by hilzoy
From the WSJ:
“The U.S. government is expected to take stakes in nine of the nation’s top financial institutions as part of a new plan to restore confidence to the battered U.S. banking system, a far-reaching effort that puts the government’s guarantee behind the basic plumbing of financial markets.
To kick off Tuesday’s expected announcement, the government is set to buy preferred equity stakes in Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp. — including the soon-to-be acquired Merrill Lynch — Citigroup Inc., Wells Fargo & Co., Bank of New York Mellon and State Street Corp., according to people familiar with the matter. (…)
Other elements of the plan, which will be announced Tuesday morning, include: equity investments in possibly thousands of other banks; lifting the cap on deposit insurance for certain bank accounts, such as those used by small businesses; and guaranteeing certain types of bank lending. It builds on an earlier plan to buy up rotten assets dragging down banks, which failed to calm investor fears, and follows similar moves by major European countries.
Formulated jointly by the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp., these moves are designed to keep money flowing through the financial system, ensuring that banks continue lending to companies, consumers and each other. A freeze in these markets rippled through the economy and helped cause stocks to crater last week.
Along with the government’s involvement come certain restrictions, such as caps on executive pay. For example, firms can’t write new employment contracts containing golden parachutes and their ability to use certain executive salaries as a tax deduction is capped. These restrictions are relatively weak compared with what congressional Democrats had wanted when they approved this spending, a potential flash point.”
Two big caveats before I go on. First, this reporting is preliminary; the report tomorrow should have more details. Second, I am not an economist, so take my opinion for what little it’s worth. That said:
This sounds a lot better than the original plan to buy up troubled assets. In fact, it sounds so good to Brad DeLong that he wants to start singing hymns of praise in Latin. And that’s a wonderful thing. So this post is not meant to detract from the fact that as best I can tell, this is a very, very good thing.
However, I note a couple of things that have generally been part of discussions of this kind of plan. First, there is no triage: no attempt to separate banks that are basically solvent from banks that are not. Second, there are no forced writedowns. I would have thought that either would be a very good idea, under the circumstances.
One of the things you really, really want, under the circumstances, is for everyone to know that the banks are now trustworthy: that no more big unpleasant surprises lurk in their balance sheets. One of the things that I gather you do not want is for banks to put off unpleasant revelations as long as possible. To do this, people seem to think that one should figure out which banks are insolvent, “and like Old Yeller, “gently” put them down.” Then:
“Before they get new equity, banks must be forced to write down the value of their assets to nuclear-winter levels. And they must disclose, in detail, the carrying value of their assets so the market can make sure they have done this.
Why?
Because the goal of investing taxpayer equity in banks is threefold:
*Improve the banks’ capital ratios, so they can start lending again
*Persuade private investors to invest in banks again
*Flush all the crap so we can start fresh…unlike Japan.
If the government does not force banks to write down their assets before injecting new equity, we won’t have fixed the problem. Instead, the US taxpayer will just be the lastest sucker to fall for the banks’ assertions that all the bad news is out of the way. Private investors, meanwhile, will stay on the sidelines and watch the taxpayer get sandbagged. Lastly, and most importantly (for the economy), banks won’t start lending again. Why not? Because they’ll want to keep all that new capital as a cushion for the next wave of writedowns.
Japanese banks played this game for a decade…and we know where it got them (NIKKEI Index is currently one-fifth of the peak value 18 years ago.) In Sweden, meanwhile, the government insisted on writedowns, and the economy recovered almost immediately.”
I suspect that Paulson and others in the administration have a hard time accepting the need for this sort of policy. They are, after all, conservatives, and this is, after all, partial nationalization of banks. But if my reading is correct, hanging back is a bad idea. If you’re going to do this sort of thing, you should be quick and aggressive about it. As I understand it, that’s the best way both the get the economy back on its feet and to get the government out of the banking business as quickly as possible.
But for all that, the plan sounds like a big step in the right direction.
