Just another Reality-based bubble in the foam of the multiverse.

Wednesday, January 21, 2009

Only cynics ask silly questions!

It seems there are a few unfashionable people left at The New York Pravda, and they're letting some of those cynical practicioners of the dismal science give voice:

Some of the better questions:

1. Ordinary taxpayers would like an answer to this question: Why have they been billed more than $45 billion to rescue Citigroup from failure when, as president of the Federal Reserve Bank of New York, you were its primary supervisor? Three major problems led to Citigroup’s downfall: bad investment policy; overexpansion, which overwhelmed Citigroup’s management; and an inadequate capital base. Why was Citigroup’s supervision inadequate to deal with these problems?

2. The Treasury and Federal Reserve have been selecting which companies in American industry and finance will get taxpayer money. What criteria do you use to decide?

3. During the banking crisis of the late 1980s, assets of failed savings and loans were acquired by the government’s Resolution Trust Corporation. The trust corporation then sold off the assets in an orderly fashion. Would you consider requesting Congress to revive the Resolution Trust Corporation, so you would not have to decide which companies to save and which not to save? Would you consider re-establishing the trust corporation now for commercial banks that are likely to fail?

— ANNA JACOBSON SCHWARTZ, an economist at the National Bureau of Economic Research and the author, with Milton Friedman, of “A Monetary History of the United States, 1867 to 1960”


1. In the past, you have praised the “resiliency” of the American financial system. But a resilient financial system would demand that banks maintain stricter capital standards in normal times so that when a crisis hits, they don’t all have to tighten lending at the same time. What exactly did you mean by “resiliency”?

— ROBERT SHILLER, professor of economics at Yale


1. This country has long benefited from the world’s confidence in our financial markets. Are financial regulatory reforms necessary now to restore investors’ confidence and revive our economy?

2. Should debt securities that are held by regulated banks and pension funds be rated by multiple independent credit reports that have been commissioned by a federal agency, or should we continue to let the issuers of debts decide who will rate their risks?

3. Should large financial institutions incur higher reserve requirements or other regulatory penalties when they become “too big to fail”?

— ROGER B. MYERSON, a professor of economics at the University of Chicago and a winner of the 2007 Nobel Memorial Prize in Economic Sciences

Then there's the infamous Dr. Krugman himself, a most vocal cynic of the Bu$h era, still keenly aware of those old partisan divisions that constitute the world for those of us who ate the red pill instead of the blue one:

Old-fashioned voodoo economics — the belief in tax-cut magic — has been banished from civilized discourse. The supply-side cult has shrunk to the point that it contains only cranks, charlatans, and Republicans...

That's awfully shrill, sir. Aren't you engaging in the tired old politics of the past instead of the shiny new era of the spotless empty open mind?

...But recent news reports suggest that many influential people, including Federal Reserve officials, bank regulators, and, possibly, members of the incoming Obama administration, have become devotees of a new kind of voodoo: the belief that by performing elaborate financial rituals we can keep dead banks walking.

To explain the issue, let me describe the position of a hypothetical bank that I’ll call Gothamgroup, or Gotham for short.

On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion.

So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope that shareholders will be rescued by a government bailout.

Why would the government bail Gotham out? Because it plays a central role in the financial system. When Lehman was allowed to fail, financial markets froze, and for a few weeks the world economy teetered on the edge of collapse. Since we don’t want a repeat performance, Gotham has to be kept functioning. But how can that be done?

Well, the government could simply give Gotham a couple of hundred billion dollars, enough to make it solvent again. But this would, of course, be a huge gift to Gotham’s current shareholders — and it would also encourage excessive risk-taking in the future. Still, the possibility of such a gift is what’s now supporting Gotham’s stock price.

A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.

The current buzz suggests, however, that policy makers aren’t willing to take either of these approaches. Instead, they’re reportedly gravitating toward a compromise approach: moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” that would resemble the Resolution Trust Corporation, but without seizing the banks first...

Sir, you have a partisan prejudice that makes you think that if the government- the taxpayers- take the risk, the bankers shouldn't reap their fair profits! You penalize the bankers and the shareholders who treated the depositors' securities like a wad of cash at Los Vegas! Politics of the past!

...In my example, Gothamgroup is insolvent because the alleged $400 billion of toxic waste on its books is actually worth only $200 billion. The only way a government purchase of that toxic waste can make Gotham solvent again is if the government pays much more than private buyers are willing to offer.

Now, maybe private buyers aren’t willing to pay what toxic waste is really worth: “We don’t have really any rational pricing right now for some of these asset categories,” Ms. Bair says. But should the government be in the business of declaring that it knows better than the market what assets are worth? And is it really likely that paying “fair value,” whatever that means, would be enough to make Gotham solvent again?

What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense, disguised as “fair value” purchases of toxic assets...

Sir, you are failing to engage in Hope and Change! "Bait and switch" is an old political tactic of the past. Our new President has pointedly said he's breaking with all the old poisoned past tactics. Even though he's got the same old usta-bees in charge.

You obviously cynically aren't taking him at his word!

...Why go through these contortions? The answer seems to be that Washington remains deathly afraid of the N-word — nationalization. The truth is that Gothamgroup and its sister institutions are already wards of the state, utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover. Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks.

Unfortunately, the price of this retreat into superstition may be high. I hope I’m wrong, but I suspect that taxpayers are about to get another raw deal — and that we’re about to get another financial rescue plan that fails to do the job.

I humbly submit it's not a single word, "nationalization", that this crew fears, sir.

It's a phrase they all fear the most despite all their high sounding rhetoric: "I won't get a piece of the action".

No comments: