The Citigroup Bailout

The Citigroup Bailout
It's bailout time. Let's start with Paul Kedrosky:
Apparently Citibank and the U.S. government (i.e., we taxpayers) have reached a deal whereby we will backstop something like $300-billion in screwed assets on Citi's balance sheet. ... Here is the gist:
Citi will carve out $300-billion in troubled assets, which will remain on its balance sheet
The first $37-$40-billion in losses on those assets will go to Citi
The next $5-billion in losses will hit Treasury
The next $10-billion in losses will go to the FDIC
Any more losses will go to the Fed
There will be no management changes at Citi, because, you know, they are all fine and upstanding people who have done nothing wrong
There will be some compensation limitations, but those have not yet been made clear
To be clear, this is not a "bad bank" model. Assets are not, apparently, being taken off the Citi balance sheet and put into another entity walled off from the Citi biological host. Instead, they are being left on the Citi balance sheet, but tagged and bagged for eventual disposal via taxpayers. ...
I'll have more when there is more, and I know the equity futures markets like it -- it's admittedly less terrifying that letting Citi fail -- but so far I'm not impressed. ...
Yves Smith:
WSJ: US Agrees to Bail Out Citi (Updated): ...Note key element of the deal is that the Federal government will guarantee $300 billion of Citi assets, a much bigger number than had been leaked earlier, with a rather convoluted loss-sharing arrangement, but the bottom line is that Citi is at risk for at most $40 billion. Citi also gets a $20 billion equity injection, on slightly more onerous terms than the initial TARP investments, but still more favorable than Warren Buffett's investment in Goldman. Oh, and it appears there will be NO management changes. I do not see how GM can be denied a rescue now (not that that outcome is really in doubt, merely how much pain will be inflicted on management and the UAW). ...
Update 12:50 AM: Bloomberg's story puts the bad asset program slightly higher, at $306 billion. ...
Calculated Risk has the Joint Statement by Treasury, Federal Reserve, and the FDIC on Citigroup, while James Kwak says the bailout is "Weak, Arbitrary, Incomprehensible." I think he has it right:
Citigroup Bailout: Weak, Arbitrary, Incomprehensible: According to the Wall Street Journal, the deal is done. Here are the terms. In short: (a) Citi gets another $27 billion on the same terms as the first $25 billion, except that the interest rate is now 8% instead of 5%, and there is a cap on dividends of $0.01 per share per quarter; and (b) the government (Treasury, FDIC, Fed) agrees to absorb 90% of losses above $29 billion on a $306 billion slice of Citi’s assets, made up of residential and commercial mortgage-backed securities. (If triggered, some of that guarantee will be provided as a loan from the Fed.) There is also a warrant to buy up to $2.7 billion worth of common stock (I presume) at a staggeringly silly price of $10.61 per share (Citi closed at $3.77 on Friday).
The government (should have) had two goals for this bailout. First, since everyone assumes Citi is too big to fail, the bailout had to be big enough that it would settle the matter once and for all. Second, it had to define a standard set of terms that other banks could rely on and, more importantly, the market could rely on being there for other banks. This plan fails on both counts.
The arithmetic on this deal doesn’t seem to work for me (feel free to help me out). Citi has over $2 trillion in assets and several hundred billions of dollars in off-balance sheet liabilities. $27 billion is a drop in the bucket. Friedman Billings Ramsey last week estimated that Citi needed $160 billion in new capital. (I’m not sure I agree with the exact number, but that’s the ballpark.) Yes, there is a guarantee on $306 billion in assets (which will not get triggered until that $27 billion is wiped out), but that leaves another $2 trillion in other assets, many of which are not looking particularly healthy. If I’m an investor, I’m thinking that Citi is going to have to come back again for more money.
In addition, the plan is arbitrary and cannot possibly set an expectation for future deals. In particular, by saying that the government will back some of Citi’s assets but not others, it doesn’t even establish a principle that can be followed in future bailouts. In effect, the message to the market was and has been: “We will protect some (unnamed) large banks from failing, but we won’t tell you how and we’ll decide at the last minute.)” As long as that’s the message, investors will continue to worry about all U.S. banks.
The third goal should have been getting a good deal for the U.S. taxpayer, but instead Citi got the same generous terms as the original recapitalization. 8% is still less than the 10% Buffett got from Goldman; a cap on dividends is a nice touch but shouldn’t affect the value of equity any. By refusing to ask for convertible shares, the government achieved its goal of not diluting shareholders and limiting its influence over the bank. And an exercise price of $10.61 for the warrants? It is justified as the average closing price for the preceding 20 days, but basically that amounts to substituting what people really would like to believe the stock is worth for what it really is worth ($3.77).
How does this kind of thing happen? A weekend is really just not that much time to work out a deal. Maybe next time Treasury and the Fed should have a plan before going into the weekend?
What, and ruin a perfect record? Robert Reich:
Citigroup Scores: If you had any doubt at all about the primacy of Wall Street over Main Street; the utter lack of transparency behind the biggest government giveaway in history to financial executives, and their shareholders, directors, and creditors; and the intimate connections the lie between Administrations -- both Republican and Democratic -- and the heavyweights on Wall Street, your doubts should be laid to rest. Today it was decided the government will guarantee more than $300 billion of troubled mortgages and other assets of Citigroup under a federal plan to stabilize the lender after its stock fell 60 percent last week. The company will also will get a $20 billion cash infusion from the Treasury Department, adding to the $25 billion the bank received last month under the Troubled Asset Relief Program.
This is not a particularly good deal for American taxpayers, but it is a marvelous deal for Citi. In return for all the cash and guarantees they are giving away, taxpayers will get only $27 billion of preferred shares paying an 8 percent dividend. No other strings are attached. The senior executives of Citi, including those who have served at the highest levels in the US government, have done their jobs exceedingly well. The American public, including the media, have not the slightest clue what just happened.
Meanwhile, more than a million workers in the automobile industry, along with six million mortgagees, and a millions of Americans who depend on small businesses and retailers for paychecks, are getting nothing at all.
As I noted the other day, the difference in urgency between saving wall street and saving main street is apparent.
John Jansen says somebody will pay for this:
Reaction to the Bailout: Tokyo is closed so there is no US Treasury trading this evening. We will have to wait for Europe to arrive to get a reaction.
Stocks are higher. That also seems ludicrous. I do not care what they call this but Citibank is effectively acknowledging that they did not have the resources to survive alone without government assistance. I did not use the words bankrupt or insolvent.
I think that when participants think about this soberly they will be very disturbed and I am saddened to say that the markets will line up one of the remaining survivors for a pre holiday turkey shoot. It has been the history of this rolling crisis since August 2007 that the worst outcome ensues. The market will seek another prey and relentlessly pursue it.
Update: Paul Krugman:
A bailout was necessary — but this bailout is an outrage: a lousy deal for the taxpayers, no accountability for management, and just to make things perfect, quite possibly inadequate, so that Citi will be back for more.
Amazing how much damage the lame ducks can do in the time remaining.
Update: More from Arnold Kling
For all of the Depression Mania, there is a lot of the U.S. economy that does not have to shrink. Manufacturing is pretty lean to begin with. Housing construction is already much lower than it has been in years. Unlike the 1930's, we have some very big sectors (health care, education, other government employment) that are unlikely to develop massive layoffs.
The one sector that definitely needs to contract is the financial sector. Maintaining Citi as a zombie bank is not really constructive. I would feel better if it were carved up, with the viable pieces sold to other firms and the remainder wound down by government. In my view, getting the financial sector down to the right size ought to be done sooner, rather than later.
From my perspective, the whole TARP/bailout concept is misconceived. The priority should not be saving firms. The priority should be pruning the industry. Get rid of the weak firms, and make good on deposit insurance. Then let the remaining firms provide the lending that the economy needs.
Update: Felix Salmon says the bailout is underwhelming.
Update: John Hempton:
The consensus is that the Citigroup bailout was bad...I am going to differ here. The bailout was well designed...
except
1). The Government should have taken a much larger fee - at least 20 percent ownership of Citigroup - and arguably more. Shareholders should be punished.
