Too Big to Fail Redux
Mervyn King, governor of the Bank of England, has shocked the staid world of British banking by raising the possibility of breaking up the UKs big banks. Mr. King is no socialist, but a worried banking regulator. He is worried about “the sheer creative imagination of of the financial sector to think up new ways of taking risk.”
Around the world, regulators and finance ministers are hoping that banks will grow their way out of their current mess. To do so, however, banks will in fact need to seek new ways of taking on risk. It is called going for broke: the upside goes to stockholders and managers, and the downside to taxpayers. Mr. King knows that it is a “delusion” that regulators can control bank risk-taking.
Whether one agrees with his solution, at least he recognizes the problem. Would that were true of Treasury and Fed officials in the United States.
Geithner Ignores Bailout History
Perhaps the biggest problem with the Obama plan to “reform” our financial system is the impact it would have on the market perception surrounding “too big to fail” institutions. In identifying some companies as “too big to fail” holders of debt in those companies would assume that they would be made whole if those companies failed. After all, that is what we did for the debt-holders in Fannie, Freddie, AIG, and Bear. Both former Secretary Paulson and Geithner appear under the impression that moral hazard only applies to equity, despite debt constituting more than 90% of the capital structure of the typical financial firm.
Geithner believes he’s found a way to solve this problem – he’ll just tell everyone that there isn’t an implicit subsidy, and there won’t be a list of “too big to fail” companies. Great, why didn’t I think of that. After all, the constant refrain in Washington over the years that Fannie and Freddie weren’t getting an implicit subsidy really prepared the markets for their demise.
Even more bizarre is Geithner’s assertion that the government can force these institutions to hold higher capital, maintain more liquidity and be subjected to greater supervision, all without anyone knowing who exactly these companies are. Does the Secretary truly believe that these companies’ securities disclosures won’t include the amount of capital they are holding? Whether there is an official list or not is besides the question, market participants will be able to infer that list from publicly available information and the actions of regulators.
One has to wonder whether Geithner spent any of his time at the NY Fed actually watching how markets work. Before we continue down the path of financial reform, maybe it would be useful for our Treasury Secretary to take a few weeks off to study what got us into this mess. We’ve already been down this road of denying implicit subsidies and then providing them after the fact. Maybe it’s time to try something different.
The Legacy of TARP: Crony Capitalism
When Treasury Secretary Hank Paul proposed the bailout of Wall Street banks last September, I objected in part because the TARP meant that government connections, not economic merit, would come to determine how capital gets allocated in the economy. That prediction now looks dead on:
As financial firms navigate a life more closely connected to government aid and oversight than ever before, they increasingly turn to Washington, closing a chasm that was previously far greater than the 228 miles separating the nation’s political and financial capitals.
In the year since the investment bank Lehman Brothers collapsed, paralyzing global markets and triggering one of the biggest government forays into the economy in U.S. history, Wall Street has looked south to forge new business strategies, hew to new federal policies and find new talent.
“In the old days, Washington was refereeing from the sideline,” said Mohamed A. el-Erian, chief executive officer of Pimco. “In the new world we’re going toward, not only is Washington refereeing from the field, but it is also in some respects a player as well. . . . And that changes the dynamics significantly.”
Read the rest of the article; it is truly frightening. We have taken a huge leap toward crony capitalism, to our peril.
Filed under: Finance, Banking & Monetary Policy; Government and Politics
Timmy Throws a Temper-Tantrum
As reported in yesterday’s Wall Street Journal, Treasury Secretary Tim Geithner called fellow bank regulators, included Fed Chair Ben Bernanke and FDIC Chair Sheila Bair, over for an obscenity-laced rant about their audacity in raising questions about his scheme to fix our financial system.
Reportedly the Secretary told regulators that “enough is enough” and that they’ve been heard, so the time for debate is over. This sounds eerily like the President’s previous comments about including Republicans in the talks over the stimulus – you’ve been heard, so you were “included,” now shut up. The shouting down of debate is becoming all too much a signature of this Administration.
The Secretary apparently also told the regulators in attendance that it was the administration and the Congress that sets policy. Perhaps next he’ll tell us that the power of the purse lies with the Treasury and the Congress. Secretary Geithner has no more constitutional authority to set policy than do any of the bank regulators. It is the job of Congress to make laws, not the Treasury Secretary’s. He can offer his opinion, just as they can, and should, offer theirs.
Of course, Secretary Geithner’s frustrations are understandable, given that his regulatory proposals have hit a brick-wall with both Congress and the Public. He has made no effort to explain to either Congress or the public how exactly his plan will stop future bailouts. Instead, any reasonable read of his proposal would lead to the conclusion that we will have more bailouts, rather than less, under the Obama-Geithner plan. Instead of directing his energies at anger, he should put them toward coming up with solutions that actually increase the stability of our financial system.
We were all told during his confirmation process that we must overlook such facts as his failure to pay taxes, because Tim Geithner was the “boy-wonder” who would save our financial system. As his recent out-bursts demonstrate, “boy-wonder” is only half-right.
What’s A Dollar Worth?
It’s not just Americans worried about the flood of dollars from the Fed. The Chinese and now the Malaysians also are wondering if they should keep dealing in greenbacks.
Reports the Wall Street Journal:
Malaysia’s prime minister said China and his country are considering conducting their trade in Chinese yuan and Malaysian ringgit, joining a growing number of nations thinking of phasing out the dollar.
“We can consider whether we can use local currencies to facilitate trade financing between our two countries,” Malaysian Prime Minister Najib Abdul Razak told reporters at a briefing Wednesday after meeting with China’s premier, Wen Jiabao.
