by Eric Martin
David Brooks veers dangerously close to the stripped down truth in discussing the origins of the current financial crisis:
The best single encapsulation of the greed narrative is an essay called “The Quiet Coup,” by Simon Johnson in The Atlantic (available online now).
Johnson begins with a trend. Between 1973 and 1985, the U.S. financial sector accounted for about 16 percent of domestic corporate profits. In the 1990s, it ranged from 21 percent to 30 percent. This decade, it soared to 41 percent.
In other words, Wall Street got huge. As it got huge, its prestige grew. Its compensation packages grew. Its political power grew as well. Wall Street and Washington merged as a flow of investment bankers went down to the White House and the Treasury Department.
The result was a string of legislation designed to further enhance the freedom and power of finance. Regulations separating commercial and investment banking were repealed. There were major increases in the amount of leverage allowed to investment banks.
The U.S. economy got finance-heavy and finance-mad, and finally collapsed. When it did, the elites did what all elites do. They took care of their own: “Money was used to recapitalize banks, buying shares in them on terms that were grossly favorable to the banks themselves,” Johnson writes.
In short, he argues, the U.S. financial crisis is a bigger version of the crises that have afflicted emerging-market nations for decades. An oligarchy takes control of the nation. The oligarchs get carried away and build an empire on mountains of debt. The whole thing comes crashing down. Johnson’s remedy is clear. Smash the oligarchy. Nationalize the banks. Sell them off in medium-size pieces. Revise antitrust laws so they can’t get back together. Find ways to limit executive compensation. Permanently reduce the size and power of Wall Street.
Instead of taking those painful, but necessary steps, it certainly appears that Geithner and Summers and the rest of the Obama administration have opted to…once again, take care of their own. Pat Garofalo:
Last week, reports surfaced showing that bailed-out banks Citigroup and Bank of America were actively speculating on toxic mortgages with taxpayer money, potentially gaming the public-private investment fund that Treasury Secretary Timothy Geithner has created to clean up the banking system.
Today, Financial Times highlighted another way in which financial institutions may be hijacking Geithner’s plan. Financial behemoths Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase are actually considering participating in the fund as buyers, in order to purchase each others toxic assets. This would drive up the assets’ prices and leave taxpayers liable for any losses, while not removing the assets from the system.
As Joe Wisenthal pointed out at The Business Insider:
Banks buying assets from each other to inflate their books has nothing to do with ‘price discovery’ or any such nonsense. It’s all about using taxpayer money to create bids that are higher than what the market currently prices those assets at. And if it turns out those bids were too high and the cash flows never materialize then, oh well, it’s the taxpayer left holding the bag.
Just remember folks: We're not Sweden!
Who Gets A Bailout?
See Also: Inside the Fed, Treasury Trying to Defend Bank Gaming of Public-Private Partnership, More Rebranding, Greed vs. Stupidity, Bush admin role in AIG? Dont say I did not tell you so, and Keep the Wolf at the Door.
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“Today, Financial Times highlighted another way in which financial institutions may be hijacking Geithner’s plan. Financial behemoths Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase are actually considering participating in the fund as buyers, in order to purchase each others toxic assets. This would drive up the assets’ prices and leave taxpayers liable for any losses, while not removing the assets from the system.”
Reading that left me in momentary disbelief.
Nothing — nothing — has changed. Wall Street’s “Masters of the Universe” do one thing and one thing well: game the system. (Is it any coincidence the Dow has soared 1,000 or so points since the Geithner plan was announced while unemployment in the real world continues to rise?)
Meanwhile, as Eric said, the Obama Treasury Department is inclined to “take care of their own,” which clearly isn’t the auto industry. Fire the General Motors CEO, but don’t dare get tough with the Wall Street elite. Make the UAW renegotiate, but make sure AIG gets theirs.
I did not comment on the GM post the other day because I get tired defending the auto industry and, frankly, see where a bankruptcy — ahem, a restructuring — may be the only alternative.
But we’ve been programmed to think such alternatives for the banking industry would ruin the economy.
These double standards must stop, and so must the Bush-like coddling of Wall Street. It is sickening. Obama, Geithner and Summers should be ashamed.
