U.S. May Buy Stakes in Banks

It is bit perverse that the powers that be had to try all sorts of measures before considering the course of action that has been the most successful in handling financial crises, namely, letting asset prices fall and recapitalizing banks. In this case it would apparently involve taking equity stakes, say preferred stock and warrants, per the UK rescue program announced earlier today. However, best practice also involves nationaliization (wiping out shareholders, replacing incumbent top brass) and we do not appear to be there yet. The UK is closer to this model, having forced the leadership of RBS out today in tandem with an equity infusion. And note it is not clear that they will stop trying to intervene in the correction in asset prices.

A good bit of news: the Treasury may purse this play through the authority granted in the $700 bailout bill. That is a far better use of funds than buying toxic assets, which is a very indirect and costly way to achieve the same end. However, note the interpretation that banks have to request help. However, the article suggests that there may be some backtreading from Paulson’s extreme pro-industry posture that the process had to “encourage” banks to participate (recall he was able to secure completely toothless executive comp provisions, when Congress wanted something much tougher but caved fast). The plan version 2.0, for equity injections, appears to have a few teeth at least as far as executive pay is concerned, but it remains to be seen how serious these measures turn out to be.

Maybe the near universal condemnation of the TARP as originally envisaged finally got the Treasury’s attention.

From the New York Times (hat tip reader Megan):

Treasury officials say the just-passed $700 billion bailout bill gives them the authority to inject cash directly into banks that request it. Such a move would quickly strengthen banks’ balance sheets and, officials hope, persuade them to resume lending. In return, the law gives the Treasury the right to take ownership positions in banks, including healthy ones.

The Treasury plan, still preliminary, resembles one announced on Wednesday in Britain. Under that plan, the British government would offer banks like the Royal Bank of Scotland, Barclays and HSBC Holdings up to $87 billion to shore up their capital in exchange for preference shares. It also would provide a guarantee of about $430 billion to help banks refinance debt.

The American recapitalization plan, officials say, has emerged as one of the most favored new options being discussed in Washington and on Wall Street. The appeal is that it would directly address the worries that banks have about lending to one another and to other customers…

As Washington casts about for Plan B, investors are clamoring for the Fed to lower interest rates to nearly zero. Some are also calling for governments worldwide to provide another round of economic stimulus through expensive public works projects.

Yet behind the scramble for solutions lies a hard reality: the financial crisis has mutated into a global downturn that economists warn will be painful and protracted, and for which there is no quick cure.

“Everyone is conditioned to getting instant relief from the medicine, and that is unrealistic,” said Allen Sinai, president of Decision Economics, a forecasting firm in Lexington, Mass. “As hard as it is for investors and jobholders and politicians in an election year, this crisis will not end without a lot more pain.”

One concern about the Treasury’s bailout plan is that it calls for limits on executive pay when capital is directly injected into a bank. The law directs Treasury officials to write compensation standards that would discourage executives from taking “unnecessary and excessive risks” and that would allow the government to recover any bonus pay that is based on stated earnings that turn out to be inaccurate. In addition, any bank in which the Treasury holds a stake would be barred from paying its chief executive a “golden parachute” package.

Treasury officials worry that aggressive government purchases, if not done properly, could alarm bank shareholders by appearing to be punitive or could be interpreted by the market as a sign that target banks were failing.

At a news conference on Wednesday, the Treasury secretary, Henry M. Paulson Jr., pointedly named the Treasury’s new authority to inject capital into institutions as the first in a list of new powers included in the bailout law.

“We will use all the tools we’ve been given to maximum effectiveness,” Mr. Paulson said, “including strengthening the capitalization of financial institutions of every size.”

The idea is gaining support even among longtime Republican policy makers who have spent most of their careers defending laissez-faire economic policies…

At the Federal Reserve in Washington, officials insisted they had not run out of options and made it clear they were willing to do whatever it took to shore up the economy.

