Tag Archives: FDIC

Farewell, Sheila Bair, and thank you (and FU Paulson, Bernanke & Geithner)

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Excellent interview here in the Times with this most decent of bureaucrats. She understood why the bailouts were not just wrong but unnecessary:

As she thinks back on it, Bair views her disagreements with her fellow regulators as a kind of high-stakes philosophical debate about the role of bondholders. Her perspective is that bondholders should take losses when an institution fails. When the F.D.I.C. shuts down a failing bank, the unsecured bondholders always absorb some of the losses. That is the essence of market discipline: if shareholders and bondholders know they are on the hook, they are far more likely to keep a close watch on management’s risk-taking.

During the crisis, however, Treasury and the Fed were adamant about protecting debt holders, fearing that if they had to absorb losses, the markets would be destabilized and a bad situation would get even worse. “What was it James Carville used to say?” Bair said. “ ‘When I die I want to come back as the bond market.’ ”

“Why did we do the bailouts?” she went on. “It was all about the bondholders,” she said. “They did not want to impose losses on bondholders, and we did. We kept saying: ‘There is no insurance premium on bondholders,’ you know? For the little guy on Main Street who has bank deposits, we charge the banks a premium for that, and it gets passed on to the customer. We don’t have the same thing for bondholders. They’re supposed to take losses.” (Treasury’s response is that spooking the bond markets would have made the crisis much worse and that ultimately taxpayers have made out extremely well as a consequence of the government’s actions during the crisis.)

She had a second problem with the way the government went about saving the system. It acted as if no one were at fault — that it was all just an unfortunate matter of “a system come undone,” as she put it.

“I hate that,” she said. “Because it doesn’t impose accountability where it should be. A.I.G. was badly managed. Lehman Brothers and Bear Stearns were badly managed. And not everyone was as badly managed as they were.”

Paulson, Bernanke and Geithner come across as callous SOBs when it comes to taxpayer funds, whose only concerns are for their friends in banking.

This next bit I do not agree with:

Grudgingly, Bair acknowledged that some of the bailouts were necessary. There was no way, under prevailing law, to wind down the systemically important bank-holding companies that were at risk of failing. The same was true of a nonbank like A.I.G., which the government wound up bailing out just two days after allowing Lehman Brothers to fail. An A.I.G. bankruptcy would have been disastrous, damaging money-market funds, rendering giant banks insolvent and wreaking panic and chaos. Its credit-default swaps could have brought down much of the Western banking system.

“Yes, that was necessary,” Bair said. “But they certainly could have been less generous. I’ve always wondered why none of A.I.G.’s counterparties didn’t have to take any haircuts. There’s no reason in the world why those swap counterparties couldn’t have taken a 10 percent haircut. There could have at least been a little pain for them.” (All of A.I.G.’s counterparties received 100 cents on the dollar after the government pumped billions into A.I.G. There was a huge outcry when it was revealed that Goldman Sachs received more than $12 billion as a counterparty to A.I.G. swaps.)

Bair continued: “They didn’t even engage in conversation about that. You know, Wall Street barely missed a beat with their bonuses.”

“Isn’t that ridiculous?” she said.

Yes, there would have been additional pain and panic had there been no bailouts at all, but we would also have cleared the banking system of bad debt and well into a real recovery by now, instead of this jobless GDP/QE faux recovery. When banks fail en masse, it’s not the end of the world – assets just move from weak to more competent hands. There were plenty of strong banks that were gyped of well-deserved deposits that should have fled crappy behemoths. The pre-Fed, pre-FDIC era saw the fastest growth and improvement in living standards of modern history because of this creative destruction, so it is a sign of the times that the most conservative, taxpayer-freindly politician or bureacrat with any significant power (unlike Ron Paul) is still in favor of bailouts.

Here’s a bit from a post I made in October 2008, when this was all going down:

What will happen if government doesn’t lift a finger?

The owners of McMansions will lose them to the banks or other mortgage holders, and those mortgage holders, if they bought the paper with loans of their own, will lose them to others, and so on. Almost every bank in the world will fail. They have all come to depend on deposit insurance and central banks to cover for the fact that they have been reckless and insolvent from nearly day one. There will be no bank lending at all.

What will happen to the depositors? Well, almost all of their money will be lost.

So, that is what we are looking at: every bank failing, zero bank lending, almost all the money in the world going to heaven. How is that not the end of the world? Simple: It is a reverse split. In 2006, let’s say, there was a million dollars in total bank deposits. Then in 2008 all the banks go under. All that is left is the cold cash in people’s pockets, let’s say $100,000 in all.

