Many commentators have suggestions for Barack Obama on what should be his first meeting at the White House. Here is mine: Mr. Obama and his economic team should convene the 300 leading bank presidents in the East Room and the president should say to each one of them something like this:
“Ladies and gentlemen, this crisis started with you, the bankers, engaging in reckless practices, and it will only end when we clean up your mess and start afresh. The banking system is the heart of our economy. It pumps blood to our industrial muscles, and right now it’s not pumping. We all know that in the past six months you’ve gone from one extreme to another. You’ve gone from lending money to anyone who could fog up a knife to now treating all potential borrowers, no matter how healthy, as bankrupt until proven innocent. And, therefore, you’re either not lending to them or lending under such onerous terms that the economy can’t get any liftoff. No amount of stimulus will work without a healthy banking system.
“So here’s what we’re going to do: we’re going to unclog the arteries. My banking experts have analyzed each of your balance sheets. You will tell us if we’re right. Those of you who are insolvent, we will nationalize and shut down. We will auction off your viable assets and will hold the toxic ones in a government reconstruction fund and sell them later when the market rebounds. Those of you who are weak will be merged. And those of you who are strong will receive added capital for your balance sheets, after you write down all your remaining toxic waste. I am not going to continue rewarding the losers and dimwits amongst you with handouts.”
Without this sort of come-to-Jesus strategy, we’re going to continue to just limp along. We’ll never quite confront the real problem because we don’t want to take the upfront pain. Therefore, the market will never clear ”” meaning start-ups in need of capital will be choked in their cribs and profit-making firms won’t be able to grow as they should.
[blockquote] “So here’s what we’re going to do: we’re going to unclog the arteries. My banking experts have analyzed each of your balance sheets. You will tell us if we’re right. Those of you who are insolvent, we will nationalize and shut down. We will auction off your viable assets and will hold the toxic ones in a government reconstruction fund and sell them later when the market rebounds. Those of you who are weak will be merged. And those of you who are strong will receive added capital for your balance sheets, after you write down all your remaining toxic waste. I am not going to continue rewarding the losers and dimwits amongst you with handouts.†[/blockquote]
I can support this. I saw enough of lies and deception when I was liquidating insurance companies. This is music to this old regulators ears.
In a way it is simple. They overstate their assets and understate their assets. The regulators have far too long let them falsify their balance sheets (and this long pre-dates Bush).
In an effort to prevent this sort of thing I wrote the following statute (but I don’t think it has ever been used):
Florida Statutes 631.157 Civil action by the receiver.–
(1) Any person who is engaged in the business of insurance, is or acts as an officer, director, agent, or employee of any person engaged in the business of insurance, or is involved in a transaction relating to the conduct of affairs of such a business, other than as an insured or beneficiary under a policy of insurance, and who willfully obtains or uses, as defined in s. 812.012(3), any funds, assets, or property, including, but not limited to, moneys, funds, premiums, credits, or other property of an insurer, shall be liable to the department as receiver for the use and benefit of an insolvent insurer’s estate, claimants, creditors, and policyholders, as follows:
(a) If the funds, assets, or property obtained or used did not jeopardize the safety and soundness of an insurer and was not a significant cause of such insurer being placed in receivership, the person shall be liable only for the full amount of any funds, assets, or property obtained or used, plus prejudgment interest provided by law.
(b) If the funds, assets, or property obtained or used jeopardized the safety and soundness of an insurer or was a significant cause of the insurer being placed in receivership, the person shall be liable for triple the full amount of any funds, assets, or property obtained or used, plus prejudgment interest provided by law on the original amount.
(2)(a) Any person who:
1. Is engaged in the business of insurance, is or acts as an officer, director, agent, or employee of any person engaged in the business of insurance, or is involved in a transaction relating to the conduct of affairs of such a business, other than as an insured or beneficiary under a policy of insurance;
2. Has actual knowledge or such constructive knowledge as should have been obtained through reasonable inquiry by a person in that position; and
3. Misreports a material fact in any book, report, or statement of an insurer
with the intent to deceive the insurer, including any officer, employee, or agent of the insurer, the department, or any agent or examiner appointed by the department to examine the affairs of the person or insurer, concerning the financial condition or solvency of such business is liable to the department as receiver for the use and benefit of the insolvent insurer’s estate, creditors, and policyholders, as provided in paragraph (b).
(b)1. If the misreporting did not jeopardize the safety and soundness of an insurer and was not a significant cause of the insurer being placed in receivership, the person shall be liable only for the full amount of any asset misreported.
2. If the misreporting jeopardized the safety and soundness of an insurer or was a significant cause of the insurer being placed in receivership, the person shall be liable for triple the full amount of any asset misreported.
