Even I am getting tired of this topic but I think it’s important to offer counterpoints to the common wisdom I’m seeing in Left Blogistan. There is a huge amount of criticism about the Geithner Plan and a lot of it has to do with things that really are no different than they would be under nationalization schemes. Now, let’s consider a real case of nationalization: IndyMac. What kind of deal did the investors get?
1. They were able to buy $20.7 billion in loans and assets for $16 billion.
2. They obtained a $9 billion loan from the FDIC (I presume that it came at a very favorable interest rate).
3. They “assume[d] the first 20% of losses from borrowers who default. The [FDIC] will cover most of the remaining losses.”Anticipated loss to the taxpayer: $10.7 billion
Size of IndyMac: approximately 1/50th the size of Bank of America and CitiGroup
Now, if we go over to Open Left and read Paul Rosenberg, we’ll see that he is quoting Krugman and making the following complaint about the Geithner Plan.
First off, what should be clear from these two exchanges is that [Austan] Goolsbee is telling the truth, but he’s being deeply deceptive at the same time. Sure it’s true that tax payers both win or lose together. But the question is, “How much?” And the answer is simple: taxpayers take on much more risk, while investors stand to pocket much more profit, as Krugman explains with his more detailed explanation. And it’s precisely that more detailed explanation that’s being sidelined in the mainstream political discourse.
Let’s start with a simple premise. If you are being critical of the Geithner Plan and calling for nationalization in its stead, the criticisms that you have about the Geithner Plan should not be equally true of what happens when you nationalize. There should be things that turn out more favorably or that involve less risk in nationalization. Nationalization should be a better deal in some sense. If all the criticisms you have about Geithner’s Plan are basically true for what happened with IndyMac, then there’s a problem with your analysis.
Now, in the case of IndyMac, the taxpayer took an anticipated $10.7 billion haircut because, in part, they are on the hook for 80% of future defaults on shitty mortgages. Under Geithner’s Plan, the taxpayer is on the hook for 85% of the toxic assets. So, that’s a five percent difference. In the case of IndyMac, the taxpayer provided (presumably) some sweetheart financing in the form of a $9 billion loan. We hope, but are not guaranteed, of getting that money back.
We nationalized IndyMac and we have no potential upside at all. There is no scenario where the taxpayer doesn’t lose billions of dollars on the IndyMac deal. In the Geithner Plan, we make money if the investors make money. In both cases, we assume most of the risk and we provide most of the capital, and we give extremely favorable terms to the investors.
Now…you might complain about both scenarios. You might argue that IndyMac was done wrong and we can do future nationalizations in a way that doesn’t lose the taxpayers $10.7 billion dollars. But if we nationalized a bank that is fifty times bigger than IndyMac and we lost the same percentage as we did on IndyMac, that would be a $535,000,000,000,000 loss. You can double that if we nationalized two banks of that size.
I don’t want to make a false argument that we will necessarily lose that kind of money by nationalizing or that we couldn’t have done better with IndyMac, or that everything would move according to scale, but we have to think about these things more carefully. There could be perverse incentives built into the non-recourse loans that are provided in the Geithner Plan and those incentives could result in a loss of money to the taxpayer. There’s risk involved in this plan. But to suggest that there isn’t staggering risk and unfairness in any conceivable nationalization plan is just wrong and I will keep pointing that out as long as I see the same arguments coming out of Left Blogistan.
Agreement with what you’re saying from Rosser at EconoSpeak: Nationalization or Buying Toxic Assets: A False Dichotomy.
Curious that you provide no links to these arguments. You’ve been beating this strawman to death, and I don’t understand why.
You’re going to be pretty busy if you insist on “pointing [this stuff] out as long as [you] see the same arguments coming out of Left Blogistan.”
But I think this is an extremely important point, worth reiterating over and over again. Seems to me that Left Blogistanians – I like that it sounds like they come from a third world country – are simply not taking a close look at what nationalization really entails.
Rather than just generalize about “stupid Left Blogistan,” I would love to see some examples of what BooMan is talking about. You know, links?
Where are you guys getting this from?
Spend some time at OpenLeft. There’s plenty of material there.
Um, you’ve got three extra zeroes in “a $535,000,000,000,000 loss”. Fifty times bigger than IndyMac would be 535 billion, not 535 trillion.
Premise accepted.
