BLOOD ON WALL STREET
February 13, 2009
The Problem is Political
and Bill Seidman is Right
Briefly nationalize, purge then re-privatize
the flailing Too Big to Fail banks
Let us not talk falsely now
The hour is getting late ...
by William Johnney
ON THIS FRIDAY the 13th, four more banks were seized by the government. State regulators working with the FDIC quickly transferred deposits to neighboring banks still on their feet.
But Pinnacle Bank, in Beaverton, Oregon, will cost the FDIC insurance fund about $12 million.
Sherman County Bank, in Loup City, Nebraska, will cost the FDIC about $28 million.
The Corn Belt Bank and Trust, in Pittsfield, Illinois, will cost about $100 million.
And Riverside Bank of the Gulf Coast, in Cape Coral, Florida, $201 million.
That's 38 banks, too small to bail, since the crisis erupted in
July 2007 -- and thirteen in the six weeks of the new year. It would seem the trend is accelerating, as unemployment makes life worse all around.
Also today, Standard & Poors reported that in the final quarter
of 2008 -- for the first time ever -- the companies of the S&P 500
suffered a collective loss.
THE MONEY CENTER DOES NOT HOLD
NAKED CAPITALISM has a nice overview of the argument for nationalizing the big wounded banks before they become Zombies (technical term now in common usage) as the Japanese banks did during the 90s.
The Japan story, everybody seems to agree, is that the government tried to patch their big banks piecemeal, but nothing changed, and they and the economy just limped along, slowly getting worse, descending into the maelstrom of chronic deflation. And Japan has never recovered.
Granted, Japan Inc is very different socioeconomically from These United States. Yet here we find the liberal New York
Times and a Free Marketeer from the American Enterprise Institute
"The lesson from Japan in the 1990s was that
they should have stepped up and nationalized
"WTF ... ?"
Instead, the Japanese first tried many of the same remedies that the Bush administration tried and the Obama administration is trying -- ultra-low interest rates, fiscal stimulus and ineffective cash infusions, among other things. The Japanese even tried to tap private capital to buy some of the bad assets from banks, as Mr. Geithner proposed.
Zombies don't die, but barely live. Zombie banks don't fail -- they're too big -- but neither do they finance their societies with vigor. Mostly they sleep, and eat whatever their worried governments might think to offer, quarter by quarter, year after year. Tax breaks, guarantees, subsidies ... And billions and billions in our case borrowed from descendant taxpayers and better banks in Asia.
AND SO, IF I WERE King, aside from tinkering with the accounting rules for certain structured finance instruments,
I would now take Bill Seidman's advice and briefly nationalize our wounded big banks.
As soon as they were in my minister's hands, I would (again following Seidman) sell their wounded assets to something like the Resolution Trust Corporation that he presided over 1989 et seq. to cure the S&L crisis.
Then: Sell the cleansed banks, with their healthy liabilities and deposits, back into the private sector, A.S.A.P., where opportunities abound to lend long and prosper.
Meanwhile the wounded assets left behind would live out their miserable lives in peace. Like Seidman's RTC, and the great lake of mortgage bonds siphoned by the Fed from Bear Stearns a year ago, the government's big new investment would likely turn a profit -- time, and the ability of the Fed-Treasury twins to live off the air
(on global goodwill), being key.
BUT ONE MAY WONDER ... Why must Mr Seidman be so circuitous? Why not just buy the bad stuff directly from the banks and otherwise let them be?
I.e., why not do what everybody, including Congress, thought Paulson was going to do with the TARP money last September?
Wyell, son ... Turns out there's a problem.
A political problem ...
Mr Seidman was on the tube frequently in January, trying (I surmise) to counsel the new president from afar. But he was consistently shouted down by his CNBC (business news) hosts, who are well paid to smile and obey orders shouted live into their earpieces.
Watching Mr Seidman walk on through the wind, walk on through the rain, 'though his scheme be tossed and scorned, by month's end it seemed clear that General Electric, which owns both CNBC and GE Capital (a big wounded bank currently characterized as a "time bomb" on creditwatch.com), doesn't like the Seidman plan. "Ten or fifteen" banks are on his list, he said in January; but these folks see among the twelve largest U.S. banks only two living dead (Citigroup and Bank of America).
