Anybody seriously following the bank bailouts cannot afford to miss this article in today's New York Times, an extensive review of Tim Geithner's relationships with Wall Street firms and executives, as well as his policy recommendations both as chair of the New York Fed and Secretary of the Treasury.
This article is not "commentary" or "news analysis," but a review of Geithner's history. We are left to draw our own conclusions. For me, it reinforces my ongoing belief that the "change" promised by the Obama administration, at least as far as the financial industry goes, continues to be mostly smoke and mirrors.
Monday, April 27, 2009
Tuesday, April 21, 2009
The Citi share swap
Pretty clearly, Citigroup (despite its vaunted "profits" for the past quarter) is in big trouble.
When the government swaps out its preferred stock in Citi for common stock, a liability is magically transformed into an asset, Citi no longer has to pay the 5% dividend the preferred stock involved, and the taxpayers instantly own 36% of the company. Note that when that happens, the value of a share of Citi is diluted by about a third. Why would the existing stockholders go along with that?
Easy. Two-thirds of something is worth more than all of nothing. They appear to believe -- with good reason, no doubt -- that the only other alternative is to be wiped out.
Mind you, they still could be wiped out, but the prospect becomes a little less likely. The government, which will become the largest single shareholder, will feel a certain obligation to the taxpayers, and work a bit harder to keep Citigroup solvent.
The reasoning of the Obama administration is obvious. Citi is "too big to fail." Citi needs more capital to avoid insolvency. Congress won't provide more capital. Hence, the only way forward is to convert the preferred stock liability into a common stock asset. Clever boy, our Timmy G.
The biggest political problem is figuring out what to do with the voting rights that come with common stock. There are plenty of free-marketeers out there who already are saying that the conversion amounts to partial nationalization. Raise the red flag, comrades!
I am not looking forward to watching Obama & Co. weaseling around, looking for ways to not exercise government's voting rights in Citi. I think that we've had enough problems because shareholders -- private shareholders -- have abrogated their responsibility to exercise control over the companies they own, and left it all to management. I don't see why government, too, should be irresponsible. Summers and Geithner are said to be two of the brightest lights in the field of economics. Let's give them a chance to show just how good they can be -- at Citigroup.
When the government swaps out its preferred stock in Citi for common stock, a liability is magically transformed into an asset, Citi no longer has to pay the 5% dividend the preferred stock involved, and the taxpayers instantly own 36% of the company. Note that when that happens, the value of a share of Citi is diluted by about a third. Why would the existing stockholders go along with that?
Easy. Two-thirds of something is worth more than all of nothing. They appear to believe -- with good reason, no doubt -- that the only other alternative is to be wiped out.
Mind you, they still could be wiped out, but the prospect becomes a little less likely. The government, which will become the largest single shareholder, will feel a certain obligation to the taxpayers, and work a bit harder to keep Citigroup solvent.
The reasoning of the Obama administration is obvious. Citi is "too big to fail." Citi needs more capital to avoid insolvency. Congress won't provide more capital. Hence, the only way forward is to convert the preferred stock liability into a common stock asset. Clever boy, our Timmy G.
The biggest political problem is figuring out what to do with the voting rights that come with common stock. There are plenty of free-marketeers out there who already are saying that the conversion amounts to partial nationalization. Raise the red flag, comrades!
I am not looking forward to watching Obama & Co. weaseling around, looking for ways to not exercise government's voting rights in Citi. I think that we've had enough problems because shareholders -- private shareholders -- have abrogated their responsibility to exercise control over the companies they own, and left it all to management. I don't see why government, too, should be irresponsible. Summers and Geithner are said to be two of the brightest lights in the field of economics. Let's give them a chance to show just how good they can be -- at Citigroup.
Monday, April 20, 2009
Stress positions
I can hardly wait. Two more weeks, and Treasury will be releasing the results of its stress tests of the banking industry. Maybe. Sort of.
I can hear it now: "We have completed exhaustive testing of the nineteen largest banks, and we are pleased to report they all passed. No details are available right now, but maybe in a month or two..."
In the meanwhile, the banks are doing their best to impress us with their "better than expected" "profits."
Yes, I had to do two sets of quotes in a row. Neither turn of phrase is what it seems, and judging by today's action on financial stocks, investors haven't been fooled.
When the "results" of the stress tests are "released," it will not be the credibility of the banks that will be evaluated, but the credibility of Tim Geithner and the Obama Treasury Department.
I can hear it now: "We have completed exhaustive testing of the nineteen largest banks, and we are pleased to report they all passed. No details are available right now, but maybe in a month or two..."