2). The attachment point of the excess of loss policy is too high. If the attachment point had been 80 billion Citigroup would survive. There was no need for a 40 billion dollar attachment point.
The problem with the bailout was not the design - it was the amount extracted from Citigroup shareholders. The government took too much risk for too little reward.
I am surprised that the shareholders were not effectively wiped out as per Fannie, Freddie, AIG.
Not displeased - but somewhere I wish the government would get a happy medium somewhere - rather than one rule Citigroup and one rule for Fannie.
Update: Andrew Samwick:
The technical term for this is a joke.
Citigroup has plenty of assets. It has just written too many claims on those assets. Those holding those claims need to face the reality that their claims are worth less than they were promised and adjust to that reality. That means either liquidating the firm, selling off the assets to the highest bidders, or becoming the new equity holders of the firm. The FDIC can get involved as needed to manage its contingent liabilities to insured depositors.
If the government is to get involved beyond that, it should be senior debt to the restructured entity, not preferred equity (i.e. junior to the most junior debt) to the existing entity.
Update: Barry Ritholtz:
Un-fricking-believable.
The US is guaranteeing $306 billion on bad investments (So much for Capitalism without failure). For Citi, its a great deal — but its a terrible one for taxpayers.
The dividend payment has been restricted to one cent per quarter for 3 years. Can someone explain why even a penny is allowed?
Where is the “Protection” for the taxpayers? Where are the clawbacks? How about going after the idiots that bought a third of a trillion dollars worth of junk, and then got paid large on it? Where is the sense of outrage and justice?
At what point do taxpayers demand that the people responsible for creating this mess must pay their pound of flesh?
Update: Brad DeLong:
It is unclear to me why they aren't just buying common stock. As it is, they're endangering their own reputations to an extraordinary degree...
Posted by Mark Thoma on Monday, November 24, 2008 at 12:24 AM in Economics, Financial System
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Mark Thoma has a roundup of commentary on the Citigroup bailout. I'll add a few thoughts. 1. For all of the Depression Mania, there is a lot of the U.S. economy that does not have to shrink. Manufacturing is pretty... [Read More]
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Just because someone is angry and clearly motivated by self-interest doesn't mean he's wrong. Former American International Group chief Maurice Greenberg has railed against the Fed's bailout of the insurer since the deal was struck in early September. ... [Read More]
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Comments

Bruce Wilder says...
This is so completely beyond ridiculous, it is hard to even express it adequately. I really wouldn't be surprised if the sheer cluelessness on display doesn't eventually trigger the final total panic.
Posted by: Bruce Wilder Link to comment November 23, 2008 at 11:40 PM
Easy Money says...
Jansen nails it. It's a delicious irony - the liquidity monster the Fed has created is chewing the Fed's own behind.
Apparently Helicopter Ben and Krugman think there is no limit to the good faith and credit of the US. They can spend at will and the world with just ask how high they must jump. They may get a rude shock someday, and for the rest of us it will be well beyond a rude shock.
Posted by: Easy Money Link to comment November 23, 2008 at 11:40 PM
Bruce Wilder says...
Karl Marx on our Great Depression Redux: “Hegel remarks somewhere that all great, world-historical facts and personages occur, as it were, twice. He has forgotten to add: the first time as tragedy, the second as farce.”
Posted by: Bruce Wilder Link to comment November 23, 2008 at 11:43 PM
ndk says...
And the Fed's balance sheet deteriorates further, while real interest rates rise. Tick tock, tick tock...
Posted by: ndk Link to comment November 23, 2008 at 11:56 PM
mmckinl says...
This is all about the bond holders. They are now back in business.
This also makes an FDR style Bank Holiday much more expensive for the tax payer. All those guarantees are money lost. According to a report in the WSJ Citi alone needs 160 billion ...
Posted by: mmckinl Link to comment November 23, 2008 at 11:58 PM
Bruce Wilder says...
So, basically, when you strip away all the mumbo-jumbo, I think Citibank gets roughly $300 billion in cash, and pays about 5% interest. Correction welcome.
Nice work. Somebody deserves a bonus for this one.
Posted by: Bruce Wilder Link to comment November 24, 2008 at 12:07 AM
a says...
For all those who supported the other bailouts, I hope you have now learned a bit how extensive the words "moral hazard" can be.
Posted by: a Link to comment November 24, 2008 at 12:15 AM
Dave says...
The US (and possibly) the world is one huge step closer to hyper-inflation / stagflation as a result of these actions.
Posted by: Dave Link to comment November 24, 2008 at 12:22 AM
Lafayette says...
Despite all this wailing and gnashing of teeth combined with the distress for the sorry plight of the eponymous "taxpayer", nowhere is to be seen the right of shareholders to a communal action against the management of the banks in question for negligence.
And, indeed, where are the ambulance-chasing lawyer vultures on this one? Nowhere to be seen ...
Which means, essentially, that these SOBs are going to get away with it.
Posted by: Lafayette Link to comment November 24, 2008 at 12:39 AM
craig tindale says...
Lets just jump ahead and declare capitalism dead, Shumpeters end of capitalism where individual motivation subsides, collectivistic mentality prevails and the growing importance of teamwork in modern firms would lead to the gradual obsoleteness and at the end disappearance of the entrepreneur.w
Let just declare capitalism dead and socialism the winner, because that where we are heading for JKBs democratic socialism?
just jump ahead a few years its starting to look like the demise of capitalism and the birth of a hybrid of socialism
Posted by: craig tindale Link to comment November 24, 2008 at 01:04 AM
Beezer says...
The value of assets is declining. Everywhere. Despite appearances, money appears to be disappearing. It simply is not visible. There is no trigger that would indicate that demand for goods and services will increase.The wealthy can only buy so much. Until some of this supposed liquidity finds its way down into more bank accounts, the pressure on prices will be downward.
Posted by: Beezer Link to comment November 24, 2008 at 01:19 AM
hari says...
Look it seems the pundits are all missing the real point of gov bailout.
German experts on finance have also read the fine print from weekend bailout and call it *nationalization* of Citigroup.
The taxpayer has become owner of Citigroup - going forward.
Posted by: hari Link to comment November 24, 2008 at 01:31 AM
esb says...
1. Locate the best and most expensive liquor you have in the house. Pour out a generous serving.
2. Calculate the market capitalization of C at Friday close.
3. Calculate the Federal exposure from the term sheet.
4. Spend a few moments contemplating the realtionship between the claculations in 2 and 3.
5. Consume the libation.
6. Repeat steps 1 and 5.
Posted by: esb Link to comment November 24, 2008 at 01:36 AM
Rick Steinberg says...
OK IT IS NOT THE BEST DEAL POSSIBLE BUT ISN'T PROTECTING THE BNDS AND STK HOLDERS PROTECTING MAIN STREET. IT SEEMS TO ME ALOT OF MAIN STREET OWNS C BNDS & STK THRU MUTUAL FUNDS AND IND. PRFD'S AND BNDS. ALOT OF EDERLY IN THE US DEPEND ON DIVIDENDS FROM THE PRFD'S TO SUPPLEMENT THEIR RETIREMENT.
LETTING C FAIL WOULD HAVE BEEN ALOT WORSE NOT THAT THIS IS PERFECT. THE BANKS WILL ONLY COME BACK WHEN REAL ESTATE AND EMPLOYMENT STABILIZES.
THIS IS THE MOST NEGATIVE BLOG I HAVE EVER SEEN. NO MATTER WHAT WOULD HAVE HAPPENED EVERYBODY HERE WOULD HAVE BEEN CRITICAL.
Posted by: Rick Steinberg Link to comment November 24, 2008 at 03:10 AM
save_the_rustbelt says...
Rubin, board member of Citi. Rubin (and his son) players in the Obama administration.
From the NYT:
Rubinomics RecalculatedBy JACKIE CALMES
WASHINGTON — It is testament to former Treasury Secretary Robert E. Rubin’s star power among many Democrats that as President-elect Barack Obama fills out his economic team, a virtual Rubin constellation is taking shape.................
Posted by: save_the_rustbelt Link to comment November 24, 2008 at 04:10 AM
Zipf says...
Rick Steinberg -
My retirement investments are highly diversified. So my exposure to C by itself is minimal. (Not so much for the entire finance industry, but C by itself is not a significant amount of my portfoloio.)
