A Flag or A Number

by Eric Martin

To make a rather mundane observation, it is quite common for politicians, legislators and others in leadership positions to leak details of a prospective policy to the press in order to market test it.  Run it up the flagpole, and see how many salute and how many set match to fabric.  I can only hope that the bank bailout plan leaked to the Washington Post today is strictly in the hypothetical, market research phase because the plan deserves every bit of the one finger salute given by Yves Smith at Naked Capitalism:

Dear God, let's just kiss the US economy goodbye. It may take a few years before the loyalists and permabulls throw in the towel, but the handwriting is on the wall.

The Obama Administration, if the Washington Post's latest report is accurate, is about to embark on a hugely expensive "save the banking industry at all costs" experiment that:

1. Has nothing substantive in common with any of the "deemed as successful" financial crisis programs

2. Has key elements that studies of financial crises have recommended against

3. Consumes considerable resources, thus competing with other, in many cases better, uses of fiscal firepower.

The Obama Administration is as obviously and fully hostage to the interests of the financial services industry as the Bush crowd was. We have no new thinking, no willingness to take measures that are completely defensible (in fact not doing them takes some creative positioning) like wiping out shareholders at obviously dud banks (Citi is top of the list), forcing bondholder haircuts and/or equity swaps, replacing management, writing off and/or restructuring bad loans, and deciding whether and how to reorganize and restructure the compan[ies involved]. Instead, the banks are now getting the AIG treatment: every demand is being met, no tough questions asked, no probing of the accounts (or more important, the accounting).

The details are, indeed, gory.  The upshot:

Now I do not labor under the delusion that there are cheap or easy ways out of our financial sinkhole. People are suffering, and we are only partway through the process of contraction and writeoffs...

But Team Obama is taking the cowardly approach of distributing the costs among the most disenfranchised group in the process, namely the taxpayer, when there far more obvious and logical groups to take the hits. Shareholders and bondholders bought securities KNOWING there was the possibility of loss. A lot of big financial institutions have been on the ropes for over a year. A security holding is not a marriage. When conditions change, prudent investors reassess and adjust course accordingly. If anyone is long a lot of dodgy bank paper now, they have only themselves to blame. Any [reason] why are rank and file bankers still exempt from pay cuts when the workers in another failing US industry, autos, expected to take big hits?

Like I said: nationalize them.  And, as this Voice piece argues: file some charges while you're at it.  Pitchforks and torches people.

Comments

[Ugh]

Any [reason] why are rank and file bankers still exempt from pay cuts when the workers in another failing US industry, autos, expected to take big hits?

They're not unionized so there is no one to negotiate with/try to destroy for giving $$ to Democratsic politicians.

[Ian]

Rank and file bankers aren't exempt from pay cuts. What makes you say that?

The industry has seen 10-20% job cuts in NYC alone. Folks who remain are getting paid 25-50% of what they received last year. I'm a big supporter of treating banks like any other bankrupt institution, but the rank-and-file in finance are getting whacked hard - no need to pretend they're not.

[ThatLeftTurnInABQ]

Ditto that, as I've been saying for some time now. I'm not cool with the idea of taxing us all into the ground so Bill Gross and PIMCO can whistle past the graveyard. Nemo thinks so too, so this isn't just one of those left wing things, either.

That was one of Yves' finer rants, BTW.

[Ian]

Let me also add that I concur with you and Yves over the absurdity of any approach that doesn't wipe out shareholders in these institutions. It's absolutely incomprehensible. There's no reason for it.

[ThatLeftTurnInABQ]

The Obama Administration is as obviously and fully hostage to the interests of the financial services industry as the Bush crowd was.

One other point: Fighting this isn't going to easy - Kevin Phillips has been pointing out for several years now that the FIRE sector (finance, insurance, real estate) has penetrated the Democratic party with its lobbying influence just as thoroughly as it has the GOP. Just ask Chuck Shumer and Chris Dodd.

This fight is going to go some distance towards determining if, having swapped geographic bases with the GOP over the last 100 years, the Dems will now morph into the party of big business interests, just as the GOP did in the late 19th Cen.

[A.J.]

Let me also add that I concur with you and Yves over the absurdity of any approach that doesn't wipe out shareholders in these institutions. It's absolutely incomprehensible. There's no reason for it.

Who are these shareholders? Are we dealing with Mr. Burns, or are we dealing with the NY State Teacher's Pension Fund? I'm afraid that the answer might be the latter; it would explain why we haven't seen a serious push to soak the shareholders.

[Eric Martin]

Rank and file bankers aren't exempt from pay cuts.

This is true. The case was overstated - but I think Yves was a bit hyperbolic throughout.

[Bernard Yomtov]

Krugman is also unhappy. Can't say I blame him.

[Ian]

I'm sorry, Eric, I read too quickly and attributed that to you.

[Eric Martin]

Are we dealing with Mr. Burns, or are we dealing with the NY State Teacher's Pension Fund? I'm afraid that the answer might be the latter; it would explain why we haven't seen a serious push to soak the shareholders.

The answer is both! But that doesn't change the assessmnent.

[wonkie]

Well.

I remember writing, in the morning after thread, that I expected to be disappointed in Obama.

But I didn't expect to tbe this disappointed. Ithought that all in all his Pesidency would be successful, prehaps verysuccessfull.

But maybe not.

[ThatLeftTurnInABQ]

Who are these shareholders? Are we dealing with Mr. Burns, or are we dealing with the NY State Teacher's Pension Fund? I'm afraid that the answer might be the latter; it would explain why we haven't seen a serious push to soak the shareholders.

