Goldman: Bank Rescue May Reach $4 Trillion (and "Bad Bank" Issues)

Goldman, in a research note discussed at CNBC, says the total tab for the US bank rescue operation could run as high as $4 trillion:

The cost of restoring confidence in U.S. financial firms may reach $4 trillion if President Barack Obama moves ahead with a “bad bank” that buys up souring assets.

The figure far exceeds even the most pessimistic estimates of how great the loan losses might be because there is so much uncertainty about default rates, which means the government may need to take on a bigger chunk of bank debt to ease concerns.

Goldman Sachs economists said ideally the public sector would step in to remove the hardest-to-value assets, which would alleviate nagging worries about future losses and hopefully help get lending going again.

“Unfortunately, with an unprecedented meltdown in mortgage credit and a deep recession in the broader economy, there is a great deal of uncertainty about the value of almost every asset,”…

Goldman Sachs estimated that it would take on the order of $4 trillion to buy troubled mortgage and consumer debt. That number could shrink if the program were limited to only certain loans or banks, but it could also grow if other asset classes such as commercial real estate loans were included.

New York Sen. Charles Schumer has said that a number of experts thought that up to $4 trillion may be needed to buy the bad assets, an estimate that a Senate aide said was based on informal conversations with people in the industry.

Given the acute need the perps have for more dough, “informal conversations with people in the industry” are the functional equivalent of lobbying.

Now admittedly, Nouriel Roubini, who is both bearish and so far, quite accurate in calling the trajectory of the crisis, pegs total securities and loan losses at $3.6 trillion. But he has only $1.9 trillion of that with US firms, and his totals include unsecuritized loans, and appear to include commercial real estate loans, which the Goldman note excluded.

I’d love to know how anyone can defend a number more than twice as grim as Roubini’s.

And even if one were to believe the Goldman figure, there is a practical problem: no way, no how is that much money going to be spent. We will limp along with a Japan style partial remedies. The US public will not stomach that level of spending on banksters in the absence of substantial spending for individuals hurt by the crisis. So you’d need to add a few extra trillion to come up with a remedy that looked fair, or at least not grossly skewed.

And we have a second set of possible issues with the Obama plans in the making, at least if the reports swirling around are remotely accurate.

A sketch of a plan has been circulating (I have seen this in print, and for the life of me, cannot track down a link) with $100 billion of TARP funds used to provide the equity for a “bad bank” that would buy dodgy paper, with another, say, $900 billion in loans from the Fed to give the new entity a $1 trillion+ balance sheet. Bloomberg tells us that the FDIC is likely to be put in charge. Reader Steve, who worked at the FDIC, isn’t keen about the idea:

Anyway, the notion that FDIC should manage the thing is more than a little questionable, because FDIC has no experience managing sophisticated instruments (let alone derivatives), and the experienced credit hands have been gone from FDIC for years. I was told about a year ago that FDIC’s bank liquidation group, which had numbered about 7,000 in 1992, was all of 200 people. So I expect that FDIC `management’ will simply mean more business for Blackrock, GS, and Pimco, who will be `supervised’ by a collection of sleepy FDIC functionaries. No doubt they will do `Sheila mods’ while trading more complex government-owned assets as test cases for their own portfolios. To be blunt, FDIC and other regulators do not have the expertise to examine banks with sophisticated portfolios, let alone manage those portfolios themselves.

Of the billions in assets acquired by FDIC over the last year — and most of those are simple credits — how much has FDIC managed to sell? Seems to be zero; the only thing FDIC understands about liquidation these days is selling to private equity while retaining the quasi-totality of the risk.

Another element of the plan that has been mentioned sans much elaboration is that the bad bank would do loan mods.One theory we have heard is:

The bad bank hires laid-off mortgage brokers to refinance each homeowner with a mortgage that’s been sliced and diced into exotic securities now sitting on the bad bank balance sheet. This is not feasible without owning a huge chunk of toxic assets, because claims on sliced-and-diced mortgages are spread all around the global banking system. Appraisals will be waived in situations of negative equity, and principal will be written down. This may include the homeowner granting the lender some sort of future ‘property appreciation right’ in exchange for a principal write-down.

Readers are welcome to correct me, but if I understand mortgage securitizations, this will not work (legally) in a significant portion of cases, one where the offering documents restricted loan mods. Note that there are three general types: no restrictions on mods, mods permitted up to a certain % of the pool, and no restrictions. Servicers do not appear to have done much in the way of bona fide mods (a payment catchup plan would not be what most readers would define as a mod, yet services include them in their reported level of mods), and it remains an open question as to whether the real issue is lack of incentives, given that some pools have no restrictions on mods (they get paid for the work involved in foreclosures, they do not get paid to mod).

