The Audacity of Dopes

We are being played for chumps. The Bush and Obama plans could only have been designed by failed bankers -- for their principal beneficiaries are failed bankers. We already know enough to confirm that the Bush administration made us the "fool" in the market by massively overpaying for assets. The Obama administration is about to compound that scandal with a "guarantee" program. The bankers that caused the crisis designed both programs. The senior officers at big bank aren't very good lenders, but they are expert in maximizing their compensation.

Worse, Mr. Geithner, the senior public official who, with former Treasury Secretary Paulson, designed the failed Bush plan is the architect of the disastrous Obama plan. Indeed, as the New York Times has just revealed, it should be called the Geithner plan. He overcame intense opposition within the Obama administration and designed a plan that is even worse than the failed Bush program. Geithner's gifts to the bankers that caused the crisis include: a unnecessary taxpayer bailout of "risk capital," a massive coverup of their banks' insolvency, gutting the proposed limits on executive compensation, and devising a "guarantee" mechanism designed to hide the expenses of the unprincipled bailouts from the American public. Remember, executive compensation is not "merely" a fairness issue. Executive compensation and the compensation systems used for appraisers, accountants, and rating agencies were designed, and served, to create the perverse incentives and ethical rot that caused the ongoing financial crises by producing a "Gresham's dynamic" in which fraudulent and abusive lending and accounting practices drove good practices out of the marketplace.

Here's the amazing part -- the bankers are so arrogant that they bragged to a sympathetic CNBC commentator they are playing us:

"What a delicious irony this is--last week, just as President Obama was publicly bashing the stupidity of the banks ... his economic team [was] privately begging for input from Wall Street. The administration was conducting around-the-clock discussions and interviews with senior Wall Street executives, including many from the same firms he was theoretically appalled with, about how to fix the lingering financial crisis. "

There are proven ways to resolve the crisis that are far cheaper and more effective because they don't subsidize bankers and "risk capital." We know how to resolve failed banks. The Federal Deposit Insurance Corporation (FDIC) can place even the largest banks in "pass through" receiverships on Friday at the close of business and reopen them as "New Federal" bank Monday morning with minimal disruption to customers and creditors and retain "going concern" value. This is how the Reagan administration resolved failed S&Ls during the debacle.

The FDIC appoints a senior manager to ensure that "New Federal" is run prudently. There is plenty of unemployed banking talent available. Hundreds of good bankers lost their jobs during the financial bubble because they refused to make bad loans. Research has shown that its sister agency, FSLIC, appointed receivership managers that greatly reduced losses during the S&L debacle. Leaving the managers in charge of failed banks that they led into insolvency is suicidal. The new senior leader is picked based on expertise in prudent lending and integrity. If we want failed banks to return promptly to making prudent loans and help lead an economic recovery an S&L style "New Federal" is the best possible device. The existing managers have terrible incentives -- to cover up existing losses and to make bad or even fraudulent loans that produce the greatest (fictional) accounting income and to "live large" through bonuses and perks. (The Obama compensation limits are political cover. The bankers have designed the "guarantee" plan to ensure that the compensation limits will be illusory.)

The FDIC managers have the correct incentives to finally produce an honest evaluation of which assets are toxic and how much they are worth. This transparency is essential if we are to end this crisis. Under the Bush and Obama plans we retain the existing managers that have overwhelming incentives to cover up the losses. The bankers have designed the guarantee plan to encourage banks to continue to cover up their toxic assets and not recognize their losses. These cover-ups make a financial crisis last longer and increase the taxpayers' costs.

The FDIC managers preserve the going concern value by making prudent loans and get the "New Federal" in shape to be acquired. By providing reliable information about the toxic assets the managers reduce acquisition risks, which expands the number of bidders and reduces the financial assistance required to aid the acquisition.

"New Federal" receiverships dramatically reduce cash needs. Most costs are deferred until the New Federals are sold.

Pass through receiverships save the taxpayers money and prevent perverse managerial incentives because they do not subsidize "risk capital" when banks are insolvent. Common and preferred stock and subordinated debt in banks are "risk capital." Their holders are supposed to receive nothing if a bank becomes insolvent, but the Bush and Obama plans reward them. There is no need to do this. Subsidizing risk capital and maintaining the failed managers at insolvent banks creates the worst possible incentives. It will cause future crises. It will delay the recovery from the ongoing crises. It robs the U.S. taxpayers and primarily benefits the wealthy -- many of them non-U.S. citizens. The contract they made was that they would get nothing if the bank failed. It has failed, and they are often complicit in those failures. The bankers have convinced the Bush and Obama administrations that the taxpayers should be looted to bail out risk capital. We should stop listening to the folks that caused the crisis and have interests hostile to our interests. Let's stop them from using us as chumps.