If Main Street had a non-diversified retirement portfolio of only C or C's bonds, then too bad - they were warned: "Not FDIC Insured - No Bank Guarantee - May Lose Value".
Posted by: Zipf Link to comment November 24, 2008 at 04:18 AM
ECONOMISTA NON GRATA says...
craig tindale:
".....just jump ahead a few years its starting to look like the demise of capitalism and the birth of a hybrid of socialism....."
This ain't no socialism. We socialists may be crazy, but we ain't stupid.
Now we have an impaired Treasury bailing out an impaired bank. I knew that sooner or later one of these boys was going to shoot his foot off. I really underestimated their ability to fuck things up. Where's Elliot Spitzer when you need him.....?
Best regards,
Econolicious
Posted by: ECONOMISTA NON GRATA Link to comment November 24, 2008 at 05:04 AM
Lafayette says...
CT: Let just declare capitalism dead and socialism the winner, because that where we are heading for JKBs democratic socialism?
Just goes to show how many Americans do not understand modern socialism.
Not to worry, the US is light-years away from European-style socialism or even Social Democrat policy.
Posted by: Lafayette Link to comment November 24, 2008 at 05:04 AM
ECONOMISTA NON GRATA says...
PS
By the way, gold is up about 30 buck this morning and the dollar is taking it up the youknowwhere. I guess that we can say that we're disengaging from the global community and forming our own planet.
ENG
Posted by: ECONOMISTA NON GRATA Link to comment November 24, 2008 at 05:24 AM
Ninja Zombie says...
From the article: "Note key element of the deal is that the Federal government will guarantee $300 billion of Citi assets,...
I do not see how GM can be denied a rescue now..."
The Iraq was poorly carried out, and is a big mess. Yet we continue to fight, hoping things will someday turn around...
I do not see how a war with Iran can be opposed now...
Posted by: Ninja Zombie Link to comment November 24, 2008 at 05:29 AM
ken melvin says...
Wouldn't we be better off to do as Alan proposed, bite the bullet and declare all the derivative crap worthless and be done with it? do we want this stuff lying around only to reappear a second time per Bruce's above?
These 'asssets' were obviously the fount of all the humongous salaries, so as Lafayette proposes, sue the p.ss out of the bas..ards for running the scam.
Posted by: ken melvin Link to comment November 24, 2008 at 05:32 AM
save_the_rustbelt says...
Ya, what Ken said.
Like castor oil, swallow hard and be done with it.
Posted by: save_the_rustbelt Link to comment November 24, 2008 at 05:38 AM
degustibus says...
Let's all loot the treasury.
Posted by: degustibus Link to comment November 24, 2008 at 05:47 AM
swells says...
Okay, I understand what's wrong with the Citi deal. What's the alternative(s)? These guys are just trying desperately to hold the center against an overwhelming force. It won't work but there you have it. As for myself, I made some money trading Citi around the time of the initial TARP (along with Bank of America). Then I took my principal and profits and invested in foreign gold mining companies. You watch, the short sellers will now pick a new institution to take down. The rules on short selling and the lack of enforcement against naked short sellers are scandalous but they will raid and raid again until the system puts some limits on their activities that make sense, like reinstituting the uptick rule and prosecuting naked short sellers for fraud when they don't hit settlement date.
The dollar is headed for the bottom of the barrel. Plan accordingly.
Posted by: swells Link to comment November 24, 2008 at 05:54 AM
ken melvin says...
From Steve Clemons:http://www.thewashingtonnote.com/archives/2008/11/bill_richardson_3/
The answer was pretty shocking.
GM said that it was taking all of the technology it could get its hands on -- whether from the labs or elsewhere -- and fully deploying it in China.
GM felt that this was a way to embed itself deeply in the Chinese economy over the next three decades and would keep the car manufacturer ahead of the more technologically-stingy Japanese firms as well as Daimler and Chrysler which had already had hiccups at that time in their China activities.
In a different realm, Citibank has been a leader in off-shoring, pushing more and more of its financial services support base overseas.
Now taxpayers are being asked to bail out these large firms which showed little interest in the economic health of the nation and which engaged in "winner-takes-all capitalism" where those at the top, like Robert Rubin, became mega-wealthy with little regard to the eroding conditions of America's middle class.
There's much more under the link
Posted by: ken melvin Link to comment November 24, 2008 at 06:07 AM
Joe says...
What a fraud on the U.S, citizen .
Posted by: Joe Link to comment November 24, 2008 at 06:09 AM
anne says...
http://krugman.blogs.nytimes.com/2008/11/24/citigroup/
November 24, 2008
CitigroupBy Paul Krugman
Mark Thoma * has the rundown of informed reactions. A bailout was necessary — but this bailout is an outrage: a lousy deal for the taxpayers, no accountability for management, and just to make things perfect, quite possibly inadequate, so that Citi will be back for more.
Amazing how much damage the lame ducks can do in the time remaining.
* http://economistsview.typepad.com/economistsview/2008/11/the-citigroup-b.html
Posted by: anne Link to comment November 24, 2008 at 06:12 AM
Worker says...
Where's Elliot Spitzer when you need him.....?
Bemoaning the losses of his families fortune by doing some blow f'ing an overpriced prostitute in his socks?
Sorry. You asked.
Posted by: Worker Link to comment November 24, 2008 at 06:14 AM
anne says...
What is too little understood is just how active and effective this Administration has been from the beginning till now, an Administration that has been almost completely united on changing the nature of government and continually at work on doing just that in every direction in domestic and foreign policies. Change back will need to be determined and painstaking, and will be long in coming if so.
Posted by: anne Link to comment November 24, 2008 at 06:15 AM
Jose Padilla says...
"German experts on finance have also read the fine print from weekend bailout and call it *nationalization* of Citigroup."
No, this is exactly backwards. What we really have is privitization of the Fed.
Posted by: Jose Padilla Link to comment November 24, 2008 at 06:17 AM
anne says...
"Bemoaning the losses of his families fortune by doing...."
Quite the disgusting degenerate comment, please do continue being disgusting and degenerate though.
Posted by: anne Link to comment November 24, 2008 at 06:17 AM
bakho says...
The taxpayers should demand a higher tax rate on bailed out banks once they recover.
Posted by: bakho Link to comment November 24, 2008 at 06:35 AM
says...
"Okay, I understand what's wrong with the Citi deal. What's the alternative(s)?"
To start, how about setting the price of the warrant more in line with the market price of Citi on Friday. Even this is generous, as that price assumed a high probability of a Government bailout. Since Citi is incapable of surviving without Government help, any price above $0 is a gift to the stockholders.
And, regarding the rest of the post, are there really people who still think that these problems are somehow the result of short sellers?
Posted by: Link to comment November 24, 2008 at 06:36 AM
lonesome moderate says...
If you click on the links from the links in Mark's original post, it turns out that this $326 billion in equity and guarantees is on top of the $270 billion of guarantees that Citi alreay got when agreed to take over Wachovia. Since Wells Fargo had been willing to take over Wachovia without any guarantees, that means that the taxpayers are apparently on the hook for $596 billion to save just one bank.
http://brontecapital.blogspot.com/2008/11/citigroup-whachovia-sheila-bair-and.html
Posted by: lonesome moderate Link to comment November 24, 2008 at 06:50 AM
ken melvin says...
Will anyone be surprised if Spitzer brings civil suit against some of these boys?
Posted by: ken melvin Link to comment November 24, 2008 at 07:06 AM
says...
Not that long ago, the majority of people on this blog were demanding that the Fed/Treasury Tag Team RECAPITALIZE the banks. Remember? TARP was a bad move, the Europeans got it right, the 700 billion should be for recapitalizing banks.
You got your wish!
Whats the problem? The banks are getting recapitalized. You asked for it.
Posted by: Link to comment November 24, 2008 at 07:12 AM
swells says...
says, nobody said the problems at Citi were the result of short selling. The problems at Citi are bad. What I was talking about was 60% of the market value evaporating in 2 days which is what precipitated this particular bailout as Citi's ability to survive is related to it's ability to raise funding.
The absurd price on the warrant is one of the things that is wrong with the deal.
Posted by: swells Link to comment November 24, 2008 at 07:15 AM
ken says...
It is time to focus on asset prices and what can be done to support them. What we need are programs to support home prices.
Fistly, money/labor needs to spent on asset improvements. Homes need to be repainted, recarpeted, remodeled, rooms added, pools put in, landscaped etc. A lot of this can be done by the labor of homeowners themselves but a lot requires professional installations.
Citibank, and others, may be better off in the long run if they cut their dividends to shareholders and used that money to provide zero interest loans, or even grants, to homeowner/borrowers for home improvements. This would raise the value of the collateral behind thier investments. How many square feet of household living space could be added to the existing collateral by spending all the dividend on house additions?
Secondly, city, county and state municipalities need to revisit all their land laws with an eye to boosting value immediately.
One quick fix would be to rezone troubled areas from SFH to R2 or R2. This can be done in large swaths by municipalities or by case by case basis. Either way the mortgages that were once secured by a single family home now become secured by a property with the potential for double or triple family occupancy. Even with no permits pulled and building taking place this action would drive up the value of the property rezoned.
Less drastic but along the same lines would be to rezone entire munincipalties where trouble assets exists to allow for granny flats with simplified permiting or permit fee waivers.
Along the same lines municipalites can utilize the redevelopment agencies for homeowners like they do for businesses. Redevelopment agencies can pull down old apartment buildings that suffer from too many persistant code violations, they can then offer incentives to rebuild into fewer units that are up to code. This along with conversion of single family homes into duplexes would support asset prices of both apartment owners and homeowners.
I think that all the concern about troubled assets on bank balance sheets is the right concern but the solution may be found quicker if go to improving the property collateral itself.
Posted by: ken Link to comment November 24, 2008 at 07:20 AM
liberal says...
"Not that long ago, the majority of people on this blog were demanding that the Fed/Treasury Tag Team RECAPITALIZE the banks. ... Whats the problem? The banks are getting recapitalized. You asked for it."
Yeah, we were asking for it on decent, intelligent terms. We didn't ask for highway robbery.
Posted by: liberal Link to comment November 24, 2008 at 07:25 AM
liberal says...
ken wrote, "What we need are programs to support home prices."
That's crazy.
First, it's inequitable; it rewards people who own homes, at the expense of people who don't.
Second, it's unworkable. You're trying to prop prices up in the middle of a popping bubble. Game ain't worth the candle.
Posted by: liberal Link to comment November 24, 2008 at 07:27 AM
im1dc says...
Interesting day to be alive. Add this to Prof Thoma's posted must reads:
Fed Pledges Top $7.4 Trillion to Ease Frozen Credit (Update1)
By Mark Pittman and Bob Ivry
Nov. 24 (Bloomberg) -- The U.S. government is prepared to lend more than $7.4 trillion on behalf of American taxpayers, or half the value of everything produced in the nation last year, to rescue the financial system since the credit markets seized up 15 months ago.
http://bloomberg.com/apps/news?pid=20601109&sid=arEE1iClqDrk&refer=home
So once again I say "What me worry?"
Posted by: im1dc Link to comment November 24, 2008 at 07:31 AM
ken says...
liberal,
What is inequitable about banks cutting dividends to shareholders and using that money instead to improve the collateral behind thier loans? That helps shareholders in the long run and it doesn't affect anyone else.
And what is inequitable about municipalities rezoning property or streamlining permitting etc in order to boost property values? That doesn't affect anyone negatively. It helps everyone.
If asset prices are the problem then the solution is by boosting asset prices. This is the fairest way for everyone. Everyone wins.
Posted by: ken Link to comment November 24, 2008 at 07:33 AM
Duke of Con Dao says...
here's a short video mash-up I tossed together on the Citigroup debacle.... I know this is a serious blog site but a bit of humor now and again can't be all bad...
http://www.youtube.com/watch?v=pPfbXFf4g2k
Posted by: Duke of Con Dao Link to comment November 24, 2008 at 07:34 AM
bullbust says...
Whatever happened has happened. So we have to pay our blood and sweat to the plutocrats again. Because otherwise it will be worse. So says Bernanke.
And so the great thinking of the acadamics and economists is now in actions. We have to save the system - so bailout first, accountability later.
I eagerly await the day of accountability. Is Mark Thoma willing to acknowledge that this "lousy deal" is a pre-ordained outcome of his "save the system" stance? Does he get the implications of what he was arguing for all this time?
Lousy deals and more looting was all baked in when they decided to save the system.
No economist should be allowed to come close to public office.
Posted by: bullbust Link to comment November 24, 2008 at 07:36 AM
Patrick says...
nakedcapitalism pointed out that the guarantee lets them pool their toxic waste and repo it. Effectively turning sludge into about $270 billion.
I think that it's now obvious that Pandit was lying. Where are the criminal charges?
Posted by: Patrick Link to comment November 24, 2008 at 07:44 AM
Ninja Zombie says...
Ken: "If asset prices are the problem then the solution is by boosting asset prices. This is the fairest way for everyone. Everyone wins."
The problem is not that homes are currently undervalued. The problem is that they are currently overvalued, and were previously overvalued even more.
Trying to make them overvalued will only make the problem worse.
Posted by: Ninja Zombie Link to comment November 24, 2008 at 07:51 AM
Vince says...
a says...
"For all those who supported the other bailouts, I hope you have now learned a bit how exPensive the words "moral hazard" can be."
Fixed.
Posted by: Vince Link to comment November 24, 2008 at 07:56 AM
Outraged_Obama_Supporter says...
Why are not Rubin, Greenspan, Summers, Geithner, Paulson, Rubin's son, etc. not in JAIL!
Also, why are some of these corrupt idiots on Obama's economic team?
Where is the outrage.
These useless corrupt idiots make Enron's Lay and Skilling look like angels.
Posted by: Outraged_Obama_Supporter Link to comment November 24, 2008 at 07:56 AM
says...
Maybe my arithmetic is off, but it seems to me that if you "buy" capital in a corporatation equal to 3 or 4 times it's market cap, you should "own" the company. Am I missing something here?
Posted by: Link to comment November 24, 2008 at 08:03 AM
Alex Tolley says...
The whole purpose of saving institutions should be to keep the economy supported. However, so far all that has happened is that the banks have taken public money to shore up their balance sheets while they contract their loan portfolios in the deleveraging process. Loans are drying up, credit is being squeezed, and the economy will tank. I'm supposed to be pleased that saving banks and their shareholders prevents some even bigger catastrophe?
As far as I can see, this is just wholesale looting of the public purse.
Posted by: Alex Tolley Link to comment November 24, 2008 at 08:04 AM
PghMIke says...
This is essentially a $266 billion dollar non-recourse loan (according to the term sheet published today), based on a bunch of non-performing, probably highly leveraged, securities holding a lot of declining CDOs. The likelihood is that those securities, being highly leveraged, are worthless.
Since it is a non-recourse loan, the Fed probably won't get anything for its $266 billion.
This is simply a gift to Citibank's shareholders and management of $2660 for each household in America.
I have no idea where Paulson gets the authority for such a give away. Can anyone explain that to me?
As for what would be better, I'd propose any of the following:
1 -- zero out the common shareholders in return for this loan, so we at least get some potential upside.
2 -- or take over the bank completely, a la what we did during the S&L crisis, payoff FDIC insured people, and company deposits in commercial savings / checking accounts, and then see what other assets are salvageable.
Posted by: PghMIke Link to comment November 24, 2008 at 08:11 AM
AT in Diego says...
Well, we should've figured it would be difficult for the FED to absorb a bank with a balance sheet twice its size. Outrageous - Paulson should just hang his hat, tuck his tail between his legs and get out of DC before he makes anything worse.
Posted by: AT in Diego Link to comment November 24, 2008 at 08:14 AM
rd says...
If Geithner was involved in negotiating this, he should pull his name from consideration as Treasury Secretary. We can't extend this type of action past Jan 20 (not that we can do it until then).
Posted by: rd Link to comment November 24, 2008 at 08:16 AM
ken says...
Ninja zombe: "The problem is not that homes are currently undervalued. The problem is that they are currently overvalued..."
