Archive for the ‘bailout’ Category

The Economist coverThe Economist recently published another article about the declining estimates of the costs of the Troubled Asset Relief Program (TARP). The article, here, notes that TARP may end up making the taxpayers money. The article quotes (my former colleague at Treasury) Lewis Alexander saying

If you follow Bagehot’s rule—ie, ‘lend freely against good collateral at a penalty rate’—you will make money.


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One of the big stories of the bailout of AIG was that it indirectly bailed out institutions with direct exposure to AIG, such as those having sold insurance on the quality of AIG’s debt (through the use of credit default swaps). One large beneficiary of this bailout was Goldman Sachs, which had written billions of dollars of such insurance (oops!) and happened to be the ex employer of then Treasury secretary Paulson (during the crisis Paulson asked for and got fed information from Goldman after getting his ethics requirement that he not deal with or communicate with Goldman waived).  While this all looks pretty suspect, Goldman has repeatedly claimed that they had this exposure hedged, so maybe there was no incentive to distort the information they gave Paulson. But as far as I know, Goldman has never said who they had this agreement with, allowing us to see whether their own counterparty would have been able to make good if AIG did not get bailed out. That is, my own suspicion, given that Goldman has never stated the name of their counterparty, is that anyone writing this insurance for Goldman was probably writing it for others and was probably not going to be able to pay if AIG went under. Also, it is now clear that Goldman objected to having any AIG debt written down as the government tried to find an alternative to a full bailout. Anyway, this story has been good gossip so far, but without many facts, only conspiracy theories. Now, some answers may be on the way. Treasury Secretary Geithner, who headed the NY Fed at the time, has accepted an invitation to testify before Congress on

Wednesday, January 27, 2010, at 10:00 a.m. in Room 2154 of the Rayburn House Office Building . . .[to] examine the collapse and federal rescue of AIG, in particular the compensation of AIG credit default swap counterparties . . . [and]. the role of the New York Federal Reserve Bank and other Federal agencies in AIG’s failure to disclose to the public the counterparty payments.

Should be interesting.

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Last week I had the opportunity to opine on this question at a lively conference on the financial crisis sponsored by the Federal Reserve Bank of Chicago and the World Bank.  Since I spoke about things I’ve been meaning to blog about for some time, I decided to post the transcript here.  Apologies that the tone is more Fed-esque than the usual posting, but here goes…

Where do we go from here?

“You never want a serious crisis to go to waste.  And what I mean by that is an opportunity to do things you think you could not do before.”  Rahm Emanuel, Feb. 2009

I would like to touch briefly on two issues in answer to the question posed for this session:  first, the integration of housing finance into the financial and regulatory mainstream; and second, the need to modernize budgetary and regulatory accounting.   I chose these topics for several reasons: they are important; they get less attention than is deserved; and I have thought quite a bit about them from both an academic and policy perspective. (more…)

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” ‘Sheila Bair would take bamboo shoots under her nails before going to Tim Geithner and the Treasury for help,’ said Camden R. Fine, president of the Independent Community Bankers.” — New York Times, Sept 22, 2009

We learn today from the New York Times that the FDIC — the independent government agency that insures your bank accounts — is effectively insolvent. It is going to ask insured banks to prepay three years worth of deposit insurance premiums in order to raise $45 billion to replenish the FDIC insurance fund. (more…)

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Dear Citigroup,

In these turbulent times who doesn’t need additional capital to get through these cold winter months? Because of your strong record of providing banking services to me, I would like to offer you a special opportunity to raise capital and gain liquidity in one easy step. This offer is available only to you, and it is only available for a short time.