PS: Image from here.
sorry about the post-over.
a question though — what is the signaling effect going to be regarding banks that aren’t part of the plan. in other words, is it a good or bad signal if a bank DOESN’T get help?
TARP Dance 1
Once Again, Let’s Call It The Plan That Worked
From Steve Lohr in the NY Times:
http://www.nytimes.com/2008/10/14/business/economy/14nationalize.html?hp
“Elsewhere, government bank-investment programs are routinely called nationalization programs. But that is not likely in America, where nationalization is a word to avoid, given the aversion to anything that hints of socialism.
“Putting this plan on the table makes a lot of sense, but you can’t call it nationalization here,” said Simon Johnson, an economist at the Sloan School of Management at the Massachusetts Institute of Technology. “In France, it is fine, but not in the United States.”
Of course not, just like we can’t call guarantees, well, guarantees.
“The goal is to get the engine of capitalism going as productively as possible,” said Nancy Koehn, a historian at the Harvard Business School. “Ideology is a luxury good in times of crisis.”
This should make me and Bob McTeer feel better.
“So when Sweden, for example, faced a financial meltdown in the early 1990s, the nationalization of much of the banking industry was welcomed. The Swedish government quickly bought stakes in banks, and sold most of them off later — a model of swift, forceful intervention in a credit crisis, financial experts say.”
Why listen to experts, or idiots like me? The TARP plan is still too complicated.
TARP Tap Dance 2
Felix Salmon with more points about TARP:
http://www.portfolio.com/views/blogs/market-movers/2008/10/13/the-weakness-of-the-treasurys-new-bailout-plan
“There’s no sure way to prevent such risk-taking altogether. But if you go the UK route and insist on board seats and the ouster of failed executives, it helps. That’s what Treasury did with AIG, and they should do the same with the banks they’re rescuing. If they don’t, they’re basically getting all of the downside of nationalization with none of the upside.
I’m quite sure that Paulson hates the fact that he’s semi-nationalizing the banking system. But he needs to get real and accept it, rather than trying to brush it under the carpet. Otherwise he’s putting hundreds of billions of taxpayer dollars at unnecessary risk.”
Paulson just can’t seem to go all the way, for whatever reasons.
TARP Tap Dance 3
Yves Smith on Naked Capitalism on TARP:
http://www.nakedcapitalism.com/2008/10/wsj-provides-sneak-preview-of-treasury.html
“But here we go, virtually no restrictions (the Bloomberg article mentions executive comp limits, but given Paulson’s stance, expect this to be cosmetic), no (a la Sweden) having a disciplined process to figure out who was worth salvaging and concentrating rescue dollars on them, and having a strategy (consolidation, liquidation, spinning bad assets off into an Resolution Trust type “bad bank” vehicle) for the ones that didn’t make the cut.
The Swedish government showed a profit by taking deliberate action. Throwing money at a dartboard isn’t likely to produce good outcomes.”
I’m sensing a pattern to these criticisms. We’re not quite up to following the Swedish Plan. That would be too clean, clear, sensible, and easy to get out of.
scratch my question — i saw elsewhere that one point is that by forcing big banks to take it, gov is trying to reduce stigma for smaller banks.
publius: my read is that they are trying to avoid signalling problems by the clever expedient of including everyone (or at least all the big banks), whether they like it or not.
I’m not at all clear that this is a good idea. But I’ll take it over nothing in a heartbeat.
Question: writedowns—do they have to be NOW? Or can they wait until a new administration takes over?
“Including everyone … whether they like it or not” is pretty much what “nationalization” means. Offering help only to banks who ask for it is pretty much what “corporate welfare” means. Conservative ideologues can’t catch a break, on this one.
Also, to expand gwangung’s question: the entire “bailout” program, whatever the details, will be handed over to the next administration to operate, right? So: do we detect any efforts by the current Republican administration to tie the hands of a prospective Democratic one? Or are they too desperate to worry about that?
