Saturday, January 31, 2009

Here Comes the BARF?


I got a kick yesterday listening to an angry Senator Claire McCaskill lambaste Wall Street executives for doling out huge bonuses while they accepted TARP handouts:
"We have a bunch of idiots on Wall Street that are kicking sand in the face of the American taxpayer," an enraged McCaskill said on the floor of the Senate. "They don't get it. These people are idiots. You can't use taxpayer money to pay out $18 billion in bonuses."

Sen. McCaskill, D-Missouri, introduced a bill stating that no employee would be allowed to make more than the president of the United States.

Of course, her bill will not pass, but she made her point. The problem is that the bonuses are no luxury for some Wall Street employees.

But guys like John Thain, the now disgraced CEO of Merrill Lynch, should be prosecuted for criminal negligence and prosecutors should demand clawbacks on their outrages bonuses. Lock up all these guys for a long time and I will show you how fast Wall Street will change its stupid behavior.

Speaking of Wall Street, as President Obama gets ready to outline the economic strategy, the 'Bad Bank' is seen as crucial to the recovery:

As the Obama administration mulls the next phase of the bank bailout, Wall Street is increasingly calling for a return to its original intention: buying toxic securities that continue to riddle the sector's collective balance sheet.

Sen. Christopher Dodd (D., Conn.) on Tuesday said he was open to using funds from the Troubled Asset Relief Program (TARP) to establish a "bad bank" that would hold financial firms' debt securities, thereby boosting boost their capital levels and restoring confidence in the sector.

Treasury Secretary Timothy Geithner has said that the Obama administration was exploring the "bad bank" idea, but provided few details. A report by Bloomberg indicated Wednesday that the Federal Deposit Insurance Corp. may be lining up to manage the program.

But news broke out yesterday that the "Bad Bank" may be put on hold:

Policy-makers have yet to reach a consensus on how a U.S. government-run bad bank would work and the idea may not move forward, CNBC television reported on Friday, citing unnamed sources.

"The government-run bad bank idea that was being floated ... apparently has hit a snag, it might not happen," a CNBC anchor said recapping an earlier report. "Charlie (Gasparino) says the government has no consensus right now on how the bad bank would work, the issue is pricing."

"Making that thing work right now from what I understand is proving to be very difficult," CNBC's Gasparino said in his report.

Gasparino said the Treasury Department has been talking with the chief executives at the biggest Wall Street banks on how to proceed and may shelve the idea of an aggregator bank and instead provide across-the-board guarantees for the troubled assets clogging up banks' balance sheets.

"The aggregator bank is been put on hold indefinitely," he said. "They may do a hybrid: aggregator bank-guarantees. This thing right now has hit a major snag."

Another issue plaguing the proceeding on how to purchase the assets from the banks is the lack of senior staffing under Treasury Secretary Timothy Geithner

Geithner was meeting on Friday with Federal Reserve Chairman Ben Bernanke, Federal Deposit Insurance Corp Chairman Sheila Bair and Comptroller of the Currency John Dugan, with the Treasury saying it was "to discuss financial and regulatory reform."

Then, late last night, news broke that a selective suspension of fair value accounting is one idea being floated as U.S. policymakers wrestle with how to price bad assets the government might buy from the distressed banking industry:

The accounting fix suggested by a bank industry group could prevent banks from having to broadly mark down all assets to the prices a government-run "bad bank" might pay.

The Obama administration is discussing setting up a government-run "bad bank" that could soak up mortgage securities and other distressed investments that have become virtually impossible to sell in the markets.

But pricing remains a thorny issue.

If the government values the assets too high, the taxpayer would be unduly burdened. If they are priced too low, an accounting tsunami would be set off as other banks are forced to write down assets on their own books.

Scott Talbott, chief of government affairs for the Financial Services Roundtable, said the U.S. Securities and Exchange Commission could send a letter to the industry, informing banks that sales involving the bad bank do not constitute a market price for accounting purposes.

"Otherwise it could trigger losses that all banks have to pick up, which is exactly opposite of what the government is trying to do," Talbott told Reuters.

There is precedent for bank-specific accounting fixes.

In October, the SEC and Financial Accounting Standards Board (FASB) sent a letter saying banks could treat warrants as permanent equity instead of liabilities in certain circumstances.

It cleared the way for banks to participate in the Treasury Department's $250 billion (172.8 billion pound) capital injection plan, in which banks received federal cash in exchange for preferred shares and warrants.