So why won’t this ducky plan work? Wellie, my understanding is that for those deals that have mod restrictions, to lift them requires the consent of at least a majority (in some cases 2/3 or 3/4) of the holders of EVERY TRANCHE in the deal.

US banks hold mainly what was once AAA paper due to its favorable risk weighting under bank capital regulations. The equity tranche usually stayed with packager, which in many cases was an investment bank. So the aggregator bank might wind up able to get a high enough percentage of those tranches.

But the intermediate tranches went to a whole host of players, and for subprime securitization, a lot went into CDOs. And from 2006 onward, most CDOs were sold overseas, often to not very sophisticated players (think German Landesbanken).

Now we’ll see if this sort of “we can mod the loans because we’ll own the securities” is part of the official plan. And if it is, one has to question either the competence or the intentions of the plan’s architects.

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  1. ndk

    So you’d need to add a few extra trillion to come up with a remedy that looked fair, or at least not grossly skewed.

    I’m more convinced that the government can make such a rescue seem reasonable, Yves. Dribbled out gradually through small packages here and there, we’ve already amassed an extraordinary volume of donations to the FIRE sector. I see no reason at present, particularly with Geithner at the helm, for that pattern to cease. We cry, we bitch, we moan, and we move on. It’s very frustrating, but it’s very persistent.

    Reader Steve, who worked at the FDIC, isn’t keen about the idea:

    I agree with Steve. The current FDIC seems particularly competent at bureaucracy and PR, but a bit lacking when it comes to regulation and management of dead banks.

    Another element of the plan that has been mentioned sans much elaboration is that the bad bank would do loan mods.

    I’d be in favor of adjusting principal in principle, but even if the serious legal barriers could be negotiated, I don’t see it working in practice. Debt-deflation is a self-reinforcing and rapidly intensifying practice, and I don’t see lenders eagerly leaping ahead of the next round of devaluation.

    Unhitch the poor indebted homeowners from the yolk so they can default or go bankrupt. Sans dramatic writedowns on the principal, these guys are toast. Let them default to rebuild and recover so they can contribute to our collective future.

    Signed, your Mellonist commentator.

  2. alexblack

    We’ve stepped through the Looking Glass. Willie Sutton used to rob banks because “That’s where the money is.” But now that that’s where the money AIN’T, the banks are concocting a way to steal money that doesn’t actually exist yet.

    Curiouser and curioser.

    If you thought stealing candy from a baby was easy, watch as they steal trillions from the yet-unborn. Future sonograms will show the shackles around their tiny ankles.

  3. mft

    I’m sorry, this is really off topic, but if global trade goes the way the news out of Japan suggests, it won’t matter who runs the bad bank! Yves, how come even you are relapsing into US navel-gazing? Obama is president, but there is NO SIGN AT ALL of the US exercising leadership in dealing with what we all know is a global economic catastrophe!

    The news from Japan suggests that the chips are down, and this IS World Depression II. Bloomberg reports Japanese factory output fell 9.6% month-on-month in December after 8.9% in November. Companies plan to lower output a further 9.1 percent in January and 4.7 percent in February. This makes for a total 28% cumulative fall in factory output over 4 months, so we are dealing with numbers of the same magnitude as in the Great Depression of 1930-32.

    This means that when Nouriel Rubini talks about a U-shaped recession, he is talking about something like 1930-32, and when he talks about an L-shaped recession, it means something even WORSE!

    I don’t think any other country is going to take a lead in forging a globally united and effective respose to this. Only the US could do it. Regrettably, that seems even less likely now than three months ago.

  4. M.G.

    I had modestly proposed a solution of the banking crisis some time ago. Prof. Buiter is now working out on the details. I called parallel new bank system. I also wrote that it would be cheaper and more effective than funding “lemon” banks. With such an amount of money we can set up many banks… Also the guarantee for the new healthy banks will be cheaper (insurance that some economists suggest as last resort). Trust in the banking system could be re-established while enhancing competition instead of reducing it as it is happening so far. I also believe that new banks should confine their activities to narrow banking. They may also have different type of shareholders and they could also take the form of cooperatives with limits on leverage. Forget about CDS and other derivative products since we don’t go to the casino with taxpayers money…
    Can we convince those dealers and policymakers of “lemon” banks?

  5. Yves Smith


    The reason for the focus on the US now is we have a lot of policy decisions pending that will have a very big impact on how things play out in the US. And sadly, I am not encouraged by what I see out of Team Obama.

