I have been critical of policy and policy response from the Federal Reserve (as well as the Treasury) for quite some time. I often refer to the Fed's approach as ostrich economics. Their short-sighted policies have dug us into a fine mess. Across the entire spectrum, people have been suckered in hook, line and sinker. This includes the average Joe who over-extended himself to buy the over-sized, over-priced home of his dreams. Somewhat surprisingly, the list also includes sophisticated investment firms and major financial institutions, several of which have been brought to their knees.
The Federal Reserve, which is given the dual mandate of full employment and price stability, has found itself facing an economic landscape with more craters than the surface of the moon. Let me list a few: Credit (Check. And not the type lenders do); Leverage (Too much); Liquidity (Not enough); Growth (Hard to find); Jobs (Even more scarce). It sounds like a bad infomercial. But wait, there's more. How about skyrocketing commodity prices, a collapsing currency and fiscal fissures at all levels of government.
Unable to confront both a deteriorating economy and rising inflation at the same time, the Fed has thrown everything it can think of (including the kitchen sink) to try and prop up the economy and protect our financial institutions. Inflation is tomorrow's problem. Unfortunately, the policy equivalent of the firepower of the U.S. Navy has "barely" put a dent in the surface of the problem. Within the last few weeks, one of our storied investment banks, Bear Stearns, was forced onto life support and then, in historic and questionable fashion, into the arms of JP Morgan. I have much to say on this latest development, but I will leave it for another time and place. I do not believe in bail-outs, but it is becoming abundantly clear at this point that there will be virtually no innocent bystanders if this vortex is not stopped.
Although I admit it begrudgingly, the Fed is directing its attention to the core of the problem: The deteriorating condition of our financial institutions. The Fed, which has aggressively lowered rates and provided innovative financing facilities to financial intermediaries, is concerned with liquidity. Their solution is reminiscent of the Japanese response to the problems that destroyed that economy twenty years ago. It is more a "rearguard" action designed to allow time to do the healing. But if Japan is any example, the healing process is glacial and time is the one thing we do not have.
As is suggested by Bear Stearns, I believe the problem faced by financial institutions is capital, or lack thereof. Illiquidity and leverage are manifestations of this problem. It is apparent that these struggling institutions need capital to survive. Unfortunately, that is not enough. Mere "survival" leaves our financial institutions in a state of suspended animation. The economy will probably find itself in the same boat. If the economy is to regain its' footing, banks have to be part of the solution. They will have to provide fresh funding to a wide array of end users, and this requires much stronger balance sheets.
Therefore, if I were in the Fed's shoes, I would insist that our major banks and financial institutions raise capital, a lot of capital. I would also press lender's to pass on to creditworthy borrowers some of the cost savings being provided by Federal Reserve policy; something that is not being done. Finally, I would try to persuade financial institutions to retain employees (actually insist), even at the expense of reducing earnings. To the extent that institutions balk at these suggestions, I would gently remind them that Fed initiatives have helped their bottom lines significantly over the last nine months and will do so for the foreseeable future; and these initiatives are being done for the good of the economy as a whole, and not just for bank management, shareholders and debt-holders.
One final thought. In the last three decades, a number of crises have been resolved by federal bailouts. I would suggest that when general taxpayer dollars are used to prop up private institutions, taxpayers should also reap the benefits.
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BUT WAIT!!!!!!!!!
I AM CONSIDERED A BAD CREDIT RISK BECAUSE I PAY MY LOANS OFF EARLY.
BAD??? BECAUSE THEY CAN'T GET MAXIUNM INTEREST FROM THE LOANS.
PAYING THEM BACK DOES NOT MAKE ME A GOOD RISK BUT A BAD ONE????
FUNNY HUH!!!!!!!11
Wow Neil, I thought your suggestions in the last paragraphs were so freakishly unrealistic, I read your bio and was shocked to learn you worked in investment. Just being honest. Riddle me this: at what price have banks already raised capital from non-Fed sources, and what does that suggest for the banks and the economy?
