Are We Doomed?
Jim Henley writes:
Let me add, from my layman’s perspective, the arguments against “nationalizing the banks” seem entirely plausible, as do the arguments against declining to nationalize the banks. The only reasonable conclusion is that we’re screwed no matter what. But at bottom, it does seem absurd that the world’s governments should devote unlimited money over unbounded time to keeping trillions of dollars of bad loans from giving up pretenses.
This is definitely my fear. I think if you look at the Sweden situation, there’s good reason to think that what they did was the only reasonable course of action. I think it’s also true that if you look at the U.S. situation and compare us to Sweden, you can come up with a whole bunch of reasons to be skeptical that what worked well there will work well here. What you don’t come up with by doing this is with any better alternatives to a Swedish solution. It could be, in other words, that we’re just doomed either way. But even though I don’t think people should downplay the cost or feasibility concerns with a Swedish approach, insofar as the other approaches are unworkable, the best thing to do is still to really put our shoulders to the wheel and try to make a Swedish solution work.
43 Responses to “Are We Doomed?”
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March 10th, 2009 at 6:11 pm
This is probably better stated as:
Somebody owes this money no matter what.
It is not that we are screwed, just that someone is going to have to take the losses, and likely the only entity large enough to cover the U.S. losses is the U.S. government.
March 10th, 2009 at 6:12 pm
Mr. Henley is exactly right when he says:
“But at bottom, it does seem absurd that the world’s governments should devote unlimited money over unbounded time to keeping trillions of dollars of bad loans from giving up pretenses.”
Losses will eventually be realized. Wall Street, Geithner and others with a stake in the outcome are doing their best to make sure the bulk of those losses are absorbed by the taxpayers. They fear a collapse of the system. That fear cannot be completely discounted but it’s entirely possible their real fear is a future financial system that can get along just fine without them. What the system needs more than any government bail out is fresh capital and fresh management. Fresh capital and fresh idea cannot co-exist with the zombies. We have to drive a stake through their collectiv hearts once and for all.
March 10th, 2009 at 6:13 pm
Losses will eventually be realized against operating cash flow of the banks. That’s who will bear the cost. Ultimately on this issue I think Warren Buffet is right and Yglesias is wrong.
March 10th, 2009 at 6:16 pm
IOW, there’s no easy way to lose trillions of dollars.
If you owe the bank $1000 and can’t pay, you’ve got a problem. If you owe the bank a billion dollars and can’t pay, the bank has a problem.
And on up the food chain.
As a matter of picking policy, the Republicans are in the position of being critical of the way we’re forced to clean up THEIR mess.
March 10th, 2009 at 6:16 pm
Everyone keeps talking about how easily the Swedes solved their problem, but even they had *three years* of negative GDP growth:
1991: -1.1
1992: -1.2
1993: -2.1
before returning to normal growth from 1994 till 2000:
http://www.ekonomifakta.se/en/Facts_and_figures/GDP/Economic_growth/
Their unemployment rate also went from only 1.4% in 1990 all the way to 9.8% by the end of 1993. And then didn’t come back down below 8% again until September 1998!
http://www.economagic.com/em-cgi/data.exe/ecb/STS-M-SE-S-UNEH-RTT000-4-000-m
Doesn’t really look like a silver bullet to me…
March 10th, 2009 at 6:19 pm
“If it were done when ’tis done, then ’twere well / It were done quickly.”
March 10th, 2009 at 6:25 pm
Bill,
The operating cash flow of the banks is dwarfed by the shear magnitude of the losses. The total value of the Credit Default Swaps market is roughly $60 trillion dollars. The SIV market is another $10 -15 trillion. Add in the banks exposure to CDO’s and the rest of the credit derivative markets and you end up with over a $100 trillion dollars. Assume that 20% of those deals are dead and unlikely to come back. That’s about $20 trillion in losses. Banking system is not capable of aborbing that loss or earning their way out of it.
March 10th, 2009 at 6:35 pm
Nick,
Yes it is….banks are generating free cash flow now and with some regulatory forbearance will earn their way. Banking sector will be in much better shape 6 months from now.
