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    Too Big To Save

    By Donal on Tue, 03/08/2011 - 10:57am | Politics

    On Baseline Scenario, Simon Johnson has posted: Testimony submitted to the Congressional Oversight Panel, “Hearing on the TARP’s Impact on Financial Stability,” Friday, March 4, 2011.


    9)  As Larry Summers put it, in his 2000 Ely Lecture to the American Economic Association, “[I]t is certain that a healthy financial system cannot be built on the expectation of bailouts” (American Economic Review, vol. 90, no. 2, p.13).

    10)  Seen in this context, TARP was badly mismanaged.  In its initial implementation, the signals were mixed – particularly as the Bush administration sought to provide support to essentially insolvent banks without taking them over.  Standard FDIC-type procedures, which are best practice internationally, were applied to small- and medium-banks, but studiously avoided for large banks.  As a result, there was a great deal of confusion in financial markets about what exactly was the Bush/Paulson policy that lay behind various ad hoc deals.

    ...

    14)  Exacerbating this issue, TARP funds supported not only troubled banks, but also the executives who ran those institutions into the ground.  The banking system had to be saved, but specific banks could have wound down and leading bankers could and should have lost their jobs.  Keeping these people and their management systems in place serious trouble for the future.

    15)  The implementation of TARP exacerbated the perception (and the reality) that some financial institutions are “Too Big to Fail.”  This lowers their funding costs, probably by around 50 basis points (0.5 percentage points), enabling them to borrow more and to take more risk with higher leverage.


    This is actually out of order, but it seems to me to be the important point:


    14)  Next time, when our largest banks get into trouble, they may be beyond “too big to fail”.  As seen recently in Ireland, banks that are very big relative to an economy can become “too big to save” – meaning that while senior creditors may still receive full protection (so far in the Irish case), the fiscal costs overwhelm the government and push it to the brink of default.
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    9)  As Larry Summers put it, in his 2000 Ely Lecture to the American Economic Association, “[I]t is certain that a healthy financial system cannot be built on the expectation of bailouts” (American Economic Review, vol. 90, no. 2, p.13).

    Sure it can.  

    What is FDIC if not our expectation of bailouts in the event of bank failures.  Why did all the money fleeing in panic from other investments in 2008 want the assurance of US Treasuries and Agencies even more than precious metals or commodities?  Why did FRB-NY feel it necessary to include a disclaimer on its website that it did not guarantee its primary dealers unless there was the perception and soon to be proven fact that, yes, it did guarantee them.

    Not that I think TARP was the best way to handle the situations.  It is just that that statement is ridiculous.  Without the backing of the US Govenment or at least the perception of it, Mr. Johnson's 13 Bankers would have had a much harder time accumulating enough money and power to hold our financial stability hostage.

    We all trust those banks and some others because the FDIC backs them.   Doesn't that make FDIC our true national bank?


    by EmmaZahn on Tue, 03/08/2011 - 11:43am

    Being bailed out is substantially different than being taken over and restructured with most deposits insured by the FDIC.


    by Donal on Tue, 03/08/2011 - 11:58am

    Not really.  At least not for our mostly storefront and shell banks.  

    Okay, maybe from the perspectives of a few individual bankers but not for the banking system as a whole nor for those of us who mostly did not make runs on the banks in 2008.  

    The FDIC is who we trust with our money and the US Treasury and Goverment Agencies are who we trust with money in excess of FDIC limits.  That trust is what makes a bank a bank.


    by EmmaZahn on Tue, 03/08/2011 - 12:14pm

    I suspect things would be somewhat different right now if those large banks had been treated the same as the smaller and medium banks.


    by Donal on Tue, 03/08/2011 - 12:18pm

    Oh, yeah. Definitely different.

    We would all have been better off long-term with a direct assault on them.  I wish someone would have called their bluff.  But no one did and so here we are back in the same situation again.

