Tag: Banking

More Bank Balance Sheets for Beginners

If you read this blog and listen to Planet Money, you may have had enough of this topic, but Calculated Risk pitched in with two posts on liquidity and solvency crises, complete with graphical balance sheet illustrations. He does a better job than I have of conceptually illustrating the workings of the various bank bailout plans that have been offered.

This is his assessment of the current strategy:

The Geithner approach is to keep injecting capital into the banks to cover the losses. This is known as the “Zombie” bank approach. . . .

Although the bank is balance sheet insolvent, the bank will never be business insolvent [unable to pay its debts as they come due] because the government will continue to provide money to cover losses.

If only a small percentage of financial assets are held by zombie banks, then this approach will probably work. These banks will be crippled, but the other banks can meet the financing needs of the economy.

I should note that CR does not say the entire banking system is insolvent, or that any banks in particular are insolvent.

The posts are from late April but I missed them, probably because they were on my birthday.

By James Kwak

Self-Defeating Marketing

Today I got a “Welcome Guide” from Bank of America because I was until recently a Countrywide customer. Countrywide, like many institutions that are in trouble, was offering some very high CD rates last year before being acquired by Bank of America, so I put money there – below the FDIC limit, of course – just like I put money at IndyMac and Wachovia shortly before they failed. (For people who like to chase high rates, I recommend Bank Deals.)

Anyway, this nicely designed welcome guide had a page titled “Clarity,” with this text:

We’re working to take the guesswork out of home lending with ideas such as our Clarity Commitment. This simple one-page loan summary clearly highlights key terms of each new loan. We’ve made it easy to read and easy to understand. So when you’re ready to buy or refinance, you can be confident that you’re choosing a loan that’s right for you.

Unfortunately, there’s a footnote that say, in very fine print:

This summary is provided as a convenience, does not serve as a substitute for a borrower’s actual loan documents and is not a commitment to lend. Borrowers should become fully informed by reviewing all of the loan and disclosure documentation provided. Not available on all products and programs.

I understand the value of high-level disclosures and the need for detailed contracts. But as a marketing message, this one seems to shoot itself in the foot.

By James Kwak

The Skirmish over Credit Cards

The Senate may be voting this week on a bill to tighten regulation of credit card issuers – or not, since you can never tell with the Senate. Despite an agreement between the ranking members of the Senate Banking Committee, there is a series of amendments from both sides to go through; Real Time Economics has a summary of the issues that were open as of earlier this week.

I wrote a post on The Hearing earlier describing the debate as one between two economic perspectives: classical economics (credit card issuers should be able to offer any terms they want; if people accept them, that by definition means it increases their utility) and behavioral economics (people suffer from cognitive fallacies, like thinking that they will never pay any of those fees threatened in the credit card agreement, so regulations should help people make better decisions and protect them from bad decisions).

Looking back over that post, it was far too balanced. There is a plausible theoretical argument that tighter restrictions have the effect of limiting the supply of credit to marginal customers, but that’s not what’s going on here. First of all, there isn’t much demand for credit these days. Second, it’s really about whether credit card issuers will be able to use increased interest rates and fees to partially offset their increased default rates. And of course, this isn’t going to be decided by economics, but by power. The more relevant question is the one that Simon was asked on MSNBC: “Do the banks own the Senate?”

Continue reading “The Skirmish over Credit Cards” →

Stress Tests: The Questions Continue

From Felix Salmon:

Why did Treasury switch from TCE to the even-more-obscure common capital metric? Quite possibly to help Bank of America and Citigroup get the amount of capital they needed to raise down to a number within the realms of possibility. After all, these tests were designed so that they couldn’t be flunked. And that might have seemed a real possibility back when Treasury was still using TCE.

By James Kwak

James Surowiecki and Me

Back when I had time to read The New Yorker, I was a big fan of James Surowiecki. I would always look for his column; if it was there, it was usually the first thing I would read. Unfortunately, he’s no fan of mine.

Surowiecki makes three points about our recent long post on nationalization:

If the government were to take over a large bank like Citigroup, it would not be able to sell it into the private sector quickly, but would most likely own it for several years, which constitutes nationalization.
Recent U.S. history, by which he means the S&L crisis, shows that the right strategy is “exercising regulatory forebearance, cutting interest rates sharply (which raises bank profit margins), and helping the banks deal with their bad assets” – not bank takeovers.
We were misleading in citing the IMF’s $4.1 trillion number instead of the lower $1.1 trillion number for U.S. financial institutions. “I assume they used the $4.1 trillion number because it’s much scarier, and offers a much gloomier picture of the state of the U.S. financial system. Unfortunately, it also offers a much more misleading picture of the system.”

