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The Bad Bank Assets Proposal: Even Worse Than You Imagined

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Dear God, let’s just kiss the US economy goodbye. It may take a few years before the loyalists and permabulls throw in the towel, but the handwriting is on the wall.

The Obama Administration, if the Washington Post’s latest report is accurate, is about to embark on a hugely expensive “save the banking industry at all costs” experiment that:

1. Has nothing substantive in common with any of the “deemed as successful” financial crisis programs

2. Has key elements that studies of financial crises have recommended against

3. Consumes considerable resources, thus competing with other, in many cases better, uses of fiscal firepower.

The Obama Administration is as obviously and fully hostage to the interests of the financial services industry as the Bush crowd was. We have no new thinking, no willingness to take measures that are completely defensible (in fact not doing them takes some creative positioning) like wiping out shareholders at obviously dud banks (Citi is top of the list), forcing bondholder haircuts and/or equity swaps, replacing management, writing off and/or restructuring bad loans, and deciding whether and how to reorganize and restructure the company. Instead, the banks are now getting the AIG treatment: every demand is being met, no tough questions asked, no probing of the accounts (or more important, the accounting).

Why is this a bad idea? Let’s turn to a study by the IMF of 124 banking crises. Their conclusion:

Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.

In case you had any doubts, propping up dud asset values is a form of forbearance. Japan had a different way of going about it, but the philosophy was similar, and the last 15 year illustrates how well that worked.

What we have from Team Obama is a bigger abortion of a “throw money at bad bank assets” plan that I feared in my worst nightmare. And (when we get to the Post preview), they have the temerity to invoke triage to make what they are doing sound surgical and limited.

Those who remember the origin know that triage means focusing on the middle third of the wounded on the battlefield : abandoning the goners to die, leaving those wounded but stable to fend for themselves for the moment (they were in good enough shape to wait to be transported or hold on to be treated later). The middle third, those in immediate danger but who might nevertheless be salvaged, get top priority.

The concept of “triage” recognizes that resources are limited, tough decision need to be made, and some are beyond any hope. But in Team Obama Newspeak, triage means everyone can be saved because resources are presumed to be unlimited:

The basic problem confronting the government is that banks hold large quantities of assets that they value on their books for much more than investors are willing to pay…

Yves here. The spin is so thick I have to interject after one sentence. Note how the problem is that the investors don’t want to pay enough, not that the assets are in most cases fetid? Back to the article:

Since the early days of the financial crisis, officials have struggled to unwind that knot. If the government buys the assets at prices that banks consider fair, the Treasury would take a huge loss when it ultimately sells the assets for much less. If, instead, the government insists on paying market prices, the banks may not survive their losses.

Yves here. See how saving the banks in their current form is presumed to be necessary? This is the phony policy constraint that is leading to all the distortions. The savings and loan crisis’ Resolution Trust Corporation is touted as a good “bad bank” model (it’s far from the only one). But guess what? It got those bad assets from banks that died. That little detail seems to be neglected in modern accounts.

Back to the article:

Instead of taking a single approach, the Obama administration plans to divide assets and other loans into three categories, each with its own solution, according to sources familiar with the discussions, speaking on condition of anonymity because the details are not finalized.

The government would buy and hold on to those assets whose falling prices are putting banks under the most pressure. Officials want to limit these purchases because of the vast expense.

The centerpiece of the plan would be a guarantee to limit losses on a second group of troubled assets that can be kept by the banks because they have more stable prices.

And it would allow banks to retain and profit from their healthiest assets.

Beyond these initiatives, the government also is likely to inject more capital into troubled institutions.

Yves again. This sounds completely arbitrary, despite the pretense of faux science. Do they want to buy the assets most underwater? The assets most at risk of further price declines? The assets with that are the hardest to value (like lower rated CDO tranches?). It may simply be that the Post reporter doesn’t appreciate the issues at work, but I wonder if the extreme vagueness reflects instead failure to come to grips with the real objectives (which means Wall Street will be able to manipulate them) or that they don’t want the public to know what is going on (per the persistent stonewalling of efforts to find out what securities the Fed has bought and taken as collateral).

As John Paulson pointed out, a lot of poor quality paper is trading. The idea that it is illiquid is a myth.

The problem is not a lack of price discovery, as the discussion above pretends, it’s a lack of investor willingness or ability to take losses. And readers have said if a particular piece of paper doesn’t fetch a bid, that’s because its real value is not materially above zero. But per above, that’s the sort of dreck that Team Obama would buy.

And what, pray tell, is the point of the guarantee? The loss exposure on a guarantee (versus a purchase) at the same nominal price is the same, although the initial cash outlay is considerably different. Ah, but if the paper is guaranteed, then your friendly bank welfare recipient can bring the junk to the Fed and get nice cash back.

So we the taxpayers are going to eat a ton of bank losses that should instead be borne first by stockholders and bondholders This program should be labeled the Pimco bailout plan, since the giant bond fund holds a lot of bank debt. That shows what a fiction Obama’s populism is. It’s mere posturing and empty phrases. Look at where the dough goes, and it is going first and foremost to the big money end of town.

Now I do not labor under the delusion that there are cheap or easy ways out of our financial sinkhole. People are suffering, and we are only partway through the process of contraction and writeoffs. I heard of a suicide today, a jewelry dealer who was $400,000 in debt (also owed a lot of money but unable to collect) who threw himself off 10 West 47th Street (from someone else in the building, this is no urban legend). A tragedy, and a visible one, and there is plenty of less acute but no less real trauma afoot.

But Team Obama is taking the cowardly approach of distributing the costs among the most disenfranchised group in the process, namely the taxpayer, when there far more obvious and logical groups to take the hits. Shareholders and bondholders bought securities KNOWING there was the possibility of loss. A lot of big financial institutions have been on the ropes for over a year. A security holding is not a marriage. When conditions change, prudent investors reassess and adjust course accordingly. If anyone is long a lot of dodgy bank paper now, they have only themselves to blame. Any why are rank and file bankers still exempt from pay cuts when the workers in another failing US industry, autos, expected to take big hits?

This is the most roundabout and probably the most costly way to not solve this problem. Another warning from the IMF paper:

All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway. Also, closure of a nonviable bank is often delayed for too long, even when there are clear signs of insolvency (Lindgren, 2003). Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the government’s fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.

The most amazing bit is the government acts as if it has no leverage. Look how Paulson sent teams in to inspect the accounts of Fannie and Freddie and put them into conservatorship. The reason it is obvious that this program is a crock is that it has been cooked up in the complete and utter absence of any serious due diligence on the toxic holdings of the big banks.

As we discuss in a separate post, the one punitive element, executive comp restrictions, are mere window-dressing. Welcome to change you can believe in.

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123 comments

  1. Anonymous

    How ’bout this: It’s a head fake. Get people to dump money into that hole, then nationalize said (less deep) hole. Hair cuts turn into decapitations, and we have something like a rebalancing.

  2. Kosta

    I’m not sure that your “nationalization” solution is all that more viable. I think wiping out the stockholders and forcing a haircut on the bondholders might cause a traumatic dislocation which the markets might not be able to bear.

    Wiping out the stockholders might not cause that large of a dislocation (after all, Citi’s and BofA’s market caps aren’t that large any more). It’s the bondholders I’m concerned with. How much of a haircut would be forced on them? Won’t that cause the credit markets to freeze like they did after Lehman collapsed?

    What would be the solution to that problem? Would the gov’t have to step in and dump billions into the system to shore it up? Would that be any cheaper than the present strategy? I don’t know.

  3. Anonymous

    So Yves, at what point will the currency be debased? Or are you of the camp that the US dollar is the best of a bad lot?

    I never believed in Obama. Some nice speeches, but even if he were JC incarnate what can you expect from him in the first few months? He has to rely on the advisers given to him by his party.

    I seriously doubt Obama woke up one morning and said-” Damn, that guy Geithner is peachy! Let’s have him head treasury!”

  4. Steve

    Americans should be delighted to learn that the taxpayer’s recent largesse has permitted Citi to submit a $2B bid to purchase a British airport.

    Political tip: get the public riled up over symbolic, de minimus expenses such as private planes, while silently permitting our financial welfare queens to look abroad to deploy taxpayer capital.

  5. Yves Smith

    Kosta,

    The IMF paper, and the Swedish and Norwegian experience all say that taking the losses early in the process (and shutting down bad institutions) stops the bleeding and puts the economy on the road to recovery faster, resulting in lower overall losses and a faster and stronger rebound. The cost is it takes political will and the downturn is sharper, although not necessarily any deeper.

    Look specifically at the IMF quotes. They clearly say shoring up weak banks often merely prolongs the inevitable and increases the ultimate scale of losses.

    And look what is happening to bank stocks anyhow. Yes, we have periods when the bad ‘uns come back from near death, but they keep retesting low values. Who are we kidding?

    It isn’t as the US says one day, “OK we will assess who lives and dies today. In the ones we deem dead, we wipe out the shareholders and whack the bondholders by x%”. Banks hit the wall when and if they do, and the degree of bondholder haircut gets guesstimated then.

  6. Ponyless

    Oy. I thought that adults were entering the White House but all we get is more puppets. Why does Citi need to survive? What real economic benefit does the existence of specific banks serve? Nice write up Yves. I hope that this does not come to be.

  7. m

    You voted for President Zero rather enthusiastically, Yves, in between your Progressive gibberish rants. Ready to eat your hat?

  8. Yves Smith

    m,

    Incorrect, I was never enthusiastic about Obama. Never. I viewed him as the least bad choice.

    I was against McCain, even more so after he chose Palin. Being voceriferously opposed to Palin is not the same as being a big Obama booster.

  9. Andrew Bissell

    Hey, this is just the philosophy of pragmatism writ large. We’ll try this and hope it works. And if it doesn’t, we’ll try something else.

    No need to complicate things with ideology and principles.

  10. Anonymous

    In a few months of this direction I don’t hink they will be able to print money fast enough to keep Merry-going-round.

    I sure as hell hope that the rest of the world stops buying our debt soon so this charade can stop.

    Why can’t Obama stop continuing in a failed direction?

  11. Yves Smith

    Anon of 1:00 AM;

    He is getting bad advice. I see this repeatedly in my little business area. I have seen too often otherwise very intelligent people go down bad paths thanks to advisors (especially attorneys, but also consultants and doctors).

