Tag: Banking

“Bad Banks” for Beginners

For a complete list of Beginners articles, see the Financial Crisis for Beginners page.

What is a bad bank? . . . No, I don’t mean that kind of bad bank, with which we are all much too familiar. I mean the kind of “bad bank” that is being discussed as a possible solution to the problems in our banking sector.

In this sense, a bad bank is a bank that holds bad, or “toxic” assets, allowing some other bank to get rid of these assets and thereby become a “good bank.” Continue reading ““Bad Banks” for Beginners” →

Global Consequences of a US “Bad Bank” Aggregator: It’s Mostly Fiscal

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 “Global Consequences of a US “Bad Bank” Aggregator: It’s Mostly Fiscal” →

Designer Talk: Bank Recapitalization (and Bair’s Aggregator)

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 “Designer Talk: Bank Recapitalization (and Bair’s Aggregator)” →

Bank Recapitalization Options and Recommendation (After Citigroup Bailout)

By Peter Boone, Simon Johnson, and James Kwak (pdf version is here)

Summary

1.       Debt and equity prices for U.S. banks at the close on Friday, November 21, indicated that the market is testing the resolve of the government to support the banking system. Allowing major banks to fail is not an option, as was made explicit in the G7 statement in mid-October. Significant recapitalization will be necessary to stem the pace of global deleveraging (the contraction of loans and sale of assets by banks around the world). However, the administration’s strategy is not clear.

2.       While full bank recapitalization is not a panacea, it is an important part of the policy mix that will get us through mid-2009, at which point a broader set of expansionary fiscal and – most important – monetary policies can begin to take effect.

3.       The response this weekend by the U.S. authorities in providing financial support to Citigroup is a partial, overly generous, and nontransparent recapitalization, including a large guarantee for distressed assets – which is very close to the asset purchases that Treasury only last week said it would not do.  This U-turn confuses the market (again), leaves the fate of other major banks unclear, and implies much larger contingent liabilities and little upside for the taxpayer.  This approach will be difficult to repeat multiple times because of likely political backlash.

4.       The most important goal now is to put in place a stable, transparent set of rules for bank recapitalization, with sufficient political support and limits on the scope for further policy changes.  Mr. Paulson’s seemingly haphazard approach has become a part of the system problem.

5.       While all recapitalization options have problems, the “least bad” is requiring firms to raise more capital and, for those that cannot, injecting capital through substantial purchases of common stock by the government. These can be managed through a special purpose agency or control board, which is designed to keep credit from becoming politicized and to sell the equity stakes when market conditions are sufficiently supportive.

6.       Another TARP-type round, on slightly tougher terms than October, may serve as an emergency stop-gap measure, but it will not solve the underlying problems and any positive effects could be short-lived.

Continue reading “Bank Recapitalization Options and Recommendation (After Citigroup Bailout)” →

Citigroup Bailout: Weak, Arbitrary, Incomprehensible

According to the Wall Street Journal, the deal is done. Here are the terms. In short: (a) the government gives Citi $20 billion in cash in exchange for $27 billion of preferred on the same terms as the first $25 billion, except that the interest rate is now 8% instead of 5%, and there is a cap on dividends of $0.01 per share per quarter; and (b) the government (Treasury, FDIC, Fed) agrees to absorb 90% of losses above $29 billion on a $306 billion slice of Citi’s assets, made up of residential and commercial mortgage-backed securities. (If triggered, some of that guarantee will be provided as a loan from the Fed.) There is also a warrant to buy up to $2.7 billion worth of common stock (I presume) at a staggeringly silly price of $10.61 per share (Citi closed at $3.77 on Friday).

The government (should have) had two goals for this bailout. First, since everyone assumes Citi is too big to fail, the bailout had to be big enough that it would settle the matter once and for all. Second, it had to define a standard set of terms that other banks could rely on and, more importantly, the market could rely on being there for other banks. This plan fails on both counts.

The arithmetic on this deal doesn’t seem to work for me (feel free to help me out). Citi has over $2 trillion in assets and several hundred billions of dollars in off-balance sheet liabilities. $20 billion is a drop in the bucket. Friedman Billings Ramsey last week estimated that Citi needed $160 billion in new capital. (I’m not sure I agree with the exact number, but that’s the ballpark.) Yes, there is a guarantee on $306 billion in assets (which will not get triggered until that $20 billion is wiped out), but that leaves another $2 trillion in other assets, many of which are not looking particularly healthy. If I’m an investor, I’m thinking that Citi is going to have to come back again for more money.

