Saving the Banks
The massive wealth destruction the world is experiencing stems from the decline in asset prices, chief of which is housing. Housing prices have to fall because they have been inflated for years, but they will ultimately reach an economic equilibrium and cease going down. When that is accomplished, the financial system will recover and the economy will also improve, which in turn will boost business investment, corporate profits and employment.
But until that happens, our banking system is rapidly collapsing before our very eyes, and the Obama administration is feverishly trying to save it and considering different plans to do so. Professor Jeffrey Sachs proposed in the Huffington Post a "contingent warrant" plan, where the amount of equity transferred to the taxpayers would be determined only after the government has sold off the toxic assets. I believe such a plan creates another devastating layer of uncertainty. It would take time, probably years, before we know the realized value of those assets. We do not have the time to figure out these eventual values. You cannot attract private capital under such circumstances, and without private capital this plan, any plan, is doomed.
The problem is not that banks are not lending, as some people in Congress and the Media have been complaining. In fact, according to Federal Reserve data, bank lending has grown 5.7% since the recession began in December 2007, and consumer loans grew 8.9% (although home equity loans actually declined). Banks have recently tightened their lending standards, as is prudent, but fresh capital courtesy of Congress has made it possible to make new loans. Banks are in the business of lending and do not need encouragement, let alone coercion, to sell their product, any more than a grocery store needs incentive to sell milk or bread.
Rather, the issue is that with yields on investment grade debt higher than the economy's growth rate, it is not financially viable to lend. The cost of new debt is higher than what businesses can earn. That is why businesses are delevering and banks are reluctant to lend. In addition, investment funds and Wall Street firms have been forced to downsize, and by doing so they continue to drag down prices of real estate, municipal bonds, credit card receivables etc., and generally exacerbate the implosion of credit markets.
Seeing this, private capital is fleeing, even from the strongest banks: Wells Fargo is down nearly 60% so far this year; US Bancorp is down almost as much (not unreasonably: marking the banks' assets to today's market would leave most banks insolvent). This indicates the market is losing confidence in the Obama team's ability to fix the crisis. Private investors are worried the policies of the Obama administration are not effective and perhaps worse, counterproductive. There's been barely a positive day in the Dow since Treasury Secretary Geithner unveiled his plan.
It is clear that without a cure for the banking system, the credit crisis will linger. To combat it, Secretary Geithner has to become more articulate and unambiguous. So far his policies have been either incoherent befuddlement, or simply outright penalizing and even retaliatory to banks' shareholders. Castigating the institutions that need government support as the culprits, which they may very well be, is not very conducive to resolving the problems at hand. Investors, already confused regarding who is in charge, will not put money in any financial institution when the government's policy is not to allow shareholders to earn significant returns in exchange for assuming the risk.
The government's experiments serve to prove the obvious fact, that none of the experts have any idea how to deal with this crisis and are simply practicing at our expense. And their actions have broad unintended consequences. In economics, every action creates a reaction, often an unexpected and undesirable one. Instead of providing calm the Obama administration provokes further fear and uncertainty, which are not welcome by the markets.
Moreover, we have other problems brewing. Recall that last year, foreign borrowers have absorbed about $200 billion of treasuries, which helped finance the $450 billion deficit we ran in 2008. The 2009 deficit is going to be more than double that, which means the Treasury department will need to raise about $1 trillion (that's 1,000 times $1 billion) next year from domestic sources, which has never been done before.
Even if US savings rate were to rise from zero to 8% of disposable personal income, which is the prevalent rate in other industrialized nations, that would create about $800 billion in additional savings available to finance the deficit, which isn't enough. Given our lax monetary policy and our vast and profligate spending, interest rates will have to rise sharply, reflecting more adequate compensation our lenders will require.
