Month: March 2009

Banks Find New Way to Hold Up Government

Some bankers say they turned the conversations into complaints about the antibonus crusade consuming Capitol Hill. Some have begun “slow-walking” the information previously sought by Treasury for stress-testing financial institutions, three bankers say, and considered seeking capital from hedge funds and private-equity funds so they could return federal bailout money, thereby escaping federal restrictions.

Ummm . . . if they could get capital from hedge funds and private-equity funds, wouldn’t they have done so already? And they are now resisting the stress tests? Simon is usually more negative about banks’ recent behavior than I am, but I’m catching up.

Distressingly, the article is mainly about how the administration is trying to “fix” this situation by offering greater access to Wall Street leaders. Apparently they actually tried to freeze out the bankers early in the administration, but recently changed course.

By James Kwak

Will It Work?

Leaving aside the question of subsidies, which has gotten piles of attention on the Internet, Simon and I are skeptical that the Geithner Plan will achieve its basic objective: getting enough toxic assets off of bank balance sheets to restore the financial system to normal functioning. We discuss this in today’s Los Angeles Times op-ed, although our regular readers could probably fill in the blanks by themselves.

Update: At 2:30 PM Eastern today, I’ll be on a live chat at Seeking Alpha with Felix Salmon and possibly Brad DeLong and Mark Thoma discussing the Geithner plan. Salmon is strongly against, Delong is moderately (strongly?) for, Thoma is moderately for.

Update 2: At The New Republic, Simon discusses one plausible scenario under which the Geithner Plan is the first step in a comprehensive bank rescue strategy. But he’s skeptical that we will see the other necessary steps.

Update 3: Chat is done; replay is here.

By James Kwak

The Cultural Costs of Bailout Nation

This post was written, at my request, by Carson Gross, one of our regular readers and a multi-talented person I have worked with in the past. (We met one night when I needed help debugging a classpath error I was getting on my computer.) I don’t necessarily agree with what he says, but I think he has something valuable to say. Everything below is by Carson.

James asked me to elaborate on a comment in which I worried about the public’s reaction to the real or perceived wealth transfers occurring during this financial crisis – in particular, how that reaction would manifest itself culturally.

“Wealth transfers” is a charged term, and a lot of smart people have spent a lot of time patiently explaining that, in fact, most of the bailout thus far involves loans and that, under some models (which, apparently, don’t include housing prices regressing to roughly 3x incomes, where they have been for most of history) we, the taxpayers, may actually end up making money on this whole thing. I think that’s fanciful, but I’m not going to debate that here. Rather, I want to focus on the bailout’s cultural impact.

I assert, without proof, that the proverbial man on the street sees the words “bailout” blaring on his TV and computer screen day in and day out, and doesn’t care to look too deeply into the details. Who can blame him? He has enough of his own problems to deal with without attempting to decipher deliberately impenetrable financial jargon. Even if the government is getting reasonable compensation for the capital injections in some cases, the man on the street just sees more of his tax dollars going into banks to pay out people who make orders of magnitude more money than he’ll ever see. That’s his reality.

Continue reading “The Cultural Costs of Bailout Nation” →

Economics, Politics, Outrage, and the Media

Warning: This is a post about economics and politics; it is a reader response post; but (here’s the warning), it’s also one of those annoying self-referential posts you only see on the Internet discussing a debate among the commentariat.

Last week went something like this:

We learned about the $165 million in retention bonuses at AIG Financial Products.
A lot of people, up to and including President Obama, got mad.
Various commentators, including Ian Bremmer (on Planet Money, around the 14-minute mark) and Joe Nocera, said, in Nocera’s words, “Can we all just calm down a little?”

Their argument is basically that $165 million is small change, the government should be working on bigger issues, and the demonization of AIG is making it harder to solve the real problems.

Continue reading “Economics, Politics, Outrage, and the Media” →

Let the People In

The Geithner Plan is out. I don’t have time to look at it in detail, but in the meantime, PK, one of our readers (and someone we correspond with a lot), had an idea: If we’re going to subsidize the private sector, why not let individuals into the deal? In his words:

If Geithner’s taxpayer subsidized toxic public/private plan goes forward, I think it would be fair if the federal government allow non-institutional investors to participate via a no-fee investment vehicle. I think if Americans had the option of investing in this program (without having to pay the egregious fees to the investment advisors/PE shops), it would be much easier to swallow since they would at least get the same deal the sharks are getting. There is probably more money on the sideline with individual investors than all these institutional investors. Maybe they could set up some ETF equivalent for it. I think the willingness of the administration to do such a thing would tell us a lot about whose for whose interest they are really looking out.