That remaining cash becomes extremely valuable. It has to work where one million did before. If you had $10 in your pocket and $90 in the bank, you now treat each dollar as if it were ten. The key is that so does everyone else. The world still has its unit of account and medium of exchange, we have just moved the decimal point over on all prices. (Note: gold and silver would rapidly re-enter circulation and quickly become the preferred money, as they always do until government outlaws them).

Of course, deflation on this scale makes debts unpayable, so essentially all debt is defaulted upon, but of course most creditors are bankrupt too. Contracts have to be renegotiated or annulled. No big deal, really. The assets are all still there, just the same as before. Nothing has burned down. A car bought on credit still gets the same mileage as before its loan went bad, a house keeps you just as dry.

Trust the prudent and smart, not bankers and politicians.

Such an event brings about a massive transfer of wealth from the reckless to the prudent and farsighted, who are exactly the people you want making the decisions about what to do with money and assets after the crash. They are statistically and philosophically the best equipped to decide what will generate the highest returns with the lowest risk. Life goes on. There is nothing to rebuild because nothing was destroyed. It is all just reordered in a more sensible fashion. The house in the desert is scrapped for materials. The Lehman mortgage traders find something productive to do, like drive cabs.

But that outcome is so quaint, so 1800s, so gold standard. We’re more scientific today. Bernanke is a wise economist. Congress is benevolent. War is peace, and lies are truth.

James Grant: Put bankers’ own assets on the line again.

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The market is the best regulator. After almost 100 years, it’s time we brought it back.

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Jim Grant has been the living best banking historian since 1995 when Murray Rothbard kicked the bucket. Last week in WaPo, he put forth is old-time solution to banking reform: make bank executives and even shareholders personally liabile for depositors’ losses.

The trouble with Wall Street isn’t that too many bankers get rich in the booms. The trouble, rather, is that too few get poor — really, suitably poor — in the busts. To the titans of finance go the upside. To we, the people, nowadays, goes the downside. How much better it would be if the bankers took the losses just as they do the profits.

Of course, there are only so many mansions, Bugattis and Matisses to go around. And many, many such treasures would be needed to make the taxpayers whole for the serial failures of 2007-09. Then again, under my proposed reform not more than a few high-end sheriff’s auctions would probably ever take place. The plausible threat of personal bankruptcy would suffice to focus the minds of American financiers on safety and soundness as they have not been focused for years.

“The fear of God,” replied George Gilbert Williams, president of the Chemical Bank of New York around the turn of the 20th century, when asked the secret of his success. “Old Bullion,” they called Chemical for its ability to pay out gold to its depositors even at the height of a financial panic. Safety was Chemical’s stock in trade. Nowadays, safety is nobody’s franchise except Washington’s. Gradually and by degree, starting in the 1930s — and then, in a great rush, in 2008 — the government has nationalized it.
No surprise, then, the perversity of Wall Street’s incentives. For rolling the dice, the payoff is potentially immense. For failure, the personal cost — while regrettable — is manageable. Senior executives at Lehman Brothers, Citi, AIG and Merrill Lynch, among other stricken institutions, did indeed lose their savings. What they did not necessarily lose is the rest of their net worth. In Brazil — which learned a thing or two about frenzied finance during its many bouts with hyperinflation — bank directors, senior bank officers and controlling bank stockholders know that they are personally responsible for the solvency of the institution with which they are associated. Let it fail, and their net worths are frozen for the duration of often-lengthy court proceedings. If worse comes to worse, the responsible and accountable parties can lose their all.
The substitution of collective responsibility for individual responsibility is the fatal story line of modern American finance. Bank shareholders used to bear the cost of failure, even as they enjoyed the fruits of success. If the bank in which shareholders invested went broke, a court-appointed receiver dunned them for money with which to compensate the depositors, among other creditors. This system was in place for 75 years, until the Federal Deposit Insurance Corp. pushed it aside in the early 1930s. One can imagine just how welcome was a receiver’s demand for a check from a shareholder who by then ardently wished that he or she had never heard of the bank in which it was his or her misfortune to invest.

Nevertheless, conclude a pair of academics who gave the “double liability system” serious study (Jonathan R. Macey, now of Yale Law School and its School of Management, and Geoffrey P. Miller, now of the New York University School of Law), the system worked reasonably well. “The sums recovered from shareholders under the double-liability system,” they wrote in a 1992 Wake Forest Law Review essay, “significantly benefited depositors and other bank creditors, and undoubtedly did much to enhance public confidence in the banking system despite the fact that almost all bank deposits were uninsured.”