Fed officials increasingly talk about the challenge they face with a phrase that President Bush used in another context: “regime change.”

This regime change refers to a change in the economic environment so radical that, at least for a while, economic policy makers will need to suspend what are usually sacred principles: minimal interference in free markets, gradualism and predictability….

But neither the individual corporate bailouts nor the Fed’s enormous emergency lending programs — including up to $900 billion through its Term Auction Facility for banks — have succeeded in jump-starting the credit markets.

“The core problem is that the smart people are realizing that the banking system is broken,” said Carl B. Weinberg, chief economist at High Frequency Economics. “Nobody knows who is holding the tainted assets, how much they have and how it affects their balance sheets. So nobody is willing to believe that anybody else isn’t insolvent, until it’s proven otherwise.”

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  1. bg

    “Maybe the near universal condemnation of the TARP as originally envisaged finally got the Treasury’s attention.”

    It would be good news if this is true, but this seems a wishful reading of evidence.

    Government is a strange beast that rarely deals well with fast moving crisis.

  2. Anonymous

    “It is bit perverse that the powers that be had to try all sorts of measures before considering the course of action that has been the most successful in handling financial crises, namely, letting asset prices fall and recapitalizing banks. … However, best practice also involves nationaliization (wiping out shareholders, replacing incumbent top brass) and we do not appear to be there yet.”

    Don’t be coy. Paulson seems to have a blatant financial conflict of interest. Congress should hold hearings and question him about whether his family foundation still holds the 510,000 goldman sachs shares he contributed to it (worth $100M upon contribution in 2006 to his Bobolink Foundation), and whether any family trusts for his wife, kids, etc still own goldman sachs shares. And also to what extent his mutual funds have investments in equity or debt of financial services firms.

    If him or his family foundations/trusts directly benefit in his overpay for dodgy debt proposal, then that is a financial conflict of interest because Paulson benefits in his capacity as an investor in these firms.

    Furthermore, unless he is prevented from accepting consultancies, directorships, or other work from financial firms that benefit from his overpay for dodgy debt proposal, he has an indirect conflict of interest.

    And these financial conflicts are problematic before even inquiring into any biases Paulson has about favoring his friends and punishing enemies.

  3. DaddieMac

    By the way heard from some people who work in banking finance. The layoffs are coming fast and furious…

  4. Anonymous

    Just doing some quick quotes on market cap, we could probably buy most of the equity in all of these banks for 700 billion. Seems like a waste, nationalize them, then use the 700 billion to recapitalize.

    BAC 100 billion
    JPM 135 billion
    Wells fargo 100 billion

    Maybe that is the point of the short sale expiring, take them down even further, then take them out.

    Short financials is a very good bet, don’t see how they can avoid nationalization at this point, just wondering how much money they loose on the way….

  5. Anonymous

    “Short financials is a very good bet, don’t see how they can avoid nationalization at this point, just wondering how much money they loose on the way….”

    It is possible for the banks to fight nationalization. The big banks pay tens (perhaps hundreds) of lobbyists to pressure members of the Senate and Congress to vote their way using campaign contributions and promises of jobs, like ex-Senator Phil Graham’s job as a VP for UBS and like various pols had working for FNM and FRE. The lobbyists pressure people in the treasury department the same way.

    And with Paulson, he has direct financial incentives to help GS if his Bobolink Foundation still owns 510,000 shares of GS stock, or if any of his family trusts still own GS stock or stock in any other bank.

    The lobbying business is korrupt, just korrupt.

  6. mxq

    I’m afraid a recapitalization will just put us back to where we were two years ago.

    These mortgages need to be worked out in order to keep supply from foreclosures off the market, otherwise housing prices can go down another 20% and we’re right back to where we are today.

    Owners of bad paper need a place to go or an incentive (mandate) so it is no longer a one-way, losing (or optional) proposition to attempt a workout of bad paper.

