Friday, March 20, 2009

“Man on Inside” Breaks Down Banking Situation

I got a "man on the inside" who works in finance. Yesterday, I sent him this article from fivethirtyeight.com thinking he might find it interesting. What follows is his response:

First, let me just say that the bonuses at AIG were despicable, and for that matter any bonuses at the top 5 investment banks. Anybody labeled too big to fail probably should have had some restrictions, because they might be bankrupt in the absence of the bailout. I have a couple of general thoughts, so it may seem a bit disjointed...

#1    One of the most important things about our system of democracy is contract law. Our ownerships rights, land, property, intellectual, music, are protected so that we can benefit. This brings stability, willingness to lend, and investment from abroad (would you lend any money to a Chinese business?) Without that, we generally fall back to unwillingness to enter into any agreement of any kind...mortgage, car loan, open a business. It's too risky, like Russia. Congress and the government effectively propped up these institutions, BUT THEY DID NOT NATIONALIZE THEM, SO THE GOVT CANNOT RUN THEM...you can't have it both ways, that's why the executive compensation limits were stripped from TARP 1, TARP2, and Obama's stimulus package. Because legally it was tough to enforce without outright nationalization, and that is something we wanted to avoid (not too pleasant to add this stuff to the US Treasury balance sheet). Congress had their chance to 1) nationalize, or 2) toughen restrictions...and they didn't (campaign season). This is political theater at its worst. This is also very distracting from the real problem. The public can bitch and moan all they want, but Barney Frank has no say so in how AIG is run.

#2    A lot of TARP recipients didn't need the money. Banks were asked to participate because if everyone was in it would reduce the perception that any one bank was worse off than the other. If we were to have split good/bad banks last October, there would have been a mad rush and the outcome would have been insane. That is not an exaggeration as there would have been a run on deposits and the stock; assets would have been sold at fire sale prices because nobody big enough would have been around to buy them.  Good banks will report good earnings in time (and some have) and will return the money. The taxes (future taxes, as nobody has paid a dime yet) will not be as high when TARP is paid back by those that can. We should want this and encourage it. It means things are getting better. But Congress has to stop playing off of public anger and this mischaracterization of what has occurred. Not everyone who has TARP is bad. Our taxes have not gone up, and we are trying to fix it so that they don't. Growth and stability would do that. This wholem we gave you money so here are the rules does not work. Either take them over, or don't give any money. Can't have it both ways.

#3    It's easy to say these Wall Street guys are idiots, and they just make millions in sales and pillage the village. Well, yes there are some dumb asses. Yes these "toxic" investments went bad....yes there is plenty of blame to go around. But the problem started with the bad assets (bad mortgages and loans), but if that was all it was, we could have stomached it. Those in charge of those assets, and the investors would have been hurt, but McDonalds wouldn't have been. The fall in stocks/houses and everything else was primarily due to fear and counterparty risk at large international banks. Once it appeared that ANY loan made to ANYBODY, may not be paid back, nobody would lend. No lending to comoanies that needed it, to rollover overnight loans, meant a collateral call. This meant fire sale on any asset to raise cash. This became a spiral, and wallah! Down went Frazier. There was a lot of idiocy going around, but that is not what caused this problem. These assets would have been good cash paying investments, but an asset is only worth what someone is willing to pay for it, regardless of cash flows generated by it. No Trust, No pay.

So in general, yes it stinks. But Congress #1, never should have repealed Glass-Steagall in 1999 that was erected in the Great Depression to separate investment banks from banks. #2 Congress never should have permitted FNMA and Freddie Mac to be privately run companies with a public quasi-guarantee. #3 large insurance companies that became hedge funds should have been regulated. #4 Congress should have just nationalized them or declined the money. Plenty of blame indeed. A 90% tax on bonuses is a scary thing, and I worry about what this does to anyone who can value these assets and properly unwind them. I also worry about what this does to the public and the willingness to bail out anybody any more. And that won't be pretty. What are we willing to spend to limit the damage? We are $20 trillion poorer in 14 months already as a country; the next 20 trillion will not feel pleasant. AIG should have known better, but I have to side with the law on this one. They had their chance.

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