Then the solution is to add value to the homes.
How do you add value to the homes? One way is to increase the square footage of the homes. Another way is to add a pool or a garage or patio or a balcony or an outdoor bar-b-que. You can paint, recarpet, remodel the kitchen or bathrooms or landscape. All these add value to the homes.
Another way is simply by changing the zoning from single family to duplex or triplex. This will work in a lot of areas very well but will not work in other areas at all. But by changing the zoning you can immediately increase the value of the house, by a lot.
There is a lot of innovative thinking going on about how to save the banking system from dropping asset prices. it seems to me the best way to do this is to support the assets prices themselves by improving the assets.
Posted by: ken Link to comment November 24, 2008 at 08:17 AM
save_the_rustbelt says...
"Outraged_Obama_Supporter says... "
Politicians seem to always disappoint us.
Rubin's son is one of the people in charge the of staffing the administration - hmmmm.
All that idealism shot to hell already.
Posted by: save_the_rustbelt Link to comment November 24, 2008 at 08:19 AM
Robinia says...
Sigh. What can be said?
"Alright... but, I swear, if they pledge one of my kidneys, I'm heading for the Canadian border (no fence there yet, right?)."
"Did they keep telling the vital workers at Aushwitz that if they didn't do this, things would only get worse?"
"Why is it so hot in here, and what am I doing in this handbasket?"
"I'm agonna hide my grandson right here, deep in the woods..."
Posted by: Robinia Link to comment November 24, 2008 at 08:19 AM
kthomas says...
ken, I like your optimism. However, all those things require money.
Posted by: kthomas Link to comment November 24, 2008 at 08:19 AM
ken says...
Perhaps the treasury is looking out the wrong end of the telescope.
If the treasury had instead committed the 200 billion dollars to adding 200 billion dollars worth of improvements to the assets behind Citibank loans, wouldn't that have been a better idea?
How many square feet of living space could have been added to the homes behind the Citibank loans? How many pools could have been added? How many garage doors or windows replaced?
Plus how many jobs would have been added to the economy for 200 billion spent on home improvements?
It seems to me that as taxpayers we would be something a lot more concrete out of spending the same amount of money on home improvements to shore up the collateral behind Citi loans than we do by letting the collateral continue to fall and gauranteeing the full value of the loans instead.
Doesn't the treasury perhaps have this backwards?
Posted by: ken Link to comment November 24, 2008 at 08:25 AM
kthomas says...
I actually feel sorry for Pandit....sorta. Still, he had it good for a while.
Posted by: kthomas Link to comment November 24, 2008 at 08:30 AM
jamzo says...
"The market will seek another prey and relentlessly pursue it"
how come people disguise the identity of entities and classes of investors in the financial sector behind the term "the market"
Posted by: jamzo Link to comment November 24, 2008 at 08:31 AM
kthomas says...
Home improvement....I've been hearing that ole rap for almost 20 years, and what has it gotten us?
American's have greedily poured money into worthless additions and pools, etc., while thier schools, thier parks, thier roads, thier healthcare, thier savings and everything else has gone to junk. Ken, you're a dinosaur.
Posted by: kthomas Link to comment November 24, 2008 at 08:33 AM
Julio says...
So, trying really really hard to be generous about these people's motives, I ask myself is this ideology trumping everything, once again?
The deal makes some sense, in a perverse way, if you decide that
a) You must save Citibank at all costs, we can't have another Lehmann,b) If the government behaved like a regular investor coming to the rescue, that would be socialism,c) We cannot create a precedent for further deals, because that would require a reasonable, repeatable deal, and that would violate b),
so it is essential that we treat this deal as a one-time crisis (yet again), and that we create these absurd terms.
Of course, the alternative is that we've fully become a banana republic, remain so for the rest of this administration, and this is just another bat hitting the pinata, to keep buddies happy.
Immoral hazard?
Posted by: Julio Link to comment November 24, 2008 at 08:47 AM
roger says...
I think the call to prop up the prices of houses is interesting, in a symptomatic way, since it shows the disconnect that is at the basis of this crisis - the prices of houses have to reflect the limits of the incomes of the householders. If a household is making 60 thousand per year, traditionally, it can afford up to three times that amount in a house - 180 thousand. But when you start going past that - to 210 thousand, 240 - you have gone from leverage to levitation. The one and only way that kind of kind of price shift could be rational is if you expect the 60 thousand household to grow its income accordingly - to, say, 90 or 100 thousand.
Now, if you set up an economy where the growth in incomes slows or stops, except in the top 5 percent, then the 210- on upwards price will eventually prove too much. This problem isn't solved by selling the house at a peak value to another family making 60 thousand a year. The miracle of the loafs and the fishes happened only once.
The whole premise of the government program with the banks seems built on a similar delusion about the difference between leverage and levitation. You can put all the money in the world in the banking system, you aren't going to get levitation - for no matter how much money the governments have, the amount of fictional money, the notional value of the shadow financial system, will always be greater.
Nationalizing the banks is probably the only way to cut this Gordian knot, followed by the nullification of many of the securities that were devised during the past decade. The latter will deliver a nice regulatory shock - if you turn the financial system into a casino, don't bet on the house.
Posted by: roger Link to comment November 24, 2008 at 08:50 AM
Julio says...
Re propping up asset prices:
We could solve a lot of our problems by propping up the NOMINAL value of houses, which would in turn prop up the nominal value of the toxic assets.
A nice bout of serious inflation would fix a lot of what ails us.
Posted by: Julio Link to comment November 24, 2008 at 08:52 AM
Bruce Wilder says...
[ ]: "Maybe my arithmetic is off, but it seems to me that if you "buy" capital in a corporatation equal to 3 or 4 times it's market cap, you should "own" the company. Am I missing something here?"
Only honest, democratic government of the People, by the People, for the People.
We're all just peons now.
And, ken, we're not saving the banks from dropping asset prices. We're saving the banks from their voracious management. There's no private capital cushion to absorb the realization that we peons can't keep up with our mortgage payments and credit card payments, because it was all skimmed off to pay hedge fund managers and bonuses to CEOs and their minions.
Posted by: Bruce Wilder Link to comment November 24, 2008 at 08:54 AM
Bruce Wilder says...
roger: "if you turn the financial system into a casino, don't bet on the house."
That's right. Bet on the blackjack dealer with bulging pockets, leaving by a sidedoor at 5 in the morning.
Posted by: Bruce Wilder Link to comment November 24, 2008 at 08:57 AM
Bruce Wilder says...
"The market will seek another prey and relentlessly pursue it"
Yes, I think something like that will happen. In part, because, among other things, the U.S. financial sector is, roughly, twice as large as it needs to be.
By not actually nationalizing Citibank, the government has failed to give itself the option of an orderly liquidation of Citibank, something that would have gone a long way toward shrinking the whole sector, and relieving the competitive pressure in the industry.
I don't see how anyone can be idiotic enough to see this as simply a crisis of confidence, at this late date. The banking/financial sector must shrink considerably. Obviously, that's a huge challenge, given the reality of the deflationary implications for real economic activity, but failing to acknowledge it, and to prepare an institutional path is just incompetence. Straightforward nationalization and firing the top management was the right thing to do, but crony capitalism required a more rigidly conservative policy of waiting until the problem gets worse, next time.
Posted by: Bruce Wilder Link to comment November 24, 2008 at 09:07 AM
ken says...
kthomas, yeah I am an old guy whose seen a lot in his lifetime. I also believe that the labor theory of value has a lot of truth to it. I have seen how the value of real estate can be improved by the sweat equity of homeowners and landlords. I've been part of this and seen this happen first hand. I know this to be true as do most people outside of acedemia who have actually rolled up their sleeves and created value through hard labor.
My insight is that if the loans held by Citibank, or any other bank, are not supported by the value of the homes behind them, then we can solve this problem by improving the value of the homes.
The problem will not be solved by allowing the values to spiral down because there is no bottom but zero to real estate prices when assets are not continously maintained and improved.
The key is to get the houses appraised at a higher value, It is not manditory to get a sale at those higher values. The buyer is entitled to a discount off of the value of property. I know, I've been involved in many a real estate transaction and I can tell you that for all the hassle involved in buying and selling the buyer should always get a discounted price from the property's true value.
