Back in September, Simon and I wrote two op-eds on the governance and pricing challenges of buying toxic assets. As many people have noted, those problems have not gone away. The latter, in particular, represents a formidable barrier to Tim Geithner’s latest proposal to create a public-private partnership to relieve banks of their toxic assets. (In summary, the problem is that banks do not want to sell at the price the free market will offer, because (a) they think the assets will be worth more later and (b) doing so would force them to take writedowns that might make them insolvent.)
Lucian Bebchuk also wrote an op-ed on this topic in September, and to his credit he is still trying to turn “TARP II” into something feasible in his new paper, “How to Make Tarp II Work.” The paper has some good ideas but I’m not sure it solves the basic problem, which unfortunately has to do with the laws of arithmetic.
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
Yesterday, Tim Geithner told reporters, “We have a financial system that is run by private shareholders, managed by private institutions, and we’d like to do our best to preserve that system.” On its face, I think most Americans would agree that a private banking sector is better than just having one big government bank. But “private” can still mean a lot of different things. For starters, here are three: (a) day-to-day operations are managed by ordinary corporate managers who are paid to maximize profits, rather than by government bureaucrats; (b) those profits flow to private shareholders, rather than the government; (c) the overall flow of credit in the economy is determined by private market forces, rather than the government.
When people debate “nationalization,” it’s not always clear whether they are talking about ending (a) and (b) or just (b). The recapitalizations to date under the TARP Capital Purchase Program have bent over backwards to avoid either one. Because the government purchased nonconvertible preferred shares, it has no ability (that I know of, although Robert Reich thinks otherwise in an article I’ll come back to) to turn them into common stock with voting rights that lead to management control; and because the shares pay a fixed 5% dividend, they are a lot like a loan, where any profits after paying off the loan flow to existing shareholders.
The Financial Times has just published an op ed by Peter Boone and me, arguing that aggressive bank recapitalization and toxic debt clean-up is essential in the U.S. – and that this can be done with strong protections for taxpayers and without nationalization. The FT did a great job cutting our draft down to fit their print edition (of Tuesday, January 27th); I don’t think they took out anything crucial. But, just in case, after the jump is the full article as submitted.
(Note: newspapers usually like to choose their own titles for op eds, and the FT is no exception. But I like their choice and I’ve used it as the heading for this post.) Continue reading
For a complete list of Beginners’ articles, see the Financial Crisis for Beginners page.
With the regularity of a pendulum, the focus of discussion has swung back to the banking system (September: Lehman and AIG; November: Citigroup; January: Bank of America, and everyone else). And as everyone waits in anticipation for the Obama team’s first big swing, there has been increased discussion of . . . Sweden, including a recent New York Times article and a fair amount of blog activity, with a broad overview by Steve Waldman. (For other accounts, see this Cleveland Fed paper and a review of the crisis published by the Swedish central bank (which, according to Wikipedia, is also the world’s oldest central bank).)
Why Sweden? Because Sweden had its own financial crisis in the early 1990s, and by many accounts did a reasonably good job of pulling out of it. A housing bubble, fueled by cheap credit, collapsed in 1990, with residential real estate prices falling by 25% in real terms by 1995 and nonperforming loans reaching 11% by 1993, while the Swedish krona fell in value by 30%, hurting a banking sector largely financed by foreign funds. As Urban Backstrom said in a 1997 paper, “[the] aggregate loan losses [of the seven largest banks] amounted to the equivalent of 12 percent of Sweden’s annual GDP. The stock of nonperforming loans was much larger than the banking sector’s total equity capital.” In other words, the banking sector as a whole was broke.
It looks like a bank aggregator for bad assets is pretty much a done deal. David Axelrod said yesterday we should expect a new approach within a few days, and leading reporters (NYT, Washington Post) have discerned that this is likely to include a “bad bank” into which troubled/toxic assets can be disposed.
We don’t yet know the details, and these matter a great deal (for the taxpayer and for the gradient of the road to recovery) but it’s not too early to think about the global implications, at least in qualitative terms. Continue reading
Sheila Bair is delivering a sensible general message: we need dramatic action to clean up banks’ balance sheets and, presumably, to recapitalize them. This initiative apparently has support from influential senators, such as Kent Conrad and Charles Schumer. Many Republicans also seem inclined to come on board.
I like an aggregator-type approach; this is quite consistent with the RTC-inspired structure that we have been advocating (see the WSJ.com article linked through that post for details; such ideas are consistent with and an update of our proposals from September, November, and December). But some of the details currently being floated seem less than ideal. Given that the design work on this program is still ongoing and the new Administration will, without doubt, seek broad support on Capitol Hill, I would suggest that the following points be considered or even stressed in the upcoming deliberations. Continue reading