In the meanwhile, the banks are doing their best to impress us with their "better than expected" "profits."
Yes, I had to do two sets of quotes in a row. Neither turn of phrase is what it seems, and judging by today's action on financial stocks, investors haven't been fooled.
When the "results" of the stress tests are "released," it will not be the credibility of the banks that will be evaluated, but the credibility of Tim Geithner and the Obama Treasury Department.
Thursday, April 16, 2009
Glimmers of Hope?
The President has seen "glimmers of hope." I'm trying to figure out where.
Maybe it has something to do with Wells-Fargo's record quarterly profits, or the determination of Goldman-Sachs to repay its TARP funds. Financial stocks seem to be staging a bit of a recovery, which is not especially surprising with the FDIC guaranteeing billions upon billions of dollars of the loans they are making -- essentially taking on all the risk in exchange for a negligible fee.
Goldman-Sachs posted a profit -- made possible, as it happens, by payment at 100% of face value on a credit default swap issued by AIG. Does a profit really count if it depends on free money provided by the taxpayers? Yes, apparently, it does count. If you can get the suckers to hand over their money, it's yours, right?
The only "glimmer of hope" I could believe in right now would be an effort to remove from government anybody and everybody with a history at Goldman-Sachs. Two administrations' worth of Goldmanistas already have eliminated virtually all of the company's competition. Isn't that enough?
Maybe it has something to do with Wells-Fargo's record quarterly profits, or the determination of Goldman-Sachs to repay its TARP funds. Financial stocks seem to be staging a bit of a recovery, which is not especially surprising with the FDIC guaranteeing billions upon billions of dollars of the loans they are making -- essentially taking on all the risk in exchange for a negligible fee.
Goldman-Sachs posted a profit -- made possible, as it happens, by payment at 100% of face value on a credit default swap issued by AIG. Does a profit really count if it depends on free money provided by the taxpayers? Yes, apparently, it does count. If you can get the suckers to hand over their money, it's yours, right?
The only "glimmer of hope" I could believe in right now would be an effort to remove from government anybody and everybody with a history at Goldman-Sachs. Two administrations' worth of Goldmanistas already have eliminated virtually all of the company's competition. Isn't that enough?
Friday, April 3, 2009
Mark to mock-up
In case you missed it: the allegedly independent Financial Standards Accounting Board (FASB) just succumbed to heavy political pressure from our duly elected pawns of the banking industry and did away with "mark-to-market" reporting. What does that mean? Basically, it means that banks now are allowed to lie about the value of their assets.
Yes, I know. You thought they probably were lying all along -- and, pretty clearly, they were lying. Under the new rules, however, they now are specifically authorized to lie by FASB.
Under mark-to-market accounting rules, banks report the value of their assets based on market value -- that is, what somebody is willing to pay for them. Of course, since the beginning of the current banking crisis, no investor has shown any interest at all in purchasing the derivatives now commonly called "toxic" assets. One might think that would give those assets a mark-to-market value of zero, but actually that left the banks fairly free to value them, shall we say, optimistically, based on what they might fetch once the "liquidity crisis" was resolved. Once investors had some free cash and some affordable credit again, the banks maintained, those frozen assets would be purchased at fairly high prices.
The whole Obama plan for unfreezing the banking system seems to be based on the assumption that the problems banks are having with those assets are problems of liquidity -- that if government provides enough cheap credit and takes on nearly all the risk, then the market for derivatives will start moving again. With so much government incentive, the more adventurous hedge fund managers are beginning to show interest -- and others are sure to follow. The problem for the banks is that hedge fund managers are notorious bargain hunters. Even with government assuming 93% of the risk, they still will do their best to low-ball the banks when they make their offers.
Under mark-to-market, a low-ball offer of 20 cents on the dollar, even if a bank refused to accept it, would establish a market price. If the bank had been valuing the asset at 80 cents on the dollar, it would be forced to write down the asset's value by 75 per cent. Enough write-downs of that magnitude, and it would be impossible for the bank to pretend it still was solvent. The new rules make it possible for banks like Citi and B of A to hide their zombification and avoid being sent to their graves.
Those who recognize that our banking problems are problems of solvency, rather than liquidity, tend to believe that it is better to bite the bullet now -- admit that most of the "wealth creation" that took place in the finance industry over the past ten years was an illusion, and that an investment in Citigroup really was no better than an investment in Enron. The Enron scandal, you will recall, was made possible by lax accounting standards -- and yes, all Enron's investors were wiped out.