  7. Yves Smith


    I don’t have a good answer here. The intent is to reflate, which would have as a side effect the depreciation of the dollar. But there is tremendous dollar buying, not just a flight to Treasuries, but a consequence of unwinding dollar based trades. So even this dramatic move may not be fully effective. Look at all the liquidity the Fed has created and the money markets are still frozen.

    In the Depression, in 1930, the Fed increased the monetary base but the money supply fell because people hoarded cash. The cash hoarding is taking place now, not via the deposit system, but in regarding all types of unsecured credits and it is even starting to affect secured credits (Matt D gets a point, referred to a FT article that discussed how firms are even reluctant to do repos. That is just unheard of and signals a near complete breakdown of normal trading. Matt, if you read this, it had better not go to your head. I have been impressed that you have restrained yourself of late in being able to moderate your tone. Avoidance of the word “i” is very helpful).

    So the effect is (presumably) to offset the massive deleveraging. Credit lines are being cut, and no one is willing to lend much more than overnight.

    So if this works, the side effect will be to hammer the dollar. But this may not succeed, or may only work partially. We are way, way outside normal bounds.

  8. john

    Thank you Yves,

    This is very encouraging. Every fiber in my body has been stressed at the thought of throwing $700 billion to the TARP program.

    it would be even nicer if Paulson played hardball and said, cooperate or else we nationalize your sons of bitches and fire the top execs that stand in Treasury’s way.

    It is time they started bending over for the Treasury. The Treasury ought to have a stable of Be-atches.

  9. john

    I wouldn’t worry about the supply from foreclosures at all. They are already priced low enough to step in and buy in the hardest hit markets.

    In fact, I am just waiting for prices to stop going down to buy. Or is it that I am waiting for my house to sell first :-)

    (I live in an area where home prices are actually appreciating during this crisis. Lucky me)

    Yves, I am a newcomer, and am pleasantly surprised by the quality of your blog.

  10. Anonymous

    What happens to the bank share prices if the Govt. injects capital? Will this dilution result in lower stock prices therefore making financials a good short one last time?


  11. mxq

    re: “I wouldn’t worry about the supply from foreclosures at all. They are already priced low enough to step in and buy in the hardest hit markets.”

    john, the pending sales data from today certainly was encouraging to this point.

    But looking at Shiller’s CME traded futures contracts, composite Nov 2009 shows 10% declines from Nov 2008, and by Nov 2010 they read 15% decline from today. Moreover, a couple hard hit areas could be considered LA and maybe vegas? 1 year futures show 17% and 12% downside, respectively.

    Shiller has said that the 1 year contracts are usually pretty accurate, but the ones going out multiple years are not time-tested, as they apparently just started trading about a year ago.

    So this is where I get my assumptions for future prices.

  12. Yves Smith

    Meredith Whitney (most accurate banking analyst as far as forecasting has been concerned, at Oppenheimer) has noted that the futures contracts have, since February, markedly underestimated housing price decay, and they have not in their short lives ever overestimated it by much.

  13. Anonymous

    Good post. The direct investment of U.S. government funds in the banking sector is the inevitable outcome. The British got it right. They might be bumblers at times but they do not screw around with the banking sector.

    Only one small quibble with your post. While the management of RBS was shown the door, I believe that it was a one off manuever on the part of the government. If you look at the terms of their investments, they do not involve board seats and they do not seem to be entering into the arrangements with a heavy hand. Sure their are bows to executive compensation but that is simply politics as usual. I don’t think much good is served by wholesale management changes at this time and I hope when we make the move that we are as light handed as the Brits. If a ritual sacrifice is called for, fine, but beyond that we may hurt ourselves as much as help.

    After all, there are only so many 35 year old geniuses to go around and Paulson seems to have hired all of them.

  14. Yves Smith

    Anon of 12:55,

    Fair point, but installing a new CEO is not trivial, even if it falls well short of operational control. I believe RBS made noises saying it was more desperate for the money in meetings with the officialdom, hence the change.

