Economist, and former savings and loan regulator, William Black says, "We have failed bankers giving advice to failed regulators on how to deal with failed assets. How can it result in anything but failure?" Black, and several others, say the current approach risks destroying the Obama presidency, and prolonging the crisis. Are they right? What evidence is available for each side of the debate?
As a starting point, we can look to President Obama, on the issue of receivership:
[T]here have been some who don’t dispute that we need to shore up the banking system, but suggest that we have been too timid in how we go about it. They say that the federal government should have already preemptively stepped in and taken over major financial institutions the way that the FDIC currently intervenes in smaller banks, and that our failure to do so is yet another example of Washington coddling Wall Street. So let me be clear – the reason we have not taken this step has nothing to do with any ideological or political judgment we’ve made about government involvement in banks, and it’s certainly not because of any concern we have for the management and shareholders whose actions have helped cause this mess.
Rather, it is because we believe that preemptive government takeovers are likely to end up costing taxpayers even more in the end, and because it is more likely to undermine than to create confidence. Governments should practice the same principle as doctors: first do no harm. So rest assured – we will do whatever is necessary to get credit flowing again, but we will do so in ways that minimize risks to taxpayers and to the broader economy. To that end, in addition to the program to provide capital to the banks, we have launched a plan that will pair government resources with private investment in order to clear away the old loans and securities – the so-called toxic assets – that are also preventing our banks from lending money.
The statement raises a number of questions. First, why does he believe that "preemptive government takeovers are likely to end up costing taxpayers even more in the end," and, second, does this allow for the possibility that such takeovers may take place further down the line?
A number of respected voices say that some form of nationalization will eventually be required. From a Wall Street Journal article earlier this week:
Some were more blunt than others, with Walter Gerasimowicz, CEO of hedge fund Meditron Asset Management saying that (regarding Citigroup) “it’s a bankrupt institution, in my eyes, and it’s not a question of receivership – it’s already in receivership, as the government is bailing it out.”
William Black, quoted above, was a deputy director at the former Federal Savings and Loan Insurance Corp. during the crisis in the 1980s. He is highly critical of Geithner and Summers, and says that Obama chose the wrong people to lead his economic team.
If cheaters prosper, cheaters will dominate. It is like Gresham's law: Bad money drives out the good. Well, bad behavior drives out good behavior, without good enforcement.
His plan essentially perpetuates zombie banks by mispricing toxic assets that were mispriced to the borrower and mispriced by the lender, and which only served the unfaithful lending agent.
We already know from the real costs -- through the cleanups of IndyMac, Bear Stearns, and Lehman -- that the losses will be roughly 50 to 80 cents on the dollar. The last thing we need is a further drain on our resources and subsidies by promoting this toxic-asset market. By promoting this notion of too-big-to-fail, we are allowing a pernicious influence to remain in Washington. The truth has a resonance to it. The folks know they are being lied to.
...The government is reluctant to admit the depth of the problem, because to do so would force it to put some of America's biggest financial institutions into receivership. The people running these banks are some of the most well-connected in Washington, with easy access to legislators.
...these international behemoths need to be broken down into smaller units that can be managed effectively. Maybe they can be broken up the way that the Standard Oil split up back in the early 1900s, through a simple share spinoff.
Even UC Berkeley economist Brad DeLong, who has supported the Obama plan, sees it as an interim step:
Well, I am not so much complaining about the proliferation as the absence of narratives. You can be (a) agnostic about the world, but believe that current policies are a necessary initial step because of political constraints in getting to whatever the long run policy is going to be; (b) confident that markets are irrationally depressed and think the government should push prices to fundamentals through the world's largest risk-arb operatin; or (c) think that we have no choice because the bankers have us by the plums. I favor (b) myself, but what distresses me at the moment is that the Obama administration doesn't seem to have a position, or a narrative, or an explanation.
Yet a variety of questions remain, and while I've looked for solid answers, they are difficult to come by. What are the relative costs of the Geithner-Summers plan as compared to a more aggressive policy of putting failed banks into receivership and restructuring?
John Hussman tells us that the costs of bailing out the bondholders (following the current plan as opposed to receivership) will eventually cost us $10-14 trillion. I don't know how he came up with the figure. More comments from the same article:
Brief remark - from early reports regarding the toxic assets plan, it appears that the Treasury envisions allowing private investors to bid for toxic mortgage securities, but only to put up about 7% of the purchase price, with the TARP matching that amount - the remainder being "non-recourse" financing from the Fed and FDIC. This essentially implies that the government would grant bidders a put option against 86% of whatever price is bid. This is not only an invitation for rampant moral hazard, as it would allow the financing of largely speculative and inefficently priced bids with the public bearing the cost of losses, but of much greater concern, it is a likely recipe for the insolvency of the Federal Deposit Insurance Corporation, and represents a major end-run around Congress by unelected bureaucrats.