Citibanks SWF bailout was at 13%; I think UBS just picked up a big chunk at 9%; I know at two of the recent deals struck require renegotiation if the entities further dilute shareholder value by raising more capital at higher rates thereby screwing the SWF buyers based on their early deals. So u have an idea of the cost of funds when they"re not provided by the Fed. Now what will the impact be on these banks, whose business models are based on borrowing cheap short term, and lending expensive long term? Or on the investment banks whose models require leverage they have too much of now?
This ponzi system requires free money from the Fed. There are no other magic solutions, and the Fed"s isn"t magic either. The great deflation has begun; maybe after the reset, we could start over with NO FED and NO FRACTIONAL RESERVE LENDING. Just a dream.
A couple of points. i did not actually look at the UBS package, and i only skimmed the Citi deal. But given the structure (which, if I recall, included escalating forward conversion prices), it is not clear what the exact cost of funding would be. I think that Citi's deal may have been better than it appears on the surface. Obviously, as the stock price drops, new equity capital will dilute prior investments made at higher prices. That is capitalism. In terms of the cost of "non-fed" funding, the higher the cost the more negative the potential impact, since banks lend money at "positive spreads", or the more the financial institution will rely on the subsidy from the government. (This is both via access to the Fed, and via the traditional bank deposits that are also lower cost due to FDIC guaranties). Finally, you may be right that my suggestion was a bit unrealistic. I tried to determine what principles should guide events like this.
Mr. Grossman,
I apologize for being flippant and thank you for your reply; I certainly did not expect one.
It seems you agree that the cost of capital works against banks, and therefore works against a recovery, and for that reason, I do believe your solution is unrealistic. I do appreciate the principles that you suggest should guide policy in events like this.
Former CEO of Citibank Prince knew how all of this would play out and confirmed so with his "then it gets complicated" remark about when the dancing stops. Yet he walked away w/ a staggering package. Bear"s CEO sold his entire stock position after the Fed bailout for $61M; this would have been $0 without the bailout. Bear bond holders were made completely whole. Entities for whom Bear was counterparty to their derivatives the same. We could start by prohibiting paydays for incompetent leadership. I don"t recall the Prince package, but I calculated at the time it would have paid for a years worth of fully loaded salaries of $50K/yr for hundreds of employees who were laid off instead. Public trials for executives and the politicians who helped them would be even better, and if we"re being unrealistic, why not start there?!?
No need to apologize. Obviously, it is impossible to reply to everyone, but i will try and pick out some comments. I know that when i take the time to respond to other people, that i hope they take the time to think about my comments and, if warranted respond. What has been happening since last summer, culminating in the Bear Stearns bailout is a watershed event. It is refocusing attention on a lot of things including regulation (i will post a note on the repeal of the Glass-Steagall Act in a day or two); economic policy, the mortgage business (including securitization) and monetary policy. There are comparisons to the crash of the stock market in 1928; I think there are many similarities to the 1970's (I actually believe that the major culprit in most of the mess has been overly accomodative monetary policy, but that is for another day). There is going to be a lot to watch and a lot to write about, and I hope that my insights will be helpful.
Shouldn't stockholders get involved with the executive compensation debacle? It seems they have a lot more power in these situations than they are exerting.
"In the last three decades, a number of crises have been resolved by federal bailouts."
Just wondering, Neil, were these bailouts approved by Congress?
the major crises that i remember off the top of my head are chrysler, the collapse of continental illinois, the s&l crisis (which i believe was by far the largest), the collapse of drexel burnham lambert, (as noted in my reply to one of the other comments), the banking crisis of the late 80's early 90's, long term capital and now bear stearns. i believe chrysler involved congressional approval; and the s&l bailout did too. the other interventions (drexel, helping the banks, ltcm and bear) did not come with concurrent authorization from our legislators. one interesting question, in fact, is whether there is congressionally authorizded authority for the fed to extend the type of help that we have seen in the bear situation; or whether the authority is sort of vaguely assumed or even ultra vires, but everyone is too afraid to actually raise a red flag.
