Winehole23
01-26-2009, 01:49 AM
First Bailout Formula Had It Right
By JOE NOCERA (http://topics.nytimes.com/top/news/business/columns/josephnocera/?inline=nyt-per)
Published: January 23, 2009
“Blink,” the mega-best-seller by Malcolm Gladwell, is about the importance of first impressions, and Mr. Gladwell’s belief that “those instant conclusions that we reach are really powerful and really important and, occasionally, really good.” Case in point, it turns out, is the banking crisis. It sure looks like the government’s first impression about how to save the banks was the right one, after all.
“It’s pretty clear that the bad assets are the problem,” Barney Frank (http://topics.nytimes.com/top/reference/timestopics/people/f/barney_frank/index.html?inline=nyt-per), the chairman of the House Financial Services Committee, told me, somewhat ruefully, not long ago. Mr. Frank, you’ll recall, had championed the legislation for the original Troubled Asset Relief Program (http://topics.nytimes.com/top/reference/timestopics/subjects/c/credit_crisis/bailout_plan/index.html?inline=nyt-classifier) last September when the financial system appeared to be on the verge of collapse. The plan had been sold to him — and the rest of Congress — by Treasury Secretary Henry M. Paulson Jr. (http://topics.nytimes.com/top/reference/timestopics/people/p/henry_m_jr_paulson/index.html?inline=nyt-per) and Ben S. Bernanke (http://topics.nytimes.com/top/reference/timestopics/people/b/ben_s_bernanke/index.html?inline=nyt-per), the Federal Reserve (http://topics.nytimes.com/top/reference/timestopics/organizations/f/federal_reserve_system/index.html?inline=nyt-org) chairman, as a way to begin buying up toxic assets and taking them off the banks’ balance sheets. No sooner was the $700 billion package passed, though, that Mr. Paulson abruptly changed course and used the money to recapitalize the banking system instead.
Everywhere I’ve turned these last few weeks, I’ve heard variations of the same refrain. “The original Paulson plan had it right — they had to get the bad assets off the banks,” said Ronald J. Kruszewski, the chief executive of the investment firm of Stifel Nicolaus & Company. “Before you are going to get intelligent capitalists to invest their money in the banks, you have to get these landmines off their balance sheets,” said Brett Duval Fromson, the managing partner of the Margin of Safety Fund. “The reason things are frozen is that nobody knows if the banks are insolvent or not — thanks to the bad assets on their books,” said Henry F. Owsley of the Gordian Group, an investment bank that specializes in “distressed situations.
“If they wanted to follow the R.T.C. script, they would come to the immediate conclusion that they have to get assets out of the banks, and establish a market clearing price,” said Tim Ryan, head of the Securities Industry and Financial Markets Association. The R.T.C., of course, was the Resolution Trust Corporation (http://topics.nytimes.com/top/reference/timestopics/organizations/r/resolution_trust_corporation/index.html?inline=nyt-org), which managed (and sold) the bad assets on the books of banks during the savings and loan (http://topics.nytimes.com/top/reference/timestopics/subjects/s/savings_and_loan_associations/index.html?inline=nyt-classifier) crisis of the 1980s and 1990s. At the time, Mr. Ryan led the Office of Thrift Supervision, and helped direct the response to that crisis.
It’s pretty much unanimous, in other words. With a new administration, and a new economic team — which includes former Federal Reserve chairman Paul A. Volcker (http://topics.nytimes.com/top/reference/timestopics/people/v/paul_a_volcker/index.html?inline=nyt-per), who was among the first to publicly call on the government to begin buying bad assets — it seems clear that dealing with the bad assets should be one of the first orders of business. So how do we go about it?
Before we go there, let’s quickly take stock. On Wednesday, during his testimony before the Senate Finance Committee, Treasury Secretary-designate Timothy F. Geithner (http://topics.nytimes.com/top/reference/timestopics/people/g/timothy_f_geithner/index.html?inline=nyt-per) applauded the senators for passing the original TARP legislation, saying that “your actions helped prevent financial catastrophe.” Whether, in fact, TARP did the trick is open to debate, but things surely aren’t as dire now as they were then. Thanks largely to actions taken by the Federal Reserve, the commercial paper (http://topics.nytimes.com/top/reference/timestopics/subjects/c/commercial_paper/index.html?inline=nyt-classifier) market has thawed, and banks are lending to each other again — if not to the rest of us. Customers aren’t racing to pull their money out of the banking system and stuff it under a mattress.
