Monday, March 23, 2009

Finally--a really good move from Treasury.

I am optimistic about the plan from the U.S. Dept of Treasury to create a public-private vehicle for purchasing the troubled assets held by many of our financial institutions. The move will help to take these securities off of the balance sheets of our banks, insurers, pension funds, etc., and to replace these assets with fresh capital. This is a move that was tried with success during the S&L crisis of the early 1990's, as well as by the South Koreans during the Asian financial crisis later in the same decade.

Of course, while I do support this action, I will be among the first to also say that this, on its own, is not enough. There are a few other things that technocrats and legislators need to consider in this process:

  • There should be a moratorium on the use of mark-to-market in the valuation of these assets.
  • Other nations, from the European Union to China, where many of these same troubled assets are held must also consider the development of similar vehicles, in order to help companies and financial institutions within their borders clean up their own balance sheets.
  • In order to avert a repeat of this disaster, Congress and the Federal Reserve should negotiate and lower the leverage thresholds for banks and financial institutions. This will essentially cut down the amount of available credit in the marketplace, yes--but doing this will also be beneficial for other reasons. First, lowering the amount of available credit guarantees that the most favorable and most qualified borrowers can actually receive credit, while their less creditworthy and even risky counterparts do not easily burden the system again. And while lending standards improve, this move will also positively impact the total money supply, helping to raise and stabilize the value of our fiat currency.
  • The government should seek to enforce its current regulatory regime with much vigor. We do not need new rules governing hedge funds, banks, or markets--and we certainly do not need additional oversight from any new supranational body. If we will simply compel the SEC and other existing regulatory bodies to do their jobs properly, then we will be able to monitor and report the development of events like these long before they occur.
  • We should also consider hiring more academics or individuals not affiliated with Wall Street for these jobs at the SEC, et al. A big part of the problem, prior to now, was that oversight of the financial industry had been left in the hands of people with legacy ties to the industry. Too many people moved from the private sector and into government agencies overseeing their old same companies and associates. That is almost like self-policing but not, and as the Paulson Treasury Department demonstrated, there can be vast conflicts of interest and distort prudent decision-making...These regulatory bodies need to be disconnected from the industries they monitor, while also becoming attractive and well-budgeted places for staffers for career-minded talent seeking an alternative to working in the industries, themselves.
  • The Federal Reserve must not be allowed to go on a reckless printing binge...No! No! No!
Of course, the Geithner plan will not save every bank or finanical firm from ruination, but it does have the capacity to help disinfect the markets. When banks have cleaner balance sheets, they will being to trust one another again. When they trust once another again, credit will begin to flow more readily between them and to consumers. When credit begins to flow more readily (hopefully, quality credit, that is), confidence returns to the marketplace, and buyers begin to spend again. When buyers begin to spend again, we can lift our real economy out of its recession, by. Alas, the dual crises of the financial system's meltdown and the real economy's downturn can be resolves more quickly.

Wall Street Journal
MARCH 23, 2009

My Plan for Bad Bank Assets

The private sector will set prices. Taxpayers will share in any upside.


The American economy and much of the world now face extraordinary challenges, and confronting these challenges will continue to require extraordinary actions.

No crisis like this has a simple or single cause, but as a nation we borrowed too much and let our financial system take on irresponsible levels of risk. Those decisions have caused enormous suffering, and much of the damage has fallen on ordinary Americans and small-business owners who were careful and responsible. This is fundamentally unfair, and Americans are justifiably angry and frustrated.

The depth of public anger and the gravity of this crisis require that every policy we take be held to the most serious test: whether it gets our financial system back to the business of providing credit to working families and viable businesses, and helps prevent future crises.

Over the past six weeks we have put in place a series of financial initiatives, alongside the Recovery and Reinvestment Program, to help lay the financial foundation for economic recovery.
We launched a broad program to stabilize the housing market by encouraging lower mortgage rates and making it easier for millions to refinance and avoid foreclosure. We established a new capital program to provide banks with a safeguard against a deeper recession. By providing confidence that banks will have a sufficient level of capital even if the outlook is worse than expected, more credit will be available to the economy at lower interest rates today -- making it less likely that the more negative economy they fear will take place.

We started a major new lending program with the Federal Reserve targeted at the securitization markets critical for consumer and small business lending. Last week, we announced additional actions to support lending to small businesses by directly purchasing securities backed by Small Business Administration loans.

Together, actions over the last several months by the Federal Reserve and these initiatives by this administration are already starting to make a difference. They have helped to bring mortgage interest rates near historic lows. Just this month, we saw a 30% increase in refinancing of mortgages, which means millions of Americans are taking advantage of the lower rates. This is good for homeowners, and it's good for the economy. The new joint lending program with the Federal Reserve led to almost $9 billion of new securitizations last week, more than in the last four months combined.

However, the financial system as a whole is still working against recovery. Many banks, still burdened by bad lending decisions, are holding back on providing credit. Market prices for many assets held by financial institutions -- so-called legacy assets -- are either uncertain or depressed. With these pressures at work on bank balance sheets, credit remains a scarce commodity, and credit that is available carries a high cost for borrowers.

Today, we are announcing another critical piece of our plan to increase the flow of credit and expand liquidity. Our new Public-Private Investment Program will set up funds to provide a market for the legacy loans and securities that currently burden the financial system.

The Public-Private Investment Program will purchase real-estate related loans from banks and securities from the broader markets. Banks will have the ability to sell pools of loans to dedicated funds, and investors will compete to have the ability to participate in those funds and take advantage of the financing provided by the government.

The funds established under this program will have three essential design features. First, they will use government resources in the form of capital from the Treasury, and financing from the FDIC and Federal Reserve, to mobilize capital from private investors. Second, the Public-Private Investment Program will ensure that private-sector participants share the risks alongside the taxpayer, and that the taxpayer shares in the profits from these investments. These funds will be open to investors of all types, such as pension funds, so that a broad range of Americans can participate.

Third, private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets.
The new Public-Private Investment Program will initially provide financing for $500 billion with the potential to expand up to $1 trillion over time, which is a substantial share of real-estate related assets originated before the recession that are now clogging our financial system. Over time, by providing a market for these assets that does not now exist, this program will help improve asset values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets. The ability to sell assets to this fund will make it easier for banks to raise private capital, which will accelerate their ability to replace the capital investments provided by the Treasury.

This program to address legacy loans and securities is part of an overall strategy to resolve the crisis as quickly and effectively as possible at least cost to the taxpayer. The Public-Private Investment Program is better for the taxpayer than having the government alone directly purchase the assets from banks that are still operating and assume a larger share of the losses. Our approach shares risk with the private sector, efficiently leverages taxpayer dollars, and deploys private-sector competition to determine market prices for currently illiquid assets. Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience.

Moving forward, we as a nation must work together to strike the right balance between our need to promote the public trust and using taxpayer money prudently to strengthen the financial system, while also ensuring the trust of those market participants who we need to do their part to get credit flowing to working families and businesses -- large and small -- across this nation.

This requires those in the private sector to remember that government assistance is a privilege, not a right. When financial institutions come to us for direct financial assistance, our government has a responsibility to ensure these funds are deployed to expand the flow of credit to the economy, not to enrich executives or shareholders. These provisions need to be designed and applied in a way that does not deter the participation by the private sector in generally available programs to stabilize the housing markets, jump-start the credit markets, and rid banks of legacy assets.

We cannot solve this crisis without making it possible for investors to take risks. While this crisis was caused by banks taking too much risk, the danger now is that they will take too little. In working with Congress to put in place strong conditions to prevent misuse of taxpayer assistance, we need to be very careful not to discourage those investments the economy needs to recover from recession. The rule of law gives responsible entrepreneurs and investors the confidence to invest and create jobs in our nation. Our nation's commitment to pursue economic policies that promote confidence and stability dates back to the very first secretary of the Treasury, Alexander Hamilton, who first made it clear that when our government gives its word we mean it.

For all the challenges we face, we still have a diverse and resilient financial system. The process of repair will take time, and progress will be uneven, with periods of stress and fragility. But these policies will work. We have already seen that where our government has provided support and financing, credit is more available at lower costs.

But as we fight the current crisis, we must also start the process of ensuring a crisis like this never happens again. As President Obama has said, we can no longer sustain 21st century markets with 20th century regulations. Our nation deserves better choices than, on one hand, accepting the catastrophic damage caused by a failure like Lehman Brothers, or on the other hand being forced to pour billions of taxpayer dollars into an institution like AIG to protect the economy against that scale of damage. The lack of an appropriate and modern regulatory regime and resolution authority helped cause this crisis, and it will continue to constrain our capacity to address future crises until we put in place fundamental reforms.

Our goal must be a stronger system that can provide the credit necessary for recovery, and that also ensures that we never find ourselves in this type of financial crisis again. We are moving quickly to achieve those goals, and we will keep at it until we have done so.

Mr. Geithner is the U.S. Treasury secretary.


Mashoud said...

Yes, I agree with you, Gary. This is a start to getting things back in order.

Anonymous said...

I guess it seems that Obama and his people have a steady hand and can get it right after all. Critics be damned.

Jonathan B. Melancon said...

Critics be damned? You know there is a word for that, its called fascism. I guess I'm one of those critics who should be "damned". Because I want our leaders in Washington to do the right thing and be responsible with the power bestowed upon them. For that, let me be damned. Yeah, ok…

As to this latest attempt to restore the economy. I'm in agreement with Gary that finally something worth while is being done. Of course as a critic of Keynesian economics (damn me to hell) I have problems with yet even more government involvement but as the saying goes "beggars can't be choosers".

