Thursday, February 05, 2009
TARP re-redux -- inevitable failure
We can fix this mess if we have the courage to act - really act. But don't mistake the talk of "decisive action" coming from Washington as anything of the kind. A desperate rear-guard action is being fought by the Fed and OCC, an effort to defend what remains of the large money center banks and domestically-owned primary dealers. Call this the Geithner Plan, which we described last week: ("The Big Banks vs. America: A Roundtable with David Kotok and Josh Rosner.") ...
Let's look at C through fair-value eyes using the year-end 2008 data released last month. If you look at the average earning assets of $1.635 trillion, only $650 billion are bank deposits, with the remaining liabilities needed to support these assets funded from market sources. If you take a relatively conservative loss rate assumption of 30% of assets, including charge-offs and additional M2M losses, we possibly are talking about total losses at C in excess of $500 billion or a multiple of tangible equity capital, meaning that the only way to mark-to-market C's assets is to accept that the equity is gone and begin by imposing a haircut on C's creditors.
Thus when you hear people in Washington talk about buying bad assets from already insolvent banks, the illogic of their position should be apparent to all. Let's walk through the two basic alternatives under a "bad bank" approach.
Scenario A: The Treasury buys the "bad" assets at inflated prices, say par value, taking the assets from the bank without incurring a loss. The unrealized loss is passed to the taxpayer, who now owns this asset at well-above market value. Unless you believe that the market value of these assets will recover at some time in the future, the prospect is for a subsidy by taxpayers to the bond holders of the large bank. The solvency issues of the large bank may or may not be resolved, but in consideration for taking the bad assets, the taxpayer is clearly now the owner.
Scenario B: The Treasury first forces the banks to write down the value of their assets in a one-time "Come to Jesus" M2M exercise, a global celebration of Fair-Value Accounting, if you will. The equity and the junior sub debt of C would be completely wiped out, with senior bondholders and new investors comprising the new owners. The large bank will then be solvent and could continue to sell assets and restructure its business to repay the taxpayer for previous support and meet a new business model.
The "Bad Bank" approach in Scenario A represents further delay and temporizing, a strategy that ensures that the US economy remains mired in crisis and recession for years to come. Scenario B represents a painful but ultimately quick remedy, the path whereby we can jump start the US private sector and get on with the process of rebuilding the global financial system. All that is required is courage and leadership, two qualities that still seem to be lacking in Washington.
given that the obama administration -- obviously cowed by the gigantic and growing size of the banks' bad asset problem -- has resorted to a very limited asset purchase plan accompanied by a fiscal-outlay-delaying tactic of "insurance" on the vast majority of bad assets (for which the taxpayer will ultimately have to foot an even larger bill); and further given that such plans will not definitively resolve the troubles of the banks because the plan will -- as is becoming quite apparent with today's news that TARP redux will be funded out of the $350bn remaining from the original congressional allocation, the better to avoid trying to pass the republican gauntlet in the senate -- not be of anything like sufficient size to make the program work and will make it apparent shortly thereafter that outright nationalization will be a far more efficient and affordable solution than making good the insurance; given these two things, it seems a very safe statement to make that TARP redux is dead on arrival.
as whalen notes in the prologue to his conversation with rosner and kotok:
It is amazing to us to see how little people understand the choices facing us with the big banks, how narrow those choices truly are and how the numbers in terms of losses are so BIG that they will ultimately force us to do the right thing.
but however long the administration and its bankster keepers delay the inevitable will determine how profound the damage to a wildly overindebted economy by the crippled money center banks is allowed to become. it does not look promising in the near-term, but whalen has hope.
A formal open bank assistance might be a default under the ISDA contract template, something the Fed's conflicted madarins would not initially accept, but when the charge-offs at C rise above total risk based capital and keep rising, perhaps minds in DC will begin to change. Then we can haircut the Big Four Bank debt in a negotiated deal pre-receivership, and sell the now M2M bank assets and liabilities to stronger hands. This is the traditional American way of dealing with insolvency in the absence of political meddling by the Fed and the Congress. Let Sheila Bair and the FDIC do the job and we can make the economy rebound with surprising speed. It only takes political courage. We have the money.
UPDATE: tim duy: supreme disappointment.
There were really only two glimmers of hope that the US could avoid a Japan-like multi-year stagnation. One was the offsetting effect of a strong global economy. Of course, we all know how that story ended. Poorly. The other was my certainty that US policymakers like NEC head Lawrence Summers and Treasury Secretary Timothy Geithner had studied the Japanese crisis up and down and realized that you needed to meet a banking crisis head-on, not with halfway measures that left the system crippled.
But today, reading CNBC’s coverage of the plan, it becomes painfully clear that we are headed full speed on a policy bullet train designed to repeat Japan’s errors.
i'm not so sure. japan never faced having to finance its remedial actions with foreign capital inflows, especially amid a global economic collapse. we may get a much faster-moving, deeper and more frightening resolution to all this than did japan. but i do agree:
We used to wonder aloud at the intransigence of Japanese policymakers. How could they allow their banking system to deteriorate? Why not take decisive action? Now we know: Fettered to an adherence to the status quo and an aversion to the concept of nationalization, the political will to attack the problem head-on is overwhelmed by the enormity of the financial crisis.