Two Hearings On Banks Today

This morning, by coincidence, there are parallel hearings on Capitol Hill dealing with the nature of our banking system and attempts to stabilize it.  In the Cannon House Office Building, starting at 9:30am, the Joint Economic Committee will hear from Thomas Hoenig, Joseph Stiglitz, and me, on whether Big Finance is too big to save (see yesterday’s preview for details).

At 10am over on the Senate side (Dirksen Senate Office Building), Secretary Geithner will appear before the TARP Congressional Oversight Panel.  We preview that event this morning on The Hearing, with a discussion of the context, the latest numbers, and our forecast of the ideas that will be expressed; it’s a viewer’s guide – but one that you can talk to by sending in comments (and, most important, your questions for the Secretary).

My questions for Secretary Geithner remain about the same as they were on February 7th.  As reflected in those questions, I continue to worry that the Administration’s “wait-and-see” strategy is just increasing the ultimate costs – in terms of financial losses and unemployment.  No government ever likes to tackle a severe banking crisis head on (mostly because that would greatly upset the financial elite), but it’s almost always the right thing to do.

I remain unconvinced by the Treasury’s line that “there is no alternative” to their approach.  Or perhaps they are shifting towards the line that: “based on information that only the government has (and can have), it is our assessment that all other approaches would be more damaging.” 

If that is now their position, we have built a financial system that is immune to democracy – today’s complexity and lack of transparency mean that it is easier than even to become too big to fail.  The major banks now know this and will behave accordingly.

By Simon Johnson

27 thoughts on “Two Hearings On Banks Today

  1. Sorry Simon, but what financial nature do you mean? What banking system will you talk about? You mean bondholders? Those holding bonds of the banks? Or those holding bonds of those holding bonds? Or the all insuring ms bair at the fdic intrernational group? Is that lot »the banking system« you mean to discuss? Them plus the tim the larry and that little ben? That is supposed to be a system? Oh please, am I m really getting confused here or are you?

  2. Is anybody going to get to the bottom of the forced AIG position unwinds? If that story is true, it represents pure “looting” of the U.S. Treasury, and somebody needs to go to jail (permanently). Nobody in the media knows whether it is true, but Geithner does.

  3. Might being too aggressive with Wall Street risk “capital flight” or some form of “capital strike”? If so, how can that risk be contained?

  4. Simon, this would be a great opportunity for a live blog for those of us who can’t watch the hearings. If not here, then the new WaPo blog would be ideal. All you have to do is set up a Live Blog post and your readers will do the rest.

  5. i think we’ll find out soon enough with respect to the AIG unwinds – there are a lot of counterparties, so it will get out eventually.

    zerohedge is an interesting source but somewhat sensational. ie rumor-mongering is part of what drives their traffic. that doesn’t make the story wrong however.

    in any case after the bonus fiasco they were going to have to unwind anyway, as they weren’t going to be able to retain qualified people.

  6. Qualified to do what? These swaps are not rocket science, nor are the real world risk distributions amenable to the Central Limit Theorem. So what are the idiots that wrote insurance policies such that the entire face amount is payable if any fraction of that amount is lost competent to do?

    Any third year accounting student can manage AIG’s affairs better than those supposedly competents who have wrought such havoc.

  7. Simon, if Treasury takes a position that doesn’t address your 10 questions how does this demonstrate that we “…have built a financial system that is immune to democracy….”?

    Your 10 questions are all valid and should be answered as you suggest, but what if to do so causes complete and immediate seizing of the financial system? How does delay contribute to a more disastrous outcome than that?

  8. There were the questions I posted at The Hearing. Probably too late in the day to matter:

    “The currently stated position of Treasury assumes that restoring the flow of credit – the “lifeblood of the economy” – is the key to recovery. TARP banks, however, have decreased lending 2.2% over the last quarter… If one excludes home mortgage refinance, this number is substantially lower.

    In Sec. Geithner’s view, is this decline a healthy number? Is the reason for this decline that banks are still balance-sheet-constrained (even after TARP funds), or that banks are being rationally conservative in the face of current economic risk?

