Wednesday, February 04, 2009
is this it? -- TARP redux and the continued ignorance of the swedish model
with banking system losses mounting spectacularly as the economy falls into depression, the obama administration is revisiting the "aggregator bank" plan initially introduced as the first-but-never-implemented version of the TARP. they are also finding, however, that relieving the banks of troubled assets to clear private balance sheets would be unimaginably expensive -- the discounts which they would have to pay for assets that would leave the banks solvent would be politically impossible for the government to countenance, indeed might spark a deeply undesirable bond market reaction. so instead treasury will buy only the most worthless assets and insure the remainder of troubled assets for little or no premium.
the concept of insurance leaves any upside with the banks, but this point is minimal -- the securities in question are worth nothing like the level they will be insured at, the better to prevent marking-to-market, and never will be. meanwhile, the banks will continue to be able to use them as collateral at the federal reserve to secure funding.
the ultimate cost to the government, then, will be no different than actually purchasing the deathly stuff -- but the outlays will be deferred, and thereby more easily hidden.
there is, of course, no mention of wiping out equityholders or forcing debt-to-equity swaps on bondholders in an effort to get the people who were theorietically responsible for taking the losses to actually take the losses. heavens no. these people paid for the obama campaign, after all.
meanwhile, the banks will be forced to use their newly-freed balance sheet capacity to try to make loans into a devastated economy in which only the worst credits want loans. this will likely result, as yves and the IMF both note, in greater overall losses to be borne by the taxpayer.
the final analysis, then, sees the monied interests walking off with nothing like the losses they deserve and the government likely doubling or worse the outstanding treasury debt float -- before, mind you, the cost of trillions in fiscal stimulus are added on. given that bad assets alone will likely run into several trillions, i suspect the question of the borrowing capacity of the united states will come into play.
as has been said repeatedly, there are other ways of repairing the banking system -- willem buiter has one, and the parliamentary body of germany is assembling another which much resembles the swedish model -- and virtually all of them would be less expensive for the government and less of a gift to bank stakeholders than this way. as noted:
The government in Berlin does not consider either of the two Anglo-Saxon approaches to be suitable. The Germans see the British model as too costly and the American approach as inequitable.
Why should the government buy up billions in worthless securities and take all risk off the hands of those responsible for the crisis in the first place, ask those behind the new bailout plan? They characterize the U.S. and British plans as gifts for shareholders at the expense of taxpayers. For this reason, the German government prefers a different concept, which it hopes to implement within the next four weeks. The plan, conceived by staff at the Finance Ministry, amounts to a radical modification of the German banking industry. Hardly any of the ailing lenders will likely manage without government investment in the future.
There are two possibilities for the disposal of bad loans. Either the securities are depreciated before being deposited into the special funds, or the "bad banks" receive large portions of the remaining equity to offset losses. Either way, the newly streamlined banks will lack capital to conduct their transactions.
This is where the government comes in. It provides the healthy banks with capital via its Special Fund for Financial Market Stabilization (Soffin). As a result, the government becomes a shareholder in many banks, initially through silent deposits but, if it comes to the aid of publicly traded banks, it soon finds itself forced, as in the case of Commerzbank, to acquire a blocking minority consisting of 25 percent plus one share. This is the only way it can prevent a buyer from simply clearing out the government's money.
The concept makes sense for both the government and taxpayers. The government can hope that its investment will eventually pay off. Once the banking crisis has been weathered, its deposits are returned and it can resell its shares, possibly even at a profit. This, at least, was the Swedes' experience during their banking crisis in the 1990s. German government experts were inspired by the Swedish experiences when developing their own rescue plan.
the article goes on to report that the german government is also drafting an expropriation law, to be used if needed in the first instance to nationalize stricken hypo real estate, a mortgage lender built on short-term financing lines similar to britain's northern rock or america's countrywide which has already burned through its initial bailout package.
however, the united states government -- no less under barack obama than under george w. bush, it is now becoming clear -- is beholden to the predatory monied classes, and these classes will on the basis of what's been floated so far apparently not be allowed to sustain losses commensurate with their hubris and error.
instead, working middleclassmen -- or rather, their children and granchildren yet to be born -- will bear a much larger proportion of the cost.
UPDATE: again via yves smith -- the ft's martin wolf on the nascent failure of the obama adminstration, which however unfairly is meeting what will likely be its sternest test in its first moments in office.
UPDATE: commenting in the ft is svein gjedrem or the nordic experience of the 1990s.
The financial strength of the banks, and hence their ability to continue to supply a steady flow of financing, can be bolstered in either of two ways: by injecting capital; or by removing high-risk loans from the banks' balance sheets – and in turn creating a "bad bank". In the Nordic banking crisis 20 years ago, we did both, and learned three important lessons:
First, government crisis resolution measures do not have to be costly for the taxpayer. The state injected equity capital, while private share capital was written down on the basis of a realistic assessment of loan losses. This ensured that the equity capital injected by the state could benefit from upside opportunities.
Second, it is not always necessary to take the bad loans off the banks' balance sheets. ... However, this presupposes that the problem loans account for only a limited proportion of total lending, so that the banks are able to continue to operate normally. Sweden and Finland established a "bad bank" that took over the high-risk loans. But this was in most cases done only after the state had nationalised the banks and was thereby able to control the kinds of loans that were transferred to the "bad bank".
Third, banking crises do not need to be prolonged. In the Nordic economies the prompt and extensive writing down of problem loans and recapitalisation of the banks limited the economic downturn, which lasted only around a few years.
this is not very difficult. but because bank capital owns the american political process, it will be excruciating and perhaps impossible to get the government to actually resolve the banking system issues in an efficient manner.