  15. Anonymous

    Yes Yves,
    The dollar is being bought back just like the yen, because the carry trade has been killed swiftly. Interestingly Gold is probably also in this category due to skyrocketing lease rates, but this is a transient phenomenon.

    I have my doubts that the fed increasing the monetary base via this new supplementary finance program vehicle along every other fix they have implemented is quite so transient.

    The money is going out there. Even though it is not being spent, swapped or shared today it will be out there waiting for better times to be spent 10:1…you are right we are in uncharted territory.

  16. Steve

    Regarding the Paulson plan vs. nationalization:

    Like others on this board I’m sure, I have invested in companies that failed. I never expected the government to pay for my bad bets. I know of work-outs involving Mr Paulson’s former employer and I don’t recall hearing about free money on the table.

    If a business has been mismanaged to the point where it can no longer raise equity or financing except from the government, then the owners and creditors of that business should suffer as they would in bankruptcy proceedings. Assuming GS and MS really are indispensable, their shareholders and creditors aren’t. They have recourse in the courts against managers who grossly misallocated their capital, let them take it.

  17. john

    mxq –

    I see home prices falling with or without gov’t intervention. So does Schiller, who is estimating another 15% decline in prices yet.

    Which is still a longer term good for the economy. For the past umpteen years, home prices have accelerated far beyond wage growth, a trend which accelerated greatly in the past decade.

    Closing the far too wide a gap of home prices vs affordability is a healthy thing for the economy. So household wealth takes a hit to get it done. But then that is the way we roll in this economy.

    We can’t very easily stem the tide of closing that gap. And worse, it wouldn’t be prudent.

    Falling home prices are like snow at xmas time.

    Oh the weather outside is frightful, but the fire is so delightful, let is snow, let it snow, let it snow.

    It doesn’t show signs of stopping, and I’ve bought some corm for popping…

    No disrespect intended, just a bit of musical humor

  18. Anonymous

    Home sales were up in August and will be for September as a result of the availability of funds for mortgages and lower rates courtesy of the fannie and freddie nationalization. But that was a transient phenomenon.

    All credit markets are frozen now, and I assume this includes the mortgage market. Home sales data won’t reflect this until the October and november sales come out.

  19. Anonymous

    Throughout much of this episode the industry’s and market’s competitive dynamics appear to be have been ignored by many commentators as if there are no costs/benefits involved in alternative actions/doing nothing.

    Interestingly, now with escalating interventions and governments
    decisions to intervene or not, individual banks decisions to participate or not, where, when and how, competitive dynamics appear to be resurfacing.

  20. Anonymous


    Is it possible to recap the various facilities made available and debate their intended and actual impact on firms, the industry, the system and various markets?

    That is to attempt to follow the money.

  21. Anonymous

    The housing sale number is a best not a bad sign, and at worst, completely fictional. Realtors, you can trust them…

    There are no more choices to be made, this is it. Banks are insolvent, nationalize them and get them the hell out of the way.

    They can keep throwing good money after bad trying to stop, it does not show any signs of abating.

    Playing in the real world, I have been in the process of trying to settle an estate over the past year. Not a good time to do this. Trying to get anyone to let go of any money is like pulling teeth, and then the check gets lost in the mail.

    One of the biggest transactions I had to do was during the bear mess. I literally had a very large sum of money disappear for 2 days, no one could tell me where it went. Finally, it did re-appear, after the end of the quarter. It has been resolved, but wow.

    Moral, if you think you can get out, its way too late. It takes 2 weeks to get anything done in a normal environment, this is not normal.

  22. doc holiday

    If the banks have to ask for help, that may be a good sign, because that allows Treasury to connect cash to a contract, like The Chrysler Bailout — if they can all do that and end up cutting taxpayers a deal closer to what Buffett got, that might work out as a path that can create progress.

