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| Tim Geithner's Black Hole |
| 2009-03-10 |
| Pity Barack Obama's economic advisers. The blogs are now demanding their scalps, and Treasury Secretary Tim Geithner and his colleagues face a nasty dilemma: There are no solutions to the banking crisis without extraordinary political and financial risks. Thus, they have adopted a three-pronged approach, delay, delay, delay, in the hope that somebody comes up with a breakthrough. Here's the problem: Today's true market value of the U.S. banks' toxic assets (that ugly stuff that needs to be removed from bank balance sheets before the economy can recover) amounts to between 5 and 30 cents on the dollar. To remain solvent, however, the banks say they need a valuation of 50 to 60 cents on the dollar. Translation: as much as another $2 trillion taxpayer bailout. That kind of expensive solution could send the president's approval rating into a nose dive. Consider: $2 trillion is about two-thirds of the tax revenue the federal government collects each year. The logical alternative -- talk show hosts' solution du jour -- is to temporarily restructure or nationalize the banks and leave taxpayers alone. Remove the toxic assets, replace management and cut the too-big-to-fail financial dinosaurs into smaller, nimbler entities. Then reprivatize these smaller banks and let the recovery begin. Oh, if it were that simple. I suspect Obama's advisers would like nothing more than to dismantle an irresponsible firm such as Citigroup. They are afraid to do so, for one reason: All the big banks are connected to a potentially lethal web of paper insurance instruments called credit default swaps. These paper derivatives have become our financial system's new master. The theory holds that dismantling a big bank could unravel this paper market, with catastrophic global financial consequences. Or not. Nobody knows, because the market for these unregulated financial derivatives, amounting potentially to over $40 trillion (by comparison, global gross domestic product is now not much more than $60 trillion), is the financial equivalent of uncharted waters. Geithner has reason to be terrified. He was part of the Henry Paulson-led team that underestimated the devastating global-contagion effect of the collapse of Lehman Brothers. Geithner won't make the mistake of underestimation again. Geithner also knows that the mood in Congress has changed. Were a global financial brush fire to break out as a result of bank restructuring or nationalization, today's populist Congress might just let it burn. Congressional anger is likely to intensify when policymakers realize that credit default swaps demand a stream of premium payments like a life insurance policy, not just a payment due at termination. And recent signs indicate that firms such as Citigroup, in recycling their taxpayer bailout funding, may have helped other financial firms, including some in Europe, meet these payment obligations. In addition, Geithner worries that because the troubled insurance giant American International Group (AIG) is a conduit for the banks' use of credit default swaps, a collapse of AIG (as an unintended consequence of dismantling the big banks) could be catastrophic. AIG's more than 300 million terrified holders of insurance-related investments and pension funds, who have investments totaling $20 trillion (U.S. GDP is $14 trillion), could suddenly rush for redemptions -- the equivalent of a run on a bank. Geithner would face a worldwide insurance collapse to accompany his global banking collapse. Or again, maybe not. Nobody knows. Here's another likely Geithner fear -- that Congress forces the banks' bondholders to take a hit. So far, only stockholders have lost out because of the banking crisis. One reason for the fragility in the credit default swap market of late is that markets fear that bank bondholders, who today are protected even before U.S. taxpayers, could soon see their status change. The worry is that if even bondholders are put at risk, U.S. and foreign investors alike would stop financing all corporate America. The administration says that won't happen, but market participants believe (probably correctly) that this White House can't control Congress. So our Treasury secretary has no choice but to talk of bank stress-testing and other tactics to buy time before the big bank bailout. Notice that the president's budget already contains a contingency fund of up to $750 billion for a future bank bailout -- a politically shrewd number that roughly matches the size of the Paulson bailout. The true cost is likely to be two or three times as much, unless some last-minute intellectual breakthrough -- a tax holiday for derivatives? -- arises. The Obama team needs to remember that we got into this mess because of a lack of financial transparency. It's time to tell the American people what the stock market already knows: that the path to recovery will probably be expensive and politically unpopular, perhaps explosively so. This dire situation could take us all down, which is why Obama should name a proven, world-class problem-solver who is not from Wall Street as his bank workout czar. James Baker, the former Republican secretary of state and Treasury secretary, comes to mind. Other possibilities: former Democratic senators Bill Bradley or George Mitchell. Perhaps the White House should name a team. In the end, at least one thing is certain: Our present position is unsustainable. The longer we delay fixing the banks, the faster the economy deleverages, the more credit dries up, the further the stock market falls, the higher the ultimate bank bailout price tag for the American taxpayer, and the more we risk falling into a financial black hole from which escape could take decades. David M. Smick is a global financial strategist and the author, most recently, of "The World Is Curved: Hidden Dangers to the Global Economy." Unbelievably, this whole problem emanated from Congress exempting the CDS market from the gambling provisions which enabled 2 parties with no interest in either side of the debt being able to make a bet on the fate of a creditor. It was always insane. Normally insurance requires a party to an insurance policy to have an insurable interest. If this basic rule of insurance had been maintained this would never have occurred. Just another example of Congress doing something they didn't understand and the rule of unintended consequences rearing its ugly head. Most people won't read this or try to understand it. So we will do it again at some time in the future. Its suicide bombing by another name. |