Capital for the investment funds will come from private fund managers (raising new capital from their limited partners) and from Treasury. Perhaps either a fund manager or Treasury could create an ETF- or mutual fund-type structure, where the government subsidizes the usual management fees, and use that to raise some of the capital. I know that because most individuals aren’t “sophisticated investors” this would subject the fund – or at least the individual part of it – to a higher degree of regulation, but that doesn’t seem like a bad thing.

I think it’s a brilliant idea.

(As far as the plan itself, my first reaction is that the Legacy Securities Program actually doesn’t do enough to attract private sector participation, since the leverage is only 50% or maybe 100% of the capital.)

Update: Matt Yglesias and F. Blair (below) have pointed out the following language: “The program will particularly encourage the participation of individuals, mutual funds, pension plans, insurance companies, and other long-term investors.” I believe that’s from the program for loans, not securities (the latter involves up to five professional asset managers, who generally raise their money only from qualified investors). So maybe there is something there.

By James Kwak

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. Continue reading “Breaking The Bank” →

Exploding Cars for Beginners

Mark Thoma does a nice job comparing government purchases, public-private partnerships, and nationalization, and gets the concluding paragraph exactly right. It won’t help you through the complexities of whatever Geithner will announce in the morning, but it explains the basic concepts.

Reader Questions: Nationalization

If I had infinite time, I would respond to all reader questions and suggestions. Unfortunately, I can’t. But I’m hoping to occasionally post some in-depth responses to some of the tougher questions we get.

Chris Uregian, one of our readers, sent us three questions by email. In summary, he thought that we were overlooking some of the problems with nationalization and the reasons why Treasury might be moving more slowly than we would like. I originally answered him in email but we later decided this would be good to post to everyone, and Chris gave us his permission. I am going to copy his questions here and add a response after each one.

Continue reading “Reader Questions: Nationalization” →

This Time I’m Not the One Calling It a Subsidy

According to The New York Times and the The Wall Street Journal, the Treasury Department is set to announce its plan for troubled assets early next week. It will include three components. The details aren’t clear since these are anticipatory news stories, but it will be something like this (combining bits of information from the two stories):

The FDIC will create a new entity to buy troubled loans, with the government contributing up to 80% of the capital and the remainder coming from the private sector. The Fed or the FDIC would then provide non-recourse loans* for up to 85% of the total funding (NYT), or guarantees against falling asset values (WSJ), which more or less amount to the same thing.
Treasury will create multiple new investment funds to buy troubled securities, with Treasury contributing 50% of the capital and the rest coming from the private sector. It’s not clear from the news stories, but I think it’s highly likely that these funds will also benefit from either non-recourse loans or asset guarantees.
The Term Asset-Backed Securities Loan Facility (TALF) is a program under which the Fed was already planning to buy up to $1 trillion of newly-issued, asset-backed securities** (backed by car loans, credit card receivables, mortgages, etc.). The idea was to stimulate new lending in these categories. This program will be expanded to allow the Fed to buy “legacy” assets – those issued prior to the crisis. This enables the Fed to buy toxic assets off of bank balance sheets.

Continue reading “This Time I’m Not the One Calling It a Subsidy” →

Modifying Securitized Mortgages

Amidst the gallons of ink spilt, here and elsewhere, over the nationalization debate, the AIG collateral payments, and the AIG bonuses, I neglected to comment on the details of the new housing plan, which were released on March 4. When the initial plan was announced in February, I was concerned about the seeming lack of any provision that would enable servicers of securitized mortgages to modify those mortgages without being sued by the investors who bought the securities. (In brief, the problem is that the pooling and servicing agreements (PSAs) that govern those securitizations may not allow loan modifications, or may require the servicer to gain the consent of all of the investors, which is practically impossible.) People who know housing better than I said there was something in there.

If it is, I still can’t find it in the March 4 documents (fact sheet, guidelines, modification guidelines). In any case, an important question is whether the plan will do enough to encourage servicers to modify securitized mortgages, as opposed to mortgages they own. “A New Proposal for Loan Modifications,” a short (13-page) paper by Christopher Mayer, Edward Morrison, and Tomasz Piskorski that will appear in the next issue of the Yale Journal on Regulation, describes the problem clearly and makes three proposals to solve it. (A longer version with appendices is available here.)