    If you are looking for an expert in a area where you don’t have much (any) experience, it is amazingly easy to be taken in by someone with a good resume, a persuasive manner, and a complete lack of common sense.

  12. Independent Accountant

    YS:
    If we should have learned anything from the S&L, 1979-86 crisis, it was this: the sooner you kill a "zombie thrift" the better. The total losses to Uncle Sam from the S&L crisis were about $175 billion. This disaster will be 10 times as large. Here I go again, "Got gold, get more. Got bonds, you fool".
    Team Obama is going through all kinds of machinations to avoid price discovery on the "troubled assets". The banks books are cooked.

  13. Jim in MN

    Thank you for your truthiness, Yves.

    It’s a simple smash and grab from the middle class and the poor (via budget cuts) to those who will never want for anything in their lives.

    The Northeast Elite is too big to wipe their own. What’s to stop ‘em wiping with our future earnings?

    If we had a serious open discussion of bondholders and the equity implications of across the board writeoffs, well that might lead to good policy but it’s just what the rich can’t stand. It would end up being (gasp!) progressive haircuts! Oh, NOOOOOO!

    For instance, just let folks get a tax break for a portion of bond losses if their incomes are under, say, $150,000. There. Fixed.

    All this squirming and hiding can only mean exactly what you and I think it means: keep the media and the public off the scent of rich people’s stealing from our children.

    From my count the bailouts so far have deprived my baby girl of about $100,000. There is no outrage that can match the depravity of it. It will no doubt reach a million and rob her of her future entirely.

    Simply immoral.

    Basic Beter Way:

    1. Get lending to commercial businesses going by any means necessary (a la FDR’s RFC);
    2. Tote up the losses; and
    3. Firm up the safety net for those who need it.

    That’s all ya gotta do, people! The rest is greed, fear and pride. This is our time, as someone recently said. How will our children remember us? How will we answer their question:

    “What did you do during the Scam, Daddy?”

    Economic warfare, indeed.

  14. Andrew Bissell

    Independent Accountant, I agree in general with your thesis, but I’m more of the state of mind that bailouts will ultimately be abandoned if they begin to seriously threaten the federal government’s ability to borrow money. The hated “bond vigilantes” will enforce upon President Obama the discipline that he and his economic advisors apparently lack.

    (I do also own some gold in case I’m wrong.)

    Expanding federal power is the number one criterion at work here, and a huge spike in interest rates and gold prices would not serve that objective.

  15. Waldo

    We just moved our business checking account from 1st Centennial Bank here in Cali a few months ago (that bank failed last week).

    I am smart: But wait our new business account is with Citibank! My idea! I have an MBA! It is making me feel stupid!

    Musical chairs with the firm’s cash. Thinking about moving the firm’s checking account(s) again. What a nightmare.

  16. Anonymous

    Canada ranks top in the world in banking surveys. And they have only 5 big banks. Toronto Domonion (now TD Bank) bought Commerce Bank and maybe has bought some other US retail banks.

    You get the same FDIC protection and a healthier parent.

  17. ndk

    And what, pray tell, is the point of the guarantee? The loss exposure on a guarantee (versus a purchase) at the same nominal price is the same, although the initial cash outlay is considerably different. Ah, but if the paper is guaranteed, then your friendly bank welfare recipient can bring the junk to the Fed and get nice cash back.

    Two other ways in which it’s different. The bank is exposed to the upside on the assets, which is nice for them. Also, depending on the nature and duration of the guarantee, the banks may be stuck with low-yielding assets in the case inflation does break out. In this latter case, there would doubtless be further rescues, but it’s true of the present.

    So we the taxpayers are going to eat a ton of bank losses that should instead be borne first by stockholders and bondholders…. The most amazing bit is the government acts as if it has no leverage.

    I think often of politically important stakeholders, such as Prince Abdullah in Citi, or various sovereign wealth funds that were suckered into other positions as the collapse began. Maintaining the value of equity and debt may serve ulterior motives: maintaining important political relationships instead.

    None of which is to say this is remotely excusable, and I think it’s quite doomed to fail miserably in due time. The longer we ignore the fundamental reasons why lending has slowed and forget that most lending supported consumption rather than investment, the worse things will get. As such, any rescue or nationalization in vacuo is a distraction that will at best imperil the sovereign while exacerbating present imbalances.

  18. FairEconomist

    One sentence makes the whole thing clear:

    it would allow banks to retain and profit from their healthiest assets.

    The goal of the program is to increase bank profits. The health of the economy is irrelevant.

    I agree with you, Yves, that Obama is relying on advice (as he must, not being an expert) and getting bad advice. But, he has in the past been very aware of governance issues, the need for transparency, and the hazards of regulatory capture. He should know better than to listen *only* to the people responsible for this horror. I am astonished that Obama intends to follow a plan *worse* than what Paulson did after Paulson had to abandon his initial plan for, basically, straight-up theft. Obama’s “bad bank” isn’t quite as bad as Paulson’s initial proposal – but it’s pretty close.

  19. Yves Smith

    ndk,

    Fair point re upside, except the US by virtue of its equity injections in most of the big banks, ought to own most of the stock. So the idea that the really sick banks are being treated as arm’s length entities is already a bit peculiar. The gains should redound to the shareholders, as in the US. But in the guarantee scenario. the bondholders get their cut.

    And since the assets guaranteed will be pledged to the Fed, the loans will be at rolling 28 day rates (I presume) and the Fed has announced it’s sticking with ZIRP for the foreseeable future.

  20. Yves Smith

    ndk,

    Rereading that section, I meant difference in terms of cost to the shareholder. And I think the notion that there is upside in any of this paper is a fantasy. We aren’t doing the borrower renegotiation, as they did in Sweden, to make that happen.

  21. sportsfan

    First issue has to be whether the WaPo has it right or whether this is just one more trial balloon.

    I think a nationalization is inevitable in one form or another and almost without regard to the difficulties that would create. Shareholders have no equity and that must be recognized.

    Concerned (like Kosta) of the impact of a bondholder haircut, yet believe one is necessary to make the point.

    Bias: concerned Obama supporter

  22. Anonymous

    Great post, Yves!!!

    What did anyone expect from a guy whose major claim to fame before becoming president was writing two books paying homage to himself???

    I thought Bush was the worst president in history. Most people don’t see it yet, but I suspect Bush will be in good company in the dustbin of history in about one year.

  23. Francois

    The most amazing feature of this plan is that it reveal to which extent the financial industry dominate Washington. The cognitive capture of the Fed and Treasury is total. These asshats cannot bring themselves to look at reality and put the insolvent banks into receivership; they’d rather believe that time and more capital will cure all ills.

    As for the real economy, and the people, they do not give a rodent gluteus maximus about their fate. They’ve never dirty their hands on an assembly line, never had to deal with building stuff, where the laws of physics, chemistry and mass psychology DICTATE what you can and cannot do. And contrary to a physician, who, looking at labs results, realize that his patient may be in big trouble and something must be done NOW, their balance sheets numbers oftentimes will compel them to look at ways to minimize of obfuscate the bad news.

    And these goons have been called Masters of The Universe? Well, our universe is about to implode.

  24. Anonymous

    Yves said -

    “He is getting bad advice. I see this repeatedly in my little business area. I have seen too often otherwise very intelligent people go down bad paths thanks to advisors (especially attorneys, but also consultants and doctors).”

    I have to STRONGLY, but very humbly, disagree with you on this one, Yves. Obama is getting great advice from Volcker and Buffett. Hell, even Stiglitz and Krugman (who Obama deigned to mention in one of his press meetings) are now telling him to nationalize the banks.

    On the contrary, Obama knows what he needs to do. What he lacks is the testicular fortitude to do it. Anyone with a lick of sense before the election could see this, but I agree with you, McCain scared me, because he’s even more clueless.

    With leadership like this, we are truly f#####!!!

  25. Yves Smith

    Anon of 2:19 AM,

    Buffett and Stiglitz are window dressing. He talked to Buffett prior to the election, but he has no ear now. Summers and Geithner are very effective, aggressive operators by all accounts, and working fist in glove for now. Hardly any room for any ideas to penetrate with those two around. save Volcker, but he isn’t up for frontal fights and probably does not get anywhere near as much face time.

  26. bb

    please stop all this bickering. one way or another it is going to hit everyone through their pension fund or later need to bail out some sunken pension funds.
    the biggest problem is the willingness to perrpetuate this system of cronyism called banking corporation.

  27. Anonymous

    This is the Yves that I love. Honest. Brutal. Take no prisoners.

    Finally someone is willing to rip the halo from the head of the Obama administration and display it for the cheap neon trinket that it is.

    We’re in deep, deep trouble, and the only way to remedy our ailments is to let the wounds be exposed to the bright sunshine and fresh air.

    Only with the honesty of accepting that our banking system is insolvent can we transition to some sort of tolerable denouement. We must write down debt that is worthless and purge the criminals who brought us to the precipice of Armageddon.

    But as Yves incisively puts it, the path is blocked by an administration as beholden to the banking cartel as Bush’s cronies.

    Pray for America.

  28. Anonymous

    Nice post. The real problem for the authorities is the multi trillion derivative one, which is far too big to bail. Say Citi goes under, well all their derivatives have to get valued at market. Then the dominoes really start falling all the way to GS,JPM and the Fed itself. The whole system collapses.
    The authorities are trying band aid remedies and just hoping things might improve. They know it too.
    The eventual collapse of the whole system is now inevitable anyway. ZIRP made it so. Interest rate movements of less than a quarter of a percent now have huge consequences as far as concerns the capitalisation of the banking system. At the end of the tunnel, we will be looking at the creditworthiness of the US Government itself with all the implications to do with the Dollar.
    Finally on gold, over 400 years of history shows gold does best in Deflations and does poorly (relative to many other assets) in Inflations. The why is explained here…. http://www.goldensextant.com/Gold%26Deflation.html#anchor126324.
    The 1979 spike was an aberration caused by the collapse of the London Gold Pool and US going off the gold standard in 1971. Most pundits have got it wrong as usual ! Definitely now is the time to acquire gold in your own hands (not ETFs !)

