Waiting for the Government to Act on Banks

There hasn’t been much inspiring me to write these days. The news across the board has been pretty much the same - the economy stinks, joblessness is increasing, housing continues its downward spiral, consumption is nowhere near recovery, bankruptcies are on the rise, banks are under stress, corporations are struggling, and Jon Stewart continues his hysterical rant at the folly that is CNBC. Did I miss anything??

Seems like these days we’re in a holding pattern waiting for the results of the bank stress tests and a decision on the GM/Chrysler aid.

So while we’re all waiting, I came across an interesting debate about the merits of various approaches to the banking crisis (e.g., nationalization versus ringfencing troubled assets versus good bank/bad bank). Paul Krugman and Simon Johnson (and the rest of the folks at The Baseline Scenario) have recently talked about what to do about bank liabilities; specifically, debt (not liabilities to depositors).

As Krugman points out (see Anti-nationalization Arguments):

Some decision must be reached on bank liabilities. Sweden guaranteed all of them. If forced to say, I would go the Swedish route; but of course we can’t do that unless we’re prepared to put all troubled banks in receivership. And I’m ready to be persuaded that some debts should not be honored — this is a deeply technical question.

What’s clear, however, is that the current system, of implicit maybe-kinda guarantees on bank liabilities — call it wink-wink-nudge-nudge-say-no-more banking policy — is failing badly.

From The Baseline Scenario (see Quick Note on Liabilities):

…The government has been doing everything it can to imply that bank creditors (at least for “systemically important” banks) will be protected, without saying so explicitly, because that would suddenly increase the potential liabilities of the government by trillions of dollars.

What’s clear is that several of the largest US banks (those subject to the stress test) are insolvent - their liabilities exceed the value of their assets. For those banks that are insolvent, shareholders will get wiped out, probably through nationalization, however administered. After shareholders get wiped out, the fact remains that the value of the remaining assets (after depositors are made whole) will not make existing creditors whole.

So the question remains, should the US government (taxpayers) guarantee the liabilities?

One of the issues, as I see it, depends upon the identity of those creditors. And this is where it gets complicated. Maybe this is what Krugman means by “deeply technical” (although perhaps he had something else in mind).

To the extent that US bank creditors include large sovereign wealth funds and central banks, forcing bondholders to take a haircut may come with political consequences. In contrast to small, private creditors, sovereigns have political and economic recourse. And, after all, we will probably need to rely on some of these same actors to fund our current deficit.

For this reason, I am inclined to believe that we will be forced to guarantee the liabilities of banks we nationalize, a la Sweden.

And we wait.

Disclosure: No positions

Comments

[User 366653:]

Today we learned that the SEC will consider holding a public hearing next month to discuss reinstating the uptick rule. With any luck, the rule might be reinstated within six months.

We also learned that FASB and SEC regulators will discuss the idea of refining the rules regarding mark to market. They first discussed this idea six months ago. It's remotely possible that this issue could be resolved before Christmas.

What's my point? Government agencies spend months or even years studying a situation before making a decision. Ask yourself who in their right mind would maintain a business relationship with a major bank that was being managed by a government agency? IBM goes to Citigroup looking for a five billion dollar line of credit. The GS-14 manager tells IBM that public hearings will be held in May, and the loan committee will meet on the third Wednesday in June. Pretty good chance that we can help you by early August.

IBM goes to a bank run by business people, and gets the funding in ten days or less. So does everyone else. Citi/Govee goes further and further into the hole.

This is what Nationalization will do for the banking system. Great idea?!

I find it interesting that, so far, EVERY proponent of nationalization that I have found is either an academic or a politician. I mean no offense to academics or politicians - God knows we need both groups - but these groups operate in a theoretical world, where economic models and financial calculations are neat and tidy on crips paper. Managing a bank, or virtually any business, requires a different skill set, and is best done by business people with a specific background.

