We're Looking for a Few Good Banks
I haven’t blogged much lately, partly because I’ve been busy, and partly because it’s so relieving to finally have adults back in charge of the federal government. By and large, the Obama administration has done a lot right in the last three months or so. The federal budget looks spectacularly progressive, perhaps even courageously so. I’m particularly intrigued by the proposed changes in the defense budget, and hopefully I’ll blog about those later. The principles being articulated about health care reform, climate change and foreign policy all look promising. So, in all, there’s a lot to be happy about.
However, there is one area where the administration’s performance has been decidedly underwhelming: its response to the banking crisis. The underlying problem is transparent. America’s banks are, to varying degrees, saddled with so-called “toxic assets,” which are basically bets on the housing market that went bad when the real estate bubble popped. We’ll call them Compromised Revenue Asset Products, or, for short, CRAP. Our banks are holding too much crap, and nobody wants to buy any crap. Because of that, banks have cut back sharply on lending, and lending is the engine that drives our economy. Our economy has engine trouble right now, why is why the economy isn’t going anywhere.
So how do we fix this problem? Treasury Secretary Timothy Geithner has proposed a plan, for lack of a better word, that looks a lot like the “cash for trash” schemes proffered by his predecessor, Hank Paulsen. The idea behind giving cash for trash is that if we buy the banks’ crap at inflated prices, that will both inject the capital that banks need and get the crap off their balance sheets, allowing the banks to resume normal lending. And it is true that if we give banks sufficiently ungodly sums of money and take on enough crap, then, yes, eventually that would achieve the desired result. But this approach would likely be exceedingly expensive and inefficient, without even producing the fastest results. And when we’re talking about the hundreds of billions, if not trillions, that will need to be committed to rescuing the system, thrift and efficiency are important objectives.
The problem with the cash for trash schemes, of which there have been several subtly different varieties proposed in search of one that makes sense, is that they all involve handing over large amounts of money to the very same banks that got us into this mess, purchasing their crap for prices that are deliberately much higher than what the market would pay, without any accountability for what the banks do with that capital. They also envision the creation of a “bad bank,” which is a pretty standard tactic in bank rescues. A bad bank, stewarded by the government, collects all the crap, and those assets do have at least some value. The bad bank then manages the holding and orderly sale of all the crap, and in this case, once the real estate market recovers, those assets should gain some more value. The taxpayers, thus, can recover some of the cost of the bailout. But the likely outcome is that the trash we get never be worth more than a fraction of the cash we paid.
There are several better options out there. One option would simply be to nationalize any banks lacking enough capital to cover all its debts. This is the approach taken by Sweden during its banking crisis during the 1990s, and Sweden’s recovery is now used as a model for how to handle a banking crisis. Nationalization is probably the simplest and most well trodden road the administration could take. Basically, instead of using taxpayer money to buy crap, we would use it to buy equity shares in the banks themselves. That way, when the market stabilized and the banks recovered, the equity shares could be sold at a profit. The state of the banks are such that in order to inject any meaningful amount of capital, the government would need to acquire so much equity that it would become a majority owner of the bank. I don’t particularly see a problem with that. There’s no reason why majority public ownership should impair an orderly recovery of the banking system.
This is probably the best alternative, and one that has been actively promoted by Nobel Prize winning economist and a personal favorite of mine, Paul Krugman. The problem is that the politics of such a proposal is wrought with danger for Obama. Conservatives have invested so much energy into bastardizing the words “nationalize” and “socialism” that any move to acquire equity in exchange for capital would set off rounds of panicked mouth-breathing about a government takeover of the economy. The fear that doing the right thing would have adverse political consequences for Obama and the rest of his agenda is probably a well founded one. Unfortunately, the administration has decided, it seems, to make a tactical decision not to invest political capital into even considering nationalization, even though the bank rescue is the single biggest obstacle to economic recovery. It requires strategic, as opposed to tactical, thinking and a willingness to invest copious amounts of political capital if need be.
So that’s disappointing. But there may be a way for the Treasury to revitalize the banking industry without giving massive giveaways to the banks, or courting the N-word. Rather than creating a “bad bank,” some economists, including another Nobel laureate, Joseph Stiglitz, think the government should create some good banks instead.