Continue reading “Modifying Securitized Mortgages” →

CEO Semiotics And The Economics Of Vilification

CEOs of major banks have started to push back against the critics – their primary job, after all, is lobbying (rather than, say, risk management). As such, they are typically sophisticated communicators who use a wide range of symbols, words, and modes of communication to get their points across.

Not everything they say, of course, should be overinterpreted. For example, calling the hand that feeds the banks “asinine” (Richard Kovacevich, chair of Wells Fargo) seems more like an outburst than a promising way to enhance shareholder value – even if he is correct about whether today’s stress tests are actually meaningful.

Lloyd Blankfein’s February FT op ed famously made the case that we need banks as a “catalyst of risk.” But this argument raises awkward questions. What does Goldman Sachs know about risk, and when did it learn this (presumably recently, after they settled up with AIG)? My risk-taking entrepreneurial contacts feel their catalysts should be somewhat smaller relative to the economy – so these banks/securities underwriters can, from time to time, go bankrupt without threatening the rest of the private sector (and everyone else) with ruin. Still, the main point of this FT article was the symbolism of the timing, appearing on the morning of what was scheduled to be Secretary Geithner’s first big speech; we were supposed to read Mr. Blankfein’s conceptual script, then look up and see the Secretary on TV.

Vikram Pandit’s recent letter to Citi employees was a nicely timed communication to his broader social and political audience. His upbeat note was plausible because he put down some very specific markers, e.g., “best quarter-to-date since 1997”; the danger is that these come back to haunt him. And as a document making the case for big banks more generally, it was weak.

The banking industry’s thought leader right now is definitely Jamie Dimon. His point about vilification is straightforward. Continue reading “CEO Semiotics And The Economics Of Vilification” →

The Bubble in Artwork by 8-Year-Olds

I got this from some friends who have an 8-year-old daughter whom I’ll call Franny:

Friend (looking at Franny’s artwork, which is labeled “$10,000”): How much do I have to pay you for that picture?

Franny: $10,000.

Friend: Is that in real money or pretend money?

Franny: You can pay me $5,000 in real money and $5,000 in pretend money. And if you only want to pay me the pretend money, then you get to borrow the picture for the weekend.

I’ve been struggling for weeks trying to think of the perfect real-world analogy – maybe something to do with assets being held on the books at $10,000 that everyone knows are only worth $5,000. Maybe one of our readers can come up with right answer (like in The New Yorker’s cartoon caption contest).

By James Kwak

More Housekeeping: PDF Archives

At the request of several readers, I’ve printed entire months of blog posts to PDFs for download. There is also a “Download the Blog (PDF)” link in the sidebar under navigation. This might be useful for new readers who want to catch up on a plane, or something like that.

I did this in a very low-tech way (explained after that link) so if you have suggestions for how to do it faster or more elegantly please post them there.

By James Kwak

Why Bail Out AIG’s Creditors?

Simon and I wrote on op-ed in the New York Times today, trying to debunk the idea that, as we put it, “A.I.G.’s traders are the people that we must depend on to save the United States economy.” The AIG bonus fiasco, as I’ve written earlier, has been particularly useful in raising the political cost of the administration’s current bailout strategy. But, as I said then, “$165 million, of course, is less than one-tenth of one percent of the total amount of bailout money given to AIG in one form or another.” And as far as the cost to the taxpayer is concerned, the big bill is for bailing out AIG’s creditors. In his op-ed in the Wall Street Journal today, Lucian Bebchuk wants to know why.

Now, the government has not explicitly guaranteed AIG’s liabilities. But the main reason for bailing out AIG in the first place was the fear that an uncontrolled failure would have ripple effects that would take down many other financial institutions who were dependent in some way on AIG; most commonly, they had bought insurance, in the form of credit default swaps, from AIG and were counting on being paid. And a major usage of bailout money has been to make whole AIG’s counterparties holding those credit default swaps, primarily investment banks trading on their own account or on behalf of their hedge fund customers.

Continue reading “Why Bail Out AIG’s Creditors?” →

Zvi Bodie on Personal Finance

Occasionally we get personal finance questions. Actually, we’ve gotten fewer of those questions lately, perhaps because readers realize we don’t have much to offer on that score, and that we try to avoid anything that might sound like investment advice.

Zvi Bodie, whose name you may have seen here before, has thought a lot about personal investing, and agrees with some of the positions I’ve offered here: notably, that most information about personal finance available on the market is not worth listening to. Bodie recently posted a series of 3-minute webcasts to the Boston University School of Management website where he lays out some basic advice on saving for retirement, including some of the implications of the current economic crisis. I didn’t watch all of them, but I liked how accessible they were.

By James Kwak