Sigh. I guess it’s impossible to make everyone like me.

I’ll take the points in reverse order.

Continue reading “James Surowiecki and Me” →

Stress Tests: What Was the Point Again?

There was been a lot of drama over the last week, which we have certainly contributed to, about the stress tests. It was all very exciting, finally seeing numbers purporting to show how healthy or unhealthy each bank was. But let’s recall what the point of this whole exercise was.

Depending on your perspective, the goal is either to restore confidence in the health of the financial system, or to ensure the health of the financial system, which are obviously closely related. We care about the health of the financial system because the financial system is critical for the health of the economy as a whole: without banks that are willing to lend money for people to buy houses, cars, and consumer goods, or for businesses to invest in real estate, factories, inventory, software, etc., none of these things will happen. So the ultimate goal is to ensure the availability of credit.

There are ways to measure the availability of credit directly. One of them is the Fed’s quarterly survey on bank lending practices, which was released earlier this week (hat tip Calculated Risk, as usual). For a quick overview, I recommend the charts. The charts show you, for each quarter, the change in supply of or demand for credit in that quarter – in other words, they are you showing you the first derivative.

Continue reading “Stress Tests: What Was the Point Again?” →

Failure Is Good

Regular readers will know that we are fans of Thomas Hoenig, president of the Kansas City Fed (see here). I was catching up on the week’s news via Calculated Risk and came across Hoenig’s recent op-ed in the Financial Times, which I recommend as a follow-up to (or shorter version of) our previous post. Nor surprisingly, Hoenig argues that large bank holding companies should be allowed to fail, meaning:

Non-viable institutions would be allowed to fail and be placed into a negotiated conservatorship or a bridge institution, with the bad assets liquidated while the remainder of the firm is operated under new management and re-privatised as soon as is feasible.

Hoenig provides a list of arguments in support of this position. He starts with moral hazard, which would not have been at the top of my list. But I particularly like these:

So-called “too big to fail” firms have been given a competitive advantage and, rather than being held accountable for their actions, they have actually been subsidised in becoming more economically and politically powerful.

As these institutions are under repair, the Federal Reserve is making loans directly to specific sectors of the economy, causing the Fed to allocate credit and take on a fiscal as well as a monetary policy role.

A systematic approach would reduce the uncertainty that has paralysed financial markets; the cost is more measurable and therefre manageable.

Here’s a link to the whole thing again.

By James Kwak

Stress Tests and The Nationalization We Got

The post was co-authored by Simon Johnson and James Kwak.

When the stress tests were first announced on February 10, bank stocks went into a slide (the S&P 500 Financial Sector Index fell from 133.13 on February 9 to 96.18 two weeks later), in part on fears that the stress tests would be a prelude to “nationalization” of the banks. This week, it has emerged that several large banks will require tens of billions of dollars of new capital, most notably Bank of America. They could obtain that capital by exchanging common shares for the preferred shares that Treasury now holds, an accounting trick that boosts tangible common equity without providing the banks any new cash. Such a conversion would greatly increase the government’s stake in certain banks, perhaps even above the 50% level, yet the markets seem relatively unconcerned this week, with the S&P 500 Financial Sector Index at 168.14 and rising.

What happened?

Back in February, America was mired in a public debate over the word “nationalization” and what it meant for our banking system, with contributions by Nobel Laureates Paul Krugman and Joseph Stiglitz, former and current Fed officials Alan Greenspan, Alan Blinder, and Thomas Hoenig, and administration figures Timothy Geithner, Larry Summers, and even Barack (“Sweden had like five banks“) Obama, among others. On a substantive level, the debate was over whether large and arguably insolvent banks should be allowed to fail and go into government conservatorship, as happens routinely with small insolvent banks. Opponents of this view who wanted to keep the banks afloat in their current form, including the current administration, beat off this challenge by calling it nationalization (more precisely, by demonizing government control of banks). Perversely, however, what we got instead was increasing co-dependency between the government and the large banks, as well as increasing influence of the government over the banks, and vice-versa. And according to the market, the banks should be quite happy with this outcome.

