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Remember when I was for the bailout?
Submitted by BradyDale on Fri, 10/10/2008 - 7:33am.
Remember when I said I was for the bailout? I'm still for the bailout that I said I was for. Not so sure that I'm for this bailout, though:
Treasury may capitalize banks by end of October. Buying into the banks makes no sense to me. I know that it's what lots of economists say would make more sense, but the logic of it just doesn't work for me. I think it was Nancy Pelosi who said that people shouldn't think of this is as a "bailout" but a "buy-in." When I heard it, in the early days of the bailout discussion, I thought: "Yeah, that's right!"
But buy in to the banks (and etc)?
I see three problems with buying in to the financial industry:
1) You can't directly improve the terms of mortgages. Whether the government directly bought mortgages or the securities that held them (the former is better), it could change the terms of those mortgages, giving consumers much more stability, insuring a more even flow of money back into those securities and greater stability across the board. It would be great for homeowners and the rest of the economy. If we just give banks some money, well, who knows what they will do?
2) We won't ever get our cash back, even if the securities make money. If we buy mortgages, it's an investment with a shelf-life. We never have to sell them again. One day, the mortgages will all be paid off and we're out, free and clear. No surprise to anyone. But, if we buy shares in a bank or other creditor, the only way we can get out/get the money back is to sell the shares. Can you imagine what a freakout it would cause on Wall Street if the government started selling off it's bajillion shares in Citigroup or AIG or whatever? Once we're in, we're there to stay. Doesn't sound great to me.
3) The mortgages are a better investment for the taxpayer (even if you throw out #2). People are talking about these securities as "junk." They aren't junk. They just aren't making much money and they aren't making it nearly at the expected rates of return. The government doesn't care about a profit and the government didn't leverage anything against those outdated prospectuses. If we bought the mortgages, we could give them better terms, stabilize homeowners lives and still pay our creditors back.
There's no justification for buying stakes in financial companies in this crisis. That's just too loosey-goosey. That's more cash for credit-institutions to do whatever they want with (including more risky investments to try to make up for lost ground). It doesn't make sense. It makes sense to buy the problem securities and erase that problematic section of the balance sheet. In and out. If a patient has cancer in his lung you don't stick someone else's lung in their without removing the one that has cancer, right?
I really hope Paulson will wise up and use the $700 billion to deal with the problems in the housing market. Buy mortgages. Adjust the terms. Cut homeowners a break and help them all chill out. Improve cash flows and consumer confidence and do it in a way that taxpayers exposure to the financial system has a very definite expiration date.
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My thoughts:
I agree on some of your points.
On # 1, I think you are generally right. But do we know that their plan is now only to buy stakes in banks? (There are other issues too with buying huge stakes in these banks, like big conflicts for lawmakers.)
#2 isn't really true. I mean, it would certainly take some time, but you could sell them off without much trouble if they were making money. Fannie and Freddie were gigantic, totally public industries, and the Govt. turned them loose without any trouble. In fact, if the stocks were making money, the investment would probably look even safer than before, because it seems apparent now that the govt would jump right in and bail them out.
As for #3, I give you Krugman:
His basic point is that the problem is serious enough that the cramdowns alone are not enough. It is a point I hear over and over, but frankly, I still don't totally get it.
That said, if you buy the premise that these banks have a liquidity problem that needs to be solved, the only way a bailout like this would actually help them and help their balance sheet is you actively overpay them for their assets... That is just a fact of life in the world of balance sheets. So, if you are going to overpay them, to me it makes sense to get a stake in the bank, too.
My sense of it
The most immediate problem is the multiplying effect upon specific institutions because they are so laden with concentrations of bad debt. As bad as the mortgage problem is for individual homeowners - the bad loans are still a fairly small fraction of the market. Don't forget that these institutions leveraged at up to 30 to 1 to buy these CDOs. I think it isn't so much the total of actual bad debt that's the problem, but that it's so concentrated in specific institutions that play such a huge role - in this age of consolidated markets - in the economy -- and that the collateralized debt was leveraged into massive amounts of uncollateralized debt.
Just a guess. I'm not pretending to understand this stuff and would welcome someone explaining it further.
Marketplace.org
Marketplace and NPR's Planet Money sites have been trying to explain this stuff.
I think you are right, DE II, there isn't that many bad loans. And I maintain that there would be even fewer if we just gave them loan mods. So let's put the "crappy" loans on government books and modify them so that the people can stay in their homes and keep up their payments. I still believe we could do it and make all our money back/pay back creditors.
Anyway, this video is a good explanation of how the collapse of one institution, Lehman Brothers, managed to have crazy, crazy ripple effects across the financial sector.