It’s the best, let me repeat that, best environment for banks in the last 25 years. Also, many losses of so far have not been real losses (they assets have defaulted) but are mark-to-market losses.
Also, you are using a notional value of the CDS market…the notional value means nothing as banks will offset a position by just writing another contract against it instead of closing out the original.
March 10th, 2009 at 6:43 pm
Rob is absolutely correct – as I’ve studied the N=2 economic models we’ve been presented, it’s become a lot harder to differentiate Japan & Sweden. I think that in a lot of ways we don’t perceive Sweden’s situation as being so bad because its membership in the EU (which arguably they joined as a result of the crash) covered up a lot of the problems.
So, I guess this means we’re screwed either way – but it’s necessary to do something, because as ny nick points out, that’s a lot of $$$ and governments (and taxpayers, who do have a stake in this through their pension funds, personal investments, and government/corporate liabilities that have been covered up with these financial industry shenanigans) have to take steps to avoid letting the unwinding process interfere with the real economy too much.
March 10th, 2009 at 6:45 pm
Exactly, i think there was a study over at Noriel Rubini’s place that the total value after novation and cancelling out the hedged contracts was in the 2-3 trillion range.
It would be highly unusual for the losses to be 100%, but recent CDS auctions after the default are only getting 15%, so maybe the exposure is very large.
March 10th, 2009 at 6:46 pm
We are not doomed if we can all agree that the Emperors clothes are beautiful. To that end the financial world is atwitter with the rumor that Mark to Market accounting will not be forced upon the big troubled banks and their bad assets which are mostly off the balance sheet. Meaning they are invisible. The rules say if those assets go bad they have to be put back on the balance sheet. So if they can be held a make believe numbers they stay off the balance sheet.
This applies to the various CDO’s, I am not sure how it applies to their derivatives.
With the stroke of a pen it will be written that the bad loans now worth ten to whatever cents on the dollar will be held at face value because they are going to come back eventually. That isn’t going to help cash flow but it could keep them from technical and then actual insolvency.
Which all underscores how the world of economics is a world of abstractions. The bigger the pile of money or the monetary ‘value’ of an asset is, the more abstract it is. Billions of people in the world may face starvation for lack of a few dollars but the important thing is that the biggest piles of money held by a few million people are almost sacred. Faith in them must be kept and nurtured. Byzantine rules, subject to change to fit the situation, will be crafted and enforced in order to keep faith and confidence in the system.
That’s what Jesus said. Go look it up.
March 10th, 2009 at 6:49 pm
Bill,
“Also, you are using a notional value of the CDS market…the notional value means nothing as banks will offset a position by just writing another contract against it instead of closing out the original.”
Writing another contract assumes there is a counterparty to the swap deal. If a bank cannot meet it’s original obligation, why would a counterparty accept another highly suspect derivative contract as a workout?
March 10th, 2009 at 6:54 pm
It seems to me that the only way to solve this situation with the banks and CDS and all of the other gambling that went on is to craft a monetary solution that shares the expense of the solution proportionally. There is no choice for the American taxpayer. We either solve a problem created by others yet effects us all must be resolved so that we can all get along with our lives in some modicum of normallity. So is it going to be the gamblers pay 60% of the loss and we pickup the other 40%. Well, that can be worked out as to what the optimum percentage is so as not to destroy the countries ability to continue to borrow money from abroad. But I guess the point I am trying to make is the bettors must lose more than the non bettors.
March 10th, 2009 at 7:07 pm
The American taxpayer is not blameless here. Even if you get past the high levels of consumer debt & housing loans & high %age of employment that was due to housing bubble-related jobs and all the other distortions that people were benefiting from – one of the reasons why we can’t just unwind everything is that it would wreak havoc in many institutions that have managed to put off being honest with taxpayers about the kind of liabilities they were putting off until some day in the future. California’s difficulty in accessing the bond market is a fairly prominent thin edge of the wedge.
Yes, most of us never made anywhere near as much as the traders and bankers and other speculators in the financial industry – but we gained from them in substantive ways, and now we have to pay. This is the price for voting for Prop 13, for rejecting politicians who proposed health care reform, by voting again and again for lower taxes and damn the consequences.
I think it’s time to move to Seoul.
