| Submit your comments on this article |
| Home Front Economy |
| Bad Plan for Bad Loans |
| 2008-09-21 |
| With truly extraordinary speed, opinion has swung behind the radical idea that the government should commit hundreds of billions in taxpayer money to purchasing dud loans from banks that aren't actually insolvent. As recently as a week ago, no public official had even mentioned this option. Now the Treasury, the Fed and congressional leaders are promising its enactment within days. The scheme has gone from invisibility to inevitability in the blink of an eye. This is extremely dangerous. The plan is being marketed under false pretenses. Supporters have invoked the shining success of the Resolution Trust Corporation as justification and precedent. But the RTC, which was created in 1989 to clean up the wreckage of the savings-and-loan crisis, bears little resemblance to what is being contemplated now. The RTC collected and eventually sold off loans made by thrifts that had gone bust. The administration proposes to buy up bad loans before the lenders go bust. This difference raises several questions. The first is whether the bailout is necessary. In 1989, there was no choice. The federal government insured the thrifts, so when they failed, the feds were left holding their loans; the RTC's job was simply to get rid of them. But in buying bad loans before banks fail, the Bush administration would be signing up for a financial war of choice. It would spend billions of dollars on the theory that preemption will avert the mass destruction of banks. There are cheaper ways to stabilize the system. In the 1980s, the government did not need a strategy to decide which bad loans to take over; it dealt with anything that fell into its lap as a result of a thrift bankruptcy. But under the current proposal, the government would go out and shop for bad loans. These come in all shapes and sizes, so the government would have to judge what type of loans it wants. They are illiquid, so it's hard to know how to value them. Bad loans are weighing down the financial system precisely because private-sector experts can't determine their worth. The government would have no better handle on the problem. But the government does have the 'cash', yes? In practice this means the government would make subjective choices about which bad loans to buy, and it would pay more than fair value. Billions in taxpayer money would be transferred to the shareholders and creditors of banks, and the banks from which the government bought most loans would be subsidized more than their rivals. If the government bought the most from the sickest institutions, it would be slowing the healthy process in which strong players buy up the weak, delaying an eventual recovery. The haggling over which banks got to unload the most would drag on for months. So the hope that this "systematic" plan can be a near-term substitute for ad hoc AIG-style bailouts is illusory. Within hours of the Treasury announcement Friday, economists had proposed preferable alternatives. Their core insight is that it is better to boost the banking system by increasing its capital than by reducing its loans. Given a fatter capital cushion, banks would have time to dispose of the bad loans in an orderly fashion. Taxpayers would be spared the experience of wandering into a bad-loan bazaar and being ripped off by every merchant. Makes sense to me, but I'm an engineer... Raghuram Rajan and Luigi Zingales of the University of Chicago suggest ways to force the banks to raise capital without tapping the taxpayers. First, the government should tell banks to cancel all dividend payments. Banks don't do that on their own because it would signal weakness; if everyone knows the dividend has been canceled because of a government rule, the signaling issue would be removed. Second, the government should tell all healthy banks to issue new equity. Again, banks resist doing this because they don't want to signal weakness and they don't want to dilute existing shareholders. A government order could cut through these obstacles. I'm not sure I like what I think I understand about this, however. Meanwhile, Charles Calomiris of Columbia University and Douglas Elmendorf of the Brookings Institution have offered versions of another idea. The government should help not by buying banks' bad loans but by buying equity stakes in the banks themselves. Whereas it's horribly complicated to value bad loans, banks have share prices you can look up in seconds, so government could inject capital into banks quickly and at a fair level. The share prices of banks that recovered would rise, compensating taxpayers for losses on their stakes in the banks that eventually went under. Someone suggested this is what the Gov was doing, and owuld eventually make a profit. Or was that just for Lehman Bros.? Congress and the administration may not like the sound of these ideas. Taking bad loans off the shoulders of the banks seems like a merciful rescue; ordering banks to raise capital or buying equity stakes in them sounds like big-government meddling. But we are in the midst of a crisis, and it shouldn't matter how things sound. The Treasury plan outlined on Friday involves vast risks to taxpayers, huge complexity and no guarantee of success. There are better ways forward. |
| Posted by:Bobby |
| #15 OldSpook, the name of the guy who needs to be punished most is revealed in the third paragraph of this 1999 NYT article: "In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders." "The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring." "Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits." http://query.nytimes.com/gst/fullpage.html?res=9C0DE7DB153EF933A0575AC0A96F958260&scp=1&sq=&st=nyt |
| Posted by: Darrell 2008-09-21 18:22 |
