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Tuesday, February 24, 2009


against FDIC resolutions

clusterstock relays a journal oped from william isaac, former FDIC man, who suggests that the FDIC really can't process a bank like C or BAC -- and so we should continue to support them as zombie banks.

Unlike the talking heads, I have actually nationalized a large bank. When I headed the Federal Deposit Insurance Corporation (FDIC) during the banking crisis of the 1980s, the FDIC recapitalized and took control of Continental Illinois Bank, which was then the country's seventh largest bank. ...

Let's begin with the fact that today our 10 largest banking companies hold some two-thirds of the nation's banking assets, and some are enormously complex. Continental had less than 2% of the nation's banking assets, and by today's standards it was a plain-vanilla bank. This is important for three reasons.

First, any bank we nationalize will be forced, both by the regulators and the marketplace, to shrink dramatically. We are in the middle of a serious economic downturn where deflation is a realistic concern. Do we really think that dismantling our largest banks would be helpful? I don't.

What's more, we won't be able to stop at nationalizing one or two banks. If we start down that path, the short sellers and other speculators that the Securities and Exchange Commission still refuses to re-regulate will target for destruction one after another of our largest banks.

Second, for nationalization to work there needs to be a reasonable exit strategy. In the case of Continental, we had scores of options for returning the bank to private hands, including a public offering or a sale to any number of domestic and foreign banks and investor groups.

Today, who has the wherewithal, legal authority, and desire to purchase our largest banks? No one comes to mind, particularly if we rule out foreign groups, which I suspect would not pass muster due to national security concerns about ceding that much power over our economy to foreign powers.

Third, who will run these companies when we dismiss the existing senior managers and board members? We had significant difficulties attracting quality people to Continental even without today's limits on compensation.

i think nationalization preprivatization is really the only option, because the alternative isaac suggests is tantamount to bankrupting the united states government. the problems are simply too large to be safely transferred to the government in the form of preferred shares. moreover, such funding of bank losses constitutes a ridiculous multitrillion-dollar gift to the bondholders of these banks from the current and next few generations of american taxpayers.

at the end of the day, an FDIC resolution is all about pushing as much of the loss resulting from bad loans onto the creditors of the bank which made them. this is right, fair and just -- and what's more, there's enough bank debt out there to absorb the losses.

but that's not to say isaac's criticisms are totally invalid. some is obvious lobbyist-speak -- i don't think anyone should much care if bank shares are nailed to a cross as a result of preprivatization, but bankers clearly do. and trying to make an argument for the need of retaining existing managerial talent based on its qualifications is rather like proposing that robert mugabe is the only person who could run zimbabwe. but some of what isaac says is not so silly.

for example -- we're seeing now that crossborder banking really is undesirable. witness what is happening in eastern europe as foreign banks pull out in order to solidify home balance sheets and leave devastated economies and currencies in their wake. this crisis and its aftermath may well end the idea of global banks entirely.

moreover, isaac is only being honest that a lot of bank assets are not saleable -- the 2005 version of banking was much too big and many bank apparatus should simply be dismantled. the FDIC can't get rid of many of the minor bank parts it already has. and resolving C is not the same as resolving a three-brancher in nevada -- who at the FDIC is going to properly evaluate the capital markets operations of the majors? FDIC simply doesn't know what it's doing in such cases -- it has no such experience and wasn't designed to resolve such banks.

moreover, i'm convinced he's absolutely right that if you wipe out the capital structure of C and BAC, the market knows already that JPM and WFC are going there -- the speculative attack will begin the moment the announcement about C comes down. and it will spread through all the majors and most of the regionals, as they're all in the same boat. what's likely needed is not isolated takeovers but a 1933-style bank holiday -- nationalize the whole system, then rerelease banks only after an FDIC audit. any bank that reopens is likely to more easily regain the trust of the public.

but in my view these are problems that have to be remedied, if only because an FDIC-style resolution process -- probably involving a long-term RTC-style bad bank to warehouse and sell assets taken over in resolution back into the private sector -- is the only remotely practicable, safe and fair way forward. it won't be painless, but it will put losses where they belong and leave in its wake a stronger and healthier banking system.

isaac's suggestion amounts to allowing slowly delevering zombie giants dominate the american banking landscape for many years to come -- peppered with bottomless pits like AIG -- and hazarding the collapse of the american treasury and the dollar as well in order to do so. what sort of option is that?

