Kevin Drum

Checks and Bailouts

| Mon Sep. 22, 2008 1:26 PM EDT

CHECKS AND BAILOUTS....As near as I can tell, conservatives are outraged by the idea of a blank check Wall Street bailout because — hey, Barack Obama might win in November, and God only knows what kind of insane nutball he might appoint as Treasury Secretary. Do we really want to trust $700 billion to whatever quasi-socialist we might end up with on January 20th?

Liberals, meanwhile, are outraged by the idea of a blank check bailout because — hey, even if you trust Henry Paulson, it's possible that John McCain might win in November, and God only knows what kind of insane nutball he might appoint as Treasury Secretary. Do we really want to trust $700 billion to whatever quasi-lunatic we might end up with on January 20th? Phil Gramm, anyone?

This almost restores my faith in the political system.

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More on Hedge Funds

| Mon Sep. 22, 2008 1:11 PM EDT

MORE ON HEDGE FUNDS....Via Atrios, Nouriel Roubini provides a potted history of the Great Financial Crisis of 2007-08. I'll skip right to the good part:

The first stage....The next step....The third stage....The fourth stage....The next stage will be a run on thousands of highly leveraged hedge funds. After a brief lock-up period, investors in such funds can redeem their investments on a quarterly basis; thus a bank-like run on hedge funds is highly possible. Hundreds of smaller, younger funds that have taken excessive risks with high leverage and are poorly managed may collapse. A massive shake-out of the bloated hedge fund industry is likely in the next two years.

Hedge fund apologists have been pretty smug about how all our current problems have been caused by investment banks, which are (lightly) regulated, and none at all by the big bad hedge funds, which operate with no regulation at all. And so far they've been right. But does anyone believe this is going to last? And what will Bernanke and Paulson do if and when a systemic rout in the hedge fund market threatens to undo their bailout plan? Will they bail out the hedge funds too?

Lehman Brothers

| Mon Sep. 22, 2008 12:29 PM EDT

LEHMAN BROTHERS....I've now read in three different places credible suggestions that last week's financial meltdown was caused not by generic "worsening credit conditions," but by the Fed's ill-advised decision to let Lehman Brothers go into bankruptcy. This led to a wave of defaults that rippled through the industry and eventually froze the credit markets.

Question: has anyone seen anything detailed and plausible that either refutes this or backs it up? I'm just curious. For now, I remain agnostic on the question.

Regulatory Reform

| Mon Sep. 22, 2008 2:04 AM EDT

REGULATORY REFORM....Congress seems likely to pass some version of Henry Paulson's Wall Street bailout bill. Maybe not precisely his version, but something close, maybe with some oversight added and a few restrictions on exactly how the money can be used. We will, of course, be promised that although the bailout has to be passed this instant and there's no time to add regulatory reform into the enabling legislation, reform will be taken up just as soon as we've all caught our breath. I figure there are three ways this could turn out:

  • Option A: Republicans will filibuster, Democrats will wither, and basically nothing much will get passed at all. In other words, suckered again.

  • Options B: There will be some kind of panic and we'll end up with a gigantic snarl of regulation that sounds tough but doesn't really do anyone any good, sort of like Sarbanes-Oxley.

  • Option C: Everyone will take a deep breath, Democrats will stand up to the financial industry, and some reasonable set of new regulations will be hammered into place.

I'd put the odds at about 60% for Option A, 35% for Option B, and 5% for Option C. My only reservation is that maybe I'm being a little too optimistic about all this.

Blank Check

| Sun Sep. 21, 2008 6:28 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.

Hedge Funds Next?

| Sun Sep. 21, 2008 3:27 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.

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Petty and Childish

| Sun Sep. 21, 2008 2:44 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 2:03 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 1:51 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?

Bailout Reax

| Sat Sep. 20, 2008 10:51 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.