  29. Anonymous

    There will be a new ecomonic model that will come out of the fall of capitalism as we know it. It will be a system where the needs are met for all. Just not the developed countries. It will be just and based on goodwill. The greed has to stop. It is cause and effect that is working here (some would use the word Karma). Do not fear but, rather trust that good will prevail.

  30. Jim T

    Can you spell D E R I V A T I V E ?

    Citi has $30 Trillion, B of A has $28 Trillion and JP Morgan has $90 Trillion.

    No company of any great size will be allowed to fail again. Lehman was lesson 101 in what damage can be involked when Derivatives get triggered when companies fail.

  31. mmckinl

    THANK YOU YVES !

    Standing up for those with little or no political power takes guts, lots of guts. Need help? shout out …. plenty of people here, including yours truly will do whatever we can. This letter will not go unappreciated.

    sincerely,

    mmckinl

  32. sportsfan

    Yves said: Buffett and Stiglitz are window dressing. . . . Summers and Geithner are very effective, aggressive operators by all accounts, and working fist in glove for now. Hardly any room for any ideas to penetrate with those two around. . . . .”

    True enough. They get first shot. If what they persuade him to do doesn’t work, there will be changes.

    Any announcement that suggested nationalization now would be met by a chorus of boos. Later this year, it may seem the only alternative.

    The guy has been President for two weeks. How long has this train wreck been coming down the tracks?

  33. IF

    I am still hopeful that the US, after exhausting all other options, will do the right thing. Unfortunately others are suffering right now (Asia, Europe following soon?)

    One thing to recognize: people had to great expectations. It is the realization of reality that is causing the pain.

    Honestly, I don’t feel for the jeweler. I don’t understand how (rich!) people kill themselves over debt. What I am afraid of is next years harvest.

    I like bashing on the bankers myself. But they have just been executing what Greenspan told them to do. Interest rates hit zero and even became negative. This is acceptable for treasuries, but bounced all other interest rates higher up and broke the banks. The bonuses, while inexcusable, are only a tiny fraction of the losses. Most of the losses are due to the reestablished risk premium and the failure of ZIRP to the general population.

    Overall, the financial industry has to shrink with regards to GDP. Trying to freeze the status quo rewards the failures and prevents the young generation from creating a system that works for them in the future, and ultimately demoralizes them. I am thinking of Japan. How to the boomers imagine a retirement, if their children get screwed and have no say?

    The word verification is “stalin”. How cute.

  34. Yves Smith

    Anon of 2:58 AM,

    FYI, the jeweler was not rich. If you have assets you cannot sell, be it a house or jewelry inventory, and bills that must be paid, you are in the same boat, on your way to homelessness. And I mean the living on the street variety, unless you have relatives who will take you in.

    I was told the big sale in Miami (the event of the year) had virtually nothing move. Lots for sale, no buyers, and in a way even more scary to everyone, no idea where things “ought” to trade. We are talking fine finished pieces and estate jewelry, the sort of thing that historically could always be sold in the “trade” (wholesale) and with enough patience, to end buyers.

  35. Anonymous

    hi Yves,

    anon 2:19am here. Thank you for your response. It’s a shame we aren’t privy to the discussions being waged right now in the inner circles of power, but listening to only Geithner and Summers would show a critical lack of judgment in our new president.

    Thank you for your hard work on the blog!

    Off topic, but I think people are missing your nuances because there are a lot of very scared, pissed off people in this country who don’t really understand more than that the dream of homeownership has turned into a nightmare, their 401(k) is now a 201(k), and their children will inherit a broken country.

  36. keenan

    Excellent post, Yves, and great comments people!

    I didn’t vote for Obama, only because I’m in California and my voting for Cynthia McKenny (Green Party) did not risk increasing McInsane’s chances one iota, so I voted my conscience.

    And now that it’s become more than obvious to an increasing percentage of the population that President Hope-N-Change is neither, especially when it comes to the 2 most important issues of our nation, #1) wars (so much for the “anti-war” candidate promising to merely shift troops from one country to another) and prepartion for war (criminally extravagent military budgets to continue indefinately), and #2) the economy (a continuaton of the screwing and sacrificing of the poor and middle classes and their kids and grandkids to pay for the extravagances of the wealthy) I hope that the population will finally get so enraged at the total moral bankruptcy and corruption and rot of our political-economic system, equally infecting both Democrats and Republicans, that our only hope is for a second American Revolution to finish the job that the first one failed to do.

    We can either have a civilized democracy, or we can have a Corporate Plutocracy founded upon a Ponzi-style fractional reserve banking capitalist system, but we cannot have both.

    We would do well to head Thomas Jefferson’s foreboding regarding our unfinished revolution:

    “I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a monied aristocracy that has set the government at defiance. The issuing power should be taken from the banks and restored to the people to whom it properly belongs.”
    –Thomas Jefferson

    “I hope we shall crush in its birth the aristocracy of our monied corporations which dare already to challenge our government to a trial by strength, and bid defiance to the laws of our country.”
    –Thomas Jefferson

    “I sincerely believe that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale.”
    –Thomas Jefferson

    “It is incumbent on every generation to pay its own debts as it goes. A principle which if acted on would save one-half the wars of the world.”
    –Thomas Jefferson

    Abraham Lincoln also was not sitting to well with the way our society is so corrupted by capitalism:

    “We may congratulate ourselves that this cruel war is nearing its end. It has cost a vast amount of treasure and blood. . . . It has indeed been a trying hour for the Republic; but I see in the near future a crisis approaching that unnerves me and causes
    me to tremble for the safety of my country. As a result of the war, corporations have been enthroned and an era of corruption in high places
    will follow, and the money power of the country will endeavor to prolong its reign by working upon the prejudices of the people until all wealth is aggregated in a few hands and the Republic is destroyed.
    I feel at this moment more anxiety for the safety of my country than ever before, even in the midst of war. God grant that my suspicions may prove groundless.”

  37. pd130

    On Tuesday’s TODAY show Pres. Obama and Matt Lauer had this exchange:


    MATT LAUER: Are you planning in the near future to announce an idea that will buy up the toxic debt from the balance sheets of these banks with perhaps a so-called bad bank? And if so, what do you think that could cost? ’Cause Chuck Schumer came out and said since we don’t really know what those debts are worth, this could cost $4 trillion.

    PRESIDENT OBAMA: No, it — we’re not gonna be spending $4 trillion worth of taxpayer money. It’s conceivable that we have more — not only is it conceivable, it is likely that the banks have not fully acknowledged all the losses that they’re gonna experience. They’re gonna have to write down those losses. And some banks won’t make it. Other banks — are gonna make sure that — we strengthen. All deposits are gonna be — safe for ordinary people. But we’re gonna have to wring out some of these bad assets.

    It must be brutal thinking you were going to be the Health Care President or something only to have to learn enough finance in about a week to weed out a regiment of shysters.

    At least that’s the way I’m thinking about it for now, and what I’m hoping is that the statement means he’s likely to propose some kind of line past which unsalvaged banks are put in the regular kind of FDIC receivership, and only the viable banks get to sell to the Bad Bank. I still don’t like this for all the reasons said, but a) maybe it’ll be better than a bailout down the line, and b) maybe Obama’s willing to be argued further on the Bad Bank.

  38. IF

    I have lived for a good month in the forest while hiking the Colorado trail. The homeless accepted me as one of their own and some more common people treated me like I was below them. I can imagine how life with very few possessions looks like, even though I clearly was just a tourist and could always escape (see Pulp).

    The point I tried to make, was that debt slavery is not a life changing event to the lower class. But it seems to shatter the self-esteem (net-worth?!) of the middle and upper class. Life is something beautiful, even without heaving money. If somebody needs wealth and status to define himself as a person, he was already dead inside.

  39. Yves Smith

    If,

    I accept your point in the abstract, but most people are not set up to get by without shelter, particularly in a city, where the indignities are many. Even the homeless get beaten up and have their few possessions taken from them.

    And some (yours truly included) have physical issues that render them unsuitable for the outdoor scene.

  40. cap vandal

    Sorry but the discussion of mark to market is missing the point.
    There are 4 banks that are the main event. C, JPM, BAC, and WFC. These 4 have 7.5 trillion in assets. As far as banks are concerned, they have most of the the problem structured finance stuff — the only true toxic assets. If we ignore C for the moment — which is a special case, they don’t really have huge amounts of this. Or if they do, I would like to see someone find it in a filing.
    There is a good argument regarding for some entity to hold the structured mortgage backed stuff until it amortizes — since the paradox of deleveraging insures that it can’t be sold. Any serious attempt to sell or dump this will continue to knock market prices down.
    No one is going to be convinced of the above, so I won’t bother attempting to support it. However, even if this point is conceded, the banks in question have $3.5 trillion in LOANS. Loans are never marked to market, unless they are classified as held for sale — which usually means getting ready to securitize. Loans are inherently illiquid, have always been booked at amortized cost less a provision for loss, and no one is seriously discussing any change. This is fundamental to banking — as opposed to trading.
    The banks that have problems with toxic asset backed securities brought this on themselves. Banks should make loans, period.
    Anyway, the banks in question have about $90 billion up on the $3.5 trillion or 2.5%. This is after tax, so they would have another $40 billion pre tax. Further, with current interest rate margins, they are earning $50 billion/quarter in net spreads. Also, as part of the takeovers, WFC has accrued another huge chunk of money, and BAC/MER and C have guarantees for over $100 billion more.
    The 4 banks have about $341 billion in capital excluding good will (all figures @ 9/2008).

    The capital levels are thin for the current mess. C has already started to do its own bad bank. Its shareholders are pretty much wiped out. On the other hand, JPM and WFC say they don’t need more help.

    The key thing is that given everything that has happened, these banks don’t have that much true toxic stuff.

    The whole loans aren’t “toxic” (as much as I dislike the term) and can’t be toxic. They can just be BAD or under reserved. More specifically, they can be much worse then their loan loss provisions.

    Some of it is to be expected, since the valuation of whole loans tends to lag and is also based on historical experience as well as current performance.

    As far as banks holding whole loans and funding via deposits, they are already “bailed out” in the sense that they can continue to obtain funding as long as they have FDIC support.

