Resolution

by hilzoy

Matthew Richardson and Nouriel Roubini have an op-ed on the stress tests in the WSJ. It makes a number of good points, but this one is particularly important:

"Stress tests aside, it is highly likely that some of these large banks will be insolvent, given the various estimates of aggregate losses. The government has got to come up with a plan to deal with these institutions that does not involve a bottomless pit of taxpayer money. This means it will have the unenviable tasks of managing the systemic risk resulting from the failure of these institutions and then managing it in receivership. But it will also mean transferring risk from taxpayers to creditors. This is fair: Metaphorically speaking, these are the guys who served alcohol to the banks just before they took off down the highway.

And we shouldn't hear one more time from a government official, "if only we had the authority to act . . ."

We were sympathetic to this argument on March 16, 2008 when Bear Stearns ran aground; much less sympathetic on Sept. 15 and 16, 2008 when Lehman and A.I.G. collapsed; and now downright irritated seven months later. Is there anything more important in solving the financial crisis than creating a law (an "insolvency regime law") that empowers the government to handle complex financial institutions in receivership? Congress should pass such legislation -- as requested by the administration -- on a fast-track basis."

It's never a pleasant experience when a large firm goes bankrupt. But the real problem with Lehman Brothers was not that it went bankrupt; it was that it went bankrupt in a completely unforeseen and disorderly way. Likewise, the reason why it's not a catastrophe when the FDIC takes over a bank isn't just that the banks it takes over are smaller than Lehman Brothers; it's that it has a very well-defined and orderly procedure that allows things that need to happen to go on happening while the bank is being taken over. 

As long as we do not have such a procedure for dealing with insolvent banks like Citi or Bank of America, they will have a gun to our collective heads, and they will be able to go on extracting money from us. We might not like it, but the alternative will be worse. 

For this reason, we obviously need to create a new alternative: a mechanism for taking over insolvent large banks that allows us to deal with them in an orderly fashion. Thomas Hoenig, President of the Kansas City Fed, proposed one such mechanism yesterday. I am not competent to say whether his version is best. But I do know that we need some such mechanism in place, and we need it immediately. 

Relying on improvised deals and ad hoc solutions might have been necessary right after the crisis hit. But it is long past time to give ourselves the tools we need to do it right.

Comments

[J. Michael Neal]

In theory, I agree with Richardson and Roubini. In practice, I want to know who they are addressing this to. I have zero confidence that Congress is able to pass a bill that would deal with any of these concerns in a constructive way. Between Democrats beholden to the financial industry, and Republicans determined to prevent anything useful from happening, I don't see it. Making a big public stink out of it strikes me as a great way of pressuring the powers to be to Do Something, under the protection of which, they will almost certainly manage to do something destructive. Then, because of the pressure, the administration will get backed into the corner of signing it.

Honestly, is there anyone who thinks that Congressional involvement is going to be an improvement?

[TJ]

Honestly, is there anyone who thinks that Congressional involvement is going to be an improvement?

Yep. Even if they do nothing, we're not any worse off. If we're in a plutocracy, I'd rather it be up front.

[russell]

Dick Durbin, after failing to get cramdowns into the bankruptcy reform bill:

"And the banks -- hard to believe in a time when we're facing a banking crisis that many of the banks created -- are still the most powerful lobby on Capitol Hill. And they frankly own the place"

Also:

"Honestly, is there anyone who thinks that Congressional involvement is going to be an improvement?"

It could go either way.

I think the issue here would be clarity of intent. What should new regulation actually *do*?

I don't think there's enough clarity or consensus about what the actual role of government should be WRT the financial sector for really good legislation to be written or passed.

Dollar dollar bill, y'all.

"If we're in a plutocracy, I'd rather it be up front."

Maybe it's just my lefty inclinations, but it's pretty damned clear to me that we are, in fact, today, living in a plutocracy. Right this very minute, right here in the US.

As of 2004, 93% of all financial wealth in the US is held by the top 20% of the population. 70% is held by the top 5%. 42% by the top 1%.