So now FASB, certainly with approval from the Obama administration, is relaxing accounting standards for the big financial firms. Why? Do the president and his economic advisors really believe the toxic assets have significant value -- that is, that the problem really is entirely one of liquidity? More likely, they are just really, really hoping the assets have some real value -- that questionable loans written to finance questionable loans written to finance pools of questionable loans collateralized by real estate might actually be worth something.
Clearly, though, the real estate collateralizing those loan pyramids will never have the value it was assumed to have when all those loans were written. Remember? Why do you think they called it a real estate "bubble?" As it was with Enron, and as it was with Bernard Madoff, the huge profits investors enjoyed during the run-up to the collapse were paper profits -- not real profits. No real value was added to the economy while it was taking place, and the "losses" suffered by investors in real estate derivatives are paper losses.
It's not that hard to put a market value on a straight mortgage backed security -- that is, one directly collateralized by mortgages. There is available data on how the mortgages in the pool are performing -- how many homeowners are up to date on their payments, how many are late by one, two, or three payments, how many are actively in default, and how many already have been foreclosed. It is my sincere hope that the banks will not be allowed to fantasize the value of those assets, and that Geithner's "stress tests" will ascertain their real, current values.
It is a lot harder to put a market value on securities several times removed from the collateral that ultimately guarantees them. A highly motivated hedge fund might invest in tracking down their real value before offering to buy such securities. More likely, though, hedge funds will do a few computer simulations to select a bouquet of securities with a high probability of producing a profit after a 93 per cent assumption of risk by government is factored in. In the meanwhile, you can bet the banks will be finding ways to game the system and unload the worst of their assets at taxpayer expense. Now that mark-to-market is gone, it will be that much easier.
To me, it looks like the Obama administration has decided that saving the big banks is better for the public good than letting them fail. It looks like Obama (read Geithner and Summers) believe our best course of action is to restore the system that created the current crisis -- albeit with more regulation. To get there, though, the taxpayers have to bail out the very same assholes who fucked it all up in the first place. (Note to readers: when vicworld resorts to foul language, vicworld is very angry!)
The solution they appear to propose is to distribute those paper losses between the financial firms and the ordinary taxpayers -- even though the ordinary taxpayers are the ones who have suffered the real losses. Think about the family that saved for years to afford a down payment on a house with a conventional mortgage, only to see the bottom fall out of home prices and find themselves underwater. Think about the families who have seen the price of their homes plummet because they live in neighborhoods with many foreclosures. These are people who had no reason to believe they were taking on excessive risk. They were screwed, both by the financial industry and by the government that failed to oversee and regulate that industry. If there is any good reason those people should be subsidizing speculators, I can't think of it.
Now, Geithner says government should have the authority to take over any firm that creates "systemic risk." Once again, the details are missing, though. Is there a real plan to help those of us who are not "masters of the universe?"
Right now, I have very serious doubts.
Yes, I know. You thought they probably were lying all along -- and, pretty clearly, they were lying. Under the new rules, however, they now are specifically authorized to lie by FASB.
Under mark-to-market accounting rules, banks report the value of their assets based on market value -- that is, what somebody is willing to pay for them. Of course, since the beginning of the current banking crisis, no investor has shown any interest at all in purchasing the derivatives now commonly called "toxic" assets. One might think that would give those assets a mark-to-market value of zero, but actually that left the banks fairly free to value them, shall we say, optimistically, based on what they might fetch once the "liquidity crisis" was resolved. Once investors had some free cash and some affordable credit again, the banks maintained, those frozen assets would be purchased at fairly high prices.
The whole Obama plan for unfreezing the banking system seems to be based on the assumption that the problems banks are having with those assets are problems of liquidity -- that if government provides enough cheap credit and takes on nearly all the risk, then the market for derivatives will start moving again. With so much government incentive, the more adventurous hedge fund managers are beginning to show interest -- and others are sure to follow. The problem for the banks is that hedge fund managers are notorious bargain hunters. Even with government assuming 93% of the risk, they still will do their best to low-ball the banks when they make their offers.
Under mark-to-market, a low-ball offer of 20 cents on the dollar, even if a bank refused to accept it, would establish a market price. If the bank had been valuing the asset at 80 cents on the dollar, it would be forced to write down the asset's value by 75 per cent. Enough write-downs of that magnitude, and it would be impossible for the bank to pretend it still was solvent. The new rules make it possible for banks like Citi and B of A to hide their zombification and avoid being sent to their graves.