I can’t wait to see the editorial cartoons on this. I foresee a daisy chain of bankers handing the next one in line money for bad paper, with a tentacular Uncle Sam handing each the money while picking the taxpayer’s pocketbook.
I gave up on Simon Johnson’s Atlantic article at the sentence
The IMF, of course, infamously misdiagnosed the Asian finanical crisis as a classic current-account crisis rather than a hot-capital panic. IMF-imposed austerity programs worsened the crisis that wiped out decades of real economic progress.
So I’d automatically discount any argument from an IMF economist that boils down, in essense, to “THIS is exactly the same as THAT”.
Eric,
The “greed” narrative doesn’t make a lot of sense as an explanation of a particular crisis because greed is a constant in the human condition, as is the mixing of economic and political elites. In fact, the latter phenomenon is *less* fully developed in Anglo-Saxon capitalism than in any other economic system.
Relatedly, you miss that nationalization would cost the taxpayer more (and leave less room for progressive spending priorities) than buying the assets at inflated prices.
How you make money, with money how you “win,” is you be the first to game the system in a new way, before they can close a loophole you were the first one to exploit. You keep it open as long as possible, all the while trying ever newer and chancier ways to game the system. And sometimes you go to prison, but a lotta times you don’t…
Relatedly, you miss that nationalization would cost the taxpayer more (and leave less room for progressive spending priorities) than buying the assets at inflated prices.
Not so. Nationalization of troubled banks would not cost more, and taxpayers would participate in the upside at 100%.
Why would paying inflated assets cost less than taking over the banks? Explain if you could.
The “greed” narrative doesn’t make a lot of sense as an explanation of a particular crisis because greed is a constant in the human condition, as is the mixing of economic and political elites
As are these types of bubbles, buy-offs and exploitations. Capitalism has continually led to negative outcomes from excesses of greed. Only through regulation can we check those impulses – or at least their ability to do massive harm.
But we peeled away regulations when we should have been fortifying them.
Same deal with the relaxing on segregations of investment banks and research divisions.
The “greed” narrative doesn’t make a lot of sense as an explanation of a particular crisis because greed is a constant in the human condition
the level of greed is not constant; nor is the opportunity to indulge it constant; nor are constant the societal pressures which could discourage the people at the banks we’re propping-up from taking advantage of the situation; nor is society’s tolerance for the bank’s indulgences constant.
so, yeah, greed is human. so is the urge to burn down the houses of the people who have wronged you.
Eric, you’re arguing ahead of the evidence. Remember that the Treasury has to approve all of the funds participating in the program. What Citi, et al, want to do is not necessarily what they get to do. Further, Whether they would benefit if they did depends upon exactly how the pools are put together.
Maybe you should wait until the administration does something to assume that they are corrupt, rather than basing your accusations solely upon what Citigroup wants them to do.
Let’s see if this keeps the system from eating my quotes.
Not so. Nationalization of troubled banks would not cost more, and taxpayers would participate in the upside at 100%.
Why would paying inflated assets cost less than taking over the banks? Explain if you could.
I can do it in two sentences. The participants in the pool will be putting in somewhere between 7% and 15% of the price of the assets they buy. That amount represents a reduction in the losses that the Treasury might absorb in the case of nationalization.
You sound hysterical.
I’m too busy to offer anything in the way of reasoned analysis, so I’ll just throw out some links which seem relevant to this topic, and suggest that it looks bad right now, but there is at least the possibility of movement in a more positive direction. Whether the admininstration goes there, remains to be seen.
Simon Johnson and Peter Boone opine regarding moves the administration is making to obtain the legal authority needed to move in a more *ahem* Swedish direction, should that be the next move in dealing with the big banks.
A story at Politico leaks some gossip about the tone (if not the substance) of the closed-door meeting between Obama, his top econ advisors, and key Wall St. CEOs. The key quote: “My administration,” the president added, “is the only thing between you and the pitchforks.”
Finally, despite a notably gratuitous slur in the 7th paragraph directed at minorities and the CRA (which is of no relevance to the arguments in the rest of the article), I highly recommend our epistemological depression, which plows over some of the same systems-theory ground I’ve already covered regarding the downturn, and concludes with the following highly apropos summation:
Please read the whole article, it is very good IMHO. Sorry to do a “drive by” comment, but I don’t have time for more at this point.
Also, to follow up on JMN’s comments, while I’d like to see the administration proceed towards a Swedish style resolution of the banking crisis, I have yet to read convincing evidence that the administration currently has in hand both the legal authority and the necessary funding as authorized by Congress (or even the weaker precondition of a favorable political climate where such funding can be obtained quickly) to proceed directly to nationalization of one or more of the major banks. In the past I also raised the issue of staffing levels at the key agencies (Treasury, the FDIC) who would be responsible for implementing an actual takeover (e.g., last time I checked, Geithner doesn’t even have all of his undersecretaries confirmed by the Senate yet). I don’t recall anyone here responding to that question, either.
Absent those necessary preconditions, I don’t find accusations that the administration is currently acting in bad faith or has sold out to Wall St. very convincing, to put it mildly.
So, encourage them to invest that amount and then nationalize? Perhaps you need more than two sentences, otherwise it still seems that that 85% giveaway is still a loss in any case where the value of the asset bought is worth less than 100% of the value of the item.
So, encourage them to invest that amount and then nationalize? Perhaps you need more than two sentences, otherwise it still seems that that 85% giveaway is still a loss in any case where the value of the asset bought is worth less than 100% of the value of the item.
The last time I looked, 85% is less than 100%, which is how much the Treasury might lose without this program.
JMN: I think this is one reason this plan is a tough sell for those of us who aren’t schooled in economics. Casually accepting an 85 percent loss is hard to stomach. Common sense suggests there must be a plan where we can do better than that; of course, a lack of common sense is one thing that got us into this mess in the first place.
So, from your perspective, statistically, 85% of the assets in question are bad, and taking the chance that we get anything is better than nothing. Now, not addressing the nature and function of nationalization of a banks assets, is this a fair representation of you opinion of all the assets that we might take over?
Looks like the banks lobbying interests though see the 7.5% minimum differently J.
Or what is your take on that new “mark to management” reassessment of those “troubled” assets?
Will it attract more investors, now that these artificial price depressors have been told to mind their own business?
You go Eric.
bedtime: Maybe there is, but most of the opponents of the Geithner plan aren’t advocating something where we can do better than that. Straight nationalization means that we own everything. Yes, it means that all the profits would flow to the taxpayer, but also all the losses.
If your primary worry is that the assets are worth less than we’re going to pay for them, then the Geithner plan saves money over the obvious alternative. It’s only a big giveaway to the pool purchasers if the stuff turns out to be more valuable. If that happens, the government doesn’t lose anything.
This is, roughly speaking, why I keep saying that the question of whether or not to nationalize really isn’t the most difficult one. It’s whether or not we pay off the creditors of the banks that are insolvent. Whether we should or not involves a lot of unknowables, particularly whether letting a a large chunk of the financial industry, much larger than Lehman, go bankrupt would cause a bigger crisis than Lehman’s failure did.
If your answer is that we do need to bail the creditors out, nationalization means eating 100% of the losses. At that point, the two relevant questions for the Geithner plan are whether or not we give up too much upside to get rid of some of the downside, and whether or not the system gets gamed. I’m not ready to join Eric in proclaiming that the Obama administration is looking to screw us over until we know what the Obama administration is doing.
Let’s see.
So, from your perspective, statistically, 85% of the assets in question are bad, and taking the chance that we get anything is better than nothing. Now, not addressing the nature and function of nationalization of a banks assets, is this a fair representation of you opinion of all the assets that we might take over?
No. I have no idea what they are worth. Neither, I suspect, does anyone else. However, a lot of the people who criticize the Geithner plan are among those who think that the “legacy assets” are worth far less than where they are marked. If that is what you believe, then you should also believe that the Geithner plan is off-loading some of the losses.
Looks like the banks lobbying interests though see the 7.5% minimum differently J.
Sure. As I said above, though, there’s no particular reason yet to think that they are right.
Or what is your take on that new “mark to management” reassessment of those “troubled” assets?
I gave my thoughts on that in the thread hilzoy posted last night.
Read this, JMN. Nothing to get worked up about, just a mostly tongue-in-cheek look at every industry plays with words — in this case, Wall Street.