    Just because I do not agree with Summers or Johnson does not mean I agree with TARP.


    by EmmaZahn on Tue, 03/08/2011 - 12:35pm

    The expression 'too big to fail' has two meanings.

    The first - bullshit - one is the idea that a prudent government would not let them fail because it would hurt the broader economy. The second, more serious, one is that banks are too 'big' in the sense of too politically powerful, and in the event of insolvency will demand and get the funds necessary to keep themselves in the style to which they have become accustomed.

    And on that latter view, there is no such thing as too big to save. Just look at the Irish, they would rather go through a massive, truly great depression-like, dip in the economy than piss off the big mega banks.


    by Obey on Tue, 03/08/2011 - 12:02pm

    Beginning in Fall 2008 I have followed a google news feed of the term "primary dealers".   Those are mainly Johnson's 13 Bankers.  They are indeed global and too politically powerful at present to regulate.  About the best to be hoped is that they will agree as a group to self-regulate rather than repeat the battles of '08.

    The financialization from neo-liberalism has been extremely good to them which is why they do not want us to realize that they as middlemen add little or no value to the process and that we can enjoy its benefits without them.

     


    by EmmaZahn on Tue, 03/08/2011 - 12:29pm

    I've drunk the cool aid.

    I accept  the consensus that  each failed bank would  bring down counter parties until the entire international banking system would fail. Followed by corporations first those with  commercial paper,coming through  then those with maturing debt issues, then by those  simply unable to collect trade payables . So the real economy would follow the financial community into a shut down.

    I can't be sure of that. I am sure it wasn't worth taking the risk.


    by Flavius on Tue, 03/08/2011 - 1:04pm

    I'm not denying the domino theory of mega bank failures. If any of the big players were allowed to fall, they all would fall. I just don't think putting them into receivership would have had any significant adverse effect on the broader economy. Quite the contrary - the government could have ensured that they expand rather than contract their loan book as they were nationalized, and/or break them up into bad-bank good-banks so that the healthy part of the bank continues to function. The current lumbering pack of zombie banks is the worst of all outcomes.


    by Obey on Tue, 03/08/2011 - 2:31pm

    OK. I only have a position about about the domino theory on which we agree.

    I don't have one on receivership vs the Paulson/Geithner solution because I simply don't know enough. So I'll withdraw and read on with interest.


    by Flavius on Tue, 03/08/2011 - 3:19pm

    There were many who didn't think that not bailing out the banks would have been catastrophic, including (the Sainted) Elizabeth Warren, and most impressively, Wm. Black and Randall Wray, who wrote a two-part piece and posted it at Huffpo detailing the steps of temporary receivership, all the way through to simpler, smaller, healthy banks with books that actually reflected their financial conditions.  Black was a regulator during the S & L 'crisis', and reminds us that over a thousand criminal bankers, etc. were put into jail.  Right now, the Dept. of Justice is very kindly letting banks know if they are being investigated (and we assume if they are a tad prosecutable, and they can then approach the DoJ and cut a deal to pay some crap fines to forestall further investigations, like Mozilo at Countrywide.  Feh!

    The second biggest financial crime wave after the fraudulent rent-seeking that has become the de facto basis for our phony-baloney GDP is that with all the stars aligned when he came into office, Obama just continued it all with his Dark Lord economics team, blood brothers to Robert Rubin whom we now learn exported neoliberalism at the end of a financial gun via the IMF and World Bank all over the planet, and destroyed economies, and created vast gaps between working people and the Dictatorial Elite class; goddam we have a lot to answer for in the world!  But I digress.  Oh yeah: and the White House blocked meaningful fin-regs every step of the way until they passed (Ta-da!) Dodd-Frank, advertised as a law that would 'prevent TBTF; how's that working out?  None of them are!  Why?  None are flunking their own Stress Tests!  Fancy that!

    You might be interested in GeorgeWashington's (umpteenth) blog naming the best of the economists who absolutely get that Wall Street Health is an utter oxymoron, and that until the banks are downsized and cleaned of their toxic assets, there will be no trust in them or the entire system, much less any recovery that isn't built on another house of cards.

