Ian Welsh

The horizon is not so far as we can see, but as far as we can imagine

Tag: Geithner

Elizabeth Warren: Finally someone with a clue how to handle the financial crisis

By

On April 5, 2009

Comments

Warren’s the chief watchdog for the 700 billion TARP fund.  Unfortunately, she has no real power, but it’s still nice to see a government official say not just some of the right things, but almost all of the right things.  Talk of how the US is following Japan’s path is finally everywhere (myself and a few others have been talking about it for years, and started really beating the drums last year).  Here’s Elizabeth:

Warren, a Harvard law professor and chair of the congressional oversight committee monitoring the government’s Troubled Asset Relief Program (Tarp), is also set to call for shareholders in those institutions to be “wiped out”. “It is crucial for these things to happen,” she said. “Japan tried to avoid them and just offered subsidy with little or no consequences for management or equity investors, and this is why Japan suffered a lost decade.”…

… Warren also believes there are “dangers inherent” in the approach taken by treasury secretary Tim Geithner, who she says has offered “open-ended subsidies” to some of the world’s biggest financial institutions without adequately weighing potential pitfalls. “We want to ensure that the treasury gives the public an alternative approach,” she said, adding that she was worried that banks would not recover while they were being fed subsidies. “When are they going to say, enough?” she said.

She also calls for the resignation of the CEOs of the worst firms.

One thing I’m tired of hearing though is the phrase “lost decade”.  Japan didn’t just lose a decade, it has never really recovered.  The good times have never come back.

I also think that bondholders need to take a haircut as well, not just shareholders, though they may not need to be wiped out in all cases.  However, if the value of a company if it was liquidated is less than zero, then yes, non-secured bondholders (those whose bonds aren’t attached to specific assets with value) should be wiped out.

I’m Sure There’s a Difference Between the Bush/Paulson, Obama/Geithner Approaches to Bailouts

By

On April 4, 2009

Comments

I’m just not sure what:

The Obama administration is engineering its new bailout initiatives in a way that it believes will allow firms benefiting from the programs to avoid restrictions imposed by Congress, including limits on lavish executive pay, according to government officials.

Administration officials have concluded that this approach is vital for persuading firms to participate in programs funded by the $700 billion financial rescue package.

The administration believes it can sidestep the rules because, in many cases, it has decided not to provide federal aid directly to financial companies, the sources said. Instead, the government has set up special entities that act as middlemen, channeling the bailout funds to the firms and, via this two-step process, stripping away the requirement that the restrictions be imposed, according to officials.

At this point in time, there seems to be no significant functional difference between Paulson/Bush and Geithner/Obama.  Both intended to give a ton of money to financial firms, either directly or by buying up crap at prices higher than justified.  Both opposed any meaningful restrictions on how they spent the money or who they gave it to.

Actually, I take it back, one difference is that when Paulson wanted 700 billion, he went to Congress.  When Geithner made up his plan he just had the FDIC and the FED pony up most of the money, because he knew Congress wouldn’t give him the money.

Some wonder if this is legal:

Although some experts are questioning the legality of this strategy, the officials said it gives them latitude to determine whether firms should be subject to the congressional restrictions, which would require recipients to turn over ownership stakes to the government, as well as curb executive pay.

Me, I don’t know if it’s legal.  What I do know is that they plan on giving money away in a manner which clearly intends to end-run Congress’s clearly legislated mandate for how it be given away.  What I know is that they are bypassing Congress when they can, because they know that the elected body which is the only one supposed to be able to pass spending bills wouldn’t give them all the money they want to spend and won’t let them spend what money it does give as freely as they want to.

Of course, that money will still have to be paid back by taxpayers, even if Congress never approved the spending.

But back to the TARP restrictions:

Congress drafted the restrictions amid its highly contentious consideration of the $700 billion rescue legislation last fall. At the time, lawmakers were aiming to reform the lavish pay practices on Wall Street. Congress also wanted the government to gain the right to buy stock in companies so that taxpayers would benefit if the firms recovered.

