Greeks v. Banks

We'll see tomorrow if the Greek parliament approves the austerity measures and the deep-discount privatizations the ECB and the richer European countries are demanding for another alleged "bailout." To me, the most likely scenario floating around is that the Greeks will go along with the demands for legislative actions tomorrow, and then just not implement most of them as they come due.

If the parliamentarians are paying attention to the riots in the streets, though, they just might say "no" to the package. If that happens, we'll have to see what ensues. A collapse of the Eurozone is a real possibility, and that certainly would be disruptive to the world economy.

Of course, there are some of us who think it just might be time to do it and have done with it. Having a single monetary policy and more than two dozen fiscal policies, from my perspective, is not a formula for success. It worked well enough when credit was cheap, borrowing standards were lax, and government leaders could buy support with all that borrowed money. Granted, the Greeks went a bit more overboard than most — and lied their way into the Eurozone to begin with — but the system was and is essentially flawed.

Whatever the original sins of Greek leaders, though, I could not condemn them if they tell the rest of Europe to screw itself. The interest Greece has to pay on the debt it incurs right now is in the junk bond category. How much higher could it go, and would it really make a difference? Greece can't afford to pay current rates, so higher rates mean nothing. The only sensible thing to do is default now, rather than enter into dubious refinancing schemes and then default for even more later.

The popular jargon for the current bailout proposal is "kicking the can down the road." It makes sense, though, to look at how the road might change a few kicks ahead.

Sarkozy has worked out a deal with private French banks that hold Greek debt to, essentially, roll it over — offer new loans to pay off the old ones (only at higher rates.) The immediate advantage of that for the banks is that it would mean they will not have to write down the bad debt for another three to five years, leaving their balance sheets looking healthier for a while. If the bailout deal goes through, we can expect other private holders of Greek debt to do the same.

Look back a little bit, though, and we see what French, German, Swiss, Belgian, and other private European banks have been doing since the last bailout — that is, selling off their Greek debt to the European Central Bank. If they can continue to do that, private losses can be minimized. Losses by the ECB would have to be offset by infusions of capital from European governments — in other words, by the European people as a whole. Fat cats, hedge funds, and corporate investors will transfer their gambling losses to ordinary people.

For the Greeks themselves, selling off public assets like their ports, utilities, railroads, etc. at this time seems like an especially foolish move. As the people in the streets and squares of Greek cities understand very well, not only would the sale of those assets sharply increase unemployment, but they would bring only a fraction of what they're worth. It makes a lot more sense to default first — tell their creditors they're not going to be paid — and save the assets for later sale, when Greece really needs the money. Cut off from credit, Greece finally would be forced to slice away the corruption and patronage from its economy. The nest egg provided by asset sales, if they turn out to be necessary, could be the country's key to survival.

US exposure to Greek debt is quite small, and the predicted domino effect on Portugal, Ireland, Spain, and Italy also would not have great impact on American holders of European debt. What we don't know, however, is the exposure of US banks and related corporations in the form of credit default swaps. How much of the impending European losses are insured in the US, or in European subsidies of US banks?

Well, we're still kind of in the process of writing the transparency rules on derivatives, so nobody actually knows.

Regulation, again...

Well, I'm still waiting to find out just how "customized" a derivative has to be to escape regulation. So far, it sounds like the bankers will be a lot happier with the outcome than I will.

So far, a substantial majority of the derivatives that have been created have been "customized" to one extent or another -- and the bankers insist that such customization is vital to "serving the interests" of both buyers and sellers. Okay. It makes sense that different CDOs requires different terms and due dates. It makes sense that different credit default swaps will insure different levels of risk to different degrees. Swell. Go ahead and customize them.

I also understand why it might be hard to write regulations for customized derivatives -- especially since we can expect that their creators are sure to "customize" them in ways that would help them avoid any regulations Treasury might write. On the other hand, I don't understand why they can't be sold like other securities -- in an open market, with full disclosure.

The pivotal word in that last sentence, in case you didn't notice the double emphasis, is "can't." Clearly, they can be sold like other securities -- the only problem being that the profit margins of the originating banks would be sharply reduced. Well, we "can't" let that happen, now -- can we?

Hey! Obama! Yes we can!

AIG again, again

About fifty years ago, I remember my mother telling me how a secretary could provide herself with job insurance. The trick was to reorganize the boss's filing system -- so that she was the only one who ever could find anything. I don't know if my mother ever really employed that system, but when I heard about how the jerkwads at AIG who wrote all those toxic credit default swaps had to be paid retention bonuses because they were the only ones who could figure out the mess they'd created, I wondered if their mothers, too, had worked as secretaries.

Most of America is outraged by the bonuses, but I'm bothered a lot more by the payouts to the banks that bought the CDSs. Yes, I wonder why American taxpayers are bailing out foreign banks, but even more important to me is the question of why the securities insured by AIG were purchased at book value. Who made that decision? Could it possibly have been the very same jerkwads who orchestrated the CDS debacle in the first place, and who now will collect bonuses for "unwinding" the mess they made?