I’m going to go with “under nationalization, the government can terminate the employment of the assholes who got us into this mess, and they will no longer be in charge of big shitpile.”
If nationalization still costs as much money as Geithner’s current plan, but under nationalization we get to fire the banksters then that’s the “things that turn out more favorably” part in my book.
“If nationalization still costs as much money as Geithner’s current plan, but under nationalization we get to fire the banksters then that’s the “things that turn out more favorably” part in my book.”
I agree with you there, to a point. But it sure seems to me that we have this small club of executives that just get recycled over and over and over again, and I doubt that any of them will be jobless for long.
Yes. Terminate the contracts. Liquidate the bastards. Wind down the positions. Whether it’s receivership or a bankruptcy court or a special government clearing exchange this needs to happen. It can’t possibly cost more than the current option. I mean, the elephant in the room is this country has spent/lent more on these banking bailouts and stimulants than it spent on WWII, the Vietnam War, The Iraq Wars, the Marshall Plan, and going to the moon. It’s insane. These parties are clearly holding our government and the people hostage because they are tied in a knot. We need to force that knot untied.
Why can’t we just blow up all their derivative bets? Isn’t the problem that the derivative knot is so complex that these dipsticks can’t get themselves out of the mess? Sounds to me like the people need to force all these parties to the table and to have a final reckoning because they are too cowardly and self-interested to come to a solution on their own.
And why do we need such a large shadow banking sector? Can’t we just wind down these bets? There’s no reason to continue the current firms’ practices of financial innovation through a receivership or bankruptcy court. I say any of that gambling in the future should be regulated on an exchange and only done by private parties with private money. As far as getting the bankers back to banking with a clean bank if necessary–that seems like something our government has experience with so let’s do that. That’s not hard. Certainly less the 11 Trillion (or whatever it is–one would think such a fundamental fact would be more widely-known).
p.s., I don’t trust Sheila Bair and there is still the possibility of government favoritism in the receivership process–I prefer the courts.
treatment of bondholder, shareholders, contractual liabilities
This doesn’t apply to the specific sites you’re responding to, but I would like to make the point that Krugman’s bottom line argument, right or wrong, is not that Geitner’s plan is unfair or that it’s generous to investors (though he does point that out in passing) or that its too expensive (he admits nationalization would be far or costly in the short run). His bottom line argument is that it won’t work. The problems in the financial system too deep and the banks are too badly in debt for this infusion of money and attempt to revive asset prices to address it.
He’s said, multiple times, that there are two schools of thought to this banking crisis:
1. That this is an “irrational panic,” borne not out of bad investments but merely a loss of confidence, and thus liquidity. In essence, a gigantic bank run.
or
2. That this is a “return to rational analysis” of banking investments, and everyone realizes that the banks made some very, very bad bets. In essence, big shitpile.
Krugman has, multiple times, said that if indeed we are merely suffering from #1, that Geithner’s plan will be fine and is perfectly suited for that. But Krugman thinks we’re in #2, and he’s laid out his reasons why he thinks that.
There isn’t anything more exotic or bad-faithed or ignorant going on here. Geithner believes #1, Krugman (and a HELL of a lot of other economists) believe #2.
I think BooMan is getting tired of carrying water for a bad plan. What I don’t understand is why BooMan decided to carry water for this plan to begin with.
Krugman’s argument relies on the ridiculous assumption that Geithner believes the asset sale plan will refloat the banks.
In fact, Krugman’s entire argument depends on highly unlikely assumptions about the politics of the process.
but I understand why. A nationalization of the banks would suck all the oxygen out of the room. I think it’s better to hope and b.s. our way through the next couple of years in order to get universal health care and a budget done.
krugman is 100% right that this plan probably wont work, that it is a bad deal and most importantly that people are switching back to a more rational valuation of assets.
however, I think Obama can half-ass it with the banks for the next two years and get that other stuff done. then maybe he can nationalize after that. it took japan like 7 years to do it, so if we can do it in 2 or 3 that’s not so bad.
anyhow, you’re right. he’s carrying water and kinda being intellectually dishonest. still, its fun to argue and we are all on the same side in the end. this whole kabuki thing is necessary to keep up appearances.
I not-so-secretly would prefer a government owned national banking system because it seems easier to control the government than private business.