Like one of those notorious exploding collateralized debt obligations, the American financial system is built as if to break down. The combination of socialized risk and privatized profit all but guarantees it. And when the inevitable happens? Congress and the regulators dream up yet more ways to try to outsmart the people who have made it their business in life not to be outsmarted…

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For the record, I agree 100% with Grant’s solution. Moral hazard is THE cause of the de-facto bankruptcy of nearly every major bank in the US.
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The US banking system pre-1913 was not perfect (unscrupulous bankers were always trying to use the power of the government’s guns to game the system), but it was much safer and more honest than today’s.
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Bankers did not yet have a license to blow bubbles, since there were no black checks from their creation, the Federal Reserve, which can simply print paper money to bail them out in the inevitable busts. Before the Fed, their own assets were on the line, and before FDIC, the depositors’ assets were at risk. These two parties had a very strong incentive to keep lending standards prudent.
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There were booms and busts, but they were localized, and at no time did the entire banking system become insolvent like it has been since 2008. Weak banks lost their depositors to those who had been prudent, and depositors knew that they were taking a risk when they chose a bank paying higher interest.
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In sum, the market is the best regulator. It’s time we brought it back.
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Discount window warfare

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I glanced at the markets at 4:30 just in time to see every “risk” market spike down hard together. That kind of instant, coordinated movement only happens on announcements, usually something out of Washington. Turns out the Fed spooked traders with news of a 0.25% hike in the discount rate, the rate at which distressed banks borrow from the central bank.

For release at 4:30 p.m. EDT

The Federal Reserve Board on Thursday announced that in light of continued improvement in financial market conditions it had unanimously approved several modifications to the terms of its discount window lending programs.

Like the closure of a number of extraordinary credit programs earlier this month, these changes are intended as a further normalization of the Federal Reserve’s lending facilities. The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy, which remains about as it was at the January meeting of the Federal Open Market Committee (FOMC). At that meeting, the Committee left its target range for the federal funds rate at 0 to 1/4 percent and said it anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The changes to the discount window facilities include Board approval of requests by the boards of directors of the 12 Federal Reserve Banks to increase the primary credit rate (generally referred to as the discount rate) from 1/2 percent to 3/4 percent. This action is effective on February 19.

In addition, the Board announced that, effective on March 18, the typical maximum maturity for primary credit loans will be shortened to overnight. Primary credit is provided by Reserve Banks on a fully secured basis to depository institutions that are in generally sound condition as a backup source of funds. Finally, the Board announced that it had raised the minimum bid rate for the Term Auction Facility (TAF) by 1/4 percentage point to 1/2 percent. The final TAF auction will be on March 8, 2010.

Easing the terms of primary credit was one of the Federal Reserve’s first responses to the financial crisis. On August 17, 2007, the Federal Reserve reduced the spread of the primary credit rate over the FOMC’s target for the federal funds rate to 1/2 percentage point, from 1 percentage point, and lengthened the typical maximum maturity from overnight to 30 days. On December 12, 2007, the Federal Reserve created the TAF to further improve the access of depository institutions to term funding. On March 16, 2008, the Federal Reserve lowered the spread of the primary credit rate over the target federal funds rate to 1/4 percentage point and extended the maximum maturity of primary credit loans to 90 days.

Subsequently, in response to improving conditions in wholesale funding markets, on June 25, 2009, the Federal Reserve initiated a gradual reduction in TAF auction sizes. As announced on November 17, 2009, and implemented on January 14, 2010, the Federal Reserve began the process of normalizing the terms on primary credit by reducing the typical maximum maturity to 28 days.

The increase in the discount rate announced Thursday widens the spread between the primary credit rate and the top of the FOMC’s 0 to 1/4 percent target range for the federal funds rate to 1/2 percentage point. The increase in the spread and reduction in maximum maturity will encourage depository institutions to rely on private funding markets for short-term credit and to use the Federal Reserve’s primary credit facility only as a backup source of funds. The Federal Reserve will assess over time whether further increases in the spread are appropriate in view of experience with the 1/2 percentage point spread.

Ok, so they are finally going to tighten up a bit, just in time for the next wave of home mortgage and commercial real estate defaults. This is a deflationary action, and it fits right into the psychology of a top, where Fed officials would be expected to conclude that the storm had passed.

When thinking about Fed decisions, I assume that it is not actually foolish economists like Bernanke and crew who make them, but their cunning and wealthy bosses — Blankfein, Dimon and company. Why would bank execs want tighter credit at the Fed? JP Morgan and Goldman Sachs likely don’t give a hoot about 0.25%, but this could push smaller banks over the edge and into the FDIC’s Friday lottery, whereby their deposits are gifted to other lucky banks.

As for the significance of this for the markets, it sends a signal that I believe will often be repeated in the coming months and years: bankers do not want to destroy the dollar any faster than they can help it. Hyperinflation is game over for the banking cartel, since the value of debt (and therefore bank assets) goes to zero.