For reference, "financial wealth" here means all marketable wealth, minus owner-occupied housing. In other words, wealth you can readily turn into money.

Cite: http://sociology.ucsc.edu/whorulesamerica/power/wealth.html

Our Congress can't, or won't, pass laws that are plainly in the public interest if those laws step on the toes of capital.

That is plutocracy.

Not saying it can't be changed, but I don't see the trend moving in that direction. And if the events of the last year aren't enough to light a fire under everyone's behind, I'm not sure what would be.

Thanks -

[TJ]

Not saying it can't be changed, but I don't see the trend moving in that direction. And if the events of the last year aren't enough to light a fire under everyone's behind, I'm not sure what would be.

Totally agree. I just want to out Congress. And when the American standard of living drops by half over the next few years, juxtaposed with the obscene wealth of the banking class, we'll at least know how many guillotines to build.

[russell]

Just wanted to add that Hoenig's proposal seems, to me, to be almost self-obviously sane. It seems like a perfectly good starting place for legislation.

We'll see what happens.

[ScentOfViolets]

Maybe it's just my lefty inclinations, but it's pretty damned clear to me that we are, in fact, today, living in a plutocracy. Right this very minute, right here in the US.

Why is this symptomatic of lefty inclinations? I don't consider myself a lefty, yet I have exactly the same assessment.

[dmbeaster]

We do have an existing procedure that would work for dealing with Citi, et al. No new mechanism is actually needed, though existing tools could be improved. The current situation has more to do with fear of using those tools, and troubled financial institutions exploiting that fear to manipulate the process.

The FDIC tackled this problem in the 80s with the failure of Continental Illinois. That was the largest bank failure in history up until WAMU, but still the largest if you adjust for inflation. The Continental Illinois situation resulted in lots of hand-wringing over the problems with failures of overly large institutions, but not because there were no adequate tools to deal with it.

My sense is that the fear to use the traditional remedies of bank receivership for the current sick crop of banks is fear of systemic failure. It is not because of a sense of inadequacy of the existing remedies. The same has been true of the AIG failure -- receivership procedures for insurance companies have been resolving insurer insolvency for a very long time, but were not implemented for AIG because its failure would trigger massive write-downs and immediate "failures" of many banks once the accounting rules immediately sent many of their assets to near zero value.

Continental Illinois was taken over by the FDIC and operated with majority FDIC ownership for ten years. The successor entity was ultimately sold to Bank of America. It seems that the reason the same is not being down now is uncertainty and lack of political will to involve the government that deeply in so much of the banking sector.

It is hard to summarize in a brief post the differences between general bankruptcy procedure and the special receivership procedures that apply to banks and insurance companies, but the critical concept is that as regulated businesses, the government has enormous powers to step in and dictate what must be done for banks and insurance companies. It is the fear to use those tools in a massively sick economy, rather than a lack of tools, that is at the root of the problem. And the financial institutions exploit that fear to try and get what they want without regard to the whether that is solving the overall problem.

[russell]

"And the financial institutions exploit that fear to try and get what they want without regard to the whether that is solving the overall problem."

And they succeed.

[Dr.Woody]

Our Congress can't, or won't, pass laws that are plainly in the public interest if those laws step on the toes of capital.

That is plutocracy.

Not saying it can't be changed

If you won't/can't say it, then I shall: Shortm of bloody, violent revolution, heads on pikes, bodies in gibbets, stuff like that, it CAN'T be changed...

Who is gonna change it?

Obama? Yeah, right...

If he posed the slightest challenge to the power of the hegemons, he wouldn't now occupy the Office he does...

[russell]

Shortm of bloody, violent revolution, heads on pikes, bodies in gibbets, stuff like that, it CAN'T be changed...

I don't agree.

The reforms of the populist movement under Teddy Roosevelt, and of the New Deal under FDR, were pretty effective in curbing harmful effects of concentrated capital. For a period of time, anyway, but it was a period of time measured in generations.

Once upon a time, long ago in a far away America, there were lots of laws limiting the accumulation of and/or influence of private capital. Extreme concentration of private wealth was seen by a lot of folks as being harmful to republican (small r) governance.

