Things are looking a bit grim for the U.S. banking system.
On Tuesday morning, U.S. Treasury chief Tim Geithner rolled out his new plan for rescuing the banks, committing more than $1 trillion to convince private investors to buy up the “toxic assets” that are fouling up the system.
Lobbyists for the big banks praised the plan, the New York Times reported. Investors were less impressed. Shares of Bank of America, Citigroup, and Morgan Stanley plunged by well more than 10 percent Tuesday; Goldman Sachs fell by a relatively merciful 8 percent. Overall, the Dow Jones Industrial Average shed nearly 400 points.
Why the ugly reaction? Martin Wolf, the venerable markets reporter for the Financial Times, ventured an answer on a TV news program (part I and part II): the U.S. banking system appears to be insolvent, sunk under the weight of bad investments. According to Wolf, the Obama team is too “politically frightened” to tell the public and investors that our banking system has essentially failed.
To a casual observer me, Wolf’s analysis seems obviously right. What’s weighing the system down is bad real estate bets. Essentially, our bank execs—decorated with fancy b-school degrees and robustly compensated for their trouble—bet heavily U.S. real estate prices would rise indefinitely. Now that prices have plunged, they’re left with reams of essentially worthless mortgage-backed paper. And as the economy continues to unravel, real estate prices look set to continue falling—which means still more of the assets held by the banks will become “toxic,” i.e., worthless.
And here’s where we get to the trouble with the Geithner plan: He seems to be assuming that private investors can be convinced, by government guarantees and financing, to buy assets that are essentially worth nothing. But where’s the upside in buying worthless assets in the first place?
One of two outcomes now look likely: 1) a wholesale nationalization of the U.S. banks (an extremely dicey proposition for a Democratic president); 2) or the the descent into bancruptcy of a vast and iconic bank like Citigroup—with who knows what consequences.
None of this should be contemplated with panic. Rather, as the banking system teeters, we should be thinking about other finance models, other styles of economic development. In the weeks to come, I’ll be focusing on other models laid out in Woody Tasch’s Inquiries into the Nature of Slow Money: Investing as if Food, Farms, and Fertility Mattered and Gus Speth’s The Bridge at the Edge of the World: Capitalism, the Environment, and Crossing from Crisis to Sustainability.
Update [2009-2-11 7:42:54 by Tom Philpott]:
Martin Wolf has now aired his dire view in the pages of the FT. Wolf lays out two scenarios for the banks: the rosy one being acted on by the Obama team, and a more urgent one, which he says he says he has “little doubt” is correct. The second scenario is as follows:
Under the second view, a sizeable proportion of [U.S.] financial institutions are insolvent: their assets are, under plausible assumptions, worth less than their liabilities. The International Monetary Fund argues that potential losses on US-originated credit assets alone are now $2,200bn (€1,700bn, £1,500bn), up from $1,400bn just last October. This is almost identical to the latest estimates from Goldman Sachs. In recent comments to the Financial Times, Nouriel Roubini of RGE Monitor and the Stern School of New York University estimates peak losses on US-generated assets at $3,600bn. Fortunately for the US, half of these losses will fall abroad. But, the rest of the world will strike back: as the world economy implodes, huge losses abroad - on sovereign, housing and corporate debt - will surely fall on US institutions, with dire effects.
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Comments
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Jon Rynn Posted 11:20 am
10 Feb 2009
Thom Hartmann of Air America calls for nationalizing the banks, and frankly, I think it is blindingly obvious. While it might seem politically impossible -- maybe not -- it might be fun to speculate what a nationalized banking system might do -- say, a regional system of infrastructure/energy banks? Just sayin'.
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amazingdrx Posted 2:52 pm
10 Feb 2009
When local grids sense a catastrophe on the super grid, they disconnect.
When local banks, and their legitimate mortgages, are threatened by the collapse of global trading "banks", they safely withdraw their exposure. Sheltering under the protection of US government regulation and FDIC guarantees on deposits.
All that electronic fun money? 800 trillion in imaginary "derivatives"? Declare it null and void, and tell the folks who think they are holding US dollats, no you are holding worthless paper written by con men. You shouldn't have trusted them, so sue.
