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March 24, 2009


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Wouldn't it be good to nationalize at least one bank right away for Treasury/Fed to get some experience in the process, just to be ready if needed?

These people really do have the potential to make a killing if the assets are undervalued.

What makes an asset "undervalued"? Unless I am much mistaken, "the market" does. That is, I have an asset I paid $100 for; it's "toxic" because I don't know what "the market" is willing to pay for it. Who is "the market", if not "these people" -- the very same people who stand to "make a killing"?

There's a price "these people" were willing to pay for my asset -- $30, say. Had I sold at that price my bank would be legally broke and I would lose my job, let alone my bonuses and perks and status. So I didn't sell, but neither did I dare lend out money.

Now Tim Geithner comes along and tells "these people" that if they put up just $15, he will put up another $75 of taxpayer money, to buy my stupid asset. I'm happy to sell for $90, since booking a mere 10% loss makes me look like a freaking genius.

And with the toxic asset replaced on my books by $90 of cash, I can lend again. Hooray! Who needs a loan? Why, hello: "these people" do -- my buddies who have this great public-private partnership deal going with Geithner ...

It's all a sick joke. I don't know if it's a joke on Geithner, or by Geithner. When "these people" offer tranches in their deal to 'investors', what do you guys want to bet that I, the clever banker, will buy in on it?


Totally wishful thinking, I suspect. Read hilzoy's following post and see what type of people Obama just bet his presidency on.

I disagree with you that if this plan fails it makes nationalization easier. It makes it impossible. If this works out like Krugman thinks six months from now Obama will have political capital of about zero.

Correct me if I'm wrong, publius, but why couldn't a super-duper bankruptcy/FDIC-style takeover do just these things?

Sure, when a company goes into Chapter 11, a bankruptcy master (if I've got the right term) is appointed by the court to take over the running of the bankrupt corporation. But that master isn't usually a nuts-and-bolts sort of person, and while maybe s/he gets rid of the well-compensated CEO who ran the company into the ground in the first place, s/he generally leaves intact the corporate structure underneath the departed CEO.

So suppose we go from owning 80% of AIG, to owning 100% of it - a move which should cost us zero in and of itself, given that AIG is seriously underwater.

Excepting the London unit that went nuts by insuring everybody's bets in the market, AIG is still a good company that's worth a lot of money. Turn it into a regular stock corporation, land a CEO from elsewhere in the insurance business to run the company, and sell the stock to investors over the next year or so in an orderly fashion, not swamping the market with 'new AIG' stock at any one time. Proceeds go to Uncle Sam, to compensate in some small part for the losses we're still on the hook for with the London unit.

Now, the London unit, which is the part that needs 'unwinding': it's in a close legal equivalent of Chapter 11. The proceeds from 'new AIG' would enable AIG's counterparties to be paid off at the rate of X% - and probably a pretty low X. Certainly not 100%, probably well under 50%, right? It's a black hole.

So nobody's got a right to get 100%, or even 90%, of what they're theoretically owed by AIG. We ask the Big Banks what happens to them if we pay off at 70 cents on the dollar - still a big bath for the taxpayer, but not nearly as bad as what's been happening so far. Those that can stay afloat when AIG pays off at that rate, take that 30% writedown, and go about their business. Those that can't, we take over in turn.

What's complicated about that? That sounds like a solution that is closer to the spirit of what you'd like to see than anything we're going to get from Geithner.

AIG has always been at the bottom of the mess; only when AIG is zeroed out in some manner will we know where we are.

I agree with LTS and second his questions. What's wrong with unwinding the banks through bankruptcy proceedings where we liquidate the "legacy" stuff, fire the managers, bring in new ones, let them run the show, and move on? As LTS notes, bankruptcy is pretty quick and dirty, relatively speaking, and doesn't involve some kinda scary "commanding heights" socialism with 5 Year Plans or anything. The fact that temporary takeover/bankruptcy/FDIC solution opponents pose this as an artificial choice between paying off the banksters and "socialism" just shows me that they've bought the Randian koolaid and won't consider (or can't) actually using government in a workable way for the public interest.