Besides the obvious semantic benefits of creating good banks instead of bad ones, the plan has a number of benefits over the cash for trash plans. First, you may have noticed that all the bank rescue plans involve buying banks’ bad assets, at inflated prices. No one seems to be considering buying the banks’ good assets, of which there are still plenty. Certainly the banks themselves would much rather sell off the crap and keep the good assets. What a good bank proposal would do is use the money allocated for TARP to purchase good assets from struggling banks. The Treasury would then form healthy banks that would be unencumbered by the old banks’ bad assets. These banks would be auctioned off to the private sector as quickly as is feasible—and there would likely be a market for shares in a bank with a totally clean bill of health. These banks would have freshly clean balance sheets and could then resume regular lending. As for the toxic assets, managing them would remain the responsibility of the responsibility of the banks that made the bad investments in the first place. The ugly business of managing a bad bank would fall to the companies that created the need for bad banks in the first place, while taxpayer money would flow to healthy banks with healthy assets, instead of putting the government in the business of overpaying for the privilege of establishing a bad bank.
More importantly, it would leave private businesses accountable for their mistakes. The cash for trash schemes are basically a form of lemon socialism. The banks made a lot of one-way bets on the housing market. If the bets paid off, they won; and if the bets didn’t pay off, then the taxpayer lost. Either way, it was a win-win for the banks. Under the good bank proposal, the banks that made bad bets become bad banks. Going forward, the moral hazard of bad lending is placed squarely on the parties who made the bad bets.
The good bank proposal is not a panacea or a perfect solution. In fact, it stands to be a lot more technically demanding than simple nationalization. But it does present the potential to rehabilitate the banking system without taking any political damage (even though the hit that might come from a nationalization plan would be totally unjustified) and, even more importantly, not affecting an unprecedented massive transfer of taxpayer money to the very same bankers who helped plunge the economy into recession in the first place. What both plans have in common is that they’re based around getting something of value for the people’s money, instead of offering up a massive handout to the most undeserving parties imaginable. My hopes that the administration will discard its obsession with handing out cash for trash and pursue such a strategy are minimal, but it’s worth noting the wealth of better options available to them and hoping against hope for a sudden fit of reason.
However, there is one area where the administration’s performance has been decidedly underwhelming: its response to the banking crisis. The underlying problem is transparent. America’s banks are, to varying degrees, saddled with so-called “toxic assets,” which are basically bets on the housing market that went bad when the real estate bubble popped. We’ll call them Compromised Revenue Asset Products, or, for short, CRAP. Our banks are holding too much crap, and nobody wants to buy any crap. Because of that, banks have cut back sharply on lending, and lending is the engine that drives our economy. Our economy has engine trouble right now, why is why the economy isn’t going anywhere.
So how do we fix this problem? Treasury Secretary Timothy Geithner has proposed a plan, for lack of a better word, that looks a lot like the “cash for trash” schemes proffered by his predecessor, Hank Paulsen. The idea behind giving cash for trash is that if we buy the banks’ crap at inflated prices, that will both inject the capital that banks need and get the crap off their balance sheets, allowing the banks to resume normal lending. And it is true that if we give banks sufficiently ungodly sums of money and take on enough crap, then, yes, eventually that would achieve the desired result. But this approach would likely be exceedingly expensive and inefficient, without even producing the fastest results. And when we’re talking about the hundreds of billions, if not trillions, that will need to be committed to rescuing the system, thrift and efficiency are important objectives.
The problem with the cash for trash schemes, of which there have been several subtly different varieties proposed in search of one that makes sense, is that they all involve handing over large amounts of money to the very same banks that got us into this mess, purchasing their crap for prices that are deliberately much higher than what the market would pay, without any accountability for what the banks do with that capital. They also envision the creation of a “bad bank,” which is a pretty standard tactic in bank rescues. A bad bank, stewarded by the government, collects all the crap, and those assets do have at least some value. The bad bank then manages the holding and orderly sale of all the crap, and in this case, once the real estate market recovers, those assets should gain some more value. The taxpayers, thus, can recover some of the cost of the bailout. But the likely outcome is that the trash we get never be worth more than a fraction of the cash we paid.
