. . .there are many interrelated parts of this deep economic crisis. Nothing improves until the banks are again stable and are lending money. The banks in turn, cannot be healthy until something is done with the mortgages. Economists are in agreement that unemployment will climb greatly this year. The stimulus was too small and it was weakened too much in order to get the votes for passage.
By Sherman DeBrosse / The Rag Blog / February 24, 2009
Last November, my retired banker friend told me the banking system was about to collapse and that another bank holiday would be necessary. Others who heard his comment registered utter surprise and disbelief. I remembered that four years before that, he told me that the housing bubble would soon collapse and would bring down with it the whole economy. He was right on target, but had actually underestimated the scale of the economic disaster we now face.
As we all know, there are many interrelated parts of this deep economic crisis. Nothing improves until the banks are again stable and are lending money. The banks in turn, cannot be healthy until something is done with the mortgages. Economists are in agreement that unemployment will climb greatly this year. The stimulus was too small and it was weakened too much in order to get the votes for passage. We are also facing the collapse of Chrysler and General Motors. If they are not rescued we are looking at a loss of up to two million lost jobs, a situation that could harm the South’s precious foreign car industry that depends on American parts firms that could go under.
When faced by a similar crisis, Franklin D. Roosevelt enjoyed considerable ability to experiment — trying one thing and then another. Obama has less of this freedom because major legislation now requires 60 Senate votes, because he was not given the traditional honeymoon, and because of other limitations, including available funds.
Our Desperately Sick Financial System
As it turned out, the banking system is so sick that a short bank holiday will not fix it. The situation is much worse than in 1933 because it is almost impossible to evaluate bad assets that did not even exist in 1929. A short bank holiday will not do the trick because so many big banks are insolvent — some say almost all of the top 50 — and their bad assets will take much effort to evaluate. Many of these assets did not exist in 1933, and we barely understand what they are or whether they really relate to the concrete, everyday economy. This writer has found no statutory power allowing the Treasury to make judgments about solvency based upon off-the-books holdings that would turn up on SEC forms 10-Q, and 8-K. But Treasury is free to refuse to assist banks with too many doubtful holdings.
With all this complexity and uncertainty, Secretary Tim Geithner has been on the receiving end of a lot of unfair criticism about his vagueness in describing Treasury’s approach. This is not 1933, when FDR could close the banks for a few days, do some simple math on assets everyone understood. And don’t forget that the Republicans, with the help of Bill Clinton and some other Democrats, gutted the legislation FDR left us to make regulation and possible bank reorganization simpler. Bill and those other Democratic Leadership Council Democrats were not against all regulation and did attempt to do some regulating, but they made a terrible mistake trying to be open to “new” ideas in an effort to appeal to a larger slice of America. But the situation is not as Time claimed, suggesting there were no chief culprits and absolving the GOP of the bulk of the blame. Senator Phil Gramm and the GOP deserve 70% of the blame.
Secretary of the Treasury Tim Geithner had no choice but to be vague about his rescue plan or how long it will take. Some decisions will be made when the “stress test” is over. By inclination, he and Larry Summers do not want to nationalize banks and have said that government is not good at running banks. Actually, the FDIC has done very well with short term management and the Resolution Trust Corporation did a very good job of remarketing distressed assets.
We do not know for certain how deep the hole is, but judging by the behavior of Wall Street, the situation is far, far worse than my banker friend thought. Indeed, financier George Soros says the financial crisis is now worse than that of the Great Depression and that it will soon be like the Russian meltdown that occurred some years ago, before that country was rescued by oil and gas revenues.
But to use the “N” word sets Wall Street into a tail spin. About two months ago, a close and very wealthy friend said his broker told him to sell everything because the market is ready to go into a real “panic” — meant both as the historical economic term and the word for intense irrational emotion — over the fate of the banks. Now the papers are quoting an expert who says the market could well fall to somewhere around 3,500 in the next six or nine months unless the street is satisfied with what the administration does.
This sounds a little bit as though Wall Street is holding hostage the value of all of our much diminished equity savings hostage unless it gets what it wants. It reminds one of the angry child who holds its breath until it gets what it wants. Come to think of it, that is how John Mc Cain actually performed as a child. Tell me about the rationality of the markets someday!
Wall Street’s Sense of Entitlement
Wall Street is worried that some of the bankers who made irresponsible decisions will be replaced and that the government will assume temporary control of some of the worst firms. There is also the grave concern that the common stock holders, who had greatly profited from the financial bubble, may have to pay the piper. President Barack Obama said some banks would not make it, but the Wall Street folks think government should use tax payer money to bail them all the bad banks.