    Most of what is going to happen is already baked into the current situation. These entities have already been bailed out, etc. in a major way — and the government is already on the hook. They are supporting all current mortgage funding via taking over the GSE’s. They are on the hook for the trillions in GSE guarantees, as well as the other federal programs, like the home loan bank boards. They already have $350 billion in junior capital in the banks (preferreds).

    It isn’t like they could say “never mind” at this point, since they are already pretty much all in.

    The only “so what” of this post is that the idea of putting WHOLE LOANS into a bad bank doesn’t make any sense. The loans are either performing or not. If they are, then the banks can hold them. If not, then they are simply bad loans and they don’t need a lot of heavy analysis. They just get written down.

    One of the worst things about all this is that C and BAC lost their capital BEFORE they had to deal with the enormous pressure of a serious recession.

    Still, it makes no sense to dump whole loans into a bad bank. So watch this carefully.

    We are stuck with too big to fail with the four mega banks. The rest are just going to have to go along being banks. The smaller banks shouldn’t have much in the way of asset backed securities, since they were “disintermediated” from this market. They do have plenty of commercial real estate and development loans.

  41. keenan

    Beautifully said, IF. I see a potential opportunity, as a result of the increasingly likely deep and prolonged economic depression the the world is going to soon experience, for a great flowering of the human potential that would have been impossible for as long as the makebelieve culture of unbridled consumption and speculation continued.

    It took nearly 80 years for people to get as reckless and conspicuous as they did in 1929. 80 years! Few are still alive that went through the great depression. No one listened to them. Children whose parents are being destroyed by debt now, will keep those memories for a long time.

    But, millions of those people who will be no longer addicted to conspicuous consumption and speculation, will have a great awakening of the human spirit and start developing a part of themselves that has long been forgotten or crowded out from their previous obsession with the rat race and materialism overload. Yes, it will be difficult and painful for many with lots of suffering to go around. And, no doubt, the majority of the suffering will not fall on those who created and benefited most from this largest Ponzi credit bubble in history but on the “little” people (though many of the little people did have a hand in the game as well). But there is great potential for human conscious evolution and new motivation to focus on developing a better society and socio-economic-political system than there has been for a very long time.

    I guess it’s that old adage again – hope for the best and prepare for the worst…better find a good spot for your vegetable garden. And I hear that rents and houses are far far cheaper out in the countryside where there’s lots more space to grow food and enjoy your time off during unemployment…

  42. M.G.

    Toxic assets are “lemon” products and lemon banking: who is going to buy a lemon? Why support to lemons? Too much asymmetry in information not to say little information on these assets…Under these circumstances any deal in lemon banking is doomed to fail (More on my blog)

  43. Charles

    “He is getting bad advice. I see this repeatedly in my little business area. I have seen too often otherwise very intelligent people go down bad paths thanks to advisors (especially attorneys, but also consultants and doctors).”

    I could agree with this if the subject was the speed of global warming or the best way to enforce a ballistic missile treaty : very technical, one-off topics.
    But Political Economy is certainly THE most important subject that any politician is sure to deal with. If one is not strongly opinionated about that, one is unsuitable for public office (and many elected officials indeed are !)

  44. Yves Smith

    Charles,

    I could write a book on this problem. Politicians do NOT know much of anything about economics, with rare exceptions. And even when they do, it is not at a level where they can play much of a role in policy development.

    The key discussions are held among the economists, with the principals not even able to follow much of the conversation. No joke, an economics prof who is deeply interested in politics and has a lot of students in policy roles, (including a key Obama player who will go unnamed) says it as if the pols are surrounded by theologians who speak only medieval Latin, and defer to them on matters technical (which are nine times out of ten the ones that really count).

  45. phil_hubb

    Treasury will buy the trash and The Fed will debase the currency until that trash is back to trading near par. At which point Treasury will slough its portfolio of trash back onto an eager market for a tidy profit.
    The Fed’s role will be to get the cash hoarders back into speculating on the newly de-toxified MBS by scaring the beejesus out of them with a knock out combination of fiat currency debasement and near zero yields.
    They’ll buy the long dated Tsys until this happens.
    All jmo

  46. Jojo

    Why are the banks getting the $$$ at taxpayer expense? I say look who gives the most money to the politicians. Money talks. New administration but SOS.

    Jon Stewart and Lawrence Lindsey had a good exchange on the stimulus plan here:
    =====================
    Mon, Feb 2, 2009
    The Daily Show with Jon Stewart
    Season 14 : Ep. 17|21:41|

    Former National Economic Council Director Lawrence Lindsey gives Jon his two cents on Obama’s stimulus plan.

    (look about 11:25 in):

    Link

  47. fresno dan

    Yves “Shareholders and bondholders bought securities KNOWING there was the possibility of loss.”
    Touching, but naive belief that the quaint belief system know as “capitalism” exists in the US. You know, where profits go to the ostensibly smart and hard working, but in reality the stupid and venal run the system, take the “profits” and stick the losses with the suckers (AKA taxpayers). Why anybody when observing reality would think that different administrations behave differently is…astounding

  48. gordon

    The “he’s getting bad advice” from Obama loyalists reminds me of the similar and widespread feeling in Revolutionary France about Louis XVI. That feeling came to an abrupt end when it was discovered that he and Marie Antoinette were intriguing with Austria to demolish the revolution.

    But don’t be too hard on Obama. He’s not Louis. He’s just a political product, carefully created to appeal to the right demographics and win an election. The election itself was the issue. All this isn’t his fault.

    And as for the inability of Govt. to deal with the crisis, well, it’s not what they’re prepared for. These guys (all the political appointees and “experts” like Summers and Geithner) are products of the era of deregulation and small Govt. The idea that Government should actually govern is something they’ve struggled against all their lives.

    Here’s a final thought, just for fun. Where does the Mob put its money? In the bank. Who launders it? The bank. Who’s going to get very pissed off if the money disappears or some Govt. accountant starts asking questions? The Mob. Who wants to live to see next Christmas? Everybody.

  49. Obey

    The thing with only guaranteeing the HTM assets is that it is equivalent to slicing the asset class into tranches and leaving the banks with the junior tranche taking the first losses. I.e. their risk profile does not materially improve. You are left with banks who know they are de facto insolvent or borderline so.

    Where does that leave management incentives? (1) Do you go all out taking outrageous proprietary bets in the hopes of swinging back into solvency? or (2) Do you hunker down and hope to muddle through with government loans, writing down the assets inch by inch without eroding your equity position too much…?

  50. MJ

    Yves,

    great post and so true. I really hope they don’t do this.

    Could somebody explain to me how the German plan is better. The article posted here somewhat differs from other accounts I read, but in the end it sounds to me like suspending accounting rules and hoping for asset values to recover. German politicians always emphasize that shareholders have to shoulder the losses, but they are already more or less wiped out, the choice is between bondholders and the taxpayer and in most european countries the liabilities are simply to large to even attempt a bailout.

    In my view the German plan pretends that market prices are wrong and they don’t force the writedowns. Even if the remaining equity goes to the bad bank, that is not enough, the problem remains.

  51. Anonymous

    Yves, you nailed it. But doing the right thing is not same as doing the politically correct thing. The political drivers are (1) to avoid more direct TARP I recapitalizations, since Paulson poisoned them, (2) to maintain the status quo ante for Big 4 banks capital owners (stockholders and, especially, bondholders) since their position is conflated with banking stability and the latter in turn with avoiding a Lehman 2, (3) to do so with the true costs disguised as much as possible and deferred as much as possible, so “cash-for-trash” cannot be too obvious.

    Citi-rescue type insurance-looking guarantees by the Treasury accomplish these objectives very well. They also turn worthless paper into collateral for the Fed so that the entirety of any losses, including the Treaury’s deficit-financed share, can be monetized. When Obama asserts that “some banks won’t make it” he is, of course, not referring to the Big 4 or any other “too big to fail” bank, only to the small fry for whom the usual FDIC take-overs can be used.

  52. L'Emmerdeur

    I voted for Obama because I knew he would mangle this up in ways even McCain couldn’t imagine, which would lead to further, deeper, longer-lasting destruction. The resulting fire sale is the perfect buying opportunity for a renter and a saver like me.

    See? There still are capitalists in America. Alas, we have been forced to be traitorous and unpatriotic to practice our faith, by voting for the worst people for the job.

    Light it up, Bam Bam! Let it burn.

  53. L'Emmerdeur

    I voted for Obama because I knew he would mangle this up in ways even McCain couldn’t imagine, which would lead to further, deeper, longer-lasting destruction. The resulting fire sale is the perfect buying opportunity for a renter and a saver like me.

    See? There still are capitalists in America. Alas, we have been forced to be traitorous and unpatriotic to practice our faith, by voting for the worst people for the job.

    Light it up, Bam Bam! Let it burn.

  54. Anonymous

    somebody said:

    “… bailouts will ultimately be abandoned if they begin to seriously threaten the federal government’s ability to borrow money. The hated “bond vigilantes” will enforce upon President Obama the discipline that he and his economic advisors apparently “lack.

    I would really like to believe this but what is happening now, and what will happen if long term interest rates rise, is the Fed will “loan” the government money by printing it and buying treasuries.

    i.e., if the US government can’t borrow the money, they will print it!

  55. Erich Riesenberg

    I am surprised to hear Buffett has no influence with Obama, considering all Buffett did to support him.

    However, Buffett seems to support anything and everything now, Bair at the FDIC and the original Pauslon plan. I sent him a letter because his description of the plan and Paulson’s description varied so markedly, namely whether to pay above market.

    Buffett’s derivatives bet requires inflation. Not sure he would oppose anything.

  56. DailyBail

    Down goes Frazier.
    Down goes Frazier.
    Down goes Frazier.

    Howard Cosell broadcasting Frazier’s Fight with Ali.

    Taxpayer is now Joe Frazier.

    This morning Squirrel links are up. 30 stories and counting in one link.

    Yves you are in there 3 times. Thanks for being so outraged. We need it.

    Click on my name for the links. enjoy.

    spread the link to help the cause of stopping the generational pillaging.

    seriously. it’s so little to ask when so much is at stake.

    start calling congress and the white house today.

    the battle has begun.

    http://bit.ly/XHOB

  57. Andrew Bissell

    There will be a new ecomonic model that will come out of the fall of capitalism as we know it.