In general the business media seemed to lose interest in the nationalization idea late last year, perhaps looking forward to Change We Need from Team Obama.
Those hopes were dashed this past week when Obama's choice to run the Treasury, Tim Geithner -- no stranger to these seas for having helmed the Fed's New York branch since before the tsumani -- paraded a gnarly vague posse of tried-and-blew ideas -- then said he'd get back, in a couple weeks, with some details. While Rome burns.
Time, then, to employ Mr Seidman's simpler, well focused and more surely productive transitory nationalization scheme, which promises to quickly jolt our newborn Zombies into healthy big banks again. Sounds spooky. But step back.
Since mid 2007, the feds have given Citigroup over $46 billion in cash and $300 billion in guarantees (the latter should wounded assets indeed fail to perform). And things just keep getting worse.
But you and I could buy Citi entire today -- all its assets, deposits, presumably its fed guarantees -- for about $20 billion.
One may wonder. Haven't we already nationalized this Zombie? And if not ... Well why the pork not?
The keepers of public thought respond: We don't want bureaucrats running our banks. (Not counting the Fed.)
But that, of course, is not the Seidman plan, where national- ization is but a tool and a moment that lasts just long enough to deal with the political heart of the matter.
SO WHAT's IT GOTTA DO WITH THE PRICE
OF PORK BELLIES?
CONTRARY to the song of some in the media, the problem that has backed both Paulson and Geithner down, leaving banks to sicken since the TARP was tossed over them in October, is not an inability to reasonably price their wounded structured-finance assets.
True, there is no longer a market worthy of the name for mortgage bonds, CMOs, credit-card bonds and the like. This lack of market is the very meaning of "wounded asset." And assets without markets have little or no market value.
But until the Bush-Cheneytime and the issuance of Statement 157 by the Financial Accounting Standards Board, banks did not use market value to mark these bonds on their books. For the notion of market value was thought inapt. (For good reason.)
Instead, banks marked to models (spreadsheets) based on
(i) short-term performance(how much interest is the bond actually paying, and how much principal is it actually losing) and
(ii) assessments of the health of the relevant industry (e.g., housing in the case of mortgage bonds).
While selling the TARP to Congress in September, Fed chairman Ben Bernanke endorsed performance-based valuation when he suggested Treasury would use TARP cash to buy wounded assets at "hold-to-maturity prices." Based on estimated return from here to maturity. Well, if some dumb bureaucrat can do it ...
So despite what many a tube boob may tell you, wounded assets are not "too complicated" to reasonably evaluate. And people who "don't even know what's in these things!" have neglected to read the offering docs and call the portfolio manager to update --
"My eyes glaze over!"
Well maybe that's a problem.
BUT THE PROBLEM that stopped Paulson from buying assets with TARP cash in October, and now seems to have pushed Geithner the same way, is that the big banks, having already taken big paper-losses on the assets, are disinclined to dump them at dead-on-the-hoof prices -- while the feds in turn are unwilling (it turns out) to pay up -- unwilling to pay that hold-to-maturity juice up front while taking on all risk -- and unwilling to force the issue.
This impasse generally gets misreported as an inability "to price the assets." But what the phrase masks more often than means is a refusal of buyer and seller to agree on a sale price in our suddenly strange and unsteady world. And businessmen may disagree.
Congress, however, bought the TARP so that Treasury would buy wounded bonds. Thus the impasse constitutes a political failure for the government, one that, as the months pass, sapping confidence, deepens the economic malaise. Hence the world's rude impatience with Geithner. Twice now to the altar and still No Deal.
ONE SUSPECTS the feds keep losing the negotiation because even as they try to strong-arm the big banks on price, they're trucking in, through the freight door out back, tens and hundreds of billions, in cash, guarantees and sweetheart loans.
