What does the administration want from the banks? Power without accountability
February 11th, 2009By David Goldman
If the government actually nationalizes the banks, then the government has to take responsibility for what they do, and for the economic outcome. Why should the Obama administration want to do something that stupid? The puzzle in Geithner’s approach is the presumption that the administration actually believes that the banking system is NOT lending, and that the economy would recover if it were to lend. That is perfectly ridiculous, of course. The banking system has been lending plenty, and as I observed in a post earlier this week, during December it added non-Treasury securities (corporates and mortgages) at an annual rate in excess of 40%. This is obvious, and Geithner is not stupid.
The administration is not optimizing economic results so much as it is optimizing its own power. The pathetic spectacle of a parade of bank CEO’s humbling themselves before the Barney [Frank] Show in Washington is a sign of the times. By dribbling in capital through the preferred part of the capital structure, along with equity warrants, the White House avoids formal control of the banks. But it runs them just the same. It has maximum power and minimum accountability.
In Europe, where civil servants and commercial bankers go to the same schools, have the same income expectations, and work the same hours, it really doesn’t matter whether you nationalize the banks or not. The same sorts of people will run them with the same sorts of results.
America is different; as the President rightly said in his Nightline interview last night, the culture is different. America has a bare-knuckles political market in public goods. The moment you nationalize a Citicorp or a Bank of America, every Congressman will have an opinion as to where it should lend, preferably in his/her home district. And why did it close branches, and fire tellers? And why isn’t it sponsoring the local sports team? Trying to run nationalized banks on the American political model would be the stuff of a Preston Sturges comedy.
Why does Geithner refuse to give details of what he will do? The classic, universal Wall Street answer applies: Because he can. He can use stress tests to prove that every bank would insolvent just one standard deviation away from where we are now (at 45% on the VIX, a standard dev is sickeningly large), and force them all to swallow Federal capital along with Federal controls. Or he can ease up on mark to market rules, and make them all show tidy profits during the first quarter. Given that bank executives are working for restricted stock, Geithner has a great deal to say about whether they eventually will get paid. He is making it up as he goes along because he can get away with doing so. As long as the credit market continues to fund the banks (and the Fed does so) it is immaterial where their equity trades during the next several months.
Keeping the banks afloat under nominally private ownership also avoids vaporizing the $800 billion universe of bank capital hybrid securities, perhaps 40% of which are owned by insurers who look much tippier than the banks.
February 12th, 2009 at 1:42 am
“Why does Geithner refuse to give details of what he will do? The classic, universal Wall Street answer applies: Because he can.”
David,
I think part of what happened with regard to Geithner was a disagreement among Obama staff on how to proceed. On one side you have Geithner who helped formulate the Paulson plan, TARP etc. and would like to retain some sense on continuity. On the other side you have Rohm Emmanuel who most likely wants to wipe out bank shareholders and teach the bankers a lesson. This divisiveness might be the reason there was a lack of clarity provided by Geithner. Mr. Obama is going to have to get some control over his administration.
February 12th, 2009 at 1:55 am
With regard to the hybrid securites owned by insurance companies, are these trust preferred securities? If so, aren’t these Junior Subordinated debt obligations owned by a trust? The question is, how would the government wipe out the trust preferreds when in fact these are low level debt instruments with quasi equity characteristics for regulatory purposes? I ask because I own some BAC trust preferreds which have performed as though they will be wiped out. The issuer can defer the payments for 20 quarters but after that I would gather it to be treated as a default on debt. I would appreciate your help in understanding how this part of the capital structure works. Specifically, how would the bonds held by these trusts be wiped out without triggering a default on debt? Thank you David.
February 12th, 2009 at 2:30 am
What about a ”penalty box” for banks? That is we declare some level of reserves as solvent, we price all the scary hidden bad stuff pessimistically, and make a point of finally airing out all the hidden gotchas. We embrace Mark-To-Market and value that junk where it belongs. Any bank that has enough reserves is free and clear. Any bank with too little reserves is stuck in the penalty box.
We let the banks operate, but they have to stay in the “Penalty box” until their reserves are high enough. While in the ‘penalty box’ we’d give a judge powers comparable to a bankruptcy judge (It’s really bankruptcy but we don’t say that because that sounds too scary.) — he could shut down silly deals like the Mets deal, stop crazy bonuses, mergers, dividends and other silliness, while we keep those Chinese/Japanese/Arab/evil global banker bond owners happy. Basically we let them operate but clip their wings a little bit. And yes, the government will have to come in to put out fires, but we have a court that has the option to spread the pain around a little more evenly if it becomes too bad.
I just always feel there’s one more looming disaster just around the corner and I just want to know what’s going on. Also punishing banks by taking their toys away will help head off the already looming political problem with all this. Politically bank bailouts are becoming poison, and this is going to be a big problem. Bank stocks would be valued based on when the bank would make it out of the penalty box.
February 12th, 2009 at 7:56 am
Bank preferred will be treated as equity, that is, vaporized, in the extreme bank nationalization case (they are counted as Tier 1 capital, that is, shareholders’ capital). That’s what happened to the Fannie and Freddie preferred’s with conservatorship last September. And that’s why they are trading so badly. I picked up a few at low dollar prices on speculation that it won’t come to that.
I think we’re past the “penalty box” stage. If you mark everyone to market the whole system is insolvent, as it was in 1981 and 1991, but even more so this time.
February 13th, 2009 at 12:26 am
[...] Inner Workings » Blog Archive » What does the administration want … [...]
February 13th, 2009 at 4:30 am
[...] Inner Workings » Blog Archive » What does the administration want … [...]