    The Japan update is dreadful, agreed, and I have tended to harp more on bad news out of China, and more general trade reports. But it is getting media attention, and I cannot cover every story, While I do comment and call attention to general economics stories, I take particular interest in ones like the bank story, where I might have something to add, I can’t provide as much useful byplay to the Japan sighting.

    In addition, I differ with your premise. Bush plus the financial crisis means the US has very little credibility on matters economic, particularly in Asia (per Wen Jinbao’s critical speech at Davos). We cannot exercise much influence here.

  6. Anonymous

    Couldn’t the government void existing restrictions on mortgage modifications? I am reminded of the Roosevelt administration’s voiding of contracts that included conversion to gold.

  7. Richard Kline

    Goldmans has, of course, a great incentive to make the losses of the financial sector seem grievous and imminent: there is a stone rookie in the White Palace, whose feet are going backwards under pressure from his bankster-advisors. If fat chunks of TARP II and Stimuli I are rushed to the banks, GS will quite possibly haul in enough to see its way through the mess; so what if competitors go under when Stimuli III and IV don’t come on line? Seriously, anything I hear from GS at this point I automatically discount, not because it is, necessarily, inaccurate, but because their self-interest is so patently naked in the ‘analysis’ which they dispense that I can’t _affort_ to trust them. Remember, if you like, the GS analyst last Spring claiming that oils was going to sustain above $150 and break $200, while certain unidentified participants were manifestly and concurrently gaming commoditiy speculation.

    I also say that passing mention, Yves, of $100B from the TARP being used as capital; I think the idea was that the Fed would back it at 10-1, for an institution credit line of $1T, which would then be used to buy up MBS and perhaps ABSs from the big financials at whatever price the latter felt like selling for. Effectively, this would transfer $1T of Fedcred directly to the private capitalists, leaving the Fed and the Treasury chartered Dummy Corp. to eat the loss. *hardy-har-har* This was mentioned by someone quoted in passing on a blog post on a wider subject. I think if was a post by Ritholtz but it might have been on Krugman’s own blog. I was so appalled at the mere idea of such mendacious theft that my mind refused to engage with the whole post, and I don’t remember where it was.

    Here’s what I say: Enough with this appeasement of incontinent plutocrats; that’s what it is, appeasement, they threaten to ‘ruin us’ if we don’t give them money, and our rubber-legged ‘leaders’ capitulate instantly. Well, no more appeasement. Don’t bail ’em, fail ’em. Bank holiday tomorrow, and nationalize on the day after. And Barack, I _guarantee_ that your approval rating will go UP 20 points on the day after that.

    Time to take the cold dead fingers of these putative masters of the universe from around the necks of our collective future.

  8. Anonymous

    Why are we surprised that Goldman put out the biggest number around. Remember when they had oil going to $200 and all the attention that garnered? They achieved their objective which is getting people to talk about their research.

    Oh and there stock picking in financials has been terrible too.

  9. john

    Possibly the 4 trillion mark is reached on the assumption that to do mods they will have to own all the paper. So those assets( I use the word loosely) held by foreign banks would be purchased to allow the government to own and make mods.

  10. Angry Citi shareholder

    Speaking of GS and banks, why does anyone believe any of the fraudulent financial statements? Why does anyone listen to anything KPMG or other auditors have to say? Most of the banks are bankrupt yet the financials keep rolling out, no problem. As an angry Citi investor, I have tried to piece together how I lost most of my money.

    KPMG audits many of the financials with all their SIV creations which are used to off load bad loans so the losses don’t have to be recognized on the financials in an Enronesque fashion like KPMG’s client Citi (which is bankrupt).

    Of course KPMG’s never ending quest for fees does not stop with fraudulent financials, it also purveyed what Mike Hamersley would describe as fraudulent corporate tax shelters (not withstanding Hamersley’s willing participation in many of them) used by most of KPMG’s big banks including Citi, like the REIT transaction which eliminated tax on real estate loans; back to back loans or rate swaps creating interest deductions; financing arrangements generating noneconomic foreign tax credits; the list goes on forever. All KPMG’s big banks used the strategies to eliminate taxes and create what Hamersley would describe as fraudulent book income (except of course for Hamersley’s own tax shelters).

    Tim Flynn is a banking guy and was brought in to purportedly clean up KPMG in 05. Yet Flynn prior to his appointment as KPMG CEO was a high level KPMG audit partner before taking over for O’Kelley and had most of his clients involved in all the fraudulent accounting and questionable tax shelters (which according to Hamersley were fraudulent).