| #14 One thing they should do, but never will, is impose accountability. Every C-level exec and the entire boards of these companies immediately be forced from their job, no golden parachute, and force liquidation of their estates and confiscate the money for the benefit of the taxpayers. Give them 10% of their estate after debt is satisfied, or $100K, whichever is less, and we the taxpayers take the rest as a penalty. This makes the PERSONALLY accountable. And it will certainly get the attention of those who follow them. They screwed up, we are holding the bag -- they should be put IN that bag and barred from all employment within the financial sector. Make the bankers and others pay a price as a consequence of them blowing up things to where we the taxpayers had to step in. |
| Posted by: OldSpook 2008-09-21 17:28 |
| #13 you, Mr. Bobby, are one of my favs, I would never dis you like that |
| Posted by: Frank G 2008-09-21 17:04 |
| #12 no - the troll that was in front of my comment- was "disappeared" by the Mods |
| Posted by: Frank G 2008-09-21 17:02 |
| #11 Frank,you were not talking about Bobby, were you? Didn't recognize me when I was sincere? |
| Posted by: Bobby 2008-09-21 16:55 |
| #10 Morgenson in the NYT today has a relevant opinion piece on this, RTWT. An excerpt: "A.I.G. had written $441 billion in credit insurance on mortgage-related securities whose values have declined; if A.I.G. were to fail, all the institutions that bought the insurance would have been subject to enormous losses. The ripple effect could have turned into a tsunami. So, the $85 billion loan to A.I.G. was really a bailout of the company’s counterparties or trading partners. Now, inquiring minds want to know, whom did we rescue? Which large, wealthy financial institutions — counterparties to A.I.G.’s derivatives contracts — benefited from the taxpayers’ $85 billion loan? Were their representatives involved in the talks that resulted in the last-minute loan? And did Lehman Brothers not get bailed out because those favored institutions were not on the hook if it failed? We’ll probably never know the answers to these troubling questions. But by keeping taxpayers in the dark, regulators continue to earn our mistrust. As long as we are not told whom we have bailed out, we will be justified in suspecting that a favored few are making gains on our dimes. " AND "Which brings us to Item 2 for policy makers. Stop pretending that the $62 trillion market for credit default swaps does not need regulatory oversight." This is the real iceberg ahead for all of us, the feds have said nothing about this whatsoever. |
| Posted by: Anguper Hupomosing9418 2008-09-21 15:17 |
| #9 Just like there are no self sustaining pure socialist economies. [Unless you classify Cuba and North Korea as 'sustaining']. |
| Posted by: Procopius2k 2008-09-21 14:51 |
| #8 trolls smell funny |
| Posted by: Frank G 2008-09-21 14:38 |
| #7 Thanks for some balance, Doc. It's sooo rare, these days. |
| Posted by: Bobby 2008-09-21 12:57 |
| #6 The suggested alternatives have problems of their own. First, you can 'force' banks to issue new equity (that is, stock), but you can't force people to buy it. In an illiquid system, how do the other players come up with the tens of billions of dollars for each bank to raise its capital? And if you have the government inject the equity by buying equity (stocks or warrants), you now have the government manipulating the banking system directly -- how long before President Obama puts Penny Pritzker in charge of naming all the new directors to the bank boards? Sure, it's hard to figure out the value of bad loans -- that's what happens when loans go bad. But better to remove them from the books, let the economy recover, and sell the assets later when you can. The good part of the current plan is that it is self-limiting: as the Treasury Dept gets rid of the bad loans and assets it removes itself from the financial markets. Buy equity and you're in for the long haul. |
| Posted by: Steve White 2008-09-21 12:38 |
| #5 the solution is to re-value real estate so that you don't run multi billion dollar banks broke with loans to buy it. |
| Posted by: Vespasian Ebbereting8800 2008-09-21 12:41 |
| #4 Fox Noise did an excellent how it happened this morninging. Sort of a Fannie and Freddie meltdown for Dummies, which I found quite helpful. Through banking de-regulation, appears we've gone back to the future with the mixing of bank loans and Stock Market gamblers. Same mess that helped bring on the Great Depression, hence the regulations put in place in the 1930's to keep banking deposits and loans OUT of the stock market. Fox emphasized that even though it showed Slick Willie signing the de-regulation legislation, there was quite enough blame to go around. Translation.... all of Washington and no one in Peoria was in on it. |
| Posted by: Besoeker 2008-09-21 10:05 |
| #3 The solution is simple. Unwind all the debt that underlies real estate bonds, then revalue the bonds to their proper levels. Financial institutions could start doing this tomorrow, but the folks running these institution won't permit that because frankly, they expect to get bailed out and they want to game this new system for their own profit. If the government insists on buying bad debt, then taxpayers not only gets any future profits generated by these financial institutions they also get all executive bonuses over $1,000. Additionally, the government reserves to sue every financial institution that made improper loans or failed to disclose all the details any financial transactions they made between 2000 and 2008, and recover any monies from anywhere. |
| Posted by: badanov 2008-09-21 09:27 |
| #2 That's called the Public School System, Red. |
| Posted by: Procopius2k 2008-09-21 08:56 |
| #1 I would absolutely love to own a business that couldn't fail, spend all you want, and when I'm broke, the Govt hands me cash to continue, WITH NO REPAYMENT EVER. |
| Posted by: Redneck Jim 2008-09-21 07:38 |