Bank runs | the financial bailout, what will it fix?
Tuesday, September 30th, 2008opinion
Exactly what problem are the polititions trying to fix with the bail out? My understanding, limited as it must be, is that the fundamental problem is an illiquid credit market.
If so. why is the fix buying up mortgages on Wall Street? That is kind of like painting a house to fix a leak in the basement.
Most people don’t understand that the present bail out of mortgages is very difficult to administer because mortgages are split in three parts, bundled as seperate derivatives and involves a full third of being sent overseas, one third to the banks and one third held by the investment banks. So two dollars in every three spent will not help the banks overcome their fear of lending. This does not guarantee the banks will lend out one dollar more.
Banks are afraid to lend. They have the means to lend, the Fed has increased their ability by $400 billion. Are they illiquid and therefore cannot lend? I doubt it but if so, long term Federal loans could fix this.
The only meaningful fix in my opinion is to offer a Government guarantee (with premiums paid by the banks) to allow banks to make risk free loans loans for commercial lines of credit, car loans, college student loans and even home loans subject to reasonable credit standards. The Government would make a fortune on this as the insurer of good credit risks.
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The Federal Reserve System has essentially an unlimited ability to prop up its member banks’ liquidity. I believe the Fed just did so Monday to the extent of another $650 billion dollars.
I believe the Fed has already pumped well over $1 trillion of liquidity into its member banks during the last year or so.
So the problem isn’t bank liquidity. The Fed itself is, however, now beginning to resemble its member banks whose liquidity the Fed has been boosting–because something like probably $400 billion or so of the collateral for the Fed’s loans to its member banks now consists of borrowing-bank assets other than the traditional Treasury securities.
The Federal Deposit Insurance Corporation’s ability to continue deterring the psychology behind bank runs isn’t really a problem yet either. The FDIC still has over $45 billion in reserves, the ability to raise bank insurance fees to restore its reserves, and the ability to borrow $30 billion from the U.S. Treasury as well.If FDIC resources became a problem, simple legislation increasing the FDIC’s line of Treasury Credit from $30 billion to whatever amount might be needed would easily solve that problem.Much of this problem has already been dealt with by consolidations which have now left the country with essentially only three major national banks–J.P. Morgan Chase, Bank of America, and Citibank.
There is room for additional consolidation–particularly with the Nation’s last two independent investment banks (Goldman Sachs and Morgan Stanley) now having become bank holding companies.
And Warren Buffet didn’t just buy $5 billion of Goldman Sachs stocks (with warrants on another $5 billion) because Buffet’s a philanthropist.
So, as far as I can see, there are only two problems remaining–
(1) radical devaluation of the national equities market and
(2) banks’ simple reluctance to lend because they’re already clogged up with toxic housing credits and don’t know what’s going to happen next.
Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke are now panicking the Nation into acting precipitously because they both want the taxpayers to pull their chestnuts out of the fire.
Paulson (Goldman Sach’s man in Washington) wants the taxpayers to prop up the stock market.
Bernanke (the banks’ man in Washington) wants the taxpayers to fix the Fed’s deteriorating balance sheet.
All the major equities gamblers in the Nation are, of course, fanatically supporting Paulson.
And all the major banking gamblers in the Nation are, of course, fanatically supporting Bernanke.
Why would they not?
Transferring $1 trillion from the people outside the casino to the people inside the casino is always nice work if you can get it.
It allows the gamblers to keep on gambling for awhile longer.
I say let both the stock market and the banks solve their own problems in whatever way they can.
Yes, the people outside the casino will have to pay for that too, but so will the people inside the casino.
Far more importantly, however, the unavoidable correction will occur now rather than later when it will cost us all far more than it will cost us now.
I say lets get it over with now, take our medicine, and then move forward after we’ve adjusted to the new reality and the gamblers have recovered from their casino addiction.
The correction is absolutely inevitable, you know.
Temporarily papering it over by now robbing $1 trillion from people outside the casino and giving it to people inside the casino will only allow them to gamble longer–resulting in a far larger crash and a far more severe correction later.
Look, the Dow Jones index didn’t reach 10,000 until 1999. The stock market was overvalued then. And it’s still overvalued now. 6,000 or 7,000 is about where the index reasonably should be.
Let it drop to that, and let the casino players take their losses. As for the banks, let them consolidate, work their own crap off their own books, and afterward recover their nerve and renew their purpose.
Yes, we’ll all have to pay for it by all going through tough times for awhile.
But we can’t forever keep robbing Peter to pay Paul in a vain effort to avoid the inevitable correction. The gamblers have been in the casino too long.
