Here’s an Idea . . .

. . . since the Geithner-Summers team seems to be looking for them.

Why not say that all bank compensation above a baseline amount – say, $150,000 in annual salary – has to be paid in toxic assets off the bank’s balance sheet? Instead of getting a check for $10,000, the employee would get $10,000 in toxic assets, at their current book value. A federal regulator can decide which assets to pay compensation in; if they were all fairly valued, then it wouldn’t matter which ones the regulator chose. That would get the assets off the bank’s balance sheet, and into the hands of the people responsible for putting them there – at the value that they insist they are worth. Of course, the average employee does not get to set the balance sheet value of the assets, and may not have been involved in creating or buying those particular assets. But think about the incentives: talented people will flow to the companies that are valuing their assets the most realistically (since inflated valuations translate directly into lower compensation), which will give companies the incentive to be realistic in their valuations. (Banks could inflate their nominal compensation amounts to compensate for their overvalued assets, but then they would have to take larger losses on their income statements.)

We can dream, can’t we?

Ten Questions For Secretary Geithner

Next week, Tim Geithner will have an opportunity to explain his plans for the financial system (Cash Room of the Treasury, Monday, 12:30pm), and defend these plans in front of the Senate Banking Committee (Tuesday, starting at 10am) and Senate Budget Committee (Wednesday, also from 10am). 

Here are the questions (in bold) we would ask him.  And, just in case any of you are involved in preparing the Secretary’s briefing book, we also suggest some answers. Continue reading “Ten Questions For Secretary Geithner” →

How Do You Like Them Free Markets?

By now everyone knows about this past year’s Wall Street bonuses: $18.4 billion total, the fifth-highest total ever; the $4 billion in bonuses rushed through by Merrill Lynch before its acquisition by Bank of America; and John Thain’s demand for a personal $10 million bonus (which was initially a demand for $30-40 million, according to Felix Salmon). This has, not surprisingly, unleashed a torrent of rage against Wall Street, up to and including Barack Obama, who called the bonuses “shameful.”

The usual defense of this sort of behavior is that you have to pay the market price for talent, the bonuses for top people are only a small fraction of the value they contribute (not a particularly good argument this year), and so on. And this is, not surprisingly, what John Thain was able to muster up in his defense on CNBC:

If you don’t pay your best people, you will destroy your franchise. Those best people can get jobs other places, they will leave. . . . you have to– pay market prices at the time.

Yes, there is a market for labor, and compensation is the price set by that market. And maybe it’s even a free market. But it’s certainly not a well-functioning market (one where price = marginal cost, for example, or where the surplus is divided between the parties, or where the right incentives are created).

Continue reading “How Do You Like Them Free Markets?” →

And Now, the Counterargument

With mainstream and not-so-mainstream economists (including us) tripping over themselves talking about the need for a stimulus plan (and how the current one may actually be too small), and having just written an article saying the U.S. can probably absorb some more national debt before things go haywire (so did Simon), I thought it was only fair to point to the counterargument.

William Buiter at the FT argues that the U.S. cannot afford a major fiscal stimulus because the government (by which I think he means the entire political system, not just the Obama Administration) has no deficit-fighting credibility. If people do not believe that the government will raise taxes in the future to generate positive balances (I’m sorry to inform Congressional Republicans that cutting spending is not really an option, given the growth of entitlement commitments in the future and our increasing military needs, although cutting the growth rate of spending might be possible), they will conclude that the debt can only be paid off by inflating it away, which will drive interest rates up, the dollar down, and inflation up. Buiter spells this argument here and more recently here where he adds the U.S. is behaving like an emerging market economy in crisis (something with which we would agree).

Continue reading “And Now, the Counterargument” →

New Report Out, TARP Still a Subsidy

Elizabeth Warren’s Congressional Oversight Panel has announced that TARP has so far exchanged $254 billion in exchange for $176 billion worth of assets, which amounts to a cash subsidy of $78 billion (full report). The numbers are based on an analysis of ten specific deals – eight of the largest under the original Capital Purchase Program (not the eight largest, however, as Merrill is missing), plus the second bailouts of AIG and Citigroup. In the former, Treasury received $78 of assets for every $100 expended; in the latter, it received only $41. These results were then extrapolated to the full sample.

This is not really news, since the CBO already forecast a subsidy of $64 billion out of the first $247 billion invested, and the OMB came up with a similar estimate even earlier – and everyone writing back in October realized that the banks were getting a sweetheart deal compared to what was available from private capital, as indicated by Buffett-Goldman and Mitsubishi-Morgan Stanley.