As you know, you are the proud owner of my mortgage. As a result you receive several thousand dollars a month from me. I am sure this helps your income statement! I am a great credit risk and this mortgage should be providing you with a great return. Sadly, I am guessing that you, like many banks in these hard times, have actually lost a lot of money on my mortgage. (Phooey on those mark-to-market rules.) We both know the troubling fact is that market values of mortgages have declined precipitously, and as you well know, my mortgage is a nonconforming mortgage. Even some AAA mortgage backed securities are trading at steep discounts, something like 50 cents on the dollar. This puts the market value of my mortgage at around half the outstanding balance.

But I am willing to buy my mortgage from you at above its market price! I am offering to buy that asset that is stuck on your books at about 50 cents on the dollar for 60 cents on the dollar. That’s right, you can sell an illiquid asset, gain hundreds of thousands of dollars in liquidity, and lower your risk of bankruptcy with one easy transaction.

In the future, you will of course not get my loan payments, but once you have sufficient capital, you can turn around and make a very similar mortgage loan at any point – rates are even currently very similar to my current rate.

So don’t sit around waiting for a government bailout! Make you and your stockholders happy. Call me now to take advantage of this exciting offer.

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In the last few months, the federal government has intervened in financial markets to an extent unparalleled in U.S. history. A partial tally includes the $29 billion, no-recourse loan from the Fed to rescue Bear Stearns; the federal takeover of Fannie Mae and Freddie Mac and their exposure to the credit risk on $5 trillion of residential mortgages; loans in excess of $100 billion to insurance giant AIG, and of course, open-ended Congressional authority for U.S. Treasury Secretary Henry Paulson to purchase up to $700 billion in troubled assets from financial institutions, part of which has already financed the purchase of over $250 billion of preferred bank stock.

Whatever you think about the wisdom of these interventions, one fact is indisputable: The government is not saying how much it expects all of this to cost us. The dearth of official estimates has, on one hand, led to Pollyannaish claims like “taxpayers could actually make money on this.”. On the other hand, it has stoked fears that taxpayers may be on the hook for trillions of dollars in losses. (more…)

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The problem with commenting on the financial rescue plan is that Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson Jr. have not told us all that they know about the financial crisis. Specifically, we don’t know about the financial health of banks individually or in the aggregate. In this entry I will offer a guess: There is widespread bank insolvency and the point of the rescue plan is to use asset purchases to save banks that are good and, just as important, to facilitate closing banks that are bad. If this is right, the rescue plan is a sensible response to the crisis. In effect the plan has a secret component: widespread and controlled bank closings. (more…)

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The U.S. Treasury’s proposed bailout plan raises a number of serious questions, many of which have been well articulated by politicians and pundits. Many of the plan’s merits, however, have been shrouded by confusion.  Is the taxpayer losing $700bn to Wall Street?  Is the Treasury paying fair value for assets?  How will the bailout help Main Street?  In fact, there are a number of merits to this proposal which all stem from markets currently being extremely illiquid.

An easy way to illustrate the illiquidity in markets is to look at the price differences between liquid assets and less liquid assets. The figure below plots interest rates over the past month for the 3-month London Inter-Bank Offered Rate (LIBOR) and the 3-month U.S. Treasury bill. LIBOR reflects the rate at which a bank borrows funds from another bank. During less turbulent times, prior to last summer, the spreads between the LIBOR and T-bill rates average around 40 basis points (bps).  The spreads recently have been more than 100 bps, punctuated by the surge to 318 bps on September 17.

Interest rates: 3-month London Inter-Bank Offered Rate (LIBOR) and the 3-month U.S. Treasury bill


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As the debate continues over the wisdom or lack thereof of Congress having given Treasury Secretary Paulson a blank check to keep Fannie and Freddie afloat over the next 18 months, a point that seems largely overlooked is that there was only one realistic alternative. Either Congress could explicitly provide a financial backstop such as the one just enacted, or the Federal Reserve could later ride to the rescue a la Bear Stearns should the need arise. After all, there is widespread agreement that Fannie and Freddie are too big, and at the moment too important, to fail, and that taxpayers are ultimately on the hook. (more…)

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