The requirements were honored in an initial program injecting public money directly into banks. That effort was developed by the Bush administration and continued by Obama’s team. The initiative is on track to account for the bulk of the money spent from the rescue package. All the major banks already submit to executive-compensation provisions and have surrendered ownership stakes as part of this program.

Yet as the Treasury has readied other programs, it has increasingly turned to creating the special entities. Legal experts said the Treasury’s plan to bypass the restrictions may be unlawful.

The problem is that while Geithner’s plan takes money from the FDIC and the Fed, it still uses some TARP money as seed money, and that money carries the restrictions.

I thought it wasn’t the executive’s job to decide that Congress is wrong and then deliberately end-run it.  I thought we had an election to stop this sort of thing.

This is one of the things we spent the last 8 years blasting Bush for doing. But in this particular case, the new administration is being less compliant with Congress’s will than the Bush administration was!

Less!

I don’t know whether to spit or cry.  I’ve always had my doubts about Obama, but in my worst dreams I didn’t think he’d try and end run Congress even more blatantly than Bush, in order to give even more money away to the richest Americans with even fewer restrictions and less protection from the taxpayer in terms of ownership stakes.

It’s going to be a long 4 years.

How To Reform Credit Default Swaps

By

On March 26, 2009

Comments

Geithner was asked today if he believed in naked credit default swaps.  Apparently he does, but it was both the wrong question and answer.  Reform of credit default swaps needs to be thorough, and though through from basic principles.  Here’s how to fix credit default swaps.

The first step is a name change.  Call them insurance, because that’s what they are.  The insure against the possibility that you won’t get paid money someone owes you.  Once they’re called insurance, regulate them like insurance.

  1. Require an insurable interest.  That is, if Joe owes Fred money, Emma can’t buy insurance on Joe not paying Fred.  This is a fundamental rule in most insurance, you can’t insure someone else’s house against fire, because then you have a reason to want that house to wind up on fire, and no reason not to want it to burn down.
  2. Don’t allow over-insurance.  No debt can be insured for more than it’s worth.  If Joe owes Fred $100, then Fred can’t buy more than $100 worth of insurance.  In fact, better, he can’t buy more than $90 worth of insurance.  Again, we don’t want anyone better off if the debtor defaults than if they make the payments.  In life insurance there are many studies which show that people who are worth more dead than alive tend to die a lot more than people who aren’t over insured.  Imagine that.
  3. The mathematical models and actuarial tables used to figure out how much must be paid for insurance, the premiums, are set by government actuaries, just like they are in most other insurance businesses.  Current credit default models tended to assume things like “this housing bubble will last forever” and “there will never be another recession” and “defaults don’t cluster”.  Those assumptions were so wrong that building them into models amounted to fraud.
  4. No product which insures against credit default can be put on the market without actuaries from government regulatory bodies reviewing it.
  5. Proper reserves.  The party issuing the credit default swaps must have enough money to back them up, based on the governments actuarial charts and reserve requirements.  Life insurers and property insurers have to, so should credit insurers.  These reserves cannot be the debts the insurer is insuring.

There are other methods one could use to regulate and fix the default market, like having open exchange traded contracts, which could be made to work as well, but this is the simplest model and one that has worked well in the rest of the insurance industry.

The larger rule is simpler: no unregulated financial markets or entities without sufficient capital to cover their bets, so the taxpayer winds up stuck with the bill.  If you want to gamble, go to Las Vegas.  If you want to sell insurance, be a nice old fashioned stody insurance company who pays your executives low six figure salaries.

Does the Geithner Plan Reduce Credit Default Swap Risk Too?

By

On March 24, 2009

Comments

Credit default swaps (CDSs) are still a big issue. Estimates of how much of the market is at risk vary, but the lowest I’ve seen is about $15 trillion.  If that goes bad, we’re probably talking another $3 or $4 trillion of damage.

