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Blank Check

| Sun Sep. 21, 2008 5:28 PM EDT

BLANK CHECK....There seems to be a growing consensus on the left that if the American taxpayers are going to give Henry Paulson a blank check to bail out a bunch of investment banks, then the American taxpayers ought to get a piece of the action in return. For example, here's Robert Reich:

The government (i.e. taxpayers) [should get] an equity stake in every Wall Street financial company proportional to the amount of bad debt that company shoves onto the public. So when and if Wall Street shares rise, taxpayers are rewarded for accepting so much risk.

Maybe this makes sense. But I wonder: do we really want equity stakes in all these firms? I don't. I'd rather have senior debt. Besides, I'm not sure I especially want the federal government to own half of Wall Street anyway.

So here's another idea. Instead of an equity stake, we offer ailing banks the following deal: the taxpayers will buy your toxic waste for 20 cents on the dollar. (Or 10 cents or 30 cents. Whatever.) We'll hold it for a maximum of 24 months, at which point you can buy it back from us at, say, a 10% premium, and then sell it off yourselves. If you choose not to buy it back, Uncle Sam will sell it off. If we sell it at a profit, we'll keep the upside. If we sell it at a loss, you guys will make up the difference. The payback terms will be, oh, let's say three points above LIBOR over five years.

And what control do the banks have over how much we sell this stuff for? None. They have to trust us to get the best possible price. To coin a term, they have to give us a blank check. Seems like a fair exchange.

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Hedge Funds Next?

| Sun Sep. 21, 2008 2:27 PM EDT

HEDGE FUNDS NEXT?....Henry Paulson announced today that the Great Wall Street Bailout will also be a City bailout and a Bankenviertel bailout and a Ginza bailout:

"The American people don't care who owns the financial institution," he told ABC's "This Week." "If the financial institution in this country has problems, it'll have the same impact whether it's U.S.- or foreign-owned." The United States is also working with foreign governments to take actions of their own.

That's not too surprising. Unfortunately, he went on to say this:

Paulson made clear that he did not expect to use the program to purchase assets from hedge funds.

That's what they usually say right before they're finally forced to admit that some particular corner of the financial industry is actually in big trouble, right? So I assume this means that a bailout of a few big hedge funds is right around the corner. After all, some of them are almost certain to be hanging on by their eye teeth right now, and at least a few of those hangers-on are Too Big To Fail. So cue up the money machine.

Will Her VP Run Hurt Palin in Alaska?

| Sun Sep. 21, 2008 2:09 PM EDT

The fact that the McCain campaign essentially speaks for Sarah Palin — answering any question directed at her office by everyday Alaskans — is hurting her popularity in-state. And Democratic legislators, accustomed to partnering with Palin, have soured on the Governor. From the LA Times:

In stubbornly independent Alaska, the sudden intrusion of a political campaign into so many corners of state government -- not to mention Wasilla, where a dozen or more campaign researchers and lawyers have also begun overseeing the release of any information about Palin's years as mayor -- has touched a raw nerve. McCain staffers have even been assigned to answer calls for Palin's family members, who have been instructed not to talk.
"Why did the McCain campaign take over the governor's office?" the Anchorage Daily News demanded in an editorial Saturday. "Is it too much to ask that Alaska's governor speak for herself, directly to Alaskans, about her actions as Alaska's governor?"

Petty and Childish

| Sun Sep. 21, 2008 1:44 PM EDT

PETTY AND CHILDISH....Matt Stoller passes along an email about the Wall Street bailout from "a lawmaker":

I also find myself drawn to provisions that would serve no useful purpose except to insult the industry, like requiring the CEOs, CFOs and the chair of the board of any entity that sells mortgage related securities to the Treasury Department to certify that they have completed an approved course in credit counseling. That is now required of consumers filing bankruptcy to make sure they feel properly humiliated for being head over heels in debt, although most lost control of their finances because of a serious illness in the family. That would just be petty and childish, and completely in character for me.

Hey, nothing wrong with petty and childish! There's a time and place for everything.

But while we're on this subject, one of the popular memes making the rounds right now is that in return for bailing out Wall Street, we should institute draconian restrictions on executive compensation in the financial industry. I'm skeptical. Any rule you can make, the rocket scientists will eventually figure a way around. Besides, I'd rather try to attack the root cause: compensation for these guys is astronomical because the finance industry itself has become so astronomically profitable, as the NYT chart on the right shows. But it's a mystery why this should be. After all, as finance becomes ever more efficient, as it has over the past few decades, arbitrage opportunities should get thinner and the industry should get more competitive. This should reduce profit margins and overall profitability — and aggregate bonus payouts along with it — shouldn't it?

