Loopy Fiasco

by Eric Martin

I find certain arguments against the size of the proposed stimulus package to be somewhat compelling (adding that much debt on to our already teetering tower could risk tipping the whole damn edifice).  I also consider arguments against the specific composition of the stimulus package to be even more persuasive (there should be fewer tax cuts - or smarter tax cuts - more long term infrastructure spending, less emphasis on undesirable "shovel ready" programs, etc.).

However, there is little to suggest that pre-privatization (temporary nationalization, then privatization) of troubled banks is the wrong approach, coupled with strict limitations on executive pay.  That is why it is extremely disturbing to read this (which seems to confirm my fears):

In the end, Mr. Geithner largely prevailed in opposing tougher conditions on financial institutions that were sought by presidential aides, including David Axelrod, a senior adviser to the president, according to administration and Congressional officials.

Mr. Geithner, who will announce the broad outlines of the plan on Tuesday, successfully fought against more severe limits on executive pay for companies receiving government aid.

He resisted those who wanted to dictate how banks would spend their rescue money. And he prevailed over top administration aides who wanted to replace bank executives and wipe out shareholders at institutions receiving aid.

Because of the internal debate, some of the most contentious issues remain unresolved.

My homey Yves Smith gets the mic:

...[H]ere we have another scowling Treasury secretary, with a bit more hair than his predecessor, serving up the same fatally flawed approach as before: let's just throw money at the banks and hope they get better. This is tantamount to using antibiotics to treat gangrene. You waste good medicine and the progression of the rot threatens to kill the patient.

In fact, the state of affairs may be even worse that I thought. I had grumbled about the fact that the earlier leaks of this plan, like the MLEC and the TARP, seemed little more than a sketch, when its success or failure founder on key details.

The elephant in the room is how do we solve the heretofore insurmountable problem that the market price of the bad assets is well below what the banks are willing to sell them for? Paulson was unable to find a way to finesse the problem to get private investors to pick up even a cherry-picked portion of the junk in the MLEC incarnation; in TARP, he (presumably) planned to have Uncle Sam buy the paper at a price the banks would find acceptable but somehow camouflage the subsidy. He abandoned that course of action quickly, perhaps because the magnitude of the payment over market prices would be so large as to be politically explosive were the bagholder taxpayer ever to find out.

There is no evidence in the various elements leaked that this impediment has been overcome, which raises the real possibility of a Paulson-like seemingly bold advance followed by an equally hasty retreat. Inviting investors in with you on the buy side does not address the issue of the pricing gap, unless the deal with the investors is intended to help obfuscate the overpayment to the banks.

Note I have no objection to equity infusions if accompanied by sufficient ownership, controls, and a methodology for the goners, say taking over or putting into receivership. No private equity investor would put 20% into a company without getting lots of goodies, such as veto rights, antidilution provisions, a board seat, etc.

Now in fairness, Geithner may treat the banks more consistently than Paulson & Co. did. But that is cold cheer if the basic approach is still fatally flawed.

In fact, the present course is the worst of all possible worlds. AIG has demonstrated that a player deemed to by systemically important has a blank check. Not only did they get additional dough with few questions asked, they got improved terms on their initial loans. Let me stress, for those not familiar with the ways of deal-land: if you ask investors for money and maintain it is enough to achieve X (get you to break even, get your first product launched) and then come back not having done what you said you promised, the next round is on MUCH more punitive terms. Having a party that badly underestimated its needs come back, get more dough, and get relief on its inital loan is from an alternative reality.

In addition, AIG had given large numbers of staff very large retention bonuses. This is when the loans per employee are $1.4 million. Now the retention bonuses may very selectively be warranted, but they have been handed out like candy, and AIG is know for generous pay, so even if extra comp might have been necessary, query whether at this level. Given the less than rosy hiring conditions in the insurance industry, a lot of these payments appear flat out unnecessary and were thus effectively looting right under the government's nose.

Thus, the banks get funding on an open-ended basis, with no requirement to write down or sell the dreck. And even if some miraculously does get unloaded via this process, we wonder how far it will get to really cleaning up the banks. Ken Rogoff estimates US credit losses at $2.0 trillion; this plan appears likely to fall far short of that, which means we still have a lot of sick banks, just somewhat less so. (We'll need to wait to see how this unfolds, but since the banks have no reason to part with bad assets and take a writedown, this is the scenario they are trying to avoid, we still have crappy assets being funded at fictive prices, but this time by you and me rather than by Citigroup). The failure to clean up the banks and write down bad assets was a big contributor to Japan's lost decade.

This is just terrible. Much worse than the Nelson-Collins-Snowe-Lieberman "compromise."  Much worse than any defect in the stimulus plan. 

Really, we didn't need the Obama administration for this dreck.  This is vintage Bush/Cheney.

Query: Will the GOP label this enormous giveaway "Socialism"?  "Reparations"?  "Welfare"?  "Bling-bling"?  "Generational theft?

Yeah, yeah I know.  Simple answers to simple questions.

Comments

[bob mcmanus]

As with yesterday's Holder argumnt on State Secrets, the Bank Bailout shows what the Obama administration is about, and more importantly, who Obama is for.

This is not a forward-looking administration, for they will not take hard steps that will lead to a better future. They are about fixing the problems in such a way that can best return to the status quo ante Bush, and protecting their friends and patrons, thos f & ps being very much the same as the previous administration.

This is the Cover-Up Administration.

At all costs, especially costs to the taxpayer, the tortured, the occupied, the children, the Obama administration seeks to protect the entrenched power elites, their power & moneys.

[Madrocketscientist]

Really, we didn't need the Obama administration for this dreck. This is vintage Bush/Cheney.