And of course, all this really does is continue to try and prop up our nation's bubble economy. Always remember this, spending more than you earn and going into debt to obtain that which you cannot afford is not a foundation upon which prosperity is built. Yet that is EXACTLY the economic situation America is in. We borrow money from China to consume the goods which they produce. We are a dependent, debtor nation, our prosperity is built on debt and this party cannot last forever. Until we repair the foundation, we will continue to have major problems. So while we take steps to lessen the pain of this recession, we need to get to work fixing the foundation.

But see, here’s the thing. And I had a conversation with Gary about this a while back. This latest "solution" (which is probably the best so far) did not come to light until after the passing of the 700 billion dollar "stimulus bill" (no one had the chance to read before voting), a budget that will generate 9.3 trillion in deficits over the next 10 years and the creation of ungodly amounts of dollars out of thin air (just to name a few). As Rob Emmanuel recently was on record saying "Never let a serious crisis go to waste. What I mean by that is it’s an opportunity to do things you couldn’t do before.”

You see, now that the boys and girls in power pulled the wool over our heads and did that which they would have never been able to do otherwise. I guess now they can get to the business of actually trying to fix this mess. Wake up people, the government is the problem!

Mashoud said...

Well said, Jonathan. What do you think of Gary's idea for legislatively lowering the leverage thresholds for commercial banks, investment banks, hedge funds, etc.?

Cedrick said...

At least the Democrats have stepped up to the plat... At least the Democrats have stepped up to the plate. It was all those "free-marketeers" who started the process of throwing good money after bad back in 2007.

Bush created this problem and his cronies got away with murder at the expense of the taxpayers. The drove up prices on everything, while making harder on regular people to just keep up. Now people are upset because a new president who hasn't been in office 3 months is trying to right our course.

It sounds to me like all of the rich boys are just upset that they will not have their way anymore.

Oh, Gary---is the GH logo for something new? It's nice.

Jonathan B. Melancon said...

Mashoud, I'm definitely in agreement with Gary on that. I'd also like to see them reinstate Glass-Steagall while they're at it.

Cedrick, that's ridiculous. I don't even know where to begin. Let me start by saying Bush was no where near a "free-marketeer", he was a status-quo, business as usual politician. He presided over the largest expansion of government this nation has ever seen (up until this administration stepped in). When Bush was in office I was a stanch critic of his economic policies. I could give a rat's ass about Bush or Republicans. I'm an independent who wants our leaders to be responsible and to do the right thing. That means we need to work our way to sound Austrian economic principles and away from a Keynesian boom-bust, smoke & mirrors economy. Give me independence from government not dependence on government. Its a battle of ideas not political parties. Free your mind of political party idolatry.

The democrats are not the only ones who "stepped up to the plate", the opposition has offered their plan as a starting point for negotiation, but Nancy Pelosi's response was we don't care what you have to say "WE WON!".

Now, what's this deal about the rich boys are upset? First off let me say I am NOT one of these "rich boys", trust me. Be careful about making blind assumptions (Gary had a blog on the subject which I know you read). I'm just your average working middle-class guy trying to raise my two little girls and be a good husband to my wife. But to the point about the rich, if you haven't noticed, its more often than not the rich who start businesses, employ people, invest, pay the most money in taxes, give the most to charity, ect. This class warfare stuff is garbage. Leave that to Castro and Chavez.

Anonymous said...

I would agree that it would be a step in the right direction if, and only if, they would take into those considerations you pointed out, GH. I guess that leaves us with one question--Are they? There is no doubt that we need a fresh start, but I just don't know/trust where we go from there. The only indication I have is we will continue on the same path of doom. They may say that they are looking out and they understand American's frustrations, but what they have been doing instead is continuing to try to "loosen" the credit markets so we may continue to build an illusion of grandeur, contine to give our money as bonuses to undeserving people, continue to triple our deficit, continue to spend, spend, spend. To me it seems the banks just want to get back to normal, but the Fed is saying, "Hey, we just loaned you money we don't have. Spend it, damnit!" Am I off base there? To me, as far as I can see, they are continuing to pile drive this economy/Country in the dirt. For every incentive they make they spend 3x as much. The only difference is, instead of investors putting more capital into their companies, they are putting it into the Fed and the Fed gives the money to whoever they damn well feel like it whether it will help us or not. I no longer believe anything the politicians say the will do, but only what they actually do. The only plan that will save us, is for us to stop ACTING like we got money to spend on this, that and the other, and start looking out for the workers. Maybe that's too much in Layman's terms for them to understand.

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