    In summary, in Sec. Geithner’s view, the banking crisis triggered the broader economic crisis. That was 6 months ago. Is expanding access to bank credit _still_ the primary key to escaping this recession? Should banks be lending even more (for example, to small businesses), in spite of concerns about default? If banks do lend more at the urging of Treasury, will Treasury still hold them accountable if that lending sours?

    Since the drop in asset values is primarily due to a liquity crisis (not a real decline), is restoring access to credit broadly still the most important driver for an economic recovery? Have other aspects of the administration’s recovery plan become relatively more important?”

    Is the current allocation of recovery funds, with many hundreds of billions (trillions counting Fed-provided leverage) still going to banks, and much less money going to discretionary federal programs (like infrastructure, energy investment, etc.) still the optimal way for the government to direct precious taxpayer dollars?”

  9. if you want a third year accounting student to negotiate exit prices with goldman’s etc. traders, then you can’t really complain when they get ripped off.

  10. If this keeps up, I think we’re going to see the emergence of an alternative economy. It is all very third world. Or perhaps this is the new world.

  11. The current evidences are quite clear on the following for the US banking system:

    1. Most community banks are healthy
    2. A number of large banks are healthy *enough*

    Today, we already have very clear evidences of both of these. From these 2 observations I have arrived at the following views:

    1. Since most community banks are healthy, they should be able to meet credit needs of local small businesses. However, during every recession, lending always get tight simply because of increase default risk. Small businesses have to borrow at a higher cost because of higher risk. High borrowing cost isn’t a reflection of capitalization level of the community banks.

    2. Since a number of large banks are healthy enough, they should be able to meet the credit needs of large businesses. If a credit worthy business can’t get a loan from Citibank, it can get it from Wells Fargo.

    The conclusion here is credit needs of small businesses and large businesses are sufficiently met by small banks and big banks. From history, we also know that “fixing the financial system is often not necessary (or actually sufficient) for a rapid economic recovery” [Simon]. Furthermore, we also know that currently there is a lack of borrowing demand. Consumers and businesses are simply not borrowing. All these facts taken together suggested our banking system isn’t a major problem to economic recovery. Instead we should focus our effort in stimulating demand and minimize shocks to the economy so that it can heal.

    Unfortunately, there are too many distractions. In deed, some of the effort of Baseline Scenario is a distraction to what we need to be focusing on.

    Too much focus on the dogma of nationalization and bail out and not enough on total economic and social cost of not turning the global economy around quickly. So silly.

  12. It appears that the Admin is backing down.

    Little Timmy just caved during the congreesional hearing and said that some of the bailout-banks may be allowed to give back the funds early.

  13. Why has anti-trust legislation not been referenced or explained more than it has been?

    I only recall brief mention of same during AIG Senate Finance Committee hearings, i.e., that banks in question (or was it AIG?) have passed ‘competition tests’.

    Is thwarting competition not inherent in what defines or drives banks/corporations too big to fail?

  14. I would like Secretary Geithner to explain why a disproprotionate number of current or former Goldman Sachs employees’ and officers in the Treasury and Fed’ bailout decision making chain? Does the good Secretary not recognize the inherent conflict of interest in this process.

    Secondly, does the PPIP process prohibit or prevent the establishment of special entities and shadow companies to launder (pillage) huge chunks of the 92.5% of government sponsored taxpayer money offshore?

    Lastly – how can there be any hope of stabilizing the financial system hope if the government colludes and participates with the toobigtofail banks in the distorting, cloaking, or stiffling information critical to the markets, shareholders, and consumers?

    Without transparency and accountability – the financial system is certain to be corrupted.

  15. Well, I generally agree with your point of view, and have in the past called the “too-big-to-fail” narrative a red herring. I still think so.

    But it’s important to recognize that SJ’s argument is not an economic one really – it’s a political one. The essence is that as long as the oligarchs are in control, they will prevent any real reform from taking place. So, first break the political power of the oligarchs, then institute reform.

