Lessons for the U.S. Banking Authorities 19 comments
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By Simon Johnson
You’ve seen it a thousand times. A country’s exchange rate used to make sense, but now it is hopelessly overvalued. And, consequently, your pegged exchange rate now looks like a one-way bet. Every Financial Times subscriber starts to think about how to either get out of your currency or, if they are feeling aggressive, how to more actively speculate that the exchange rate will soon depreciate.
And the beauty of this situation - from a speculator’s point of view - is that the relevant authorities will never move quickly or decisively to the inevitable end point. Sooner or later, the currency will be devalued and, if the country’s citizens are lucky, sensible economic policies (and perhaps external financial support) will be put in place to support the new exchange rate. But, for a surprisingly long time, the government will make statements along the lines of, “we will defend our exchange rate,” “we have plenty of reserves,” “we will never devalue,” or - my favorite - “the fundamentals are fine.”
This analogy sprang to mind when I read this morning’s joint statement by Treasury, the FDIC, OCC, OTS, and the Fed.
The U.S. government stands firmly behind the banking system during this period of financial strain to ensure it will be able to perform its key function of providing credit to households and businesses. The government will ensure that banks have the capital and liquidity they need to provide the credit necessary to restore economic growth…
Any government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position and can be retired under improved financial conditions before the conversion becomes mandatory. Previous capital injections under the Troubled Asset Relief Program will also be eligible to be exchanged for the mandatory convertible preferred shares…
Because our economy functions better when financial institutions are well managed in the private sector, the strong presumption of the Capital Assistance Program is that banks should remain in private hands.
This would be a fine statement in many contexts. But there is now an obvious endpoint, which is very much on everyone’s mind - there is no point in pretending otherwise. Either banks will be taken over by the government - and then reprivatized (and I insist on immediate reprivatization) - or they will not. And “not” is fine with me, but this option is only persuasive if you can really explain how it is going to happen and provide a decent deal for taxpayers (given that this will effectively insure bankers’ bonuses).
I’m not saying there are any easy or attractive alternatives. In particular, the lack of prior stress tests mean the government does not yet have full information on banks’ balance sheets (aside: what exactly have bank regulators been doing for the past two years?)
But this morning’s statement feels like another partial, vague, and underfunded commitment. This does nothing to reduce uncertainty. And, just like fears about fixed exchange rates in other contexts, this will undermine confidence in the economy more generally. Whether it will speed or slow our movement towards the endpoint remains to be seen.
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If nationalize, treasuries should go up in yield as this will effectively unjam this whole crisis.
If not nationalize, then XLF will fly; since the banks will be around for another round; stoking short covering.
I say it's win win!
Unfortunately, this administration seems more worried about pleasing all the people screaming "socialism!" and bank stock holders. With any luck, we will see a Swedish solution soon.
mess with the proceedings? is this or recession
Outside of wiping away the debt all "solutions" are a crapshoot. In a perfect world the US, China, Japan, Europe, etc would get together and just wipe away the debt. Learn the lessons..Apply them and move on. It would be a win for all parties involved, period.
One man's debt is another man's asset!
That old grandma's life savings parked in a CD somewhere is the same thing you're trying to wipe away.
That cash sitting in a bank account for a small business, waiting to be accumulated for machinery or capital expansion next year is the same thing being wiped away.
People seem to have no qualms beating the crap out of banks and making them lose money -- but they forget that those money are OUR money. It's a very bizzare cognitive disassociation way of thinking.
If China, USA wanted to wipe away savings; then you can empty everyone's account. For assets where you've financed and own less than 50% of it (rest of it is technically owned by the bank's -- whose assets need to be canceled out remember?); Perhaps the bank will take it back, liquidate it and only talk to you if there's any leftover.
Goodbye cars, homes, malls, factories, companies, pretty much anything heavily leveraged. (Read: pretty much everything in the USA, even govt) Oh, and goodbye pension, SS and 401Ks -- those are "claims" on debt aren't they? We're talking about forgiveness here... no claims allowed.
Careful what you wish for. We may get there yet.
It's not that rosy picture everything think when they imagine debt forgiveness. What everyone wants isn't debt forgiveness -- it's asset gifting. (i.e. I only own less than 1% of my home, but gift it to me anyway and don't collect on the rest. Ditto to my car, credit card purchased items, etc)
If that gifting is what gets executed in the end. I'll borrow and buy all the available land in the USA; then dispose of the debt. Surely you see how ridiculous it is?
On Feb 23 05:24 PM CJJ wrote:
> Sweden had like 5 banks. Let's not just say copy Sweden and call
> it a day.
>
> Outside of wiping away the debt all "solutions" are a crapshoot.
> In a perfect world the US, China, Japan, Europe, etc would get together
> and just wipe away the debt. Learn the lessons..Apply them and move
> on. It would be a win for all parties involved, period.