Why anyone thought Obama would make it all better is beyond me. Granted McCain would be just as much a piece of sh*t.

[blogbudsman]

Then again, by paying executives what the market will bear, and having proper incentives for wealth creation will continue to provide New York's coffers with tax money that keeps that trough full - not to mention endowment money for the arts and such stuff. To you it's slop, to all you little piggies, it's sustenance. Set them butterflies free.

[Eric Martin]

Then again, by paying executives what the market will bear

The market? The market is set by the executives themselves! I mean, obviously, the market will bear the salary of 0 dollars and 0 cents for each of these executives, seeing as how the companies they're employed by are underwater.

and having proper incentives for wealth creation

What incentives would those be? If you create wealth, you will get an enormous bonus. If you don't create wealth, on the other hand, you will STILL GET AN ENORMOUS BONUS!!!

That is the opposite of incentive.

will continue to provide New York's coffers with tax money that keeps that trough full

If we want to use federal taxpayer money to fatten the coffers of New York State, then why don't we funnel it to more deserving individuals/causes.

[bob mcmanus]

Don't Cry for me, Argentina

Fed Expands TALF to $1 Trillion ...Calculated Risk

Argentina not really the model for the Obama administration. Probably an Argentinian default followed by Bolivia

Some dare to care to compare Obama to FDR?

[fledermaus]

Really, we didn't need the Obama administration for this dreck. This is vintage Bush/Cheney.

Wow. It's almost as if we have a one party system with only cosmetic differences on non-economic, non-military issues. Woocoodanode?

Even now they DC consensus is that there are all these credit worthy people aching to take on even more debt in an orgy of continued consumption - completly neglecting the massive increase in debt of all kinds that is currently going sour.

They are simply too isolated from the real economy to understand the problem. Instead they believe that there are hordes community college teachers making $100K/year just desperate to take on new debt.

[MikeF]

Ken Rogoff estimates US credit losses at $2.0 trillion; this plan appears likely to fall far short of that

From the plan recently put up on financialstability.gov

2.
Public-Private Investment Fund ($500 Billion - $1 Trillion)
3.
Consumer and Business Lending Initiative (Up to $1 trillion)

Looks like up to $2T to me.

[wonkie]

This bothers me quite a bit:

Now, just in terms of the historic record here, the Republicans were brought in early and were consulted. They were pleasantly surprised and complimentary about the tax cut that were presented in that framework. Those tax cuts are still in there. I mean, I suppose what I could have done is started off with no tax cuts, knowing that I was going to want some and then let them take credit for all of them. And maybe that’s the lesson I learned.

That's what he learned? How come he didn't know that already from having been in the Senate?

The lesson he shuld have learned long ago from having been in the Senate is thaht Congressional Relublkicans are for the most part bad people who are not interested in anything but the pursuit of power and money form themlselves. Tthey do not negotiate in good failth, they do not engage in discussions with any degree of intellectual honesty, they do not repsect facts or expertise, and they do not care about the future of this country. I really didnt no t think that Obama had illusions about this. I thought that all of his talk of bipartisanship was kabuki for aour asshole pundit class. I am very disappointed that he has not got the measure of the Republicans yet. I did not expect him to be naive.

[wonkie]

I should have put the p[aragraph starting with the word "now" in quotes because it is a quote from Obama.

[GoodOleBoy]

I agree that what's is being presented by the new administration is not encouraging. The bankers who led the charge over this cliff and the equity holders who invested in their institutions should take all the losses appropriate to the risks taken. Where taxpayers are making investments, they should exercise influence to constrain excesses in incentives for managing these institutions on a path back to profitability. Obama and his cabinet and advisors are making a mistake in allowing the bankers to continue business as usual regarding pay and incentives, since these have had no historic relationship to performance. This is unacceptable to taxpayers.

If the Federal Reserve is given new responsibilities to protect the financial system against systemic risks, then I believe part of what the Fed should do is examine the concept of too big to fail that has been strangling us and introduce approaches similar to what goes on in business anti-trust matters. Steps should be taken to insure that any free market business should be able to fail without creating a systemic risk to the economy.

I watched some of the House hearings today with Bernanke testifying, and it is disheartening to see Barney Frank and several others who made statements heartily defending the business practices of Fannie Mae and Freddie Mac while those organizations were going bankrupt and to realize they are still in charge of spending our tax dollars.

[GoodOleBoy]

Really, wonkie. Do Republicans get to retain their rights and standing as U S citizens?

[Phil]

If the Federal Reserve is given new responsibilities to protect the financial system against systemic risks, then I believe part of what the Fed should do is examine the concept of too big to fail that has been strangling us and introduce approaches similar to what goes on in business anti-trust matters.

Doesn't this lead to the question of why the Department of Commerce hasn't been doing exactly this all these years?

[Phil]

Department of Justice, actually. In either case, it's been partly a regulatory environment that's afraid to say "no" to M&A activity and such that's resulted in the "too big to fail" institutions.

[Stefan]

I heart this post heading. Moar puns, plz!

[GoodOleBoy]

Yes, Phil, that is exactly what I believe. Approving mergers and acquisitions that accomplish nothing except to create a new business entity with greater market share is not always in the public interest, especially if that leads to institutions that become too big to fail. So maybe the guidelines used need to be changed.

Federal Trade Commission and Federal Reserve are also players in this but not Commerce as far as I know.

[wonkie]

I was specific: my comment was about the Reppublicans in Congress. Given their track record of behavior over the last eight years I think my opinion is easily defended.

[Eric Martin]

I heart this post heading. Moar puns, plz!

Was wondering if anyone picked up on that.

Free T-shirt for you!