In response to all this, the U.S. government seems to be on course to nationalizing the banks, or putting them in conservatorship. That will mean suffocating free enterprise, and sounds like something Hugo Chavez does. And I am skeptical government management can really revive the banks. Mr. Geithner is a central banker, Dr. Summers an academic and President Obama a lawyer by training. All are very smart, but none of them, as far as I know, has any experience working in the private sector or running private, for-profit firms. Management by a committee of experts is bad enough; management by a committee of amateurs is truly scary.
Just imagine Washington regulators, previously in charge of Fannie Mae and Freddie Mac, deciding the appropriate size for banks, the level of compensation to attract employees or the suitable dividends. This is not only quasi-Marxist but also highly inefficient and unsustainable, particularly if you plan on raising private capital alongside government financing.
Alas, it seems we are already on that road, with no turning back possible. De Facto, we have already nationalized most banks, given that even relatively solid banks like Wells Fargo would be 35% owned by the government if all the TARP money was converted into common equity today. In the case of weaker banks like Citigroup, the government would own a majority stake.
The damage to the system is done, and all that is left for the government to do is plunge in, eliminate the weakest banks, provide plenty of capital to the surviving ones and gradually sell off the bad assets. It is not a "bailout" if bank shareholders are being eliminated, and it will at least end uncertainty, cleanse the system and enable a fresh start, which is necessary. This lugubrious episode might serve as a reminder that Thomas Jefferson was right when he commented that banks are more dangerous than standing armies.
Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at aschram@wellcappartners.com.
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BULL !
THERE HAD TO BE COLLUSION BETWEEN THE SEC OR FED OR BANKS WITH HEDGE FUNDS FOR THAT MUCH BAD COMMERICAL PAPER TO GET INTO THE ECONOMY !!!!!!
LAWS WERE BROKEN TO ALLOW THAT MUCH BAD PAPER TO BE WRITTEN !!!!!
This is clear and logical argument explaining why we should not nationalize banks.
Banks lost our trust and some of them need to die as dinosaurs did. If we let it happen in October 2008, most of the pain would be over by now, http://www.huffingtonpost.com/henryk-a-kowalczyk/its-time-for-financial-di_b_128466.html .
The government should recognize that banks had unfair advantage in manipulating the homeowners. Subsequently, the government should use its power to correct this flaw of the free market. However, it should do it not by limiting freedoms of banks in conducting their business (as proposed by Obama), but should do it by expanding freedoms of homeowners. It can be done by forcing banks to take the government loans to cover all the defaulting mortgage payments for the next six months.
This way, the government would stay as the guarantor of the constitutional freedom of enterprise. Details of this proposal are here, http://www.huffingtonpost.com/henryk-a-kowalczyk/the-simplest-plan-for-hel_b_167642.html . In this concept, the government does not spend a dime, and does not need any new bureaucracy.
WHEN IS THE OPERATIVE WORD.
Sub-prime mortgages were bundled and collateralized, swapped and branched to derivatives. These toxic instruments is weighing hard on banks and the economy.
In a stunning reversal and revelation by Sec Geithner " too big too complex " . RECOVERY PLAN for these toxic assets WILL NOT BE RESOLVED any time soon. And I mean years. They have yet to make a plan how to value and sell these toxic assets.
Sorry, but I beg to differ.
" WHEN " a word Socrats decided should not exist.
"When" like the word "IF" means someone has to take a loss for someone else.
Understanding Jefferson's comment is important.
He was decrying the idea of creating a system of private bank money-issue in this country.
Which is what we have today in the FED.
He favored government-issue.
Which is the only real solution of the day.
The banking system cannot continue to function because the monetary system that underpins the banking system is broken.
The debt-money system creates ALL new money issued every year as a debt, repayable with interest. The debt-money system NEVER creates the money to pay the interest.
Except as a new debt. Repayable with interest.
We're sorta like the cat that caught its tail.
The real threat to the economy today is this.
There is no money to make our debt-service payments.
The solution to the broken debt-money system of the private bankers is a debt-free, government issue money system.