Those who recognize that our banking problems are problems of solvency, rather than liquidity, tend to believe that it is better to bite the bullet now -- admit that most of the "wealth creation" that took place in the finance industry over the past ten years was an illusion, and that an investment in Citigroup really was no better than an investment in Enron. The Enron scandal, you will recall, was made possible by lax accounting standards -- and yes, all Enron's investors were wiped out.
So now FASB, certainly with approval from the Obama administration, is relaxing accounting standards for the big financial firms. Why? Do the president and his economic advisors really believe the toxic assets have significant value -- that is, that the problem really is entirely one of liquidity? More likely, they are just really, really hoping the assets have some real value -- that questionable loans written to finance questionable loans written to finance pools of questionable loans collateralized by real estate might actually be worth something.
Clearly, though, the real estate collateralizing those loan pyramids will never have the value it was assumed to have when all those loans were written. Remember? Why do you think they called it a real estate "bubble?" As it was with Enron, and as it was with Bernard Madoff, the huge profits investors enjoyed during the run-up to the collapse were paper profits -- not real profits. No real value was added to the economy while it was taking place, and the "losses" suffered by investors in real estate derivatives are paper losses.
It's not that hard to put a market value on a straight mortgage backed security -- that is, one directly collateralized by mortgages. There is available data on how the mortgages in the pool are performing -- how many homeowners are up to date on their payments, how many are late by one, two, or three payments, how many are actively in default, and how many already have been foreclosed. It is my sincere hope that the banks will not be allowed to fantasize the value of those assets, and that Geithner's "stress tests" will ascertain their real, current values.
It is a lot harder to put a market value on securities several times removed from the collateral that ultimately guarantees them. A highly motivated hedge fund might invest in tracking down their real value before offering to buy such securities. More likely, though, hedge funds will do a few computer simulations to select a bouquet of securities with a high probability of producing a profit after a 93 per cent assumption of risk by government is factored in. In the meanwhile, you can bet the banks will be finding ways to game the system and unload the worst of their assets at taxpayer expense. Now that mark-to-market is gone, it will be that much easier.
To me, it looks like the Obama administration has decided that saving the big banks is better for the public good than letting them fail. It looks like Obama (read Geithner and Summers) believe our best course of action is to restore the system that created the current crisis -- albeit with more regulation. To get there, though, the taxpayers have to bail out the very same assholes who fucked it all up in the first place. (Note to readers: when vicworld resorts to foul language, vicworld is very angry!)
The solution they appear to propose is to distribute those paper losses between the financial firms and the ordinary taxpayers -- even though the ordinary taxpayers are the ones who have suffered the real losses. Think about the family that saved for years to afford a down payment on a house with a conventional mortgage, only to see the bottom fall out of home prices and find themselves underwater. Think about the families who have seen the price of their homes plummet because they live in neighborhoods with many foreclosures. These are people who had no reason to believe they were taking on excessive risk. They were screwed, both by the financial industry and by the government that failed to oversee and regulate that industry. If there is any good reason those people should be subsidizing speculators, I can't think of it.
Now, Geithner says government should have the authority to take over any firm that creates "systemic risk." Once again, the details are missing, though. Is there a real plan to help those of us who are not "masters of the universe?"
Right now, I have very serious doubts.
Thursday, March 26, 2009
Bonus busters
Anybody still braying with populist fervor over the retention bonuses at AIG should have a look at this letter of resignation from Jack DeSantis, recipient of one of the million dollar contracts that created all the stir. It certainly resolves the questions I was left with last week when I advanced my "sneaky secretary" hypothesis (which turns out to be invalid, by the way.) A few interesting points, widely overlooked:
(I'm also one of those who believes that the highest paid employee of a company should not be earning more than twenty times what the lowest paid employee earns. If the CEO is paid a million, the clerk doing data entry should be paid fifty grand -- but since this entry is not entitled "utopian schemes," I'll say no more about that idea.)
Anyway, if a Congressional Committee ever manages an opportunity to question, say, Dick Cheney or Donald Rumsfeld, I hope it can manage to be a lot more focused and thoughtful than Financial Services was when it grilled Ed Liddy. Anybody who needs bloviation and outrage can listen to Rush Limbaugh. From our elected representatives, I think we deserve something more.
- In the case of DeSantis, at least, the retention bonus was to be his entire compensation for the year. Like Liddy, his salary for the year was one dollar.
- A relatively small number of employees of AIG's Financial Division were involved in the credit default swap mess, and almost all of those are gone from AIG.
- Confronted by frothy-mouthed Congressmen, Liddy just quaked and quivered, failing to explain the justification for offering the bonuses -- justification that actually makes some sense if you're not choking on your own bile.
