Too Big to Bail: Lehman Brothers Is the Model for Fixing the Zombie Banks 24 comments
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We've been hearing a lot from readers lately, as you might imagine. Many of them thank us for speaking frankly about the issues regarding the growing but soluble solvency problems facing the largest US banks. We appreciate the comments.
Click here to see our discussion yesterday on TechTicker with Henry Blodget regarding the Geithner plan for the banks. We tried to lay out in simple terms how we see the next few weeks and months unfolding regarding the larger banks. We also try to understand and articulate why the Obama Administration seems so reluctant to engage on the large bank solvency issue.
Notice that the Obama Administration remains in campaign mode, but with a crowd of people in the room who should have been left at the victory party. During one exchange last week on the performance of the Obama Administration to date, we ventured the opinion that our brilliant new leader resembles a young, inexperienced monarch, surrounded by the conflicted, incompetent family members and cronies tied to the now dead former king.
To this, a reader of The IRA replies: "The former king is alive and flourishing, with the former queen wandering the castle."
Another reader chides: "I think you're giving the Republicans in Congress too much credit" regarding fiscal restraint. He continues: "As far as I can tell, they're still trying to prop up the housing industry."
Fair point. But we sure are delighted to see Senator and former TX treasurer Kay Bailey Hutchison (R-TX) talk about haircutting the bondholders of the large banks. Bet she'd make a great Treasury Secretary if President Obama hasn't lost his desire to include Republicans in his government!
Memo to Joe, Carl, and Becky at CNBC. Get Kay on the Squawk Box pronto to talk about crew-cuts for the big banks. Readers of The IRA in TX will recall a certain episode involving Bank United Corp in the early 1990s that Senator Hutchison also remembers. More on regulatory discretion regarding who lives and who dies in a future issue of The IRA.
By the way, in her otherwise surprisingly good testimony last week, Elizabeth Warren agreed with our comment that the primary task is to deal with the housing sector, because that's where the meltdown started. Going even further, Martin Feldstein has said that the real estate sector that got the economy in trouble will lead it out. Yada, yada.
We'd never admit to being economists, but it seems like an awfully facile assumption, however politically correct, to look to a broken sector for leadership when fantasizing about turnarounds in the financial market and the economy. Our working hypothesis is that the speculation-crazed banking/real estate disaster has badly diminished the US economy, and horribly damaged the financial systems of some of our key economic partners. Look at places like Poland, Iceland and even China. This damage will only increase as long as resolution process for zombie banks continues to be postponed by the Obama Administration.
While you might think that Treasury Secretary Tim Geithner and his counterparts at the Fed are focused on helping the US economy, in fact they believe they have a larger mission, which is to maintain the Too Big To Fail banks. This conflict between what is good for the big banks and good for the US economy continues to widen as the financial pressures build on the US Treasury. But fortunately the available resources are forcing the issue as to expenditure.
A big obstacle to progress remains the insistence by the Treasury and the Fed that we go "back to the future" in terms of remaking the world of large New York dealers and securitizations, but fortunately rising pressure of financial reality is forcing Geithner to change his plans almost daily. Not surprisingly, President Obama prefers to be on the campaign trail rather than face the dismal discussions in Washington, but sooner or later Barack Obama must make his case to the financial markets.
As we noted in a post on TheBigPicture last week, "Bondholder Haircuts at Citigroup: At the End of Q1, the Children's Hour Ends in Washington," the Q1 2009 numbers at Citigroup (NYSE:C), Bank of America (NYSE:BAC) and JPMorgan (NYSE:JPM) are going to make clear, even to members of the Obama Administration, that talking about injecting new equity into the largest banks without first resolving these institutions is a waste of time and money.
Remembering that half of the liabilities of C, BAC and JPM are funded out of the bond markets and not via deposits, it should be clear to one and all that the US taxpayers are not in a position to subsidize the bond holders of these three banks, representing some $1.5 trillion in debt, if the deposits of these banks are to be protected. Some people, indeed, many people believe that we must avoid another Lehman Brothers type resolution where bondholders take a loss, but to us the only scenario where depositors of C, BAC, JPM do not take a loss is if we haircut the bond holders.