The reason it hasn't appears to be a combination of fraud, vastly increased leverage, asset bubbles, and the increasing use of finance-for-the-sake-of-finance to tap into the global savings mega-glut in any way possible — regardless of whether the investment vehicles are of any real-world use or not. I may be off base here, but it strikes me that if the industry is properly regulated, reducing allowable leverage ratios and forcing managers back to using finance as a tool to provide capital to actual businesses, rather than as an end in itself, this would go a long way toward reining in compensation in a way that's more robust than artificial rules. Add in mortgage reforms, a legislative mandate (with regulatory teeth) for the Fed and the Treasury to pay more attention to asset inflation, and higher tax rates on extremely high incomes, and not only would compensation packages become halfway reasonable, but we'd actually reduce the insane bubble psychology that prompted the current collapse in the first place.

Can this be done? Would it work? I don't know, but I'd like to hear more about it from people who understand the intricacies of modern finance. But the bottom line is that skyrocketing compensation is a symptom of the problem, not the problem itself. So why not attack the problem directly?

European Banks

| Sun Sep. 21, 2008 1:03 PM EDT

EUROPEAN BANKS....A few days ago I asked whether any big European banks had collapsed. A couple of days later HBOS essentially did just that. Today, via Matt Yglesias, Daniel Gros and Stefano Micossi suggest that European banks are actually worse off than American banks:

The dozen largest European banks have now on average an overall leverage ratio (shareholders equity to total assets) of 35, compared to less than 20 for the largest US banks. But at the same time most large European banks also report regulatory leverage ratios of close to 10. Part of the difference is explained by the fact that the massive in-house investment banking operations of European banks are not subject to any regulatory capital requirement.

....The key problem on this side of the Atlantic is that the largest European banks have become not only too big to fail but also too big to be saved. For example, the total liabilities of Deutsche Bank (leverage ratio over 50!) amount to around 2,000 billion euro, (more than Fannie Mai) or over 80 % of the GDP of Germany....With banks that have outgrown national regulators and the financing capacities of national treasuries, European central banks and regulators are living on borrowed time. They cannot simply develop "road maps" but must contemplate a worst case scenario.

For now, I'm passing this along without comment. Just something to keep an eye on while we all contemplate the end of the world.

From the Annals of Regular Guy-dom

| Sun Sep. 21, 2008 12:51 PM EDT

FROM THE ANNALS OF REGULAR GUY-DOM....The McCain family owns 13 cars, including "three 2000 NEV Gem electric vehicles, which are bubble-shaped cars popular in retirement communities." Mostly in Cindy's name, of course. Don't you wish you owned three bubble-shaped electric scooters?

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Bailout Reax

| Sat Sep. 20, 2008 9:51 PM EDT

BAILOUT REAX....Paul Krugman opposes the Paulson/Bernanke bank rescue because there's no guarantee it will work. Atrios doesn't like it because it gives Paulson a blank check with no oversight. Brad DeLong doesn't like it because it lacks necessary reforms to balance the bailout. Sebastian Mallaby, by contrast, just doesn't like it, period:

Within hours of the Treasury announcement Friday, economists had proposed preferable alternatives. Their core insight is that it is better to boost the banking system by increasing its capital than by reducing its loans.

....Raghuram Rajan and Luigi Zingales of the University of Chicago suggest ways to force the banks to raise capital without tapping the taxpayers. First, the government should tell banks to cancel all dividend payments. Banks don't do that on their own because it would signal weakness; if everyone knows the dividend has been canceled because of a government rule, the signaling issue would be removed. Second, the government should tell all healthy banks to issue new equity. Again, banks resist doing this because they don't want to signal weakness and they don't want to dilute existing shareholders. A government order could cut through these obstacles.

Meanwhile, Charles Calomiris of Columbia University and Douglas Elmendorf of the Brookings Institution have offered versions of another idea. The government should help not by buying banks' bad loans but by buying equity stakes in the banks themselves. Whereas it's horribly complicated to value bad loans, banks have share prices you can look up in seconds, so government could inject capital into banks quickly and at a fair level. The share prices of banks that recovered would rise, compensating taxpayers for losses on their stakes in the banks that eventually went under.