But they have nothing to do with actual deposits in officially regulated and insured US banks. No nationalization needed, only protection.
This sounds too simple to work, but that's why it just might work afterall. Whatever "instruments" these "bankers" used were counterfiet. We don't back counterfiet currecny.
http://amazngdrx.blogharbor.com/blog John Schneider, Northern Wisconsin
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Russ Posted 5:01 pm
10 Feb 2009
It is blindingly obvious, both from the pov of sound policy and politically.
The people would certainly support this over more direct handouts and lemon socialism.
As for the decisively repudiated republicans, there's no real reason to accommodate them one bit.
There's only one problem, and it's name is "Obama".
It's becoming increasingly clear that
As a policy matter, he is determined to continue with the corporatist/neo-feudalist Bush agenda largely unchanged, both domestically and abroad;
By temperament he's committed to appeasement: of the Republicans, of corporate malefactors, of the stock market (whose "emotional" crashes and surges look more and more terroristic with every new iteration).
These are why to a man Obama's economic and foreign policy appointees, starting with this corporatist ideologue Geithner, are all disaster capitalist retreads.
"Change" nobody should have believed in.
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archigeek Posted 1:17 am
11 Feb 2009
The mellotron is your friend.
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Whiskerfish Posted 5:43 am
11 Feb 2009
I mean, if we're talking about toxic mortgages, have they become toxic because the houses 'behind' them are worth a tiny fraction of what they were a year ago?
Or because the owners of those houses used them as surety for loans that were, a year ago, worth in excess of those houses?
If debt was piled upon debt, i.e. assets were used to leverage loans of many times those assets' value, then whoever granted those loans should be prepared to lose the excess value. That in itself, although massively disruptive, might not mean the end of the US economy.
However, if many houses are now pretty much permanently worth a fraction of what they were worth a year ago, because people realise that they are too big to heat cost-effectively or too far from jobs to commute reliably to and from in a world of insanely volatile oil prices (the Kunstler scenario) then the US really is in deep, deep doodoo. That would mean that the US really has misinvested an enormous pile of capital, and the whole country will have to suffer for that.
If this second scenario is true, no amount of bank bailout is going to help -- you'll just be throwing promises of value into a void that'll be unable to turn them into anything useful -- the only thing that will build real value in the US economy is a fundamental restructuring of living arrangements to make life far more energy and time-efficient than it is now for most suburban/exurban communities in the US.
Am I making sense? It all revolves around how you view what money represents, in the end, and what the material value sitting behind money might mean for money's value.
Cheers
Whiskerfish
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Tom Philpott Posted 6:13 am
11 Feb 2009
When you read stuff like George Packer's recent piece in the New Yorker, "Ponzi State," about the massively overbuilt real estate market in Florida, you start to see what Wolf is getting at: our banks (and our banks' overseas partners) are holding trillions of dollars of assets that will be repaid at pennies on the dollar. You've essentially got too much supply and -- with job losses mounting -- not enough demand.
I agree with Jon that nationalization looks like the only way to go. Obama and his team should have expressed shock at the sheer scale of the problem and just done it. But then again, Obama tapped one of the architects of the old failed bailout, Geithner, as his Treasury chief. It would have been awkward for Geithner to express shock. But it really does look like the Geithner plan is doomed to failure. Wolf's conclusion is worth noting:
Why then is the administration making what appears to be a blunder? It may be that it is hoping for the best. But it also seems it has set itself the wrong question. It has not asked what needs to be done to be sure of a solution. It has asked itself, instead, what is the best it can do given three arbitrary, self-imposed constraints: no nationalisation; no losses for bondholders; and no more money from Congress. Yet why does a new administration, confronting a huge crisis, not try to change the terms of debate? This timidity is depressing. Trying to make up for this mistake by imposing pettifogging conditions on assisted institutions is more likely to compound the error than to reduce it.
