Barry Ritholtz has a very good piece of advice for policy makers which there is no likelihood whatever that they’ll heed:
When Bear Stearns first began to wobble in 2007, the initial error in this era of bailouts was in rescuing their bondholders. Instead, in 2008, they should have been forced to take the loss.
Its the same for creditors of Citi, Bank of America et. al. — instead of rescue packages, their creditors should have had to take the loss.
Mortgage delinquencies growing? More and more defaults in the pipeline? We can extend & pretend, or we can take the loss.
Note that via the FDIC, some bank lenders did take the loss. Washington Mutual’s collapse led it to being bought by JPM. Wells Fargo picked up Wachovia. Other examples abound, In each case where losses were forced to be realized, we ended up with a healthier few banks, and no moral hazard.
Zombie banks get created when they do not take the loss.
Now we have the European crisis, wherein all of the parties involved refuse to (say it with me) take the loss.
When you’re not willing to accept any losses you end up in the fix Japan has landed itself in.
This is a problem that extends past economic policy into fiscal and foreign policy, where it is particularly acute. If you’re not willing to take a loss in order to achieve something you want and that’s known to be the case it puts you into a weaker bargaining position.
I’ve quoted it before but this snippet of poetry from James Graham puts it well:
He either fears his fate too much,
Or his deserts are small,
That dares not put it to the touch,
To gain or lose it all.
” In each case where losses were forced to be realized, we ended up with a healthier few banks, and no moral hazard.”
Do you really believe that? Our TBTF banks are even bigger, and I still dont believe they are all that healthy. Look at this Zero Hedge piece. Their risks remain huge and in a scenario with anything other than a perfectly ordered resolution in case Greece defaults, we have frozen credit markets and banks collapsing like dominos.
http://www.zerohedge.com/news/five-banks-account-96-250-trillion-outstanding-derivative-exposure-morgan-stanley-sitting-fx-de
Steve
The best solution is not letting banks become big enough to present systemic risk in the first place. That’s something I’ve been complaining about for thirty years.
Now we’re in the realm of third, fourth, or more best solutions rather than the best solution. There are simply no good choices any more. Back in 2007 I thought the Sweden solution the best: nationalize and organize orderly breakups. Not only did we proceed to bail out banks who’d put themselves in the soup their own mal-, mis-, and nonfeasance, we took precious few steps to ensure that they mended their ways going forward. Dodds-Frank is wholly inadequate.
What’s your prescription? Eternal bailouts? Note that supporting bailouts for big banks on the one hand and complaining about income inequality is incoherent. When banking becomes a risk-free proposition it will inevitably pay its top people exorbitant compensation. What’s to stop them?
There seems to be a very big “blame the borrower” mentality when the opposite should be true. The professional in the situation is the lender, who has a responsibility to evaluate the borrower’s ability to pay. Yet there are far bigger protests with the lender taking a haircut, whether through default or inflation. The result is unsurprisingly more irresponsible lending.
I guess its implicit in his piece that the equity should take the loss first. Otherwise, I totally agree.
People in my business have a point of view, or gallows humor saying: the loss is already there whether you like it or not, its only who is going to take the hit. With the banks the taxpayer bailed out the financial claimants. As Charles Barkley would say “that’s terble.” Just terble.”
I argued the Ritholtz position until I was blue in the face at OTB and here, with little agreement.
“There seems to be a very big “blame the borrower†mentality when the opposite should be true.”
This is the Mr. Smith goes to Washington view. Well, I’m not from Kansas anymore. Vast numbers of home buyers were driven by the very greed attributed to others in the mix – all from cocktail or barbeque event talk about easy gains, or the notion they were going to get something for nothing. If you can finance a refridgerator, a credit card or a car you know that if a home financing pitch sounds too good to be true, it probably is.
Back when things were good (before I had kids :)) I was looking for a helmet in a motorcycle shop. A man and his son came in looking to buy a dirt bike on credit. He said something to the effect of, “but my credit is bad, I mean REALLY bad”. Yet the store still worked with him! That man was a completely irresponsible doofus, but he had plenty of incentive to keep borrowing as long as people kept lending. Anyone who lent money to him deserved to lose it.
“Anyone who lent money to him deserved to lose it.”
You won’t get an argument from me there. “Removing a fool and his money, if you will.” But it doesn’t absolve the borrower of culpability.
I’m not trying to absolve him. I’m just saying everyone would be far better off if people stopped lending to him sooner rather than later, and you cannot depend on borrowers to turn down money he doesn’t ever intend to repay. One is sleazy, the other is stupid. The stupid one is supposed to know better.
“..you cannot depend on borrowers to turn down money he doesn’t ever intend to repay.”
Perhaps we are dancing on the head of a pin.
My observations are few: a) borrowers were every bit as “greedy” as lenders or mortgage brokers etc, and they knew something wasn’t right; its just not politically correct nor does it have the political utility to point that out b) the whole damned thing was spawned by EZ credit (“Bad credit?! No credit?! No problem! Come on down to SpoilSport Motors……where no one is turned down!!) c) to wail and moan about the 2006-2008 problem and then truncate the analysis of origins of the problem at some date like 2003 and dereg is pure politics and pure dishonesty. Similarly, to hive off responsibility singularly to greedy bankers is just crap. The housing bubble took off like a rocket in 1996. CRA enforcement was in vogue. Home ownership public policy was in vogue. When sensible lenders said “EZ credit extension will take us down”………syndication and laying off risk to OPM through both public and private enterprises came into vogue. And government loved it.
This really isn’t that complicated…………….unless we are doing the blame game. Then it becomes an explanation Rube Goldberg would be proud of.
borrowers were every bit as “greedy†as lenders or mortgage brokers etc, and they knew something wasn’t right; its just not politically correct nor does it have the political utility to point that out
Well, who made more money in the end, the borrowers or the lenders?
Also, education comes into play. I remember hearing a pair of statisitics back in the day. One was from a 2003 study that found something like 53% of Los Angeles’s adult population was functionally illeterate. In 2004 median home prices passed the $500,000 mark in that market.*
It doesn’t take a genius to figure out that these two stats cannot possibly lead to a happy ending in the LA housing market. So, should we blame the completely ignorant borrower if they actually believe it when some professional (who presumably knows their job) tells them that housing prices will go up forever and there’s no possible way they can lose money? Who’s more culpable there?
* Been a while since I thought about this much, and I may be misremembering that number. I suspect it may be on the low side.