Maybe we cannot really blame Wall Street for believing that it is entitled to limitless taxpayer dollars. From 1981 to about October, 2008, the government bailed out the banks to the tune of $7 trillion. Several hundred billion was in cash, but most was in guarantees. It began when Ronald Reagan issued Brady Bonds to rescue banks that had loaned too much to insolvent Latin American regimes. The amount ponied up from November until right now is in the trillions, with the amount of cash from TARP and the FED about 2.5 trillion. But that figure includes quite a lot issued on a short term to foreign banks. Bear Sterns experts say there is a trillion in bad sub-prime loans. That figure is deceptive because a great part of that might not be under water. Experts offer the conservative estimate that banks hold another seven trillion in bad assets. Again the question is how bad are they.
Limitations Facing the Obama Administration
President Franklin D. Roosevelt dealt with the last depression by experimentation. Barack Obama says he will do the same, but circumstances and some very adroit politicians together have arranged things so that this good man is boxed in, with little room to experiment or make honest mistakes.
The only cash the Obama administration has on hand to address the multiple economic crises is the balance of TARP money, about $350 billion. That money must be used to cover the $75 billion commitment to the mortgage restructuring program, the automobile industry bail out, and the restoration of liquidity to the banks. That is not really a great deal.
This writer has no idea what the limits are of U.S. borrowing power abroad. It was noted that the interest rate the Treasury pays for money advanced sharply in January. Can we ultimately live with as much as $18 to 22 trillion in guarantees without unleashing inflation, or even worse the stagflation we had in the late 1970s? Somewhere along the line we may pay the price for pouring gasoline on a fire.
The FED prints money by accepting others’ debt instruments and placing them on its books as assets. It must not exhaust its ability to print money in this manner. It needs to be able to strengthen the mortgage restructuring plan if that becomes necessary. The administration plan looks about right, but we are in unchartered waters. To preserve its options, it should resist simply giving vast amounts to the banks without getting a measure of control and taking away all the bad assets. It needs to be ready with money for some alternative liquidity plan if the new bailout again results in banks hoarding funds and not making loans.
Right now Obama faces the implicit threat that the Dow will go down when Wall Street thinks he is not doing what they want. The president cannot be expected to govern with one eye on the Dow! It will probably go down sharply because government simply cannot fulfill Wall Street’s wish list when it comes to rescuing the banks. If Obama does what must be done to quickly correct the financial system, there will be a sharp plunge in any event.
He needs to prepare people for this and remind them that the Dow will rise when the bank fix takes hold over time. It is likely that this jawboning will do little to arrest what seems to be a deepening panic. He might consider balancing the taking back of the tax cuts for the rich with drastic cuts in the long term capital gains tax. That might stimulate some investing. A second step to halt the downward spiral would be to place a moratorium of selling short.
Given the Senate minority’s ability to use the threat of a filibuster to veto legislation, Obama cannot look for more cash soon. It also mystifies this writer why people are talking about acting on universal health care. If considered separately, the GOP veto, which began with Bob Dole in 1993 and now is an institutionalized part of the way we do business, will prevail.
Yes, universal health care would cut costs at least 20 to 25% and would restore competitiveness to US industry. It would also trim Medicare and Medicaid and positively influence the COLA formula for Social Security, thus contributing to fixing Social Security. It could be a vital part of recovery, but politicians dependent upon donations from medical insurance and pharmaceuticals will certainly continue to put their cash cows above ordinary people. The leadership in Congress might consider making health reform part of the budget because a budget cannot be filibustered. But they would be inviting an enormous battle that still might not be won.
WE have to consider the possibility that the economy will not regain the strength to thrive as it once did or soar as it pursued bubbles such as the dot.com, tech, housing and financial bubbles. If that occurs, universal health care will be necessary to make bearable lives that will be far more difficult and affluent.
The public saw tens of billions go to banks that refused to lend. The same banks helped Americans escape taxes and they also sped up their gambling in derivatives, perhaps hoping to win enough in the casino to get out from under federal salary caps. Moreover, the big banks have been bringing in thousands of foreigners to put on their payrolls at wages less than Americans command. All their arrogance and damnable misbehavior has so angered all of us that it makes it much harder for the Obama administration to help them.
Even if some Republicans would decide to vote hundreds of billions more for their banker friends, it is likely that many Democrats could not now safely cast such votes. For this reason, we must get used to the idea that some banks will have to crash and burn, and in other cases common stockholder equity will have to be diluted or disappear. Obama, Geithner, and Summers cannot work magic.
Unnatural Restraints on Obama’s Ability to Address the Bush Near-Depression
There are political constraints. The GOP lost not one point in popularity refusing Obama a honeymoon and in trying to damage and obstruct the stimulus package. Indeed, their financial base seems to have been restored to where it was before November last. Moreover, Obama’s popularity among Republicans was driven down 25% in one month, and he has lost a few points in other quarters. Some of this was to be expected. As the GOP continues to talk down the economy by attacking Obama we can expect more damage to his ability to persuade and expend political capital.