Asked whether the SEC would be willing to amend aspects of fair value accounting, an agency spokesman indicated the agency was not closed to improving aspects of the requirement also known as mark-to-market accounting.

"While the SEC does not recommend suspending existing fair value standards, our recent report to Congress makes several recommendations to improve fair value's application, including a reassessment by FASB of current impairment accounting models for financial instruments," the spokesman told Reuters.

The Obama administration has not yet consulted the SEC on fair value accounting changes, according to a source familiar with the communication between the two groups.

Accounting tweaks were also used during the savings and loan crisis in the 1980s.

Regulators encouraged investors and healthy institutions to take over failing thrifts by changing an accounting rule related to acquisitions to let buyers circumvent normal capital requirements. The change was later reversed.

Mark-to-market accounting rules have been a hot topic of discussion in recent months, as they have been blamed by some U.S. banks and lawmakers for billions of dollars in write-downs.

Fair value accounting took full effect last year in the United States and was designed to let investors truly see what is on the balance sheet and to help them understand which assets are under stress.

It requires assets such as mortgage-backed securities to be valued at market prices, but the rules have been difficult to apply in current market conditions when there is little to no market for such assets.

And the financial industry worries government purchases of illiquid assets could only amplify fair value accounting's damaging effects.

"There is concern that if the government buys massive amounts of this stuff, you reinforce the markdowns and you kind of lock them in, and banks are sitting with massive capital losses," said Bert Ely, a banking industry consultant in Alexandria, Virginia.

However, proponents of fair value accounting say temporarily suspending the rules for transactions involving a government-run bad bank would only temporarily suspend the truth of what assets are worth.

"When accounting diverges from economic reality, that's where you run into problems," said Hal Schroeder, director of relative value arbitrage at Carlson Capital.

Let be clear on something, temporarily suspending fair value accounting will do nothing to cure the cancer plaguing the financial services industry and pension funds that are loaded up with toxic illiquid securities.

Go back to read the FT article on the Swedish model for western banks which I referred to earlier this week:

Under this model banks were nationalised, fully aligning the interests of the institution with that of the taxpayer, while the depositor was fully protected. In the process shareholders were in effect wiped out, as they should be, and incumbent management was replaced, as it should be.

This left none of the massive conflicts of interest, as well as perverse unintended consequences, caused by the present anomalous situation in the west where too many banks are being rewarded for failure – leading, incidentally, to a massive competitive disadvantage for those banks that managed their affairs more prudently.

A crucial principle of the Swedish model is that banks were forced to write down their assets to market and take the hit to their equity before the recapitalisation began. This is of course precisely what has not happened in either the US or Britain, where too many policy measures seek to delay asset price clearing and only add public sector debt on top of existing private sector debt.

This is why the current approach in the west to the banking crisis can be compared more accurately with Japanese policy in the 1990s, and that clearly did not work. The outcome, as then, is increasingly zombie-like banks.

The ultimate endgame in countries such as the US and Britain is still likely to be full-scale nationalisation of most of the banking system, as the logic of such action finally becomes overwhelming.

But it would be much better if this were done proactively rather than reactively, since it would accelerate resolution of the financial crisis. This is why nationalising the banks would also be bullish for stock markets, if not for the specific bank stocks themselves – although, obviously, there are powerful vested interests wanting to prevent such an ultimate course of action.

Instead of implementing this logical approach, here comes the BARF:

First there was TARP. Get ready for BARF.

They haven't named it that yet, but calling a federal "bad bank" to soak up toxic assets the Bad Asset Repository Fund would be truth in advertising at least. Despite Washington's renewed enthusiasm for the idea, there is a strong case to be made against it.

The problem boils down to bank profitability, which is depleted, and the industry's ability and willingness to lend. Offloading the worst assets into an aggregator fund would still leave banks with loan books under pressure from rising defaults. Banks would still be forced to build reserves at a time when their earnings power is reduced, and that earnings power would only shrink more with a smaller asset base.

And there is no way a "bad bank" will induce banks to lend. "Lending standards have tightened dramatically and there is an unavoidable restructuring of risk taking place," says Meredith Whitney, the Oppenheimer & Co. analyst who was among the first to point out the looming bank crisis. "Such causes money to come out of the system and lending to contract, with or without this 'bad bank' structure."

But facing a mounting banking crisis, federal regulators and the new Obama administration have returned to the original idea of the Troubled Asset Relief Program as one way to solve the credit crisis. New Treasury Secretary Timothy Geithner said this week that a new plan is expected to be announced soon.

One idea is for the government to buy assets that banks have classified as "available for sale" and create a guarantee program for assets classified "held to maturity."