>
On Feb 23 05:24 PM CJJ wrote:
> Sweden had like 5 banks. Let's not just say copy Sweden and call
> it a day.
>
> Outside of wiping away the debt all "solutions" are a crapshoot.
> In a perfect world the US, China, Japan, Europe, etc would get together
> and just wipe away the debt. Learn the lessons..Apply them and move
> on. It would be a win for all parties involved, period.
>
First; release all stress test passing bank results immediately and off they go as shining stars helping the economic recovery programs. The government needs all possible help it can muster from all quarters of the economy. Fear, lack of confidence, and reluctance to act constructively are the worst enemy at this critical stage.
Next; delay marginally viable bank results until the economy starts showing signs of recovery. This way those banks' questionable balance sheets will no longer matter as more investors become satisfied with the fast rising solvent banks and are becoming hungry for more but are not willing to chase the first batch of banks to new heights.
Finally, delay stress test results of obscure banks with too much off balance sheet assets until the economy reaches half-way through the recovery process. More banks will be needed as the economy recovers at a fast clip and there will be not enough time to create new solvent banks with knowledge and experience needed to push the economy harder as it climbs the wall of worry and with fear starting to creep into the process. By that time, most if not all toxic assets have already lost their toxicity and are becoming high priority assets investors would be willing to buy at slightly depressed prices. Likewise, housing prices should be able to have reached rock bottom levels first time homebuyers will be able to afford; also by that time delinquences will finally approach historical norms thus relieveing the most involved banks of more foreclosure losses. Re-insert "de-toxified" assets back to their balance sheets and presto - massive marked-up asset paper profits courtesy of accounting wizardry. Hail mark to market methodology - it really works magically during the upturns. A true genie for all purposes (except the downturn). Nightmare finally over; everybody relieved of finally beating the beast and avoiding complete chaos. Now, we have to face a new found enemy - inflation - at least we know how to tame this beast rather than deflation for which we have no extensive successful experience.
As I have explained in previous posts of Oct/Nov 2008; the Dow Jones is defining an Expanding Flat on the 100 year chart history. The C wave of an A-B-C is the most panic driven part of the expanding flat. We are now at the C wave that usually consumes considerable acreage at less time than the A wave or the B wave.
This is the highest probability scenario most expanding flats go through in daily, weekly, and monthly charts. Only this time, we have to tackle this problem that is highly visible on the quarterly and yearly charts of the Dow Jones. You are going to be able to see the trees and not the forest looking at the daily and weekly charts.
The massive problems that have been bombarding us for the last 8 years are thruly worth the size and scope of the 100 year old history of the stock markets and the economy it supports. The attempted solutions, while deemed inadequate by many, are gargantuan too and have never been implemented in the past with so much vigor, speed, and resultant confusion and apprehension. The shock waves of the 3rd wave of the C wave in Elliott Waves parlance have no equal in severity and scope that scorched not only the United States but the whole world at large. Nobody is safe in a global economy when extreme panic originates from the 800lb gorilla.
The resultant recovery after the expanding flat has completed it's course is equally impressive as it usually consumes less than half the time the whole ABC pattern has consumed. For Dow Jones; the expanding flat started year 2000 and projected to end by late 2009 or early 2010. That means the resulting rally back to 14,200 level should or rather "it must" consume less than 5 years.
Not bad when expectations are so low with 10 to 20 years deflation or depression are becoming the topic for many economists. This extremely low expectation will provide help to initiate a searingly hot initial rally needed in order for the stock markets to be able to reverse the massive downward momentum at the least possible time. This expanding flat chart pattern is quite different from 1929 to 1932 which was a triple zigzag down. Triple zigzags seldom got retraced in a short period of time and in most cases will need 3x to 5x more time than the downturn to recover. Triple zigzag is a 3rd level triple combination complex pattern while an expanding flat is a 1st level or common/simple pattern.
Now, only if we can arrest Dow Jones at or above 6,000 level or prevent it from dipping way below the nominal 5,000 target level and/or the timeframe for the downturn prevented from going way past May 2010; the danger of systemic failure can be avoided. A drop to 700 to 1000 levels is not entirely impossible but with low probability status. At any rate, it must be prevented using every available resources otherwise the expanding flat can easily morph into a complex double combination or triple combination that usually consumes 200% to 400% more time than the simple expanding flat. Meaning 18 to 36 years of painstakingly complex corrective processes starting year 2000 for the Dow Jones, SnP500 and Nasdaq and the economy that they support.
"Wipe away the debt equals wipe away the savings too!
One man's debt is another man's asset!"
It is extremely important to repeat basic facts clearly and often. Your words should be tatooed in neon inside the eyelids of lots of people I can think of.
1) How to deal with the bond holders. These are pension funds and insurance companies. Given the AIG mess, that must bring some pause. The intertwined relationships here need study and some modelling to get the risks right.
