Archive for the ‘bailout’ Category

Here is the Dallas Fed’s report that argues for breaking up the large banks in order to end “too big to fail.”  Very interesting reading.  My view (blogged about before) is that it is not enough to break up the large banks.  A sector that is critical and comprised of many small firms is not immune to the TBTF problem.  If banks all do a similar activity and are exposed to similar risks, then they all go under in response to the same losses in the same state of the world and the sector needs bailing out.  No firm is too big to fail, but if the sector just is too important to fail, then the concern is similar exposures as much as size.  That said, there is still an advantage to breakup, which is that the worst offenders can be allowed to fail, which may push the crowd back somewhat from the brink.

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An interesting aspect of the European rescue plan for Greece is that the ISDA (the International Swaps and Derivatives Association) ruled  that the restructuring was not a credit event for the purpose of settling credit default swaps. ISDA’s rationale is that the restructuring was voluntary — if you want to continue to hold unrestructured Greek debt, you can. Nevertheless, many bondholders will have a financial experience equivalent to a default; they will take a writedown on their debt, accept lower coupons, and have a guaranteed principal payment.

Probably a goal of the rescue was to avoid creating a credit event. There were fears that an official Greek default would cause CDS sellers to fail (remember AIG?), in which case CDS buyers (such as banks) who thought they had hedged their Greek government bond positions would not have been hedged, and this could have caused a cascade of failures. It’s hard to know if this was a plausible scenario, but this time at any rate, we won’t have to find out.


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The Congressional Oversight Panel has released a report on the eve of the expiration of TARP. The report summarizes the state of TARP.

First, TARP is likely to make money (even making money on what I thought was the worse investments from a return perspective). Of course, as TARP accounting has focused on all along, the ex ante costs were substantial because of the risks. And we will be debating for a long time to what extent the TARP investments were “good deals,” only available to an informed investor with deep pockets and not the average (or low income) tax payer. But making money was not the raison d’etre for TARP.

Second, the report asks

How is the American Economy Performing in the Wake of the TARP, Particularly those Sectors – Financial Markets, Housing, Autos – that have been the Specific Target of TARP Assistance?

Well, the recession is over, spreads that spiked up are down, and the labor market is not losing jobs but is also not generating many new ones (on net). But how about the effect of TARP on the financial system? Here the report relies on opinions (not facts) from four academics – good reading : see pages 91-108. The reports has few answers but many provocative criticisms and topics for future research.

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Everything Finance has been quiet for a while as the summer work gets done, but an interesting SIGTARP report just came out on the closure of auto dealers, link here. At the heart of the report is the question of whether Treasury (the auto team really, which includes White House economists and others) should have imposed the rapid closure of GM and Chrysler dealerships or accepted the companies’ plans for slower rollbacks. My first reaction is to disagree with a large amount of this report, but in completely inconsistent ways, so I post this really as food for thought. Should Treasury have been acting as an owner, maximizing viability and value, or as a government entity pursuing larger policy goals? Should it have been trying to maximize viability and value or get out as quickly as possible? Or another example, consider the reports call for the Treasury to monitor to ensure that the actions are carried out in “fair and transparent manner.” This seems potentially to conflict with both the maximization of shareholder (taxpayer) value and economic stabilization. But there may be some value for SIGTARP, meaning the necessity of monitoring the public bailout of a private company. Anyway, a report rich with the multifaceted issues of a the government running a private company temporarily to preserve jobs.

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The Congressional Oversight Panel released a great report on the AIG bailout, here.  Lots of fun stuff about the timeline of events, explanations of Maiden Lane and TARP involvement, a nice discussions of whether AIG is now solvent or not, etc.  But what I really liked was the debate on whether there were more than two options on those fateful days in September 2010. The principals contend that it was either let AIG fail or instead bail completely, the way they did, making counterparties whole.  But the COP suggests that the Treasury and NY Fed could and should have used their powers of intimidation. Let me quote the report:

“ . . .was it the role of FRBNY to attempt to use all the tools at its disposal to induce entities it regulated to do something they did not want to do in the interests of systemic stability? The Panel believes that FRBNY at that moment did not see such inducement as its role. The Panel believes that in such a crisis, with the stability of the financial system and the integrity of the regulatory system in jeopardy, that FRBNY’s role was to do just that: to ensure that those private parties that benefited from the stability of the financial system would contribute to its preservation.”


Seems like dangerous ground to me. With GM, some counterparties refused to negotiated writedowns, and the government let GM go into bankruptcy and there, with the help of a judge, writedowns were imposed with the usual rules.  In the case of AIG, the government was prepared to pay the full cost of not letting AIG go under, so any attempt to get writedowns/concessions from counterparties would be bluffs and potentially only enforced by strong-arm tactics. What if I, a private bank, was willing to risk my direct losses from an AIG bankruptcy and believed the contribution of such a bankruptcy to systemic risk/crisis was small.  Would it be appropriate for FRBNY to lean on me as my regulator to force me to take less from a private contract?  Very interesting debate.