Mar 12 11:49 PM

[Chemist29:]

So a doctor who graduates med school who makes lets say 200k a year, and who has debts from undergrad and med school that total 250k, right when he graduates is insolvent right? Because his liabilities exceed his assets...makes sense. must declare bankruptcy right away huh? Yeah, I agree the banks common equity is probably negative but cash flow is there and liabilities are being paid. time is all that is needed, not government making more irresponsible lending decision (fannie and freddie anyone?)

Mar 13 12:43 AM

[Tradememe:]

The problem is that they don't want to save the banks, but they don't want to see the banks fail either. So, we are in a kind of economic limbo.

Mar 13 12:58 AM

[flashrob:]

big problems for banks... BIGGER PROBLEMS FOR BIG INVESTMENT BANKS!

FIRST: regional and local banks!
the problem headed their way: though they have little exposure to "real estate based derivatives," etc., like most of the "big investment banks and financials,"
and their "assets" are already NOT "mark to market," but based on more realistic valuations, they HAVE A BIG PROBLEM in the future... as the economy continues spiraling downward (with more high-paid job losses to the payers of their more standard type mortgages). Their WILL BE MORE FORECLOSURES as unemployment continues to increase....

bottom line for regional and local banks in the future:
continued ASSET deterioration of NOW "non subprime" type mortgages. (also raising of reserve requirements)

note: these stocks and etfs are losing ground and going down, but more slowly since their assets are priced to the "more realistic" local type valuations (like real estate values in a region, might only be down 30-40%). So, their assets might be .60 cents on a dollar as opposed to "big investment bank" asset valuations (real estate derivative type) which some are "marked to mkt" at like .10 cents on a dollar, because that's all that the "global derivatives players" are willing to "bid" for them.

SECOND: most of "the big investment banks"

this group has "lots of problems:"

1. continued ASSET DECLINE - the overall decline in the economy and continued increasing job loss WILL CAUSE FURTHER DECLINES TO THEIR ASSETS, "mark to mkt," or not.

2. increased government regulation of and intervention in their activities and oversight of their assets.
(plus what else might the gov might find in there.)

3. modification of "mark to market" WILL HAMPER their speculation in the "global derivatives mkts" ...something these banks "DON'T WANT," and were probably counting on TO LEVERAGE UP THEIR PROFITS (based on asset vals... "mark to mkt" works great in an UPWARD mkt... works against you in a down mkt...IN A HIGHLY LEVERAGED WAY).
It's somewhat like trading options as opposed to trading stock. The banks think we're near bottom in the stock market, and want to be able to run their "stock prices" up quickly by using LEVERAGE. Take away or limit "mark to mkt" and THEY HAVE A PROBLEM ...not in recovering, BUT IN RECOVERING QUICKLY when the economy improves somewhere in the future. (probably a much farther future than they think!)

BUT THE BIGGEST PROBLEM "large investment banks" will face:

*Much is made of the "credit liquidity crisis" ...and groups like the G20 and the Obama administration are feverishly working on "freeing up liquidity."
Now, no doubt WE NEED more WORLDWIDE AND AMERICAN CREDIT LIQUIDITY in the financial system.

With governments around the world working on "increasing liquidity" (by various methods ...moving "bad assets" off banks books, suspending or modifying "mark to mkt," etc....

bottom line: LIQUIDITY WILL INCREASE, but Banks are borrowing cheap from gov right now, and lending at high-spread rates, thereby showing profits, like those announced by some BIG INVESTMENT BANKS recently, but increase liquidity and rates COME DOWN...banks MAKE LESS ON LOANS...do they want that? I don't think so, and that leads us to...

And an equally BIG ISSUE ...in a declining economy with biz slowdowns, company downsizings, WHO NEEDS ALL THIS MONEY provided by making HUGE AMOUNTS OF LIQUIDITY AVAILABLE.

BIZ borrows to EXPAND ...seldom to CONTRACT...and their are less potential borrowers going forward as the world economy continues to decline...

bottom line: In my opinion BANKS LOSE MORE (in this recessionary time, only) WHEN LIQUIDITY IS INCREASED!!!

