There’s been a lot of news (here; here; here) about giving the government expanded powers to take over troubled financial firms and lead them through some form of bankruptcy (these powers already exist with FDIC-insured banks, but not for hedge funds and investment banks). I believe this is a really, really good idea. If something like that were in place now, the banking crisis would be much less severe.
Although I don’t think this is being spelled out clearly by the media, perhaps the biggest problem with banks right now is that they are afraid to lend to each other out of a fear that their lending partner will go bankrupt and they don’t be able to get their money back. To see why they’re worried about this, take a look at how worthless Lehman debt is: a friend of mine who’s a higher-up at a hedge fund says that his fund values their Lehman Europe debt at about 15 cents on the dollar right now. He’s not sure why it’s so little, but it has everything to do with how bankruptcies are administered, since Lehman’s assets and debt were approximately equal in value, meaning that creditors should have been able to get something like 95 cents on the dollar if the assets were sold at market value. Now, suppose that there were a government take-over followed by an immediate mass auction; that might depress the value to the point where creditors got about 70 cents on the dollar, say.
According to my friend, that would be a perfectly acceptable loss. Creditors would take their lumps and get most of their money back and no one would care that much (his words, not mine). Part of the big problem with the current bankruptcy system (and a big part of the reason why Lehman debt is so worthless) is that it takes years and lots of court time for creditors to get their money back.
What’s very interesting here is that a system along these lines would require no government capitalization — it wouldn’t be like the FDIC in that sense.
So that could be the good news that comes out of this big bank mess, some kind of new government-run system of bankruptcy that erased fears of large financial bankruptcies the same way the that the FDIC did with depository banks, and one that didn’t even require any tax-payer money.
Update. In the comments, schrodinger’s cat writes:
Also we don’t need banks and financial institutions that are “too big to fail”.
To paraphrase Bill Clinton, that depends on what the definition of “fail” is. Nearly everyone believes that Citi and BofA *are* too big to fail in the sense that under our currency bankruptcy system, their creditor’s assets (trillions of dollars) would be tied up in court for God knows how long, which would (a) hurt their creditors’ financial standing (and hamper their ability to lend to anyone else) and (b) scare the bejesus out of any institution that was thinking of lending money to any other institution that might go under.
The whole point here is to change what happens when a big institution fails. That way, no one would be too big to fail.
Stiglitz is a dirty f***ing hippie.
Also we don’t need banks and financial institutions that are "too big to fail".
I don’t know. Simply waving your hands and demanding a "simplier bankruptcy system" sounds like a great idea until you try to formulate one. There’s a reason bankruptcies are messy and complicated. You’ve got a heirarchy of claims that are spelled out in a web of contracts and debt obligations – bonds, preferred stocks, common stocks, loans, employee obligations like severance and back pay, service contracts, back taxes, penalties – and everyone wants to get paid. Try deciding who gets preference, from a legislative level, and all the other actors will eat you alive.
@schrodinger’s cat: The question is whether we should beat down institutions that get "too big" (and then have to pin-point what "too big" is) or whether we build in a bigger safety net that can handle these titans when they tumble.
And a pony!
I’m not actually sure that it’s feasible without "any tax-payer money" – even if the actual process doesn’t require government capitalization (and I’m still not quite certain how that works – perhaps because I’m slow today), there would still be a bureaucratic infrastructure that would be needed to handle these things – even if it’s just beefing up the FDIC to handle the new work.
I suppose it would be possible to structure it like the FDIC, call it "insurance" and make the institutions covered under it pay for it themselves. But I guess I still consider that a tax, though I know that politics makes it easier to use some word other than "tax" for certain things (lately I don’t have the aversion to the word "tax" that I used to have – the word just doesn’t sound as vile to me as it did a couple of decades ago). It would also require heavier regulation of hedge funds and investment banks, since you would assume they would have to conform to some kind of standards in order to get protection (as depository banks need to).
Which is not to say that I think these are bad things – I don’t. I just question how we’ll be able to get a "free ride" on this. Someone has to pay for it somewhere in the process.
OT: DougJ, what is the latest news on the special election in NY. According to the Corner, Tedisco is gaining (though they have no polling to confirm this) because Obama it seems is no longer popular, because of the AIG bonus fiasco. Since I don’t exactly trust the Corner as news source, I was wondering about your take on the situation.