I’m chiming in with some agreement with JMN here. Just because JP Morgan or Citigroup want to do a thing doesn’t mean that Obama and Geithner will roll over and let them do a thing. No, Obama’s not going to carry out a root and branch destruction of the financial sector as it’s evolved over the last thirty years, but that doesn’t make him a Tool of the Man.
I strongly suspect that he’s not going to let the banks simply swap their toxic assets and have the taxpayer foot the bill.
My language was conditional. I said it “appears” that this is the way things are going. I welcome the opportunity to be proven wrong.
Part of the reason that it’s good to respond to these reports is that, in some instances, they are trial balloons, and in other instances, we can help get the attention of government officials that might not have been focusing on this aspect.
I can do it in two sentences. The participants in the pool will be putting in somewhere between 7% and 15% of the price of the assets they buy. That amount represents a reduction in the losses that the Treasury might absorb in the case of nationalization.
But in putting up money, they are also pumping up the price – which we tag along for and insure. And if we nationalize, we can dole out haircuts as needed.
Further, the funds will be buying up toxic assets even from solvent banks that don’t need the subsidization. So it is a less focused, more scattershot means of injecting capital.
And if the assets are truly worth more than the market suggests, we participate in the upside 100%. If not, we’re on the hook for a masssive recapitalization of banks in such a manner that the brunt is borne by the taxpayer in order to save the shareholder/management.
Eric: We’re already on the hook for a massive recapitalization. Whether or not we implement the Geithner plan, that’s true. The only way in which we can lose more money doing it is if the bids at the auction go 10%-15% above the level that we would impose as a haircut.
Will the pools involve buying assets from solvent banks? I don’t know. Again, I suggest reading the white paper the Treasury put out. They have to specifically approve any pool any pool that gets put up for auction. Further, even if a bank is solvent, there is still the problem of liquidity. Getting the markets unfrozen is a good thing, even if everyone has more assets than liabilities.
My suspicion as to what’s going to happen is the opposite of yours. I don’t think that buyers are going to be willing to pay enough to get the banks to want to sell, even with the Treasury subsidy. In that case, we move on to nationalization without it having cost us much, and with evidence that it is necessary.
Is Obama in the pocket of ‘The Combine’, or is he making the best of a bad hand? That’s hard to say at this point. I believe it was Galbraith who opined that “The American people get it right, eventually.” ‘Eventually’ being an indeterminate, but relatively long time. Bear in mind that it took thirty years of walking into the woods to get to this pass; the odds are it will take thirty years to get back. The first round then is to wrest control from some of the larger – and more parasitical – players. That’s not really going to happen without even more backing than already exists. Unfortunately, (imho), that’s not going to happen unless everyone feels a lot more pain.
On the subject of Obama’s political calculations, this could be a forking strategy, with a win-win no matter how this plays out.
JMN: Again, I am more than willing to wait for all facts to come out. I did not use definitive language – but rather qualified.
That being said, the early signs are not promising:
http://www.washingtonpost.com/wp-dyn/content/article/2009/04/03/AR2009040303910.html?hpid=topnews
We’re already on the hook for a massive recapitalization. Whether or not we implement the Geithner plan, that’s true. The only way in which we can lose more money doing it is if the bids at the auction go 10%-15% above the level that we would impose as a haircut.
But what about the inflated prices we’ll be paying for the assets themselves? Couldn’t that create a spread that could take care of the 10-15%?
And what about the money spent on solvent banks’ toxic assets?
These details are kind of key.
Eric:
That being said, the early signs are not promising:
Your citation has nothing at all to do with the question under discussion. I should also point out here that I agree with the administration on the necessity of this. If you want anyone to participate voluntarily in these programs, you have to exempt them from the pay limits. I can’t speak to whether the law allows it, but, if they are enforced, the only companies that will participate are the ones that are insolvent, thus guaranteeing the result you are complaining about.
But what about the inflated prices we’ll be paying for the assets themselves? Couldn’t that create a spread that could take care of the 10-15%?
Inflated relative to what? In this regard, inflated relative to the current market price doesn’t matter. The only place that an inflated value makes a difference with regard to how much money the Treasury could lose is the value at which it thinks that it would eventually have to pay out.