Continue reading “New Report Out, TARP Still a Subsidy” →

The G20 Has A New Website: HM Treasury

I’ve been calling for the G20 to modernize its communications strategy, including by updating their website from time to time.

I know the British (incoming chairs) are working on this, but there are still glitches.  At the time of posting, if you click on www.g20.org, you get http://www.hm-treasury.gov.uk/, which is not exactly the same thing.  And the link at the top of that page (next to the signature red phone box) doesn’t work… 

I suggest you try this instead: http://www.londonsummit.gov.uk/en/, and write up your reviews (on substance, process, or technology in and around the summit) as comments here – I will bring them to the attention of the appropriate authorities.

(Update: they fixed the links within a few hours; now they could edit their FAQ so they make more sense, or just use a spellchecker, e.g., ”The G20 is carrying out the parpartory work for the Leaders summit in London on 2nd April”)

Insuring Bankers’ Bonuses

Here’s what we know so far about the plans for the US banking system that Tim Geithner will unveil next week.

  1. The heart of the scheme will, most likely, be an insurance arrangement, in which the government (part Treasury and mostly Fed) insures a big part of large banks’ portfolio of toxic assets against further loss.  The devil is in the pricing of this insurance and how transparent that is – and we will put out more on this shortly – but the clear signal so far is that this will be a veiled major recapitalization of banks at taxpayer expense.
  2. As announced yesterday, the government will set restrictions on the pay of executives in banks that participate.  But note that, under these rules, bonuses are not restricted.  Instead, they are just deferred and paid in shares.  In other words, if there is cheap recapitalization through government-provided insurance, these executives are getting an incredibly good deal. Continue reading “Insuring Bankers’ Bonuses” →

Framing the Geithner Bank Plan

What are your expectations for the impending Geithner Bank Plan?  Listening carefully to the messaging from the top, you are probably hoping for an increase in bank lending.  In fact, over the past few weeks, Congressional leaders (e.g., at the Senate Budget Committee hearing last week) and the President (e.g., see the penultimate paragraph of last week’s TV address) have repeatedly insisted that, going forward, banks that receive government support should increase their lending.

And you’ve probably seen matching statements from the banks recently, either (a) explaining why the fall in lending was not their fault, or (b) celebrating the fact that, against all odds, they did manage to increase loans in the last quarter. 

So the perception has been created that the new Bank Plan will succeed if it raises bank lending, and that it can be judged by this metric.

But this is the wrong framing of the problem.  Or, perhaps it was the right framing for last October, when credit supply was severely disrupted, but it is an out-of-date and perhaps dangerous way to think about what is now needed. Continue reading “Framing the Geithner Bank Plan” →

Searching for a Free Lunch

I don’t envy President Obama’s economic team. When it comes to fixing our banking system, there is no easy solution.

I’ve been sick the past few days, but someone pointed out this article in The New York Times a few days ago that has a concrete illustration of the problem: a bond that an unnamed bank is holding on its books at 97 cents, but that S&P thinks is worth 87 cents (based on current loan-default assumptions), and could fall to 53 cents under a more negative scenario . . . and that is currently trading at 38 cents. Assume for the sake of argument that all of our major banks are insolvent if they have to mark these assets down to market value. The crux of the issue is that any scheme in which the banks receive more than market value is a gift from taxpayers to bank shareholders, and any scheme in which they are forced to take market value is one that the banks will not participate in. Let’s look at a few possibilities:

  1. The government forces banks to write down their assets to reflect worst-case scenarios (unless they do this, no one will have confidence that the asset values won’t fall further), and then recapitalizes them to make them solvent. This is a desirable outcome, but bank shareholders won’t go for it because they will be mostly wiped out. This is roughly what Sweden did with two banks, but Sweden nationalized them first, so the shareholders didn’t matter.
  2. The government creates an aggregator bank to buy up toxic assets. If the aggregator pays market value, no bank will sell; if it pays above market value, it’s a gift. The current idea I’ve heard is that the aggregator will only buy assets that have already been significantly marked down, but that doesn’t really help the banks any.
  3. Another idea is having the government guarantee toxic assets, as it did for Citigroup and Bank of America so far. But this doesn’t solve the problem. There is already a market to insure toxic assets – it’s called the credit default swap market. If the government provides insurance at existing market prices, no bank will buy it, because the cost of the insurance would make it insolvent. If the government provides cut-rate insurance, as it almost certainly did for Citi and B of A, then it is a gift. The only “benefits” of an insurance arrangement are: (a) it’s much less obvious that the government is giving bank shareholders a gift; and (b) the way Citi and B of A were structured, it wouldn’t require a lot of cash from Treasury (and hence from Congress), because most of the guarantee was provided by the Fed.
  4. Meredith Whitney thinks that the banks should sell their “crown jewel” assets – presumably, businesses they have that are still in good shape – to private equity firms, and use the cash to repair their balance sheets. This would be a nice solution, but I don’t foresee it happening. Given the choice between selling the good operations and being left with barely-solvent portfolios of runoff businesses, or holding onto the good operations and hoping for a government bailout, I think all the Wall Street CEOs are betting on the latter.