Untangling credit default swaps from Marketplace on Vimeo.
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This Too Will Pass, for the guts in your cerebrum.
On Stakes: No, we don't know
On Stakes: No, we don't know it's only stakes in the banks/industry. So, you're right... a bit probably is fine. Maybe even good. So long as they don't go whole hog.
On 2, can we sell shares after we buy them: I still don't agree with you here. The Fannie & Freddie case is not the same at all. They were totally public institutions that the government then made public and sold to the investing community. That's not the same as buying a ton of shares in a company and then unloading them. Whenever a big holder of shares in a company starts selling off its stake, it hurts the stock's performance. You can guarantee that a big part of the work of the banking lobby will be to make sure the government a) never unloads its stake and b) never actually tries to use it to control the banks. I'm not with you on this one.
On 3) On Krugman: I almost always agree with Krugman, but... if what the financial sector needs is cash, wouldn't buying a ton of mortgages give it to them? So, okay... buy them at a discount but not as big of a discount as we could. Fine. It's not really a rip-off if that was the point anyway. So if we could get them for 50% discount, only take 25%. Still sounds good to me. They still get cash and we don't get permanently rapped up in bank equity.
Krugman's right that it's a liquidity problem, but I don't see how we can't solve that by buying stuff with cash and then also doing a bajillion loan-mods en masse (for the record, I could care less if we were even that careful about making sure that we didn't give loan mods to rich people. I say, give easier terms - within reason - on every single mortgage we buy across the board. Do a home value estimate and income estimate and fix the rates at a reasonable level and send the homeowner a congratulatory letter with his new/better/shinier terms). If we buy stuff with cash then the industry becomes liquid.
They need cash. Let's give it to them, but let's get actual assets rather than equity.
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This Too Will Pass, for the guts in your cerebrum.
I start with this premise:
I start with this premise: if Paul Krugman is on one side, and Bush is on another, I generally go with Krugman.
Anyway, I am really not getting your logic. The only way the bailout homeowner plan would come close to working is if they paid a significant premium to Wall St. for the mortgage backed securities in a two step process. The government would first buy the mortgages, then have to figure out how to actually cram then down. So, you bail out the bank, and get nothing for it. And Wall Street gets a huge premium on their stupidity.
Or, option two, just take big stakes in banks, and make them do it. I am not sure why option 2 is worse for homeowners in anyway, and now we actually get paid when banks start doing well.
And if the banks are making money in the future, selling their stock, either to the public, or back to the banks themselves, will just not be that hard. There is always a market for huge profitable enterprises.
Equity versus Assets
Brady embedded in what Delong is arguing below is that there is a run on the world banking system. Buying up equity in banks will both directly increase capital and increase confidence in those banks so people/institutions will be more willing park their cash with the banks. Buying mortgage backed securities will simply clear up bad loans on the banks balance sheet. The bank could then take that money and loan it out-so each dollar of government purchases of mortgage backed securities will produce a dollar of news loans. But Delong is arguing that each dollar of capital injected directly will produce $8 of new loans. He is arguing that buying equity has more bang for the buck because each dollar of bank capital supports $8 in new loans – the wonders of leverage.
Here is Brad Delong on the issue (he calls buying equity the Elmendorf plan).
--Mark Price
Why buying into banks makes sense
I always thought the initial plan to buy toxic securities was second best to actually capitalizing banks.
The initial plan puts us in a dilemma:
1. If the government purchases bad mortgage securities at what they are worth--very little--little new capital is provided to banks and thus a) their balance sheets don't get better and b) they can not expand their lending.
2. If, on the other hand, the government purchases bad mortgage securities at much more than they are worth, the government is providing a subsidy to stockholders of financial institutions and, at the same time, making it less likely that the government recoups the initial bailout by selling mortgage securities at a profit.
By taking preferred stock for an investment in banks, this dilemma is resolved.
1. New capital is directly injected into banks which, as Krugman points out today, can lead ten times as much new lending since banks generally maintain reserves of about 10% of lending.
2. When bank stocks recover, the government can sell the stock at a profit. In the meantime, the value of existing stock is diluted and the current owners of the bank don't get as large a reward.
Neither of these program actually have a direct effect on the terms of current mortgages. Renegotiating the terms of curren mortgages was, as far as I understand, never on the table in the plan to buy mortgage securities. Nor is it part of the new plan.
Both plans are meant to save the financial system from collapse which is in the interest of all of us. If we want to do something to directly help those who are going to lose homes--and we certainly should do that--we need some other plan.