The banks, that is to say, would like to continue receiving their welfare checks while also holding on to their wounded assets -- until the markets revive, upon which they'll enjoy write-ups courtesy of FAS 157 to wipe out a lot of current paper losses.
Makes perfect business sense: Got a sugar daddy with bottom- less pockets? Well let him help you out, and ride out the storm. But don't go selling your pretty assets on the Street pennies pound, girl,
whatchu doin'? Yes, quite. But actually it's a bit stickier a wicket than that. To peel back another layer ...
When credit markets seized last fall worldwide in the wake of the Lehman bankruptcy, calls for suspending mark-to-market reached a pitch. The FASB then issued supplemental guidance (ahem) with Staff Position 157-3, which in good vague language allows holders of assets in markets "not active" to move those assets on their books to Level 3 -- where the old in-house mark-to-model method applies.
Banks aren't required to itemize their Level 3 holdings in public. But many probably enjoyed a goose this past autumn (did you notice?) when (say) a mortgage bond with a (non) market price of 22 cents moved to Level 3, where the model said (say) 65 cents.
But you see the problem. Today, were Treasury to buy same for 35 cents, Bank would re-write a 30 cent loss -- trading a bond marked at 65 cents for 35 in cash.
All the more sensible, then, that Bank prefers to stay on the dole and hold its wounded assets until the sun comes out.
makes perfect sense, too:
Banks that have managed themselves into the toilet must not walk away from their rescue with that hold-to-maturity juice
(that 30 cents) in their pocket, leaving Treasury-Fed with all risk of future performance but little or no reward. If government buys it must buy down, in the name of Moral Hazard (the brazen hussies), and to leave its taxpayers and overseas creditors some cushion.
As for worries that Bank, selling down, will suffer another round of losses as it re-writes down the autumn's 157-3 writeups ...
Well, the worry concerns only ongoing concerns. Paper losses don't signify under Seidman, since the corporate Zombie folds. Just one more reason to stop nursing them. Private sector partners, government guarantees, herding assets like wogs about the books, stuff and nonsense -- drops in the bucket, sir! Death by a hundred cuts. Barbarism, sir. No. What's called for is a firm clean stroke ...
SO BOTH SIDES at the TARP table make business sense, so much so as to block twice, across four months, under presidents from both parties, the will of Congress and a broadening movement among tenured brains to get wounded assets out of the big banks and into a governmental trust that cannot fail and will not burn down the city. All other roads seem headed to Pandemonium or Tokyo.
Broken markets for the assets are a necessary but insufficent cause of the impasse, which at bottom sits on palpable value roughly measurable: each side, where it sits today, needs the juice to do right by its obligees. There's nothing at odds with the businessman's calculus about not closing TARP sales; it has merely become too dangerous for society to tolerate.
Was the tipping point the sight of Bank of America suddenly out there on the sidewalk before Christmas, with its hand out for more ($20 billion cash and $118 in guarantees) to complete its already well subsidized buyout of bonus baby Merrill Lynch?
One felt the hand of the Salvation Army Santa in one's pocket.
Smelt liquor on his breath.
The businesslike impasse leaves the society with a political problem: public values have to be prioritized, and then somebody working in the public interest has to act accordingly.
Merrill (Emeritus), Bank of America & JPMorgan Chase
MR SEIDMAN's temporary nationalization (he uses the term "bridge bank") acknowledges the political problem and addresses it head on: The assets are sold out of the banks into the reso trust at a moment when both buyer and seller are loyal soldiers of Uncle Sam.
That is: During the moment of nationalization, there are no banker-shareholders in the loop to say Thanks but no thanks (but keep that TARP cash coming). This is precisely why the moment is necessary to get the Big Bank show back on the road. Otherwise we get more of the old Paulson-Geithner soft shoe.
Seidman's plan, then, bears likeness to the way Alexander finally dealt with the Gordian Knot: Out of patience, it stops talking and fiddling while Rome burns and forces the issue. Rough stuff. But
it's clear as the news continues to bleed that rude awakenings and manners are now called for.
The Gordian violence of Seidman's way is this: It wipes out the stockholders of the taken banks, as in a liquidating bankruptcy.