While I agree that CDSs are an issue, I also think that taking bad assets off firm’s hands makes defaults on CDSs more unlikely, and thus reduces exposure to them.

Of course, this really depends on whether the fundamental problem lies with the economy or the financial market—or both.  If the economy keeps going south, then bailout after bailout will be needed, defaults will happen anyway, and CDSs will be called.  If the combination of fixing the financial sector plus the stimulus bill and military spending is enough to stop the economy’s downward spiral, on the other hand, then Geithner’s plan may well do the trick (once a couple more trillion are spent). We’ll see.

(Aside: Interest rate and currency swaps are about a 7 times larger market than CDSs.  The real risk is a currency meltdown by a major economy.)

Market Rallies On News of Trillion Dollar Giveaway

By

On March 23, 2009

Comments

Image by TW Collins

Image by TW Collins

Is anyone really surprised the DOW is up almost 500 points, after Geithner promised to give private investors almost $1 trillion to gamble with?

The details of the giveaway are fascinating.  I sure wish that I could get financing like this to play the market:

Under one part of the plan focused on bad loans, the Treasury will provide up to 80 percent of initial capital alongside investment by private funds. The FDIC would then offer debt financing for up to six times the pooled amount.

Now, unless I’m messing up my math, that’s 24/1 leverage.  If older details hold, and the 80% is a non-recourse loan, meaning that it’s secured only by the value of securities bought, then it’s even sweeter.

PIMCO has announced it’s interested in participating, which means that the plan has succeeded in one sense—it has the buy-in of some very smart money.  That doesn’t mean that it’s necessarily good for taxpayers, or that it will be good in the long term for the economy, necessarily, but at least it isn’t being laughed out of Dodge.  On the other hand, would you refuse 24/1 to one financing?  Or even matching funds, as contained in part two of the plan?

I sure wouldn’t.  And PIMCO have been scavengers before.  They bet heavily in Fannie and Freddie bonds after it was clear Fannie and Freddie were insolvent, which was a bet that the government wouldn’t shear bondholders when it bailed out Freddie and Fannie.  Smart bet, but not a good return for taxpayers, who would have been better served by letting Freddie and Fannie’s debtholders lose money.

I am becoming increasingly convinced that my original call was the right one: that the various bailouts would lead to Japanification.  For 20 years now, since its own bubble burst, Japan has had an economy which slips in and out of recessions like clockwork and which never ever really got good again.  In Japan’s case, the lousy economy was in large part because they left a lot of debt debt on the books of private corporations.  In America’s case, the debt may be transfered to taxpayers, but the end result is likely to be the same, only compounded by attempts to create secondary bubbles so that the toxic waste regains enough value to claim a win.

Given that Geithner’s trillion dollar giveaway has been greated ecstatically by the financial sector, I expect we’ll see more money used in this fashion.  This plan appears to be good for about $2 trillion of lousy debt ($1 trillion from the matching 1/1 program, $1 trillion from the high leveraged portion).  Total current toxic waste on the banks books is probably about $4 trillion, which will still have to be dealt with.

That money will have to be paid off, eventually.  Doing so will cost the US  and the world a great deal of future growth, and individuals a great deal of future income and employment.  As things stand right now, I don’t think employment levels as measured by employment/population ratios will recover in the forseeable future—post recession “full” employment will just be lower than pre-recession “full” employment.  There are still some ways this could be made to work for everyone, and I’ll discuss those at a later date.

The AIG Bonus Clawback Bill Won’t Work But Here’s What Will

By

On March 23, 2009

Comments

Historical top tax ratesLast week the House passed a bill designed to claw back bonuses over $250K from recipients of TARP money.

Now I’m a class warfare guy on the side of regular folks (as opposed to the rich, who are winning the current war and won the last one), but this bill is counterproductive and won’t work.  It is too easy to work around and it is targeting the wrong people.

