European Banks

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....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?

Bailout Reax

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

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

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

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?

IT HAS TO MAKE SENSE BEFORE YOU CAN CALL IT SLEAZY....Joe Klein calls this John McCain's "sleaziest smear," but I'm just plain mystified. What is this supposed to mean:

My friends, this is the problem in Washington. People like Senator Obama have been too busy gaming the system and haven't ever done a thing to challenge the system. That isn't country first, that's Obama first.

Obama has been gaming the system? Huh? Is McCain just letting the Attack-otron 3000 put together random words for him and then delivering them without bothering to see if they make sense or not? He's been all over the map for the past week.

FRIDAY CATBLOGGING....Fall is here! I know your puny human calendar says it's still a few days away, but I know better because my seasonal alarm clock has spoken. A few days ago, after a summer of ignoring it, Domino once again demanded (literally) that we clear the junk off the sheepskin pod and put it back up on the couch for her to sleep in. This is a much better indicator than all that solstice/equinox stuff.

Though it may be a little iffy about which season is coming up. Last year Domino demanded the return of the pod right before winter. This is either an indication of a chilly fall ahead of us, or else an indication that Domino has a brain the size of a peanut. But look: if you had a brain the size of a peanut, you'd have trouble keeping track of seasons too. So don't be too judgmental.

Meanwhile, Inkblot doesn't need a pod or any other kind of sleep aid. Just a paw over his eyes and he's set to go.

Market Reform Update

MARKET REFORM UPDATE....Dean Baker is unhappy with the SEC's decision to ban short selling in financial stocks:

So where does the SEC get off banning shorts? Has it determined that bank stocks are undervalued? How did it make that determination? Does it ever determine that stocks are overvalued and therefore ban buying?

....If the issue is price manipulation, it is hard to believe that this is the first time market actors have manipulated prices. If they have the ability to do it on the down side now with financial stocks, then presumably they have also manipulated stock prices on the upside on other occasions. Why is the former worse than the latter?

Point taken. I probably agree, though I don't think I object to temporary restriction during panics. For a more impassioned defense of restrictions on short sellers, "Mad Money" senior writer Cliff Mason has you covered in comments to yesterday's post on the subject.

On another subject, Jon Taplin believes that one of the financial reforms we should insist on once the immediate crisis is resolved is to do away with mark-to-market accounting. He quotes William Isaac:

Fair Value Accounting dictates that financial institutions holding financial instruments available for sale (such as mortgage-backed securities) must mark those assets to market. That sounds reasonable. But what do we do when the already thin market for those assets freezes up and only a handful of transactions occur at extremely depressed prices?

....When there are temporary impairments of asset values due to economic and marketplace events, regulators must give institutions an opportunity to survive the temporary impairment. Assets should not be marked to unrealistic fire-sale prices.

This is an old controversy, and I won't pretend to have a sophisticated opinion about it. Still, I'd be careful about "reforming" this. Mark-to-market is a basic matter of transparency, and overall it helps prevent financial abuses by keeping banks from hiding worthless crap on their balance sheets. Our goal should be to prevent (or ameliorate) panics in the first place, and if we do that then mark-to-market is a feature, not a bug. I'd be inclined to move very slowly on this one.

THE DECLINE AND FALL OF SARAH PALIN....The Sarah Palin chickens are coming home to roost, and I'm here to crow about it:

Me, on August 29: "Conservatives on the tube are really, really struggling to defend this choice. I almost feel sorry for them. I'm sticking to my guns that before long this will be seen for the debacle it is."

My colleague Jonathan Stein, today: "Palin is simply not the giant-killer we thought she was. Take a look at this chart....she now has the lowest approval rating of any member of either ticket."

The clear lesson from all this: more people should listen to me! Spread the word.