Time to Change the Rules Rather Than Throw More Money at the Banks
Barack Obama has time to consider how his administration will minister to the ailing auto companies, as their demise will be protracted. In the real economy, failure takes time. Sixty days from now GM will still be there.
But the same cannot be said of Citibank.
Today, after investing almost half of the $700 billion appropriated by Congress to buttress the capital reserves of the banking system, the evidence suggests that the Treasury and the Federal Reserve have not achieved their goal of easing the cost or availability of capital. Instead, the major banks are cutting back credit, increasing fees and looking for ways to further solidify their balance sheets. Unless these trends are reversed, the concerted federal action will have been for naught, the recession will deepen and recovery will be forestalled.
More capital alone is not sufficient to fix the commercial banking sector, and a new injection of funds into Citibank will not allay the fear the continues to grip the system. Like Citibank, all of the commercial banks have problem loans and problem business lines, and, traditionally, new injections of capital would provide banks with the resources necessary to work out those issues. But today, the risks are different, and more dire.
The collapse of AIG two months ago highlighted for all market participants the risks presented by derivative contracts on the books of financial institutions. AIG's demise came in a matter of days--if not hours--once its credit ratings were downgraded from the double-A level to the single-A level. On Friday, September 13th, AIG was in business. On Monday the 15th, AIG was downgraded. On Tuesday the 16th, the global insurance giant was effectively bankrupt.
In the case of AIG, the rating downgrades resulted from write-downs in its holdings of mortgage-backed securities--to comply with mark-to-market accounting rules--which depleted its capital reserves. The downgrades triggered collateralization requirements under the terms of its $450 billion portfolio of credit default swaps. Faced with demands for collateral that exceeded its financial resources, AIG was insolvent.
The lesson for the major commercial banks that face similar risks was simple: Do everything in your power to rebuild your financial strength and stabilize your credit ratings. Cut back lending, reduce outstanding credit facilities, increase fees, conserve capital, and rebuild your balance sheets. In sum, the lesson for the commercial banks is that if you want to survive--if you don't want to be the next AIG--you should not do any of the things--such as increase lending--that the Treasury is trying to get you to do.
Today, Citibank is rated AA-, which by any measure is a strong credit rating. But the markets are anticipating Citibank's demise. On Friday, Citibank shares fell 20% to $3.77 and its total market value fell to $20.5 billion, a decline of 90% from a year ago, and less than the $25 billion that the US government gave Citibank just last month. In the credit default swap market, the cost of insuring against a Citibank default rose 20% on Friday.
In normal times, a downgrade to A+ would not be a catastrophic event for a commercial bank, but these are not normal times. While there has been no public indication from Citibank of what the financial consequences of a credit rating downgrade to single-A would be, Citibank is currently the guarantor on $1.6 trillion of credit default swap contracts--almost four times the size of AIG's portfolio--and it is not unreasonable to imagine that those contracts have comparable collateralization terms. If this is AIG all over again, a downgrade of Citibank's ratings would lead to the swift collapse of what one year ago was the nation's largest bank.
But this is not just about Citibank. Over the next several days, the Treasury may announce its plans to pour billions more into Citibank. But even if Citibank survives, the Treasury will not have addressed the fear that is gripping the banks. For this, the Treasury and the Fed need to change the rules of the game: They have to tackle head-on the two issues that conspired to lead to AIG's swift collapse.
First, they should change the mark-to-market rules that have made the balance sheets of financial institutions captive of swings in asset market prices. These rules exaggerate the importance of unrealized gains and losses, and exacerbate economic volatility by undermining stability in the banking sector. Instead, consideration should be given to rules that allow for the smoothing of unrealized gains and losses over time, as is the case in pension fund accounting, to mitigate market volatility by recognizing gains and losses over a multi-year period.
Second, immediate regulatory action should be implemented, vitiating the linkage between changes in credit ratings and collateralization requirements under outstanding swap agreements. While changes in bond ratings have always had effect on an entity's cost of capital over time, the rating agencies never intended for rating actions to trigger cataclysmic events. In fact, until the collapse of AIG, the collective impact of the collateralization triggers in swap contracts was barely recognized as a material risk factor for financial institutions. Any counterparty who objects to this change should be free to void the agreement to which they are a party.
With the implementation of these two steps--changes in the mark-to-market rules and removing the collateralization provisions from existing derivatives contracts--the Treasury can immediately reduce the pressure on Citibank and on other financial institutions. Then they can focus on the real job of recapitalizing the banking system, and perhaps the banks will get back to the business of lending.
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Spend those trillions on energy, infrastructure, states, unemployed, facing foreclosure.
Order a trillion dollars in Wind turbines to install
200 GW !!!!!!!!!!!!!!! (600GW nameplate)
Don't ya think that would jump start the economy?
Cover appropriate roofs with a trillion dollars worth of Solar Cells:
Generate an Average of 125-500 GW !!!!!
Electricity sells for roughly 1$ per Watt per year.
100 to 500B$ per year.
10 or as little as 2 years. Only Maintenance cost, from then on for 20-40 years.
ROI of 100% to 500% over 20 years
And that doesn't even include carbon credits!
Stop Copying Hoover, and start following FDR!
Giving these bailout to gambling banks will Force us into the Depression,
Just like the GOP conservatives want,
So they can drown the US gov in a bathtub.
THE GOP IS PURPOSELY PUSHING THE ECONOMY OVER THE CLIFF!
Matthew 25:27, and "Wherefore then gavest not thou my money into the bank, that at my coming I might have required mine own with usury?"
What idiot would take money from the people so the banks could loan the money back to them for a profit.