| Posted by:Omoter Speaking for Boskone7794 |
| #17 Yet it could suprisingly show profits. If comperable enough, you wont have to take it out back and shoot it. |
| Posted by: newc 2009-03-10 23:15 |
| #16 Must use "newspeak". Recapitalization after fed control for limited years. No if's ands or buts. |
| Posted by: newc 2009-03-10 22:45 |
| #15 The bank already is nationalized if you bought share on it. They just forgot the part where you root out corruption and congress shys away from it on purpose. They are the shareholders likely. |
| Posted by: newc 2009-03-10 22:41 |
| #14 the federal government can't even run a whorehouse for a profit. Are you implying that the banksters have been better at ru |
| Posted by: Anguper Hupomosing9418 2009-03-10 22:00 |
| #13 Do you really want the banks nationalized? If they've failed already, really what's the difference. At least it cuts out the expense of middlemen. As to the quip about the government running stuff, I believe we've just seen one element of the government rebuild an entire country nearly from ground up while fighting a war. And those who did it, did it with on the job training since no one had 'written a book' on how to do it in a half century. |
| Posted by: Procopius2k 2009-03-10 21:52 |
| #12 Do you really want the banks nationalized? Remember, the federal government can't even run a whorehouse for a profit. When they took over the Mustang Ranch in Nevada, they eventually had to close it. As someone said, if you can't sell sex to drunken truckers, how the hell can you run any business? |
| Posted by: Rambler in Virginia 2009-03-10 19:07 |
| #11 After all, I don't believe the donks ever really gave a damn about Iraq either. They were delighted to use it as a club to beat Bush but I don't believe the likes of Obama, Kennedy and Pelosi ever gave a rat's ass about the troops. I think they wanted defeat in Iraq because it would embarrass Bush. Now, if they would stoop that low they wouldn't have any qualms about wrecking the country's banks either if they thought they could use it for political advantage. |
| Posted by: Ebbang Uluque6305 2009-03-10 14:33 |
| #10 That thought has occurred to me, Trader. It's awfully paranoid but sometimes I wonder...What gets me is the timing...the way it all went to hell right before the election and all the donks started screaming it's Bush's fault. |
| Posted by: Ebbang Uluque6305 2009-03-10 14:25 |
| #9 Just another example of Congress doing something they didn't understand... Who says they didn't understand? I'd bet money that there were some who understood exactly what would happen. |
| Posted by: Trader_DFW 2009-03-10 13:34 |
| #8 That is, if the banks were nationalized then the taxpayer would absorb the toxic asset and still end up footing the bill? The bailouts are being arranged were we the people pick up the toxics off the banks books, but the banks keeps operating independently with its books cleansed and garnering profits to 'restart' the economy. So we're going to get stuck with the bad anyway. We might as well get the good as well. |
| Posted by: Procopius2k 2009-03-10 13:19 |
| #7 <<< but when an organization absorbs another does it not also absorb its liabilities? >>> No unless it takes specific action in the form of a novation. The liability stays with the legal entity which undertook it in the same way that the asset remains in the target. On acquisition ordinarily the acquirer would simply manage the wind down and/or inject capital after settling the liabilities. A sort of informal Chapter 11. But if insufficient DD is done on the way in, the acquirer might find they have bought a dog rather than something they can manage. BOA did this with ML hence the need to get more capital from the Treasury under the threat that they would not proceed with the transaction. But there has to be residual value in the first place otherwise the deal will never get done. That is why LEH went under. No-one wanted it and there wasn't enough the Treasury could legally do at the time to put lipstick on the pig. |
| Posted by: Omoter Speaking for Boskone7794 2009-03-10 13:18 |
| #6 James Baker and George Mitchell are not independent czars and part of the same toxic cabal that needs cleaned up. |
| Posted by: Thealing Borgia122 2009-03-10 12:23 |
| #5 Someone help me here, maybe the weather change has my head cloudy - but when an organization absorbs another does it not also absorb its liabilities? That is, if the banks were nationalized then the taxpayer would absorb the toxic asset and still end up footing the bill? |
| Posted by: swksvolFF 2009-03-10 12:05 |
| #4 My solution would be to declare all credit default swaps fraudulant. Tell anyone who bought one that the have to sue the issuer of the swap to recover. Watch AIG dwindle to nothing. Send issuers to jail. Make sure every Wall St. trader sees these guys do a perp walk. |
| Posted by: Frozen Al 2009-03-10 11:43 |
| #3 Keynesianism You have two cows. The demand for milk plummets. You come up with a plan to get people drinking again. You have another drink. And another ... and console yourself with the fact that in the long run even our children's children will turn to drink in times of crisis ... |
| Posted by: 3dc 2009-03-10 11:32 |
| #2 Here's the problem: Today's true market value of the U.S. banks' toxic assets (that ugly stuff that needs to be removed from bank balance sheets before the economy can recover) amounts to between 5 and 30 cents on the dollar. To remain solvent, however, the banks say they need a valuation of 50 to 60 cents on the dollar. Translation: as much as another $2 trillion taxpayer bailout. Then absorb the banks that are insolvent into the reconstituted First Bank of the United States. Limit it for twenty years. Why in the blazes should the citizens be stuck with the institutions insolvency bill but get nothing really in return [except more campaign contributions into the usual suspects coffers]. We take all or nothing. |
| Posted by: Procopius2k 2009-03-10 11:15 |
| #1 You're right OSofB, I don't really understand what is going on but I suspect I am not alone. I do know that BHO and Geithner have that "Deer in the Headlight" look. And they keep saying "It's all Bush's fault". |
| Posted by: tipover 2009-03-10 11:03 |