The FDIC is one hell of a lot more of a pony. Depositors are made whole. I don’t think giving creditors 70 cents on the dollar is a pony.
Our current bankruptcy system is so fucked up that if we could create a wooden horse in its place, it would feel like a pony.
I’m sure that’s bullshit.
Tedisco should win because he has so many structural advantages. But I doubt he’s gaining right now.
I’m not sure you get schrodinger’s point. It’s not necessarily to ‘let these fail now,’ it’s ‘we should now begin to structure the financial system so that the entire economy is not vulnerable to the bad actions of an oligopolist / oligopsonist few corporations.’
No, the idea is to have *no insurance at all*, just liquidate and pay. I don’t if that’s what Geithner will propose (somehow I guess not), but it would be a big improvement (from banks’ perspectives) on what we have now.
Yes, exactly. (I didn’t mean to suggest otherwise, I was just expanding on his comment.)
This about sums up the options.
I’d go for constructing firewalls, finite dollar amounts (pin-point) that limit the growth potential. Well, not to limit growth but to establish some point which would signal the creation of some sort of subsidiary or cloned entity. (I’m not a financial wizard so, yes, I’m making this up as I go along. But I don’t think this idea is outside of the realm of possibilities.)
An ounce of prevention (limits) is worth a pound of cure (bailout). [please pardon the cliche]
@ El Cid
I think you put it better than I did. I am not a lawyer, but could anti-trust laws be used to break up these huge financial institutions which threaten to destablize not just the US but the global economy if they go under as a result of bad decisions (think Barings bank and Leeson).
I’m still not getting who pays for the infrastructure to be able do this – it’s going to take a lot of lawyers, accountants, and other staff to make an operation work. That’s my point. I think I understand now what you mean by the "liquidate and pay" model, but it still presumes (at least to me) that you already have an infrastructure in place that’s capable of taking one of these huge giants, going through all of their records, separating the wheat from the chaff, and auctioning it off. That sounds a lot bigger than going into a small regional bank one Friday, looking through the books, finding a buyer and getting the place transferred over to the new buyer within a few days (as is the FDIC’s normal MO).
Again, it sounds like a good idea to me. But the idea that we’re going to be able to get it without paying for it seems wrong – I’m always a little leery of folks promising me something really good that I don’t have to pay for (which is where my snarky "and a pony" comment comes in). The FDIC is paid for by the banks, which means that to some degree it’s paid for partially by me as a depositor because I (at least in theory) get a lower rate of return on my money so they can afford to pay the insurance (in actuality, I don’t think it’s that simplistic, as I think it gets spread out a bit more among the shareholders, depositors and employees to pay the extra overhead, but the point is that the money has to come from somewhere).
That’s any choice for me. Break ’em up now, and don’t ever let them get that big again. Period. Then if they go down, they are more like any other failed (big) business.
Mergers and swallowing of small banks that result in a few huge megabanks is not good for anyone. File it under anti-trust for all I care. And for God’s sake get that wall between deposit and investment banks back up ASAP.
Does that tie to the reason why many folks are hesitant to "just let the banks fail"? If it takes years and years for creditors to get their money, any portion of it, then for a super large bank, it would grind their activities to a halt, and grind activities of a major portion of the world financial system to a halt.
The Mother Bank, as it desires continued growth, becomes the insurer of its own spawn. This incentivizes responsible growth through sound practices and insures that "they" always have some "skin in the game". The FDIC would only insure the losses at the limit of the Mother (original charter).
The best idea I’ve heard to limit the size of financial institutions is to increase the required capital account amount as they got bigger. You could do it easily enough, and it would make larger firms LESS competitive than their smaller cousins.
This last go around, the biggest five went to the SEC which allowed them to "self regulate" and lever up to over 30-1 in some cases, just exactly the opposite of what this proposal would require.
Somehow they must get smaller, seems to me. The proposals to make a better system to liquidate the behemoths smacks of doing nothing and calling it "reform." As Zifnab laid out, it’s impossible to make the liquidation of an entity spread across several continents with billions or trillions of interconnected relationships a streamlined process.
One thing is certain, unless the financial giants scream like stuck pigs when the "reform" is announced, we’ll know it’s a farce.
