A Couple of Items on the Bank Bailout

by Dollars and Sense

Here are a couple of items on the bank bailout that I've been meaning to post. First is a post from back in late February (seems like years!) on Megan McArdle's blog at the Atlantic (whose spiffy redesign I admire, if not the politics of its columnists). It is a response to this post on Paul Krugman's blog at the New York Times, but it relates to Fred Moseley's cover article in the March/April issue of D&S. Here's McAdle's post in full:

Lost

Paul Krugman channels Adam Posen on Japan's lost decade, and what it means for us:

The guarantees that the US government has already extended to the banks in the last year, and the insufficient (though large) capital injections without government control or adequate conditionality also already given under TARP, closely mimic those given by the Japanese government in the mid-1990s to keep their major banks open without having to recognize specific failures and losses. The result then, and the emerging result now, is that the banks' top management simply burns through that cash, socializing the losses for the taxpayer, grabbing any rare gains for management payouts or shareholder dividends, and ending up still undercapitalized. Pretending that distressed assets are worth more than they actually are today for regulatory purposes persuades no one besides the regulators, and just gives the banks more taxpayer money to spend down, and more time to impose a credit crunch.

These kind of half-measures to keep banks open rather than disciplined are precisely what the Japanese Ministry of Finance engaged in from their bubble's burst in 1992 through to 1998 ...

Why is the government so reluctant to hand losses to the bondholders? The standard explanation on both far left and far right is that Treasury and the Fed are in the pocket of the banking industry, and Geithner et. al. are simply bailing out their corporate masters. I don't entirely discount this theory, though I would (and did) put it more nicely: all the information the regulators has comes from the people they are trying to regulate. This naturally biases them towards the regulated. Every time I am tempted to get outraged about this, I think through the alternative: regulators who don't have much interaction with those they oversee. I'll take Tim Geithner over Maxine Waters any day of the week, and twice on Sunday.

And in this case, I don't think that's the whole, or even the greatest part, of the explanation. Rather, I think their problem is largely political: avoiding the "n" word, yes, but more importantly, avoiding any more crisis injections of capital into the system.

It's easy to blithely say "Why don't they just make the bondholders take a haircut?" Harder when you think about who those bondholders are: insurers. pension funds. the bond component of your 401(k). Financial debt makes up something like a third of the bond market, and the largest holders are pensions and insurers.

The insurers are the biggest problem, because they're just so heavily regulated. They're not allowed to hold risky assets. Convert their bonds to equity and they will be forced to dump that equity at prices that will trend towards zero. Many insurers will see their capital impaired below the regulatory limits, requiring a government bailout.

Pension funds are the next biggest problem. They're already in big trouble because of stock market declines. The bonds are the "safe" portion of their portfolio, the stuff that's supposed ot be akin to ready cash. Convert their bonds to equity--or worse, default--and suddenly they're illiquid and even further underwater.

Nor is the 401(k) problem small. Bond funds are typically held most heavily by the people closest to retirement; they're for income, not capital gains. What is your mother going to do when a third of her mutual fund income gets converted to equity that produces no cash and can't be sold because the insurers have all had to dump their shares on the market at once? Or simply disappears into the land of bankruptcy lawsuits?

There's also the problem of what it does to the ability of banks to raise capital. Bank bonds are sold on the implicit assumption that the taxpayer, not the lender, will eat capital deficiencies. Changing that understanding risks runs on the bank a la Lehman whenever a financial institution looks the least bit shaky. Banks are inherently highly leveraged institutions even in a good regulatory environment; this might make our banking system much more volatile in the future. It's somewhat akin to what would happen if we simply announced that the FDIC would stop tomorrow.

I think what Geithner et. al. fear is that nationalizing or reorganization will put the government on the hook for massive and immediate losses in both the banking system, and the "safe" entities that lent it money. I fear they may be right. But I think the lesson of Japan is that we have to do it anyway. I don't know what form the fix should take. I don't know how painful the fix will be. But I'm pretty sure any fix that makes us recognize the losses, recapitalize the banks, and move on, will be better than two decades of zombie banks and glacial growth.

I asked Fred Moseley (who, again, wrote our current cover article on bank nationalization) how he would respond to McArdle. Here's what he wrote back to me:

My main response to McArdle is this: if it is true that the only way to avoid an economic catastrophe is to bail out the banks and their bondholders with taxpayer money, then I would say that this strengthens the case for the nationalization of systematically significant banks. If taxpayers have to pay for their losses this time, then surely we want to make sure that we never have to pay again, that we are never put in this situation again. And the best way to ensure that it never happens again is to nationalize the systemically significant banks. Then we would never again be forced to decide between bailing out the bondholders or economic armageddon.