    Nonetheless, the structure of this bailout remains linked to derivatives that will destroy cash flow. I fail to see how Treasury can backstop 100’s of partnerships that are connected to potentially trillions of dollars of losses.

    It seems to me, that Treasury is going to have to step into business with a lot of banks, entities, hedge funds and assorted business deals and socialize losses in the private sector for years — but in doing so, how will they close out these partnerships and collect fees for the cash that was injected and who will have a clue as to what is worth what and who is connected to which derivative?

    Bottom-line, Bear Stearns should have gone under, and if it would have cost a trillion to fix, that would have been 50 times cheaper than all the chaos caused by Bernanke and Paulson!

  23. David Habakkuk

    Thanks Yves — this is the most cheering bit of news I have heard in weeks.

    But it may not actually be so surprising, surely?

    The only possible way in which Paulson’s plan could have made any sense was if the problem was one of illiquidity, rather than insolvency.

    As Richard Kline remarked on an earlier thread, the British initiative was an ‘unequivocal though tacit admission’ that the problem was one of solvency. This reflected a quite dramatic shift in perceptions over recent weeks.

    Once one concludes that the problem is insolvency, the evidence presented in the IMF report to which Yves linked makes it crystal clear that state purchases of dodgy assets are a particularly bad response — and that direct recapitalisation and nationalisation are far preferable, particularly given the vital importance of triage.

    The problem with Paulson and Bernanke is not that they are dense — but rather that they have been in denial. (Hardly surprisingly, as acknowledging the reality of the solvency crisis implies acknowledging that, in their different ways, they have been instrumental in putting the global capitalist system in danger of meltdown.)

    But they are both intelligent men, and if the very visible evidence which caused the British authorities to change course has finally broken through the denial, there is a good chance that they may take note of and attempt to follow international best practice.

    Whether the change comes too late to avert meltdown is of course another matter.

  24. ndahi

    The problem is that they are not in denial, but rather very rigid and ideological. They have been reared in a free market ideology for too long that they have become inflexible.

    I remember an exchange between Paulson and a member of Congress who suggested the Swedish model to solve the banking crisis. Paulson simply shut her suggestion down w/o any real explanation as to why beside the ideological free market BS.

    Paulson/Bernanke are more ideological than hard core communists used to be. They should take Deng Xio Peng’s saying about Chinese market reforms to heart: “It does not matter if the cat is black or white as long as it catches mice.”

    It does not matter if the solution to this crisis is market based or govt based as long as it solves the crisis. Buying toxic bank assets will not solve this problem, part ownership of the banks would. The Swedes showed the way and now the British are adopting a similar solution.

  25. kristiina

    This blog is obviously doing a public service by providing real information in a situation where there’s a lot of disinformation flying around. A work worthy of a real human being.

    The situation in the financial sphere makes me remember a famous novel by Kafka – Metamorphosis. Gregor Samsa wakes up one morning and realizes he has metamorphosed into a cockroach. The supposedly good stuff in financial institutions has turned into cokroaches and this is not an individual catastrophe like in Samsa’s case, but an epidemic. Like in Samsa’s family, the transformation is kept secret. But as there’s an epidemic, everybody suspects that all finacial families are hiding cokroaches. Current remedy seems to be an attempt to exchange the cockroaches into viable stuff, and keep pretending that the cokroaches are not really cokroaches, but good stuff just having a temporary nasty spell. Maybe it works. Samsa was killed with a slipper by his sister. The family could not get over the revulsion of having a cockroach for a son.

  26. Suzi Orman

    The supposedly good stuff in financial institutions has turned into cokroaches and this is not an individual catastrophe like in Samsa’s case, but an epidemic. Like in Samsa’s family, the transformation is kept secret. But as there’s an epidemic, everybody suspects that all finacial families are hiding cokroaches. Current remedy seems to be an attempt to exchange the cockroaches into viable stuff, and keep pretending that the cokroaches are not really cokroaches, but good stuff just having a temporary nasty spell. Maybe it works. Samsa was killed with a slipper by his sister.

