The misguided policy response from Washington has focused almost exclusively on squandering public money and burdening our children with indebtedness in order to defend the bondholders of mismanaged financial institutions (blame Paulson and Geithner ”“ I’ve got a lot of respect for our President, but he’s been sold a load of garbage by banking insiders). Meanwhile, I suspect that the little tapes in Bernanke’s head playing “we let the banks fail in the Great Depression” and “we let Lehman fail and look what happened” are so loud that he is making no distinction about the form of those failures. Simply letting an institution unravel is quite different from taking receivership, protecting the customers, keeping the institution intact, replacing management, properly taking the losses out of stockholder and bondholder capital, and issuing it back into private ownership at a later date. This is what it would mean for these banks to “fail.” Nobody is advocating an uncontrolled unraveling of major financial institutions or permanent nationalization as if we’ve suddenly become Venezuela.
Make no mistake. Buying up “troubled assets” will not materially ease this crisis, nor will it even improve the capital position of financial institutions (see You Can’t Rescue the Financial System if You Can’t Read a Balance Sheet). Homeowners will continue to default because their payment obligations have not been restructured to any meaningful extent. We are simply protecting the bondholders of mismanaged financial institutions, even though that bondholder capital is more than sufficient to cover the losses without harm to customers. Institutions that cannot survive without continual provision of public funds should be taken into receivership, their assets should be restructured to better ensure repayment, their stockholders should be wiped out, bondholders should take a major haircut, customer assets should (and will) be fully protected, and these institutions should be re-issued to the markets when the economy stabilizes.
[i]Simply letting an institution unravel is quite different from taking receivership, protecting the customers, keeping the institution intact, replacing management, properly taking the losses out of stockholder and bondholder capital, and issuing it back into private ownership at a later date. This is what it would mean for these banks to “fail†[/i] —Hussman
Hussman is advocating the use of receivership and [b]bridge banks[/b].
Receivership, the bank counterpart to bankruptcy, involves taking control of a failed bank and using its assets to satisfy its liabilities. Receivership can be used to liquidate the failed bank. The FDIC immediately transfers the bank’s insured deposits to a healthy FDIC-insured bank (and pays that bank cash to assume liability for the deposits). The FDIC then sells the failed bank’s loans and other assets and uses the proceeds to recoup the cost of protecting depositors. Alternatively, the FDIC can and often does sell the failed bank as a going concern. The purchaser receives the bank’s good assets, including its offices and its good loans and other investments. The purchaser pays for these assets by assuming liability for the bank’s insured deposits. The bank closes on Friday afternoon and reopens Monday morning with the same offices and tellers but under new ownership.
A “bridge bank” is used to sell a failed bank as a going concern when the FDIC has not yet lined up a purchaser. The FDIC as receiver takes control of the bank, transfers its insured deposits and good assets to a new FDIC-controlled bank, and has new management run the bank until the FDIC sells the bank to a new purchaser. The FDIC did this most recently in the case of IndyMac Bank, which failed last summer and was sold to new investors last month.
Note that many have taken to calling bridge banks and even receivership “nationalization,” which suggests an ideological driven decision to impose state ownership. Calling receivership “nationalization” is as preposterous as calling bankruptcy “nationalization.” Bridge banks involve temporary FDIC ownership, so the N-word is at least within the range of fair debate. But every bridge bank the FDIC has every established has been sold to private buyers.
In any event, Hussman’s endorsement of receivership and bridge banks is worth noting.