    There can be no doubt about the fraud as beginning as early as 2003 many were predicting the implosion that would result from the unsustainable lending patterns of KPMG’s banking clients. In fact, most of KPMG’s banks are bankrupt, what to do?

    Flynn decided to throw a bunch of tax partners having nothing to do with all KPMG’s bankrupt banks under the bus for individual shelters which were miniscule in relation to all KPMG’s failed fraudulent audits.

    Flynn hired Bennett and Holmes to do his dirty work and assist with the DOJ. Flynn had Bennett and Holmes lie to the DOJ according to an email wherein Joe Loonan KPMG’s head lawyer stated that he did not know if any of the allegations were true (“freedom is just another word for nothing left to lose”). Then to seal the deal Flynn denied legal fees to the tax partners he threw under the bus to the DOJ, even Ernst and Young paid its partners legal fees. Why would Flynn do this after O’Kelley had promised to pay the legal fees?

    One can only infer to hide the greater tragedy at KPMG, all of the failed fraudulent audits (not to mention after Flynn cut his deal, KPMG was awarded the audit of the DOJ). If I were a KPMGer, I would not only be extremely concerned about all the civil litigation that is coming for the fraudulent audits but the potential criminal actions that must be coming once the books are scoured (which you know they will be in the civil litigation plus the fraud is relatively easy to discern) because KPMGer’s must know by now the first thing Flynn will do is throw you under the bus and cut off legal fees.

    As a decimated Citi investor I am looking for any KPMGer to come forward and tell the truth.

    Angry Citi shareholder

  11. Richard Smith

    One reference to the 100Bn TARP geared to 1Trn was Soros in the FT:

    Can’t find a direct source. Nearest I can get is Bair on the aggregator bank:

    Some similar mechanism underlies the TALF – this from the guardian back in Nov (4th para from the end):

    Hope that helps. Looks a bit dodgy (that’s probably British for ‘mendacious theft’).

  12. Anonymous

    Yves — the Roubini/ Parisi-Capone estimates (don’t forget Nouriel’s co author!) are for losses. Presumably the Goldman estimates are for the assets the US would need to buy to leave the banks with clean balance sheets. They are estimating different things i suspect.


  13. mft

    Yves: “the US has very little credibility on matters economic, particularly in Asia (per Wen Jinbao’s critical speech at Davos). We cannot exercise much influence here.” This is ghastly. I hope you realize what you’re saying.

    Richard Kline: “Bank holiday tomorrow, and nationalize on the day after”. Right, some of us were already saying that in November. But it may happen in the UK first. I think Gordon Brown is just waiting for the banks to request yet another recapitalization, then he’ll nationalize them and shortly afterwards call a general election (the British system allows that). Then lugubrious Gordon, whom everyone had written off in September, will probably win a landslide majority.

  14. Anonymous

    I’m not sue I saw it mentioned, but is that 4 trillion US or Zimbabwe dollars?

    Vinny Goldberg, Wiz Kid Economisto extraordinaire

  15. mft

    Another perspective from a philosophical standpoint on why the bad bank is just a bad idea. It’s about power and responsibility. They should go hand in hand. Now since last fall the Fed and Treasury have had not just theoretical ultimate responsibility for the US banking system but actual day-to-day responsibility. But they do not have the power that should go with that, because THEY DO NOT OWN THE BANKS! That has to change – nationalize the banks and give the federal authorities the power to audit and reorganise them commensurate with the responsbility they have been exercizing.

  16. Dead Blog Walking

    This sort of sensationalism blogging and pseudo commentary, while not reckless or entertaining, is the equivalent of reading garbage about alien babies and movie stars. Take a look at how many “economist retards” got the GDP wrong, then ask why printing anything they say and commenting on it, is any different than focusing attention on astrology forecasts from Roubini!

    I have a prediction: Economic blog traffic will crash during 2009!

  17. AP

    Forgive my naivete post, but it seems like common sense to me to let the bad banks fail, and liquidate all the ‘bad assets’.

    What’s wrong with putting a real value as everything is? It seems like everyone just wants to maintain this illusion of assets bring worth much more than they really are.

    Is it because people don’t want to believe all their holdings simply won’t add up to what they used to be worth?

    Funny how people want capitalism as long as it favors them, but when they those their gains, they want socialism to cover their losses.

    My final question is, how long can this be maintained? It’s obvious the Obailout part 2 let alone 3 isn’t going to fix a broken system. At what point does it all come crashing down? When we’ve auctioned off the third unborn generation of taxpayer revenue? Even that has to end somewhere.