In addition, the plan is arbitrary and cannot possibly set an expectation for future deals. In particular, by saying that the government will back some of Citi’s assets but not others, it doesn’t even establish a principle that can be followed in future bailouts. In effect, the message to the market was and has been: “We will protect some (unnamed) large banks from failing, but we won’t tell you how and we’ll decide at the last minute.)” As long as that’s the message, investors will continue to worry about all U.S. banks.

The third goal should have been getting a good deal for the U.S. taxpayer, but instead Citi got the same generous terms as the original recapitalization. 8% is still less than the 10% Buffett got from Goldman; a cap on dividends is a nice touch but shouldn’t affect the value of equity any. By refusing to ask for convertible shares, the government achieved its goal of not diluting shareholders and limiting its influence over the bank. And an exercise price of $10.61 for the warrants? It is justified as the average closing price for the preceding 20 days, but basically that amounts to substituting what people really would like to believe the stock is worth for what it really is worth ($3.77).

How does this kind of thing happen? A weekend is really just not that much time to work out a deal. Maybe next time Treasury and the Fed should have a plan before going into the weekend?

Update: Bloggers start trying to be funny, world to end soon:

  • Calculated Risk (on the aborted plan to divide Citi into a “good bank” and a “bad bank”): “Hey, I thought Citi WAS the bad bank!”
  • Tyler Cowen (on the same plan, which morphed into the government’s guarantee of the “bad bank” part of Citi): “Didn’t Paulson tell us just a few days ago that TARP wasn’t needed after all? Doesn’t this mean that Paulson should speak less frequently?”

Update 2: I made a mistake in the original post: although the government is getting $27 billion “worth” of non-convertible preferred stock, it is only paying $20 billion in cash. $7 billion is being granted as the fee for the government guarantee. Thanks to Nemo for catching this. (Note to self: No posts after midnight!)

The Citigroup Betting Pool

I’ve been catching up with my family and not on top of the news the last 24 hours or so – wasn’t there a time that the financial world shut down on weekends? – but for those of you who may not have a feed reader clogged with economics blogs (first, good for you), I wanted to point out some of the various outcomes you may want to bet on when it comes to Citigroup. Some people are betting that a deal (bailout, FDIC takeover, merger) may be announced as soon as this weekend. I doubt it, because Citi shouldn’t have a liquidity problem per se; now that the Federal Reserve is accepting pocket lint as collateral, Citi can keep functioning even after the markets have completely lost faith in it. The problem is that no one believes its assets are still worth more than its liabilities, so everyone expects the endgame will come (in one form or another) sooner or later. The big questions are whether no one will get wiped out, shareholders will get wiped out, or shareholders and creditors will get wiped out.

  • Mark Thoma has an overview with excerpts from some other posts.
  • The wildest idea is that Citi might merge with Goldman or Morgan Stanley, although this is only floated by unnamed analysts. What such a merger would accomplish is unclear to me. (Although various people have come up with the name for a Goldman-Citi merged entity.)
  • Felix Salmon has a quick rundown with a lot of links (some of which I reproduced below); he thinks that at least creditors will not get wiped out to avoid a repeat of Lehman.
  • John Hempton explains how creditors might be wiped out and why it would be a bad thing.
  • Brad DeLong says to the government: go ahead, just buy the whole thing. With the change, buy a cup of coffee.

To Bail or Not To Bail, Banking Edition

This was a bad day for the market and a very bad day for banking; the credit default swap spread for at least one major bank rose above 400 basis points – a level of implied default probability that we have not seen since mid-October. 

Mr. Paulson suggested earlier this week that the government’s Troubled Asset Relief Program (TARP) take a break from bank recapitalizations, through at least January 20th (listen to today’s NPR story).  After today, I seriously doubt this is a good idea.  And I sincerely hope that the administration is preparing (another) policy U-turn. 

Potentially more sustainable approaches are suggested in my previous post (and the associated WSJ.com article).  Don’t be shy.  Congress in particular needs to hear your suggestions – post them here or call your favorite representative.  Just don’t urge inaction.