And HERE comes "INCREASED LIQUIDITY" complements of like... O'bama and the G20....

SO, I WOULDN'T BE GOING "LONG" BANK STOCKS! local, regional, or BIG INVESTMENT BANKS!

Until, the economy REALLY STARTS TO RECOVER - and that looks LIKE YEARS OUT, it DOESN'T LOOK GOOD for the banking sector, AND IT LOOKS PRETTY BAD FOR THE "BIG INVESTMENT BANKS"
in particular.

flashrob

Mar 17 11:49 AM

[flashrob:]

...a shorter version of my previous post on the prospects for banks....

here's the REALITY:

1. bank assets CONTINUE TO DECLINE in a world economy continuing to SPIRAL DOWNWARD...continued high-paid job losses, more foreclosures, etc. NO HELP FOR BANKS HERE!

2. RECENT PROFIT ANNOUNCEMENTS by some of the BIG INVESTMENT TYPE BANKS...

a. mostly due to BORROWING CHEAP GOV MONEY and LOANING OUT at "high interest rates" due to WORLDWIDE CREDIT ILLIQUIDITY.

b. as soon as Obama and G20 (around the world) take various measures to PUMP LIQUIDITY into the banks...GUESS WHAT...

spread interest rates ON WHICH THESE BIG INVESTMENT BANKS are stating PROFITS will DRY UP!

...LOWER SPREAD RATES = LESS PROFIT FOR BANKS ON THEIR LOANS.

...COUPLE THAT WITH "real world WEAK DEMAND," because in a severely declining economy...FAR FEWER BUSINESSES "NEED LOANS!"

So, the banks MAKE LESS MONEY on the loans they are writing because of the gov etc. getting money pumped into many banks for competition to provide lower "interest rate loans" ...

and THERE ARE LESS LOANS NEEDED and demanded...

so lower profit rate loans for banks

and far less loans will be made

plus less leveraged recovery speculation by banks when "mark to mkt" is modified...meaning: they can't use as much leverage to recover.

IS THERE SOMETHING YOU "FANTASY LONGS" CAN'T SEE IN THIS EXPLANATION...

IT'S BAD NEWS FOR ESPECIALLY "BIG INVESTMENT BANKS" GOING FORWARD...and there position is getting worse....

flashrob

Mar 17 12:43 PM

[flashrob:]

why BIG MONEY is not in this daytrader spin driven bear-rally!

why they are not itching to buy...they know it's going DOWN...

this is a daytrader spin-based rally...

listen carefully: WHEN "MARK TO MKT" IS RESCINDED OR MODIFIED...THE BIG BANKS "LOSE ALL POTENTIAL" TO RELEVERAGE HUGE PROFITS ON THE DERIVATIVES MKTS...

no world traders will touch them WITH UNCERTAIN ASSET VALUATIONS...

their stock prices WERE INITIALLY BOOSED TO THE HEIGHTS OVER THE YEARS because of "highly leveraged trading" in the derivatives mkts. Kill that, and you kill them.

They can't recover AS WHEN THEIR ASSETS are revalued to "higher fantasy numbers" so the fed don't have to bankroll them...

THEY CAN ONLY WATCH THERE "NOW REAL WORLD ASSET VALUES" DECLINE WITH REAL WORLD REAL ESTATE PRICES.

couple that with "lower interest rates" (they are only showing profits with cheap gov money loaned out to "the few" who want to borrow and will pay the high rates.

as soon as govs loosen credit...those interest rates go down as banks worldwide have tons of money, few who want to borrow, and they are all scrabbling for the crumbs...

however those OTHER INTL BANKS with "mark to mkt" can watch
their "highly leveraged derivatives" soar back up, in the event of a recovery...and we all expect a recovery somewhere down the road.

flashrob

Mar 17 01:43 PM