Tag Archives: Geithner

AIG Bonuses – The Fix Is In

This AIG business is so transparent and I’m afraid Timothy Geithner is in it up to his eyeballs.  President Obama may be too.  He probably is.

They are using a well known trick in negotiating with unsophisticated buyers.  Every hondler in every stall in every market in the Middle East knows this trick like his mother’s own face.

You go in with a price that is sure to create sticker shock.  Then you negotiate down from there giving the buyer credit for this, and savings for that, and a discount for the other thing, and a tax break here, and oh, my manager says I can throw in the DVD player for free… and at the end of the day the unsophisticated buyer walks away happy because he only got screwed by 20% instead of the 50% he was initially afraid he’d get screwed by.

By the time AIG and our worthies are done with this charade, the bonus pool for this round (this is only the first round of three) will be reduced from $165 million to just a sliver under $100 million.  AIG will walk away like the car salesman… bonuses in hand and alive to fight another day, Obama and Geithner will walk away “heroes” for having fought for justice and the American way and saved the us a shred of our pride, and $70 million or so, and we’ll walk away happy we only got screwed by $90 million and change instead of $165 million.

Mark my words.

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The Second Major Flaw in the NEW Bank Bailout

Immediately after Treasury Secretary Geithner announced the framework of the new bank bailout program the stock market sank hundreds of points, as I hope he expected it would do.  The plan fails to address the real banking problem and fails to fully acknowledge the real housing problem.

The plan includes a variety of programs and provisions that will help lower mortgage rates on new purchases, make it possible for many borrowers to refinance into mortgages with lower rates, and for some borrowers to be able to restructure their mortgages to avoid foreclosure.  Lowering home owners’ mortgage payments by lowering their interest rates will have a significant stimulative effect on the economy and will reduce the number of families forced into foreclosure by some marginal amount.  It will not solve the core problem and may actually make it worse.

There are two foreclosure crises going on right now.  The first crisis is hitting speculators, many of whom look like very normal people, like you and me, and who would not consider themselves speculators.  But they were.  Any family that used an adjustable rate mortgage or any of the other specialized tools to buy more house than they could afford with a traditional 30 year fixed mortgage was speculating that the price of their house would continue to increase and that they would be able to sell for a profit before their rates started increasing.  When the housing market peaked, these people found themselves unable to sell and they are the ones who have been getting picked off by the adjustable rate mortgages in droves.  To a degree this phenomenon has happened all over the country, but it has only happened in crisis proportions in a few places.  California and Florida had the most upside speculation and have had the worst downside losses.  Nevada’s and Arizona’s populations have soared as people have retreated from the untenable California housing market, which created mini-boomlets in these communities, which now have also collapsed.

For every one of the families that has taken a loss on a speculative real estate investment, remember that another family took a profit earlier.  In fact, very often the families that were able to parlay a series of houses into bigger and better houses through market forces rather than the sweat of their brow, are the same families that are now being forced into the reality of what their money should have been buying them all along.  We should have minimal sympathy for people who took profits on the way up but are now screwed on the way down.

The second foreclosure crisis is a result of the recession created by the credit crisis that sprang from the first foreclosure crisis.  Michigan and Ohio have been hit particularly hard by this crisis as unemployment has soared.  With the deepening recession and spiraling job losses, there will be more of these foreclosures and they will be distributed more evenly around the country.  While they don’t feel any better or worse for it, these are the “innocent bystanders” of this mess.  These are the people who mostly bought homes they could afford, financed with jobs they had every right to expect they could keep, and who have been caught in a crossfire that never should have happened.

Here’s the problem.  These two foreclosure crises are qualitatively different but the solutions on the table only apply to one of them and may aggravate the other.

The main thrust of the mortgage relief program is a variety of ways to lower mortgage interest rates.  When rates are lower, payments are lower, and the line between keeping your house and losing it moves so that a marginal number of people get to stay in their homes who otherwise wouldn’t have.  When rates are lower, houses also become comparatively better investments.  They may not be as good an investment as they were several years ago, and they may even just be a less bad investment than they were last year, but either way, since their competitive position improves compared to other investments, their prices will either go up a little or, at the very least, fall less.  This will have a dramatic impact in California, Florida, and other markets where the primary cause of the foreclosures is the real estate bubble.

Around the rest of the country, where foreclosures are happening because of job losses, no amount of restructuring or changing interest rates is going to make up for a catastrophic loss of income.  The only solution in these parts of the country is getting everybody back to work.  In fact, the prospect of increased housing demand in parts of the country where demand is only depressed because of a poor economy will, what?  That’s right… it will create an artificial increase in housing prices which will likely lead to a whole new batch of dislocations further down the road.