Posted by: ken Link to comment November 24, 2008 at 09:10 AM
macburger says...
http://www.bloomberg.com/apps/news?pid=20601109&sid=arEE1iClqDrk&refer=home
Nov. 24 (Bloomberg) -- The U.S. government is prepared to lend more than $7.4 trillion on behalf of American taxpayers, or half the value of everything produced in the nation last year, to rescue the financial system since the credit markets seized up 15 months ago.
The unprecedented pledge of funds includes $2.8 trillion already tapped by financial institutions in the biggest response to an economic emergency since the New Deal of the 1930s, according to data compiled by Bloomberg. The commitment dwarfs the only plan approved by lawmakers, the Treasury Department’s $700 billion Troubled Asset Relief Program. Federal Reserve lending last week was 1,900 times the weekly average for the three years before the crisis.
When Congress approved the TARP on Oct. 3, Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson acknowledged the need for transparency and oversight. Now, as regulators commit far more money while refusing to disclose loan recipients or reveal the collateral they are taking in return, some Congress members are calling for the Fed to be reined in.
“Whether it’s lending or spending, it’s tax dollars that are going out the window and we end up holding collateral we don’t know anything about,” said Congressman Scott Garrett, a New Jersey Republican who serves on the House Financial Services Committee. “The time has come that we consider what sort of limitations we should be placing on the Fed so that authority returns to elected officials as opposed to appointed ones.”
....
How about if we start putting all the bankers in Gitmo. All of them. God can figure out who was guilty later on, but let them all rot in Gitmo.
Posted by: macburger Link to comment November 24, 2008 at 09:18 AM
says...
The government is doing the right thing. Recapitalizing the banks is the solution. Recapitalizing failing automakers is also necessary. Recapitalizing all failed businesses is the next step.
As indicated by brainiacs above, re-inflating assets like housing is also a sure winner.
Recapitalization and re-inflation is the one true path to a sound economy and unlimited prosperity.
Posted by: Link to comment November 24, 2008 at 09:24 AM
ken says...
roger, your analysis is flawed in that it does not take into account the manner in which home prices can be propped up. You analysis is true if it is merely by inflation that house prices increase.
But my suggestion is that value be added not through inflation but through real improvement consisting of both labor and materials.
Another way to increase house value is by changing zoning from single family to duplex or triplex. This will work in some areas better than in other areas. But it will immediately increase the value of the homes that are held as collateral on real estate loans.
The banks might also be forced to participate in shoring up the value of their collateral by making home improvement grants to their homewner/borrowers instead of paying dividends to shareholders.
Any program to improve the value of the housing stock would be stimulative to the ecomony as well and would therefore have additional benefits beyond just the obvious benefits to the banking system itself.
Posted by: ken Link to comment November 24, 2008 at 09:25 AM
awake says...
I watched in disbelieve this morning as Cramer appeared on the Today show, to lie to the American people,and tell them what a good deal this is.Sickening!They truly have no shame.
Posted by: awake Link to comment November 24, 2008 at 09:27 AM
ndd says...
PghMike asks a vital question:
I have no idea where Paulson gets the authority for such a give away. Can anyone explain that to me?
The TARP gave the Treasury plenary authority over that Congressional appropriation (which apparently is not being used here). The Fed has emergency authority, per its founding Act.
But where, exactly, does Treasury get the authority to pledge the full faith and credit of the Americ.n taxpayer to the tune of ~$300 Billion, without Congressional authorization?
This is not a trivial question at all.Anyone?
Posted by: ndd Link to comment November 24, 2008 at 09:43 AM
Worker says...
"My insight is that if the loans held by Citibank, or any other bank, are not supported by the value of the homes behind them, then we can solve this problem by improving the value of the homes."
Makes sense. So does bruce's comment that the financial sector is too big.
Likewise, with over-investment in housing. The most indebted mortgage holders likely have the least need for more investment in granite countertops or square footage. For society, it would be a foolish investment.
I guess to the contrary, since we're doubling down on the loser lenders, why not the deadbeat borrowers too.
Posted by: Worker Link to comment November 24, 2008 at 09:53 AM
Francois says...
The fundamental problem is simple: Fed and Treasury seem incapable to distinguish between saving banks and saving the banking system.
If you want to save the system, some of its compoenets must be put throught either the purifying fire of bankruptcy and re-organization, or, be nationalized, cleaned up and recapitalized. Apparently, Paulson and Bernanke suffer from a tremendous blind spot in that regard. They can't fathom a BIG US bank going under or being seized by the go-vermin. And why should they? After all, we, the pigs, a.k.a. taxpayers are there, aren't we? And it looks pretty obvious we won't muster the initial collective outrage toward the bailout as it takes place now. So, bend over and have the K-Y jelly (Astroglide or Surgilube works fine too) at the ready, people.
That the Bushies are absolutely opposed to nationalization as an option does not surprised me in the least.
However, when I see who will be on Obama's economic team, I can't feel reassured one bit.
Time to learn Japanese I guess.
Posted by: Francois Link to comment November 24, 2008 at 09:54 AM
Francois says...
"There will be no management changes at Citi"
Reminds me of the old joke:
"Why sharks refuse to eat lawyers? Professional courtesy".
Mr. Secretary of the Treasury: FYVM!
Posted by: Francois Link to comment November 24, 2008 at 10:00 AM
Thomas says...
Why didn't the government demand a forced 7 year break-up plan? It's clear that citibank is far too large to be managed effectively and splitting into smaller competitors would probably serve the market well.
Posted by: Thomas Link to comment November 24, 2008 at 10:01 AM
ken melvin says...
There's some reality somewhere. May it be that the economy will settle at its real level? Perhaps 1/2 previous? Most of the economy was based on creative finance, MEW, etc. Why should we go back to that?
Posted by: ken melvin Link to comment November 24, 2008 at 10:04 AM
roger says...
ken, I'm sympathetic to your notion of the real value of the houses. Hey, my dad was a carpenter who went bankrupt building very very good houses.
But the point is that the labor theory isn't just about houses. It is about the sum total of labor - for instance, the labor people put out to earn their wages. And if that labor is remunerated at a diminishing rate - as it has been over the past decade, which is really the endpoint of a trend that has been in place since the middle of the 70s - then it is going to be impossible to segregate this trend from that of the housing market. Unfortunately, one of the things we are watching is the destruction of the captured labor value in the financial sector - it is as if we were the serfs in a manor run by a gambler who, instead of plowing the profits made by the serfs back into the estate, lost it at roulette. The "innovative financial products" which took the place of plain vanilla products - like the ones, back in the hazy 90s, that came on line and produced a bubble in computing that at least left behind a whole new manufacturing sector - are proving to be a bust.
It is one of those busts I do hope the economists discuss at the Milton Friedman Institute, since after all, Milt was the pioneer in the field. Back in the primitive seventies, even betting on currencies - which is what our seignorial class likes almost as much as a tax cut - was illegal. Friedman was hired by the President of the Chicago Merc to write a paper justifying it. And so successful was that paper, according to Edward Chancellor's account, that the Merc could introduce the first derivative proper - one that entailed no plebian delivery of the commodity bet upon - in 1976. To celebrate the auspicious occasion, Friedman rang the bell at the Merc on that day. So we have much to be thankful to him for in this Thanksgiving holiday, and I do hope he is in all of our thoughts. Without this simple and ingenious change, our economic activities would have been stifled, and the working man would have to depend on increases in his earnings instead of increases in his credit limit to make it through this dreary vale. And you know how greedy they are, they would have organized and blackmailed wage increases out of our entrepreneurs. No economist can contemplate that prospect without a shudder.
Posted by: roger Link to comment November 24, 2008 at 10:09 AM
bubbles says...
Hey, you guys hit the nail on the head!
"Recapitalization and re-inflation is the one true path to a sound economy and unlimited prosperity". Right on, says!
Why stop with housing? Re-inflate prices of commodities, equities, and derivatives. This is a great solution!
Breathtaking! Brilliant!
Posted by: bubbles Link to comment November 24, 2008 at 10:10 AM
jso says...