Most important, the government has made clear it will not allow a major bank to default, to avoid the replay of the Lehman (http://topics.nytimes.com/top/news/business/companies/lehman_brothers_holdings_inc/index.html?inline=nyt-org) catastrophe. (Though it would have been nice if Mr. Geithner, who had been involved as head of the New York Fed, had acknowledged that the Lehman default was a terrible mistake. Instead, he fell back on the old “there was nothing we could do” dodge. Not exactly confidence-inspiring.) The government showed its determination to stick by this thinking when it rushed in to shore up the faltering Bank of America (http://topics.nytimes.com/top/news/business/companies/bank_of_america_corporation/index.html?inline=nyt-org).
L. William Seidman, the former chairman of the Federal Deposit Insurance Corporation (http://topics.nytimes.com/top/reference/timestopics/organizations/f/federal_deposit_insurance_corp/index.html?inline=nyt-org) — and who, like Mr. Ryan, was deeply involved in getting us through the S.& L. crisis — describes the current approach as “muddling through.” He added, “If you can muddle through, it is a lot more pleasant than what we had to do.” Without question, if we keep taking the current approach — throwing more capital at a bank whenever it falls into crisis because of its mounting losses — eventually the losses will end. They have to someday.
But Mr. Geithner strongly implied in his testimony that muddling through was no longer acceptable, and he’s right, for two reasons. The first is that it lacks the appearance of fairness. When the government concluded that Washington Mutual (http://topics.nytimes.com/top/news/business/companies/washington_mutual_inc/index.html?inline=nyt-org) was insolvent, it forced a fire sale to the stronger JPMorgan Chase (http://topics.nytimes.com/top/news/business/companies/morgan_j_p_chase_and_company/index.html?inline=nyt-org). Yet Bank of America, which has made a series of disastrous acquisitions, gets government support.
“We need to know what the rules are,” complained Michael Mayo, the veteran banking analyst for Deutsche Bank (http://topics.nytimes.com/top/news/business/companies/deutsche_bank_ag/index.html?inline=nyt-org). He pointed to the even more egregious case of National City Bank (http://topics.nytimes.com/top/news/business/companies/city-bank/index.html?inline=nyt-org) of Cleveland, which had a capital ratio higher than most banks that are still standing. Yet it was refused TARP funds, and was forced to merge with PNC, which got as its reward National City’s share of the TARP money. The government might argue that National City was going to be pulled down into insolvency because of inevitable losses in the months to come — and that may well be true. But how many other banks are in the exact same position, yet remain alive and will continue to receive support?
Muddling through will take years — and we don’t have years. We’re not trying to save the banking system for its own sake. We’re not doing it to help shareholders or even bondholders. We’re not even doing it to save the taxpayer. The core issue is that the longer the banking industry struggles, the longer it will take for the recovery to kick in.
The urgency, in other words, is not about the banks. It’s about the rest of us. This is about pushing along an economic recovery, which won’t happen until banks start lending again. Which they can’t do until they are healthy again. Which they won’t be, as long as they have assets on their balance sheets that they must keep writing down, quarter after blessed quarter.
•
During the time it was using TARP money to shore up the banking system, the Bush Treasury Department bent over backward to prevent shareholders from being wiped out, while at the same time trying to protect taxpayers. In retrospect, that never really made much sense. The preferred shares the government got in return for its money have indeed helped protect taxpayers — and have also kept shareholders from being diluted. But because it is sheltered behind the common equity held by shareholders — and is expected to be paid back — it can’t really be put to use. As the losses wipe out tangible common equity, the preferred shares just sit there, doing little or nothing to help the banks.
As for taxpayers, the harsh truth is this: there are hundreds of billions of dollars of prospective losses still on the balance sheets of banks that will have to be written down. Everybody knows that. Someone has to eat those losses. Even wiping out shareholders will only get you so far. The rest is going to have to be absorbed by the government. There is no other option. This fact needs to be faced squarely.