The answer?  If we are so screwed that we have to accept that we have no choice but to make speculators whole for their bad investments… we should limit that to those markets where the most speculation occurred.  Around the rest of the country, we should take whatever funding is going to go into lowering tens of millions of home owners interest payments and put it toward economic stimulus that will benefit the entire economy, including renters.

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The First Major Flaw in the NEW Bank Bailout

Immediately after Treasury Secretary Geithner announced the framework of the new bank bailout program the stock market sank hundreds of points, as I hope he expected it would do.  The plan fails to address the real banking problem and fails to fully acknowledge the real housing problem.

The real banking problem is that the asset bases of hundreds of banks including the very largest among them have collapsed in value.  Banks typically lend about $12 for every $1 in assets they have.  Because the value of their assets have crashed, without moving a muscle many of them have become devastatingly over-leveraged with loan to asset ratios of 30 to 1.  We have known since time immemorial, although we willfully ignore it every time we think we have found free money, that bank leverage ratios at this level lead only to one place… dead banks.

This is why when the first $350 billion of the TARP funds were distributed to the banks they didn’t suddenly start lending.  Those funds rescued them from the brink of collapse but did not reduce their loan to asset ratios to any sort of level that would have made it responsible for them to lend more money out.  If prudent ratios are 12:1, the banks ended up at 30:1, we rescued them by bringing them back to, say, 20:1… they still are going to need a lot more money before they can start resp0nsibly lending again.

To make matters worse, the banks are not teetering on the edge of insolvency.  According to a number of prominant economists including Nobel Laureate Paul Krugman, the big banks are already insolvent and have been for many months now.  The only way these banks have been able to continue functioning in remotely bank-like ways is by everyone agreeing not to realistically value their mortgage backed assets.  By looking the other way and pretending that they are worth more than they are, the banks have continued to borrow money from the Federal Reserve to pay off their own lenders but, in reality, the gig is up.  The banks have collapsed, even if they haven’t fallen down yet.

When banks collapse three groups of people get hurt.

  1. Bank investors lose their investment in the bank.  The value of their stock goes to $0.  This is bad for them, but no worse than when any of their other investments go bankrupt, and they get compensated for this risk through the return they demand on their investment.
  2. Bank bond holders lose their investment in the bank.  The value of their bonds goes to $0.  This is bad for them too but, again, no worse than when any of their other investments go bankrupt and, like stockholders, they get compensated for this risk through the interest they demand on their loans.
  3. Bank customers are the big losers.  There are no mechanisms like interest or dividends that compensate them for the risk that their uninsured deposits and day-to-day operating funds will vanish overnight in a puff of Wall Street smoke.  They lose everything, and the economic ripples start here as businesses, suppliers, employees, and customers all end up eating a share of a loss for which they never received compensation.

The fact that bank customers lose without compensation is the one and only factor that differentiates an insolvent bank from any other insolvent business.  FDIC insurance, to the extent that it covers deposits, was created to ensure that bank collapses would not leave savers penniless.  It does not, however, provide for continued short term operating loans.  So it helps, but it doesn’t help enough to avoid economic shock waves, closures, Main Street bankruptcies, and unemployment.

Protecting these vulnerable, uncompensated bank customers from the effects of bank collapses should be the government’s one and only banking related concern right now.  But that is not what we are seeing in any of the bailout proposals that have come along so far.  All of the bailout proposals and actions have maintained at least some mechanism that maintains at least some value for bank stockholders and bondholders.  That is reason number one why Wall Street crashed dove today.  Making people whole for losses they have already been made whole for does nothing at all to solve the problem and is just patently, blatently, disastrously, unfair.

The second reason Wall Street doesn’t like the new bailout proposal is that it insists that banks lend out the money the government gives them!  This seems logical on the surface, but remember the problem in the first place is that the banks are insolvent!  They already have loan to asset ratios of 30:1.  If we add to their assets and then insist that they lend those assets out, it does very, very little to reduce the lending to asset ratio to a responsible, sustainable level.  We may be able to defer some problems this way, and we may be able to soften the economic blow to the customers this way, but it is massively inefficient and doesn’t ultimately solve the problem.  The banks are insolvent and the only real solutions are going to have to have that as their starting point.

What this means is that the stockholders and bondholders have to be wiped out.  In order to keep the banks functioning without impact to their customers, the government will have to assume their operations and provide them with new assets at a sufficient level so that their loan to asset ratios are sustainable.   Once the government does this, it can go about selling them back to a public that will be as eager to invest in clean, healthy financial institution as they were before this mess.  It is a trade.  The government puts in the money that the old investors lost, and then new investors put their money in so the government can get its money back out.  Bank customers, in the meantime, experience a seamless transition as if nothing had happened.

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