March 10th, 2009 at 7:08 pm
Nick,
That’s why you don’t let the counterparties go under…because what’s a manageable problem becomes an unmanageable problem (that means the shit hits the fan).
I don’t mean to understate the severity of the problem but the problem is solved by restoring confidence to the system and ensuring that banks have the funding they need to lend. Just to be clear, you don’t install confidence in the system by vaporizing bondholders as the Swedes showed.
March 10th, 2009 at 7:09 pm
Oh, and effing unions of city workers, and the spineless city councils that gave into their demands by running up pension fund liabilities and then messing around with accounting to avoid having to raise taxes or cut services. They can go to hell too.
March 10th, 2009 at 7:28 pm
I wonder if somebody has addressed the following: if I’m not mistaken, there are several thousand banking institutions in the US. A great many of these — perhaps the vast majority — are in reasonably strong shape. The big danger — the “doom” of Matt’s post — is not that we don’t have banks that can step in to fill the gap if a half dozen of the big ones “pull a Lehman.” The danger, rather, flows from the side effects of their messy, painful, failure. I think if we can find a way to deal with the problem (whether that be the Swedish approach, or a bad bank, or even (God forbid) simply making good on their debts without equity in return), we’d actually be better off winding these banks down or breaking them up. As numerous people have mentioned, “too big to fail” is not a desirable state of affairs for the US or the world economy. Well, now’s our chance to do something about it.
March 10th, 2009 at 7:38 pm
Okay — here’s one other idea: if the government — through its stress test effort — were able to determine that X, Y, and Z banks were indeed in good shape — wouldn’t that open up the possibility of ignoring the debts of the distressed banks (the Citis and BOAs s of the world). What I’m getting at is, we all know making good on their mistakes will be extremely expensive. Probably over a trillion additional dollars. Maybe two trillion, who knows? Long story short, I know that people are afraid of a repeat of the Lehman scenario, but on an even larger scale. Well, if we learned as a result of the stress tests that a number of US banks (including a few fairly big ones) are actually healthy — and aren’t in the dire straits that several of the money center banks are in — wouldn’t that go a long way toward allowing us to get out of this crisis cheaply? Because the problem with the Lehman situation was that nobody dared lend to anybody — because the very survival of the US financial sector itself was suspect (and so the money markets freezed up, etc.). But if we know that a bunch of banks are in fact healthy as a result of careful government auditing, mightn’t we be able to avoid a repeat of Lehman?
I’ve been of the opinion for while now that a recapitalization of the financial sector costing an additional trillion plus is inevitable. So, I’m just “thinking out loud” as to the possibility that I’ve been wrong, and that there might be another way out…
March 10th, 2009 at 8:11 pm
Aw, there’s nothing to worry about – look Citibank is like totally profitable now!
Er, pay no attention to that man behind the curtain…
March 10th, 2009 at 8:14 pm
Or rather that should have been:
Er, pay no attention to the derivatives behind the curtain…
March 10th, 2009 at 8:28 pm
Losses will eventually be realized. Wall Street, Geithner and others with a stake in the outcome are doing their best to make sure the bulk of those losses are absorbed by the taxpayers.
Yes. Losses will have to be realized. They can be realized by making the people who bet they would make money PAY for their own losses. Or they can be realized by making ALL the rest of us pay for the losses. What Wall Street wants us to do is pay for THEIR losses. This is done under the guise of: if the housing market collapses completely, your house will not be worth very much.
Well I got news for you: Your house is not worth very much.
I’m a little surprised at how this moves from bailout to nationalization without considering the possibility of letting banks fail. There will always be money to be made in banking, so new banks will form. Or the ones that are viable will soldier on.
That’s the ultimate stress test, not a phoney baloney stress test that’s being propounded by some commenters here.
But in lieu of that, the answer is to nationalize.
They fear a collapse of the system. That fear cannot be completely discounted but it’s entirely possible their real fear is a future financial system that can get along just fine without them. What the system needs more than any government bail out is fresh capital and fresh management. Fresh capital and fresh idea cannot co-exist with the zombies. We have to drive a stake through their collectiv hearts once and for all.