The latter category avoids the need to mark the assets to market, and in recent months banks have moved "massive" amounts of assets from the "available for sale" category to "held to maturity" for this reason, says Joshua Rosner at Graham Fisher.

That would create an incentive for banks to avoid the pain of marking down values of assets sold to a bad bank, Rosner notes. They could simply shift the assets to the category destined for the guarantee program, "delaying the day of reckoning."

Last fall, as Lehman Brothers failed and other banks scrambled for safety, thoughts turned to the revival of an idea from the last real estate lending crisis. The Resolution Trust Corp. came to life in 1989 after the failure of the Federal Savings and Loan Insurance Corp., then the thrift industry's version of the Federal Deposit Insurance Corp. (FDIC). In the thick of the savings and loan debacle, FSLIC was swamped by the collapse of 296 thrifts in a short span of time. It too failed.

So Congress put together the RTC, funded it with $50 billion, and tasked it with taking on the assets of failed thrifts and working them off. The RTC lasted until 1995 and required additional injections of capital, ultimately totaling more than $100 billion.

It did serve its purpose, however expensive. In its six-year lifespan, the RTC worked with 727 failed thrifts, totaling some $394 billion of assets.

Last fall, former Treasury Secretary Henry Paulson convinced Congress to approve the $700 billion rescue program for the banking system with a similar plan in mind. But that part of the TARP never got off the ground, mainly because the government couldn't figure out how to price the assets it was buying. Price them too low, and banks had no incentive to participate. Price them too high, and taxpayers wind up with socialized losses while banks benefit with private gains.

Paulson decided to use $250 billion of TARP funds to take direct equity stakes in banks instead.

Some don't think a new RTC-like structure is needed. The FDIC already functions as a buyer of troubled bank assets. During the savings and loan crisis, the FDIC handled the failure of 1,911 banks, totaling $703 billion of assets, and didn't succumb to failure like the FSLIC.

Concerns that the FDIC will run out of insurance funds to cover deposits are overblown, many say. For starters, the insurance fund isn't a separate account, as many imagine it to be. It is part of the Treasury Department's general fund, meaning it can be expanded to how ever big it needs to be.

Analysts at Keefe Bruyette & Woods estimated in recent days that for a new or improved TARP to really be effective, the government would have to take on roughly 25% of the banking industry's assets, or $3.5 trillion.

An alternative to selling their loans at distressed prices to a bad bank structure is selling "crown jewel" assets, Whitney from Oppenheimer notes. Citigroup, which has taken $45 billion from the TARP in two installments and needed the government to back $300 billion of its assets, agreed to sell 51% its Smith Barney brokerage to a joint venture with Morgan Stanley for $2.7 billion.

"Private capital will readily invest in businesses that make money and grow," says Whitney. "The banks do not fit this description."

Even George Soros thinks the 'Bad Bank' is a bad idea:

Billionaire financier George Soros told CNBC he disagrees with plans to create a new government entity to buy up troubled bank loans and believes former Treasury Secretary Henry Paulson mis-managed the first rescue attempt of financial institutions.

"That (the "bad bank" proposal) will help relieve the situation, but it will not be sufficient to turn it around," Soros said during a live interview at the Davos economic conference in Switzerland.

Instead, Soros said he would create a "good bank" and re-capitalize the good assets. He admitted his alternative plan is not likely to get support because it too closely approaches nationalization. "The political will to do that is not there," he said.

As to Paulson's handling of the first half of the $700 billion Wall Street bailout fund known as TARP, Soros said the money was used "capriciously and haphazardly." He said half of it has now been wasted, and the rest will need to be used to plug holes.

Although Soros saw trouble ahead, he stresses he did not foresee how bad it was going to get after the "life-changing event" of the Lehman Brothers bankruptcy.

"The storm that started in the financial system has now spread, in a very big way, to the real economy," he said. "It has fallen off the cliff following the Lehman thing."

He believes still more must be done to turn the slowing of decline into real economic growth, including the reorganization of the mortgage system, and skillful handling of the international repercussions.

Finally, please take the time to read Dr. Michael Hudson's latest counterpunch article on Obama's new bank giveaway:

First, here’s the silhouette of the giveaway, as outlined Thursday in the New York Times:

“Treasury Secretary Timothy F. Geithner said Wednesday the administration is working on a comprehensive plan to “repair the financial system.” … bank stocks surged on hopes the government was moving toward creating a “bad bank” to purge toxic assets from balance sheets that are rapidly deteriorating as the economy worsens… administration officials believe that trillions of dollars more may be needed to buy the majority of bad assets from banks. …

“The concept of a bad bank has gained momentum in the financial industry as the economy deteriorates, slashing the value of risky assets on banks’ books and increasing the need for banks to hold capital against those losses. Shares in Citigroup and Bank of America, which both recently received a second taxpayer lifeline, surged 19 percent and 14 percent respectively as the stock market rose on optimism that the administration would relieve banks of money-losing assets.”