  18. Anonymous

    To "Dead Blog Walking".

    It's been CONSISTENTLY TRUE for 2+ years that ONLY on the blogosphere has one found economic projections that are sufficiently negative that they correlate to how the popping of the credit bubble has played out. The bears of the blogs have been borne out. They may not have all of the carefully accumulated stats you'd like, but stats have been used to justify undue risk by the banking industry – all while more experienced hands told us, based on "mere anecdotal evidence" and their conjecture that an unsustainable credit bubble was building.

    Not everything one reads on a blog like this will prove to be true, but it's only on such blogs that people are free to fully imagine & predict how things could play out when most of the economic world is in a major negative feedback loop.

    You may suffer from a failure of imagination. Most of the perennial optimists who contitute the bulk of financial managers clearly have evidenced a total inability to imagine a worst case that's worse than anything they've seen in their short careers (even a 40 year career may be too short a frame of reference). They're like ducks quacking "buy, buy, buy".

    Time will tell, but I think we gotta cut the bloggers some slack. Let's hear what they're imagining. The most illuminating calculations are always done on the back of a napkin.

  19. DanyBoy

    YVes: As today’s news appears to confirm, I agree that a Japan style solution of piecemeal soring up of bank balance sheets will be the path we take in the US.

    As I have said, the Japan solution is looking (unfortunately) like the BEST CASE Scenario.

    An aggregator bank has too many adverse forseable and unforseable downstream consequences which could ultimately burn municipalities, pensions, endowment funds, foreign governments. the danger is setting off another cascading wave of financial calamities in uncovered financial institutions and other areas during a very fragile period.

    Yes, the better part of virtue in this case may not be the “Radical Surgery” approach whereby the government tries to cut quick and deep into the cancerous financial netherworld.

    Discretion will be the better part of valor: keep the problems under the carpet and hidden in the closet for as long as possible. Don’t let the world ever see the full, horrible extent of financial folly which our institutions have wrought for fear that others can impugne us on political and philosophical grounds.

    No proposals so far on how to PREVENT a recurrence in the future! That’s because our peaders and our collective psyche is still in the shock and denial phase. Also it’s easier to dream of a quick fix to all your problems, a return to the “good ole days” with nothing really to learn or face up to, nothing to change or correct.

    Was it folly to bonus executives BEFORE they brought home any bacon? The disconnect happened when we stopped rewarding PAST performance and began rewarding performance Anticipatorilly.

    Was it foly to allow execs to loot their banks? A massive transfer of wealth from the pockets of pension funds, municipalities, endowments and retail investors took place directly into the hands of the likes of Thain, Prince, O’Neill, Fulde and all their inner circles took place over the last few years. At the time it was happening it looked like “incentive”. In hindsight the same facts look like a “Ponzi scheme”.

  20. S

    If this is really about lending, why is GS even part of the conversation. Lending (for you)seems to be the current PR spin by the ministry of trurth and their apapratachesks at Cnbc. GS is a parasite on the real economy and should be left to shrivel. I would really like to know who bought that GS unssecured debt….

    Nice to see Geithner picking a former GS head and womnan who sat on the AIG board. Do you think she was instrumental in settiong up the meeting for Blankfein? This is getting to the point of a circus. Geithner should be thrown out on his ass. He was worthless during the run up, and worse than usless the past year plus.

  21. Richard Smith

    Anonymous of 2:37

    If you are new round here, note that you have directed your ire at the house troll, who usually posts as Dan Duncan, but switches pseudonyms and even genders at the drop of a hat. He is a bit of a wate of time.

    Still, you have cencelled him out with a good passionate post.

    Good on yer.

  22. Anonymous

    4 trillion divided by 350 million = approx $11,400 per resident.

    Please send me a check for that amount.

  23. Richard Kline

    So mft, I’ve been saying close-and-nationalize since July 07, but when the Grey Lady stutters maybe on it we may be getting closer. So I’ll crank the wheel around again. Me and Big Bill Haywood: check him out Mr. Haygood sez I.

    I’m not a fan of the government staying in the bank running business indefinitely per se; that is a long and complicated issue. But we will not, WILL NOT get any possibility of improvement in the US economy until we get a handle on our crashed banking system. The present management of the major banks are _a direct OBSTACLE_ to getting such a handle, and their determination to stick the public with all their losses is, furthermore, odious. So we have two real choices: declarations or infernal machines. I’m a nonviolence man (unless you’re inside, say, Gaza, when choices reduce to one), so I’m for declarations. Let’s get ON with it.

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