March 10th, 2009 at 8:38 pm
DTM, shilling for the banks, says:
I think that is exactly where we are heading: a sorting of the banks that the private capital markets can believe in, such that the good banks can be sent on their merry way. But we’ll still have to arrange an orderly cleanup and sale of the bad banks. That is because they have things our banking system needs: deposits, staff, infrastructure, and so on.
But this is nonsense. There already is an orderly process. It’s called Bankruptcy. There’s even an entire section of the US Code devoted to it. Go look it up.
As far as things “our” banking system needs. First, this is not “our” banking system anymore than it’s “our” auto industry or “our” computer industry or “our” pizzeria industry. Also, deposits are federally insured. But that’s it. Banks don’t need staff, insfrastructure and SO ON any more than your look Subway sandwich shop needs those things. In other words, those staff can be laid off and find other employment. And the “infrastructure” – what do you mean, the computers and buildings? Those can be leased to other companies.
This is all made “complicated” by industry representatives who get on the TV to explain about how catastrophic it would be to lose these banks. Bull…. SHIT. I’m not saying that it will all be awesome. But it’s going to be awful no matter what we do. The key is to make it as LEAST awful as possible.
Also, if I hear one more representative of the banking industry get on the Diane Rehm show to explain how 90 percent of all banks in the country are financially sound, but how we need to save Citi, Wells, and B of A, I’m going to scream.
Citi, Wells, and B of A are, what, 60 percent of the industry. The rest are small potatoes. But please, do fail. Fail and rebuild. I’m 36, I don’t want this carrying on until my mid-40s, which is how it looks like it’s going given the state of things.
March 10th, 2009 at 8:42 pm
Common sense would tell you that there isn’t $20 trillion in losses to make up, because no one had $20 trillion to put on the table to lose.
Uh huh. Nobody leveraged a dime. Which is why the banks are picking up the tab out of their own money.
March 10th, 2009 at 9:48 pm
Second, I didn’t say it couldn’t be done. My point is substantive–to use Bankruptcy Code analogies, what we really need is more a Chapter 11 reorganization (perhaps with the taxpayers providing DIP financing) than a Chapter 7 liquidation.
This is exactly what we have now. We have debtors in possession with some government oversight and a lot of taxpayer financing. This is not working. Whether it’s done through Chapter 7 or done through the FDIC manages the paying of the depositors insured funds, whatever.
We need Chapter 7 liquidation. As far as the computers and “infrastructure” go, new banks forming with new private capital can buy that crap and lease the space. What is the big deal?
And these are not “our” utilities. Of course we need banks in the same way we need supermarkets to buy food. But that doesn’t mean we need taxpayer financed banks.
March 10th, 2009 at 10:13 pm
I’m not a financial wiz, but the idea of letting the major banks in question just slip in to bankruptcy seems to me to be shear insanity. The assumption that this is possible assumes essentially that they exist in a vacuum. However those banks are critical to keeping loans going to companies small and large alike, many of which are like my employer which basically exists on short term credit.
Even if other institutions could make up the losses to the credit market, there will undoubtedly be a critical failure in confidence in the financial markets as a result, not only sparking a wave of additional banking collapses (including those that might otherwise survive), but probably dry up credit outright. That in turn will guarantee that huge swaths of companies that are unrelated to banking, regardless of profitability, will fail because of lack of short term credit. If you doubt this then look back to the fallout from Lehman Brothers just a few short months ago. Also remember, basically everyone is existing at a level of mild panic already.
Believe me, I don’t want to hand another dime over to the schmucks, but they essentially have us by the balls (or rather, “Nice economy you’ve got there. Be a shame if something happened to it.”). The best we can probably hope for is something like nationalization which at least holds the possibility of punishing the losers who got us into this by causing them to lose their jobs.
Anyway, unless you are wealthy and can weather it somehow, I wouldn’t be wishing for bankruptcies here (which is incidentally why I think people like John McCain have so little understanding). Otherwise any one of us, all of us for that matter, could be out there saying, “Brother, can you spare a dime?”
March 10th, 2009 at 10:24 pm
Let me put it another way – forgetting numbers and figures, the idea of letting these banks go bankrupt ignores a critical component. That critical component is “market sentiment” or more elegantly, “the mob”.