What idiot would think if you take money from the people who already are over extended and out of work and expect them to qualify for a loan of there own money they do not have
This idiot just created what I call USARY of money I don't even have to create usary of money I might have if I could only qualify?
Common sense or devinity, is there a difference?
I appreciate and agree with your point about taking money from people for a bank profit, and loans back to people who no longer qualify for loans.
However, your use of Matthew 25:27 first of all is a misquote.
It wasn't a question but a statement.
Further the illistration had nothing to do with real money and/or usury, but rather the Kingdom message and the "interest" or number of those whom responded to the message.
Banks seek their own interest. The Federal Reserve should be made responsible for the Congress.
You can't let tax payers money go into private pockets. I agree with "Research".
Invest in Public works energy infrastructure, not investment bankers!
Let's hope after 7 Trillion Bailout, 10 Trillion Tax Cust to the top 400 and 700 Billion War Debt there is paper left to print paper that is worth more than swapped paper. I heard REIT is distroying the physical paper market and soon there will be no paper. Maybe we can use THIN AIR for money
The GOP, the conservatives are trying to bankrupt the US gov do there can be
NO social program
NO public works.
The GOP is trying to drive the USA and the World into another Depression.
There never was any intention of freeing up credit, even on the part of the Treasury. It's all just a ploy to have our grandchildren pay for the money they looted from the Treasury on the way out the door.
The amortization or smoothing of unrealized gains and or losses related to credit default swaps [CDS] et al is a very bad idea. Not because the concept doesn't deserve consideration, but it does nothing to fix the underlying problem. Besides, credit agencies would look through this treatment and it would not change the issued Credit Rating.
What first needs to happen is to force by regulation the proper capitalization of the CDS issuers. Currently there are none and the result is what we see today. Organizations like AIG made billions off of creating, selling and trading these derivatives without having a reasonable level of liquidity/capital on reserve to back them up.
I have read somewhere that one of the problems with the morgage situations is that the banks that people went to for home loans took those morgages and sold them. Thousands of morgages were cut up and bundled and resold. WHY were they cut up?? I have friends who went to their bank to refinance and the bank could not tell them who owned their morgage and would not refinance them. They originally got a variable interest rate because it was lower. Now, that interest has climbed and they are within two months of loosing their home!!!
WHY are the morgages cut up?? And to put it another way, WHY can't banks hold on to your morgage so you know who owns your morgage?? And can we make it illegal to do the above???
here here starlady In my capacity as an Attorney in Texas filed a suit to remove a cloud of a Mortgage from a property on grounds that it was not a lien that was good against a homestead (Texas only permits liens for purchase money improvements taxes and recently home equity loans by licensed lenders on homesteads). It was almost impossible to determine who was the owner of the Mortgage and my opponents couldnt figure it out either.
I am not against regulation in general, but I think it's important to note that the mark-to-market rules put into place by congress had a lot to do with the downfall of some institutions, AIG being the most prominent example. Mark-to-market was set into place with Sarbanes-Oxley, a regulation bill in response to the Enron scandal among others. I definitely think we need some smart and well-thought-out regulation of securitizing of debt packages......but I hope those in congress realize that an over-reactive regulation bill can have very harmful effects down the road. I hope any regulation is written with the collaboration of finance experts who actually know how the finance world works, as opposed to your average congress person who pretends to know how it works.
We need heavy re-regulation of the banking biz.
The banks ignored dubious ratings to begin with at their own peril (and ours). Bankers are greedy and don't know how to be anything else so any solution has to involve them making more money or at least have the illusion of it. Your solution at least gives the banks that face. I hate it because it is essentially coddling a bunch of adult-children that can't get together and do what's right. I also hate any solution that doesn't involve every one of these people being put out onto the streets and returning all the hard-working Americans back to the homes they deserve to own and be able to afford.
Insured by AIG, checking and savings with WAMU and mortgage held by Citimortgage. Can I pick 'em or WHAT!
The U.S. is the new Argentina. Unfortunately, I doubt this is the "change" anyone really wanted.
Oh, well. At least Dubya managed to fake it until after he was sworn in.
I don't believe you should change the mark to market rules or ratings rules. The banks don't deserve relaxing rules so they can start their Ponzi banking, bonus larceny, and highly leveraged financial garbage all over again. They should fail just like my small business should fail if I had not run it in a very financially frugile way for the past 25 years. I would be bankrupt in a nonosecond if I was as cavalier regarding money and finance as these greedy arrogant financial "wizards". So, my opinion is: let them all fail. They made decisions and lost. Aren't decision makers supposed to be responsible for their results? Its all socialization of losses, and handouts, and food stamps for big wig losers, and strict capitalism (survival of the fittest) for the masses.
It is all about derivatives! They need to be eliminated. The only real solution is to replace the global monetary system with a global credit system. This has been argued for years by some economists, notably Lyndon Larouche, and is supported by a number of major countries, but Bush and the British oppose any changes to save the situation. Pouring more billions or even trillions into a dead global economic structure will not save it but make it worse by far.
Common sense did not rule here. We're witnessing the downside of de-regulation with these massive banks that are now riddled with debt. The thing is if they're broken up, they'll wind up back together again later like AT&T is now with its acquisition of Bellsouth a year or so ago.
I think Citigroup needs to suffer the consequences of their gigantic greed. When you lobby Congress in order to make it harder for some of us to go bankrupt while at the same time erecting higher interest rates, over the limit fees, late fees, finance charges making even harder for folk to get you paid and issuing credit cards to college kids whom you know can't seriously pay you, you deserve to fail.
Break the institutions back up into the smaller entities they once were and institute very strict regulations on the system. This is the people's money and life blood. No more golden parachutes, stock options and 10 million dollar a year salaries. They should not be able to run loose as they once were.
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