There are no easy answers here, but the guiding principle left by the Founders that bankruptcy be used to quickly and finally resolve insolvency is instructive. In that sense, Lehman Brothers is the ideal example, not something to be avoided. The model of the conduct of the Lehman liquidation by the US Trustee is an excellent archetype that should be carefully studied and considered as the Obama Administration considers the next move. If we are going to consider a restructuring for General Motors (NYSE:GM) and what remains of Chrysler, then Washington better be in a position to talk with finality about resolving the big banks at the same press conference.
What is required in Washington is an adult conversation, between the US government on the one hand and the holders of the bonds of the largest banks on the other. Many of the bond holders of the large banks are foreign governments, central banks and investment funds and not a few of these sovereign names are in really serious financial difficulties. Since the receiverships for Lehman Brothers and Washington Mutual, where bond holders took a near total loss, these foreign investors have been vocal in demanding that US taxpayers protect them from further harm.
But to deflect these cowardly, expedient arguments, the US government must be willing to lead by example to show that there really is only one way to restore confidence in zombie banks: use receivership to wipe out the common and preferred shareholders, conserve the deposits and sell the good assets to new investors, and then restructure the remaining operations of the bank to maximize recovery to the bond holders and other creditors.
Such a process as Lehman is painful and politically very difficult, but remember that nobody is surprised now. The definition of "systemic risk" is when markets are surprised, but these are political distinctions. Repeat after us: "there is no such thing as systemic risk," at least that can be measured scientifically. SysRsk is a political concept, a manifestation of fear and uncertainty. As the Fox told the Little Prince: "All that is essential is invisible to the eyes."
We all mostly understand the problem now. The swiftest and surest way to restore market confidence is to create solvent banks and begin the process of rebuilding the global markets for both finance and commerce. That is why we say that the competent and efficient handling of the Lehman Brothers liquidation by the US Trustee, SIPC, other state and federal regulators, and most important the professionals of the US Bankruptcy Court for the Southern District of New York is the model for dealing with the large banks.
Days, weeks and months are precious now. If we delay and pretend that this problem will just go away with time or that the markets of yesterday will miraculously be renewed, then the economic slump will indeed worsen and we shall have all talked ourselves into a bona fide global economic catastrophe. Here's our two key points again, distilled from our previous issues of The IRA and the many comments we have received from you:
1) Finality for the Banks: The US should announce an open-bank conservatorship for C before the Q1 results drop and be prepared to include BAC, JPM and WFC, in that order of urgency. The deposits of the institutions should be explicitly conserved, but the bond holders and other creditors must be put on notice that their position is a function of the net recovery from the parent holding company a la Lehman Brothers. Keep in mind covering all deposits is a huge concession and may require a subsidy from the FDIC unless the bond holders take the loss. The process of conservatorship for C could go on for years and would ensure that consumers and other customers of the bank are protected.
2) Finality for Markets, Homeowners: As per our previous comment, 'Can We Fix the Banks, Help Homeowners, and Rebuild the Mortgage Markets? Can Do.', the Treasury should begin a systematic process for an at-the-market buy-in all of the extant toxic securitizations, transfer ownership of these assets to the Deposit Insurance Fund and then use the receiver powers of the FDIC to reorganize the DE trusts that are the issuers of the notes. Start with the paper on repo to the Fed. Once the FDIC gains legal custody of the collateral, it can then sell these assets through the resolution process now ongoing with financing backed by the Fed. Our preference is to see these loans sold to community banks with branches near the property, a move that would immediately enhance the quality of these credits and also make modification/refinancing more practical. Either tasks requires manpower and the thousands of solvent American community banks in the US are the mechanism to make foreclosure abatement a reality. But any and all buyers should be encouraged.