  27. David Habakkuk


    I would not in any way deny that both Paulson and Bernanke are rigid and ideological.

    But the form this has taken — as Richard Kline rightly stressed — is a persistent reluctance to accept that there are fundamental problems of solvency in the North Atlantic banking system, as distinct from illiquidity problems due to an underpricing of opaque assets.

    This view has now become patently untenable — as has been evidenced by the sharp change of view of many rigid and ideological people in the U.K. At the end of the September, the Tory leader David Cameron was denouncing ‘cheap lines beating up on the market system, bashing financiers’: now he is talking to Carl Bildt to learn how the Swedes handled their financial crisis.

    Also relevant here is the developing tide of popular resentment against these ‘financiers’. On both sides of the Atlantic, people who had been led to believe that the fortunes earned in the City and Wall Street reflected the wonders these did for the economies of the U.S. and the U.K. have been coming to feel — quite rightly — that this was a structure of illusion, whose collapse threatens their own livelihoods.

    The way Paulson structured his plan made quite clear that he had no conception of this explosive upswelling of anger — just as Cameron patently did not only days ago. That the plan brought the anger into the open may have come as a major and salutary shock.

    I am reluctant to rule out the possibility that Paulson and Bernanke may be readier to shed ideological blinkers than they were, if only because if we have to wait for more relevant approaches until an Obama administration is sworn in and gets its act together, an inordinate amount of mayhem may happen in the meantime.

    So it makes more sense to watch Paulson like a hawk, and complain vociferously if he shows preferential treatment for his old colleagues and cronies — rather than simply taking for granted that he must inevitably do so.

  28. River

    Once the Feds take the necessary steps to nationalize (or take stakes) in banks, those steps will not be retraceable. For numerous reasons, the least of which is admitting a mistake was made, the commitment will be a one way avenue.

    What then if the deterioriation of house prices continues unabated? I have more than enough reasons to doubt any stats published by the NAR. The NAR continually releases articles to the press, which are reprinted by local newspapers, that twist the facts to suit their ends. How many times have we read in our local paper that the ‘Bottom is near in home prices’, only to reach the last paragraph to find that the entire article is a misrepresentation of the facts?

    If the Feds nationalize the banking sector and home prices continue to fall (which they will), employment continues to plummet, and consumers fail to spend then the Fed will be at risk of a hit to the US credit rating. The Fed will be owners of a lot of zombified banks that they will be extremely reluctant to allow to fail. This nationalization scheme is a trap, imo.

    I also believe that the Fed has been aware of this from the start and avoided taking stakes in banks, whenever possible, to avoid exposing the US credit rating to downgrade. This is a truly desperate move.

    The only solution that I see is the same one that has been obvious all along…Let the system crash and then rebuild from what is left.

  29. Richard Kline

    So Dave Habukkuk, Mervyn King’s move may be what got Paulson’s attention, althought he broad spectrum crisis in Europe makes for transformational thinking as well. King at least was perceived to have Paulson and Bernanke’s back on holding the line against socialism and for fake prices. When he bugged out, the Daffy Duo are exposed as the only real laggards globally. If even the UK is nationalizing its banks, we are beyond the lie structure and into the re-structure. King has made mistakes; he has also been deeply critical of bank capitalization since long, and operates in a political environment where nationalization is not unthinkable: he was clearly prepared, and don’t doubt he’s made his views known to Hanky Panky.

    The games afoot!

  30. tompain

    “Best practice” involves wiping out shareholders? How can it possibly be good idea to scare away equity capital at the very time when the banking system is most in need of it. We do still live in a country where private property rights are respected, do we not? If shareholders lose their money due to bad business outcomes, that’s the risk they take. But pre-emptive confiscation by the government based solely on assertions that the business would have eventually wiped the shareholders out anyway? That’s a fig leaf for government theft. It’s what you see in Russia and Venezuela. Pushing the cost of capital through the roof is no way to aid an economy.