“Geithner Says Plan for Banks Is in the Works”, By Stephen Labaton and Edmund L. Andrews, The New York Times, January 29, 2009.

After (1) threatening for eight years that the prospect of a trillion-dollar deficit spread over a generation or so is sufficient reason to stiff Social Security recipients and abolish debts to the nation’s retirees, and (2) after the Bush administration provided $8 trillion over the past three months in cash-for-trash swaps of good Treasury bonds for Wall Street junk derivatives, the Obama Administration is now speaking of (3) some $2 to $4 trillion more to be given in just the next week or so.

Not a single Republican Congressman went along, just as Rep. Boehmer refused to support the Bush bailout on that fatal Friday when Mr. McCain and Mr. Obama debated each other over marginal issues not touching on the giveaway, which both candidates passionately supported. The Party of Wealth sees the political handwriting on the wall, for which the Party of Labor seems happy to take all responsibility. This probably is the only place where I’d like to see “bipartisanship.” Watch the campaign contributions flow for an index of how well this will pay off for the Democrats!

How many families would like a “give-back” on every bad investment they’ve ever made? It’s like a parent coming to a child who has just broken a toy, saying “That’s all right. We’ll just go out and buy you a new one.” This from the apostles of “responsibility” for poverty, for mortgage debtors owing more than they can afford to pay, for people who get sick and can’t afford medical care, and for states and cities now left high and dry by the fiscal wipe-out that the Bush-Obama “cleanup” has foisted onto the economy. No do-over for anyone but the hundred or so billionaires who have just been endowed with enough free money to become America’s ruling elite for the rest of the 21st century.

After spending a lifetime denouncing socialism as inherently unfair, Wall Street is now doing a hideous parody – as if “socialism for the rich” were not an oxymoron in the first place. Certainly the banks are not being “nationalized.” Giving away the largest sum of spendable securities in history without direct managerial power that goes with ownership is not “nationalization.” Ask Lenin.

Now that the details of the new, larger but definitely not improved bank giveaway of between $2 and $4 trillion more have been leaked out in time for Wall Street’s Davos attendees to celebrate, we may ask whether, financially speaking, the Obama Administration should best be thought of as Bush-3 – or indeed, whether it is still on a pro-creditor trend that may better be traced as Clinton-5, or perhaps even Reagan-8. Since 1980 the financial sector has made a sustained money grab at the expense of labor and “taxpayers.” More accurately, it has been a debt grab, on the opposite side of the balance sheet from assets.

Backed by Larry Summers, Boris Yeltsin’s Harvard Boys transferred trillions of dollars of Russian mineral wealth and public enterprises into the hands of kleptocrats. That was an asset transfer, pure and simple. In 1997, to be sure, the IMF gave Russia a loan that immediately disappeared into the kleptocrats’ bank accounts, to be paid out of subsequent oil-export proceeds. But assets were the name of the game. Today’s U.S. giveaway has a new twist.

The analogy is the “watered stocks” and bonds of yesteryear that railroad magnates and Wall Street emperors of finance gave themselves and their political mouthpieces, simply adding the interest coupons and dividends onto the prices charged the public as if they were real “costs.” Today’s version – “watered Treasury bonds” – are being created on the public sector’s balance sheet. “Taxpayers” must pay bear the interest charges – leaving less for the infrastructure investment that Mr. Obama suggests we may need.

The Bush-Obama bailout bore “small print” stipulations that have already given Wall Street a decade’s tax-free status by letting it count its financial losses against its tax liability. So not only has there been a great fiscal giveaway, there has been a tax shift off finance onto labor and industry. States and localities already have begun to announce plans to sell off roads and airports, land and other public assets to the financial sector in order to finance their looming budget deficits (which localities are not allowed to run under present legislation). No federal funding has been granted to finance the cities as their tax receipts plunge.

There has been a token amount to relieve some low-income families saddled with junk mortgages. But this does not involve actually giving them a spendable money “bonus.” Their role is simply to be trotted out like widows and orphans used to be, as justification to bail out banks for their bad gambles on currency, interest rates and bond derivative gambles. Insolvent debtors are merely passive vehicles to get a book-credit of mortgage relief that the government will turn over in their name to their bankers to make these institutions whole.