Take an asset that a bank has on its books at 80. The current market price is 30. The Treasury believes that, if it nationalized the bank, it would have to pay out at 65, which would be a 35% haircut on the creditor. Let’s say that the cash flows on the asset over its life work out to it having a true value of 50.
The buyer paying more than 30 is irrelevant to the Treasury being on the hook for greater losses. The same is true for the price of 50. The Treasury only ends up with more money at risk if the price paid for the asset is 65 times the reciprocal of the percentage of money that the government puts in, which works out to somewhere between 70 and 77.
If the Treasury thinks that the assets are already carried on the banks’ books as low as it can go on paying out, this figure is even higher, and it is highly unlikely that the prices will go that high.
And what about the money spent on solvent banks’ toxic assets?
I already answered that. In a lot of ways, it makes more sense to be buying these assets than those of banks that are insolvent. These are precisely the institutions that can use the increase in liquidity and the unfreezing of the markets to get the credit system going again. A number of the critics of the program have based their objections on the premise that we are going to be buying assets from banks that are insolvent, and that that doesn’t do any good.
The article itself gives a few insights:
I can’t read this as any other way but as some sort of null-speak, designed for deniability. Am I wrong in reading this as ‘We were very careful to stay within the letter of the law’, and ‘we are going to funnel more money to the zombies because we think this is what we say we believe will lead to economic recovery’. Iow, the same ‘ol same ‘ol street-fighting that we were supposed to get past post-Bush.
Here is the significant nugget:
I read this as a wedge tactic, designed to get lenders to get with the program to deal with toxic assets. Or rather, the executives who are steering the ship. Crooked Timber had a nice take on the decision tree:
This seems to cover all of the bases, as well as being a fairly obvious strategy. Bear in mind that this is a short-term problem, there are also long-term problems with National solvency that have to be dealt with as well.
Your citation has nothing at all to do with the question under discussion. I should also point out here that I agree with the administration on the necessity of this. If you want anyone to participate voluntarily in these programs, you have to exempt them from the pay limits. I can’t speak to whether the law allows it, but, if they are enforced, the only companies that will participate are the ones that are insolvent, thus guaranteeing the result you are complaining about.
Wait, I’m not sure we’re reading the same thing. The article talks about banks being able to receive government money without being subject to restrictions. My point being that this seems like one more give away to the bankers, and that is a bad sign of the overall direction of the Obama admin’s efforts.
But let me be clear: I only want banks that need government money to get it. For those banks that think they are solvent without it, they shouldn’t get it.
I was not complaining about solvent banks refusing to take government money.
Generally speaking, I would rather shareholders, bondholders and management take the hit than taxpayers.
Under the Geithner plan, it’s the taxpayers all the way. Especially if they allow the bailed out institutions to keep paying out phenomenally enormous compensation to executives while receiving that taxpayer largesse.
Doesn’t add up to me.
Eric:
Wait, I’m not sure we’re reading the same thing. The article talks about banks being able to receive government money without being subject to restrictions.
No. It says that participants in the auctions aren’t subject to the restrictions. Some of those will be banks. They are also the recipient of government money, since the FDIC is making loans to them to cover a large part of the purchase price of the assets. Technically, anyone that participates in the action is covered by a regulation on companies that receive government money. The administration is trying to prevent them from applying to the buyers.
My point being that this seems like one more give away to the bankers, and that is a bad sign of the overall direction of the Obama admin’s efforts.
There is no way for this not to involve a give away to the bankers. The only way to avoid that would be for the government to stop all of these programs, and just let all of the insolvent institutions go legally bankrupt. The fear is that such a course of action would repeat the crisis when Lehman went bust, only an order of magnitude worse.
Unless that is what you are advocating, there will be money given to the bankers. That’s a useless criterion to criticize the plan for.
But let me be clear: I only want banks that need government money to get it. For those banks that think they are solvent without it, they shouldn’t get it.
This is short sighted. A liquidity crisis among the banks is just as destructive for the general economy as a solvency crisis for as long as it lasts. In fact, its effects are pretty much the same as a solvency crisis until it is solved. The advantage of a liquidity crisis is that it is much more easily solved than a solvency one. Just find a way to provide liquidity, such as participating in a public/private partnership designed to unfreeze the markets.