Continue reading “Stress Tests and The Nationalization We Got” →

Is Everyone Confused Yet? (Bank Stress Tests)

The public relations campaign packaging the bank stress tests is kicking into high gear and our professional information managers are really hitting their stride. They face, of course, a classic spin problem: you need to get the information out there, but you don’t want to be too definitive on the first day or soon after – if you’re easy on the banks, that looks bad; if you’re tough on the banks, that might be dangerous.

The best way to handle this is by jamming your own signal – which they are starting to do in brilliant fashion. To the WSJ you leak that BoA needs to raise a great deal of capital ($35bn); they run this story on the front page, next to a great frown on the face of Ken Lewis. But you tell the FT that Citi will need “to raise less than $10bn” (note that the on-line FT version of this story, as of 8:30am Eastern, seems to have been adjusted downwards relative to the print edition that arrived at my house 4 hours ago.) The NYT yesterday sounded quite upbeat.

Of course, deliberately or inadvertently confusing people is made much easier by the fact that the experts are in sharp disagreement. Goldman’s Jan Hatzius says that the worst is now behind us in terms of loss recognition and pre-provision earnings will be much higher in the US than they were in Japan during the 1990s – here he and others are taking on the IMF’s Global Financial Stability Report. And he has two good points in this regard, Continue reading “Is Everyone Confused Yet? (Bank Stress Tests)” →

All About Optics (Predicting Stress Test Outcomes)

The bank stress tests are beginning to create a perception problem, but not – as you might think – for banks. Rather the issue is top level Administration officials’ own optics (spin jargon for how we think about our rulers).

At one level, the government’s approach to banks – delay doing anything until the economy stabilizes – is working out nicely. This is the counterpart of the macroeconomic Summers Strategy and in principle it is brilliant. “Don’t just do something, stand there,” is great advice in any crisis – eventually everything bottoms out and you can take the credit, justified or not (unless an election catches up with you first; check with Herbert Hoover.)

But American bankers apparently just cannot cooperate by lying low, keeping their mouths shut, and refraining from anything that looks like picking other people’s pockets. Continue reading “All About Optics (Predicting Stress Test Outcomes)” →

Guest Post: Size Really Does Matter

This guest post was contributed by Lawrence Baxter, a member of the faculty at Duke Law School and formerly a divisional executive in a large banking organization. He takes a look inside the large mergers that created the behemoth financial institutions we know today, and the assumptions that encouraged and allowed those mergers.

A friend recently observed to me that he had maintained zero interest in banks and banking all his life—until the past year. Now everyone is engaged in a swirl of emotions and punditry as we focus as experts, taxpayers or consumers on almost every dimension of the financial crisis, from bailouts to complex executive compensation schemes. Yet throughout the commotion we have not lost our faith in one quintessential American value: bigger is better. How quickly we forget such disasters as Daimler Chrysler and Travelers-Citicorp, even as we hail Chrysler-Fiat.

True, a consequence of great scale has informed the public policy debate on banks: what do we do with a financial institutions that is “too big to fail”? Yet answers to this question have, for the most part, turned on whether a particular company should be allowed to fail, or be propped up by government action. The underlying pathology receives only passing attention. Why do we let these institutions get so large in the first place? Is it not likely that many of the institutions requiring massive injections of public capital and other forms of subsidization and public assistance are, and have been for some time, simply too big to manage?

America’s obsession with bigness has led us to assume glibly that organizational growth, vertical and lateral, is a natural consequence of business success and must be respected, even celebrated. Armies of consultants, lawyers and investment bankers devote their businesses to the science of corporate enlargement, encouraged by economists who celebrate not only economies of scale, but even “economies of super scale.” Ken Thompson, then CEO of one of the most venerated banks in the United States, Wachovia, spoke for an industry when he declared in 2006, at the very moment the company was making its fatal acquisition of Golden West Financial, that ““[c]onsolidation continues to make economic sense. Done right, size enhances competitive power. With economies of scale, a company can better afford the technology and longer branch hours that customers demand.”*

Continue reading “Guest Post: Size Really Does Matter” →

Stress Tests for Beginners

The big news on the banking front this week will be the public release of the stress test results, currently scheduled for Thursday (originally it was supposed to be today). Over at The Hearing, I wrote an overview post recapping the context for the stress tests and the current dilemma the administration faces: whether to keep quiet about the details, and risk undermining the credibility of the exercise, or whether to release signficant bank-specific information, and risk undermining the reputation of certain weak banks.