Obama must privately put aside his daydreams about bipartisanship. WE and he cannot afford delusions. For the GOP, it is all about damaging his programs to get him out of office. He should read Newt Gingrich’s recent comments and those of Alabama’s Sessions. Gingrich is a sharp historian and certainly knows that the voters only once punished the GOP for unremitting obstructionism, and that was when it went way too far by shutting down government. The GOP will do absolutely anything to regainin power, even if “Taliban tactics” must be deployed and the Bush near-depression deepens.
Very few Republicans accept the old concept of “loyal opposition.” Even former Senator John Warner, once a leading Republican, has said this about his own party. In the long run, this approach can do massive damage to the republic we love. In the short run, it can substantially delay the recovery.
When FDR fought the Great Depression, the filibuster was a Senate institution, but it was not deployed on a regular basis. Now it is institutionalized and Obama needs 60 Senate votes to pass anything important. The Democrats must find the courage to take on the Dole Veto or forget implementing much of their program or being able to react quickly as this disaster deepens.
The pundits in the mainstream media are setting up Obama to take a fall. He took too many hits for the tax problems of his appointees. He could not have had all the information the IRS had about these people. Now, they say that Obama owns the economy. In my childhood, voters were sharp enough to know that FDR did not “own” depression that Herbert Hoover and the Republicans created. It just goes to show how far the science of opinion manipulation has advanced since then. Last Sunday, a CNN anchor spent two hours indirectly hammering the Obama mortgage restructuring plan. Not once did he or his subjects recall that McCain offered a much larger plan and that weeks ago the Congressional Republicans offered a still larger one, neither of the last two plans did much for the poor, prevented more flipping of mortgages or failed to help people who had exercised terrible judgment in the past.
Given the success of GOP/MSM criticism and just anger at the behavior of the auto executives and banks, President Obama may not even be able to find votes for another stimulus package next year, even though GOP columnist George Will now admits that the original stimulus was too small by two thirds.
Choices in Dealing with the Banks
The fastest and best solution would be to emulate Sweden in 1992 and buy all the bad assets of the banks, briefly nationalize them, repair damage under new leadership, and then sell them off to private investors. We cannot do this because out banks have a much greater proportion of very toxic assets. There simply is not enough money or borrowing power to do that. Second, we must avoid the poison word “nationalize,” it is politically lethal in right-center America.
The Republicans and even some Democrats like George Soros seem to want us to emulate the Japanese in the 1990s and continually pour good money to rescue bad debt and bad banks and leave the banks to manage their own affairs. It produced “zombie banks” like some we now have — soaking up more and more taxpayer money and was continually unable to make loans. Like the Japanese, Hank Paulson invested hundreds of billions of taxpayer money to rescue their share holders. These lavish gifts produced to the banks and shareholders produced nothing for ordinary Americans. That approach did not work, and we lack the funds to just throw money around again.
The Japanese did the same thing, time and again frittering away massive amounts in a doomed effort to rescue stockholders in banks that were already dead — the zombies.
That proved to be a disaster for the Japanese, and it even meant that a great deal of their multiple stimulus packages accomplished little more than easing pain because the economy could not restart without working banks. A long succession of bank bailouts might please the Republicans because they represent the banks and their shareholders and because it would doom Obama’s efforts to jump start the failed economy. The GOP might even expect the Democrats to provide most of the votes because that party has too large a dose of the idea it must take hits for the common good. Continual cash transfusions into “zombie” banks guarantees the economy will spiral down, down, down. Today’s code for following the Japanese road is references to the need for massive cash injections into the banks with few strings attached.
Why so many Americans think it is our sacred duty to make endless cash infusions without taking any equity or decision-making rights is a great puzzlement. It is all about an ideology that has been sold with near perfection to a huge chunk of Americans. Why so many ordinary folks do not share my fury at these people who are responsible for the loss of most of our paltry savings is a puzzlement.
The Japanese option is the great danger for us. Some of Obama’s advisors show some sympathy for this approach, and the Secretary has already signaled that cash will continue to be showered on institutions that have roles of international significance. One hopes that the Japanese approach ends there. Some of their suggestions resemble too much the Bush plans that lavish cash on banks and leave the taxpayer holding the bag. One such plan the Obama people floated was guaranteeing firms that bought bad debt. The firms are guaranteed big profits and the taxpayer will take any loss hits. If there were a limit to showering goodies on special interests, and if this approach guaranteed the cleansing of banks, one could hold his nose and once again let the banks play taxpayers for chumps. But it did not work that way here or in Japan.
If Obama lets them veer in that direction, we could lave a “lost decade” or more, as did Japan. We will also have many “zombie” banks, continually taking in federal largess but not functioning as lenders. The difference is it would be worse because Obama might not find votes for future stimulus plans that would somewhat mitigate the harm done. He has talked about the possibility of being a one term president; the Japanese option would guarantee it.