I was shocked to read: "Bank bonds are sold on the IMPLICIT ASSUMPTION that the taxpayer, not the lender, will eat capital deficiencies." Really? The bondholders make money on the assumption that taxpayers will eat the losses? What a racket!

In addition, as I argue in my article, there is a third alternative, nationalization with debt-equity swaps (for unsecured senior creditors). And this nationalization should be permanent, pace above, so we never have to face a similar crisis again.

On the difficulties of debt-equity swaps for insurance companies (the "biggest problem"): just declare that insurance companies will be allowed to own THESE equities, and ONLY these equities. The non-equity rule is intended to prohibit insurance companies from making risky investments. Well, it is too late for that; the cows are already out of the barn. The insurance companies have already made these risky investments. The only alternative to allowing the insurance companies to own these equities is for taxpayers to pay for their losses. Allowing the insurance companies to own these equities is clearly the only equitable option.

On pension funds: bank debt is less than 2% of the total assets of pension funds. So a modest loss on bank debt would not be that significant, especially since the values of all the other assets of pension funds are falling too. Plus, the managers of these pension funds made investment decisions for which they, not the taxpayers, should not bear the consequences. Maybe the management of these pension funds should be changed.

So in the end McArdle seems to want pseudo-nationalization, without bondholder haircuts and with large taxpayer losses. She wants to make explicit the "implicit assumption" that taxpayers eat the losses. The only way to avoid this is real nationalization, with haircuts for the bondholders.

When Fred says "the only way to avoid this is real nationalization," he's including under the rubric of "nationalization" the possibility that the gubm't could set up "good banks," and I'm assuming that in that scenario the "too big to fail" banks could be allowed to whither and die (i.e. enter into bankruptcy, and let the good assets be sorted from the bad in court). This is what Joseph Stiglitz seemed to be saying in his presidential address to the Eastern Economics Association meetings a few weeks ago (about which I blogged here; his article in the current issue of The Nation seems to be more of a proposal for pseudo-(i.e., temporary) nationalization, however). Something like a "whither and die" proposal also seems to be Dave Lindorff's position in a recent piece over at Counterpunch:

The futility and stupidity of the Fed's and the Obama administration's policy of pumping ever more money into failing banks and insurance companies in a vain effort to get them lending again was demonstrated—if anyone was paying attention—by the collapse in auto sales this past month, with all the leading companies, Ford, GM and Toyota, reporting sales down by about 40%.

This fall off in car buying was despite record discounting by the auto industry, and offers of 0% financing.

Clearly, obtaining financing is not the reason people are not buying cars.

People are not buying cars because they are worried about having a job to enable them to pay back the loan.

It's the same reason people aren't buying houses. It's not that you cannot get a mortgage. There are plenty of smaller banks that would be happy to lend money to buy a house these days. But who's going to go out and buy a house in this economy? First of all, to buy a house, unless you are a first-time buyer, you have to sell your current house, but that would mean taking a huge loss. Indeed, one in five homes in America today is technically "underwater"—that is, it is worth less than the outstanding mortgage on the property. Probably another one in five are worth little more than the outstanding mortgage. No one would sell a house under either such circumstance.

The point here is that if people aren't willing to spend money, then what good is it to give more money to banks and their shareholders, in hopes that they will start lending it? The lending business has two sides—those offering to make a loan, and those wanting to borrow. If there's no borrower, no amount of money available for lending is going to change the fact that there will be no loans written.

Read the rest of the article.

Labels: bank nationalization, credit crisis, Dave Lindorff, financial crisis, Fred Moseley, Joseph Stiglitz, Megan McArdle, nationalization, Paul Krugman

 

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3/10/2009 01:29:00 PM 0 comments

 

Confusion, Tunneling, and Looting

by Dollars and Sense

Interesting post from the blog Baseline Scenario.

Emerging market crises are marked by an increase in tunneling—i.e., borderline legal/illegal smuggling of value out of businesses. As time horizons become shorter, employees have less incentive to protect shareholder value and are more inclined to help out friends or prepare a soft exit for themselves.

Boris Fyodorov, the late Russian Minister of Finance who struggled for many years against corruption and the abuse of authority, could be blunt. Confusion helps the powerful, he argued. When there are complicated government bailout schemes, multiple exchange rates, or high inflation, it is very hard to keep track of market prices and to protect the value of firms. The result, if taken to an extreme, is looting: the collapse of banks, industrial firms, and other entities because the insiders take the money (or other valuables) and run.

This is the prospect now faced by the United States.