It's not like alternative to pitchforks and guillotines aren't available, or have no precedent.

I share your opinion that Obama is not particularly inclined to go that way. Maybe we can get Congress to do it.

Or, maybe we're screwed.

[Sebastian]

"The same has been true of the AIG failure -- receivership procedures for insurance companies have been resolving insurer insolvency for a very long time, but were not implemented for AIG because its failure would trigger massive write-downs and immediate "failures" of many banks once the accounting rules immediately sent many of their assets to near zero value."

And again we see how the accounting rules for bank capitalization can trigger disorderly bank failures even when it isn't clear that the bank is insolvent in the normal sense (of having asset/income flows that can't meet the liability flows), or in some cases when it is absolutely clear that the bank is not insolvent in traditional terms.

Can we please consider some sort of moving average for the valuation of such assets at least (or maybe even only) for the purpose of cap requirements. It doesn't make sense to trigger a cascading series of immediate bank failures that way.

[Creamy Goodness]

Dear President Obama,

No more bailout money until you solve the too-big-to-fail problem.

[ThatLeftTurnInABQ]

The reforms of the populist movement under Teddy Roosevelt, and of the New Deal under FDR, were pretty effective in curbing harmful effects of concentrated capital. For a period of time, anyway, but it was a period of time measured in generations.

But those reforms in TR's era became politically expedient only after a lengthy period of political violence (political assassinations, anarchist bombings, violent strikes and other labor actions) in the late 19th cen, and the threat of far worse in the form of red revolutionary movements.

Similarly, FDR's reforms came only after a collapse of the economic system at least twice as bad as what we have on our hands now, as measured by such metrics as GDP decline, unemployment and market indices such as the DOW.

So I think Dr. Woody has a point - I don't think it has gotten bad enough this time around to make it politically expedient to really throw the money changers out of the temple. Instead we will get timid incremental reform at best. Anything more than that will not occur unless there is a real threat of widespread political violence, and I don't see that happening today.

Indeed I sometimes wonder if part of the purpose for the GWOT (under Cheney's direction) was to forestall that possibility by creating a stronger legal and logistical infrastructure for domestic political repression (extralegal detention, disappearances, torture) which was prototyped against an external "other", but which ultimately is aimed at US domestic "enemies" in the event that discontent with our plutocracy reaches a level where political violence is triggered. My guess is that Cheney thought Peak Oil would be the trigger rather than a financial crisis, but in any case he foresaw the need for strengthening both our capacity and our willingness to cross the lines which (in his view) will need to be crossed when the time comes for putting down anybody in the US who poses a threat to the established order.

[The Crafty Trilobite]

Indeed I sometimes wonder if part of the purpose for the GWOT (under Cheney's direction) was to forestall that possibility by creating a stronger legal and logistical infrastructure for domestic political repression

Only sometimes?

Actually, I don't wonder at all. I'm certain. The purpose of power is power. Cheney simply picked up again where his old boss Nixon left off. FISA has already been used to spy on political enemies and journalists, the National Guard is now well integrated with the Army, which will make domestic crackdowns even easier, and we've all gotten rather acclimated to the idea that free speech can be exercised only in little zones.

[russell]

Instead we will get timid incremental reform at best.

That's my take on it as well.

Indeed I sometimes wonder if part of the purpose for the GWOT (under Cheney's direction) was to forestall that possibility by creating a stronger legal and logistical infrastructure for domestic political repression

My take on Cheney is that he was by temperament and personal inclination an authoritarian, and that he was incapable of imagining a way to resolve conflict other than through the naked exercise of power. To be honest, my guess is that he found the naked exercise of power to be quite congenial.

Regarding suppression of domestic dissent, we now have widespread use of tazers by police in even trivial situations, we have police departments equipped with military grade gear, we saw the use of rubber and wooden bullets against domestic protesters in the WTO actions and some anti-Iraq actions, we have US Army being posted stateside, and we have Raytheon's microwave-based Active Denial System being considered for domestic crowd control. The latter burns you, but only 1/64 an inch deep, so you have no lasting marks and you don't die. Sweet.