–TP
Gwangung, my understanding is that something must happen NOW to free up the credit markets, because so much of our economy depends on the availability of short-term credit to provide liquidity to companies making payroll or purchases. The capital injection, if it works, might free up that credit. Because the capital injection is a purchase of equity, if the bank doesn’t first write down its assets then the purchaser overpays and gets less equity. It would be hard to fix later. That, at least, is my lay opinion. I do wonder about one thing: credit is tight in part because banks can loan out money leveraged at some multiple of their assets. These multiples got dangerously high, and now banks are refusing to do even safe loans in order to reduce this multiple (“deleveraging”) at the same time that the underlying assets are declining in value, some catastrophically. Might forcing them to write down assets actually exacerbate this problem?
The modern Buddhist teacher and scholar, Joanna Macy, often speaks of the Prophecy of the Shamballa Warriors as told to her by her teacher Choegyal Rinpoche. It speaks of a time when the world is in extreme danger, when so called “barbarians” of east and west have gathered great wealth and built unimaginable weapons of mass destruction and developed technologies that can “lay waste our world”. It is at this time, when life seems to be hanging in the balance, that the kingdom of Shamballa begins to emerge. This kingdom is not an ecotourism destination, a place you can find on the map, but an inner kingdom, an interior state of mind and heart existing within the “warriors”. These Shamballa warriors are the people who understand without question that all life is interconnected and that all life is sacred. You wouldn’t recognize them on the street because they have no badges, no uniforms and no leaders. They walk in the lands of the barbarians, holding no territory of their own and are called on to act with moral and physical courage, to go into the center of the controversy and dismantle the weapons of mass destruction, the systems of chaos and materialism.
http://www.worldservicegroup.com/bv-libra-2008.html
That photo made me laugh out loud. Well played.
Warren Terra: the idea, I think, would be to have the capital injection be larger (a lot larger) than the writedown.
They invented a new kind of share – the super-duper preferred. It has no equity stake and pays a ‘dividend’. How this dividend will be determined is not specified. In other words, a perpetual loan with an unspecified interest rate. Free money to the banks.
Not unlike when they invented a new type of prisoner in the war on terror with an unspecified status.
I think that when this becomes widely known people will not be happy. Especially when the interest rates Zoom as a result of the liquidity they are dumping into the system.
http://www.nytimes.com/2008/10/15/business/economy/15bailout.html?hp
A Credit Stimulus Package
As I understand TARP, it is essentially a credit stimulus package. The first part was forcing 9 large banks to jointly participate because:
“Bringing together all nine executives and directing them to participate was a way to avoid stigmatizing any one bank that chose to accept the government investment.”
I’m not so sure that this wasn’t done to move the plan forward quickly and avoid negotiating with each bank, but I get the point, sort of.
Then, because each bank could use the money for something other than loans, the plan forces them to loan the money.
“The needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it,” Mr. Paulson said, who offered some details of the plan along with the Federal Reserve chairman, Ben S. Bernanke, and the chairman of the Federal Deposit Insurance Corporation, Sheila C. Bair.
The problem here would seem to the quickness, intelligence, and risk of these loans.
“In a letter to Mr. Paulson on Monday, Mr. Schumer, chairman of the Joint Economic Committee, urged the Treasury to demand that banks receiving capital eliminate their dividends, restrict executive pay and stick to “safe and sustainable, rather than exotic, financial activities.”
I’m still not reassured.
Summary in cartoon format.
This is what Roubini has recommended as well – a triage phase.
And really, it is pretty clearly necessary before anyone with an ounce of brains would buy equity in a bank — you need to go in, audit the sucker, write down the bad, or even suspiciously hard to value, assets, and then see if there’s a viable company left. Then, and only then, do you invest.
What Paulson has done is buy some time. It sounds like, by guaranteeing loans made between now and June, he’s trying to get people to lend to banks even though they may still be insolvent.
It still seems like he’s trying way too hard to protect the bank shareholders, but then again, they’re the people he used to work with.
With luck, we’ll have a new Treasury Secretary next year whose first priority is the American economy, not the stock positions of his friends.