It doesn’t matter what the reality is (and the reality is pretty bad anyway), if you let those bombs drop people are just going to freak. When they do so, just like it did with Lehman Brothers (just like it did with the great depression), the credit market will dry up, the stock market will crash, and all the associated fallout will hit.
So, while at some level I agree that the ideal solution would be to let these things just iron themselves out, doing so is really the nuclear option.
You can jump out of an airplane and go “splat”, or you can jump out with a parachute and survive. The former costs you nothing up front and gets you there faster, but the later has a few, shall we say, “critical advantages”. I think you can figure out what bankruptcy represents in this metaphor.
March 10th, 2009 at 11:04 pm
Nothing, aside from the resulting break in banking continuity sending us into a second Great Depression. Again, we played this scenario out once before: under Andrew Mellon’s leadership, making the exact same arguments–market share would eventually be recaptured by other banks–we let something around 40% of the U.S. banking industry fail.
We’re just going to go round and round. We ARE in the second great depression. We are looking at trillion dollar deficits as far as the eye can see. We are looking at millions of looming foreclosures and the job market continues to shed between 500 to 600 thousand a month for the rest of the summer and into the fall. We are looking at insolvent banks.
You just want to believe that banks are different. If 40 percent of the banking industry fails, that’s fine. We overproduce cars in this country, and we overproduce banking services.
People don’t want to bear the consequences of their mistakes and bad judgment. That especially goes for bankers who have the political and cultural power to jaw-jaw us all into believing that THEY above all others ought to be rescued.
Well, quite obviously, neither what I say, nor what you say on this comment blog is going to matter at all. But it should be said that these companies must fail.
And just because because TARP and the assorted bailouts don’t comply with Chapter 11 formalities doesn’t that they are anything different from the essential substance of Chapter 11 re-organization. Letting the same yahoos, excuse me, DIPs, continue along while getting additional credit from the government is while they pay their counterparties (errr creditors) and hope for the best is pretty much what Chapter 11 amounts to for companies that suck shit.
March 10th, 2009 at 11:11 pm
It doesn’t matter what the reality is (and the reality is pretty bad anyway), if you let those bombs drop people are just going to freak. When they do so, just like it did with Lehman Brothers (just like it did with the great depression), the credit market will dry up, the stock market will crash, and all the associated fallout will hit.
I have news for you. The stock market has lost, what, 50 percent of its value since its 14,000 peak. And it is going lower.
Now, as for your parachute analogy, that’s cute. But it assumes away the cost of the parachute. Of course, economies can’t die. We go on living, to make a perfectly mundane point. And yet, the parachute, so to speak, is going to inflate this currency to the extent that we will be facing some very awful consequences for decades.
People forget that in 1900, Argentina was one of the 10 richest countries. We are Argentina. We are done. And if you have kids, they are screwed too.
March 10th, 2009 at 11:38 pm
It’s worth reading John Hussman on this, as he’s been ahead of the curve on the financial crisis for a while. From Dr. Hussman’s latest market commentary:
March 11th, 2009 at 12:23 am
Common sense would tell you that there isn’t $20 trillion in losses to make up, because no one had $20 trillion to put on the table to lose.
That’s one thing that DTM said that I agree with. Some of this money never existed, and some people are just going to have to realize that they never had the money they thought they had.
I don’t exactly understand how leverage works in these cases, but my impression is that these $20 trillion represent some money that someone is theoretically owed if the housing market goes bust (it’s like several people took out insurance policies on mortgages getting paid back). If this is the case, then most of those creditors are simply going to have to lose all of that money they were supposedly owed. Easy come, easy go.
March 11th, 2009 at 8:24 am
With all due respect, shove it up your ass you tool.
For someone who professes no concern for bankers, shareholders and bondholders you spend a great deal of time on any post pertaining to nationalization.
March 11th, 2009 at 8:37 am
With all due respect, as someone who was telling me to look up the Bankruptcy Code, you might consider doing that yourself. In a Chapter 11 bankruptcy, a trustee would take over operation of the firm. If liabilities exceeded assets, existing ownership rights would be terminated and ownership would be reallocated to the creditors. The stock would be delisted. Certain contracts would be legally cancelled and an automatic stay of most litigation would be put in place. All interested creditors would be heard by the bankruptcy court, and both the debtor and the creditors could put forward reorganization plans explaining the new interests, if any, the various creditors would take.