"If asset prices are the problem then the solution is by boosting asset prices. This is the fairest way for everyone. Everyone wins. "
Perhaps not everyone. Seems your thesis is predicated on the fact that everyone is an asset holder. What about the recent college grads? Families just starting out? Individuals on the lower rungs of society? What if you don't have assets that are subject to re-inflation? Seems like propping up home prices is politically convenient and expedient; advocacy is harder for the ramshackle group of people that have no idea that they are getting fleeced. So with no assets to re-inflate, and a severely distressed mechanism for tapping into credit . . . it seems like we're creating another open-ended commitment. Maybe we can get a program to pump out affordable mortgages for the masses?
Posted by: jso Link to comment November 24, 2008 at 10:19 AM
craig tindale says...
Wall street has made itself obsolete, creative destruction at its best, yet the Fed wants to push back , it wants to cement Wall streets role in place, the banking sector got to big , its now adjusting and the Fed says it knows better than the market. American capitalism is dead, American socialism is being born, after this is finished there will be no path back, the birds will have eaten the bread crumbs.
Posted by: craig tindale Link to comment November 24, 2008 at 10:23 AM
Bruce Wilder says...
Francois: "Fed and Treasury seem incapable to distinguish between saving banks and saving the banking system."
Maybe. But, I would say it differently.
In a simple panic or crisis of confidence, policymakers just need to calm everyone down, and life can go on, as before. Maybe, one or two institutions have failed, or some sector has gone down, but, most of the structures are sound, and no alterations are necessary.
I think Bernanke is the sort of person, who is inclined to think that is always the case: that the fundamentals of our economy are sound, and things can go on as before. He thought the subprime mortgage crisis would be "contained". In many ways, I feel that was his view of the Great Depression: if deflation and banking system collapse had been avoided thru sensible Fed policy, life would have gone on -- no depression. (His view of the Depression is more subtle than that, but he wrote books, and I'm writing a blog comment, so sue me.)
It is harder to conduct policy, when going forward, everything must change.
The natural tendency is to be reactionary and conservative, to use the past as a model of the future, and to try to restore or re-create an idealized version of the past. Re-inflate the bubble. Home improvement! (That's a good one, ken! Glad you can keep a straightface.)
It is harder to be realistic. And, policy -- which is a collective response, after all -- can not be realistic in a democracy (or plutocracy, as the case may be) until consensus views are made realistic by the experience of events. You cannot expect government to stop trying to "save" the old economy, until the old economy is clearly past saving, until it is so thoroughly destroyed, that saving it is out of the question.
The system is fundamentally rotten. Very little is worth saving, or capable of being saved.
With each new bailout, more people are coming to that realization. It is pretty thoroughly understood, in general if not in detail, outside the inner circles of power in New York and Washington. But, the inner circles have a big stake in the status quo.
Posted by: Bruce Wilder Link to comment November 24, 2008 at 10:27 AM
save_the_rustbelt says...
Lunch time conspiracy chatter:
Citi was bailed out on Bush's orders to protect his Saudi buddies.
Sounds kinds goofy, right?
So I stop at home, and who does CNBC interview as an expert on Citi?
The 5% owner from Saudi.
Maybe not so goofy.
Posted by: save_the_rustbelt Link to comment November 24, 2008 at 10:50 AM
me says...
> Back in the primitive seventies, even betting > on currencies - which is what our seignorial > class likes almost as much as a tax cut - was> illegal. Friedman was hired by the President of> the Chicago Merc to write a paper justifying > it. And so successful was that paper, according> to Edward Chancellor's account, that the Merc> could introduce the first derivative proper - > one that entailed no plebian delivery of the > commodity bet upon - in 1976.
Thank you Roger. Got a pointer to the source?
Posted by: me Link to comment November 24, 2008 at 10:56 AM
Bruce Wilder says...
Arnold Kling also says that the part of the problem is that the banking sector has to shrink. I think this is right, as I wrote above. Keeping Citi just ensures that the pressure to drive out banking resources falls on other banking institutions, and the crisis lurches onward.
But, I disagree with Arnold a little about the general shrinkage in the economy. Unlike the Great Depression, we don't have a huge farm population no longer needed in agriculture, or large areas of the country unable to participate in the economy of autos and electricity, for lack of infrastructure.
But, there really are some huge shifts underway. The fall in consumer spending, as household savings rates rise, is pretty big. The internet revolution compounds that. So, we're seeing pretty rapid shrinkage in retail storefronts.
There's a lot of investment in communications because of technical obsolescence, but the actual value of capital stock is also shrinking rapidly, because the equipment costs orders of magnitude less. A telephone company with a cellphone & fiber optic base -- even if it is also supplying television programming -- is only about 1/5 the size of the old phone company sitting on a mountain of copper wire. That's a tough transition in the real economy.
If peak oil is right, we may hit that commodity ceiling again in two or three years, and the cost of jet fuel, relative to other petroleum fuels, will rise fairly steeply -- changing the relative cost of air travel fairly significantly. Hawaii and Las Vegas may not be happy places.
I'll try to think of some other real economy shifts.
Posted by: Bruce Wilder Link to comment November 24, 2008 at 11:00 AM
ken says...
"The system is fundamentally rotten. Very little is worth saving, or capable of being saved."
This is the kind of thing that people say when they have nothing of value to say. A little more constructive thought would be helpful before you hit Post.
In truth, Bruce, the banking 'system' will not be essentially any different in the future than it has been in the past. It has been a damn good system not without flaws but still a very good system when all is considered.
The things that need to be done going forward are simple and straighforward. First, return to a regulatory system that keeps bank excesses at a minimum. Second, address the bank bad asset problem from both top down and bottom up.
Government money has been essential in the top down solution. It has helped banks recapitalize and prevented many banks from failing. The next step is to work on assets from the bottom up by increasing the value of the assets themselves.
Instead of throwing up your hands and saying all is lost why not spend some time thinking about creative solutions to our problems. If anything should be obvious to you Bruce is that nothing is off the table when it comes to innovating solutions. Bernanke has shown great innovation, Paulson has shown great innovation, I have suggested some innovative ideas, what are yours?
Remember, this is one of those siturations where failure is not an option. The banking system will not be allowed to fail. So what can we do that will have some better results that what has been tried already?
Posted by: ken Link to comment November 24, 2008 at 11:04 AM
ken says...
jso, you have a flawed understanding of inflation.
When asset prices are increased by labor and material it is not an inflationary increase in price that takes place but a real increase in value.
When you add 500 sq ft to a 1800 sq ft bungalow you are not inflating the price of the home by degrading the currency you are adding value by adding something real and tangible.
Any home improvement adds real, not inflationary, value to the house. Some add more and some add less but any improvement will increase the homes value.
Since the problem is that the value of the collateral is not supportive of the loans then we can solve this problem by increasing the value of the collateral along with the already realized write downs of the loans themselves. Somewhere in the middle we will reach equilibrium between asset value and loan value.
Posted by: ken Link to comment November 24, 2008 at 11:14 AM
roger says...
me - Edward Chancellor's book, Devil take the Hindmost, is a truly entertaining read about bubbles. Nicely written, too. You'll find the chapter entitled Cowboy capitalism pretty suggestive. That's where the Friedman stuff is.
Posted by: roger Link to comment November 24, 2008 at 11:16 AM
calmo says...
Absonootely ken (and kudos to the gods that gave us "siturations"):
This is the kind of thing that people say when they have nothing of value to say. [Hark the Harold Angels Sing ...a little venting is good for the lungs...maybe mo) A little more constructive thought would be helpful before you hit Post.And kt tried this with you. And ninja. So examine the constructiveness of "spend more money on home improvements", "upgrade existing zoning regs to improve the lot values"...anything in short to support bloated house prices...bloated only in relation to wages, yes?...if they wasn't so high, then wages wouldn't need to be supplemented by all this here financializationity...tis in our faces finally, yes? Tis in your face, by now, right? Right?
Rusty brings it to our attention that the off-shore interests were...the majority. And now about that composition of foreign ownership, can we have a breakdown since it is taxpayer money?
Posted by: calmo Link to comment November 24, 2008 at 11:23 AM
Anonymous says...