Thanks, Neil, as I suspected. Chrysler paid back their loan early, and I believe there was a small interest charge. The S&L bailout was another taxpayer sponsored free love fest for Silverado (Neil Bush) and the Keating Five (John McCain)
Maggie, you're right.
So it's pretty safe to assume that we have no checks and balances? In otherwords, our government is operating outside of the Constitution...
Neil...sadly...you are a dreamer..the first to go will be the secretaries... I just read on a news flash that JPMORGAN..put top Bear Stearns millionnaire shitheads on their executive levels...the same idiots who invented snake oil-type hybrids, CDO's etc... no the multi millionnaires are safe in their upper east side condos... you wrote :
"As is suggested by Bear Stearns, I believe the problem faced by financial institutions is capital, or lack thereof"
Hey..they had enough capital to give multi million dollar bonuses in Dec.to their Wharton MBA's...
Am I the only one who wants these prigs to go to PRISON? They brought down a GLOBAL economy...
Also, sadly..we are greedy..as stockholders..we WANT those nice PE/rations..many will talk liberal...but when their Merrill Lynch stock sits there for a year or two...they will DEMAND cost-cutting..never thinking that means some poor schmuck's job...
perhaps i am a dreamer. i don't believe the government should bail anyone out, which means that if you are a stockholder, you lose; and by the way, if you are a bondholder you lose to. what most people don't realize in the bear case, and most of these bailout situations, the creditors have been protected in total. however, getting past my personal views, if a bailout does occur, i do believe certain principles should govern: one, the capital providers should be the benefiaries; which means the taxpayers get the upside; two, there is nothing wrong with insisting that societal imperatives be part of the bailout, in this case jobs the. if you remember, we have been through this before. in the late 80's, early 90's american financial institutions were in the same situation. the money center banks were citi, jp morgan, chase (which are still around); but do you remember chemical bank, manufacturers hanover trust, bankers trust. (i think ther was a seventh, but i must admit i don't remember). survival required mergers, rate help from the fed and, yes lots and lots of job losses. senior managements were not the one's penalized; in fact many ended up making fortunes. a good example is the former chairman and ceo of citigroup, who ran the institution while it choked on bad loans. citi survived with him at the helm, and i believe he profited handsomely many employees were not so fortunate.
Good point, Halsey. As stockholders demand continually increasing profits, the point of diminishing returns with respect to employment seems to be forgotten. When you max productivity, what do you do? In conjunction with increased compensation demands by executives, job cuts and lower cost replacements are the order of the day. Does this really improve the outlook for the company?
Management has a general lack of employee development skills. The use of labor as a major cost cutting tactic has proven to be a bust. For all the talk of poor education in the average workers whose jobs don't require much school-book-learning, it is obvious our greatest liability rests in the education of corporate America's business managers who are resorting to unethical practices to meet shareholder demands of increased profits.
These banks are lovely examples. Faced with losses due to shady practices put in place by executives, what's their answer? Increase executive compensation, lay off employees. These are customer service-based companies! Who will the customers talk to when they need to deal with the banks to straighten out their mortgages, credit cards and loans? The windows of time in dealing with past due credit are fairly small--in the meantime, additional charges rack up, and the foreclosure clock keeps ticking whether someone is available at the bank to talk to you or not. This seems to be a time when the banks need MORE employees, not less. And the compensation of one executive replaces HOW MANY EMPLOYEES????????
I'm not the brightest bulb on the tree but when these silly morgages first hit the market I could see they were a bad thing. But I thought they'd only be bad for people that got them so I didn't get one. I had no idea I'd be a loser on that game even if I didn't play... now my tax dollars are propping up the fortunes of the thieves who perpetrated the con in the first place.
one other thing for you to ponder, your tax dollars are going to be used to help both the lenders (who issume you are referring to) and the borrowers.