2) This one is a doozy—foreign, sovereign stakeholders (bonds, shares, anything really). There was political pressure for the last few years to get some of the US debt repatriated via direct capital infusion into certain banks. We just saw a news story about the extreme reluctance of foreign buyers with regards to Fannie & Freddy debt given that there is still no explicit US government guarantee. I suspect that behind the scenes there are diplomatic negotiations to compensate foreign asset holders in oblique ways not readily apparent, perhaps not even known about for years. The US taxpayer will be left holding the bag, but such is life. Sell Guantanamo to the Chinese for $1?! ;-)
Disturbingly complex market with high, high stakes.
In this other corner the balance sheet of a few too-big-to-fail institutions hiding the past sins from a decade of ultra-leverage and ridiculous bonuses.
My bet is on the challenger, "reality," TOK in the 13th round.
On Feb 23 06:00 PM pimpjui wrote:
> The issue of banks being nationalized or not is not really relevant
> to the main topic, which is: the transfer of wealth from working
> people to Wall Street. This is what is happening, and it's happening
> because that is the natural way things have worked for the history
> of our great nation. I can name 4 different transfers of wealth from
> 1970 to the present (e.g. oil crisis 1970's, S&L fiasco '80's,
> dot.com bust, sub-prime). If I go back to the begining of the country's
> history, I suspect I could find 20 or so. Today, the banker parasites
> will continue to milk this taxpayer cash cow for as long as they
> can. Nationalization has not occured becuase it would become painfully
> obvious that the people running the banks are doing nothing (and
> have been lying and/or doing something illegal). This would mean
> firing the parasites/criminals. When banks become nationalized, you
> can be rest assured that the US government will have been milked
> so dry, that it will be more beneficial for the banker parasites
> to simply quit. That's the telltale sign. Look for it. I suspect
> that it will occur when bankers have to accept government employee
> wages (i.e. nationalization), or when massive infaltion and stagnating
> wages (including for bankers) destroys any incentive to hang on--this
> is coming soon, or when it becomes obvious to the public that the
> bankers are doing something illegal (e.g. lying, again, about profits,
> etc).
It is not a lack of faith in Geithner's words. It's a lack in someone either being honest or facing the simple facts of life which will be hoisted onto us sooner rather than later.
As the downturn spreads out from real estate into the broader economy this year the erosion of bank's assets and reserves will only get worse.
can be pushed up to 4% all the problems we currently have start to be solved. Debt is worth less, real estate is worth more, wages rise, stocks rise, as real estate rises it is sold and mortgages are paid off.
The US government knows that this is the answer. Any measure of money supply is growing at least a 20% annual rate. The velocity of money has slowed and that is why we have deflation.
Eventually, it seems that inflation will prevail, but you cannot be sure.
That is why you should own some stocks, some US Treasury securities, and certainly some gold.
Problem is, time has run out. The technocrats never did have the time to get this working before the banks cratered. Now short sellers are targeting the insurance industry (see: business.timesonline.c...) as this mess keeps cascading. No one trusts anyone else's capital positions.
The FDIC, Fed and Treasury all issue a statement saying that everyone is "well-capitalized" as they try and get private capital back in, but private capital is betting against the rhetoric.
So, you're right. More bleeding from the banks. From binary to black hole, with the Administration behind the curve.
On Feb 23 09:47 PM constructe wrote:
> The author is quite right this is a binary option. Either you nationalize
> or you don't. If you don't either you spend a trillions or so on
> failed institutions trying to keep them from bankruptcy or you don't.
> These are you options. Picking none of the above gets you an F in
> basic logic which is what the market is pointing out.
>
> It is not a lack of faith in Geithner's words. It's a lack in someone
> either being honest or facing the simple facts of life which will
> be hoisted onto us sooner rather than later.
>
> As the downturn spreads out from real estate into the broader economy
> this year the erosion of bank's assets and reserves will only get
> worse.
I figured the market would tank on Tuesday or Wednesday in response or preparation for Obama's State of the Union.
But they had to open their mouth on Monday too.
If they are not going to DO anything, then at least they should SHUT UP.
Because obviously their words are not appreciated by the markets.
So the government has made it simple. Institutions now get a cushion, and it doesn't cost them anything if they don't use it. If they use it, or if they clearly need it, they get the cash and have a limited period of time to pay it back before it automatically converts to common and dilutes shareholders. If the institution keeps spiraling down the government winds up owning it, and that is the end. If the institution can dig itself out of the hole with the limits of the aid then IT wins. Simple. If the institution needs the aid but can raise capital later on, they can also win.
Seems to me this is much better then having the institution simply vanish over the weekend. Now investors can get a fairly good idea how much trouble the institution is in before they go into receivership. There are lots of warnings signs, now.
-Matt