You didn't really think that the Bush administration was going to help the people PUP are concerned about, did you Brady? Some Democrats tried to add provisions to the bailout bill to give judges greater power to force the renegotiation of home mortgages. It was not part of the final bill.
On the bright side
President Bush assures us that we can solve the problem. I'm filled with confidence now.
On the other side - questions: If the government buys up preferred stocks, and the stock value is diluted, then that only further degrades the banks' balance sheets as their assets decrease in value, doesn't it? Also, buying preferred stocks is better than buying common stocks but (1) if the banks go under, even though the government would get their money before common stock holders and other creditors, it would still mean the government could get back much less than it invested, and (2), given that we have no real idea how much debt these banks are carrying, how could a share price be valued? It would mean buying stocks without having any real idea what their worth is. If you just buy the debt, you know exactly how much you're buying.
Taking a stab.
The biggest threat to the economy is neither fluctuations in bank share prices nor the horrible number of folks facing foreclosure. Those are part of what set off the problem in the latter case, and what are reeling like a crazy roller coaster as a side effect in the former case.
The core problem putting the economy on the brink is the freeze up the credit market. Banks won't lend to each other, so they don't have enough capital on hand to lend to the rest of us - businesses managing short term imbalances between inventory and payroll on the one hand and cash on hand and 30-day billing schedules on the other, regular people taking out auto loans and mortgages, state and municipal governments borrowing money off of future tax revenue.
You are absolutely right that the government is in essence buying up stocks of mysterious value but the idea is to pump in capital to keep their doors open and them making "rest of us" loans while the plan to buy up the toxic mortgages has time to work. Its an odd situation in that normally fear and panic amongst the "rest of us" topples banks in a run on the banks assets, or there are panics that drive the stock market bonkers. In this situation the effects like that we are seeing are secondary - its the fear between the banks - the fact they won't lend liquidity amongst themselves that is the point of freeze up. Its backwards in a way because its the banks themselves that are locked up in terror and the public and Mom and Pop business owner that are only beginning to feel the panic creeping in.
I'm still mulling it over myself, but I can see the point of the idea of rapid capitalization as quickest way to stave off a collapse. Its ugly with a capital "U" but I understand the logic.
I found this story useful:
http://www.npr.org/templates/story/story.php?storyId=95099470
As I understand it, the most important index to follow is the LIBOR which measure bank-to-bank loans and that is still looking absolutely dire.
http://www.iht.com/articles/ap/2008/10/10/business/EU-Europe-Credit-Logj...
In terms of buying bad mortgages at face value (McCain's plan basically) versus buying bank stocks to infuse capital, Marc basically had it right and probably said it better than i am going to. More of the money goes into rewarding bad lenders and bad loan repackagers while having much less impact on the credit crunch under the first plan. The second plan does more to ease the credit crunch because the banks the government buys into have more capital (i.e have a multiplied impact in terms of more to lend) and the banks seem more creditworthy themselves. The cash infusion loses less money to the people most responsible for the mess in the first place however because while people currently owning the bank can do more in terms of lending/moving the economy what they own already is difused in value by the percentage of the emergency government investment. Later when things stabilize the government can sell at a profit. Or at least in theory.
That however doesn't actually help homeowners, which is something we should do separately anyway.
I liked this piece, though I admit its still a hard thing to get your head around.
http://delong.typepad.com/sdj/2008/10/john-mccains-ne.html
On a side note, here's to hoping for less threads with the search tag of "dark-evil-looming-signs-of-the-apocalypse" in the near future.
-Sean
MrLuigi, my cat, actually only types half as badly as I do.
Both homeowners and the banking system need help
Brady, injecting capital into banks for equity is a partial nationalization of the banking system. As with the takeover of Fannie and Freddie doing so both prevents the banks from going bankrupt but also assures other banks and financial institutions around the world the U.S. government will not let the banks go bankrupt.
The Paulson plan as originally proposed was worse for the taxpayer because the taxpayer was giving capital to the banking system with no equity. Think here of Warren Buffet. Did he invest billions in Goldman Sachs for equity or did he buy billions of dollars worth of assets from Goldman Sachs that currently have no value (your right they will eventually have value)? He invested for equity and technically became a part owner of those same bad assets. He saved Goldman and he will be rewarded in the future as the value of shares in Goldman Sachs appreciate. Hard to see why taxpayers shouldn’t also benefit from saving the banking system from collapsing.
Homeowners facing foreclosure also need help now, saving the banking system does not make that less likely.
Here is a link to a story on what was done in the case of Sweden
http://www.nytimes.com/2008/09/23/business/worldbusiness/23krona.html?em
--Mark Price