    If we had had anything remotely approaching capitalism these past 20 years, these big banks would already have been sold off in bankruptcy and their executives would have been thrown out on their asses.

    Hell, Citigroup probably wouldn’t have even survived 1990 in a free market.

  58. Independent Accountant

    Bissell:
    I don’t believe there are bond vigilantes. They are some fantasy of Bill Gross. With 30-year T-bonds at 3.5%, where are they?

  59. They Trashed-talked Reagan, too

    I was against McCain, even more so after he chose Palin. Being voceriferously opposed to Palin is not the same as being a big Obama booster.

    Because Palin is stoopid, right? Because Palin had no experience putting big corporate interests in their place, right? Because she said she could see Russia from her cabin, or whatever SNL punchline turned into a lefty meme, right?

    Incorrect, I was never enthusiastic about Obama. Never. I viewed him as the least bad choice.

    … and how’s that workin’ out for ya, Yves? Even “least bad choice” has turned out to be absolutely wrong.

    Your post on Bad Bank is excellent, BTW.

  60. Born Again Democrat

    It seems that everybody knows what they are talking about. But nobody agrees. Me, I know less and less the more I read. I have become a dumb idiot in my own mind and have no idea what is happening.

  61. Don

    "This program should be labeled the Pimco bailout plan, since the giant bond fund holds a lot of bank debt."

    The purchasing of Toxic Assets by the government has been the advice of William Gross since September:

    http://www.washingtonpost.com/wp-dyn/content/article/2008/09/23/AR2008092302322.html?hpid=opinionsbox1

    "And so, instead of mild medication and rest, it became apparent that quadruple bypass surgery is necessary. The extreme measures are extended government guarantees and the formation of an RTC-like holding company housed within the Treasury. Critics call this a bailout of Wall Street; in fact, it is anything but. I estimate the average price of distressed mortgages that pass from "troubled financial institutions" to the Treasury at auction will be 65 cents on the dollar, representing a loss of one-third of the original purchase price to the seller, and a prospective yield of 10 to 15 percent to the Treasury. Financed at 3 to 4 percent via the sale of Treasury bonds, the Treasury will therefore be in a position to earn a positive carry or yield spread of at least 7 to 8 percent. Calls for appropriate oversight of this auction process are more than justified. There are disinterested firms, some not even based on Wall Street, with the expertise to evaluate these complicated pools of mortgages and other assets to assure taxpayers that their money is being wisely invested. My estimate of double-digit returns assumes lengthy ownership of the assets and is in turn dependent on the level of home foreclosures, but this program is, in fact, directed to prevent just that.

    In effect, the Treasury will have the fate of the American taxpayer in its hands. The Resolution Trust Corp., created in the late 1980s to deal with the savings and loan crisis, dealt with previously purchased real estate, which was flushed into government hands with a "best efforts" future liquidation. Today, the purchase of junk mortgages, securitized credit card receivables and even student loans will be bought at prices significantly below "par" or cost, and prospectively at levels allowing for capital gains. This is a Wall Street-friendly package only to the extent that it frees up funds for future loans and economic growth. Politicians afraid of parallels to legislation that enabled the Iraq war are raising concerns about a rush to judgment, but the need for speed is clear. In this case, there really are weapons of mass destruction — financial derivatives — that threaten to destroy our system from within. Move quickly, Washington, with appropriate safeguards. "

    Also in Sept., Gross said he would buy Toxic Assets for the government for free:

    http://www.nytimes.com/2008/10/04/business/economy/04plan.html?hp=&pagewanted=all

    "Mr. Ryan is a former director of the Office of Thrift Supervision, where he played a key role in the savings and loan cleanup. Still, some investors are troubled by the government’s heavy reliance on private firms. They said it would be difficult to prevent firms from steering capital in ways that favor their private customers.

    Inevitably, large asset management firms own, or are tied to banks that own, some of the same securities the government is seeking to sell. Pimco, for example, is owned by Allianz, one of Germany’s largest insurance companies. Merrill Lynch owns a stake in BlackRock.

    “I can’t even fathom how I would manage that,” Mr. Siegel said. “How would I manage one side, where I’m seeking to maximize profit, and the other side, where I’m looking out for the social good?”

    The law stipulates that the government must prevent conflicts of interest in the hiring of firms, the decision of which assets to buy, the management of those assets and even the jobs held by employees after they leave the program. But it leaves the details to the Treasury.

    The Treasury plans to publish guidelines for hiring the asset management firms in the next day or two, officials said. Some experts say that the department simply needs to gird itself for protests.

    “You’re never going to get past conflicts of interest, so you take your lumps,” said Peter J. Wallison, who was general counsel of the Treasury during the Reagan administration.

    The bailout legislation itself highlights the contradictory goals that the Treasury will face when it goes on its buying spree. Among the goals it is supposed to consider are “protecting taxpayers,” “preventing disruption to financial markets” and “the need to help families keep their homes.”

    What's he buying?

    http://www.forbes.com/2009/01/05/intelligent-investing-pimco-gross-bonds-stocks-Jan6.html?feed=rss_news

    "What should investors do?

    We're buying bank preferred stocks — JP Morgan Chase (nyse: JPM – news – people ), Bank of America (nyse: BAC – news – people ) and Wells Fargo (nyse: WFC – news – people ). The government is in the market [through its Troubled Asset Relief Program] to the tune of $150 billion. Its interest rate is 5%. With its equity warrants, that effectively boosts the yield to 6%. We can buy–the public can buy–[similar] preferred shares for yields of 12% or 13%.

    How safe are these securities? There's no government guarantee.

    In for a nickel, in for a dime. Or in this case, in for $150 billion, in for $300 billion… It's close to a guarantee. [The government] is assuming the survival of these companies…

    …The banking industry has been nationalized. People don't realize that. There are so many programs. It's hard to keep up."

    As I read this, he's saying that the government has guaranteed the bank's losses, but will not actually nationalize.

    Here's the major point from Gross:

    "For now, our Ponzi-style economy and its policy remedies encourage bond investors to mimic Uncle Sam and its global compatriots. Buy what they buy, but get there first."

    Pretty clear. There's nothing about his strategy that's not public. However, since he won big on GMAC, I've noticed a major distancing of himself from the government and even boards ( GM ).

    From Paul Kedrosky:

    http://paul.kedrosky.com/archives/2009/01/29/bill_gross_pick_1.html

    "Having said his strategy is to stay under the Treasury/Fed umbrella, PIMCO fund manager is now cheerily suggesting that the umbrella be re-positioned a little to give him better rain protection. He wants Treasury/Fed to start buying the bonds that he owns:

    Policymakers should not focus entirely on one-off bailouts of large real estate developers, municipalities, or even credit card issuers like they have with Citi, BofA, and AIG. Rather, they should recognize that supporting critical asset prices such as municipal bonds, CMBS, and even investment grade corporate bonds is a necessary step towards eventual economic revival.

    [via PIMCO]

    Pick me!, as it were."

    I read this a bit differently. Gross was saying "We're not in the inside and have no special power over you, so please pick us".

    Since Gross is a very smart man, I have been arguing the opposite from what he advises. Not because I don't respect him. On the contrary, I do. But his plan is going to be the plan that favors keeping the big players in place. Since Gross says that we've already nationalized and we haven't, the best bet has always been to nationalize. That's what the banks fear, and what the banks fear is what the taxpayer should want.

    By the way, I'm advocating as short a period of government running these banks as possible. Otherwise, we'll end up losing more money. It's not clear to me how these banks are going to do going forward, and we don't want to be invested in them. They might do well, but we don't need to be on the hook if they don't.

    Don the libertarian Democrat

  62. Charles Kiting

    The savings and loan crisis’ Resolution Trust Corporation is touted as a good “bad bank” model (it’s far from the only one). But guess what? It got those bad assets from banks that died. That little detail seems to be neglected in modern accounts.

    The other little detail being lost is that the RTC lost over 120 billion dollars. Taxpayers never saw a return, they absorbed huge losses. All the spin about taxpayers eventually making money on the deal is nothing but a bald-faced lie.

  63. Anonymous

    Yves, excellent blog post! Your points are right on, however, reading stuff like this (from you and other well-informed people) simply gets me angry and frustrated without any seeming resolution. I frequently write my elected and appointed officials and post on blogs like this, yet I feel no one is listening, the situation is going from bad to worse and I feel powerless to do anything about it. So, reading all this stuff just raises my blood pressure.

    Let’s look at one facet of this: the bad bank. If the Govt. buys toxic assets at the true market value, banks (e.g., shareholders and bondholders) will be wiped out. If they buy at the prices banks want to sell (e.g., inflated values) then the tax payers will eat any/all loses.

    I’m with you “brother” on all your points, yet there comes a time when talking and blogging about these problems and how the Govt. intends to deal with them doesn’t solve anything and simply serves to rile up those who want to be informed. So, keep blogging and informing, however, I think the collective “WE” need to also switch into “action” mode.

    What can you, me, others do to change things? Our elected/appointed officials don’t seem to have the “back” of those who elected them, otherwise (for one of many examples) how could it be that Citibank gets billions in tax payer funds to lend back to those tax payers and then turns around and raises the interest rates on most of its cardholders? I’m not a Phd, but I can tell you that raising credit card interest rates will not spur additional borrowing/lending.

    Have you thought about coordinating with other bloggers to start a national petition? Or, how about starting a grass roots petition to remove any elected official that votes for additional TARP, bailout or bad bank stuff? Something, anything. Our elected and appointed officials are not listening to Americans, partly because most of us are apathetic and do nothing and also because at an individual level we don’t donate millions to their campaigns like Citi and others.

    Things will only change when those in power are taken to task and held accountable for their actions. If the collective WE do not stand up for ourselves, then, sadly, we deserve what we get.

  64. S

    The well planned PR program is proceeeding apace…we get the populist speech about the bankers with token measures. Then we get the hysteria about the world ending and how we have top do this. Then the part about the guarantees and how banks will participate in the “upside”. Is this really a shock. Jamie Dimon has been on a months long marketing campaign to convince people he is a good bank. WFC used the dividend increase to establish itself as a good bank – almost assuredly designed in the warroom at the NYFed. Let us not forget that Jamie Dimon still sits on the board of the NY Fed. The derivatives point is well made. As for the M2M comments, Jamie Doimon said yesterday it would have an immaterial impact on them.