Publius's post reads very weirdly to me. On the one hand, he (she?) talks about his pro-regulation street cred but blithely advocates paying and leaving in control the same class of folks who've bankrupted the economy. Yeah, I'm much more confident that the Geithner plan will be administered by brilliant, hands-on hedge fund managers who......made the stupid insane bets based on abstract models that got us into this mess. Hmmmmm. One thing this debate has taught me is how much childlike faith many so-called "liberals" have in the magic healing power of the infallible Market God, despite substantial recent evidence to the contrary.

But at the end of the day, I think my tepid support has essentially two foundations: (1) I am a pitiful lapdog (2) and not particularly clever.

Johnny Canuck - how about an extended trial with a Venezuelan style dictatorship - you know, to control the citizens and protect those who have currently seized power. Just for a little experience. Take it out for a spin. See if it works. A little social experiment. Couldn't hurt. Much.

What's wrong with unwinding the banks through bankruptcy proceedings where we liquidate the "legacy" stuff, fire the managers, bring in new ones, let them run the show, and move on?

This is my problem with the liberal opposition to the Obama/Geithner plan. The liberal opposition does not have a realistic plan at all! Do you really think this is going to be an easy walk in the park? How long do you estimate it will take to push BofA and Citi through the bankruptcy system? Just a couple of weeks?

Drum smells conspiracy

What's wrong with unwinding the banks through bankruptcy proceedings where we liquidate the "legacy" stuff, fire the managers, bring in new ones, let them run the show, and move on?

Do you have a couple years to spare?

Bankruptcy proceedings, as I understand it, helps figure out who gets in line where. With these banks, do you really think this will be done cleanly?

The problem with FTA96 is not entirely that the plan is impossible to administer -- though it is not exactly a model of clarity, true -- but that it was farmed out to an incompetent federal agency whose entire purpose theretofore had been to enable the ILECs it was now expected to regulate.

Worse, this was attempted in the midst of a sea change in the underlying industry technology paradigm, such that a bunch of bureaucrats with only (usually third-hand) knowledge of copper infrastructure were tasked with regulating the changeover to fiber pipes.

Oh yes -- the ultimate point of that comment was that, for what it's worth, the FDIC and the SEC are not the FCC, not by a long shot. In the pantheon of administrative agency competency they're about as far apart as you can get.

As far as methods and means are concerned, I'm perfectly willing to discuss that and to discuss how (or whether) bankruptcy proceedings would be adequate to deal with the current crisis. But I think the burden of proof here shouldn't be on those who urge bankruptcy proceedings but those who support the alternative Geithner plan. Everything I'm reading at least suggests that many of these banks we're funnelling money to are insolvent in any realistic sense. The established mechanism for dealing with insolvent concerns is bankruptcy or related proceedings, and even on a large scale we've had some experience dealing with that (remember the New Deal? or more recently, the S&L mess). Why turn your back on that process in order to establish a very artificial and probably fraudulent process where we hand billions of dollars to hedge funds so that we can "discover" what the price of toxic assets "really" are? All we're really doing is overpaying the banks for stuff the market won't touch now (gee, why is that?) at the taxpayer's expense. If this is a monumental problem and you doubt the ability of current bankruptcy processes to deal with insolvent banks, let's discuss how to change that as quickly as possible so that we have the money and the people to do it. But let's not throw up our hands, wish and hope the assets were worth more than they are, and pay a bunch of economic leeches a premium to deal with the problem, all the while hoping they have our interests at heart. If there's a criticism of naivete or magical thinking to be made here, frankly, I think it's more fairly levelled at Mr. Geithner than at his critics.

... The government can't get competent help to run the Citibank part of Citigroup for five years?

Enforce a haircut on some Citibank debt holders, guarantee the rest of the debt (or convert to equity), and sell it back to the public in 5-10 years.

I don't think the government has to invent some new bureaucracy to be the Bureau of Citibank - is that what you're saying?

Surely there's plenty of managers available to run the company in exchange for a decent salary and stock options.

Keep most of the employees who actually do things like make loans and collect interest.

Another note: After being seized by the FDIC, Indymac's portfolio of subprime/Alt-A was saleable for about 1/3 of what Indymac had it valued at.