Re Krugman’s argument:
The logic of this example falls on its face on three levels. First, no professional investor is going to invest in a 50/50 bet (20 points I win, 19.5 points I lose). That ½ point return advantage is all of 38 basis points of upside potential! Does anyone reading this believe that PIMCO, for example, will make such a bet? I don’t. Moreover, since the US government is involved in the process, it is equally hard to imagine that Geithner and Bernanke would allow the US equity stake to engage in boneheaded bid up purchases. Lastly, and most importantly, just what valuation methodology will the PPIP parties engage in? How about one that is rooted in sound economic principles, say, the discounted cash flow method. In the Krugman math example, no such sane and prudent approach will occur.
http://www.istockanalyst.com/article/viewarticlepaged/articleid/3143117/pageid/1
Ok. Here are my two cents or 10 cents. I have noticed that many of the commenters here are way ahead on this and probably have addressed many of the same points I make – I just have not had time to read everyone posting in the past days. So apologies in advance if I ramble on too long or cover the sane points. The main points I want to make are less to do with which approach is cheaper than with who should be in control and why.
There are costs and benefits to nationalization. I don’t believe anyone is arguing that nationalization will be cheap or easy. The problem with the Geithner plan(s) is that it makes its arguments in support of a private-public partnership emphasizing the upside and stressing the benefits but pointedly omits discussing the downside risk. It is just not plausible that we need a 3% partner and while doing so give up a great deal of the internal controls that would be in place if the institutions were nationalized. Let’s for sake of argument accept that a good argument can be made that the Geithner plan will in the abstract succeed in limiting losses as compared to government ownership. One can only make such an argument if you make the very big assumption that assets will not be overpaid for. The auction process discussed will not lead to lower prices but higher prices for these very distressed assets. As long as we are happy to just believe that it is some sort of very temporary aberration that these assets are undervalued than I guess you can celebrate this plan. What hard evidence is there that they are in fact undervalued? Is it really useful to speculate on the investment strategies ( or loose talk ) of John Paulsen to bet on where values are at ? Real estate markets around the nation are still in deep trouble; even with help from other programs that Obama and congress have initiated there is little reason to see how those programs will lift real estate values, including the values of the toxic assets. Stabilize, in some areas, possibly.
The key point I would like to make relates to the quality of leadership at the top of the troubled financial institutions and the management teams in place that will be running the day to day business. The people at the top have demonstrated that they are very poor managers and very big risk takers. They have not managed the risks in their business at all well in the past, so what is the evidence that they will manage it well going forward? Just as they ‘gamed the system’ on the way up in order to rake in large profits for top executives, managers and traders, why should we not assume that they will game it on the way down or out of business. Isn’t past behavior a good indication of future behavior? It seems more than plausible to me that the banks will find many ways to manipulate which securities that are brought to auction. They have proven very adept at deceiving supposedly sophisticated investors on the way up, why not on the way down and out?
In severe financial crisis’s such as the present their is an incentive to create confusion and to present issues in as obscure and muddled a way as possible. This way only the ‘smartest guys in the room’ can possibly understand what is going on and we could not possibly part ways with such indispensable people. By delaying accountability and remaining at the wheel as long as possible such insiders are effectively empowered to continue a program of internal looting. I, at least, do not believe the people within these companies are indispensable at all. I would venture a guess that there are now a great many of both experienced and well educated people available to perform critical functions within these companies. And they might be more than willing to work for a lot less than the Prince and Princesses of Wall Street and still be paid very handsomely. Replacing insiders has the additional advantage that they are have no vested interest in cover-up or nursing along a host of rube-goldberg boondoggles that are being kept in motion at great expense.
( I recall reading somewhere that financial elites during the Great Depression made similar arguments as to why they should remain in control and were irreplaceable and yet as it turns out – not so much.)
Really, it seems to be that we really already own these companies anyhow,, we just are not in control. Does anyone believe Citi or BAC are solvent and would be in business without taxpayer dollars? At what point do taxpayers get the benefits and not just the losses of being investors? What about the costs of the failure of Geithner’s plan? Unfortunately I have come to conclude that Obama is handling this the way he is mostly out of political considerations. I believe that he is trying to demonstrate that he tried everything before moving on to solutions such as seizure by the FDIC, Resolution Trust Corp etc.
PS. This quote found in today’s NY Times seals the case that we are screwed:
“For the first time in seven months, I can say they’ve done it right,” said T. Timothy Ryan Jr., president of the Securities Industry and Financial Markets Association.