...So what the Fed is really doing is printing enough money to crater the exchange value of the U.S. dollar, while leaving foreigners with a trillion dollars of savings that they would otherwise have invested in Treasury bonds, which they will now use, not to buy our lousy, toxic assets, but to acquire our productive assets, and at a steep discount thanks to the currency depreciation. So yes, the extra trillion in dollar bills will ultimately end up as bank reserves (and currency in circulation), but only by encouraging Beijing to go on a shopping spree to acquire a claim on our future production. Ultimately, funding the bailout of lousy assets comes at the cost of debasing our currency and selling our good assets to foreigners.
Make no mistake - we are selling off our future and the future of our children to prevent the bondholders of U.S. financial corporations from taking losses. We are using public funds to protect the bondholders of some of the most mismanaged companies in the history of capitalism, instead of allowing them to take losses that should have been their own. All our policy makers have done to date has been to squander public funds to protect the full interests of corporate bondholders. Even Bear Stearns' bondholders can expect to get 100% of their money back, thanks to the generosity of Bernanke, Geithner and other bureaucrats eager to hand out the money of ordinary Americans.
If I am looking for solid and detailed analysis, I keep coming back to Roubini. Recently Roubini has been more complimentary to administration plans, supporting the new proposed insolvency regime for systemically important financial institutions. Roubini says such a regime sets the stage in case nationalization is required, and would help avoid consequences faced after the failures at Bear Stearns, AIG, and Lehman.
He also voiced support for the recent plans for toxic assets.
“Having five people bid on a toxic asset, rather than a clueless government, will ensure that the government doesn’t overpay,” Mr. Roubini said in a telephone interview. “People say, ‘the government is putting in 95 cents on the dollar, so why not put 100,’ to do it all by itself. It’s because private-sector participants have the incentive to get the best price.”
Of course, these private sector participants are playing with government money, so we might temper our enthusiasm there. He goes on to say that nationalization is definitely a possibility going forward:
But unlike many critics of the plan, like Paul Krugman, a Princeton economic professor and columnist for The New York Times, who prefers full nationalization of the banks now, Mr. Roubini believes that the Treasury’s plan does not preclude nationalization at all. Rather, he said, it will help to clear the way to full government takeover some troubled institutions.
“I see the option of nationalization” and the one presented by the Obama administration “as being complementary,” Mr. Roubini said. He believes that the stress tests the government plans on conducting on the banks will reveal which are solvent and which are insolvent.
In his view, those banks that are deemed insolvent will not participate in the toxic-asset plan and will be taken over by the government. Banks deemed solvent will be the ones that get to participate.
Nationalization “is fully on the table for banks that are insolvent,” Mr. Roubini said.
More recently, Roubini was highly critical of the stress tests, saying, "Actual macro data for 2009 are already worse than the more adverse scenario in the stress tests. These are not stress tests but rather fudge tests." I am not sure how this reconciles with his earlier statement that the stress tests will reveal insolvent banks. Perhaps they will not...
Go back to Roubini's February 10 article to find his more detailed analysis regarding nationalization of insolvent banks.
Roubini's qualified support notwithstanding, there still remain major questions about the administration's approach. Perhaps Obama is pursuing a shrewd political path, only time will tell. As citizens, I do not think this is a time to simply trust in our government to do the right thing. Vast sums are being channeled to the mega-banks, and it is truly unclear whether the taxpayer is getting a good value out of these expenditures. We are right to worry about the people creating the solutions, since many of them contributed to the problems. Lastly, we have yet to see the transparency Obama promised, as it pertains to problem banks. While Speaker Pelosi is advocating investigations, we have not heard of any aggressive action coming from the administration. Obama may be playing a masterful political game out of our view, but that remains to be seen.
In closing, here is a bit more from William Black:
I keep asking myself, what would we do in other avenues of life? What if every time we had a plane crash we said: 'It might be divisive to investigate. We want to be forward-looking.' Nobody would fly. It would be a disaster.
We know that with planes, every time there is an accident, we look intensively, without the interference of politics. That is why we have such a safe industry.
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