Let us also not fail to ponder that these "tax dollars" that will be used for the bailouts do not exist today, and will go straight to the deficit bulge, with interest, of course.
That's my personal biggest point of aggravation about these bailouts WIpatriot - we are spending money that we don't have, and that our kids (should we have them) are going to have to scrimp to pay back.
Much like the unbudgeted debacle of the occupation of Iraq, and the mismanagement of Afghanistan's 'recovery' - it is money we don't have, and money we can't now borrow against for more important issues like industrial capital redevelopment, infrastructure additions & improvements, government sponsered R&D for things like alternative energy, education and healthcare.
Could not agree with you more, i-pete. Why am I going to have to pay the (c)losing costs?
the bailout of bearstearns need not have been become a taxpayer risk. all that would have been needed is an orderly unwinding of its positions. if the assets bear claimed to have literally days before the collapse then all would have ended well. the fact that the fed will not disclose the assets the fed is on the hook for makes me suspect the assets are garbage and the idea is to let them stay buried in a vault until their loss can be counted without damaging other banks. this shell game is unethical at best and criminal at worst. it violates disclosure rules. it violates fiduciary rules. it violates capitalism. bear stearns investors made a bet and lost. the bondholders and stock holders deserve nothing for their misfortune, that's the downside of capitalism, sometimes you lose.
Just wait, yappy, until these financial institutions suddenly discover that they 'overestimated' their loss position and suddenly have new assests form what, nothing? Yup. Sneaky bastages.
Neil, you have listed the problems but perhaps there is no "solution."
What we have created here is "socialization of risk." The Wall St. bankers have gotten used to the gravy train. Now when the shit hits the proverbial fan, they raise capital among their other cartel buddies in the Middle East.
What investors like I face is the new paradigm. Instead of getting paid a premium for risk, we get premium-free risk. Heck, why didn't Citigroup offer me an 11% coupon on a convertible debt offering they placed with the Arabs? The deck is stacked.
So, I say screw them all. Let's have a damn depression already.
The Fed has made all the wrong moves by LOWERING interest rates. Not only are they pushing on a string, but they have disincentivized saving and punished those who already have done so.
As I said earlier, some bridges cannot be crossed going back. They screwed it up and now the piper must be paid. Big time.
We SHOULD be having our depression, but thanks to Helicopter Ben, Spanky Paulson and the cadre of Wall Street wizards, it's going to be delayed just a little longer. When it does finally come, it's gonna hurt, big time and long time.
Thanks, geniuses. I really hope the masses come for you when they figure it out.
Neil. When the producing economy goes overseas the service jobs that support these jobs wither on the vine. The American economy is fundamentlly flawed by: 1. Unmanaged trade policy which has turned our economy into the receiving end of mercantelism; 2. Social Darwanian competition, totally unregulated,that, as Capitalism critic, Karl Marx rightly asserted, permits the ownership and power to accumulate in a few conglomerates. This accumulation of wealth and power has thrown citizen authority out of Washington and bought corporate, banking power in. It is a fact, not opinion, that the control of our Federal government resides with foreign and domestic trading, banking , manufacturing and business retail interests. 3. The unregulated banks have pyramided debt into exotic instruments that will crash and endanger the entire banking and financial system. We can thank Republican and Clinton Administrations for deregulating the banking industry which has created the immediate easy money lending debt, hedge funds and derivatives and other insane instruments of leverage. 4. The refusal to regulate natural monopoly such as telecommunications, electricity, gas , water, and transportation has resulted in a choatic, crisis ridden economic system. The cost and supply of basic needs are increasingly unpredictable.5. The unwinding of protections against unwarranted unfair business practices has undermined the small businessman and we now have wall mart, target, home depot, and declining communities. Essentially, the unsound American economic system is fertile ground for speculators financial mauraders and Wall Street swindlers operating on the backs of bankrupt and anchorless people.