William K. Black, Associate Professor of Economics and Law, University of Missouri - Kansas City. He held senior regulatory positions during the S&L debacle and is the author of "The Best Way to Rob a Bank is to Own One" (2005)

Comments

[alderwood]

I feel like a complete fool. I voted for Obama and now I see it did not matter at all. To hell with the Democrats! Call me a Libertarian.

[derWahrheit]

Now if Professor Black only had the courage to put a name on this criminal element in Washington and on Wall Street! The Lord knows I have tried!

[kymlosang]

great article! what you said is so right on. we ARE dopes. everyone is in lala-land saying obama will fix it. when will we ever take responsibility and realize WE have to fix this mess? and we can. we take our monies out of these banks, refuse to purchase goods from foul companies and on and on - we can do it, we have all the power, but instead we are dopes who do nothing and let others do the thinking for us. we are a lazy nation, material driven nation that is going down faster than i ever thought possible.
i will be the first to say i am disappointed in obama for picking geithner. obama wont or cant stop these banks from looting us. he cant or wont stand up to them. that is very disappointing.

[Huffingbrownbag]

Great article Mr. Black.
We've been dopes for a long time now. See the "ascendency of the credit card industry" for an disturbing history of how our leaders in business and govt decided to make a virtue instead of a curse of usury. http://www.pbs.org/wgbh/pages/frontline/shows/credit/more/rise.html

[JimTinOZ]

"CHANGE WE CAN BELIEVE IN" my ass! President Obama has shown nothing at all that resembles change of any kind.
1.) Look at his V-President & Cabinet! How Democratic Old Guard could he have possibly gotten?
2.) He's against harsh limits on banker compensation! Kissing banker ass just like Bush?
3.) $78 Billion gone missing from 1st TARP! That's OK we won't go after it, let's give them more!
It's only been a couple of weeks, but you would have thought he might have shown a glimmer somewhere that he is any different then the OLD DEOMOCRAT POLITICAL MACHINE which makes if slightly different then the REPUBLICANS. BUT "NO" HE HAS PROVEN it was all a lie and he is the POSTER BOY for 4 more years of the same old bullshit!

[philonous]

You call them dopes. I call them twits. Register your vote below, or nominate your own candidate. Until we see our "elite" class for the dopes and twits that they are, nothing is going to change.

http://payam.minoofar.com/2009/02/11/wish-there-were-an-american-twit-of-the-year-contest/

Really, what happened to satire in the US? Harry? Care to weigh in, again?

[Newt Globaldisorder]

Google Andrew Jackson. Our 7th President was the only one to get rid of the banksters. Asked on his death bed what what his greatest accomplishment, he said, I KILLED THE BANK! Of course, this is what Obama should do. But he is too busy being a Caesar puppet for bipartisan Brutuses to throw the Fed (moneychangers) out of the government (temple). He will be a one term Chief Exec at best. #44's change? It's loose at best.

[Scottsdalian]

I worked with Bill Black during the S&L crisis and I can assure you he is smart, legit and as honest as the day is long. There were good guys who were trying to do the right things in the gov during the S&L crisis - Bill and I were two of them. Listen to what he is saying - he has been there before, is a good guy in a white hat...and is right. Obama would be well-served by bringing Bill back to DC to help clean up this mess.

Remember...the S&L crisis occured during a republican administration (Reagan) and the current banking crisis happened during a republican administratiion (Bush). Note any trend here?????

[TinNC]

Listen people, this is all by design to keep us all in economic slavery. Check this out, it lays this whole sack of crap put very nicely.... please spread this around!

pt. 1
http://www.youtube.com/watch?v=of4sVULsAJM&feature=PlayList&p=5A7FE38D944CDB40&playnext=1&index=1

pt. 2
http://www.youtube.com/watch?v=o27fGAeM5vk&feature=PlayList&p=5A7FE38D944CDB40&index=2&playnext=2&playnext_from=PL

[guyfrombrooklyn]

Thank you AURA.

Checking fees. ATM fees. Savings account fees. Minimum check penalties. Bounced check fees, and it's not your check, you deposited it. Minimum balance fees. Withdrawal penalties for taking your money out. Points on mortgages. Insane closing costs. Mortgage rates that look like sports scores. Creative (criminal) lending. Allowing the max home equity loans. Balloon loans. Sub sub subprime loans. Credit card interest rates in the 20's and sometimes 30's. Annual fees. Broker fees. Interest calculation fees (not a joke). Late fees.

Anyone care to add, feel fee... I mean free.

With all the fees, and penalties, what REWARD POINTS Jane Q Citizen get for bailing them out?

How can we teach them a lesson?

We can't. If they recover, it will be your money making it business as usual.

[hmargret]

We CAN teach them a lesson:
1- remove all our funds from large, national banks & bank locally
2- pull out of all markets...search for micro-investments
3-never again use credit

[Phideaux]

Bravo!