Treasury has made it clear that they will proceed with a "mix-and-match" strategy, as advertized. And people close to the Administration tell me things along the lines of "it will be messy" and "there is no alternative." The people involved are convinced—and hold this almost as an unshakeable ideology—that this is the only way to bring private capital into banks.

Read the rest of the post.

Labels: bank nationalization, Baseline Scenario, Corporate Fraud, financial crisis, fraud, nationalization

 

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3/06/2009 02:33:00 PM 0 comments

 

Job Creation Proposal from 1973

by Dollars and Sense

From Bob Feldman:

Perlo's 1973 Alternative Jobs Creation Proposal Revisited

Most hip anti-war people in the United States (and most long-time readers of Dollars & Sense) probably realize by now that the U.S. government's recently passed "economic stimulus" legislation won't really create enough high-wage jobs for U.S. workers to really restore economic prosperity for most U.S. working-class people; or quickly stop the rapid rise in long-term unemployment rates for U.S. blue-collar and office workers.

Yet until anti-war left dissidents in the United States are able to quickly present some kind of anti-militarist alternative left jobs creation program for U.S. working-class people to mobilize in support of on the U.S. streets, the suffering of U.S. working-class people in the current U.S. historical "era of permanent war abroad and economic depression at home" will probably continue to increase--until there's finally some kind of upturn in U.S. capitalism's business cycle.

In a 1973 book, The Unstable Economy: Booms and Recessions In The U.S. Since 1945 (International Publishers), a Marxist economist named Victor Perlo indicated what an anti-war alternative left jobs creation program for the U.S. economy might look like by proposing the following:

"Nationalization and government operation of major economic units are essential for overcoming monopoly domination of the economy to the extent necessary for realizing significant progressive reforms.

"Plants abandoned by private owners, or left with substantially curtailed operations, are prime targets for nationalization. Conspicuous in this respect are enterprises in the aerospace and other armament-connected industries, whose private owners have proved unwilling or unable to shift to civilian production. Also there has been large-scale phasing out of electornic plants, as multinational corporations have shifted output to foreign lands. There continues a constant flow of industrial enterprises from urban areas, where workers are organized into relatively strong unions, into rural areas, and especially to open-shop southern areas offering special tax concessions and a prospect of low wages and no resistance to inferior working conditions.

"The government should take over all such plants, fully maintain employment, and charge the corporation with all transitional costs.

"It should take over munitions plants generally, thereby weakening the economic base of the notorious `military-industrial complex.'

"The transportation system should be nationalized...The entire system should be made into an integrated public system for freight and passengers, covering all modes of transportation, with lowered fares and rates, greatly increased and improved service.

"The telephone system and other `public utilities' should be made really public, to end the superhigh charges and corresponding private profits now guaranteed by business-dominated regulating commissions.

"Along with a system of socialized medicine, available without charge to all, there should be nationalization of the drug industry, hospitals, and related industries.

"The construction of new housing should be nationalized. That is the only way to build quickly the tens of millions of units needed to decently house America at rents the illl-housed can afford, with adequate employment opportunites for Black and other minority workers...

"Nationalization of industry should not be like that of the `public authorities' and some quasi-government corporations run by boards of directors and managers from the officialdom of the private big corporations and banks, for the profit of these enterprises rather than service to the public.

"Democratic nationalization is required, involving direct, major participation by the workers of the nationalized enterprises in their management, and a real voice for the users of the services. It calls for boards of directors to be elected directly by the voters and by the enterprise workers...

"Aa whole series of measures would be directed towards cutting unemployment...A major element in the fight against unemployment is to win a shorter work week and the elimination of overtime. This, of course, would directly add millions of jobs...

"...The demand has become popular among workers for continuation of unemployment insurance for the full term of unemployment. This should be accompanied by expanding coverage to all workers, minimizing the waiting periods, ending the exclusion of strikers and other categories of workers, and ending the humiliating compensation offices with their pressure on the client to take sub-standard jobs at sub-standard pay.

"A uniform Federal system should be substituted for the state systems, and the payments should be financed out of general revenues.

"Every enterprise, private and public, should be required to employ Black and other minority workers at least in proportion to their numbers in the area's population at each occupational level, including the highest managerial and professional levels...

"All Government support for and privileges granted to existing foreign investments would be ended. New private corporate foreign investments would be completely prohibited or sharply curtailed. This would encourage economic growth in the United States, by making it not longer possible for big corporations to give priority to overseas operations while cutting back at home..."

--b.f.

Labels: 1973, employment, jobs, militarism, nationalization, Victor Perlo

 

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2/25/2009 11:23:00 AM 0 comments