Who do we have to thank for that, and when did this happen?
@passerby: I question that method for two reasons.
One, its not very feasible politically. We already have a few anti-trust provisions on the books that rarely if ever get enforced. By the time a company is "too big to fail" it already owns large chunks of the federal bureaucracy and has been inoculating itself against retaliation.
Two, you end up with a system that is very inflexible. So, fifty or sixty years down the line you get a situation kinda like the Alternative Minimum Tax where people who aren’t "too big to fail" under the existing system start hitting the wall. Alternately, you fall back to problem one, where companies with insider Washington friends continue to grow while competitors get smacked down.
I’m more of a mind to just increase the safety net. Determine how to take apart a large, partially functioning company (perhaps via the Good Bank / Bad Bank strategy) and feed it to the FDIC.
Seriously, where’s W(aldo)? Any discussion of this has to include the past several years. Or is America going through Post Traumatic Memory Loss? While the media at large microparses and fiddles with Kroftian "gotcha" questions, the real issues never get addressed. Perhaps becasue the reptilian luddite brain cannot comprehend the gravity of the situation while microfocused on the next email or Twitter coming in from the internet. /shrug.
In other words: "We’re going to need a bigger boat"?
But Zifnab, given the problems you outline, the abuse caused by the ability to buy politicians, wouldn’t that safety net just encourage that exact bad behavior? Talk about deep pockets, the potential money well of the American taxpayer is nearly bottomless. Other people’s money and all that.
Isn’t this what we want? Strict enough to prevent "too big to fail" yet porous enough to allow for growth. The new paradigm must ensure that the bankers always have skin in the game. That way they can’t go all Ponzi on us (U.S.).
Our current system is little more than organized crime. Speaking of criminal, it should be illegal for a bank lobby to give $$$ to ANY politician.
I think they’re trying to kill us.
– Senator Byron L. Dorgan, 1999
– Bob Kerrey, 1999
What most people don’t realize is that if we were to nationalize the banks, even by way of Krugman’s magic bullet ‘Swedish model’, there’s still a good chance that the whole thing will still blow up. If you nationalize any one of the top 10 largest banks, you have to do them all. And Congress would have to approve it. And as we all know, Congress could fuck up a cup of coffee. That’s 10 incredibly large corporations worth trillions upon trillions of dollars collectively. How in the hell could you manage such a thing? To me, it seems to be a logistical impossiblity. Where the fuck would you even start? Also,there is no way of telling what would happen after the axe fell. What if the banks were not able to open thier doors afterwards for say a week? A month? What if it take 5, 10 or even 20 years to unload the assets off the government’s back? What if the Markets (evil bastards that they are) completely shit themselves? There are too many unknowable outcomes when dealing with companies this large, that have such a large foothold in the global marketplace.
At worst, Giethner’s plan will buy us some time. Time to figure out how to shrink these institutions down (perhaps by unloading the toxic assets, along with other measures) to the size that they can be managed effectively and start lending again. Time to install new regulations that won’t allow this to happen again. Because if the banks are allowed to fail (total economic armageddon)or become nationalized institutions (a somewhat less damaging economic armageddon, one in which you may not have to eat your cats) things could get real ugly. And if that happens, I say bring on the Wasilla Wingnut! I always wanted to die in a fiery explosion.
i was just reading roubini being named as a finalist for times top 100 influential people. his bio points to his his having warned about subprime meltdown as early as 2006.
nice, but geithner warned about the dangers of derivatives as early as 2004, and he tried to reign them in. does geithner get any credit for it?
The safety net is designed to dissolve bad businesses. Expanding the safety net would mean we wouldn’t need to go through another round of bailouts. Currently, the financial giants are skating by under the notion that Chapter 11 just couldn’t handle a company of their size. If it could, they’d have just been taken apart like Lehman was.
By contrast, putting some sort of size cap in place would just set up a ripe target for Republicans to rail against in the future. All banks would be hindered to provide assurance that the system could handle if one bank failed. That would only maintain political support if the banks and the public continued to fear another recession. If recessionary fears faded, the law would be scrapped the moment Republicans got back in power – and would likely be a driver in delivering them back to power again.
Banks did have skin in the game. In fact, they had more skin in the game than they had skin on their backs. The leveraging problem is entirely different from "too big to fail" and desperately needs to be addressed with the biggest, nastiest, most painful regulations possible.