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This article has 24 comments:
Wow, naked's won't even have to cover if everyone else is WIPED OUT.
Disloyal folks like you will face a reckoning some day.
Make your few short bucks now while we still have a market/country/world economy.
You're in good company with jailbird Henry Blodget.
That may be worst-case scenario, but you have to admit to yourself, its not implausible. Thus, its not worth the risk to dismantle these banks. If Lewis and Pandit are able to keep their businesses going with a few injections here and there, that is by far the better option.
When your solution is worse than the problem, it's time to keep looking. Get a clue!
I'm not touching those commons not because I don't think they make sense as long term investment, I'm not touching them because I don't know what the rules of the game will be next month... but I’ll tell you if they do force them to go bankrupt the most eminent (CITI & BOFA), I think it will cause a sever damage to the equity markets on the confidence side, because lets face it, if we were to have a "depression" type event, none of the bank will be safe not even JPM, so that means that they will destroy all equity holders?, is that the solution?... is that what we really want?
One question also that lingers in my head is, if BOFA and CITI were to be Nationalize or put in conservatorship or whichever? What will happen to the preferred and bond holders?
If its done as AIG or FNM way, it will hurt the markets, but at least the bond holders will be hold at par.
But if they decide to do what Mr. Whalen says, to destroy the commons and oblige the preferred and unsecured debt to "take a haircut", he doesn’t says what will happen to the preferrd invesmnet that the government did on TARP 1.0, could they legally avoid that "haircut"?, because your missing that point Mr, Whalen is the curren administration gonna share the losses to on those who are at the same capital structure or higher?
What you don’t realize is that very large investors did what the government did on last October and November recapitalize the banks on higher capital structures, we “shook” government hand and invested on what government told us was under their umbrella, if they change their mind and hurt what they told us was safe…. I think it will make the LEHMAN crisis seems like "peanuts", some people like Christopher Whalen and others don't realize that it was a credit crisis, not and equity crisis what we suffer last year, BOFA and CITI bond holders are all over the world to have them lose what it was considered very secure type of investment it will leave institutional and international investor (which by the way in this time the U.S. heavily relies on) very badly hurt, IMO it will make a 2nd “Great Depression” come true…. Maybe is what they want.
¡Give a holiday on accounting rules to major banks, liquidity is essential price premium on illiquid assets you cannot have banks been valued to liquidation value each quarter, that wasn’t what banks were made for!... actually every bank is insolvent to meet their debts in a immediate term so to me all of this discussion is nonsense, and I’m very suspicious that everyone that wants this outcome of "nationalization" is speaking its own trading agenda.
Good definition of systemic risk and of the best solution I've read. First time I've had this much hope. Sure there are risks, why should the taxpayers take all of them?
I'm sorry the bondholders didn't do enough due diligence. Ditto, the fiduciaries of pension funds. They are big enough, rich enough generally to have been responsible for themselves. I have no pension and I sympathize but can't see why my kids and I need to pay for bondholders. They have some recourse in this plan, that's the market for you.
I believe Lehman Brothers was less the cause of the meltdown than AIG. This plan resolves the deadly uncertainties at this time with the greatest fairness and dispatch.
"The definition of "systemic risk" is when markets are surprised, but these are political distinctions. Repeat after us: "there is no such thing as systemic risk," at least that can be measured scientifically."
I find this to be an absolutely remarkable statement, considering it was made by a person who is obviously so intelligent. To write such a thing, one would have to believe - in essence - that people's behavior never changes or at least that all behavior changes that are economically meaningful exist on a smooth continuum. Unable to deal with reality outside his lovely Gaussian models, he simply calls all that enormous amount of human behavior: "political" and dismisses it. It's no longer part of his world so he doesn't have to deal with it.
The very real, very well-understood *economic* fact is that when the circumstances of people's lives change - when events actually occur in their lives - their behavior changes in a quantized, discontinuoos way - no matter how much they are expecting the change. It's just a fact.