I think there are two possible outcomes to all of this: (1) the government makes a gift to bank shareholders and justifies it on the grounds that there was no other choice; or (2) the government forces the banks to sell assets at market value and accept a government recapitalization program – either by exercising its regulatory authority (similar to an FDIC takeover) or by just buying out all the common shareholders at their current low prices. In option (2), the government would then re-privatize the banks at some point. But there’s no easy solution.

The IMF Sends A Message

The IMF communicates its view of the world economy in two ways.  The first is quite explicit, in the form of a World Economic Outlook with specific growth forecasts.  The latest update to the Outlook, published last week, recognized that world growth is slowing down, but anticipated a V-shaped recovery (there is a reassuring V in their Figure 1, or you can look at the Q4 on Q4 numbers for 2009 in the pdf version – the US does not contract during the coming year, according to this view.)

According to the forecast – which factors in only actual policies in place; no assumed miracles allowed – this is not much of a global crisis, particularly for emerging markets (e.g., emerging market growth dips to 3.3% for 2009 and then pops back up to 5% for 2010 in the annual average data; China’s growth will accelerate from now through end of 2010, etc.)  Given that, among other things, the IMF is the point organization for emerging market troubles, the message seems to be a soothing one.

But the IMF also communicates with both its lending to countries in difficulties, and with statements on and around this lending.  Here the news is in striking contrast to the forecast.  Continue reading “The IMF Sends A Message” →

Rahm’s Doctrine And Breaking Up The Banks

According to David Leonhardt, writing in today’s New York Times magazine,

TWO WEEKS AFTER THE ELECTION, Rahm Emanuel, Obama’s chief of staff, appeared before an audience of business executives and laid out an idea that Lawrence H. Summers, Obama’s top economic adviser, later described to me as Rahm’s Doctrine. “You never want a serious crisis to go to waste,” Emanuel said. “What I mean by that is that it’s an opportunity to do things you could not do before.” (Links in the quote are from the on-line original.)

Leonhardt explains how this Doctrine can be applied to issues ranging from health care costs to education, and some of this is already apparent in the fiscal stimulus details currently before Congress. 

Can the same approach also guide actions regarding our deeply broken and broke financial system?  There are three possible answers. Continue reading “Rahm’s Doctrine And Breaking Up The Banks” →

Transparency And Power

Put this morning’s articles on Bank Rescue Plans in the Financial Times and the Washington Post next to each other, and you can see where we are heading.  (Remember: policy announcements need to be bigger than what is leaked, so expect headline numbers larger than floated here – the FT suggests “total buying power” of the initiative will be $1trn; I expect closer to $2trn.)

The foreclosure mitigation steps seem reasonable, although on the small side – with perhaps $80bn of the available $320bn from TARP II being committed here.  The heart of the matter is the banks’ balance sheets, including their toxic assets and presumably deficient capital.  The principles at work seem to be: Continue reading “Transparency And Power” →

Trial Balloons: Insuring The Bad Assets

The Administration is obviously floating ideas to assess potential reactions, particularly from Congress.  Today’s front page WSJ article on banking should be seen in this light.  It’s obviously not a fully-fledged proposal, but the concepts are there to elicit opinions and I don’t think it’s particularly helpful if we hang back.

The article raises the possibility that bad assets from banks will be divided into two parts, (a) bought by an aggregator bank, and (b) insured against further losses by the government.

We’ve covered the general principles of an aggregator bank and good/bad bank splits elsewhere.  Let me focus here on the specific (and credible) permutations in the WSJ article. Continue reading “Trial Balloons: Insuring The Bad Assets” →