Of course, a solvent bank is less likely to participate, because, as I read it, the sellers are covered by the restrictions that the buyers are not. Further, if a bank is actually solvent, that’s probably because the assets their holding actually are worth more than the market thinks, and so there is less likelihood of the government losing any money when they are purchased.
Remember, the private partners are in this to make money. The government participation reduces their downside risk, but they don’t make any money unless they bid less than the asset is worth. They don’t have any incentive to overbid, it just costs them less if they do.
Generally speaking, I would rather shareholders, bondholders and management take the hit than taxpayers.
Forget the shareholders. For all intents and purposes, they already took a complete hit. The difference between C at $2 and C at $0 is symbolic, rather than material. The shareholders who owned the company before the crisis lost all their money.
As for the bondholders, I’d bet that some of them do take a loss. I suspect that all of the assets sold in the PPIP auctions won’t ever get paid off at 100. Anything less than that, and they are taking a loss. The bondholders that might escape it are those who hold the actual companies’ paper. I’m fairly comfortable with that. These are people who weren’t making silly gambles. Bank bonds are supposed to be pretty safe. They didn’t trade with much premium. The types of institutions that generally hold them are pension funds. If they lose money, the government is on the hook for it at the back end, through things like the PBGC, which just lost a ton of money thanks to the Bush administration’s investment strategy.
The new Administration, in fact, seems determined at all cost to prevent such an ideological polarization by bringing on board as many temperate defenders of the ‘established order’ as possible. With economic crisis-management firmly in the hands of Citigroup and Goldman Sachs alumni, foreign policy delegated to the sub-presidency of Hillary Clinton and her spouse, and the ‘surge’ doctrine of Gates and Petraeus preserved in the Pentagon, Obama has built a dream team that delights The Economist and Foreign Affairs to the same degree that it disconcerts The Nation. As in the Clinton era, labour and environment have been seated at a second table, with important but secondary posts that lack leverage over the Administration’s line of march.
Selling Out America To Financial Elites
More of a passage of the day:
Obama’s agenda, however, became less opaque in June 2008 when he chagrined labour supporters by appointing Jason Furman, the director of the Brookings-affiliated Hamilton Project, as the head of his economic polic…
“and the ‘surge’ doctrine of Gates and Petraeus preserved in the Pentagon”
Neither Gates nor Petraeus were creators of the surge idea. Gates was a supporter of the Iraq Study Group‘s recommendations, and was a member of the ISG until his nomination as SecDef. Retired General John Keane was the primary military figure behind the creation of the “surge” idea. Frederick Kagan was the main other pusher.
From them it was adopted by Bush, who subsequently made Petraeus commander of Central Command.
Attributing the “surge” to Gates is all wrong: he opposed it, at least initially, as did the ISG. Attributing the “surge” to Petraeus is to confuse both timeline and responsibility.
Is there any sense of whether this administration is making the best of a bad hand, choosing where to make their stand, steering events for a better long-term outcome?
Because I see a lot of commentary from people who have claimed to know better that they are shocked – shocked – that even with a decisive numerical advantage in both houses and a command of the executive branch, Democrats in general and Obama in particular aren’t doing much for the little guy while at the same time treating the Titans of Finance with kid gloves.
I would say rather that the gloves have come off to some extent and a lot of people are gut-punched with the realization(as opposed to merely intellectually owning it) that the elites really do run the show, and their interests are not the interests of most people. It’s just that this bare fact is not usually so nakedly displayed. I recall what Clinton allegedly asked, “You mean to tell me that the success of the economic program and my re-election hinges on the Federal Reserve and a bunch of f@#$%*g bond traders?”
Given what is apparently the current reality in Congress, is there anything Obama could have done differently? As opposed to should have done?
Forget the shareholders. For all intents and purposes, they already took a complete hit. The difference between C at $2 and C at $0 is symbolic, rather than material. The shareholders who owned the company before the crisis lost all their money.
So if the taxpayers recap the banks, and the stock prices rise, the shareholders won’t get any of that gain?
See, that’s one of the key differences from the current approach, and nationalization. And why nationalization will not cost more in the long run:
The government collects the revenue from selling the banks back to the public, whereas under the Geithner plan, the shareholders that ride out the storm get to cash in at the end.