You said it, tml.
I'm not even using banks right now--keeping as most of my money as cash if I can, and it's the best thing I've done for my finances--no more fees or random charges taken out without my explicit consent by computers based upon policies of greed. As someone pointed out, there are distinctly two (at least) ecomonies, one for the haves and one for the have nots. Money is after all just a symbol we've decided to use to assign value to things. We're making it all up anyway, so the economy? It better start working for all or it will stop working.
Wow, this is interesting.
The author clearly postulates the incomprehensible dimensions of the morass in the financial services industry.
Half of the comments call for a complete switch in just one of the minor players of our present debacle - the banks.
The commercial banks.
They take your deposits, "leverage" them up, do some mortgage-lending, and maybe sell those loans to something that I call, Not a Bank!
These guys are in real trouble. The non-banks.
But, I digress.
Half the commenters advocate a move by depositors ( and borrowers) to credit unions.
One of the reforms we need to look at is extending the powers of credit unions in this country.
Cooperative banks have been around a long time and actually work like most cooperatives do - for the good of their membership.
Cooperative businesses will be the wave of the future.
But, we need to more than just join credit unions (I am a member).
We need to re-do the way we create money, in a manner without creating debt, which takes three times the principal to pay off.
Solution?
http://www.neweconomics.org/gen/uploads/CreatingNewMoney.pdf
1946 Full Employment Act..... Dust the darn thing off!
If were going into inflationary debt at least "make" jobs which will tighten labor markets and increase "wages" , then demand will pick up....and productivity as it did in the late 90's when the Fed slashed rates to respond the Asian market crisis.
If our economy still responds, investors will regain confidence in the dollar and Wall Street. Then deal with the longer term 30yr imbalances that led to this mess, hugh trade deficits public and private debt. and the Milton Freeman/Greenspan school of deregulated markets and robber baron economics, that led to this decline.
Neil, You say: "Mere "survival" leaves our financial institutions in a state of suspended animation. The economy will probably find itself in the same boat." I think you may have it twisted around...the economy is what feeds the banks, isn't it? When will people realize that it is hard to operate two separate economies--one for the haves and one for the have-nots. The haves need the have-nots, whether they care to admit it or not. One day the upper crust will admit that they get their fortunes from US--the workers, the average Joe. Unless these people want to keep trading dollars among themselves, things have got to change.
Banks and credit are part of our economic engine. when banks stop lending (and this includes loans to corporations and little guys (like credit cards, auto loans, mortgages, etc) the economy suffers. One of the strengths of the american system has tended to be trying to move quickly to confront problems. We did this in the late 80's and early 90's, cleaning up the mess created in the 80's. the recession was relatively mild. japan did the opposite. They let the banks languish with problem loans, allowing time to be the medicine. It took over ten years, and the economy is still relatively soft. I think the Fed and the bank's themselves have been taking the latter approach. maybe the collapse of Bear Stearns will change the approach, maybe it won't. I am strongly of the view, however, that the Fed should make clear that Fed support requires banks to protect jobs. In the S&L crisis, the government provided a mechanism for the banks to stay afloat; but jobs were cut by the boatload. In the end, senior management made a fortune.
I agree that our jobs situation is driving many of our problems. When you have a consumer credit based economy, you don't have to have a Harvard degree to know that when jobs go away and wages are devalued, there will be serious problems.
Banks have come to rely on people with bad credit histories--the associated premiums on interest rates and the additional fees are now incorporated as increased bottom lines. There is no motivation for a bank to deny someone credit with a bad history--these people are cash cows. Banks are predators, and apparently it's open season.
Until such time as banks are held accountable for their roles in handling U.S. currency transactions, we will be made to suffer. These people have got to learn to read economic indices and react accordingly. When they see that jobs are disappearing, rather than extending increased amounts of credit, they should back off. Banks are capitalizing on our hardships and they know it. What we are witnessing is government endorsed loan sharking.