As Jefferson and Lincoln both called for.
Lincoln:
"" The government should create issue and circulate all the currency and credit needed to satisfy the spending power of the government and the buying power of consumers.""
""The privilege of creating and issuing money is not only the supreme prerogative of government, but it is the government's greatest creative opportunity.""
Greenbacks '09.
Housing was never the primary cause of our economic woes. All along it has been the grifters of Wall Street. At Angry Bear Cactus observes:
"We've been rewarding the financial time bomb makers more and more since Reagan took office. And this is also the second time since Reagan took office we've been bailing out the financial time bomb makers at great cost to the rest of us - the previous time was during the S&L crisis.
Things have now evolved to the point where for some reason, when the market for time bombs disappears its considered some sort of a tragedy. This time around, we've already helped out the grifters, including many investment banks, commercial banks, derivatives traders, and now we've moved on to helping the marks. And rewarding any of them, the grifters or the marks, is a problem for several reasons. It rewards the bad behavior of the financial time bomb makers and reduces the incentives the rest of us have to watch out for the crooks."
Source: http://angrybear.blogspot.com/2009/02/foreclosures-are-not-problem-those-who.html
The real estate bubble is not what caused this mess!! It was in fact brought about by the real underlying CAUSES of our economic meltodown. Are you ignorant or willfully trying to mislead people? Massive deregulation which led to an actual shadow economy in this country based soley on speculation and fueled by corrupt ponzi schemes is the cause of our current troubles. The "assets" that you speak of are not even real assets, such as homes. They are paper representing bets made by greedy gamblers on Wall Street.
Nationalize the zombie banks. Take them over. Wipe out the shareholders and the executive management. Clean house. And most important begin the task of building a real economy focused on production and actual value for the middle class.
You wrote "Just imagine Washington regulators, previously in charge of Fannie Mae and Freddie Mac, deciding the appropriate size for banks, the level of compensation to attract employees or the suitable dividends."
This exactly what has to happen. The kids messed up the banking houses while the parents looked the other way. Now responsible adults have to come in and clean up the mess. What do you do when trying to educate and discipline a child? You take away his or her privileges and structure their lives. You might even reduce or take away their allowance.
Oh, you say you need to pay high, unfettered salaries and bonuses to keep and attract talent? Well may I ask, where are they gonna go if they don't like the restrictions? Every banking system in the world is in this mess. There isn't anywhere to go!
Specious arguments are not going to change the hard fact: the banks need to be nationalized and restructured, then sold to new ownership (management) while subject to strict federal regulation. The 'free market' doesn't always work, and in this case, it failed utterly.
No Bank executive is worth more than $150K per annum including *all* compensation.
No investor has a right to more than 5% earnings per annum.
Let the zombie banks die a necessary death.
Let homeowners who bought prudently be rewarded.
Let homelosers who wanted to play greedy lose, as well as the lenders, national and international alike.
The markets will right themselves, there will be far less almost worthless money floating, and the Yankee Dollar will be worth a dollar again.
Once more--
"The massive wealth destruction the world is experiencing stems from the decline in asset prices, chief of which is housing."
How can you continually get this so wrong?
The derivatives--mortgage based securities--have (or had) a book "value" where leverage had increased their worth on paper by 32 or more times. The entire amount outstanding is greater than the value of all the real estate sold during Bush's tenure.
That is where your inflation is, and that is what brought the market down, once holders of those products realized that they had bought into a ponzi scheme and would never be paid--not even by AIG or other investment insurance companies.
This started at the top, not the bottom.
Agreed.
Apparently the players believed the risk was so diluted it had effectively disappeared. They didn't seem to realize that beyond a certain point excessive leverage intercouples risks to the point that the realization itself constitutes a catastrophe.
The trigger was Lehman Bros.
And mocks, my reply was for Alan, really, not intended to impugn you.
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