And who is the DIP with all the powers of the trustee? WHO? Well, it’s almost always in Chapter 11 cases the CURRENT management. And what do you think is currently happening to all kinds of contracts? They’re being re-negotiated because veryone in the real world understands that receivership is looming. Just nationalize or fail these things.
March 11th, 2009 at 11:13 am
“Oh, and effing unions of city workers, and the spineless city councils that gave into their demands by running up pension fund liabilities and then messing around with accounting to avoid having to raise taxes or cut services.”
No, blame the post-Reagan unwillingness of politicians to say “if you want this service, you’re going to have to fucking pay for it” to their voters.
Local government was just doing the GM/Ford/Chrysler cost shuffle – workers want pay raises (cost of local government will track personal income growth, not inflation), you don’t want to give them said raises, so you promise them jam tomorrow (that Someone Else will pay for) in the form of increased pension benefits.
The weird think is, Reagan did not cut government: e.g. when he was governor of California, state expenditures grew from 5.0% of Gross State Product to 6.3% of Gross State Product. Reagan gave the “smaller government” equivalent of phone sex: all talk to get the GOP hot and bothered, but nothing in reality.
March 11th, 2009 at 11:17 am
The Citibank news yesterday suggests that there is at least a lot of raw earning power left in the banks with no dividends to pay and free Fed loans. Its chairman suggests they can absorb $55 billion in writeoffs that may come due in the next 18 months.
And Citibank is the weakest of the big banks; the Bloomberg site shows analysts expect all the others to be profitable this year.
So, perhaps with some regulatory forbearance concerning mark-to-market, etc., maybe the time to an economic recovery can be bridged. The banks can be leaned on to make more constructive loans to small business, etc, and aid in the recovery.
Private equity could fill potentially in gaps in capital base if the nationalization chorus quiets down.
March 11th, 2009 at 1:17 pm
DTM says:
“Common sense would tell you that there isn’t $20 trillion in losses to make up, because no one had $20 trillion to put on the table to lose.”
The fact is, Wall Street sold insurance in the form of Credit Default Swaps but they did not act like an insurance company. Insurance companies are regulated. They have to keep reserves to cover their loss exposure. Wall street sold CDS’s without regard to potential losses. That’s how we ended with potential losses that dwarf the balance sheets of some of the biggest financial institutions on earth. Had they been required to keep reserves to cover their potential losses, the market would never have grown to its present size and scope. If you don’t think banks can loss more money than they have, you just haven’t been paying attention these last few months. If the losses or potential losses could have been contained inside the banking system, they would have. Unfortunately, whether the idiots on CNBC or anyone else likes to admit, government intervention was required because the banks and broker/dealers simply could not contain or cover their positions. The system was insolvent.
March 11th, 2009 at 1:42 pm
DTM Says,
“If enough supermarkets were going to shut down for long enough without taxpayer financing, we would provide taxpayer financing for supermarkets to keep them open. That isn’t desirable, but it would be worse than the alternatives.”
Well, that’s not exactly true. The demise of the supermarkets would represent an opportunity for someone else.
Private capital would race into the void and quickly build new supermarkets under new management. The loss would also represent a business opportunity for butchers, fruit stores and other smaller food sellers. We wouldn’t stop eating just because the local Safeway closed. We’d alter our patterns and change our habits to adjust. The same is true in financial services. What’s needed more than any government bailout is fresh capital and fresh management. Government intervention is blocking the normal functions of capitalism. Poorly run businesses go away to make room for better run organizations. This idea that Citi or BofA are so critical to the financial system that we cannot let them fail is just plain wrong. What they do, their core business strengths, their best performing businesses, will be swallowed up by someone else who will hopefully manage them better.
March 11th, 2009 at 2:34 pm
So, perhaps with some regulatory forbearance concerning mark-to-market, etc., maybe the time to an economic recovery can be bridged.
That was what Holman Jenkins argued in his WSJ column today, “Buffett’s Unmentionable Bank Solution”.