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bailing out Wall Street « Previous | |Next »
February 12, 2009

US Treasury Secretary Geithner's big plan to sort the Wall Street problem. Trouble is no one really knows what Geithner is up to with his bailout for bunglers as it looks to be more a plan to come up with a plan to spend a lot of money to help banks clean up their balance sheets. Though the Federal Reserve has already committed over $2.5 trillion to the financial system, in order to get credit markets moving again-- with limited results so far--the public doesn't trust Wall Street and has big doubts about Treasury's playing nice with banks and their shareholders.

The hard choice facing the Obama administration is between partially nationalising the banks, or leaving them in private hands but nationalising their toxic assets. How tough is the administration willing to be on the people who control the country’s large banks? According to the New York Times Treasury administration officials are committed to flood the financial system with as much as $2.5 trillion — $350 billion of that coming from the bailout fund and the rest from private investors and the Federal Reserve, making use of its ability to print money.

The basic idea of Geithner's plan is to lend government money (US Federal Reserve) or guarantee borrowings (Federal Deposit Insurance Corporation) at a suitable spread to anyone- e.g., hedge funds and pension funds - who wants to buy toxic assets from the banks. The plan has three components:

---- a bad bank(s) that would rely on taxpayer and private money to purchase and hold banks’ bad assets;
----a bailout that would enable the government to become involved in the management of markets and banks;
----give banks new helpings of capital with which to lend.

Basic questions about how the various parts of the program would work, especially those involving the unsellable mortgages that banks are holding and preventing home foreclosures, were left for another day. Should the US government once again bail out the very banks whose mistakes contributed to the loss of more than three million jobs and caused acute financial pain? Are they paying the banks inflated prices for poison assets or subsidizing investors to pay the banks for poison assets? is the Obama administration rolling over for the banker lobby because the banks are too big to fail?

The emphasis is on providing credit to private investors who are willing to buy the banks toxic assets. Loan losses on a total of $12.37 trillion unsecuritized loans are expected to reach $1.6 trillion. Of these, U.S. banks and brokers are expected to incur $1.1 trillion. The US financial sector’s losses are close to its equity capital.

But who are investors who will buy the banks' toxic assets (with guarantees from the Treasury and loans from the Fed limiting the investors' downside risks)? The hedge funds? From investors in China or Japan? Why would they commit even more money to the United States when they're already nervous about their US loans and investments, and when their own economies are under more and more stress? The trouble is that the market price of the bad assets is well below what the banks are willing to sell them for.

Doesn't fully escaping the grip of the financial crisis really mean breaking the power of the banks that created the crisis? As Simon Johnson at Baseline Scenario usefully points out:

Our unsustainable debt-fuelled boom, in other words, produced both the conditions for a major global financial disaster, and a political strengthening of the people who benefited most from the risk-taking and associated compensation packages that made this disaster possible. Ending the financial crisis is relatively straightforward - a forced recapitalization and change of ownership/management in the banking system - although this will not immediately lead to an economic recovery.... But seen in deeper political terms, decisive action to restructure large banks is almost impossible. Such action would require overcoming perhaps the single strongest interest group in the United States today. How can you do it? The answer must be by splitting this powerful interest group into competing factions, and taking them on one by one.

I cannot see that happening, even if it should.

| Posted by Gary Sauer-Thompson at 4:53 AM | | Comments (4)
Comments

Comments

As David Bassanese points out in the AFR someone has got to bear the loss for the trillions of dud assets on US bank balance sheets. There is a Mexican standoff between the banks---who want the government to take them over at inflated prices (very expensive) and the government which insists on market value (may wipe out the banks).

So what to do? As things currently stand Wall Street is unable to raise new private equity capital and it lacks the capacity to lend to Main Street. So no credit is flowing. Big problem.

It means a deepening recession in the US wherein reduced private consumption shuts down China's export sector and its growth paradigm of the last 20 years, thereby causing a big recession in Australia.

The banks aren’t lending because of the weakening U.S. economy. The economy is weakening because the banks aren’t lending.

The core of the problem is that the banks' huge holdings of bad assets: losses on US-originated credits assets are estimated at $US2.2 trillion by the IMF and $US3.6billion by economist Nouriel Roubini.

Somebody has to bear the losses and it should be the banks' shareholders, who have to be forced to accept deeply discounted market prices for their bad assets. If banks are insolvent, then governments need to accept the need for capital injections and some form of nationalisation, or wind them up.

Anon,
Geithner's plan recognizes that only the private sector can unlock the value of toxic debt, and second, it removes the toxic assets from the balance sheets of the banks.