But look -- the shareholders have already taken the bulk of the hit in the stock market. Wiping them out entirely, at this point, would not be earthshaking.
Mr S reports joyfully at every opportunity: "We take out the shareholders and bring in new management!" The point -- at this point in the negotiation -- is political.
And after all, shouldn't a good Reaganaut insist that investors and management bear the burden of their mismanaged investments? It's the American way, they always say when people get fired. (Half a million last month.) That's Capitalism.
Yet this seems to be the hurdle before which on Tuesday the new administration balked. Odd.
Then again, at the World Economic fest at Davos the week before, JPMorgan Chase chief Jamie Dimon, who owns company stock, had told the folks who own and operate the world:
"JPMorgan would be fine if we stopped talking
about damn nationalization of the banks."
When J.P. Morgan talks ....
... Obama listens?
APPLYING MARK-TO-MARKET accounting to structured finance instruments across the board was a misconceived coup d'ideologie now horribly gone awry. The new rule suddenly required these bonds to publicly trade in size sufficient to produce price discovery, a holy grail of sorts for Free Marketeers.
But for segments of structured finance no secondary market worthy of the name ever existed, even in boom times, because these bonds are more like "deals" or "trades" (the terms the bankers I worked with, while drafting them, always used). CDOs, in particular, are custom-crafted deals, between two or three institutional players, full of idiosyncratic mechanics and side bets.
Vanilla corporate bonds, in contrast, are regulated and standardized by the SEC, and issued with (sound) generic credit ratings: built for public consumption and to trade in size rather interchangeably. But the SEC never reviews a CDO's Private Placement Memo, which is laden with prolix warnings about Liquidity Risk: the lack of markets where a seller can get fair value without getting a haircut.
So as FAS 157 drew near, the writing was on the wall. Absent active markets for their arcane bonds, institutions would have to start writing them down, regardless of how well they might be performing.
And (bad luck) the timing of FAS 157 could not have been worse. It came fully into force in
2007 -- as fallout from July's
funds founded on subprime mortgage bonds
Indeed, seeing that institutions began to implement 157 well ahead of the regulatory deadline, some have suggested that the accounting change was a cause of the Bear Stearns failures. The first tremblor here came in February 2007, when HSBC bank shocked and awed by reporting a big writedown of mortgage assets.
It's piquant, too, while looking over year-end 401(k) statements, to recall that the stock markets peaked a month before the FASB deadline. October 2007. When the Dow 30 briefly poked its head over 14,000. Today: 7900.
The investing public, the industries that rely on securitization (housing, credit card, auto loan, student loan, commercial leasing, etc) and the Treasury-Fed twins (each now deeply invested in Wall Street) would be served by replacing the FASB scheme re structured finance with a price control regime. !?!
First nationalization ... and now price controls?!
Which is to say: A regulatory body that does the modeling and prescribes the marks, segment by wounded segment, and in return for its efforts requires banks (at least) to itemize on Level 3. This would bring transparency and level-playing-fieldness to structured finance, rehabilitating its reputation, and thus jolt high finance and the globe's economies back to a better life.
Long, long ago, in a world far away -- 1999 -- Senator Phil Gramm of Texas capped his career with the repeal of the Glass-Steagall Act, which ever since the Great Depression had restricted commercial banks from behaving like investment banks. The last gasp of Reaganite deregulatory fever, one might say. Gramm's Folly. Nobody on today's tube seems to think about it much.
But one may wonder if the global finance system might have survived the pop of the U.S. housing bubble if these two regulatory moves (de-regulate the banks and mark structured finance to the Market god) -- sold with nostalgia for Gilded Age laissez-faire --
had never happened.
There must be some way out of here
Said the Joker to the Thief
There's too much confusion
I can't get no relief
A RECENT IMPORTANT STORY in the Times, well briefed on the vague Geithner plan the weekend before its unveiling, confirmed rumors that Obama's closest advisors both strongly disagreed with Geithner and nevertheless rolled over to him, conceding principles and every single point of the sketched plan.