Mr. Whalen may pretend that this doesn't apply to him, but he's living in a fantasy world. So too are the bondholders of our major banks. When that fantasy world cracks, both Mr. Whalen and these bondholders will start to act very differently, very quickly and that will be a bewildering day for them.
Christopher Whalen, you are a stupid and dangerous idiot. Lehman wasn't a model of what to do in a disaster of this nature. Lehman was a disaster which helped create the present crisis. If your solutions were implemented it would go a long way to destroy the American way of life. Do you think the foreign investors will sit idly by and passively accept that their investments will be wiped out? Not on your life, there will be a giant whooshing sound heard throughout America as money is withdrawn by foreigners and invested elsewhere outside the purview of American control. And who in government is qualified to run C and BAC if they are nationalized? Answer: Nobody! Unless of course the government hires Lewis on contract to run the show, if he is willing that is. Idiots like you should stop publishing your drivel. You add to the crisis and do nothing to help resolve it. You are an enemy of America, not a patriot.
Any unkind words above ditto that too. Mr. Whalen you are just simpleton!
Mr. Whalen I hope it was worth the few bucks you got. You truly are just part of the problem not any solution.
Boesky and Milken are also behind this.
Read about who to distrust and exactly why here:
www.deepcapture.com/
Who is providing the injections? The bondholders or the taxpayers? Yeah, I thought so. To borrow from the Iron Lady, the problem with bailouts is that you eventually run out of other people's money.
Bondholders seem to forget that they take risks just like everyone else when they invest. They may have seniority when assets are sold but to get back all of their investment is ludicrous if the numbers don't add up.
The government shouldn't be in the position of propping up bondholders. Geithner played that role at the NY Fed, but I hope he doesn't continue to do so in his unqualified role. If he does, he is even more corrupt than we thought.
The markets would likely rebound quicker if there was a swift resolution of the bad debt situation by letting the insolvents fail. We have evidence of this from other countries that made these same tough choices in the past.
"…bankruptcy be used to quickly and finally resolve insolvency is instructive. In that sense, Lehman Brothers is the ideal example, not something to be avoided...." what about counterparty risk, you know how many institution were left out naked with their OTC derivates position, and I’m not talking of only exotic derivates, also plain vanilla, do you know who’s the biggest currency derivates market maker in the world? Its CITI can you imagine the mayhem that could be cause if CITI just imploded like LEH, institutions, corporations and alike will be left out naked with their derivates position; not to mention some clients who still haven’t got their money invested abroad in LEH.
"…use receivership to wipe out the common and preferred shareholders…” ok, so basically you are saying that you’re willing that the almost 100 billion invested by the US government in CITI & BAC to be wipe out?, I mean for someone defending so fiercely the Tax Payer that doesn’t seem so helpful.
"....these foreign investors have been vocal in demanding that US taxpayers protect them from further harm...." ¿And who do you think will fund all the fiscal stimulus that Obama and the congress just pass?, Joe the Plummer?.. I guess not; but if you’re right, if the government does what you suggest I’ll be shorting US Long Treasuries to oblivion.
"....The definition of "systemic risk" is when markets are surprised..." How do you call when government spends 350 billion USD to stabilize the banks and reassure institutional and foreign investors not to flee from US assets and then 4 months letter tells them "You know what, forget what I told you 4 months ago, you’re going to have to take up the chin!"... ¿Do you really think the PIMCOS, CALPERS, of the world and the Central Banks like BOJ, BOC, and etc. are gonna just says "ups" we got screwed!
“…Bondholders seem to forget that they take risks just like everyone else when they invest....” no they don’t senior debt pays so little yield because its consider safe, pension funds invert in this assets because they are safe “investment grade” and by the way you know who are the investors in this pension funds?... you and the Tax Payer!
So is not that simple, I don’t argue that some drastic measures have to be taken, but you cannot change the rules of the game every time you like and you cant keep destroying so much wealth in the world. The markets wont take another blow like that.