Aug 16, 2009
Do I Hear Five?
"Bank bailout could cost $4 trillion," according to Fortune. It's good thing the feds are sitting on all that paper that they can print money with.
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BillWoolsey - 1/31/2009
Bob,
I agree with everything you say in general.
However, as Luigi Zingales has pointed out, traditional bankruptcy procedures not appropriate to banking.
He has emphasized that they are "too slow."
If the insolvent banks were a small part of the banking system, it wouldn't matter much. The rest of the banking industry could take up the slack on the lending end. Bank creditors might even be able to borrow against what they are expected to get out of the final resultion.
But Citi and BoA have 30% of bank assets. If they closed down for a
protracted liquidation, it would be difficult for the other 70% of the banking indusry to expand by 40% or so.
What about Chapter 11 operations? I
think something like that would be possible but borrowing money and repaying the money is 1/2 of the banking business.
The question isn't whether they can make enough from sales to cover variable costs. While GM finances current operations, borrowing money and paying it back isn't a core part of their business.
The systemic risk is the idea that if the bank stops paying people back (and they have to wait) then they won't be able to make payments, so they will default, and the rot spreads.
The problem needs to be resolved quickly.
Bank assets are mostly outstanding loans. The issues relevant in other businesses regarding the best use, really don't matter. Every day that good loans stay on Citibank's balance sheet doesn't represtent a waste. But then, there is no great loss if someone else owns the loans and collects on them either.
There is a whole lot of "sunk costs" involved here. Who takes the loss from past mistakes?
As an aside, GM is having dificulty becaues few people want to buy their cars. If they quit making them altogether, this would create a shortage of their cars, but I suspect this would just result in a shift to Fords, which has excess capacity. So, car production would be little effected.
And, even if total car production did drop so that the surplus turned to a shortage, say of 30%, this wouldn't result in 30% of workers not being able to get to work for six months. We can just use old cars longer.
So, Chapter 11 is workable with GM. If not, shutting down GM production results in a shift of production to other firms. Rather than surpluses or excess capacity being spread out, it is all at GM. Once the industry recovers, perhaps assets from GM can be brought into production.
The problem in the fiancial industry wasn't that people stopped wanting to borrow so that there is excess loan capacity and the when Citi closes, those still borrowing can go to the other banks dying for customers.
And, finance really is important to other parts of the economy. Closing down 30% of the industry is like 30% of people not being able to get to work because they can't buy a car.
Anyway, Zingales proposes rapid resolution. As a Money and Banking guy, it reminds me a bit of the over-the-weekend purchase and assumption approach FDIC uses to resolve insolvent banks.
But rather than setting up a merger, so another bank pays FDIC for the new bank, some (or all) of the banks debt holders get stock in a newly organized, fully capitalized bank.
Rather than FDIC taking over the bad assets, and then selling the "good bank," Zingales suggests giving the new stockholders/former debt holders shares in a bad bank holding the bad assets.
This could be done at zero cost to the taxpayers. The bank debtors take the loss. (The insured ones, I suppose would create an expense for taxpayers.)
But, FDIC could "inject funds" to limit the loss to the former debtholders, all the way to zero.
To what degree that should be done to avoid panic, with the recognition that bank debt holders will be even less likely to monitor bank risk taking, is the only relevant issue.
But, of course, we are likely to really get a bailout of existing bank stockholders too.
Robert Higgs - 1/29/2009
Bill,
You say: "Those figures suggest that the 'let them fail' and then the sound banks (if any) can take up the slack, is questionable. (The other options may be worse, but just closing Citibank is a 15% reduction in "intermediation" alone.)"
This statement seems to assume that if a bank fails, it completely disappears. My view is that when a firm goes bankrupt, its remaining assets are disposed of for the best offer they can bring, and the new owners, having paid that price, expect to use those assets profitably. Life goes on, with new owners using any assets that have genuine value in the circumstances.
If banks hold assets that do not have genuine value, then every moment that those assets are employed signifies a waste of resources. If banks cannot operate after bankruptcy proceedings have reallocated ownership claims in their assets, then that cessation of their operation is a good thing: they should not operate when their operation promises only waste.
We heard the same sort of assumption voiced in regard to the auto companies: if GM and the others go bankrupt, people presumed, then those companies just disappear in a puff of vapor. But the buildings, equipment, materials, labor and management skills, and so forth remain after a bankruptcy, and if those assets have any potentially profitable use, someone will bid to acquire them and put them to that use. If no such potential exists, then manifestly the apparent assets are not genuine assets, but debris, and ought to be abandoned.
In bankruptcy, shareholders may lose everything, then creditors may lose some or all of what they expected, in their order of legal priority in the disposition of the firm's assets. But ALL of these parties should bear ALL of the losses, and it is a travesty of justice if third parties, such as taxpayers, are compelled to bear losses in order to prop up firms that do not possess assets truly worth employing in a free market.
Bob Layson - 1/29/2009
Not so much a stimulus more a tsunami of spending. But yet worse - the waters will never retreat.
Bill Woolsey - 1/29/2009
Banks hold 1.2 trillion in mortgate backed securities. The banking system has 13 trillion in assets.
Citi, JP Morgan Chase, and Bank of America are each about 15 of the total. The "big 3" are 45 percent all together. Then there are some banks that are 5%. and pretty quick it is down to 1#.
Those figures suggest that the "let them fail" and then the sound banks (if any) can take up the slack, is questionable. (The other options may be worse, but just closing Citibank is a 15% reduction in "intermediation" alone.)
Anyway, I did figures assuming that 20% of the assets are toxic and that they will eventually be worth 50%. The scenario I worked on was a debt to equity swap and the current stockholders wiped out. All those who have deposited in or other wise lent to banks get bailed out. It is like 1.8 trillion (working capital) and a 900 billion bill for tazpayers.
Banks hold a lot of home mortgages. But if it is only MBS that is the problem then that is the cost.
If the stockholders are going to be bailed out too, it will be more expensive.