(I'm also one of those who believes that the highest paid employee of a company should not be earning more than twenty times what the lowest paid employee earns. If the CEO is paid a million, the clerk doing data entry should be paid fifty grand -- but since this entry is not entitled "utopian schemes," I'll say no more about that idea.)
Anyway, if a Congressional Committee ever manages an opportunity to question, say, Dick Cheney or Donald Rumsfeld, I hope it can manage to be a lot more focused and thoughtful than Financial Services was when it grilled Ed Liddy. Anybody who needs bloviation and outrage can listen to Rush Limbaugh. From our elected representatives, I think we deserve something more.
Wednesday, March 25, 2009
Detoxification of the banking industry
I've had a chance to look at the new bank detoxification plan. On the surface, it has some positive features, foremost among them the opportunity to get a better idea of what the frozen assets are worth. If hedge funds or private investors are willing to risk any of their own money, one would assume they think there is a reasonable chance of turning a profit -- especially in the current, risk-averse environment. If "Hedgehog Investments", say, will bid fifty cents on the dollar for a batch of Citi's CDOs -- even with 93% government leverage -- one could finally establish at least a nominal value for those CDOs -- half of face value.
True, without the government leverage Hedgehog would not have bought them at all, but by buying a diverse assortment of derivatives the Hedgehog traders might assume that some of those would turn out to have real value. (This is the classic definition of a "hedge.") On the winners, Hedgehog takes 50% of the profits. On the losers, the taxpayers take 93% of the losses. Do the math. If a substantial majority of the paper is pure crap, Hedgehog still comes out ahead -- but unless the opposite is true, and most of the paper turns out to be worth more than the price paid, the taxpayer loses, big time.Great deal, huh?
Let's look a little harder. Under Treasury's plan, the banks get to decide which assets go up for sale. The most senior tranche of a security -- the shareholders entitled to be paid first when the asset pool is distributed -- is fairly safe even if the security as a whole is not performing well. Banks traditionally hold on to those senior shares. The problem for megabanks like Citi and BofA was that they were unable to unload the more junior tranches, and are stuck holding them on their books. Only those junior tranches will go to the auction block, and I think it is safe to assume that, by this late date, the banks have a pretty clear idea of which are likely to yield a profit and which are completely worthless.
Trying to get rid of the ones that are totally worthless may be tempting, but hedge fund managers rarely are total idiots, so nobody will want to buy the most junior tranches. Nobody buys a turd, no matter how deeply discounted it may be -- so the bank that made the offering would be forced to mark down the unsold turds on its books, perhaps all the way to zero. Uh oh! Here comes formal insolvency! Better to keep the turds on the books, and pretend they're still worth thirty or forty cents on the dollar.
So all trading necessarily will be in the middle tranches, but even with their heavy government subsidies, private investors still may be unwilling to pay as much as the banks need to regain real solvency. It's quite possible that hedge funds will make large profits, taxpayers will suffer enormous losses, and the big banks still will fail.
Here is one last scenario -- and I certainly hope somebody at Treasury has thought of it and is making sure it can't happen:
Citi bids 100 cents on the dollar for $300 billion worth of B of A's most toxic "assets." Under the government program, Citi puts in $21 billion of its own money, and the rest comes from the government. In the meanwhile, B of A bids 100 cents on the dollar for $300 billion worth of Citi's most toxic assets, similarly investing $21 bilion of its own money. Then, both Citi and BofA "discover" that the assets they bought are worthless, so each writes down $21 billion in losses. Each bank ends up $279 billion ahead of when it started, and the government is on the hook for $558 billion. Brilliant!
In that scenario, the taxpayers have purchased a truckload of worthless crap for 93 cents on the dollar -- probably a substantially higher price than even Henry Paulson would have been willing to pay. Could the banks get away with it? Not in the form I just presented it, but with appropriate use of proxies and the usual lack of transparency, perhaps. With complicity from key players in government, well...
Doesn't it make a lot more sense to nationalize all the big banks that can't make it on their own -- now? Fire the thieving buffoons who ran their banks into the sewer, and replace them with technocrats on the government payroll. Let those specialists take as many years as necessary to break up the megabanks and and sell off their assets, getting the best price possible for the taxpayers. In the meanwhile, Congress must enact legislation to make certain that no bank ever again becomes too big to fail. (Glass-Steagal comes to mind, for starters!)
A bank that is too big to fail is too big to exist. If Obama and company would just grow some balls and stop cringing when Republicans call them naughty naughty socialists, they will discover a great deal of popular support. Americans will accept nationalization, provided the "evil, greedy bankers" who "did it to us" are punished.
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