The worst thing we can do is make the non-gamblers pony up the money to keep the gamblers in the casino. Because they’ll just keep gambling until they have to come back and ask for more next time. We need to get the gamblers out of the casino now. And close down the casino. And send the gamblers home.
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This mortgage bailout isn’t going to cost the taxpayers $700 billion.If the Federal Government get its hands on this type of authority, it’s going to cost the taxpayers $700 billion a year for the next ten years.
The Federal Government told us the savings and loan crises would cost $100 billion to fix. It actually cost $1 trillion and took ten years to finish.
What incentive is there for the banking industry to solve its own problems if it knows it can keep coming back to the Federal Government for a decade or more to once again force the taxpayers to bail it out of the next $700 billion of bad credits?
The Federal Government needs to accomplish essentially only two objectives to get this crisis behind the Republic:
(1) put the Federal Deposit Insurance Corporation in a position to close down and liquidate bad banks and, thus, prevent bank runs and
(2) facilitate the Federal Reserve System’s ability to keep the still good banks liquid.
We can achieve the first objective by giving the FDIC as much of an additional line of credit at the Treasury as the objective requires. The FDIC does not need to get involved in servicing junk mortgages.
All the FDIC needs to do is
(1) convince depositors their deposits are safe and
(2) shut down and liquidate bad banks by selling them to good banks for whatever their realistic net values are.
The good banks buying bad banks in FDIC liquidation can then immediately either
(1) refinance, with lower principal at lower rates, the majority of troubled mortgages they’ve just bought or
(2) for the minority of troubled mortgages beyond all reasonable help, liquidate them for whatever they’re worth.
Why wouldn’t the good banks do exactly that? And in a year or less? The good banks have already bought the troubled mortgages at the appropriate deep discounts inherent in the prices they paid for the bad banks in FDIC liquidation.
These losses have been realized–by the bad banks, their stockholders, and bond creditors (but not by their previous depositors). What do the good banks have to lose by equitably and objectively disposing the troubled mortgages which the bad banks previously owned?
Nothing. All the losses have already been realized in the discounted purchase prices the good banks paid for the bad banks in FDIC liquidation.
It is, then, manifestly in the good banks’ interest to immediately restructure as many salvageable mortgages as they can and simply liquidate the unsalvageable ones without further ado.
This is, happily, also the best possible result for the troubled mortgagors themselves–at least the majority still capable of being salvaged by reduced principal balances and interest rates.
It is a phony argument that a substantial percentage of the Nation’s business will go bankrupt without a massive Federal mortgage bailout which allows bankers to continue financing business lines of credit.
No doubt, some will–particularly businesses which live from day-to-day on credit. Perhaps they should anyway. And no doubt some people who live from day-to-day on credit will also fail. But so also perhaps they should anyway.
The point is the system needs the correction to occur so it can recover and move on–so the few may fail and the majority may survive. But, if the Federal Government prevents the correction from occurring, the problem will only grow worse year by year.
And more businesses and people will ultimately fail at a far greater cost to the Republic as the Federal Government itself comes closer to failure.
The Federal Government already has a massively unsustainable debt. Adding another $10 trillion to it by socializing the Nation’s mortgage industry will only make this worse.
When the Federal Government itself approaches failure, the only possible result is a world-class inflation which reduces everyone in the Nation to something like a third-world status.
The future is not the Federal Government. The future is private citizens in a private market taking risks for rewards and retrenching when they take the wrong risks until they and the system has recovered its feet and its nerve.
If some fail, some fail. If all fail, failure no longer matters.
As for the stock market, let it trade down to where it reasonably should have been all along (say, 7,000) and let people learn to regard the stock market as what it is rather than as a casino.
I do not care if Nancy Pelosi’s net worth trades down from $300 million to $200 million. Or Henry Paulson’s net worth trades down from $1 billion to $500 million.
That is their business. It is not my business. It is not my children’s business. It is not my grandchildren’s business. And it is not the Federal Government’s business.
Nancy Pelosi and Henry Pauling do not share their rewards with me. If they lose, why should I repay their losses? If casino gamblers win, they don’t share their winnings with me. If they lose, why should I repay their losses?
Let them risk their own capital, rejoice in their own rewards, and live to regret their own losses.
Make no mistake about it, the 800-pound gorilla in the present rush to a massive Federal mortgage bailout whose eventual cost will be more like ten times $700 billion is the equities market and the desire of those who have for years gambled their assets there and reaped its rewards to have the Nation’s taxpayers preserve them from now taking their losses.
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