January 29, 2009
The $700 billion Troubled Assets Relief Program (TARP) doesn’t seem to have accomplished much in the way of relieving banks from the ownership of “troubled assets”. In fact, nobody seems to know exactly what was done with the first $350 billion in TARP funds, and those who do know are not talking. Meanwhile, the nation’s banks have continued to flounder. As David Cho reported in The Washington Post on Wednesday, January 28:
The health of many banks is getting worse, not better, as the downturn makes it difficult for all kinds of consumers and businesses to pay back money they borrowed from these financial firms. Conservative estimates put bank losses yet to be declared at $1 trillion.
The continuing need for banks to unload their toxic assets has brought attention to the idea of creating a “bad bank” to buy mortgage-backed securities and other toxic assets, thus freeing-up banks to get back into the lending business. Bloomberg News and other sources reported on Wednesday that FDIC chair, Sheila Bair, is pushing for her agency to run such a “bad bank”. Our new Treasury Secretary, Tim Geithner, has also discussed the idea of such a bank (often referred to as an “aggregator bank”) as reported on Wednesday by Reuters:
Geithner said last week the administration was reviewing the option of setting up a bad bank, but that it is “enormously complicated to get right.”
The idea of creating such a bank has drawn quite a bit of criticism. Back on January 18, Paul Krugman (recipient of the Nobel Prize in Economics) characterized this approach, without first “nationalizing” the banks on a temporary basis, as “Wall Street Voodoo”:
A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.
The current buzz suggests, however, that policy makers aren’t willing to take either of these approaches. Instead, they’re reportedly gravitating toward a compromise approach: moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” that would resemble the Resolution Trust Corporation, but without seizing the banks first.
Krugman scrutinized Sheila Bair’s earlier explanation that the aggregator bank would buy the toxic assets at “fair value”, by questioning how we define what “fair value” really means. He concluded that this entire endeavor (as it is currently being discussed) is a bad idea for all concerned:
Unfortunately, the price of this retreat into superstition may be high. I hope I’m wrong, but I suspect that taxpayers are about to get another raw deal — and that we’re about to get another financial rescue plan that fails to do the job.
Krugman is not alone in his skepticism concerning this plan. As Annelena Lobb and Rob Curran reported in Wednesday’s Wall Street Journal, this idea is facing some criticism from those in the financial planning business:
“I don’t see how this increases liquidity,” says Paul Sutherland, chief investment officer at FIM Group in Traverse City, Mich. “This idea that we should burn million-dollar bills from taxpayers to take bad assets isn’t the best path.”
Billionaire financier Geroge Soros told CNBC that he disagrees with the “bad bank” strategy, explaining that the proposal “will help relieve the situation, but it will not be sufficient to turn it around”. He then took advantage of the opportunity to criticize the execution of the first stage of the TARP bailout:
As to Paulson’s handling of the first half of the $700 billion Wall Street bailout fund known as TARP, Soros said the money was used “capriciously and haphazardly.” He said half of it has now been wasted, and the rest will need to be used to plug holes.
Former Secretary of Labor, Robert Reich, anticipates that a “big chunk” of the remaining TARP funds will be used to create this aggregator bank. Accordingly, he has suggested application of the type of standards that were absent during the first TARP phase:
Until the taxpayer-financed Bad Bank has recouped the costs of these purchases through selling the toxic assets in the open market, private-sector banks that benefit from this form of taxpayer relief must (1) refrain from issuing dividends, purchasing other companies, or paying off creditors; (2) compensate their executives, traders, or directors no more than 10 percent of what they received in 2007; (3) be reimbursed by their executives, traders, and directors 50 percent of whatever amounts they were compensated in 2005, 2006, 2007, and 2008 — compensation which was, after all, based on false premises and fraudulent assertions, and on balance sheets that hid the true extent of these banks’ risks and liabilities; and (4) commit at least 90 percent of their remaining capital to new bank loans.