But regulations ‘Strict enough to prevent "too big to fail" yet porous enough to allow for growth’ are a fairy tale. If you have regulation, you’re going to be restricting growth in some way almost by definition. The only reason the business exercises activity you’d want to regulate against would be to hasten growth. You have to ask how much growth you want to restrict.
But Ponzi schemes can exist with or without this kind of regulation. We’ve got plenty of laws on the books that should have busted Madoff, for instance, but no one at the SEC was enforcing them. We don’t need new regulations for these crimes. We just need new regulators.
Oh, sorry. That just slipped out.
But that’s not the reason that bankruptcies are messy and complicated. The "web" of which you speak is actually NOT all that complicated as the heirarchy is pretty straightforward and every institution knows them WELL. What takes the most time when a large institution fails is the extensive valuation of assets.
But, the longer those assets are held in this environment the more their value decreases as the creditors hold out no immediate hope of recouping. If those assets were just immediately sold and then had bankruptcy court just be responsible for administering the proceeds to pay the creditors and other claimants in proper order it would be a much better system than what we have now. Creditors wouldn’t recoup 100% but they wouldn’t value it as worthless either because they know it won’t be tied up forever.
I mean, if someone owes you $20 and they come to you and say look, I have $15 now or you can wait 15 years and I’ll give you all $20 back, to which deal would you assign the most value?
And for God’s sake get that wall between deposit and investment banks back up ASAP.
cat: Who do we have to thank for that, and when did this happen?
that was the glass-steagall act. pushed for by phil gramm and signed into law by clinton in 1999. it was originally put in by FDR as a new deal reform to prevent another depression.
robert rubin also recommended to clinton that it be struck down. and during the primaries, hillary clinton was still defending it having been being dismantled.
right. it was norquist who just put out the most progressive budget that’s ever been seen. a budget that even krugman praised.
That would work for large investment firms but not for depositor institutions which is why 1) It is SO SO SO SO important that we go back to the days when those two activities were not EVER to be intertwined and 2) The administration, Congress, economist, finance people, etc have NO idea what to do with this crap. Damn dummies should have seen this predicament from a mile a way when they repealed the Glass-Steagall act.
Those two activities were kept separate for a REASON and it is no coincidence that while it was on the books we didn’t suffer anything remotely approaching the financial meltdown that we are currently facing – AND it kept colossal, "too big to fail" institutions from forming. It only took less than ten years to undo nearly 70 years of uninterrupted functional financial markets. It’s really breathtaking when you think about it.
WRT the politics, have a gander at the vote roll from the 1999 Senate vote for the deregulating Graham Leach Bliley Act of 1999. It’s not just Republicans we have to worry about. Note: McCain voted "Present" . Pres Clinton signed this into law.
Also Geithner and Benanke are on the hot seats in a House hearing on CSpan 3 right now (12:00pm EDT).
Finding out who voted for this bill and are still in Congress right now, would be interesting, I think.
From the article in NY Times, cited by srv
Seems like the bill passed with strong bipartisan support.
Isn’t the highest priority imperative behind a "bailout" format based on the supposed shock to the rest of the economy, the amount of time it would take to settle it all down, and the fact that we are not operating in a vacuum, but instead are operating intertwined tightly and dangerously with a worldwide financial and money system that may not be able to sustain that sort of shock?
And isn’t the real "right thing to do" here based on taking the action that presents the smallest ding to the entire system, not just the one that presents the cleanest and most likeable banking result for the US?
In other words, isn’t the solution you propose just a really nice answer to the wrong question?
It’s one thing to say that a different approach would have prevented a fire, but another to say that once the fire starts our first order of business is to look at fire prevention.
Let’s go back to that (in)famous day last September when supposedly an electronic run on the banks was underway and our clueless overlords at the time realized that the whole house of cards was falling down. Isn’t that the day that it became too late to focus on the remedies that you are proposing here, until the worldwide economic system, whatever you happen to think that is, is stabilized?
No. I think your criticism makes absolutely no sense at all, to be honest.
Yes, that’s a big part of why the current system is such a mess. The hierarchy of claims is complicated, unclear, and requires years of court time to sort out. That’s precisely what needs to be reformed.
