As featured on p. 218 of "Bloggers on the Bus," under the name "a MyDD blogger."

Thursday, February 26, 2009

Bad Stuff

I you just read President Obama's budget and the surrounding documents, you would say as a progressive that the Administration has the exact right priorities, that they have identified the problem, will seek to make the tax code more fair and work rewarded rather than wealth, and will invest in the fundamental elements like health care, energy and education that will make this nation prosperous for decades to come. But if you read the financial sections, you are looking on in absolute horror. We are turning on an endless spigot to the very banksters who got us in this mess.

Taking the wraps off its much anticipated bank-rescue plan, the Obama administration on Wednesday announced that it will provide a virtually unlimited solvency guarantee to the nation's 19 largest banks [...]

The plan works like this: Through the end of April, federal regulators will pore over the books of the 19 largest banks — such as Citigroup, Bank of America, Wells Fargo and others. They'll be looking at conventional measures such as the composition of a bank's cash on hand, and at unconventional ones, such as how financial firms are valuing complex and opaque investments that are often shorthanded as toxic assets.

The idea behind the so-called stress tests is to gauge if the banks have enough capital to cope with a more severe downturn than even today's — one in which the economy contracts by 3.3 percent and the unemployment rate tops 10 percent. That's far from the worst-case scenarios that some of the gloomier forecasters predict.

At the end of the exercise, if it's determined that banks lack enough capital to weather such a storm, they'll be given six months to raise more capital from private investors or to ask for a capital buffer from the government.

If a bank is unable to raise private capital and needs to get capital from the federal government, it would do it in exchange for "convertible mandatory preferred shares." They could be converted into common stock on an as-needed basis, which would inject new capital into the bank. The government would become a shareholder in the company through its ownership of common stock.

Banks don't have to complete the stress test to apply for this capital buffer. Citigroup is expected to get a fresh injection of capital through this program in coming days. In exchange, the government is expected to take a stake as high as 40 percent.

Calculated Risk has the full terms. This is just going to cost a fuck-ton of money. Obama's team is planning to prop up zombie banks forever. And it will be forever, or at least for as long as most of us will be comfortable with. There is no way Congress will be able to allocate the money for such a maneuver - the anger over the banks will be overwhelming - so Obama wrote it into his budget. He basically made room for up to $750 billion more in banking aid, while calling it a $250 billion dollar expenditure - 8% of total federal spending in the budget - because of a presumption that we will get some of that money back. So the cash is already earmarked.

And it will all be used. The idea that firms will be able to find capital in six months, or will even try to if they know the government will come in with a handout afterwards, is absurd. Here's Yves Smith:

If anyone really believed these banks' capital was adequate, would we have this never-ending parade of special facilities, rate cuts to near zero levels, and programs to rescue stressed borrowers? All the interventions say loud and clear that most if not all of the big banks are in parlous shape, but the Administration keeps repeating the canard that the banks have more capital than needed "to be considered well capitalized." Well, either the standards for capital adequacy are rubbish or all the weekend specials and Congressional high stakes poker have been a complete waste of taxpayer money. You can't have it both ways, and you reduce your credibility by peddling this sort of thing. And this isn't just my reaction; readers who have seen this sort of formulation (it has shown up before) find it either comic or pathetic.

Anyone with a passing familiarity with the banks suspected of being in most urgent need of new funding, Citigroup and Bank of America, knows that their stock prices have fallen to levels that suggest serious doubts about their survival. Meredith Whitney, the bank stock analyst whose forecasts have been most accurate, said her best idea was to short Ciitgroup, last week, even at super depressed levels [...]

What Ben Bernanke does not say but clearly suggests is that asset prices are being depressed artificially by ‘irrational despondence.’ Stepping in to offer a bid to these assets will lift them — at which point the despondence will go away and all will be fine with the world.

This view is misguided because many asset prices are still above their long-term trend. This is certainly the case with house prices, where renting is still significantly cheaper than purchasing in many locales.

What is amazing is the degree to which Bernanke has been unable to process what has happened over the last year and a half. It isn't simply that he is trying to restore status quo ante; he seems to see the only possible operative paradigm as the status quo ante. Worse, he has a romanticized view of it too.

Even the stress tests seem to be envisioning a world where the "bottom" of the recession is substantially higher than what most economists would predict in their most pessimistic scenario (which is the point of the stress test). This would paint a rosier scenario for the banks than should be assumed, and would allow the Administration to continue to claim that nationalization is not the answer.

Timothy Geithner's main concern seems to be bailing out his friends and sparing no expense in doing so. All those late-night phone calls must have convinced him. He may also think, and has convinced Obama, that this is the only way to restore functioning credit markets. But that neglects both economic and political reality:

If the banks are owned by the same people who own them now, and managed by the same people who manage them now, then it’s going to be extraordinarily difficult to persuade the congress and the public that we ought to make enormous transfers of funds from the taxpayers to those owners and managers. What’s more, the banks will continue to be managed by the same bad managers who got us into the current situation. As a result, we’re going to wind up giving the banks less money than they really need to take off. And they’ll continue to be managed poorly. So they’ll continue to be wards of the state. And no private investors are going to want to give smaller, healthier banks the capital they would need to expand and thrive. Consequently, our economy will continue to be dominated by large, semi-dead financial institutions that hamper growth.

Paul Krugman nails it:

What they’re actually doing is underestimating the problem, doing too little too late, and not being open and honest in trying to assess the true cost. The actual plan seems to be to keep the banks semi-alive by implicitly guaranteeing their liabilities and dribbling in money as necessary, all the while proclaiming that they’re adequately capitalized — and hope that things turn up. It’s Japan all over again.

"Japan" refers to their decade of zero growth as a result of propping up zombie banks instead of taking the necessary steps of temporary takeover, wiping out the shareholders and starting over. It's basically throwing money down a black hole. And that's the path we're headed down.

Very scary.

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