= This brings me back to the Resolution Trust Corporation, which strikes me as a model for how the new administration should proceed. Mr. Ryan told me that the very first bill signed into law by the first President Bush was the one that set up the mechanism for dealing with the S.& L. crisis. The Office of Thrift Supervision took over insolvent banks — some 700 by the time it was all over — which meant wiping out an awful lot of shareholders. The S.& L.’s were — no question about it — nationalized. The bad assets were stripped out, and handed over to the Resolution Trust Corporation, which was charged with selling them off.
Did the S.& L. crisis cost the taxpayers money? You bet it did — some $130 billion. But, said Mr. Ryan, “it would have been triple that” without the R.T.C. “Over time,” he added, “we got really smart about selling the assets. If we sold at a discount, for instance, we kept a residual.” He described a case to me in which one package of mortgages was sold off to investors at a loss, but with the government retaining some of the potential upside if the assets recovered some value. In the end, the government doubled its money. What is particularly appealing about an R.T.C.-type approach is that the government doesn’t have to value the assets right away, which has always been the sticking point with the toxic assets on the banks’ books. It can simply take control of them, and then figure out ways to sell them off over time. The process would certainly mean losses for the taxpayers, though presumably that could be mitigated with the kind of shrewd selling the R.T.C. did.
But to carry out this kind of program, the government has to be in control of insolvent banks. This also has to be faced squarely. Then it can do the same thing the Office of Thrift Supervision did in the early 1990s: close down the worst, sell others to healthier institutions and recapitalize the strongest. You can shovel capital into banks until you’re blue in the face and they are not going to lend so long as they have toxic assets on their books. They are going to hold onto their capital, fearing new losses. Only when the banks have shed their toxic assets will they lend. It’s really that simple.
I heard a number of other good ideas for dealing with the banking crisis this week. I plan to post several of them on my blog. But they all have this in common: they don’t dance around the issue. Shareholders are going to have to take a hit. Taxpayers are going to have to take a hit. Bankers most certainly are going to have to take a hit, as they should, since they got us into this mess in the first place.
This is the painful road to recovery.
By JOE NOCERA (http://topics.nytimes.com/top/news/business/columns/josephnocera/?inline=nyt-per)
Published: January 23, 2009
“Blink,” the mega-best-seller by Malcolm Gladwell, is about the importance of first impressions, and Mr. Gladwell’s belief that “those instant conclusions that we reach are really powerful and really important and, occasionally, really good.” Case in point, it turns out, is the banking crisis. It sure looks like the government’s first impression about how to save the banks was the right one, after all.
“It’s pretty clear that the bad assets are the problem,” Barney Frank (http://topics.nytimes.com/top/reference/timestopics/people/f/barney_frank/index.html?inline=nyt-per), the chairman of the House Financial Services Committee, told me, somewhat ruefully, not long ago. Mr. Frank, you’ll recall, had championed the legislation for the original Troubled Asset Relief Program (http://topics.nytimes.com/top/reference/timestopics/subjects/c/credit_crisis/bailout_plan/index.html?inline=nyt-classifier) last September when the financial system appeared to be on the verge of collapse. The plan had been sold to him — and the rest of Congress — by Treasury Secretary Henry M. Paulson Jr. (http://topics.nytimes.com/top/reference/timestopics/people/p/henry_m_jr_paulson/index.html?inline=nyt-per) and Ben S. Bernanke (http://topics.nytimes.com/top/reference/timestopics/people/b/ben_s_bernanke/index.html?inline=nyt-per), the Federal Reserve (http://topics.nytimes.com/top/reference/timestopics/organizations/f/federal_reserve_system/index.html?inline=nyt-org) chairman, as a way to begin buying up toxic assets and taking them off the banks’ balance sheets. No sooner was the $700 billion package passed, though, that Mr. Paulson abruptly changed course and used the money to recapitalize the banking system instead.