Congress and the administration may not like the sound of these ideas....But we are in the midst of a crisis, and it shouldn't matter how things sound. The Treasury plan outlined on Friday involves vast risks to taxpayers, huge complexity and no guarantee of success. There are better ways forward.

The tide has started to turn against the bailout plan surprisingly quickly. Is this just because the market recovered on Thursday and Friday and things seem slightly less scary now than they did a couple of days ago? Is it because this plan is flawed at its core? I'm not sure. But by the time Monday rolls around, I suspect there's going to be at least a strong minority consensus that we should all have a little more information before we get steamrollered into approving this thing.

Meanwhile, if you're looking for a good old fashioned screed against greedy bankers written by someone from within their own ranks, check out Eric Hovde in the Post today. It'll help clear your arteries.

UPDATE: And then there's this:

"A lot of those people will have to sell their homes, they're going to cut back on the private jets and the vacations. They may even have to take their kids out of private school," said [Robert] Frank. "It's a total reworking of their lifestyle."

...."It's going to be very hard psychologically for these people," Frank said. "I talked to one guy who had to give up his private jet recently. And he said of all the trials in his life, giving that up was the hardest thing he's ever done."

Anybody got a tissue? I think I may start crying.

After the Bailout

| Sat Sep. 20, 2008 7:35 PM EDT

AFTER THE BAILOUT....Following on to my post this morning about the Wall Street bailout, you might be wondering what happens after Hank Paulson buys up all the toxic waste that U.S. banks are currently holding on their balance sheets. If the feds pay some kind of halfway reasonable price for this stuff (whatever that might be), and after everything is cleaned up it turns out that — surprise! — everyone is insolvent after all — what then? Hell if I know. I guess we're just hoping that this turns out not to be the case. If Hank & Co. are wrong about this, it means yet more taxpayer dough down the rathole, I suppose. We have to have a functioning banking system, after all, so we're sort of over a barrel here.

If I can be allowed to state the obvious for a moment, one of the things that makes this so frustrating for us little people is that most of the tycoons who made fortunes off this Ponzi scheme are going to get off scot free (or close enough not to make a difference). Sure, we can punish the banks if we want to, but who really cares about that? They're just legal fictions. What you'd really like to do is punish the people who were running the banks while all this was happening. But they've already got their money, and there's no legal way to take it back. The poor saps who are losing their homes, however, are easily and personally identifiable, so it's easy to punish them. And we will. In the end, the titans of Wall Street will funnel their newly titanic fortunes into numbered Swiss bank accounts and lie low for a couple of years, while all the rest of us pay the price. Makes you feel all tingly inside, doesn't it?

The only upside from this steaming mess is the possibility that Congress might pass laws to rein in bad behavior in the future and make the Wall Street casino a wee bit less insanely profitable than it is today. Maybe by taxing extremely high incomes at higher rates. (Hell, taxing extremely high incomes at normal rates would be a start.) Or regulating leverage ratios for everyone, not just commercial banks. Or putting an end to no-down-no-doc-no-asset mortgage idiocy. That's closing the barn door a few years too late, of course, but at least it would force tomorrow's rocket scientists to go to the trouble of figuring out new ways to fleece us.

Atrios says: forget it. Sensible new regulations aren't gonna happen. And he may be right. Republicans will certainly fight any serious reforms that might hurt rich people, and Democrats haven't exactly covered themselves with glory on this score either. But look: that's what we're all here for. We should be raising hell with our congressional representatives to get serious about this stuff, and if they won't do it we should be working to elect new ones. If the current crew won't commit to changing things, then stop giving them money. After all, this is at least as important as net neutrality or immigration reform or raising the minimum wage, isn't it? So pick up the phone and start complaining.

And while we're on the subject, it's easy sometimes to lose sight of the outright fraud (and might-as-well-be-fraud) that was the foundation stone for so much of our current crisis. After all, most of the day-to-day coverage over the past few weeks has been about arcane financial maneuverings and numbers with lots of zeroes after them. To refresh your memory, then, you might want to check out Dean Starkman's "Boiler Room" in the current issue of CJR. If you're not mad enough to call your congressman yet, this ought to help get you there.