An economy based on the amount of bank debt held by the average citizen is not one that has much chance of success. As a country, we should concentrate more on providing people the opportunity to earn money to spend...we need to discontinue the practice of depending on the banks' infusion of cash into the hands of the public as our survival mode--that is nothing more than living an illusion.
the banks tried to raise capital recently by selling stock to foreigners and SWF (sovereign wealth funds). that did not work out so well in cases like Blackstone selling stock to Chinese investors who promptly saw the value of their investment drop 50% - various SWF's have paper losses of billions after having invested in US banks recently.... on the other hand, Visa just sold over 20 bn. in stock via an IPO that raised a very large chunk of cash for US banks, in particular JPMorgan. The balancing act goes like this; for years, banks could raise more money trading their own accounts (with arb. as you well know); and these arb. trades are fueled by lower interest rates... depositors were getting the short end of the stick; but banks didn't care so much if depositors were happy - as long as banks could keep piling 'spread trade' on top of spread trade; monetizing houses, cars, CC receipts, etc. In today's environment, it seems like banks can no longer abuse depositors... they will have to offer people an incentive to put their money in the bank (and take it out of commodities and foreign banks)... The US banking system has to 'come to Jesus' and begin embracing the advantages to their balance sheets of higher rates...
Wow, I guess we're both dreamers.
"I am strongly of the view, however, that the Fed should make clear that Fed support requires banks to protect jobs."
I guess they forgot to throw that in there, Neil.
You know.
Priority Use of the Money Supply - as my Dad used to call it.
You would think that bankers had a nationality.
You would think that the reason they want the freedom to "compete" in international finance is something other than the freedom to finance the offshoring, the outsourcing, the downsizing and the current contraction of the US economy - ALL to the good of the bank's investors.
We need a public, sovereign central bank of the US.
And the charge to that bank is the Priority Use of the Money Supply to do exactly what you "wish" they had in the bailout.
Sorry, Neil.
The bailout is about bankers helping bankers, and about screwing yet further the American taxpayers who will pay for it, in case you haven't noticed.
Quoting Honest Abe, our greatest President, again:
"The privilege of creating and issuing money is not only the supreme
prerogative of government, but it is the government"s greatest creative
opportunity."
Sovereignty.
So, if you really want to create good ole American prosperity, of the sustainable kind, we need to do as Lincoln subscribed, and drive the international money-changers from controlling our well-being.
Just a thought.
You could also put your money into a co-operative bank. depositors in co-ops, as in credit unions, are the owners.
"Their short sighted policies" you say when referreing to the FED. And... banks need more capital.
How about the millions who have or will soon have their home loans foreclosed on? (do you give an ariel expletive deleted about these people?)
Are we even close yet to knowing how these boys, the mortgage securitizationers, could have been so so stupid?
Henry: Here is the thing. People bought homes with mortgages, the terms of whichthey agreed. The lenders lent them the money under certain conditions, chief among them was a repayment schedule. The borrowers failed to repay. Hence, foreclosure.
I bought my last house with a mortgage. 15 year mortgage. I paid an extra amount each month, reducing the principle owed. As a result, I paid my mortgage off in about 12 years, and saved thousands of dollars. I also knew how much house I could afford to buy, and that I would be able to at least pay the mortgage payment in lean times. The borrowers you fret about bought too much house, under terms they could not afford to fulfill in lean times. They are now being foreclosed on. It is their fault. Ah, you say, but what of predatory lenders. Yes they are at fault also. they should be prosecuted for their illegal lending practices.
I insist that I should not be penalized by the use of tax dollars that I pay to forestall foreclosures on people who did not live up to their obligations.
There is much wrong with this economy of ours. Bailing out foolish people is not going to correct any part of it.
Posted April 4, 2008 | 03:39 PM (EST)