Tag: Banking

Defending A Peg: Lessons for the US Banking Authorities

You’ve seen it a thousand times.  A country’s exchange rate used to make sense, but now it is hopelessly overvalued.  And, consequently, your pegged exchange rate now looks like a one way bet.  Every Financial Times subscriber starts to think about how to either get out of your currency or, if they are feeling aggressive, how to more actively speculate that the exchange rate will soon depreciate.

And the beauty of this situation – from a speculator’s point of view – is that the relevant authorities will never move quickly or decisively to the inevitable end point.  Sooner or later, the currency will be devalued and, if the country’s citizens are lucky, sensible economic policies (and perhaps external financial support) will be put in place to support the new exchange rate.  But, for a surprisingly long time, the government will make statements along the lines of, “we will defend our exchange rate,” “we have plenty of reserves,” “we will never devalue,” or – my favorite – “the fundamentals are fine.”

This analogy sprang to mind when I read this morning’s joint statement by Treasury, the FDIC, OCC, OTS, and the Fed. Continue reading “Defending A Peg: Lessons for the US Banking Authorities” →

Dublin (and Vienna) Calling

If you think credit default swap (CDS) spreads are informative with regard to developing pressure points and issues that policymakers should focus on (or will likely spend hectic weekends dealing with), you should look at the latest CDS spreads for European banks.  The Irish story we have already flagged.  I’m also concerned that developments in East-Central Europe are starting to affect the prospects for West European banks, most notably in Austria. Continue reading “Dublin (and Vienna) Calling” →

Reprivatization After Paulson

The worst possible way to nationalize would be to assume responsibility for the liabilities of banks, at the same time as not putting in place adequate oversight and failing to ensure that the taxpayer gets any upside.  Even worse, we could install managers with a proven track record of incompetence.  Anyone who proposed such a scheme today – as we collectively kick the tires of plausible alternative approaches – would be dismissed as an ridiculous crank.

Yet it is exactly this kind of nationalization that we – or, more specifically, Hank Paulson – already did. Continue reading “Reprivatization After Paulson” →

The Stress Test: Time for Transparency

Like many people, I was disappointed by the Financial Stability Plan announced on Tuesday. But I think there is one glimmer of hope: the “stress test.”

A key component of the Capital Assistance Program is a forward looking comprehensive “stress test” that requires an assessment of whether major financial institutions have the capital necessary to continue lending and to absorb the potential losses that could result from a more severe decline in the economy than projected. (Emphasis added.)

The stress test is supposed to indicate which banks are healthy and which aren’t (so they can be fixed or closed). We need this for the reason most of you already know: nobody thinks the banks (meaning, mainly, the big ones) are healthy. The New York Times has a good summary of the situation. Nouriel Roubini thinks U.S. banks are facing another $1 trillion in write-downs. The IMF thinks it’s more like $500 billion. The only people who think the banks are healthy are the bankers themselves:

“Our analysis shows that the banks have varying degrees of solvency and does not reveal that any institution is insolvent,” said Scott Talbott, senior vice president of government affairs at the Financial Services Roundtable, a trade group whose members include the largest banks.

Edward L. Yingling, president of the American Bankers Association, called claims of technical insolvency “speculation by people who have no specific knowledge of bank assets.”

Continue reading “The Stress Test: Time for Transparency” →

Rahm Emanuel’s and David Axelrod’s New Dilemma

The President’s top political counselors face the following dilemma.  They want to be tough on banks because that makes sense politically and, presumably, because it fits how they – with considerable relevant experience – would like to address the deeper underlying problems in the financial system.

But at least some prominent economic counselors to the President strongly disagree.  The Treasury Secretary, in particular, articulates the view that being tough on the banks and top bankers would further worsen credit markets and thus deepen/prolong the recession.  Mr Geithner wants to try other routes, and while he does not rule out imposing policies that banks would not like, it is not in his Plan A or likely a feature of his Plan B.

The President has evidently sided with Treasury, either because he decided they have superior technical competence, or because Emanuel and Axelrod themselves gave way when the experts stared them down.

The dilemma is this.  Continue reading “Rahm Emanuel’s and David Axelrod’s New Dilemma” →

Secretary Geithner’s Speech: A Viewer’s Guide

At 11am this morning, from the Cash Room at the Treasury, Secretary Geithner will lay out his vision (and hopefully some convincing details) regarding how to get the US financial system back on its feet.  What should we listen for as indications that this is heading in the right direction? Continue reading “Secretary Geithner’s Speech: A Viewer’s Guide” →

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” →

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.

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” →

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” →

What Does “Private” Mean?

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.

Continue reading “What Does “Private” Mean?” →

To Save The Banks We Must Stand Up To The Bankers

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 “To Save The Banks We Must Stand Up To The Bankers” →

The Emerging Political Strategy For Bank Recapitalization

Here’s a tough problem. 

  1. The nation’s leading banks are short of capital, and only the government can provide the scale of resources needed to recapitalize, clean up balance sheets, and really get the credit system back into shape.  Any sensible approach will put some trillions of taxpayer money at risk.  We should get most of it back but – as we’ve learned – things can go wrong.
  2. Everyone hates bankers right now, and these feelings only deepen as we learn more about how the first part of the TARP was spent and mis-spent.  No one wants to hear about anything that sounds like a bailout to bankers and their careers.

How does the Administration and Congress sort this one out?  This weekend we seeing an approach take shape which, most likely, will work.  There are five closely related moving pieces. Continue reading “The Emerging Political Strategy For Bank Recapitalization” →