Everywhere I’ve turned these last few weeks, I’ve heard variations of the same refrain. “The original Paulson plan had it right — they had to get the bad assets off the banks,” said Ronald J. Kruszewski, the chief executive of the investment firm of Stifel Nicolaus & Company. “Before you are going to get intelligent capitalists to invest their money in the banks, you have to get these landmines off their balance sheets,” said Brett Duval Fromson, the managing partner of the Margin of Safety Fund. “The reason things are frozen is that nobody knows if the banks are insolvent or not — thanks to the bad assets on their books,” said Henry F. Owsley of the Gordian Group, an investment bank that specializes in “distressed situations.
“If they wanted to follow the R.T.C. script, they would come to the immediate conclusion that they have to get assets out of the banks, and establish a market clearing price,” said Tim Ryan, head of the Securities Industry and Financial Markets Association. The R.T.C., of course, was the Resolution Trust Corporation (http://topics.nytimes.com/top/reference/timestopics/organizations/r/resolution_trust_corporation/index.html?inline=nyt-org), which managed (and sold) the bad assets on the books of banks during the savings and loan (http://topics.nytimes.com/top/reference/timestopics/subjects/s/savings_and_loan_associations/index.html?inline=nyt-classifier) crisis of the 1980s and 1990s. At the time, Mr. Ryan led the Office of Thrift Supervision, and helped direct the response to that crisis.
It’s pretty much unanimous, in other words. With a new administration, and a new economic team — which includes former Federal Reserve chairman Paul A. Volcker (http://topics.nytimes.com/top/reference/timestopics/people/v/paul_a_volcker/index.html?inline=nyt-per), who was among the first to publicly call on the government to begin buying bad assets — it seems clear that dealing with the bad assets should be one of the first orders of business. So how do we go about it?
Before we go there, let’s quickly take stock. On Wednesday, during his testimony before the Senate Finance Committee, Treasury Secretary-designate Timothy F. Geithner (http://topics.nytimes.com/top/reference/timestopics/people/g/timothy_f_geithner/index.html?inline=nyt-per) applauded the senators for passing the original TARP legislation, saying that “your actions helped prevent financial catastrophe.” Whether, in fact, TARP did the trick is open to debate, but things surely aren’t as dire now as they were then. Thanks largely to actions taken by the Federal Reserve, the commercial paper (http://topics.nytimes.com/top/reference/timestopics/subjects/c/commercial_paper/index.html?inline=nyt-classifier) market has thawed, and banks are lending to each other again — if not to the rest of us. Customers aren’t racing to pull their money out of the banking system and stuff it under a mattress.
Most important, the government has made clear it will not allow a major bank to default, to avoid the replay of the Lehman (http://topics.nytimes.com/top/news/business/companies/lehman_brothers_holdings_inc/index.html?inline=nyt-org) catastrophe. (Though it would have been nice if Mr. Geithner, who had been involved as head of the New York Fed, had acknowledged that the Lehman default was a terrible mistake. Instead, he fell back on the old “there was nothing we could do” dodge. Not exactly confidence-inspiring.) The government showed its determination to stick by this thinking when it rushed in to shore up the faltering Bank of America (http://topics.nytimes.com/top/news/business/companies/bank_of_america_corporation/index.html?inline=nyt-org).
L. William Seidman, the former chairman of the Federal Deposit Insurance Corporation (http://topics.nytimes.com/top/reference/timestopics/organizations/f/federal_deposit_insurance_corp/index.html?inline=nyt-org) — and who, like Mr. Ryan, was deeply involved in getting us through the S.& L. crisis — describes the current approach as “muddling through.” He added, “If you can muddle through, it is a lot more pleasant than what we had to do.” Without question, if we keep taking the current approach — throwing more capital at a bank whenever it falls into crisis because of its mounting losses — eventually the losses will end. They have to someday.
But Mr. Geithner strongly implied in his testimony that muddling through was no longer acceptable, and he’s right, for two reasons. The first is that it lacks the appearance of fairness. When the government concluded that Washington Mutual (http://topics.nytimes.com/top/news/business/companies/washington_mutual_inc/index.html?inline=nyt-org) was insolvent, it forced a fire sale to the stronger JPMorgan Chase (http://topics.nytimes.com/top/news/business/companies/morgan_j_p_chase_and_company/index.html?inline=nyt-org). Yet Bank of America, which has made a series of disastrous acquisitions, gets government support.