How'd that new young fella who didn't pay his taxes and had to go on TV and say he was sorry get the better of Obama's inner circle? Lack of confidence in principles honed across two years of campaigning? Or was Tim backed by powers that proved irresistible?
(One recalls members of the House, during the bitter TARP debate, complaining the administration had threatened them with martial law. Surely riots would ensue if the TARP were tabled ...)
Whatever Obama's people may have thought and done and why, Geithner's debut Tuesday confirmed worries long on hand. It's now clear he is Paulson II. (Some had insisted all along he was Paulson's left brain.)
Most salient: The Big Bank idea at which Geithner gestured is the same that inspired the so-called MLEC, with which Paulson tried in late 2007 to stabilize staggering Structured Investment Vehicles (conduits for short-term commercial credit) then weighing on the money-center banks.
Loathe to signal nationalization, the Paulson-Geithner idea relies on the private sector to buy wounded assets from the banks, but with backdoor encouragement (guarantees, tax breaks, etc) from the feds.
The strategy quickly and completely failed in the MLEC, because the private sector said no thanks. Paulson gave a fire sale and nobody came. Too busy writing down their structured-finance portfolios. FAS 157 had hit the Street weeks before.
Today, the Ossa of Zombie junk on the block makes a wart of the SIV lawn sale, and it seems safe to assume that private sector buyers are worse off. There are eight million reasons in the Naked City why stocks tanked, gold spiked and every pundit on the planet gave Geithner the raspberry Tuesday afternoon -- this is one of them: There is no reason to think his rehash of the Smart-Money-to-the-Rescue idea has a chance to cure what ails our Zombies.
Maybe he'll wise up, while fleshing it out these coming weeks, and let it die. Brush it under the rug some Friday afternoon. While Rahm takes Helen Thomas to the Mayflower for happy hour.
The Secretary is disappointed to report that
the Zombies have failed their Stress Tests ...
Yeah, that's what Zombies do, sleep and eat flesh of the Body Politic. Time to take their freakin' heads off.
Otherwise we're going to stagger like it's Tokyo 1999. A year hence hundreds of banks will have failed, too small to bail (one analyst recently said 500), millions more people will be unemployed (half a million fired last month alone), and housing will still be swirling down, down, down into the maelstrom. In time Mr G will move on to the private sector and finally somebody smart like Seidman will get tapped to seize the Zombies, stamp their stock certificates "DEAD" and return a few healthy big banks to the system.
Yes we can.
Businessmen they drink my wine
Ploughmen dig my earth
None of them along the line
Know what any of it is worth
THAT THE PRESIDENT appointed and then rolled over to Mr Geithner -- despite much advice since election day that he was part of the problem since before we knew we had a problem -- will be looked back on as another early indication of Team Obama's inability or unwillingness to formulate and/or enforce its own ideas.
Might part of the problem be (see Vanity Fair) that a good deal of the team consists of tweenagers? WTF ...?
However that may be, it's a shocking plain fact, as the trumpets of a two-year campaign for Change still echo, that from high finance to the Pentagon the Bush- Cheney leadership is still at the helm.
Bernanke, Geithner. Gates, Mullen.
No change we need. No change at all.
Who woulda thunk it?
Can it be that Obama has the style and publicity chops of a revolutionary, but neither the ideas nor the nerve?
Let us not talk falsely now
The hour is getting late ...
HILLARY WAS my man early on in the primaries. Then John Edwards, too. Both were marshalling the Democratic forces to counter the 30-year assault on American workers of globalizing Neo-liberalism (aka Thatcherism aka Reaganomics).
Meanwhile Obama sang that beautiful song of Change, while showing the world, as Bill Clinton did in 1992, what the world under GOP leadership was missing.
When the air cleared after the Donkey dust-up, I was very happy with the candidate, just hoping he could win (maybe see postscript here). And when he won I was dumbstruck with well founded joy.
But I thought he had the chops. The ideas and nerve to carry
the torch. Today ... I dunno. Man's looking like the cover of True
Well. Kennedy had a queasy first couple of months too. Then things got rough. Here's hoping our President finds his sea legs soon.
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