Caving on Torture

| Sat Sep. 20, 2008 5:10 PM EDT

CAVING ON TORTURE....Jonathan Alter points out that, by Sarah Palin's standard, John McCain has passed only two major laws during his 26 years in Congress. But it turns out that even that's giving him too much credit:

While McCain deserves credit for the landmark 2002 McCain-Feingold campaign-finance reform bill, the only other major law on which his office says his "name appears" (Palin's standard) is the "McCain Amendment" prohibiting torture in the armed forces. But that has little meaning because of a bill this year, supported by McCain, that allows torture by the CIA. Under longstanding government practice, military intelligence officers can be temporarily designated as CIA officers ("sheep-dipped" is the bureaucratic lingo) when they want to go off the Army field manual. In other words, the government can still torture anyone, any time. McCain caved on an issue he insists is a matter of principle.

Italics mine. I knew about the CIA torture exemption, of course, but I didn't know that this exemption essentially guts the anti-torture provisions that apply to military intelligence as well. Nice job, senator.

Solvency vs. Liquidity

| Sat Sep. 20, 2008 12:27 PM EDT

SOLVENCY vs. LIQUIDITY....Paul Krugman says he's uneasy about the proposed Wall Street bailout because it seems to be based on the mistaken idea that all we have is a liquidity problem. Atrios amplifies:

Again, the problem is that lots of bad loans were made, lots of people made highly leveraged investments in those bad loans, and still more people bet on those loans by insuring them. The loans are bad. The mortgages are not going to be repaid in full. Housing prices are not going to magically shoot up 50% over the next 6 months. People gambled and lost and now the Democrats are racing to bail them all out.

I'll make the standard disclaimer that there's no way for an ordinary layman to have enough information to truly judge what's going on behind all those closed doors in Washington. And I'll add further that as laymen go, I'm as ordinary as you can get. Nonetheless.

It's true that the Bernanke/Paulson bailout is aimed at illiquid debt instruments. And those instruments are illiquid largely because they contain lots of toxic mortgage securities and nobody knows how much this stuff is really worth. It's unlikely that the toxic sludge makes these instruments literally worth nothing, but who knows? The mere possibility that they're worthless means that any bank who owns them might be insolvent, and since everyone owns at least some of them, this in turn means that everyone might be insolvent. Result: no one is willing to loan money to anyone else, because who wants to loan money to a bank that might never pay it back? And since huge flows of overnight interbank loans are the oil that lubricates the credit markets, when this flow seizes up, the entire credit market seizes up. (What's more, if this WSJ tick-tock is correct, the seizure became critical on Wednesday, which is why B&P changed their minds midweek about pursuing a systemwide bailout that they'd opposed earlier.)

The purpose of the bailout, then, isn't to recapitalize the banks, it's to put a firm value on the toxic sludge once and for all. Maybe it's a dime on the dollar, maybe it's 50 cents on the dollar. Whatever. When that's done and the feds have purchased the sludge, some banks will turn out to be insolvent, and perhaps they'll be allowed to fail. Others will turn out to be in bad shape but still solvent, and they'll continue doing business. Once that's sorted out, the commercial paper market will loosen back up since everyone will know who it's safe to loan money to and who it's not.

Now, there are obviously all sorts of problems here. How is the Treasury going to value all the sludge? If they value it too high, then we really are bailing out irresponsible bankers who made stupid loans, and the taxpayers will foot the bill when the sludge eventually gets sold off at a loss. Value it too low and the feds are acting as vultures, causing more bank failures than we really ought to have. Furthermore, once the sludge is off Wall Street's books and some big banks turn out to be involvent for certain, will they really be allowed to fail? Or will Bernanke and Paulson prop them up yet again?

Beats me. Obviously skepticism is warranted on these scores, especially since we're all being asked to approve the bailout basically at gunpoint. Still, it's not clear to me that Bernanke and Paulson are unaware that the real problem is insolvency, not illiquidity. Their plan, as near as I can tell, is to liquidate the sludge precisely so we can tell who's really involvent and who isn't. What's more, if Democrats manage to grow a spine over the next few days (and no, I'm not taking bets), the bailout bill could contain provisions to restructure loans for distressed homeowners, which means, contra Atrios, that all those bad loans could genuinely become a little less bad. It would be nice if this were set up so that restructuring was mandatory for any bank that wanted government help, but given the way all these mortgages have been sliced and diced over the years, I don't even know for sure if that's possible.

Again: I'm guessing here based on my current knowledge of what's going on. Anybody who thinks I'm missing the point should let me know. And obviously we should all be watching like hawks to make sure that B&P aren't offering sweetheart deals to the masters of the universe who caused the meltdown in the first place. But that's why God invented Democratic committee chairmen, right?