    SJ’s arguments on the oligarchs are not so easily dismissed, but there are many reasons against attacking big banks _first_, here’s a partial list:

    1) What evidence do we have that the incentive problem described by behind too-big-to-fail (moral hazard) will be fixed by cutting banks down to size? Instead of having a few big failures, we may end up with many many smaller failures (e.g. Great Depression, somewhat the S&L crisis). Certainly many small banks (Countrywide began very small, and grew rapidly) created some of our “innovations”…

    2) I don’t see that spending Obama’s effort for 6 months on cutting down banks is the best use of what little is left of his political capital – and it _certainly_ will not help the economy in the short run. He might succeed, but at the cost of every other initiative on his plate – and those are simply more important.

    3) It will be a lot easier to fix the banks when the broader economy is stabilized, since the markets are less likely to overreact to a federal initiative to take a big bank into receivorship. The market volatility is strengthening the oligarchs’ hands…

    4) I don’t fundamentally believe we are in a liquidity crisis – there are plenty of banks lending, plenty of capital for well-collateralized credit-worthy borrowers. Just no capital for highly leveraged business borrowers (commercial property, small businesses)… Even SJ admits there’s no liquidity crisis (in his arguments that the sour assets on banks’ books really aren’t being undervalued by the market). So if there is no liquidity crisis, why do we have this incessant focus on spending so much time and effort fixing banks _first_, rather than fixing the economy first? (Still no response on this question…)

    5) We are in a demand crisis (with modest deflation in spite of semi-aggressive monetary policy) and a structural production crisis (we produce stuff no one wants or needs). Why are we spending precious assets rebuilding an industry that everyone thinks should be smaller, when we have insanely huge needs to build sustainable energy/health/education/physical infrastructures?

    Or, to put the problem differently, ask yourself this question:

    If the government had invested 700 billion in matching grants to states and local governments for investment in energy projects, infrastucture, education… and funded this partially through Fed purchases of T-bills? Would things look as bleak as they do today?

    What if the Govt. matched that 700 billion by borrowing from the Fed, and extending the states 2 trillion dollars worth of 0.25% interest loans?

    Or, to use a different metaphor… the economy is a big bathtub with a hole in the bottom. Water (aka, money) is flowing out the hole (insolvency which is destroying debt and asset values). Rather than plug the hole, we keep pouring in more water.

    So SJ is certainly right about too-big-to-fail; but SJ comes to this issue wearing IMF-colored glasses. He has thus taken it up as a crusade, and the too-big-to-fail narrative is picking up steam – heralded by people like Henry Blodget – who would absolutely love to see Obama spend his political capital attacking banks instead of fixing the real structural problems with this country.

  16. Wow, where to begin …

    “Easier to fix the banks when the broader economy is stabilized”?

    If the health of the banks weren’t relevant to stabilizing the broader economy we wouldn’t be having a discussion (or a TARP). You can’t get to stabilization without coming to some kind of fix for the banks.

    I agree, we don’t have a liquidity crisis, we have a solvency crisis. Can the US create anything of value that the rest of the world wants? If so, in excess of our consumption level?

    If sour assets aren’t being undervalued – why would they need government support? Why would be they even be called sour?

    You cannot fix the economy without a financial sector – the government is not going to step in and start commanding production and consumption. They don’t know how and no one would give the plan any confidence. Events could change people – but it’s not happening tomorrow.

    So how do you get investment moving when capital quality is questionable, demand is falling off a cliff, and banks want to take no risk (e.g., only lending to “well-collateralized credit-worthy borrowers”). You don’t and there aren’t any easy ways out of this.

    The government could not “invest” 700 billion into infrastructure, actually place the money into circulation – that would produce ACTUAL inflation – they want to produce THE EXPECTATION of inflation. It’s a big difference.

    I think it’s all a bit naive: you can’t make the bad guys go away by wishing them away or ignoring them – either take them out or live with their demands. You can’t negotiate with financial terrorists.