Assume that the problem is insolvency and the modest market value of US commercial banks (about $400bn) derives from government support (see charts). Assume, too, that it is impossible to raise large amounts of private capital today. Then there has to be recapitalisation in one of the two ways indicated above . Both have disadvantages: government recapitalisation is a bail-out of creditors and involves temporary state administration; debt-for-equity swaps would damage bond markets, insurance companies and pension funds. But the choice is inescapable.
If Mr Geithner or Lawrence Summers, head of the national economic council, were advising the US as a foreign country, they would point this out, brutally. Dominique Strauss-Kahn, IMF managing director, said the same thing, very gently, in Malaysia last Saturday.
The correct advice remains the one the US gave the Japanese and others during the 1990s: admit reality, restructure banks and, above all, slay zombie institutions at once. It is an important, but secondary, question whether the right answer is to create new "good banks", leaving old bad banks to perish, as my colleague, Willem Buiter, recommends, or new "bad banks", leaving cleansed old banks to survive. I also am inclined to the former, because the culture of the old banks seems so toxic.
By asking the wrong question, Mr Obama is taking a huge gamble. He should have resolved to cleanse these Augean banking stables. He needs to rethink, if it is not already too late.
Victual Reality
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Pompey Road Posted 7:48 am
11 Feb 2009
A J.P. Morgan whiz kid come up with a new type derivative where you could let the world share the risk. Of course it was based on home value's climbing. Then you get people selling mortgages on commission all those beautiful ARM's with no money down and just wink when you ask for the monthly income to see if it matches the premium.
Clinton wanted to get lower income people into home ownership. Helped the conservatives repeal Glass Steagal. Bush wanted to do the same thing plus help his buds on Wall Street. Freddie and Fanny loosened up lending guidelines and got a big infusion of cash. Now all the banks had to jump on board or get left in the dust.
Why did not Stndard and Poor's or Moody's, any of the rating institutions miss this. This new type of leveraged derivative had a decent rating. The market gobbled these things up from the banks without a second look. To share the risk we sold them to the world and since Wall Street bought the things they must be ok.
Maybe no transparancy to see how much the banks and other institutions had in assets as opposed
to how much leveraged debt
The same ratings agency's will rate our government bonds lower than a subprime mortgage after the first big round of borrowing to float the stimulus package. The Wall Street and banks that now have a earning to debt ratio that is in the toilet will look good when compared to what the U.S. Government's debt to GNP will look like after this first round of borrowing. When we go back fot the next two trillion to buy up all the toxic debt, and we will. As someone in another post pointed out the private funding is not going to be there. We are all looking at the same post crash ratings now. It would take a fool to invest in most of these banks.
Geithner is peeing on our leg and telling us it's raining. The whiz kid knew what they were when he let a lot of New York employee money get bet on this crap shoot 2 years ago.
The last bubble based on credit will be just that. We will never be able to pull this crap on the world again. The emerging markets will have to take control when this band aid fails. I just hope the dollar survives this mess.
Over 60 years of regulation seperating banking from the markets and the system held up. The deregulators finally got their way and it took only 8 years to destroy the U.S. and most of the worlds finiancial markets.
I hope the deregulating, trickle down, theorist that let it all ride on J.P.'s new untested derivative scheme have a safe place to put the money they are now stealing from the tax payer.
The new round of interest rate hikes that will follow China and Saudi Arabia's new demands for more interest on the next money should provide some safe sheltered finiancial instruments earning a decent return. I would also be looking at the currency exchange rates. I know that is OTC but there will be more credability and reliability there than the U.S. Market.
When we went off the gold standard all we had was the conservativeness and integrity of our regulated market to back the dollar with. Before we outsourced our manufacturing base we had a GNP to debt ratio that made us an attractive investment.
The eons of time and nature was good to us down here. It was not until we become civilized that destroying our habitat become fathomable or fashionable.
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thomasivy Posted 3:07 am
15 Feb 2009
I hear your logic, but I am dissapointed that you didn't wait for Geithner's plan to actually come into effect to judge insolvency. I would bet that you understand how fickle the stock market can be in a time like this. Of course, time is of the essence, but perhaps judgment is to soon.
Tom
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