However, Reich’s precondition: “Until the taxpayer-financed Bad Bank has recouped the costs of these purchases through selling the toxic assets in the open market” is exactly what makes his approach unworkable. The cost of purchasing the toxic assets from banks will never be recouped by selling them in the open market. This point was emphasized by none other than “Doctor Doom” himself (Dr. Nouriel Roubini) during an interview with CNBC at the World Economic Forum in Davos, Switzerland. Dr. Roubini pointed out:
At which price do you buy the assets? If you buy them at a high price, you are having a huge fiscal cost. If you buy them at the right market price, the banks are insolvent and you have to take them over. So I think it’s a bad idea. It’s another form of moral hazard and putting on the taxpayers, the cost of the bailout of the financial system.
What is Dr. Roubini’s solution? Face up to the reality that the banks are insolvent and “do what Sweden did”: take over the banks, clean them up by selling off the bad assets and sell them back to the private sector.
Nevertheless, you can’t always count on the federal government to do the right thing. In this case, I doubt that they will. As David Cho pointed out at the end of his Washington Post article:
The bailout program “is a public relations nightmare,” one government official said. He added that Obama officials are sure to face criticism for whatever course they take.
It’s Time For Obama And Geithner To Blink
February 16, 2009
On Tuesday, February 10, our newly-appointed Treasury Secretary, “Turbo” Tim Geithner, rolled out a vague description of his new “Financial Stability Plan”. Most commentators were shocked at the lack of information Geithner provided about this proposal.
This was in stark contrast with President Obama’s description of what we would hear from Geithner, as the President explained during his February 9 press conference. In response to a question by Jennifer Loven of the Associated Press, concerning his earlier statements about the worsening recession, Obama stated:
Later in the conference, Julianna Goldman of Bloomberg News asked the President how he could expect the remaining $350 billion in available in TARP funds to solve the problems with the financial system when individuals, such as economist Nouriel Roubini, have explained that the price tag for such a fix could exceed a trillion dollars. Again, the President explained:
Yet again, in response to a question from Helene Cooper of The New York Times as to whether financial institutions receiving federal bailout money would be required to resume lending again, the President responded:
Despite this hype, the following day’s presentation by Tim Geithner offered neither “clear and specific plans” nor “great detail” about the principles involved. Nearly all of the editorials dealing with this strange event voiced a negative appraisal of Geithner’s discourse, particularly due to the complete absence of any discussion of specific measures to be employed by the Department of the Treasury. Did something change between Monday night and Tuesday’s event? Recent developments suggest that disagreements over the details of this plan, particularly those related to the possible “nationalization” of insolvent banks, forced the entire project into a state of flux.
Prior to last Tuesday’s fiasco, Geithner admitted to David Brooks of The New York Times that he was averse to the idea of nationalizing insolvent banks, even on a temporary basis:
Geithner’s throwaway argument was disputed by Joe Nocera in the February 13 New York Times:
Geithner’s resistance to nationalization of insolvent banks represents a stark departure from the recommendations of many economists. While attending the World Economic Forum in Davos, Switzerland last month, Dr. Nouriel Roubini explained (during an interview on CNBC) that the cost of purchasing the toxic assets from banks will never be recouped by selling them in the open market:
Dr. Roubini’s solution is to face up to the reality that the banks are insolvent and “do what Sweden did”: take over the banks, clean them up by selling off the bad assets and sell them back to the private sector. On February 15, Dr. Roubini repeated this theme in a Washington Post article he co-wrote with fellow New York University economics professor, Matthew Richardson.
Even after Geithner’s disastrous press conference, President Obama voiced a negative reaction to the Swedish approach during an interview with Terry Moran of ABC News:
Obama’s strident resistance to the Swedish approach could force him into an embarrassing situation, in the event that he changes his view of that strategy. This may happen once Geithner begins applying his “stress tests” this week, to measure the solvency of individual banks. On the ABC News program “This Week”, Republican Senator Lindsey Graham of South Carolina expressed his opinion that the option of nationalizing these unhealthy banks should remain open:
President Obama and Turbo Tim need to keep similarly open minds about the nationalization option. They wouldn’t want to be on the wrong side of the “moral hazard” argument, forcing taxpayers to eat the losses risked by investors — especially with a prominent Republican wagging his finger at them. This situation calls for only one response by the new administration: Blink.