There is nothing wrong with the concept of the stress tests, and arguably regulators should have been doing them constantly as the crisis worsened, so that this particular iteration would not create such a political challenge. The idea is that not only do you want to know how much capital a bank has right now, but you want to know how much capital it will have left if the economy continues to get worse. If you did this analysis in a way that was credible with the market, it would go a long way toward restoring confidence in the financial system, since the current lack of confidence is based on people’s not trusting the information they are getting.

Continue reading “Stress Tests for Beginners” →

Bankruptcy Cramdowns Defeated in Senate

President Obama, he of the 68% approval rating, asked Congress to allow bankruptcy judges to reduce the principal amounts of mortgages on primary residences (they can already modify almost all other loans in bankruptcy). The goal was to pressure mortgage lenders, or the investors who now own those mortgages, to modify the mortgages themselves to give homeowners a better option than foreclosure. Because, you know, we have a housing foreclosure crisis going on. But after passing the House, the measure got only 45 votes in the Senate, with zero Republican support and twelve Democrats defecting.

Banks campaigned against the measure by – get this – threatening that it would destabilize financial markets. The New York Times reported:

A letter signed by 12 industry organizations this week to senators warned that the legislation would “have the unintended consequence of further destabilizing the markets.”

Translation: banks are weak; weak banks are dangerous; therefore Congress should not do things that might be bad for banks.

According to the Washington Post:

[Senator Richard] Durbin negotiated with Bank of America, J.P. Morgan Chase and Wells Fargo for weeks, hoping their support would bridge the gap. Even after the proposal was weakened significantly, the financial services industry refused to sign on.

I know the main legitimate argument against bankruptcy cramdowns: it increases the riskiness of mortgages, and therefore mortgage rates would have to go up a little for everyone. (Which sounds fine with me.) But the way this issue played out had nothing to do with what would be best for the country as a whole; it had everything to do with what the banks wanted.

Instead of bankruptcy cramdowns, the Times reports that the banks got a reduction in the insurance premiums they will pay the FDIC for deposit insurance – which is like a group of car owners voting themselves lower premiums on their auto insurance. But because there is zero chance the government will let insured depositors lose money, any shortfall in the premiums paid by banks to the FDIC will be made up by the taxpayer.

Not that this should surprise anyone.

By James Kwak

The Importance of Battlefield Nuclear Weapons

I’ve been writing a lot about the game of chicken recently, most often in connection with the GM and Chrysler bailouts. On the Chrysler front, the game is in its last hours. Even after a consortium of large banks agreed to the proposed debt-for-equity swap, some smaller hedge funds are holding out for more money, and even the extra $250 million that Treasury agreed to kick in seems unlikely to keep Chrysler out of bankruptcy.

The problem is that bankruptcy is the only weapon Chrysler and Treasury have in this fight, and it’s a strategic nuclear weapon. Bankruptcy is the only threat that can get the bondholders to agree to a swap; but because a bankruptcy carries some risk of destroying Chrysler (because control will lie in the hands of a bankruptcy judge – not Chrysler, Treasury, the UAW, or Fiat), and taking hundreds of thousands of jobs with it, everyone knows that Treasury would prefer not to use it. The bondholders are betting that they can use Treasury’s fear of a bankruptcy to extract better terms at the last minute. (And it’s even possible that the large banks agreed to the swap knowing they could count on the smaller, less politically exposed hedge funds to veto it.) But Treasury may still press the button, because it needs to make a statement in advance of the bigger GM confrontation scheduled for a month from now.

But there’s a much bigger, slower game going on at the same time, and the administration’s basic problem is the same: all it has is strategic nuclear weapons that it absolutely does not want to use. The New York Times had an article today about how “a growing number of banks are resisting the Obama administration’s proposals for fixing the financial system.” It didn’t have a lot of new information, but it summarized the outlines of the game.

Continue reading “The Importance of Battlefield Nuclear Weapons” →

Larry Summers’ New Model

Larry Summers spoke on Friday afternoon at the InterAmerican Development Bank in Washington DC. As he was addressing a group with much experience living through and dealing professionally as economists with major crises, he spoke the “language of economics” (as he called it) and largely cut to the analytical chase.

Summers made five points that reveal a great deal about his personal thinking – and the structure of thought that lies behind most of what the Administration is doing vis-a-vis the crisis. Some of this we knew or guessed at before, but it was still the clearest articulation I have seen. Continue reading “Larry Summers’ New Model” →