Again from the report:

“The record appears to be clear that in the absence of outside funding AIG would have been insolvent by the end of the day on September 16, 2008. In the end, FRBNY provided immediate funding that night. Ultimately, it is impossible to stand in the shoes of those who had to make decisionsduring those hours, to weigh the risks of accelerated systemic collapse against the profound need for the financial firms that FRBNY was rescuing along with AIG to share in the costs and the risks of that rescue, and to weigh those considerations not today in an atmosphere of relative calm, but in the middle of the night in the midst of a financial collapse.”

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The Financial Crisis Inquiry Commission has just released a preliminary staff report entitled “Shadow Banking and the Financial Crisis.”  The underlying view of the report is that 1) the shadow banking system is like the traditional banking system – leveraging its own equity to fund long-term investments with short-term borrowing, and 2) problem that lead to the Great Recession and bailouts was a lack of a regulator/lender-of-last-resort of the types that covered the traditional banking sector.

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Sometimes the government does something that warms an economists’ heart (yes, economists have hearts).  The House Financial Services Committee approved legislation to pool disaster risks across states. The legislation sets up a system in which U.S. states can choose to participate in a disaster insurance pool.  States would pay premia into a fund, the money would accumulate (god willing), and then be used to pay for disaster relief when and where it occurred, for participating states. It would cover disasters like earthquakes, hurricanes, wildfires, tornadoes, etc. We still have to hope that the actuaries price the insurance reasonably fairly. And that the state politicians pay their premia instead of saving the funds and keeping their fingers crossed and hoping for Federal Bailouts. But the structure encourages planning for disasters and setting aside resources to deal with them, and so reduces the likelihood of Federal bailouts.

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The Senate Agriculture Committee just passed a bill regulating the derivatives market. Summary here. The legislation imposes clearing and trading requirements and real-time reporting of derivatives trades. It provides exceptions for some businesses like electric cooperatives which have argued that hedging business risks are important. It also tackles the moral hazard problem that the possibility of bailouts creates. (That is, if banks feel that the government will bail them out when they lose money, they take more risks since the downside is smaller for them). If the bill becomes law, the Federal Reserve Board and the Federal Deposit Insurance Corp. will be prohibited from providing any federal funds to businesses who are involved in derivative deals. This seems to imply that banks engaging in naked swaps transactions would have to spin off their swap dealer desks or be out in the cold in a crisis when others might be receiving bailouts. Of course, in a  crisis, laws change, and if no one spins off their desks, we are unlikely to let all banks go under (see Fall 2008).

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While we the people — through we the government – own the majority of GM and AIG, and a small share of most US banks, we completely own the GSE’s, that is the Government Sponsored Enterprises Fannie May and Freddie Mac. These institutions need a new charter, one that does not give executives and stockholders high pay and dividends when things go well and leave taxpayers footing the bill when they do not.

On Friday, the Republicans on the Committee on Financial Services have released a set of bullet points called “Goals and Principles for GSE Reform.” While the devil in legislation is in the details (not to say it isn’t also sometimes in the title too), the main points are right on track. The critical weak link in the release is: what is the mechanism that insures that we the taxpayers will not be bailing out these institutions again? Still, I am used to Barney Frank saying mostly the right things (post-crisis), and this document is on target and good to see. It makes one wonder what is taking the House so long to get a program in place?  Oh, that’s right, I forgot, the parties can’t even agree on what to order for lunch.

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TARP and the Federal Reserve’s actions during the finance crisis and recession have been extensive.  Keeping track of all the policies that have been implemented has been mind boggling.  But now there is a Pew Foundation project and webpage devoted to keeping track of what businesses or investors have gotten subsidies and how big they were/are, often in terms of current or recent subsidy rates.

TARP map SubsidyScope.com

TARP Capital Purchase Program (CPP) recipient institutions by county (Source: Pew Charitable Trusts - SubsidyScope.com; click on the map to go to their site)

The subsidy rate (or cash subsidy) is based on the difference between what the government pays (and/or the market value of what it commits to pay) and the market value of what it receives in return. For example, if TARP gives money and lines of credit to AIG in exchange for an 80% ownership stake in AIG, the subsidy rate is based on the cost of the program – the money given and the market price the government would have had to pay to buy that conditional line of credit from the market – and the market value of 80% of AIG at its post-bailout value (a subsidy rate of 1 is pure gift, a negative subsidy would make money for the government). Having been involved in valuation of TARP holdings, I know first-hand how difficult it is to evaluate the direct subsidy involved in a bailout many months later.  The current AIG subsidy rate is around 60%. But what is really important for evaluating whether the cost of different programs were worth their costs are the initial subsidy rates of the programs at the time they were undertaken. (more…)

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