“The key point I would like to make relates to the quality of leadership at the top of the troubled financial institutions and the management teams in place that will be running the day to day business. The people at the top have demonstrated that they are very poor managers and very big risk takers.”
Personally, I think they were only dealing rationally given their environment, and in fact are pretty bright people.
What would have happened if one of these CEO’s had decided to not engage in the risky behavior, but told his board and stockholders they were gonna settle for lower profits? I think it’s obvious they woulda been fired and a more compliant individual found do do what everyone else was doing.
Now, we might feel good by booting the leadership and boards, but I think in our minds we think these guys will go away and be pushing a broom at mcDonalds as punishment. Ain’t gonna happen. There’s a limited number of people in this club, and they’ll just recycle thru other firms.
JDW. No doubt you are correct that they are really bright and that they are behaving ( somewhat ) rationally within the existing framework. I believe the framework is both broken and rigged for the benefit of what is sometimes called “crony capitalism”. The fact that there are codes of honor and accepted business practices among gangs and criminal organizations does not mean that we need to accept their continuation. Perhaps the meltdown will discourage the best and the brightest from Princeton, Wharton and all from living exclusively in worship of the almighty dollar. You could be right though that just more soldiers will be brought in – very pessimistic. I hope you are mistaken!
Although there are clearly serious problems related to the elimination or gutting of regulation that need to be addressed going forward I personally believe that the bigger problem is a lack of will and a cozy, clubby relationship with regulatory authorities. This is why the SEC and the OTS have been so ineffective.
What kind of ‘investigation’ did the SEC really do in the Madoff affair? They just never noticed that he really had no trading records to support his supposed record of performance??
In the case of the real estate meltdown, from the mortgage brokers to the banks there was not just recklessness but knowing connivance and fraud at every level. Keep those pipelines flowing with product, there is money to be made!
I look forward to an army of investigators poring over the books and actions of these companies. There is real and substantive fraud and theft to be found, we just need to have the will to hold those of rank and wealth accountable, not just the small fry.
Unfortunately, our leaders may not have the will to deal with this, so you could be right in the end. Obama seems to have a limited appetite to ‘look back and hold people accountable’ as we see in other areas as well. I hope you are wrong on that.
I am glad to see you ask this question, I know the answer, but haven’t seen it described well anywhere. Only seen occasional fleeting references, and it is a key point. The difference is all in the bondholders, a gift to PIMCO.
Under nationalization, say a bank has good assets of $200M (million), toxic assets marked at $300M, has deposits of $250M, owes bondholders $250M, owes a hedge fund $50M and has shareholder equity of $50M on nationalization day.
So they have assets worth maybe $500M, and owe $600M. The shareholders are wiped out. The hedgie’s subordinated debt is wiped out, leaving $550M in debt. The toxic assets are sold at 1/2 the marked price (what the going rate is best I can tell), leaving the $200M in good assets, and the toxic sales proceeds of $150M. We send the depositors on their merry way with $250M in assets. This leaves $100M to pay off the bondholders- oops they take a haircut!
In this case the taxpayer is out bupkis, nada. Every bank will have a different story, but a very large amount of the liabilities of the financial firms are owed to bondholders, and they get eaten alive if a zombie bank is nationalized. What we really should do is let the bondholders get a choice- get assets from a haircut of 1/2 the marked price, or let them hold the toxic assets to maturity- they probably would make out better that way. Of course in many cases that wouldn’t work, and of course taxpayers would share a burden in many/most cases.
PIMCO helped design the Geithner plan. What a shock.
The big scary in nationalization is from the credit default swaps. We REALLY have to declare them null and void. That is where all the systemic risk comes from. Plus they jump in front of all other debt in bankruptcy- how sweet. Killing them is the first/ most imprortant law to pass. Without the swaps, nationalizing would be much more straightforward. Of course every bondholder will tell you nationalization is a bad idea. The key principle in all the bailouts so far has been make all bondholders and counterparties whole at the taxpayers expense- pure BS.
In Booman’s example, Indymac may or may not not have had much in the way of bondholders, but I sure can’t imagine FDIC paying them off fully and letting their fund eat the cost.
And I hve to add that I agree with the previous comments about new management. Current management has the worst instincts for the public. But along with new management is new regulation- I wouldn’t want the new buyer racing out of the gate pulling the same stunts.