(3) If the asset or property that has been obtained or used was reported to the department as being available to the insurer as an admitted asset and such asset is unavailable to the receiver for payment of the obligations of the insurer at the time a receivership proceeding is instituted, the obtaining or using shall be presumed to have jeopardized the safety and soundness of the insurer and to have been a significant cause of the insurer’s being placed in conservation, rehabilitation, or liquidation, with the burden of proof on the defendants to show otherwise.
(4) If the receiver is successful in establishing a claim under this section, the receiver shall be entitled to recover all of its costs; investigative and other expenses, which shall include the department’s in-house staff and staff attorney’s expenses, costs, and salaries, expended in the prosecution of the action; and reasonable attorney’s fees. The receiver shall be exempt from the provisions of s. 57.111.
(5) An action under this section may be brought at any time before the expiration of 4 years after the entry of the initial order of rehabilitation or liquidation under this part but shall be filed before the time the receivership proceeding is closed or dismissed.
Sorry they: They overstate their assets and understate their liabilities.
I strongly disagree that the problem is overleveraging. Indeed, if banks were overleveraged the wisest thing for everybody involved would be for them to sit on new fund infusions: it would be folly to push them to lend out -i.e. leverage themselves- still more.
As I have stated again and again and again, [u]banks do not stop lending to each other when they are over leveraged or over risked: Rather, they [b]raise interest rates[/b][/u].
[b]Banks stop lending to each other when they [i] don’t know[/i] how leveraged they are[/b].
Rather, the (still continuing) problem is a wholesale abandonment of the underwriting function in the current generation (i.e. us).
Why such an abandonment? Because underwriting is an unglamorous cost center the results of which inevitably become a “public good”. That is, you sink money into the underwriting and inevitably the whole market gets to enjoy the benefits for free. That is, underwriting is one of those inconvenient little things that can keep The Smartest Guys In The Room from Getting Rich Quick
Why does this matter? Here’s why:
[blockquote] My banking experts have analyzed each of your balance sheets. You will tell us if we’re right. Those of you who are insolvent, we will nationalize and shut down. We will auction off your viable assets and will hold the toxic ones in a government reconstruction fund and sell them later when the market rebounds.[/blockquote]
There ARE no “experts” who can “analyze the balance sheets” and separate out the good ‘off balance sheet’ assets from the bad. [i]That’s why these assets are called “toxic”! [/i]DO YOU THINK FOR A MINUTE IF THERE WERE SUCH EXPERTS THAT THE BANKS WOULDN’T HAVE HIRED THEM IN 2007 AT INCREDIBLE SALARIES?
The values of the toxic assets are [i]by definition[/i] indeterminate. Long strings of highly conditionalized property interests have been levied on these assets and then splintered anonymously throughout the global market. This is a fire that will have to burn itself out. The best hope for minimizing pain is to trigger a wave of industrial and real estate refinancings (this is happening) which will remove the underlying assets and burn off the conditionalized interests.
All the morality stuff about firing and fining people is entirely appropriate. Capitalism is a grotesque con game if those greatly rewarded for taking risks are allowed to avoid failure. But before we spank the kid for playing with matches, we need to save the house from burning down. Magical thinking about supermen- whether presidents or bank examiners- is not going to save the house.
Sorry for the screaming. I feel much better now.
Brother Michael and Mr Friedman are both correct and score salient points, yet i must ask – how did we get in this mess? I see two villains, first, the deregulation advocates who carried “free market reforms” to ruinous extremes,{never put the fox in charge of the henhouse}, and the economic atmosphere which permitted too many mega-banks at the expense of regional and neighborhood banks. Bigger is not always better.
Part of a problem — a big part — is that in the business world liabilities are solid, and known, but the assets are not. Apart from the “cash” component of a balance sheet, all non-cash asset entries are guesses and nothing more. They become known and solid only when sold and converted to cash. If they are illiquid (hard to sell in a thin market) there’s now way to know what they’re worth and the balance sheet becomes, well, largely “worth-less.”
We are in a balance sheet adjustment, compared to your garden-variety inventory-adjustment recession. Once balance sheet corrections begin — historically they tend to be labelled ‘depressions’ — they will continue in one form or other until all the bad debt and dubious assets are wrung out of the system. ALL of them.
Right now, one of the reasons banks are sitting on the cash they receive is that they still don’t know how bad many of their assets really are. Many of them are (perhaps knowingly) protecting their existing book. The pandemonium ensuing were banks to begin calling in their existing good loans to productive businesses is absolutely mind-warping. So far that seems to be the only good thing arising from this mess.