The Geithner plan (due to the implicit subsidy of no-recourse loans) ends up setting a price x% higher for the toxic stuff than what the market would rationally pay.

x% is not unlimited, since the private investors do have some of their own money exposed; seems like it should be between 10% and 100% (that's where it ends up if you try various numbers.)

Well, in the case of Indymac, even if they had gotten 100% above market worth for their loan portfolio, they would still have been insolvent.

Maybe Indymac was unusually bad or maybe not. Keep in mind Indymac sold a large proportion of the loans they originated into the market.

In my uninformed view, looks like the Geithner plan will very likely show that this plea from the banks that "the market is just illiquid that's all" is a load of hooey, and that many banks are still insolvent even if they are heavily subsidized.

What happens then - I don't know.

In any case, it's not totally true that there is no price discovery in the Geithner plan. There is a sort of price discovery - the discovery of the 'anti-sale' (subsidized) price.

If that still doesn't help the banks, then ... that's not good for them.

But the Geithner plan does discover at an upper bound for the 'real worth' of these assets. They are worth "at most" the Geithner price.

I think you're probably right, publius, although no one really knows. What the nationalization fetishists miss is that share purchase and asset purchase are ultimately interchangeable. If the USG nationalized, it would be buying exactly the same crap and undoubtedly paying more than the current market rate. So either way we'd have to hope that the current market rate understates what the USG can get for the crap in the end.

The question isn't whether the taxpayer is taking on an uncompensated risk: one way or the other, it is. The question is which scenario creates the higher risks: buying the assets or buying the liabilities and the assets.

Of course, even if the asset purchase part works for some banks, there are still going to be institutions that need to be wound up (nationalized), so those looking forward to this are likely going to be satisfied.

TheWesson --

You make it sound easy. But if the Govt imposes a haircut on Citi's liability holders, then it has to decide (a) the amount of the haircut; (b) the priority of the liability holders. By hypothesis, it doesn't want to leave this to ordinary bankruptcy law because some of those debts are owed to grannies and pension funds and foreign governments who thought they had a safe thing. But if Congress decides on some other set of priorities than the Bankruptcy Code, then it all depends on who has political influence. Does this sound like a good idea to you? Chances are that the liabilities the taxpayers are going to guarantee will be a lot bigger than the assets the taxpayers are going to get.

In case anyone is still reading:

Having, say, AIG go into bankruptcy proper would be a mess. The first thing that happens is that all of the derivative counter-parties seize the collateral that has been pledged. Thanks to the Gramm-Leach-Bliley Act, the stay on getting assets out of a bankrupt company doesn't apply to the derivative counter-parties with regards to collateral that has been pledged. It appears that all of AIG's assets were pledged as collateral prior to the government stepping in in September. Chapter 11 means that there really is no bankruptcy proceedings worth talking about, because there's nothing left to split up. So, all of the other creditors, which includes everyone with a whole life insurance policy with them is out in the cold.

There are similar, though not exactly the same, concerns with the big banks going into bankruptcy proceedings.

So, that leaves us with the idea of nationalization in some fashion. That, too, has some problems. The biggest is that the government doesn't have the authority to nationalize them. The FDIC can take a depository bank into receivership, but depository banks are only a small part of these companies. For the rest of them, no one has that sort of power.

Unless and until Congress passes a bill granting the administration that power, we can only use plans that involve voluntary participation on the part of the financial companies.

There are also very serious international issues with nationalization. One is that it's illegal in many countries for a foreign government to own a bank. Most of these companies have subsidiaries that operate in these countries. What do you do about them? Also, Americans get upset when some other government nationalizes American owned assets in their own country. How do you want to bet that the governments will react when the US expropriates assets in their countries?

Thanks, JMN. But if that's the problem, then it seems more reasonable to amend Gramm-Leach-Bliley and whatever statute(s) create similar problems for other creditors of banks in bankruptcy, than to gamble $TT.

I don't think that would be in impairment of contract, by the way. It changes the background presumption that made the contract seem more reasonable, but that happens all the time. It sux for the derivative counterparties, but, as a great man once said, "somebody's got to take the fall." They knew they were gambling.

Besides, the collateral for many of the derivatives is nothing but the right to other, equally suspect derivatives. Let 'em have it, it's worthless anyway.

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