A modified Swedish approach must be tried fairly quickly and very decisively. A basic rule should be government directors and voting stock wherever government money goes. Another is to do as little as possible to help with exotic instruments. Shareholders must eat them. Some banks, that cannot pass the stress test, must be allowed to crash and burn. Their assets can go to something like the Resolution Trust Corporation or an aggregator bank that will try to market them and pay some of their debts.
In many cases the financial distress is so great that we must stop just short of nationalization. Rational economists are saying nationalize and be done with it. But this so challenges American folklore that it could depress confidence and the markets still more.
Banks that need short-term help can receive FED or FDIC short term “cushion funds” but they might have to accept new leadership and strong FDIC oversight.
Some of the weaker banks might have to be combined into new entities, with the common stockholders unfortunately taking a considerable hit. Some bad assets will simply be eaten by the stockholders, and other toxic assets purchased on a limited basis by the FED and put in an aggregator bank for reevaluation and remarketing.
The word “nationalization” must be avoided. Lessons can be learned from the Roosevelt Bank Holiday. After the stress tests are done, give the sound banks a resounding bill of good health. Right now the plan is to avoid such statements. This is what the American people long for so they can get on with business.
Whatever bad news there might be should be confined to the same few days of announcements. Announcing now, weeks before the stress tests are over, that CitiCorp asked and got the government to convert its senior preferred stock to common shares set off a round of needless and silly TV interviews from Wall Street insiders about the evils of nationalization and how wonderful the management of the banks has been up until now. This could only happen in a country addicted to bumper sticker slogans and adverse to careful thought about economics. Back as far as the 16th century, people were writing about how one gives out all the troubling news at once. Don’t dribble it out. Why help your opposition? What inept information management!!!
Right now CitiCorp’s assets are worth $30 billion and the government has given it $45 billion. Deep national ideological considerations prevent the government from simply nationalizing it, reforming it and selling it in two years, probably at a loss. That is the rational thing to do with this and other terribly sick banks. The best we can do is purge it of bad assets at the expense of stockholders, quickly reorganize it under some federal supervision and hope it improves enough to sell off federal shares in two years.
We also need to be careful about large subsidies to firms that deal in bad assets or purchasing bad assets on terms that are too generous. Critics will be watching these matters for ammunition to hurl at our new president and to talk down the efficacy of the plan.
The Auto Industry: No Ideal Choices
If the auto industry is not rescued, the industrial sector will remain a weak cell in the American economy. There are no easy choices here. We should remember that the industry has done some useful restructuring, that it is the victim of a worldwide near-depression, that foreign governments are subsidizing their automobile manufacturers, and that the southern states have subsidized their foreign firm at least to the tune of three billion. After digesting these facts, we should keep in mind that people will keep driving cars and that our auto stock is aging rapidly. That means we will retrieve the money we loan the two Detroit firms.
When we cut to the chase, most Republicans want to drive GM and Chrysler into bankruptcy. If it is Chapter Seven, it means a couple million jobs will be lost and the assets will be sold off. This seems to be what the Southern Republicans desire. Liquidation would so deepen unemployment that Obama would have no chance whatever of easing the situation in one term.
If it is Chapter Eleven, a bankruptcy controlled by creditors, many would still be working in the plants. The administrative costs would probably run $100 billion or more, but we would keep many people on the job and have jobs for others to eventually reclaim. The companies put that figure much higher, but that is for bargaining purposes. Chapter Eleven would do massage damage to future sales. The money to finance Chapter Eleven would have to come from the federal government. There is a remote possibility that Republicans would provide enough votes to come up with the $100 billion.
If you doubt my take on what is going on, consider the character of the people leading the attack on Detroit. Senator Richard Shelby now doubts that Obama was born in the U.S., thus questioning his right to be president. Senator Robert Corker ran an ugly racial advertisement against his African American opponent in Tennessee. It might be a good investment for them as they are so hell bent on crushing labor and helping their local foreign car firms. Eighty-five percent of Americans say they would not buy a car from a company in bankruptcy. There is no private money available for financing Chapter Eleven. That federal investment would essentially be an investment in the Republicans’ partisan agenda; it would yield us nothing.
Unfortunately, we probably cannot set aside enough TARP money to save jobs as well as the good wage and benefit packages. Some sort of government- sponsored arrangement that resembles pre-structured bankruptcy, but avoids that legal category, is our only choice to save jobs and the industry. It’s a terrible way to repay the UAW for all it did for all workers and it probably means that, in the future, few blue collar workers can expect good wages. In return for TARP money, the federal government would get common shares, votes on the boards, and changes in management. If more money is needed, the FED could pick up their commercial paper in return for warrants and seats on the boards. In time the FED and the Treasury would sell off its interests to private entities.