The economic woes that are bedeviling us are of two distinct varieties: the problems being caused by the financial crisis and the problems of the crisis of the economy at large. Of these two I think that the former is the more pressing since it touches every other sector of the economy.
As I write this the total book value, based on shares outstanding and share price for Bank of America is less than $35 billion and for Citibank less than $19 billion. Under the circumstances I don’t think it makes any sense to throw big wads of cash at these banks. In my view the only sensible alternatives are to allow them to fail or to nationalize them and liquidate the assets. The latter looks like the better alternative of the two and I don’t appear to be alone in thinking so:
“The Treasury plan is a step in the right direction, but it does not go far enough in addressing banks’ tangible common equity or the problem assets on their balance sheets,” Paul Miller, an analyst at Friedman, Billings, Ramsey, told investors this week.
The U.S. financial system needs at least $1 trillion in tangible common equity to be sufficiently capitalized, he noted. Common shareholders are the true owners of businesses. In banking, when loan losses happen, they’re the most exposed. Without more common equity, banks will likely remain reluctant to increase lending.
“We would prefer to see the government take bold steps now, either putting the much-needed capital into financials or providing a closed-back solution, in which the government briefly takes over the weakest financials (regardless of size), strips out the bad assets, and sells the good back to public markets,” Miller said.
Gerard Cassidy, a banking analyst at RBC Capital Markets, suggested a similar “tuff love” approach.
“U.S. regulators need to move in and close down insolvent banks (regardless of size),” Cassidy wrote in a note to clients this week. “The banks are seized, the deposits are sold along with any good assets, and bad assets are transferred over to an ‘RTC II,’ which liquidates the troubled assets.”
The assets of these two banks are in the tens of trillions. There’s certainly got to be $60 billion of actual value between the two of them.
Some are recommending, as they have for some time, suspending mark to market rules:
One way to take the insolvency issue off the table is to suspend mark-to-market accounting, which compels banks to value assets on their balance sheet at the price they could fetch in the open market. Ryding says a big reason for the negative reaction to Treasury Secretary Geithner’s plan on Tuesday was that he did not go this course, which would certainly be controversial but would give banks significant breathing room to deal with these legacy (nee toxic) assets.
That would maximize the likelihood of “zombie banks”, banks which are actually insolvent but shamble on in a state of undeath. That’s what happened in Japan and they still haven’t recovered from their financial crisis twenty years on. It would also be likely to maximize the costs of the eventual clean-up.
Arnold Kling has suggested lower banks’ capitalization requirements:
My alternative is to encourage new lending by lowering capital requirements at the margin. Tell banks that loans issued after September 1, 2008, require half the capital of similar loans issued before September 1. Some banks are in such bad shape that even with those lower capital standards they will not be able to make new loans. Fine. You don’t want those banks to grow. But other banks have room to grow, and you want them to grow more than they would under the existing regulations.
That was proposed back in September and I think it’s now too late in the day. There’s just too much risk for that solution.
We can either take the hit of allowing the banks to fail or we can nationalize and liquidate them. Time to nationalize.
Various prescription for the banking problem have been put forth. Could we do a quasi-decision tree?
Option 1. The government declares banks insolvent. Fresh private equity is invested in the banks in the (Nourebian) amount of $2T. The banks are now solvent by definition, and march ahead, making loans.
Pros and Cons? Pros: old equity is wiped out, the new equity takes the risk and gets the upside – the fair result. The current banking infrastructure is intact, moving forward and making loans, just about immediately. Cons: How do you assemble $2T in private capital? The old “toxic” assets may continue to be an administrative distraction and drag on the banking insitutions’ day to day activities. Valuation – new vs old equity. Classic, but limited.
Option 1a. To address the cons above, let the taxpayers (government) be the fresh equity, and hive off the bad assets in an RTC II. Its “nationalization,” and down the road you reprivatize. Pros: the financial capacity of the Feds. No administrative distraction of bad loans. The taxpayers get the benefit of the “good banks” equity result, and the RTC II recovery on toxic assets. (No more bandaids.) Cons: Valuation issues – Taxpayers vs old equity. Same as Option 1.
Option 2. Declare the banks insolvent, then sell them off to healthy banks, with the bad assets held in an RTC II. Pros: Again, how do you assemble enough private capital? (One assumes that, after reimbursing taxpayer administrative costs, the RTC II portfolio recovery is for the benefit of the current bank owners/creditors.’) Cons: Valuation: you are now pitting three interests: old equity/new equity/taxpayer at each other’s throats. Operationally, are you selling entire institutions, or pieces of portfolios? If entire institutions, then you can keep the banking infrastructures in place and the business of banking moves forward quickly. If pieces of portfolios, I can envision alot of lost jobs, data transfer problems, lost time before the business of loaning resumes………
Option 3. Declare the banks insolvent, “liquidate” them, and start new banks. This is a go-round I had with Bernard Finel on OTB. Pros: I just don’t see them, unless this is just really Option 2, above. Cons: It depends on the meaning of “liquidate.” Sell them off to healthy banks? See Option 2. Liquidate in the traditional sense – auction off assets. That’s administratively difficult, and expensive. RTC II on steroids. Who pays for the startup – the taxpayers. Then why not Option 1 or 1a? And further, the notion that new banks would get up and running any time soon seems a pipe dream. Why start new banks on taxpayer money when the taxpayers can just buy the existing banks?
It seems to me that Options 1 and 1a are the only real solutions. I’d do 1. in a heartbeat if I thought it could be done quickly. Otherwise, you’ve got to go 1a.
And the experts tell us time is of the essence.
Ooops. In Option 2, above, I should have started “pros” with ‘the same as 1, but how do you……’
Come on, all of this is relying on “fresh” private or public equity. Look at the facts: the fed, the trez dept, a handful of govt. departments and govt. backed “companies” (i.e.- Fanne and Freddie) been manipulating the markets to be so overvalued, people are now overextended.
The US is now on a savings spree. You will get no private equity until there is sufficient real value for for the banks to draw upon for real growth.
And “public” equity? well, we all know where that will come from: wiping out debt holders accounts at the expense of cash savings (the constitutional limitations on the federal govt be dammed!) Inflation here we come!
Will this drum up true opposition to the deadly ideas coming from the left and right, conservatives and liberals? Or will this give the current administration the opportunity to make another panacea of executive “emergency” orders and rushed bi-partisan bills to “save us” and destroy what is left of our our civil liberties.
Ask yourself about all of these federal measures, executive orders, bail out bills, tax policies, etc: at WHO’S expense? yes, you have it! a massive redistribution of wealth. Are we back in Germany 1933? There are some ominous parallels.
A democracy gets what is deserves, and it seems (with the current bad ideas driving it) is is only going to get worse.
Cheers!