  31. David Habakkuk


    I think you should look back to Yves Smith’s earlier discussions of what the Swedes did — see her post on September 29.

    A key advantage of nationalisation in Sweden was quite precisely that it meant that ‘zombified banks’ were put out of their misery quickly — as they were not in Japan, and would not be in the U.S. under the Paulson plan as originally conceived.

    As to the notion that a Swedish style approach would represent some kind of irreversible process of socialisation, I fear that this an example of the kind of exaggerated fear of state intervention which — as Richard Kline has pointed out — makes sensible debate about how to get out of the hole we are in so difficult.

    The plain fact of the matter is that these steps were reversed in Sweden. And they will certainly be reversed in the U.K — both because nobody wants to see permanent state control of the banks, and because any future government will want the cash.

  32. Peter C

    Speaking of watching Paulson like a hawk, we intend to perform independent valuations of mortage backed securities bought at auction by the taxpayer, and aggregate the details at http://www.taxpayertab.com. We welcome all assistance.

    Readers should also be aware that only companies with $500 billion in assets under management have been invited to assist in the bailout. We worry that this rules out any possibility of truly independent valuation, and hope to be proven wrong.


    Peter Cotton

    Source: U.S. Department of the Treasury notice to Financial Institutions Interesting in Providing Custodian, Accounting, Acution Management and Other Infrastructure Services – Issued Oct 6, 2008.

  33. Richard Smith

    Suzi Orman,

    Congratulations! Your impersonation of a human being is actually slightly more convincing than some of the genuine flesh and blood commenters we’ve had lately hereabouts.

  34. David Habakkuk

    peter c.

    That sounds a most helpful project.

    How difficult is it, using a financial mathematics toolkit, to work back from the prices the Treasury pays to its underlying assumptions about house prices and default rates?

    It has never been entirely clear to me how far Paulson and Bernanke envisaged paying more than the market price because they were looking for a covert means of recapitalisation — how far they genuinely believed that this market price was deflated by a kind of reverse ‘irrational exuberance’.

    It seems likely that both elements are involved, but a key problem is that neither Paulson or Bernanke have faced up to quite how low housing prices are likely to go. It is denial on this narrower point which has facilitated their denial of the fundamental nature of this crisis — as one of insolvency, not illiquidity.

  35. River

    David Habakkuk, thanks for your comments.

    What happens if the Fed/T inject capital directly into the US banks and then the US banks use the capital to strengthen their balance sheets? Every banker that I have listened to wants to retain the assets that are currently on their books untill ‘some future date when their value is near or above what the bank paid for them’. The banks are ignoring time preference. Since the banks would not mark their poor quality assets to market, how would the situation be improved?

    The US is not Sweden. The US politicians will not take a long term view of what is best for America, but a short term view for political gain. Neither is the US the same as England. Both England and Sweden already have systems that incorporate many more aspects of socialisim than the US. Will the US make a successful jump to socialized (or nationalized) banking and then switch back to capitalisim during the biggest economic upheaval in eighty years? I find this a dubious prospect. How many times have you seen the US Government relenquish any power that it was granted or that it took by fiat?

    The current crop of politicians are no different than the ones that will replace them in the next election. Any power that they garner through times of upheaval, they will be loathe to give up if economic conditions improve. If they say otherwise, they are lying.

    There is a way to let the system repair itself but it will be painfull. I do not see how America can go forward with two forms of economy…capitalisim during the good times and socialisim during the bad. It will not work.

  36. john bougearel

    River, LOL

    Its a bit like playing hopscotch
    th is capitalism in the good times socialism in the bad times.

  37. Anonymous

    I agree that the fundamental ignored factor is home prices, and the inevitability of their further decline. It is astonishing to me, simply astounding, that the basic issue of median home prices being dramatically out of whack with median income, is never even acknowledged let alone discussed. Income inequity is the underlying issue; if this isn’t addressed, how can any arcane financial technique possibly work?