[unanimous]

Yesterday, I called the bank (Chase) which holds the last of my credit cards with any credit left on it only to find out that they had lowered my credit limit so that it, like the others, was now maxed out. Wasn’t the bank bailout supposed to free up credit? I got mad. I decided to act. I decided to start a petition to nationalize the banks. http://www.PetitionOnline.com/natbanks/petition.html. This seems like the only step that actually has a chance to stop the financial meltdown. Certainly just giving more money to the thieves who got us into this mess will not help at all. I mean, I love Obama, but he is mistaken in allowing the foxes to guard the henhouse of Wall Street and needs our help to shift direction. Lest you think this is a radical idea, it is consistent with the proposals being advanced by Nobel laureate, economist, and NY Times columnist Paul Krugman http://www.nytimes.com/2009/02/02/opinion/02krugman.html?_r=1&partner=rssnyt&emc=rss (Though personally, I think the nationalization should be permanent, not temporary). So, if you agree, sign the petition and circulate it widely to your contacts. Thanks!

[PS9]

"the last of my credit cards with any credit left on it"

Are you kidding me. This is the banks problem? Pay off the debt. This is is a big part of the problem this country is in. Living beyond one's means.

[Henryk A. Kowalczyk - Huffpost Blogger]

In my view, http://www.huffingtonpost.com/henryk-a-kowalczyk/its-time-for-financial-di_b_128466.html , we got in hot water as in our system bankers were able to collect hefty commissions on moving around inflated (toxic) assets.

The most what the government can do is buying some time, so bankers can figure it out between themselves what they are worth. The simplest way of buying time is issuing at hoc emergency loans to individuals who cannot afford paying their mortgage. If by issuing these loans, the government would guarantee that no one house would be foreclosed within the next six months, but six month only, than within this time banks would figure it out the real value of their assets. Just to be clear, if an individual receiving a loan to cover the next six-month mortgage would fail in paying mortgage afterward, bank would repay government first before getting any money from the foreclosure.

[aura39]

Where's the public outrage? The banks charge outrageous interest, have fees for everything except breathing, acted with greed and irresponsibility and the public is supposed to bail them out. The people who got us into this mess are the same ones giving away our money; it wasn't just Republicans. When is the last time a bank helped an individual that was late or lost their job?

My wife and I have paid out taxes all our working lives and not complained, services don't come free. We are tired of whining Republicans and rollover Democrats; how much is each one of these pathetic people costing the taxpayers?

[ClareP]

Just wait- it can get even worse. When I lived overseas, there was a fee of a couple dollars worth each time for the "privilege" of making a cash deposit to your account.

Where's the public outrage? What's the alternative-- you have to have a bank account (or you can't even get paid by your job, much less pay any bills), and politicians and media of all stripes seem to think that the meaning of America is make the most money you can in whatever way you can get it. Try to voice outrage and stand up for something like fairness & you're being unamerican (or leftist, pinko, socialist, and all the rest)....

It's time to get back to the understanding that a significant part of any government's job is regulation, for the public good. We do still have an india of public good, don't we?

[guyfrombrooklyn]

Great article.

The large banks were dog eat dog. Now that they've created a dog that they can't fight, ATTRITION and TRIAGE is UNFATHOMABLE. If they fail it will be APOCALYPSE. Or so THEY TELL US.

How about dispersing TARP money to local financials that show some measure of prudence in lending and investing.

Add a stipulation that more than half loaned to each bank must be utilized for investment in small business, loan refinance, and projects that promise employment and re-vitalization.

Allow no LARGE CAP business lending what-so-ever.

Monitor it with a state agency, that reviews every cent and reports to the FEDS.

It would definitely be cheaper than continuing to shovel benjamins into the failing furnaces we have now.

[connski]

When enough Americans realize that the insolvent banks are playing chicken with the taxpayers so that their overpaid executives can keep their jobs and status and their investors can keep their money the political scales will weigh on the side of nationalization. When you see Lindsay Graham aligning with Nouriel Roubini, the writing's on the wall.

[ntmessage]

Expending all this energy into rationalizing a solution into an ideological outcome like nationalizing the banks does nothing for confidence and accelerates the negative feedback loop. In addition, it forces all the banks to write off massive amounts of debt at 100% and then having the government resell those assets at pennies on the dollar there by making the taxpayer pay twice! Much more than even just recapitalizing the banks directly.

You cannot calculate the cost without adjusting for the tax write off itself! It is only one-half of the equation. Taxpayers pay for those write offs!

A better solution is to recapitalize the banks until a market exists for the 60% of those assets that are still performing and then have the banks pay us back with interest.

If we want to unfreeze credit we should focus on housing values and workouts which is a related and underlying problem that nationalization does nothing to fix. That issue is addressed differently than forcing the banks into a faux insolvency due to mark to no market accounting rules.

Which one is the bigger chump?