UPDATE: bill gross too is out there talking his book.

PIMCO would not dispute the need to further capitalize systemically important banks via convertible bonds held by the government, which unfortunately dilute shareholders’ interests. To go further, however, and “haircut” senior debt or even existing preferred stock similar to that issued via the TARP would create an instability policymakers should not want to risk. In turn, forcing creditors to take haircuts would undermine other financial sectors such as insurance companies and credit unions. The goal of future policy should be to recapitalize lending institutions while maintaining the basic infrastructure of credit markets. Outright nationalization and haircutting of creditors will do just the opposite.

PIMCO is utterly screwed if losses are passed up the bank capital structure as it owns a hell of a lot of bank debt. it thought it could safely buy ahead of the government and realize profits as rescue plans materialized by scalping the taxpayer. oops! perhaps that's not such an easy arbitrage after all....

but again, that's not to say his criticism is entirely invalid. instability is a possible result. but the alternative gross proposes is essentially to continue to make it possible for him to rake the taxpayer ad infinitum while the society suffers a thoroughly japanese denouement -- if it's lucky.

UPDATE: more from jck at alea -- he too thinks the systemic risk of nationalization, at least of only a few banks, is prohibitively large.

some excellent thoughts from the atlantic's megan mcardle on the appearance of impropriety.

UPDATE: felix salmon on AIG -- it strikes me that salmon's argument in defense of AIG's receivership is also an argument against sending C or BAC to resolution, at least in the conventional sense.

There is no doubt that, absent nationalization, AIG would be bankrupt by now. And the systemic consequences of an AIG bankruptcy would have made Lehman look like a walk in the park. For starters, Wall Street would be in much worse shape than it's in right now, since AIG Financial Products insured hundreds of billions of dollars of assets on banks' balance sheets, and has been putting up precious magin as the value of those assets has continued to decline.

On top of that, AIG's bonds would be largely worthless at this point, and the write-downs on those bonds would have caused another few hundred billion dollars in wealth destruction at precisely the financial entities which most need healthy assets.

And most importantly, the failure of AIG would probably have caused what the failure of Lehman brothers didn't -- a catastrophic cascade of counterparty failures in the multi-trillion-dollar CDS market, from which the global financial system might never have been able to recover.

Against all that, we have some very large and painful losses for the US taxpayer, which will never fully recover the money it's put into AIG. But compared to the alternative, we're all much better off.

that is, until or unless saving the AIGs of the world precipitates a run on the dollar. said gross:

Much like we are the world’s strongest nation militarily, we entered this crisis with certain economic and fnancial strengths relative to all other nations. Our reserve currency status was the primary one which means that we can write checks in our own currency and they are accepted all over the world – sort of like American Express Travelers Cheques. This privilege, however, can be and is being abused. Travelers Cheques are acceptable only when redeemed at 100 cents on the dollar. Lately, quasi-American dollars in the form of Aaa CDOs, corporate bonds, and even national champion bank stocks have foundered closer to zero than par. There is fear on foreign shores that even U.S. agency debt may not be honored and that U.S. Treasury debt itself, when “repoed” as in prior years, may now suffer from counterparty risk. Global willingness to accept American dollars is being tested. Granted, the U.S. currency has appreciated strongly against its counterparts during most of this crisis, but technical short covering as opposed to a fight to quality may have been the dominant consideration. Watch the dollar. If it falls hard, there may be nothing policymakers can do to restore the ensuing fnancial chaos.

UPDATE: via clusterstock, megan mcardle with more on what nationalization could precipitate.

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don't worry gm, bernanke says it's almost over.

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Bernanke said he "hoped" it was almost over...

And, Bill Gross has been talking his positions for as long as I can remember. When they were overweight Treasuries it was "yields could go to 1%." Now it's about credit, so the song changes but the goal is the same.

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"national security concerns about ceding that much power over our economy to foreign powers": my how I laughed.

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