Here’s the key: [i]recessions[/i] very rarely last more than six quarters, and never more than eight. If we enter 10Q1 still in a serious slowdown you can feel confident in calling the situation a Depression. If, however, the economy improves by 09Q2 or so [i]but[/i] the balance sheet problem has not been resolved — in other words, deadbeat companies are kept on public life support — the improvement will be little more that what’s commonly called a “sucker rally.” and you should plan on the economic situation being very grim by about 11Q2.
It won’t be over ’til ALL the bad debt is cleared away, and government attempts to prevent that eventuality will only make things much worse, and for a much longer time than people now imagine.
I do not see this problem originating with the banking system. Rather, it originated with Congress requiring that banks make these ridiculous loans to unqualified purchasers. Now the very same people are in charge of trying to fix things. It’s absurd. To suggest that this Congress or the new President will do anything that resembles streamlining anything doesn’t understand Democrats. They grow grow government because they like people and business dependent upon them.
#7 Daniel, you might want to give some numbers. The CRA and Fannie were not mean to give to unqualified purchasers. That started with the NINA loans, and with the global pool of money looking for some sort of safe investment that returned better than treasuries.
Bankers were making a killing from the loans. That was enough incentive.
[i] This problem . . . originated with Congress requiring that banks make these ridiculous loans to unqualified purchasers [/i]
A flat-out falsehood, no less false for being so often repeated.
The Community Reinvestment Act (CRA) contains essentially two basic rules. First, regulators must periodically “assess the institution’s record of meeting the credit needs of its entire community, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of such institution.†This evaluation occurs annually for large banks and every four or five years for small banks.
Second, regulators must take account of that record—along with all other relevant factors—if the bank seeks certain kinds of regulatory approval: e.g., to acquire another bank or to establish a branch. Even when a bank has a problematic CRA record, the other factors almost always prevail. On only a few occasions, during the entire 31-year history of the CRA, have regulators denied an application on CRA grounds.
Most banks receive satisfactory CRA ratings. Using the following link, you can see every CRA rating assigned to every national bank during the past 14 years: http://www.occ.treas.gov/cra/electric.htm The ratings are overwhelmingly positive (i.e., “satisfactory†or outstandingâ€). “Needs improvement†ratings are relatively rare and “substantial noncompliance†is rarer still. So much for banks having to make bad loans to get good ratings.
The CRA has neither the substance nor the teeth nor the coercive results you attribute to it. It certainly does not force banks to make bad loans.
Believe it or not, federal law already generally requires regulators to close or sell an FDIC-insured bank if the bank has more than $98 in liabilities per $100 of assets. 12 U.S.C. § 1831o(h)(3).
What Friedman is suggesting here is akin to the latest moves being made by the British government to stabilize things here. While this is no golden bullet, it does seem to be a well-intentioned effort to discover the truth and then deal with its implications.
There appears to be a lot of financial expertise commenting on this blog. And I see some who find the fault to be primarily with banks and financial institutions, and others who believe fault to lie with the government and / or regulators.
None seems to believe that we need to look in the mirror to lay I primary blame. And I am not an expert, for sure. But I wonder, isn’t at least a part of the problem laid at my doorstep, and at yours? WE are the ones who borrowed money we didn’t have, couldn’t pay back, and often didn’t need, to buy things that were a waste of raw materials to build, and a waste of money to buy, store, and provide no real added value to our lives. I read, a few weeks ago, where President-elect Obama has said: “We will spend our way out of this?” Again, I’m not an expert, and would never claim to be. But. . . didn’t we spend our way into this mess? What am I missing here?
[i]The CRA has neither the substance nor the teeth nor the coercive results you attribute to it.[/i]
How about this:
For the next five years, I will evaluate your business on the number of non-white employees, vendors and customers you have and make those surveys public for all to see. Care to predict how that changes your performance matrices?
Kendall,
The market does all these things. The market [i]is doing[/i] all these things. And without impoverishing your children in the process.
Irenaeus, as a banker at the time I can tell you that you are right – all the banks did comply and thus received the nice ratings you point to. That was the problem, CRA was a government mandate to suspend the rules of sound credit policy. It was precisely a policy which forced banks to make bad loans. Those who did not comply were not going to survive as banks endured years of constant mergers. If it was not coercive, why write the legislation?
Kendall, because I agree with you so much on matters besides the governement recovery policy, I am shocked that you state that this article “hit one out of the park” with the suggestion that what we need is less free market and more government decision making. Nothing will drive away investors faster than a government review board deciding who is insolvent, who should be merged and who gets to survive. Just imagine the politics of trying to implement that program and “fairly” allocate more government tax-funded “capital” to the “deserving”.