    Obama is a lightweight. His reverential tone doesn;t compensate for anything. 2nd year associates almost certianly have a better understanding of the financial system and globalization than mr. audacity.

  65. Anonymous

    If Palin could balance her checkbook, she qualified to be vice president.

    Gridlock is the best that can be hoped for in Congress as they argue and discuss fixes the worst banks will fail in the background.

    What is the total cost of outstanding debt? Either they don’t know or can’t count that high.

    Expect more of the same unless you want a bank holiday for an extended period.

    Shouldn’t be long before we have pictures of the bid O in a fetal position off in the corner sucking his thumb.

  66. Anonymous

    Indeed, who are the big bondholders? Honestly I would want a detailed accounting of this, not simply saying “it’s the Chinese or the Japanese”. For all this “debt” in the world, who controls it? If we are both lenders and debters to one another, it’s a self-cancelling mechanism. But I doubt that’s the case.
    For Obama, I think there is real physical danger for him if he were to clip the bondholders or actually BK Citi or any other large, well-connected corp, even this is the right thing to do. Perhaps he knows this already and has to do a dance to try and make a good show of it and live to make 8 figures of income in his post-presidential days a la Clinton. Send O-man some kevlar and hope for the best.

  67. mwah

    The problem with wiping out shareholders and moving up the chain can be summarized in one word: Prince

    Choose the correct answer below:
    a) Fresh Prince
    b) Freddie Prince Jr
    c) Chuck Prince
    d) Prince Ibn tokn Allataweed
    e) All of the above

    The Citi never sleeps

  68. Anonymous

    I’m not expert enough on finance to give intelligent commentary. But I can write fan mail.

    I really appreciated this post. And I really like your blog. I read it every day.

  69. Anonymous

    The difference between socialism and capitalism? Under socialism, banks are first nationalised and then go bankrupt. In the capitalist system it appears to work the other way around.
    Read more on Crunchreport.com.

  70. Max

    I’m not sure I agree with Yves here (thanks to the input of some commenters here).

    The reason why they did not go the nationalization/haircut road is because it will trigger another LEH fiasco, only on a much much larger scale. Does Yves even realize what will happen in a credit event like nationalization of City? Yes, we all talk tough, but in the end, would any of you pull the trigger and blow your head off?

    Yes, the path of propping up bad assets is long, inefficient, and drawn-out. However, it is _free_ of unpredictable second-order effects, like massive unemployment, social unrest, and collapses of bond markets (that will affect each and every one of you in a very-very bad way). California is already close the junk territory.

    It is obvious that the safest path chosen by the administration is to overpay for the bad assets, with Fed propping up the long-term Treasuries. Cheating? Outrageous shell game? Yes. But who said anything about your insight abilities? It’s not their job to please everyone, they’re trying to save a patient with a massive corollary attack.

  71. Anonymous

    Yvesm you said:
    Being voceriferously opposed to Palin is not the same as being a big Obama booster

    My question is, what do you think that Palin would have done by this point that is worse than what BO is set to do? (Don’t get me wrong, I love your blog.)

  72. Eric L. Prentis

    Without the Glass-Steagall Act, bankers, aided and abetted by the Federal Reserve, have caused two economic depressions, one in the 1930’s and the other developing now. Geithner, Summers, Bernanke, Greenspan, Paulson, Rubin, Gramm, Schumer, Dodd, Frank, Goldman Sacks and the rest of Wall Street pressed for financial market deregulation and the creation of derivative financial instruments which are now worthless. What gets my goat is that the slimy-on-the-take, fascist/corporatist politicians are protecting Wall Street welfare kings, directors, stock/bond holders and throwing the taxpayers and the US economy under the bus. Let these large bankrupt banks fail, e.g., Citi and BofA, they are a cancer killing America’s recovery.

  73. Anonymous

    @ Max:

    “Yes, the path of propping up bad assets is long, inefficient, and drawn-out. However, it is _free_ of unpredictable second-order effects”

    I gather that the IMF, based on their research, concluded otherwise.

  74. Max

    anon 2:58 PM,

    who is IMF, and what creds does the said organization have in this business? Can IMF produce favorable evidence of its own track record? Does IMF takes into account extreme coupling of the US financial system?

  75. Yves Smith

    Max,

    Many have proposed theories and courses of action by which CDS would be voided save for those who owned the underlying bond at the time of default.

    And the problem with Lehman was NOT the CDS settlement. That went smoothly. It was the $100 billion plus hole in its balance sheet, the wipeout of unsecured creditors and freezing of various accounts (London is a real mess, my impression NY not so bad, maybe not bad at all).

  76. Yves Smith

    Max,

    The IMF is cetainly capable of sponsoring research. The study was of 124 banking crises. Research by Carmen Reihard and Kenneth Rogoff, and a Cleveland Fed paper on the Swedish banking crisis comes to broadly the same conclusion.

    Your attack is ad hominem. If you can provide counterevidence, that’s one matter, but having not read the paper or having your own independent evidence to cite means your counterargument does not pass muster.

  77. benj.

    people saying that Obama will be worse than Bush – oh dear. I don’t like any of these plans either, but the comments here seem to be largely Naderite territory. yawn. hopefully Obama will abandon Geithner and Summers sooner than later. but come on, saying merely that McCain was ‘worse’ on this issue is inverted hyperbole.

  78. Max

    Yves,

    thanks, but I wasn’t specifically talking about the CDS (even though nobody knows if this animal is inside or outside the cage). Let’s talk about pension funds, Pimco, foreign creditors (which were royally pissed at LEH). I mean, the possibilities are endless.

    We can wipeout the stakeholders with no further pain since they have nothing to lose at this point. What about the bondholders though? It will be very “interesting” to watch waves of retirees with no income, wouldn’t it?

  79. joebhed

    Yves,
    One of the greatest of many great posts.
    I wish there were two folks working in the background to actually get anything done.
    That would be Volcker and Orszag.
    History and brains.
    They beat Geithner and Summers all to hell.
    I am sure that by the comments, you know how much you are appreciated.
    Ever upward.

  80. Max

    Yves, there was a successful bad bank solution – the RTC. It brought back the investors who were too scared of touching the thrifts.

    How is it different? What does the IMF say about this episode?

    People often say that falling faster instead of slower is the way to go. But what if you fall so hard that you are thrown back decades in development and punish those who have nothing to do with it (usually the weakest and the poorest in out society)? Even in the stagnant Japan I do not remember seeing massive social unrest, no soup lines – only high living standards, in a country with rapidly aging population and restrictive immigration and cultural barriers.

    I hope that nobody sees this as some sort of trolling, it’s just that there is no solution that will please everyone.

  81. Anonymous

    My hope is that TARP2 in whatever form it takes is the end of it. I’m still on hopium so this is what I imagine Obama will say when they announce the plan “The financial system is important to our economy that’s why we put up $700B+…Our resources are limited…If after a this investment by the taxpayer a bank is still insolvent they will be taken over (FDIC, Nationalized, Other?)…Think of this the next time you calculate your bonuses, pay dividends etc. Wouldn’t it be better to money on our balance sheet.”

  82. purple

    someone wrote it at the beginning of these comments – “the system is broken”.

    They don’t even bother to pay their taxes. The canary in the coal mine.

  83. me

    30-to-1 leverage and someone imagines there really still _is_ money out there somewhere waiting to buy stuff?

    Get real. Most of the “money” was vapor; the little real money was what was taken in salaries and bonuses and turned into hard stuff like coins and canned tuna fish, eh?

    Word verification says:

    wring

    Yep.

  84. slidge

    Great post. Bottom line is that Obama has no ideas. In addition, he has managed to piss off both China and the EU in just 2 weeks, while worrying about Rush Limbaugh and a whole host of other crap that doesn’t matter.

    That said, I refuse to assume the position. I am a Texan. We don’t give up, even when prudent to do so. I am taking the necessary steps to protect myself and my assets. This too shall pass. Assets will eventually be valued at their worth. The government will fight this with everything they have, but at the end of the day, it won’t be enough.

    Patience is a virtue. I will get what I’m after. As we like to say in Texas, all in good time.

  85. Tim Geithner's Mom

    Anonymous 4:04 PM: “I’m still on hopium so this is what I imagine Obama will say when they announce the plan ‘…Our resources are limited..’”

    But our resources aren’t limited, are they? Isn’t there always this mechanism?

    1. US Treasury wants to try yet again (TARP3, TARP4, etc.), so they issue bonds to “borrow” more money

    2. The Fed, trying to keep rates down, trades the Treasury Fed IOUs (aka “cash”) for Treasury IOUs.

    3. Treasury goes off and gives the financial system a new set of Christmas presents with “TARP3″, “TARP4″, etc. on the gift tag.

    4. Fed is happy as a clam, as they have even more “assets”, namely even more Treasuries (that the US taxpayer will “someday” have to pay back).

    It’s almost like printing money!

    Uhhhhh….uh oh!

    Luckily for them, they’ve got this big “credit destruction” deflationary hole to fill up with all that printed money.

    It’s almost like everyone bet that a 200′ foot tall pile of $100 bills could never catch fire, and then got together to prove it. Woops, they do burn, hoodathunk? Oh well, we’ll print up some new ones for you, no harm, no foul.

  86. Tim Geithner's Mom

    Anonymous 4:04 PM: “I’m still on hopium so this is what I imagine Obama will say when they announce the plan ‘…Our resources are limited..’”

    But our resources aren’t limited, are they? Isn’t there always this mechanism?

    1. US Treasury wants to try yet again (TARP3, TARP4, etc.), so they issue bonds to “borrow” more money

    2. The Fed, trying to keep rates down, trades the Treasury Fed IOUs (aka “cash”) for Treasury IOUs.

    3. Treasury goes off and gives the financial system a new set of Christmas presents with “TARP3″, “TARP4″, etc. on the gift tag.

    4. Fed is happy as a clam, as they have even more “assets”, namely even more Treasuries (that the US taxpayer will “someday” have to pay back).

    It’s almost like printing money!

    Uhhhhh….uh oh!

    Luckily for them, they’ve got this big “credit destruction” deflationary hole to fill up with all that printed money.