If you're trying to understand why this bailout was structured the way it was, the answer is here.
The short answer is that all the policy makers appear to be terrified of blowing up the CDS market. I'm not in agreement with parts of the article I link to above, because I'm hoping that the Fed is taking on all this CDS liability (CDOs are called assets, but big chunks of recent vintages are actually liabilities) because it will have the muscle to force counterparties to cut a deal.
But this aspect of the article above is correct: either we see a final resolution to the CDS problem taking form within Obama's hundred days, or we may very well stop calling this the worst economic crisis since the Great Depression.
Posted by: Anonymous Link to comment November 24, 2008 at 11:24 AM
Bruce Wilder says...
ken: "This is the kind of thing that people say when they have nothing of value to say."
Or, they (I) feel frustrated at not being able to articulate (or find articulated elsewhere) a point of view or a simple acknowledgment of reality.
I rant. I know that. And, I know it has little value to others. So point taken.
ken: "the banking 'system' will not be essentially any different in the future than it has been in the past. It has been a damn good system not without flaws but still a very good system when all is considered."
The banking system has been morphed considerably just over the last 30 years. It's not at all the same system, that it was, when Jimmy Carter was in the White House, that's for sure.
Some of those changes have been hard to ignore, others very, very hard to understand. (Quick, what's a derivative? What's a hedge fund?)
The point of rottenness is not that hard to see, if one cares to look, and it centers on management compensation. Paul Volcker and a very few others have said this clearly.
I have tried to say it here, but I usually do it in my populist rant mode, and maybe others take it less seriously as a result. Or, maybe, it is just too simple and straightforward to be accorded the importance it deserves.
Financial markets have their ups and downs, just like play in any casino. The trick to institutional stability is having a big pot of money over the long-haul; the pot gets bigger on the winning streaks, and shrinks a bit in bad times. Shareholders and bondholders supply that pot.
In the great leveraging up, and the orgy of bad mortgage lending, banking and the financial markets were on a great winning streak. It was a synthesized streak, born of manipulation, imho -- a "bubble" as they say. But, very little got added to the pot. The cream was skimmed and left the building in the pockets of financial industry insiders.
The big investment banks levered up a lot, and paid out the big bucks as bonuses, so there was nothing in their pot when the downturn came. The hedge funds were the most lucrative of all, in squeezing out inconceivably big bucks as noncontingent compensation.
Now comes the downturn. The money paid out as compensation is mostly gone, and irretrievable. Not part of the equity pot available to absorb losses.
So, the government steps in. I don't need to repeat the rest.
When I say the "system is rotten", what I mean is that much of the management is grossly overpaid and corrupt. The system simply cannot be stable when so much is being siphoned off into top management compensation. It is an incentive for management to take on very large risks, where they share in the upside, but not the down.
This is not how the banking and financial system worked in 1980. Really it is not. The sums are more than an order of magnitude greater. The proportionate stake of leading managers in their companies typically a fraction. Mutual companies, staid and designed to be conservative, still prominent in 1980 as savings and loans and in insurance, are gone.
The foxes are in charge of the hen house. And, we are the chickens. That's a serious political problem.
Posted by: Bruce Wilder Link to comment November 24, 2008 at 11:35 AM
Robinia says...
Bruce Wilder: you are not in a good position to judge the value that your "rants" may or may not have to others. Please keep thinking, writing un-self-censored. Not much indication around here that you are anything but a net gain-- a net big gain. True value in a world that has precious little. Thanks.
Posted by: Robinia Link to comment November 24, 2008 at 11:50 AM
kthomas says...
BW, you keep on ranting, brother! Swing that hammer hard!!!
Posted by: kthomas Link to comment November 24, 2008 at 11:57 AM
Worker says...
Bruce,
Don't you think the banking sector is shrinking, by the number of major firms, scope of cap market activitivies (ie. elimination of structured products, reduction in volumes, anticipated regulation of OTC products), employemnt levels, reduction in compensation, etc.)
I think that shrinkage is on par with 25%-50% reduction in size of financial sector that you call for.
The key is to keep the beast from growing back. Whatever excess is left, can be dealt with by regulation. The anti-regulatory forces have no intellectual capital or political support, at least until the regulators screw up.
Letting citi fail would be a global catastrophe.
Posted by: Worker Link to comment November 24, 2008 at 11:58 AM
anne says...
Bruce Wilder:
"The system is fundamentally rotten. Very little is worth saving, or capable of being saved."
What precisely is the systemic problem, then?
Posted by: anne Link to comment November 24, 2008 at 11:59 AM
craig tindale says...
obviously very smart, much smarter than any of us herethey are taking brilliant contrarian central measure, they find bankers who have made stupid loans and they offer them piles of money to make more silly loans,meanwhile the banks who were not incompetent get nothingthe smart bankers who watched their risk and made conservative decisions , who may be the best to drive things from here on now wall street understand what they must do, the new source of funds is the fed, the imperitive is to invent ways to get bailed out, the dumb bankers who made stupid loans are in fact the wise bankers, the smart bankers are i fact dumbwhat have they got to show for their efforts ? nothing they failed to make dumb loans and the fed needs many more dumb bankers, to make more dumb loans so that we can get out off this crisisthe dumb stupid idiot bankers know now what they must do, they must lend, lend to anyone, lend lend lend, for they are the dumbest of the dumb and they wont disappoint usrun dumb bankers ! run like the wind, lend lend lend, we have set your free!
Posted by: craig tindale Link to comment November 24, 2008 at 12:16 PM
erewhon says...
Things have gone from bad to worse. Stop the baloney about transparency- every time I hear that word I know someone is ducking the issue- or Main Street. This country has been run for the benefit of the investing classes for 25 years. We had a trickle up policy, endorsed by Reagan, Bush 41, Clinton and Bush 43. Rubin & Greenspan are accessories to theft and corruption and deserve jail time. Instead they will go to their soft and gilded graves rolling in money while little people have shrunken healthcare, even more stressful retirements, all manner of cruelty.
Bernanke and Paulson are beneath contempt- don't tell me that Obama will make Larry Summers the next fed chief. Would that arrogant sob promise to work for the good of people earning less than 100,000 a year?
Posted by: erewhon Link to comment November 24, 2008 at 12:24 PM
David Thompson says...
In an era of networked information, it seems terribly ineffectual to try to fix a complex financial system with such blunt measures as multi-billion dollar bailouts of lending institutions. This is like trying to repair your iPod with a sledgehammer. Also, there seems little hope of getting a return on the equity investment, just as the sledgehammer smashes the iPod.
A kind of Catch-22 is involved. We can hope on the one hand that some pressure is put on management to use the capital infusion to make loans, to keep the financial system working. That hope, however, is predicated on the assumption that the best way out of the crisis is to get banks to make more loans. Wasn't that the problem to begin with?
To make it worse, the equity infusion goes to an institution that has displayed aboslutely imprudent (nonexistent) risk management.
Posted by: David Thompson Link to comment November 24, 2008 at 12:27 PM
BJ Feng says...
Bruce, while compensation in the financial sector might have to be reformed (I don't disagree with you there) I'm not sure that all the gains were siphoned off to management as you say. If I remember, compensation was no more than 5% of yearly earnings at maximum. The financial firms then paid out anywhere from 35% to 50% of their earnings to shareholders in the form of dividends. Add to that stock buybacks (now you know why I support dividends, but not buybacks) and that increases the payout to the 40% to 70% range. Only Goldman paid out 50% of earnings as compensation, but that includes all employees, not just management.
It seems that the earnings were paid out to investors mostly, not management. Banks have capital structures that called for paying out "excess" funds. Look at the leverage ratios, THAT is the real problem. If the banks had held those earnings, then they would have levered those earnings 30x as was their policy and we would be in very very very deep trouble, the financial system would be destroyed for sure if that had happened. Thankfully they did not keep that much earnings and only levered up what they hadn't distributed.
Citigroup lost more than $200 billion in market capitalization. No way management received that much. A lot of compensation was in the form of stock options and restricted stock. Those options are now underwater and just about worthless since the strike prices are in the double digits and the stock is $6. Management was able to cash out on some of their options, but the millions of shares yet to be exercised are essentially near worthless.