You are right about the overleveraging. But that is why lending is being pulled back so hard, everyone now recognizes that we were or perhaps are still overleveraged and the market is trying to come to terms with what the proper value of assets and investments should be. What is a shopping center worth, what is your house worth, what is a share of stock worth? Meanwhile credit is a much bigger risk and thus loans are harder to come by. Adding fresh new government regulation will add to the uncertainty and risk which will delay the process further.
This suggested policy is not a home run, it is a foul ball. I wholeheartedly agree that the market is doing what needs to be done. This is not the time to shoot the bankers first and aim later. Patience!
#14 The market isn’t doing very much, or very fast. Banks aren’t lending to corporations. Perhaps in 10 years there will be enough misery and bank will lend. It was, after all, the biggest proponents of the free market who got us into this mess. But it makes sense that the government can jumpstart the economy for the long term, because most institutions in the free market are suffering, or they aren’t helping.
The government participates in the market. It can buy and sell things.
CRA was an added benefit. But financially, individual mortgage lenders had plenty of personal incentives to make NINA loans, CRA or not. If CRA was so instrumental in the global crisis, we’d have to explain why the event happened now, and not 10 years ago – for most of the bad loans that were given out happened during the Bush administration. The CRA act did not cause the invention Credit Swaps, Mortgage BAsed Securities. This was the market looking for ways to make money after 2000. Blaming the poor isn’t backed by numbers, although it makes an interesting narrative.
The vague fear and whining about “regulations” makes sense. Especially for those free marketeers who don’t themselves like to play by the rules, and hope that since there aren’t any, they can make suckers of the rest of us, make a few billion, and then escape before the regulators.
But I don’t see why people would get upset about requiring open books. Without it, there’s plenty inspiration for Fraud. Personally, given the irresponsibility that Bankers have shown over the last 10 years, I think the government deserves a shot. It’s been MIA for a long time now.
RE: “You are right about the overleveraging. But that is why lending is being pulled back so hard, everyone now recognizes that we were or perhaps are still overleveraged and the market is trying to come to terms with what the proper value of assets and investments should be. What is a shopping center worth, what is your house worth, what is a share of stock worth? Meanwhile credit is a much bigger risk and thus loans are harder to come by. Adding fresh new government regulation will add to the uncertainty and risk which will delay the process further.”
I so agree.
People and businesses are rightly — very rightly — being cautious in their expenditures. That will mean a greatly slowed economy and probably recession. The faster the market works through all of this — the fast that individuals and corporation get out of debt and onto a reasonable spending plan — the sooner this will be over.
Bankers have made some collosal mistakes and many went far astray. (Like in some other areas of public life on this planet.) And for too long the trading of packaged and repackaged mortgages as securities allowed everyone to fool themselves that the bad debt crisis did not exist. When it finally became evident, it quickly took the new home construction and related hard goods markets down too. From there people started pulling back on personal spending and business investment while concluding that layoffs were to be expected, car purchases should be deferred and on and on. So we now have a crisis of confidence and are trying to find the bottom. Hopefully some vision of a brighter future will soon take hold so we can reclaim the optimistic expectations needed to move forward. May President Obama lead the way. But bankers, investors and the general public are now all very well aware of the error and trying collectively to figure out how to get back on track. Yes, some of them are still greedy and stupid and always will be, but deciding to implement centralized control of the economy or the banking system is not the right way to make things better. The first efforts at truly turning things around will likely come from individuals across the globe in unexpected places, they will all be some brave person with a better idea or fresh thought, but almost certainly they will not be elected officials and bureaucrats.
#9 Irenaeus, I’ve seen you write attempting to refute this assertion, and I find your attempt here pretty weak.
“assess the institution’s record of meeting the credit needs of its entire community, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of such institution.â€
To me, this is just coercion cloaked in nice language. The mere fact that the assessment is being made – the threat – is all that is needed to make banks do stupid things. None of these banks wants to get a bad rating in this department because they know that they’d get bad publicity – might even take a blackmail from a social justice organization in order to avoid a boycott. So they’ll make the bad investments to avoid the risk of a bad rating. You then go on to say that CRA has hardly ever been a major factor. But there’s no way you can prove that. If there’s anything I’ve learned from my years in the work force, it is that the ‘reasons’ given for an action are often not the real reasons. The reasons given can be just used to cover up the real reasons. So a bank could be denied that new branch or acquisition simply because a regulator looked at the assets, didn’t think they were diverse enough, and exaggerate some other factor as a front for denying the bank’s request.