    It’s almost like everyone bet that a 200′ foot tall pile of $100 bills could never catch fire, and then got together to prove it. Woops, they do burn, hoodathunk? Oh well, we’ll print up some new ones for you, no harm, no foul.

  87. wwew

    looks like being president of a smoking crater isnt so great after all.

    basically were on one of its walls, sliding down into the pit at the bottom.

    doesnt matter what obama does, it wont make a difference.

    doesnt matter if we stop putting carbon into the atmosphere tomorrow either. same thing.

    its too late.

  88. Carnap

    During the election I noticed my Grandma (born in the 20′s) refused to watch any of the coverage. I asked her why and she essentially stated “It doesn’t matter, nothing will change”.

    Suppose I should have listened, Obama is sure proving to be a dud.

  89. Jojo

    Yves blog post got referenced in the NY Times Blogroll (first time I have seen Naked Capitalism there):

    http://www.blogrunner.com/snapshot/D/8/1/the_bad_bank_assets_proposal_even_worse_than_you_imagined/

    ==================

    In my prior post, I said that one of the reasons the politicians were so focused on giving money to big banks was the money that the financial industry gave to pols. Here’s an article that details the numbers:

    TARP Recipients Paid Out $114 Million for Politicking Last Year
    Published by Communications on February 4, 2009 9:52 AM

    The companies that have been awarded taxpayers’ money from Congress’s bailout bill spent $77 million on lobbying and $37 million on federal campaign contributions, Center finds. The return on investment: 258,449 percent.

    http://www.opensecrets.org/news/2009/02/tarp-recipients-paid-out-114-m.html

  90. Anonymous

    With taxpayer purchases and backstops of toxic assets so that bank shareholders and bondholders don’t get creamed and the banks don’t fall below statutory minimum reserves, what exactly is the difference between fractional reserve banking and Ponzi banking? The only way this makes any sense at all is if the scale of outstanding CDS contracts make bond defaults so risky that engaging in Ponzi capitalism makes sense (?) to avoid a cascade event of gargantuan proportions. If avoiding such an event is the unspoken reason, I would prefer some form of contract nullification to this insanity.

  91. masaccio

    My broker told me that PIMCO is organizing a mutual fund to buy toxic waste, and he was being pressured to sell it.

  92. dd

    Figure the ultimate answer is making investment management assets available to support traditional banking. Once the SEC is merged into Treasury then it’s only a matter of time before the assets are “bankified.” Money Market Funds will be “unified” first.
    Notice that Gross is now not so much a “bond vigilante” as captured member of the Fed team.

  93. Laborboy

    Yves mentioned that Pimco had a lot of bank bonds. I reviewed the Pimco Total Return Fund holdings, and found very little of that. What are you referring to?

  94. Kosta

    Thank you for the response Yves, but I am still skeptical of any plan involving the haircuts of the bondholders.

    I’ve read the IMF paper, and I am aware of the Swedish and Norwegian experiences, and I am well aware of the ineffectiveness of the Japanese method to recapitalize their banks. In a perfect world, I absolutely agree that it would be best if we could just audit the banks, kill the ones that can’t survive, inject capital into the ones that can survive and then privatize them again.

    But we don’t live in a perfect world. The problem arises in auditing the banks, determining how much their assets are worth, and deciding which banks survive. While each of those hurdles are surmountable, they would take time to surmount, and during that time, there would be a ton of uncertainty in the markets. A ton of uncertainty about which banks will survive, which banks are next to be nationalized, and what each bondholder will get. And we all know how much damage uncertainty can do.

    Sure, the Swedes managed to nationalize, recapitalize and privatize their banking system, but their banking system was smaller, and much more importantly, much more isolated than the US system. By this I mean that the failure of a Swedish bank had limited global impact, and would not cause dangerous feedback.

    Now, I am assuming this, but when Sweden nationalized its banking system (just part of it actually), I assume the dislocation in the markets was contained to primarily Sweden, with some spillover to Norway, Finland, Denmark and the Baltic countries. These countries all likely had temporary drops in their markets and economies, which in turn fed back to Sweden. But the feedback loop was undoubtedly limited to this. And importantly, Sweden’s neighbors could all turn to other neighbors unaffected by Sweden’s crisis for stability.

    If the U.S. made a similar move, the effects would be felt globally and these effects could be large. The dislocation in the US markets would likely cause a similar dislocation in the UK’s markets, which could then very wall cause problems in Switzerland and the Euro area. All of that dislocation would then feed back on the US. Add in China and Japan, and one could easily see a global meltdown developing. This in turn would cause further problems in the US, which would then feed back onto the global system.

    I don’t see how any plan to nationalize systemically important parts of the US banking system could be pulled off without causing a major dislocation that would be felt globally. Let me give you some examples of why.

    FNM and FRE (1). They were “rescued” in July. Part of that rescue was termination of the dividends on their preferreds. As many have posted (including you I believe), this move hurt a lot of smaller banks in the US, and probably contributed to the fragility of the system.

    FNM and FRE (2). They were taken over in early September. Did that stabilize the system, or did it make everyone run for cover? Whatever it did, Lehman imploded within a week and AIG had to be taken over by the gov’t.

    RBS. On Jan 20th, they released horrendous earnings and the UK gov’t was forced to bail them out again (and take a larger stake). How did the markets respond to the bailout? The US financials dropped 20% across the board. RBS was already partially nationalized, but the fear of who else might get nationalized hit every other bank.

    Today’s sell off in financials. On a day where advanced details of the bailout indicate that the banks will get nearly everything they want, the banks have an abortive rally and sell off all afternoon on fears of nationalization, dragging all the indexes lower.

    The point of these examples is that nationalization and the potential for broad haircuts to stockholders and more importantly bondholders will cause a profound dislocation in the markets. This dislocation will be felt globally, and will lead to dislocations in other markets that feed back to the US. That’s the problem with the nationalization plan.

    I agree that the nationalization plan is both fairer, and more efficient at getting these banks back on their feet, but only in theory. I am just not convinced that the plan can be implemented without causing more damage than it cures.

    It’s the implementation part that I doubt.

  95. bondinvestor

    two thoughts, yves:

    1. the extent to which the banks have captured washington blows my mind. i think it is worth pointing out that geithner's patron is none other than steve friedman (ex GS, ex NEC, current chair of the NY Fed). friedman also made kevin warsh a fed governor. his influence is vast and one really has to question whose interests he and his proteges are really looking out for. it looks suspiciously like he's playing favorites (let's not forget that jamie dimon and jeff immelt – two players who have benefited from enormous govt largesse – are NY Fed board members.)

    2. you are wrong about the extent to which treasury did due dilligence at the GSE's. senior execs at both firms told me that treasury hadn't done any analysis of the credit exposure of the firms when they put them in conservatorship. the loan tapes were shipped to india in late august, and morgan stanley was going to begin working on a credit model in september. the sad thing is that morgan stanley isn't even a good mortgage shop, so it would have taken them months to figure out what the range of losses would be on various securities. i was told that they didn't even have a firm-wide roll rate model they could use to predict delinquencies!

    the bottom line is that EVERY single decision made so far in the washington reaction to the crisis has been political. they haven't been grounded in a deep analysis of the issues, or even a coherent framework.

    politics dictacted that fnm/fre/leh shareholders get wiped out while the sub debt holders (and agency note investors) were made whole. politics dictated that WM sub debt holders get wiped out while WB's are saved. politics dictated that c & bac get "exceptional" assistance a la AIG without severe dilution. and politics dictated that nat city and sovereign were forced to submit to take-unders in order to strengthen the balance sheet of the acquiring firms (here's one for you – i was told that bair herself told santander to pay no more than $3/share for SOV.)

    the politics are still gumming up the works. IndyMac was sold to mindich & flowers for a cut-rate price with a freaking stop loss! yet the PE firms looking to recap the few remaining option arm lenders have been told to expect no stop loss on their investment, which caused proposed deals to fall apart.

    the sad thing is that there's a lot of evidence that the downturn accelerated in reaction to the events of september. if the govt had just nationalized them all – FNM, FRE, AIG, LEH, GS, MS, MER, JPM, C, WB, WM, SOV and NCC – they could have worked the problem out without scaring the public and corporations. i also bet the equity market would be higher than it is today, since the marginal loss in value from the current mkt cap of the banks would be trivial to the then mkt cap of the S&P.

    instead, they hit the panic button and the entire freaking world decided to de-lever at once.

    stupid.

  96. Anonymous

    Yves, I have a question for you.

    First though, wow, what a great post. Thanks for saying what so many of us were thinking. A Naked Capitalism instant classic.

    My question is, how do you know that Buffett doesn’t have Obama’s ear any more, that their relationship was just window-dressing? Is that based on fact, or just speculation? I am one of those who think Buffett has deep insights and it’s troubling to hear that Obama could talk to him if he wanted to, but doesn’t want to. So, on what basis do you say this? Likewise with Volcker.

  97. keenan

    Kosta, I disagree with you that a total panic and collapse of the entire financial system would ensue if some or all of the “big 4″ were seized and placed into receivership/conseratorship with the bondholders being informed they would have to take a haircut. As long as the FDIC or whatever government agency took charge, ensured that the banks would be allowed to conduct regular business and that short term interbank loans will continue to be insured, as they previously setup in the aftermath of the Lehman collapse fiasco, and took other continuity measures, there is no reason for a system wide panic and collapse.

    Sure, there would be an immediate rush to the exits of bondholders of the banks as soon as they got wind of the impending takeover. But this scenario would be different than what happened last September, when the government decided to just stand aside and let Lehman go BK with no plan or contingency regarding the domino effect or continuity of crucial interlocking financial relationships. In this case, the government would be taking a proactive role to re-assure the markets of continuity, on top of all the post-Lehman-collapse Federal Reserve liquidity programs and “windows” now in place. Other than the specific bonds of the specific banks, or of any banks that are questionable, why would the rest of the bond market and financial market necessarily have to sieze up? The government would need to be explicit and transparent about their plans for the receivership operation of the banks. This is the only way that the banks can come “clean” about their balance sheets and then start dealing with the reality of their true insolvency with their new partner/owner – the government -who are the only entity who can ensure a smooth transition without sudden bankruptcy and panic.