I’m working the problem backwards. Every blurb I’ve seen anywhere that takes the tack you suggest is based on the idea that the remedy is better because it produces a particular outcome (a more stable banking infrastructure, say) and better long term prospects (it addresses systemic problems).
However, it’s clear to me from the language coming out of the government since September that those two imperatives are not their highest priority. The higher priority seems to be to stave off near-term and calamitous effects of a collapse. An effect that your proposed remedy does not seem to offer.
In lieu of any other rational explanation (that I know of) for NOT choosing the scheme you suggest, isn’t that the most likely explanation for the what we shall call the Geithner scheme? And if is ….. then how do we not choose Geithner’s scheme?
If the choice is between (best possible remedy long term but with short term chaos and unpredictable worldwide effects while we straighten it all out) and (short term fire drill, preventing chaos and collapse, but requiring the better long term remedy eventually), then isn’t B the right move, and isn’t that why the administration is picking it?
Mind you, nobody in authority is going to spell out the rationale the way I did, because it sounds too scary. Which is the whole point … the current situation is too scary. The main purpose of Geithner’s scheme seems to me to be to calm the system down enough to come back later and apply lasting remedies.
What I’m proposing is not an alternative to Geithner’s plan, it’s to prevent similar situations in the future (though maybe the nearish future). I’m with you in thinking the Geithner plan may be a good idea, and for the same reasons you suggest.
@srv: @schrodinger’s cat:
thanks for pointing out what srv linked to. i had missed it. very interesting.
has bob kerrey ever been right about anything?
Nah, this is the result of utter stupidity not inevitibility, cripes all the Congress had to do was to peg the Alt Min to a floating point, say a multiple of the median wage, and the problem goes away, the entire tax code could be so pegged. The difficulty is that it would lag real time by some but scarcely as bad as the current.
Okay, cool. I had lumped you in with other posters here who have various versions of all this in their heads (as we all do at this point) but I think you and I are essentially on the same page with this (per this particular thread).
Along that line of thought, the longer I see Geithner’s general plan for dealing with all this, the better I like it. I realize that he is talking to an audience that wants heads on a stick and not dense technical arguments, and that the punditocracy is just itching to get him. But the more I see, the more I like.
here is the senate record:
biden voted for it.
the house vote:
And while I would love to skewer him for it, I feel like I can’t. He was, quite literally, working for his constituents. He was the Senator from Delaware for FSM-sakes. The banks are like half of this guys constituents, make up a great deal of Delaware’s economy and tax base, and employ a great deal of Delaware’s citizens.
"The whole point here is to change what happens when a big institution fails. That way, no one would be too big to fail."
Here’s the problem: Wall Street and the Republicans will try to undo the fix as soon as they possibly can.
Therefore, it makes sense to BOTH change what happens when a large institution fails, AND erect defenses against institutions growing very large.
Make them work to overturn both.
@Adrienne: Maybe we should give Delaware to the Canadians.
one of my beefs with biden is for mishandling the clarence thomas hearings. he failed to call witnesses who backed anita hill’s story.
guest @42 and @43
Thanks for the info.
Speaking as someone who is originally from PA but whose family has all decided to move to Delaware (for whatever reason), I’m more inclined to agree with you than you might think! They say Jersey is the armpit of America? They must have never been to Delaware. Give me Jersey anyday.
Now that’s a horse of a different color! I was only six at the time though so I have ZERO recollection of the hearings nor have I studied that part enough to have formed a solid opinion on the Anita Hill scandal. What I do know is that he tried to give the impression that he has no legal philosophy and that he hadn’t formed an opinion on Roe. That means he was either lying or not fit to wear ANY judicial robe, much less that of Supreme Court justice. Any jurist who claims he/she hasn’t seriously considered Roe, one of THE defining SC decisions of the 20th century is either a fucking liar or a fucking idiot. Neither one should describe a SC justice.
I’m so with you on this "too big to fail" stuff! I see no consumer benefit in having giant banks, and a lot of taxpayer risk.
I propose a progressive tax on financial assets. Let’s say no tax on anything under $1 billion, with a small tax that ramps up from there. That way if anything large does blow up, we’ll have socked away the dough to pay for it. We can add a similar tax on financial risk, so it’s expensive to concentrate a lot of it.