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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