“We need to know what the rules are,” complained Michael Mayo, the veteran banking analyst for Deutsche Bank (http://topics.nytimes.com/top/news/business/companies/deutsche_bank_ag/index.html?inline=nyt-org). He pointed to the even more egregious case of National City Bank (http://topics.nytimes.com/top/news/business/companies/city-bank/index.html?inline=nyt-org) of Cleveland, which had a capital ratio higher than most banks that are still standing. Yet it was refused TARP funds, and was forced to merge with PNC, which got as its reward National City’s share of the TARP money. The government might argue that National City was going to be pulled down into insolvency because of inevitable losses in the months to come — and that may well be true. But how many other banks are in the exact same position, yet remain alive and will continue to receive support?
Muddling through will take years — and we don’t have years. We’re not trying to save the banking system for its own sake. We’re not doing it to help shareholders or even bondholders. We’re not even doing it to save the taxpayer. The core issue is that the longer the banking industry struggles, the longer it will take for the recovery to kick in.
The urgency, in other words, is not about the banks. It’s about the rest of us. This is about pushing along an economic recovery, which won’t happen until banks start lending again. Which they can’t do until they are healthy again. Which they won’t be, as long as they have assets on their balance sheets that they must keep writing down, quarter after blessed quarter.
•
During the time it was using TARP money to shore up the banking system, the Bush Treasury Department bent over backward to prevent shareholders from being wiped out, while at the same time trying to protect taxpayers. In retrospect, that never really made much sense. The preferred shares the government got in return for its money have indeed helped protect taxpayers — and have also kept shareholders from being diluted. But because it is sheltered behind the common equity held by shareholders — and is expected to be paid back — it can’t really be put to use. As the losses wipe out tangible common equity, the preferred shares just sit there, doing little or nothing to help the banks.
As for taxpayers, the harsh truth is this: there are hundreds of billions of dollars of prospective losses still on the balance sheets of banks that will have to be written down. Everybody knows that. Someone has to eat those losses. Even wiping out shareholders will only get you so far. The rest is going to have to be absorbed by the government. There is no other option. This fact needs to be faced squarely.
= This brings me back to the Resolution Trust Corporation, which strikes me as a model for how the new administration should proceed. Mr. Ryan told me that the very first bill signed into law by the first President Bush was the one that set up the mechanism for dealing with the S.& L. crisis. The Office of Thrift Supervision took over insolvent banks — some 700 by the time it was all over — which meant wiping out an awful lot of shareholders. The S.& L.’s were — no question about it — nationalized. The bad assets were stripped out, and handed over to the Resolution Trust Corporation, which was charged with selling them off.
Did the S.& L. crisis cost the taxpayers money? You bet it did — some $130 billion. But, said Mr. Ryan, “it would have been triple that” without the R.T.C. “Over time,” he added, “we got really smart about selling the assets. If we sold at a discount, for instance, we kept a residual.” He described a case to me in which one package of mortgages was sold off to investors at a loss, but with the government retaining some of the potential upside if the assets recovered some value. In the end, the government doubled its money. What is particularly appealing about an R.T.C.-type approach is that the government doesn’t have to value the assets right away, which has always been the sticking point with the toxic assets on the banks’ books. It can simply take control of them, and then figure out ways to sell them off over time. The process would certainly mean losses for the taxpayers, though presumably that could be mitigated with the kind of shrewd selling the R.T.C. did.
But to carry out this kind of program, the government has to be in control of insolvent banks. This also has to be faced squarely. Then it can do the same thing the Office of Thrift Supervision did in the early 1990s: close down the worst, sell others to healthier institutions and recapitalize the strongest. You can shovel capital into banks until you’re blue in the face and they are not going to lend so long as they have toxic assets on their books. They are going to hold onto their capital, fearing new losses. Only when the banks have shed their toxic assets will they lend. It’s really that simple.
I heard a number of other good ideas for dealing with the banking crisis this week. I plan to post several of them on my blog. But they all have this in common: they don’t dance around the issue. Shareholders are going to have to take a hit. Taxpayers are going to have to take a hit. Bankers most certainly are going to have to take a hit, as they should, since they got us into this mess in the first place.
This is the painful road to recovery.