One thing is certain: Geithner, Summers, Bernanke and, yes, Obama all have been entirely too deferential to Wall Street to this point. Unless the President shows some genuine guts and leadership soon, those high approval ratings he's enjoyed so far will plummet like the Dow.

Again, again, again (later)

And so it seems, according to NPR, that Edward N. Liddy, Obama appointed CEO of AIG who testified before Congress today, says the executives who designed and sold the credit default swaps all have been fired -- the guys collecting (or voluntarily giving up part or all of their) "retention" bonus payments in the CDS division are not, perhaps, the same guys who screwed the company and the American taxpayers and the world.

That would appear to sink my "secretary's new filing system" hypothesis -- but it also would appear to sink the "We have to keep them because they're the only ones who understand it" hypothesis. Me, I figure the bullshit still is flying fast and thick. We can't have any names of executives, it seems, because if their names became public they might be strangled with piano wire. (No kidding! That's exactly the justification for secrecy Liddy offered Congress.)

So we must wait, and see, and put our faith in Barney Frank, I guess.

AIG again

How about a real stress test?

So here come another $30 billion for AIG -- but when you take a good, hard look, it's not for AIG. Who is it for? Nobody at AIG, nor in the Obama administration, is being especially transparent about that.

AIG lost $62 billion last quarter, and without another bailout would have had to default on its "obligations" to banks all over the world. Without the bailout, that is, all the idiotic credit default swaps AIG issued would be worthless, and banks all over the world would have to write down a load of bad paper. To wit, the Treasury continues to animate zombies -- not just in the United States, but everywhere else as well.

Naturally, this can't be the last bailout. As AIG continues to pay out claims on credit default swaps, it will continue to hemorrhage money, and Treasury will continue to cough up the vast sums needed to keep it alive -- but, do American taxpayers really want to bail out banks in the UK and Switzerland? How about the France and Germany? How about China?

At the risk of boring anybody who actually reads this blog on a regular basis, I will lay out my AIG prescription yet again. Split the company into it's four component divisions, and take the finance division into bankruptcy -- that is, default on all those credit default swaps. That will leave the "insured" derivatives worth whatever they really are worth. That's a real stress test.

Bailing out our own mismanaged banks is bad enough. We really can't afford to bail out the world.

The next bank bailout

It's Saturday. Geithner won't give his speech until Monday, and who knows how much he'll be willing to lay on the table even then? I figure it is incumbent upon me to speculate a bit, so that, as events develop, my forecasting ability may be evaluated. (By the way, I never go back to edit earlier postings -- except for obvious typos.)

And, so, it looks like what will be announced Monday could be a fairly clever compromise. Instead of "sin eating" Wall Street's toxic assets, government will invite private investors to buy them -- but with reduced risk because of government insurance. In essence, the Treasury would be issuing credit default swaps.

If done right, it could work. The only way to get a fix on what all those "troubled assets" are worth is to get people buying and selling them again -- but will it be done right? That remains to be seen.

To my mind, doing it right involves a few basic rules. First, no asset should be insured for more than half of what the investor pays for it. Insuring assets for full "face value" is the same as buying them outright, except without the opportunity to sell them if their value increases.

Second, pre-existing credit default swaps should not be re-insured. Since the lion's share of those were sold to buyers who did not even own the securities they supposedly insured, covering them is tantamount to insuring gambling losses.

Third, government should charge a fee for the insurance it issues. Investors were willing to pay for credit default swaps in the past, and they still should be willing to do so -- especially since the insurance is being issued by government, an institution which will not default.

Fourth, participating banks should be required to write down the alleged value of all derivatives that do not find buyers in a reasonable period of time. Only in that way can we discover which banks are essentially healthy and which are among the walking dead.

Speaking of zombies...

Okay, here's a thought. AIG, at this point, is as zombielike as any financial company you can name. Even after two bailout attempts, it remains as good as dead. It's also sucked up enough government money to be mostly nationalized already. So, here's the idea:

Why not nationalize it completely, wiping out the shareholders completely? Shares have so little value left, most shareholders hardly would notice. Break the company in half, with General Insurance, Life Insurance and Retirement Services, and Asset Management in one part, and Financial Services in the other. Sell the first half, which continues to make money, and recover many of the billions of taxpayer dollars now sunk in the AIG swamp.

The Financial services sector then should be taken into bankruptcy, wiping out the debts owed on credit default swaps. Banks that continue to count CDSs from AIG as assets then would be obliged to write them down, and everybody would have a much better idea of just how well capitalized those banks may or may not be.

It's a safe bet that some more zombies would emerge from the shadows. Those, too, should be nationalized by some RTC-like agency, and their remaining assets sold when things start getting back to normal.

I understand that not all financial stocks are held by hedge funds and wealthy fat cats. I have no doubt that both my pension fund and my 403(b) would suffer further losses, but neither one stands much chance of recovery until a lot more light is shone into the obscurity of derivatives markets. Since AIG turned out to be such a central player, AIG seems like a great place to start.