    I'd love to hear from Obey if the folks who predicted that QEII would lead not to banks lending or investing in uh...America...but would just generate another round of gambling on commodities is partiallyt what's driving up gas and food price spikes (and I do get that crops have failed, etc.), but still...it looks like this round may be the other.

    One Black/Wray piece I found; not the one I was looking for, and an excerpt:

    First, it is time to stop the foreclosures until the banks and servicers adopt corrective steps, certified as adequate by FDIC, that will prevent all future foreclosure fraud. They must also adopt plans to remedy the injuries their foreclosure frauds have already caused, and assist the FBI, Department of Justice, and legal ethics officials investigations of their officers’ and attorneys’ frauds and ethical violations.

    Second, it is time to place the financial institutions that committed widespread fraud in receivership. We should remove the senior leadership of the banks and replace them with experienced bankers with a reputation for integrity and competence, i.e., the honest officers that quit or were fired because they refused to engage in fraud. We should prioritize the receiverships to deal with the worst known “control frauds” among the “systemically dangerous institutions” (SDIs). The SDIs’ frauds and fraudulent leaders endanger the global economy.

    http://economics.arawakcity.org/node/788

    George Washington:

    http://www.washingtonsblog.com/2011/03/top-economists-trust-is-necessary-is.html

    Uh-oh; TLTR, I fear; even I don't want to read it for typos; we'll have to live with them.   ;o)

     


    by we are stardust on Tue, 03/08/2011 - 6:22pm

    And It's baaaaccckkk.. Subprime lending. Now with new car sales.


    by cmaukonen on Tue, 03/08/2011 - 7:56pm

    Hi Stardust,

    I'd love to hear from Obey if ... QEII ... is partiallyt what's driving up gas and food price spikes

    Personally I'd love to hear from anyone who knows something about it. ;0)

    I haven't really been keeping up. I was a fan of QEII before it happened and still am. But I don't know what the evidence is showing now...


    by Obey on Tue, 03/08/2011 - 7:59pm

    Ack!  'PartialTy'?  (F me.)  I will do some searching; it's a hotly debated subject.  I ususally count on Angry Bear and George and Yves for cool graphs and charts; digging may require more time that I have tonight.  RL is sucking just now, and I ain't got much online time lately to hunt.  ;o)  Try to be back, and glad to hear the SO news.  (Shhhhhh.)  Remember dancing.  (See Gaga video)  Cool


    by we are stardust on Tue, 03/08/2011 - 8:10pm

    Well there are a couple of little glimmers of hope here in Europe, imho. the tax on size in the UK and the regulatory zeal around the BofE, and Sarkozy's talk of a tobin tax. It's just a foot in the door, but it will be useful when one or another of the big European banks go under, as seems likely.

    As for self-regulation...? Fat chance. I get the impression they all feel quite vindicated in their risk management. After all, they're still standing. And here in Switzerland, the worst of them all - UBS - thinks of the cushy bailout they got as ultimately a testament to their smarts and talent in negotiating a sweet deal. I.e. just another great business decision...

    Like I've said a few times:

    sociopaths.


    by Obey on Tue, 03/08/2011 - 2:44pm

    I'm close to the end of The 13 Bankers and all I can say is our current Congress is the best legislative body money can buy.

    What's repeated thru out the book is subtle references to what was brought out in the initial pages. Both Jefferson and Jackson opposed a central bank based on their belief it could undermine the government. In fact, Jackson locked horns with the 2nd central bank. The bank was giving campaign contributions to members of Congress to ensure they passed legislation favorable to the bank over the objections of the Executive office, being Jackson. And it's still the game today. One would think the Treasury would have enough on the ball to keep tabs on both Congress and the banks, but Congress controls the purse strings and chokes off any government initiative that may cause harm to the bank's bottom line.


    by Beetlejuice on Tue, 03/08/2011 - 1:45pm

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