“What worries us is that the [U.S.] deficit is being financed by printing more money,” Mr. Najib said. “That is what is happening. The Treasury in the United States is printing more notes.”
The dollar won’t easily be displaced as the world’s principal reserve currency. But Washington appears to be doing everything possible to hasten that day.
Perhaps Americans should consider keeping their wealth in yuan or even ringgits. At least they might retain their value even as the Fed and Treasury attempt to inflate and spend the U.S. economy into oblivion.
Filed under: Finance, Banking & Monetary Policy; International Economics and Development; Tax and Budget Policy
Bailouts Could Hit $24 Trillion?
ABC News reports:
“The total potential federal government support could reach up to $23.7 trillion,” says Neil Barofsky, the special inspector general for the Troubled Asset Relief Program, in a new report obtained Monday by ABC News on the government’s efforts to fix the financial system.
Yes, $23.7 trillion.
“The potential financial commitment the American taxpayers could be responsible for is of a size and scope that isn’t even imaginable,” said Rep. Darrell Issa, R-Calif., ranking member on the House Oversight and Government Reform Committee. “If you spent a million dollars a day going back to the birth of Christ, that wouldn’t even come close to just $1 trillion — $23.7 trillion is a staggering figure.”
Granted, Barofsky is not saying that the government will definitely spend that much money. He is saying that potentially, it could.
At present, the government has about 50 different programs to fight the current recession, including programs to bail out ailing banks and automakers, boost lending and beat back the housing crisis.
We used to complain that George W. Bush had increased spending by ONE TRILLION DOLLARS in seven years. Who could have even imagined new government commitments of $24 trillion in mere months? These promises could make the implosion of Fannie Mae and Freddie Mac look like a lemonade stand closing.
Filed under: Finance, Banking & Monetary Policy; Tax and Budget Policy
Too Big to Fail
One of the most pernicious public policies aggravating the financial crisis is that of “too big to fail.” The doctrine states that some banks (now financial institutions generally) are so large that their failure would incur “systemic risk” for the financial system. That sounds terrible and it is intended to. Financial services regulators and Treasury secretaries use it to frighten small children and congressmen. How can an elected official vote to incur systemic risk? He must vote to approve the bank bailout of the day. In fact, people who use the term cannot even agree among themselves as to what it means, much less what causes it and, therefore, what the appropriate response would be. I suggest the reader substitute the phrase “too politically connected to fail” whenever he sees “too big to fail.” What follows will then be rendered intelligible.
Beginning of the End for Bernanke
Fed Chairman Bernanke’s term as Chair ends in January 2010. So far President Obama has offered Bernanke praise for his performance, but little else. After last week’s House Oversight Committee hearing focusing on Bernanke’s role in Bank of America’s purchase of Merrill Lynch, it is now readily apparent that the Chairman has few supporters on Capitol Hill. While his nomination will not be subject to the approval of the House of Representatives, or any of its Committees, the Senate Banking Committee’s reaction to Treasury Secretary Geithner’s plan to extend the Fed’s power serves as a useful proxy in gauging that Committee’s view of the Fed’s recent performance.
Several recent polls show President Obama to be broadly popular with the American public, while the public holds some concern over the scope and cost of his policies. His policy that garners the least support has been his bailout and support for the auto industry. It is no secret that the American public was not enthusiastic about the bailouts at the time, and is even less so now. With Hank Paulson having left the stage, Bernanke is now the public face of corporate bailouts. While having Bernanke around may offer President Obama a convenient target for the public’s anger over bailouts, re-appointing Bernanke would finally force Obama’s hand — so far he’s managed to support the bailouts with little fallout, as Bush and others have taken the blame. Re-appointing Bernanke makes him Obama’s pick.
In addition to political risk to President Obama, one can assume that many Senate Democrats are not looking forward to having to vote for the man who bailed out AIG. It is a fair bet that many Republican Senators would not vote for Bernanke’s re-appointment, leaving it up to the Democrats to secure his re-appointment.
Whatever the merits, or flaws, in his performance as Federal Reserve Chair, support for Bernanke’s re-appointment is becoming a proxy for one’s support, or opposition, to corporate bailouts.
Going Bankrupt Double-Quick
George W. Bush and the Republicans worked hard to ruin the U.S. government’s finances. The Obama administration and the Democrats are doing an even better job of wrecking the Treasury.
Treasuries headed for their second monthly loss, pushing 10-year yields up the most in almost six years, as President Barack Obama’s record borrowing spree overwhelmed Federal Reserve efforts to cap interest rates.
Notes, little changed today, also tumbled this week on speculation the worst of the economic recession is over. A private report today will show confidence among U.S. consumers gained in May for a third month, economists said. South Korea’s National Pension Service, the nation’s largest investor, plans to reduce the weighting of U.S. bonds in its holdings, the government said in a statement.
“It’s a disastrous market,” said Hideo Shimomura, who oversees $4 billion in non-yen bonds as chief fund investor at Mitsubishi UFJ Asset Management Co. in Tokyo, a unit of Japan’s largest bank. “I expected yields to rise but not this fast. We will see new highs in yields.”
The benchmark 10-year note yielded 3.61 percent at 6:29 a.m. in London, according to BGCantor Market Data. The 3.125 percent security due in May 2019 traded at a price of 95 30/32.
Ten-year rates rose about half a percentage point in May, extending an increase of 46 basis points in April. The two-month climb was the most since July and August of 2003. A basis point is 0.01 percentage point.
As borrowing costs rise, so will future deficits, requiring more borrowing, which will push up interest rates, hiking future deficits, requiring…
Just how are we going to finance trillions of dollars for health care reform while wrecking the economy with cap and trade? And then there’s the $107 trillion in unfunded liabilities for Social Security and Medicare.
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