In short, we have a police state on tap, all geared up and ready to go.

So if it comes to actual violence, or even just lots of people in the street, things could get hectic in a hurry.

I'd prefer to just see more aggressive legislation reining in the banksters. So far, nada. I like Obama but I don't mind saying I've found his deference to Wall St consistently disappointing.

[Eric Martin]

I like Obama but I don't mind saying I've found his deference to Wall St consistently disappointing

Me too.

[Pithlord]

Hilzoy's exactly right. After the fact improvisation, even if it works, undermines the rule of law. What we need are solid ex ante rules for orderly bankruptcies.

Unless we're trying to bail out the UAW, in which case the rule of law can be damned.

[russell]

Why is this symptomatic of lefty inclinations?

I'd say that a suspicion of excessive concentration of private capital is right at the top of what makes me self-identify as a lefty.

Glad to hear other folks share it.

[mightygodking]

Unless we're trying to bail out the UAW, in which case the rule of law can be damned.

I believe you meant to type "in which case existing pension obligations present a method of dealing with the problem traditionally accepted in bankruptcy law." HTH!

[John Thullen]

Procedure? A Plan?

That's antithetical to freedom.

Better that everything be a total surprise. It swells the feeling of spontaneity to see people running around with their hair on fire attending to their own self-interest.

Besides, it takes away the self-satisfaction of the banking types looking down from high-rises, no doubt snapping their suspenders after unloading their holdings, (what would a rant be without some sterotypes?) at the folks below running every which way asking each other: "Can someone please tell me what the procedure is?"

What do we think this is?

The United Socialist Sultanate of Procedure?

[ScentOfViolets]

I'd prefer to just see more aggressive legislation reining in the banksters. So far, nada. I like Obama but I don't mind saying I've found his deference to Wall St consistently disappointing.

Posted by: russell |

As I understand it, the conventional wisdom is that the timing was all wrong for a cramdown provision. The banks, so the thinking goes, want at all costs to avoid any valuation of their assets that is both accurate and public. Cramdowns would leave them very exposed in this regard. After this 'crisis' has been provisionally gotten through, don't be surprised to see this sort of bankruptcy provision back on the table.

[russell]

"The banks, so the thinking goes, want at all costs to avoid any valuation of their assets that is both accurate and public."

That's great. What about everybody else?

That's what I'm talking about when I say "deference to Wall St".

[J. Michael Neal]

We do have an existing procedure that would work for dealing with Citi, et al.

No, we don't, and no amount of invoking Continental Illinois will change that. The biggest problem isn't the difference in size between the institutions, though that is a problem. We don't have any procedure for dealing with it, because Citibank is a different kind of institution. The word "bank" covers a broad range of types of financial companies. The FDIC only has the authority to take one specific type of bank, commercial or depository banks, into receivership. No agency of the federal government has the authority to do so with any other type of financial institution. Absent new authority passed by Congress, nationalization is not an option.

[Nell]

JMN: The word "bank" covers a broad range of types of financial companies.

Thanks to the corporate tools who voted to repeal Glass-Steagall.

[ScentOfViolets]

"The banks, so the thinking goes, want at all costs to avoid any valuation of their assets that is both accurate and public."

That's great. What about everybody else?

That's what I'm talking about when I say "deference to Wall St".

Posted by: russell

The thinking by our fearless legislators is supposed to be that they don't want to cause needless panic, or tip fundamentally sound banks into insolvency by causing a run on their assets. Not in these troubled economic times, wouldn't be prudent.

I don't necessarily agree with this, btw, just pointing out that the power politics aren't as naked as all that - it's probably less that Congresspeople are outright threatened by the banksters than that they are cajoled into believing that what they are doing is for the Good of the Country and the right, though regrettable, thing.

[Sebastian]

"Thanks to the corporate tools who voted to repeal Glass-Steagall."

Calling Citibank something other than the word 'bank' wouldn't change our position. Glass-Steagall had very little to do with it. (See also Canadian banks).