there will be the wealth destruction to consumers and taxpayers not free lunch private investors or producers. I think every country face the same problem; all the loss going to taxpayers but all the gain going to investors and producers and this is the real crisis of economic sustainability and the huge burden to the next generation.

  51. Extract from FT/Alphaville today, re:- Geithner Plan

    Now we’ve got our house view sort of straight we can move on to the conspiracy theories.
    Of which there are lots
    And lots
    And lots
    Okay I like this one – hat tip reader TC (aka Polit2k)
    Actually – read the whole post – its not a conspiracy theory – it’s just suggesting that history will repeat itself – as in the Panic of 1907, when JP Morgan himself locked everyone in a room and said LEND!
    And here’s Marginal Revolution suggesting that banks might game the system – setting themselves up as buyers of the assets and putting insanely high bids on the table – safe in the knowledge that when it all turns to crock they can offload most of the losses on the taxpayer
    Readers may also know this former bank as Northern Rock.
    Let’s say that I am a bank (“financial institution”) with $100 billion in “toxic assets”. I have them on my balance sheet at 80 cents on the dollar. The market has them marked at 30 cents. We do not know what the held-to-maturity performance will be, since that requires knowing the future, although for the moment let’s assume that they are cash-flowing at the present time.
    What I (the bank) do know, however, is that if I sell them at 30 cents I take a monstrous loss – perhaps enough to force me under Tier Capital limits and thus render me subject to an FDIC enforcement action. I therefore will not sell for 30 cents so long as I have any belief whatsoever that the cash flow – or any government subsidy – will exceed that value.
    If I, as a “financial institution” can participate as a bidder in these auctions I can foist off my loss onto the taxpayer. Here is how I can rig the game so as to avoid an otherwise-inevitable loss:
    I become a “bidder” and “bid” on my own assets at 75 cents.
    I am providing 5 or 10% of the money. The rest is covered by Treasury, The Fed and the FDIC via guaranteed bond issuance.
    The loan, ex my contribution, is non-recourse. That is, I can lose 5 or 10% of the total portfolio purchased, but nothing more.
    Now the “assets” (a passel of CDOs?) turn out to be worthless. I lose 5% of $75 billion, or $3.75 billion that I put up, plus the other nickel on the original mark, but that’s all.
    The taxpayer gets hosed for the remaining $71.25 billion dollars.
    This can and will be done if the “sellers” of these assets are allowed to bid either directly or indirectly as it provides a means for banks to intentionally dump bad assets at a certain loss that is much smaller than their expected realized loss over time, shifting the rest of the loss to the taxpayer.
    This program has the potential to shift literally $500 billion or more in losses onto the taxpayer, not through the operation of “bad luck” but rather through what amounts to a bid rigging operation.
    Fortunately that example is a pure hypothetical.
    Actually that is from The Market Ticker
    Open Letter To The FDIC Ombudsman

    Just to be fair.
    Karl Denninger

    The message is: Don’t invest alongside the likes of PIMCO etc because you are being taken for a ride.

  52. Are banks permitted to bid on their own assets (one would think not)?

    Are you therefore suggesting that banks would cooperate by bidding on each other’s assets (each bank taking a direct loss, which is compensated by other banks’ purchases of that bank’s assets at similarly inflated prices)?

    What an interesting cooperation/defection game.

  53. The government can seize anything it wants under the fifth amendment provisions, there’s no other authority or law necessary. They have to pay some just compensation, and I would say that trillions/quadrillions in toxic insane derivatives are worth a big fat zero.

    The government should seize them, then wipe them off the books for the good of the planet, and ban them for all time. That is what this problem really is, trying to cover billionaires gambling debts with future tax payer labor. That’s crazy. They (the derivatives and the bankster quants conmen gamblers) should be airgapped from the real economy before it is too late.

  54. I agree with Mr. Simon, but would include Central Banks in his analysis-after all, Mr. Greenspan vehemently opposed any regulation and created the largest bubble the world has ever seen based on the premise that a house is worth more every year and fostered the environment (ultra low interest rates based on his fears of deflation)

    And let’s not forget Mr. McTeer (FED) who told us all “if everyone would go out and buy an SUV-everything would be alright”

    History has been unkind to nations which have followed Mr. Greenspan and Mr. McTeer’s lead.

    The real problem is that Central Banks have overly defined money and capital formation-as credit.

    When borrowers are bankrupt, they cease to both spend and borrow. As such, money ceases to be created in a fractional reserve banking system, and a system must continue an expansion or risk implosion. We remain at this tenuous point in the boundary layer.

    Sadly, there is simply too much debt and given the present architecture, with all currencies being dollar derivatives, and as such-inflation remains a most attractive exit for
    FED and US Treasury and all other economies.

    The biggest fear is it will be inflation without stimulating real economic activity to a meaningful extent.

    The best way to restore confidence in the global markets is a diminishing role for the US Dollar as a reserve currency.

    The sooner such architecture is in place-the sooner the real economy can begin to function properly.

  55. from today’s post:

    By Alistair Barr, MarketWatch
    Last update: 12:01 p.m. EDT March 24, 2009
    Comments: 5
    SAN FRANCISCO (MarketWatch) — Hedge-fund investors expect $168 billion to drain from the industry this year after punishing losses in 2008, according to a Deutsche Bank survey released Tuesday. ……….
    The hedge-fund industry was hit hard in 2008 by the credit crisis, which forced many managers and investors to sell assets, cut leverage and return money to meet client redemptions. Managers lost more than 18%, on average, last year, according to Hedge Fund Research. That was the industry’s worst performance since the research firm began tracking returns in 1990. ”

    We now know that Goldman Sachs was getting pounded with calls from client hedge fund managers, and could not wait for a delayed settlement on their AIG deals.
    The hedge fund managers could care less when Treasury’s scheduled workout would occur. This is the pressure that pushed Goldman Sachs to call Warren Buffet.

    Goldman Sachs earned $3.2 billion in 2007 with these clients, and admit to losing $2 billion in 2008. The real damage is probably much higher.

  56. The big banks are frozen and seem to be threatening to go Galt unless we stop trying to regulate them and stop saying nasty things about their bonuses. But the top 20 banks are only 50% of the finance market in this country. I also hear everyone saying that we don’t want banks that are too big to fail. So how about instead of rescuing the big banks to get capital flowing, the US Government was buy up some of the outstanding loans from mid-sized banks to give them capital to lend? I mean the real issue is to get loans going out to businesses once again. Wouldn’t it be easier to get the banks which are not buried in toxic assets to loan, rather than wait for CITI to get its mojo back?

  57. Anything that is too big too fail–should not exist in a capitalist economy. I feel like I contradict my own thinking every other week on baseline but…it does come back to the moral hazard issue (sigh).

    The buzz among some financial engineering students at MIT is that they are feverishly working to id the non-toxic assets…more as a game really–which makes me sad–that they don’t appreciate the seriousness of the situation.

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