There are several better options out there. One option would simply be to nationalize any banks lacking enough capital to cover all its debts. This is the approach taken by Sweden during its banking crisis during the 1990s, and Sweden’s recovery is now used as a model for how to handle a banking crisis. Nationalization is probably the simplest and most well trodden road the administration could take. Basically, instead of using taxpayer money to buy crap, we would use it to buy equity shares in the banks themselves. That way, when the market stabilized and the banks recovered, the equity shares could be sold at a profit. The state of the banks are such that in order to inject any meaningful amount of capital, the government would need to acquire so much equity that it would become a majority owner of the bank. I don’t particularly see a problem with that. There’s no reason why majority public ownership should impair an orderly recovery of the banking system.
This is probably the best alternative, and one that has been actively promoted by Nobel Prize winning economist and a personal favorite of mine, Paul Krugman. The problem is that the politics of such a proposal is wrought with danger for Obama. Conservatives have invested so much energy into bastardizing the words “nationalize” and “socialism” that any move to acquire equity in exchange for capital would set off rounds of panicked mouth-breathing about a government takeover of the economy. The fear that doing the right thing would have adverse political consequences for Obama and the rest of his agenda is probably a well founded one. Unfortunately, the administration has decided, it seems, to make a tactical decision not to invest political capital into even considering nationalization, even though the bank rescue is the single biggest obstacle to economic recovery. It requires strategic, as opposed to tactical, thinking and a willingness to invest copious amounts of political capital if need be.
So that’s disappointing. But there may be a way for the Treasury to revitalize the banking industry without giving massive giveaways to the banks, or courting the N-word. Rather than creating a “bad bank,” some economists, including another Nobel laureate, Joseph Stiglitz, think the government should create some good banks instead.
Besides the obvious semantic benefits of creating good banks instead of bad ones, the plan has a number of benefits over the cash for trash plans. First, you may have noticed that all the bank rescue plans involve buying banks’ bad assets, at inflated prices. No one seems to be considering buying the banks’ good assets, of which there are still plenty. Certainly the banks themselves would much rather sell off the crap and keep the good assets. What a good bank proposal would do is use the money allocated for TARP to purchase good assets from struggling banks. The Treasury would then form healthy banks that would be unencumbered by the old banks’ bad assets. These banks would be auctioned off to the private sector as quickly as is feasible—and there would likely be a market for shares in a bank with a totally clean bill of health. These banks would have freshly clean balance sheets and could then resume regular lending. As for the toxic assets, managing them would remain the responsibility of the responsibility of the banks that made the bad investments in the first place. The ugly business of managing a bad bank would fall to the companies that created the need for bad banks in the first place, while taxpayer money would flow to healthy banks with healthy assets, instead of putting the government in the business of overpaying for the privilege of establishing a bad bank.
More importantly, it would leave private businesses accountable for their mistakes. The cash for trash schemes are basically a form of lemon socialism. The banks made a lot of one-way bets on the housing market. If the bets paid off, they won; and if the bets didn’t pay off, then the taxpayer lost. Either way, it was a win-win for the banks. Under the good bank proposal, the banks that made bad bets become bad banks. Going forward, the moral hazard of bad lending is placed squarely on the parties who made the bad bets.
The good bank proposal is not a panacea or a perfect solution. In fact, it stands to be a lot more technically demanding than simple nationalization. But it does present the potential to rehabilitate the banking system without taking any political damage (even though the hit that might come from a nationalization plan would be totally unjustified) and, even more importantly, not affecting an unprecedented massive transfer of taxpayer money to the very same bankers who helped plunge the economy into recession in the first place. What both plans have in common is that they’re based around getting something of value for the people’s money, instead of offering up a massive handout to the most undeserving parties imaginable. My hopes that the administration will discard its obsession with handing out cash for trash and pursue such a strategy are minimal, but it’s worth noting the wealth of better options available to them and hoping against hope for a sudden fit of reason.
posted by Ithakid | 5:13 PM
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