Whole, and then some! Chris Matthews just reported his statistic of the day (January 29): $18.4 billion in Wall Street bonuses, paid for out of the government giveaway.

This is called “saving the economy.” That is as much an oxymoron as “socializing the losses.” Socializing the losses would mean wiping the mortgages and other bank loans of debtors off the books. These giveaways are to keep the debts on the books, but for the government to buy them and make the creditors whole – while a quarter of real estate has fallen into Negative Equity as its debts are not being bailed out but kept on the books. The economy’s “toxic waste” remains. But a matching volume of new waste is being created and given to a few hundred families. No wonder the stock market soared by 200 points on Wednesday, led by bank stocks!

In the seemingly frenetic ten days since Obama took office, it is beginning to look as if his good political decisions regarding Guantanamo, Iraq, employee rights to sue for employer wrongdoing, are sugar coating for the giveaway to Wall Street, a quid pro quo to avert opposition from his Democratic Party constituency. At least this seems to be their effect. To accuse Obama of a giveaway would seem at first glance to contradict the basic thrust of his actions – or would be if one did not take into account his appointments of Larry Summers at the White House and the conspicuous leadership role in the bailout played by Barney Frank in the House and Chuck Schumer in the Senate.

There is a simple way to think about what has happened – and why it won’t help the economy, but will hurt it. Suppose the new $4 trillion “bad bank” works. The government shell will give away Treasury bonds for bad bank loans and derivatives gambles, without the government “marking to market.” (So much for the pretense that giving Wall Street credit is “free market” policy. But the alternative to free markets does not turn out to be “socialism” at all, even if “socialism for the rich.” There are worse words for it, which I won’t use here.)

The real question is what the Wall Street elite will do with the money. From Chuck Schumer and Barney Frank through Larry Summers, the Obama administration hopes that the banks will lend it out to Americans. Borrowers are to take on yet more debt – enough to start re-inflating house prices and making homes yet more unaffordable, requiring buyers to take on yet larger mortgages. Larger mortgages at rising prices are supposed to help the banks rebuild their balance sheets – to earn enough to compensate for their gambling losses.

But this neglects the fact that today’s looming depression is caused by debt deflation. Families, businesses and government having to spend more wage income, profits and tax revenues on debt service instead of buying goods and services. So why is the solution to this debt overhead held to be yet MORE debt? Is there not something crazy here?

The government’s solution, placed in its hands by the financial lobbyists, is to bail out the bankers and Wall Street while leaving the “real” economy even more highly indebted. All this talk about “more credit” being needed, all this begging of banks to lend more money and then extract yet more interest and amortization from the economy, is leading it even deeper into the debt hole. It is not helping families repay their debts. And indeed, homeowners whose mortgages already exceed the market price of their property are not going to be able to borrow more.

It would take only $1 trillion or so – or simply to let “the market” work its magic in the context of renewed debtor-oriented bankruptcy laws – to cure the debt problem. But that obviously is not what the government aims to solve at all. It simply wants to make creditors whole – creditors who are, after all, the largest political campaign contributors and lobbyists these days.

The most important thing to understand about the present economic crisis is that it was not necessary technologically, politically or fiscally.

Government at the state, local and federal levels are strapped for funds – but only because the natural source of taxation, land rent and monopoly rent and the user fees from public enterprise have been financialized. That is, whereas property taxes used to finance about three-quarters of state and local budgets back in 1930, today they supply only about a sixth. The shrinkage has not been passed on to homeowners and renters or commercial users. Prices for homes and office buildings are set by the marketplace. The rise in market price has been pledged to bankers as mortgage interest. The financial sector thus has replaced government as recipient of the economic surplus – leaving the public sector starved of cash.

The financial sector also has replaced the government as economic planner. This role has followed from its monopoly in credit creation, which turns out to be the key to resource allocation.

Bank credit is created freely. Governments could do the same. Indeed, this is what the U.S. Treasury did during America’s Civil War, when it issued greenback credit.

If today’s looming economic depression is a manmade (that is, lobbyist-financed) phenomenon, then what policy is needed as a remedy?

So there you have it, a tour of opinions on the 'Bad Bank' idea being proposed by the new administration.

I sure hope President Obama and his team get this right because if they don't we are going to need a 'Mega Bad Pension Fund' to deal with all those pensions funds who blindly followed the advice of bad banks and are now teetering on collapse.

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