  38. River

    anon at 12:37 PM…You are absolutely right. Everyone is looking for ‘the easy way, the painless way’…There is no easy way. Home prices have to adjust to wages or wages have to adjust to home prices or a combination of the two. We all know that stagnant wages were hidden, to a large degree, by cheap Chinese imports for many years. Had all prices escalated as those of medical care there would have been outrage among the public long ago. ATM home loans also helped hide the fact that wages were stagnant.

    In Sweden, it is in the best interests of government to keep payrolls high because of the very high tax rates that support their socialized system. Many basic changes to the US economy and system of governance would have to change to accomodate real socialisim and it will not be accomplished on a temporary basis. Anyone that believes that a change to socialisim and then back to socialisim will be accomplished is simply not thinking clearly.

  39. Greg Byshenk

    “Best practice” involves wiping out shareholders? How can it possibly be good idea to scare away equity capital at the very time when the banking system is most in need of it. […]Pushing the cost of capital through the roof is no way to aid an economy.

    One answer to this question is that the capital is already “scare[d] away”. No investor wants to put capital into a bank when he has no way of knowing whether it is as an actual “investment” in a going concern or is merely throwing money down a hole. Until investors can determine this, there is no way for financial institutions to acquire additional private capital.

    I would submit that the current crisis is neither a ‘liquidity’ nor a ‘solvency’ crisis (or at least not plainly one or the other), but a transparency crisis. Many banks have liquidity problems, and almost certainly some are insolvent. The important question is: which ones? Until that can be decided with some degree of certainty, the crisis will continue as it has so far.

  40. David Habakkuk

    Greg Byshenk,

    You are clearly right in stressing the importance of the lack of transparency.

    It may however be that transparency is something not easily achieved in current circumstances. The scale of the banks’ problems depends upon how one values complex financial instruments, which are tied to conditions in housing markets.

    So not only is the complexity an obstacle, one is going to get very different results, depending upon one’s anticipations about housing markets. Clearly these are going to get much worse. But how much worse, and on what trajectory, is inherently unpredictable.

    And it is all the more unpredictable, as the extent to which these markets get worse is a function of the results of government policy.

    What is at issue here is not simply success against failure. If Bernanke’s belief that monetary policy can prevent debt deflation turned out to be wrong, one would get one outcome. If it turned out to be right — and one had U.S. reflation associated with a trashing of the dollar — one would have another.

    So it could perhaps be that only the most imperfect transparency is possible. If however this is so, it is not clear to me what is the least worst option in terms of designing a recapitalisation programme.

  41. Greg Byshenk

    David Habakkuk,

    I agree that the matter of transparency is extremely difficult to work out. But it is in part because this is so that nationalization (at least in some form) is very likely the only viable option. That is, if private capital will not be forthcoming without increased transparency, and if transparency over the short (or even medium) term is not practical, then the only option is public capital.

    And further, the better (or less bad) option for the infusion of public capital will be an option that increases transparency. That is (at least in my inexpert opinion) something like the “Swedish” plan. That is, nationalization, cleanup, and then — if the result is viable — reprivatization.

  42. David Habakkuk

    greg byshenk,

    I think your logic is compelling.

    In one way this is easier for the UK than the US — because here one is really dealing with a small number of big banks.

    I find myself wondering whether in the U.S., where the system is I think much more complex, once some banks are nationalised in whole or in part, funds will migrate to them from institutions which are probably solvent but not absolutely and demonstrably so.

    If this is the case, then the logic may lead to a progressive extension of the nationalisation.

    What all this does for government finances, both in the U.K. and the U.S., boggles my mind.

    I think a couple of months the whole financial landscape — not simply in terms of the institutional structures that prevail, but in terms of the way people think about finance, may be transformed beyond recognition.

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