    Everybody already knows they are insolvent, but it’s the “too big to fail but too big to save” thingy that is causing the endless never ending uncertainty. In this case, we would trade a few days of sharp and painful uncertainty limited to bank bondholders, for the long agonizing uncertainty that could drag out for years and years hoping that the economy will eventually reflate so that the banks might be able to avoid ever having to really and truely show us their honest balance sheets. Anyway, it could be short and sharp mini-disaster, but we would then be on the road to recovery a lot faster, and the taxpayers wouldn’t be stuck with the bill.

  98. keenan

    “if the govt had just nationalized them all – FNM, FRE, AIG, LEH, GS, MS, MER, JPM, C, WB, WM, SOV and NCC – they could have worked the problem out without scaring the public and corporations. “

    Exactly. An orderly nationalization is much better than a disorderly and sudden bankruptcy OR a long, dragged out bailout with no end in sight and endless stumbling around the issue of the need to shrink and deleverage the bloated financial Ponzi credit bubble industry. The latter will result in a mugging of the taxpayers and shafting of future generations who have a rock on their chest from being put into national debt servitude to the banking industry that caused the mess.

  99. backerman

    I agree with Keenan here that the cloud of Lehman is a false fear. It’s been turned into a mushroom cloud to bludgeon the taxpayer into never-ending bailouts of insolvent institutions. It’s absurd to imagine that we’re sitting here debating whether wholesale theft of the treasury–which everyone on this page recognizes is wholesale theft–should be allowed because otherwise there might be an explosion. The money that is going to bail-out bondholders is OUR money. To the extent the debate has successfully been reduced to this simple equation of bailout versus chaos, then the banks–and their shareholders and bondholders–have won. We are then expressions of the very ‘regulatory capture’ that Buiter talks about; we can’t see past the essential absurdity of the question being asked. We take on the despairing role of powerlessness at the very same moment that we ladle out trillions of dollars to institutions that are otherwise totally bust.

  100. Yves Smith

    Laborboy,

    That factoid comes from someone in Pimco’s employ. Pimco owns a lot of junior bank debt.

    Max,

    As I mentioned in the post, the RTC got its “bad” assets from the FDIC from banks that had been seized. Not a comparable.

    bondinvestor,

    Appreciate G2 on the lack of investigation of FNM/FRE accounts by the powers that be. That is even more discouraging. However, it does not disprove the general point: the authorities should have a better handle on the true state of affairs at these firms. There was NO excuse after Bear failed. In fact, that would have been the prefect pretext to get cracking.

  101. Kosta

    Keenan, thanks for the reply.

    I understand your argument about a “short sharp mini-disaster” being better than a long period of poor growth as the zombie banks try to recapitalize themselves, and on many days I agree with it. The problem is that we don’t know what the effects of nationalization really would be. You claim the effects would be short and sharp, but maybe they will be worse. Quite conceivably they could be worse.

    As an example, look what happened when the UK increased their stake in RBS from 40-some percent to 70%. The US financial industry dropped by 20% in a single day. 20% is huge, and it was caused by the increased nationalization of a foreign bank (admittedly the world’s largest by assets).

    Extrapolate from there what would happen if the US nationalized Citi and BofA (essentially the same size as RBS). What kind of shockwave would that cause? Would it be for just a single day? How can you claim with any certainty that the disaster would be “mini” or “short”. Sharp I believe ;)

    We use the Lehman collapse as a yardstick. You’re right to point out that Lehman was let go. But Lehman was a lot smaller than either Citi or BofA. Also, the markets were warned ahead of time that Lehman could fail. The very act of the US nationalizing one of the big banks would cause in the system all by itself.

    But I do agree with your point about transparency of the receivership process. Indeed, if there was a transparent process, with predictable outcomes, then I would fully supportive of the nationalization program. However, there is no transparency, nor can there be any transparency.

    Why? Well, the plan is to seize the banks, write down their assets to nuclear winter levels, kill the banks that can’t survive and recapitalize and privatize the ones that can. And along the way, force a haircut on the bondholders. A priori, tell me, which banks can survive? Goldman Sachs maybe. Are there any others? As for the bondholders, how much will they get for their bonds? Will the haircut be based on market value for the toxic assets or will they be held to maturity in a bad bank?

    I don’t see how a transparent receivership plan could be formulated ahead of time.

    It’s not that I am against the nationalization plan, there are a lot of merits to it. I just think that not enough thought has been devoted to considering the dislocations this move would cause in the markets, as well as potential strategies to mitigate these issues

  102. Yves Smith

    Kosta,

    If the US banking industry IS insolvent, why do we care if bank stocks fell 20% in a single day (save for innocents like small bank stocks that got caught in the downdraft)? This is rearranging the deck chairs on the Titanic.

    “Investors” have been conned into thinking they have real rights and possible residual value in bank stocks. The equity of any big impaired bank is really a long dated option, and options are more volatile than equities. A 20% delta in a day is not surprising.

  103. keenan

    Kosta, all good points. A couple of final comments I’d like to make in response:

    “The US financial industry dropped by 20% in a single day. 20% is huge, and it was caused by the increased nationalization of a foreign bank (admittedly the world’s largest by assets).”

    First of all, you are assuming a direct cause and effect that hasn’t been proven, and can’t be proven. It is just as likely that the financial market tanked 20% due to the realization that the big banks are worse off than they thought (or wanted to admit) the day before, rather than a fear of nationalization, per se. But even if it was 100% due to the fear of further nationalizations, a lot of these bank stocks should have already dropped much further by now. The only reason they haven’t is because the current stockholders are playing a highly risky and speculative game of hoping and praying that the taxpayers will continue to be mugged to keep propping up these insolvent institutions. I have no sympathy for anybody who still holds these bank stocks knowing full well that in a real free market, they would have already been wiped out in many cases.

    Second of all, you make it sound like a 20% delta in one day in one industry is a big deal. Not only is that not a big deal for the stock market, it is insignificant to the overall economy.

    If your fear is largely based on the further collapse of financial markets, then I think you’re not putting things into perspective, economically speaking. The financial market is only an indirect measure of the health of the economy. There are endless examples of changes that we, as a nation, should make to our financial/economic systems to build an ultimately more robust and sustainable and efficient economy that would cause severe contortions in the financial markets in the short term.

    The obsession with short term stock index prices on the 6 O’clock news has done a great disservice to the population by inflating the importance of such measures way out of proportion to other economic measure as well as long term views.

    Personally, I think the concern over “the dislocations this move would cause in the markets” is way down the list of the most important concerns we should be looking at overall.

    And, you’re forgetting how easy it would be to create new banks with clean slates and new and better regulatory oversight. There are Trillions of investment dollars out there in a holding pattern waiting for such a good bank or banks to invest in, as the current banks have lost so much credibility.

  104. M.G.

    Can you immagine the effects on the market of this announcement: 4-5 new “good banks” will be set up mirroring the following banks…They will be operational as from…with a capital of …Their main mission is to start lending and renegotiate mortgages. Their acctivities are confined to narrow banking with maximum leverage of …They will not be involved in “lemon” and “toxic” products…
    It’s a dream, but it would be the end of the mess and nightmare for the banking sector…
    To be continued…More on my blog

  105. Richard Kline

    Got any spare change I can believe in, buddy? Not you, Prez O: I never believed in you as a populist. Your record and actions—all that counts in politics—have shown you as the bankers’ friend all along. Your gang of econo-advisors, with perhaps one exception, are all shills for everything wrong with this country and the financial industry for a generation. That lot are wholly willing to loot the public, and saddle them with every suckers bad bet in the government’s name: that is their role as they see it, taking value from those who don’t understand it for those who do.

    —And for all that, I am not unnerved by this impending robbery of a nation. Why? We are significantly closer to revolution in the hour is passes, and I can vote for _that_. . . . Of course, revolutions are bad for children and flowers and such other (few) things of real intrinsic value. Hmmmm.

    Can we just to _pretend_ to enact this tera-theft, and move directly to the non-cooperation movement?

  106. Richard Kline

    And please spare us, folks, the ‘he’s been there x weeks’ excusification; that is true, but irrelevant in a way that misleads. He was elected three months ago. This bank crisis is EIGHTEEN MONTHS OLD. He as campaigning for much of that time true: there was no more important issue in the country. BO thinks he’s got what it takes to be political executive of the US of A? Show me, son. ‘Cause what he’s showin’ so far makes stuff and nonsense look like gold dust in comparison.

    —And that is beside the point. The man made it through law school, that means an ability to study, of a kind. I guarantee you, as an ace fella at this larnin’ thing, I could get up to speed on best-worst-neither options on this crisis in one week. Since he has other things on his plate, alright give him _two weeks_. It isn’t time, it’s whats above the neck, below the waits, and the columnar linkage twixt the two, and he ain’t showin’ much there, neither. PresO is sold to the Chicago’s Boys ‘Privitization is the Finest Kind’ credo. He can’t get his head around the fact that everything he has ever known about ecnomics is WRONG.

  107. Murph

    Great post Yves – glad to see SOMEBODY is not afraid to unflinchingly take on the Administration’s policies.

    Few remember, but price discovery had actually begun, at the end of July, when MER sold $30 Billion (nominal) or of its toxic waste to Lone Star Funds for ~$7 Billion (much of which was financed by MER – Lone Star’s actual risk was something like $2 Billion).

    Had we not gone into full bailout mode, the rest of the banks would have necessarily followed this example and found market-clearing prices for all the junk which is now guaranteed by the US Gov’t, held as collateral by the Federal Reserve, or still hiding on bank balance sheets.

    We’d be much farther along in the process of price discovery without intervention

    The process would have liquidated Citigroup and others. Why did we not allow this to happen?

    “Counterparty Risk” was the main reason cited for all the bailouts (particularly Bear Stearns and AIG). But Yves, as you pointed out, the orderly resolution of $400 Billion nominal CDS exposure to Lehman down to $4 Billion proved
    this to be a complete fallacy.

  108. marvin

    There are still lots of billion of dollars left from the $700 billion bank bailout, and, according to news, there could be a debate in congress on how the remaining money be dealt with. IMO, the bailout plan somehow help some companies but there are still lots of them who are under crisis. I just hope that the remaining fund will be used wisely to lessen the economic crisis.

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