    I do agree that it’s a political problem – but there is no large-scale organized opposition to the banking and financial interests. Until that happens Obama is going to play it *safe* (for him, not the economy).

  17. I am not being argumentative, but I do fundamentally disagree with the extraordinary emphasis given to the financial system above all other industries…

    “You cannot fix the economy without a financial sector”

    We have a financial sector. It is on life support – where it can stay, while we concentrate on fixing the underlying economy. The economy will lead the banks to health; banks will not lead the economy to health.

    “Until that happens Obama is going to play it *safe*”

    Yes… he thinks he has no choice. If he is really a ‘good guy’, then his gamble is that he can stabilize the economy, take his time to figure out regulatory changes, then implement the changes after the markets are less neurotic.

    This is clearly the plan he seems to have taken with GM – and I suspect investors may think he will apply the GM model to banks. Note the seemingly different stories being told by bank stock prices and CDS prices on bank debt. So long as the banks can take down the entire economy with a panic, Obama has no bargaining leverage against bank bondholders.

    “The government could not “invest” 700 billion into infrastructure, actually place the money into circulation – that would produce ACTUAL inflation – they want to produce THE EXPECTATION of inflation. It’s a big difference.”

    Unfortunately, you can’t create the expectation of inflation unless you _really mean it_. And frankly, the reason we have disinflation expectations is because it seems that the US govt. doesn’t really mean what it seems to be saying.

    As to actually spending $700+ billion on energy/environmental/physical/education infrastructure using the states as conduits, it could easily be spent (certainly over 2 years), and some inflation would result, and this would help end our current predicament.

  18. Look – in a perfect world what you say makes sense. But in a perfect world, people are trustworthy and do the right thing.

    I don’t think you can ignore the banks. First of all, they don’t want to be ignored. Second there are no fixes to the economy without financing – and unless you propose putting the banks out of business – you need them for financing. Now, I think some should be put out of business – but that is not “ignoring” the banks.

    My point on actual inflation vs. expectations: I agree with you that it’s silly – but that IS the Fed policy right now. They do not want to create inflation but they want to create inflation expectations. Now, you can create expectations without fulfilling them – that’s why we don’t call them promises. But as policy its already failed – banks would rather put their money in 0% treasuries than loan it. They must be expecting something other than inflation – probably deflation.

    In theory, the policies you lay out would probably work – expect for the political reality on the ground. The public needs to wake up and demand action against the financial interests. They can’t ignore it any longer – it’s been going on way too long.

  19. The reality of the bank bailout is in fact a lot simpler than many people seem to think. The REALITY, is that you good “friends” in China informed the O’Bama administration that if there are any further losses realized by those who hold bank debt, they, the Chinese, will boycott US debt auctions. America is toast without the injection of real capital into their economy, where “real” is not the treasury buying back it’s own debt with fiat currency credits on banks balance sheets. “Real” money, is when third parties, in this case China, actually purchase Americas debt. Without the Chinese, and in fact Asia collectively funding Americas deficits, America must fold it’s hand and leave the table.

    Thus the bailouts.

    Painful, but reality


  20. Could someone respond to this statement regarding the bondholder’s position r.e. Chrysler

    – It is unclear what assets would be left to the banks, but representatives of those financial institutions have warned the members of the task force “that a bankruptcy would be very messy and everyone would lose — those of us who carry the debt, and those in the government who are trying to save jobs,” according to one banker involved in the negotiations who also requested anonymity because of the delicate nature of the discussions.-

    Apparently the current market value on the debt is ~0.15/1.00 and they want 0.65/1.00. This group of debt carriers includes our old friends, the too big to fail.

  21. In all this endless discussion of saving big banks I read nothing concerning the off balance sheet derivative exposure of non financial corporations, which makes any stock market investment a shot in the dark. We seemed to have abandoned any idea of accounting as a window on the value of public companies. What is left is simply a fantasy world in which traders react to announcements and executives dilute the gullible through stock option giveaways. For those who have somehow managed to preserve capital there now seems nowhere safe to invest it at a positive return. Does anyone have a sensible idea?

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