Thursday, September 18, 2008
RTC RFC reprise
Wall Street soars on report that federal govenment will create entity to hold banks' debt
NEW YORK (AP) -- Stocks are surging with the Dow Jones industrials up more than 300 points following a report that the federal government is considering creation of a repository for banks' bad debt.
CNBC said Treasury Secretary Henry Paulson is considering creation of an entity like the Resolution Trust Corp. that was formed after the failure of savings and loan banks in the 1980s.
The Dow, which had been showing modest moves in the final hour of trading, jumped nearly 330 points to the 10,939 level following the report.
at some point it had to come. it's been in the cards for months.
but -- if this proves to be true, and i suspect it is because it makes a lot of sense -- the primary focus will immediately turn to the funding capacity of the united states government. this will cost trillions. there is growing suspicion of the american financial system around the world. it has become actionable already.
it will be interesting ot see what sort of structure this 'RTC2' takes. the original took on the unliquidated debts of seized banks after selling what could be sold in an orderly fashion. i have the somber feeling that RTC2 is going to be instead a vehicle for direct capital injections into banks to keep them solvent, in an effort to prevent price discovery through asset sales.
Bank of America Corp., American Express Co. and General Motors Corp. climbed more than 10 percent after Senator Charles Schumer proposed a new agency to pump capital into troubled financial companies. Wachovia Corp. rallied 48 percent, while Morgan Stanley and Goldman Sachs Group Inc. erased most of their earlier plunges ...
just a bigger bailout, on this reading. in another bloomberg article, the model isn't RTC but reconstruction finance corporation (RFC):
Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke are considering a new plan to address the credit crisis, said Senator Charles Schumer, who proposed an agency to pump capital into troubled banks.
``The Federal Reserve and the Treasury are realizing that we need a more comprehensive solution,'' Schumer, a Democrat who chairs the congressional Joint Economic Committee, told reporters in Washington today. ``I've been talking to them about it.''
Schumer urged forming an agency to inject funds into financial companies in exchange for equity stakes and pledges to rewrite mortgages and make them more affordable. His remarks indicate momentum is building for some wider plan after the Fed and Treasury's takeovers of Fannie Mae, Freddie Mac and American International Group Inc. this month.
Schumer advocated a Great Depression-era Reconstruction Finance Corp. model, different from the Resolution Trust Corp.- type plan others have floated. Another RTC, which was a 1990s agency that sold devalued assets in the Savings and Loan Crisis, would ``simply transfer excessive risk to the U.S. government without addressing the plight of homeowners,'' he said.
UPDATE: more from yves smith.
in this skeletal form, this seems like a world class bad idea. The only successful example of dealing with a financial crisis is Sweden, which did not try to prop up troubled banks, but instead nationalized them, wiping out equity, brought in new top executives, and recapitalized them. The cost of failure was high to the incumbents and the solution was comprehensive, not piecemeal.
There seems to be a surprising willingness to accept its positioning as a "permanent solution" at face of the fact that this is a more like blood transfusion into a very sick patient: it will keep them alive without in many cases restoring them to health. Without other measures, such as the son of Resolution Trust Corporation proposed by Nicolas Brady, Paul Volcker and Eugene Ludwig in yesterdays Wall Street Journal, this runs the risk of being a page out of the failed Japanese playbook, where losses were not recognized and zombie banks were not permitted to fail. This US variant may keep them in a slightly more vital state, but that's a long way away from a solution.
However, a potential shortcoming of the RTC version 2.0 idea is that we now live in a world of mark-to-market accounting. One imagines that sales out of this entity would be deemed to be fire sale prices (even though the Brady/Volcker/Ludwig piece used the formula "fair market prices") and financial firms holding similar assets would not be required to mark them to those levels. But will anyone trust any non-market-price-based valuation approach? As much as the purge needs to (and inevitably will) happen, the RTC was not formed until a lot of thrifts had already fallen over. Implementing a similar vehicle at this juncture could have nasty unintended consequences.
... Perhaps the biggest shortcoming of this idea is it assumes the US has the wherewithal to pull this off without the tacit support of our friendly foreign funding sources. Unlike Japan in the 1990s, which had a high enough savings rate to deal with its crisis internally, we are at the mercy of our overseas creditors.
RTC worked toward price discovery by means of orderly liquidation. RFC was all about preventing price discovery along with liquidation. big, big difference.
you're tearing my heart out man, "but the truth will set us free".
if you're ever in STL, MO - dinner's on me.
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of course this will end up on the floor, but congress has already been pushed into a position of having to accept whatever it is paulson wants done.
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you nailed it in your "hearts" piece - congress is an afterthought whose authority has been usurped.
markets are up 4%, gold's down $80 from today's high.
what a frikkin' ride. picked a bad time to give up anti-anxiety drugs. (hoping a little humor takes off some of the sting.)
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