  1. The clawback only affects bonuses, leaving a loophole where TARP recipients can just recategorize bonuses as salaries.
  2. If the clawback applied to all income, then employees would be moved to contract status or to companies which haven’t received TARP money (even if artificial companies have to be created for the purpose).
  3. The threshold of $250K of household income is not that high, as Henry Blodgett points out.  Don’t get me wrong, no family making that amount is poor, but they are still affluent.  (I’ve never made anything close to it, so this isn’t a personal thing.) At the same time, they aren’t filthy rich, either, and they shouldn’t be taxed as if they were.

But concentrating on bonuses for employees at firms which have been bailed out misses the point.  It’s not just those firms whose employees need to be taxed more heavily, it’s everyone.

The logic for increasing taxes is simple enough. For the last 20 years, American executives have been able to pay themselves such large bonuses that in 3 to 5 years they could amass enough money that hey would never need to work again.  This executive compensation system created the incentive to do whatever was required in order to get those bonuses—leading to flagrant risk taking and outright fraud.  It also led to a short-term focus on the business.  When executives know that it doesn’t matter to their personal financial well-being if their firm exists in 5 years, they don’t worry about the long term consequences of their decisions.  All that matters is booking “profit” now, so you can get money now, and become rich now.

Wall Street and the banks didn’t make any money in the last 10 years, for all that they booked record profits.  The combined losses of the financial firms is larger than their entire reported profits.  What they did was sell synthetic securities based on dubious assumptions about the future—that the housing bubble would continue forever, there would never be another recession,  and defaults wouldn’t cluster; and book the entire calculated future profits of these securities as profit in the year they were created.  Of course, those future profits were fictional, but the bonuses based on them were in real money.

In order to make sure this never happens again compensation needs to be restricted in every firm, not just in the US, but in the industrialized world.  Executives and salespeople and auditors and loan officers (if banks decide to rehire any) need to know that ten years from now if a loan goes bad that they’re going to be on the carpet for it, that they might lose their job for it, and that they will still need a job in 10 years.

I recommend 7 measures to restrict compensation:

Read More

More Details On Geithner’s Plan

By

On March 23, 2009

Comments

US Gold Coin

US Gold Coin

Bloomberg’s has more highlights of Obama’s plan for toxic assets that will be unveiled Monday by Treasury Secretary Geithner.  Newer details include:

  1. Geithner will ask Congress to give the Treasury and FDIC more powers: to guarantee more types of debt, limit payments to creditors,  and break executive compensation contracts.
  2. The Federal Reserves Term Asset Loan Facility program (TALF) will expand to riskier assets. Financing will be 1:1, and will apparently include private partners (in a way similar to the Treasury fund) who will make the investment decisions.  Profits and losses will be shared between the government and the private sector.

I still don’t like the FDIC funding plan, because the public component is up to 97%, but the Fed TALF plan makes a lot more sense.  Doing the funding 50% public, 50% private is much more fair, is not nearly as heavily leveraged (although leverage can be applied in other ways) and losses are shared much more equally, assuming these are not non-recourse loans (which they appear not to be, though that’s not certain.)

The additional powers Geithenr is asking for are acceptable, except for the ability to guarantee more types of debt.  The FDIC is already guaranteeing many bank assets: the idea of them guaranteeing even riskier classes only serves to set up  taxpayers to shoulder even more losses from the private sector’s.

Many of these concerns would be moot if the administration would just nationalize firms which are effectively insolvent. But, given that the administration won’t nationalize the banks, at least parts of this plan are not completely stupid.

The plan does however appear to perpetuate the trend of taking on private losses and putting taxpayers at risk for most of them.

Krugman Song

By

On March 22, 2009

Comments

This song about Paul Krugman raises an important point: why isn’t Krugman or someone like him calling the shots, rather than people like Treasury Secretary Timothy Geithner and White House National Economic Council Director Larry Summers who helped cause the crisis?

Plus it should make you laugh.

(Hat tip to Thers at FDL.)

Powered by WordPress & Theme by Anders Norén