Almost certainly some of both, but I think it is unwise to focus on the shareholders. The price of equity in the big Wall St. firms has already taken a nosedive - any shareholders who haven't already bailed have been hurt badly. The biggest beneficiaries on the equity side would be bottom feeders who bought in just recently, assuming that financial stocks rebound in the event of a bailout (to a degree that isn't already baked into their current price).

The real big money game here is over how much pain (if any) is inflicted on bondholders - folks like PIMCO who purchased bonds issued by the investment banks (and were paid a nice risk premium to do so). The bondholders need to take a haircut to reflect the failure of the firms whose paper they purchased, or else we are just transferring taxpayer wealth to them.

I don't know how much of a haircut would be justified - I've seen the figure of 20 percent bandied about but I haven't seen any detailed anaylsis to justify that figure in particular. Seems to me that this is something that should be determined by the detailed circumstances of each bond issue rather than a flat figure across the board.

This is going to be very much one of those "pay attention to all the little details" kind of issues. I'm sure the mainstream media will be a great help in sorting this out.

[J. Michael Neal]

My idea for a haircut is to figure out how much they would have made had they invested in treasuries in the first place. Short term Treasuries, since that's the risk-free rate, and they are, apparently, not going to bear any risk. From the time the bond or other asset was created, figure out how much interest the 30-day T-bill would have earned for each period. Add the principal and the risk-free interest that would have been earned, and subtract out the interest that actually was earned, and that's what the asset should be worth now.

That probably overstates what they should be worth, since the asset holders had a chance at upside that didn't materialize. If it had, they wouldn't be coming to the Treasury now for a handout. Still, it's a start.

[Gus]

wonkie, let's wait until his first full month is over before we say he's a failure. I'll admit the future doesn't look bright, but give the guy a shot first.

[Eric Martin]

Just to be clear: I'm operating under the theory that this WaPo story is a trial balloon, that can and will be shot down. And that something smarter will be enacted.

That said, the presence of Summer and Geithner is not encouraging.

[Justin Slotman]

"That was one of Yves' finer rants, BTW."

Yves also doesn't rant very often (a lot of finance bloggers seem like they want to be Howard Beale)--that's why it was awesome, and also why I am officially more worried about Barry's ability to handle Great Depression II: At Least We Have Ipods.

[Ugh]

Atrios:

Deep Thought

I wonder if this is how civilizations fall.

[ThatLeftTurnInABQ]

Yves also doesn't rant very often (a lot of finance bloggers seem like they want to be Howard Beale)--that's why it was awesome, and also why I am officially more worried about Barry's ability to handle Great Depression II: At Least We Have Ipods.

Ditto that. When Yves starts to sound seriously pissed off, it is time to start paying attention, IMHO.

[Eric Martin]

When Yves starts to sound seriously pissed off, it is time to start paying attention, IMHO

True. That's what caught my attention and led to this post.

[Nell]

@TLTIA and Eric:

The point about bondholders needs to be made as clearly and strongly as possible, and pushed into the headline of the furious response this proposal deserves.

I'm afraid to go look at other sites...

[Gary Farber]

I just have to say, off topic, that "Eyes On The Prize" is one one of my PBS channels, and anyone who receives it should go turn it on and watch it and the rest of it! It's the greatest documentary, and the greatest drama, I've ever seen in my life!

[B]

I want to know what hilzoy makes of this ---- http://www.guardian.co.uk/world/2009/feb/04/guantanamo-bay-torture

[Bernard Yomtov]

J. Michael Neal,

Wouldn't your Treasury bill calculation produce a bonanza for the bondholders relative to any reasonable estimate of the bonds' market value?

[cleek]

let's wait until his first full month is over before we say he's a failure

yes, and also... this is ONE issue.

indeed it's a big issue and probably even the biggest facing the country as a whole. but still, Obama has already done some good things, and there's more to come.

a presidential term is 208 weeks long, not 2.

[wonkie]

I know. Sometimes I just get depressed.

[J. Michael Neal]

Wouldn't your Treasury bill calculation produce a bonanza for the bondholders relative to any reasonable estimate of the bonds' market value?

It probably depends upon the bond. If they're old enough, the spread between T-bill rates and what they were getting could be enormous, I'd think. I can't find a good place to look at the rates on various securities, though. I'm not a bond guy.

[gwangung]

I know. Sometimes I just get depressed.

Who wouldn't, looking at all the stuff that HAS to get done.

And this is the easy stuff...

[CharleyCarp]

Well, B, I'll express an opinion: if someone in the WH isn't on the phone with Sec. Clinton about this, I'll be both surprised and disappointed.

[Rebecca]

This is NOT the easy stuff. There are plenty of very smart people who do think this is a good idea (or at least a reasonable idea that might work and will be less disastrous for the existing order if it does). We (obwi readers) just trust the very smart people who say this is a very bad idea much, much more (in my opinion, rightly so, but then I would think that). Buying toxic assets was just a few short months ago, considered a good (or at least reasonable) idea for people on both sides of the isle, though I admit to being seriously disappointed to hear that from someone I though had better taste in advisors.

[hilzoy]

B: I agree with CharleyCarp. I do note that the article indicates that it was a Bush administration demand, and I hope that it gets changed. ASAP.

[TJ]

This is NOT the easy stuff. There are plenty of very smart people who do think this is a good idea (or at least a reasonable idea that might work and will be less disastrous for the existing order if it does).

This actually is the easy stuff. The people pushing this are the same people who screwed it up in the first place. They're only smart where it's their own gain involved. It really doesn't take a rocket scientist to do the opposite of what the boneheads have been doing.

[Nell]

OT on the US intel threat issue:

This Meteor Blades diary at Daily Kos poses the question

whether the British Foreign Office has been using the threat as a cudgel against the High Court to protect itself from unpleasant revelations regarding UK complicity in torture.

Worth reading, as MB's posts usually are.