The Fed is likely to look tougher from here on out (and actually they have not created new base money for about 12 months), especially in comparison to their European, Australian and Canadian counterparts. The Aussies and Canadians still have to liquidate their housing bubbles, and it is a very safe bet that the high rates that have made for such a lucrative carry trade are going to fall hard, along with their currencies.

Don’t be surprised if the dollar climbs all the way back to its 2000 peak.

In praise of bank runs, the only regulator we need

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Graphite here. Mike has asked me to join up as a guest blogger, and since I’ve always loved the spirited mix of finance, politics, and righteous anger of The Sovereign Speculator, I’m happy to come aboard.

If you needed another sign that this deflationary crash is just getting started, take a look at this blog post over at The Baseline Scenario. It’s stunning that in August 2009, with the FDIC in a state of de facto bankruptcy, anyone can write “the FDIC works” with a straight face. Just because it’s not the kind of horrible fascist “solution” that the current pack of knaves in Washington would pursue, doesn’t mean it’s some kind of brilliant idea.

The FDIC’s explicit purpose is to bail out imprudent depositors at the expense of prudent ones. If it wasn’t for the FDIC, all those people strutting into Corus’s Chicago branches to put their money in CDs yielding 0.25% more than the competition might have been just a little bit more concerned that it was going to fund condo development projects in Florida. Instead, they got a free lunch — why look at where your money’s going when Uncle Sucker (sorry, Sam) gets to eat the losses?

The idea that the FDIC “self funds” out of the banking system is nothing but a polite fiction. It has nearly always had to rely on taxpayer bailouts when resolving banking crises. Meanwhile, the banks that stayed prudent, made reasonable loans, and kept their reserve deposits in more liquid holdings are being slammed with huge assessments and fees, which are preventing them from recapitalizing themselves or offering better rates to their customers — in effect, spreading the stress and weakness of America’s worst banks to its best ones.

Yeah, this is a great solution to the problem of bank runs. Let’s see what happens when we really do get a full banking panic and the FDIC needs to go draw on its $500 billion line of credit with the Treasury. If you think that story ends with American depositors happily riding off into the sunset with their cash, I’d love to have some of whatever you’re smoking.

People talk about bank runs as though they’re some kind of unmitigated evil, just because some people lose money. As a matter of fact, they impose discipline and order on both banks and depositors, and ensure that the banking system as a whole remains diverse and resilient to major shocks. The moral hazard created by the FDIC was one of the most important drivers of the concentration of deposits at a few mega-banks, which (all carping about the “unregulated shadow banking system” notwithstanding) were the primary source of the awful lending binge which precipitated the credit crisis.

Look for a bottom after people finally start to dismiss, ignore, and ridicule the FDIC and its absurd apologists.

Greenspan was Framed! Blame bankers’ moral hazard, not their lackey.

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Source: The Johnsville News

Source: The Johnsville News

The Cover Story

It has become commonplace to lay blame for the greatest of asset bubbles on the inflationary policies of Sir Allen Greenspan and his employer. A typical critique goes something like this: For the last 20 years, every time the market started to liquidate bad debts and malinvestments (the junk bond bust, the crash of ’87, the early ’90s recession, the LTCM blowup, and dot-com crash), Greenspan just turned on the money spigot and made it all better again with lower rates. Because he so encouraged borrowers and lowered or eliminated reserve limits for lenders, we avoided the necessary catharsis and let bad investment pile upon bad investment, with ever increasing asset prices and debt levels, until we reached the stratosphere last year. By then the system had become so saturated with debt, and asset prices so high, that mass bankruptcy and liquidation was inevitable.

The Real Killers

This history is correct, but not complete, and it lays no blame on the true evil at the heart of the age-old problem of the credit cycle. In any analysis of historical events, one must sift through dunes of BS, and the best way to do that is to ask, Qui Bono? (“as a benefit to whom?”). The answer of course, is bankers and their perennial sidekicks, politicians. The latter designation includes the ‘Maestro,’ whom, while valuable for his mastery of obfuscation, could have easily been replaced had he not played ball. Bankers have no qualms about overextending credit, because they, more than any other party, control the government. Politicians and the bureaucracies they create have always worked for money, and bankers have always been the highest bidders.

The Means

The primary mechanism by which bankers steal from the public is fractional reserve lending, which is enabled by the socialization of losses through FDIC insurance and the Federal Reserve’s monopoly over currency.  FDIC absolves commercial bankers from responsibility for their client’s deposits, and the Fed and Treasury lock the public into the rigged system.

The Motive

Within FDIC limits, depositors have no incentive to seek out banks that employ sound lending standards. Because banks are all equally safe from the depositor’s point of view, bankers have no incentive to be cautious. They have a strong disincentive to be so, because the more credit banks extend (the higher their leverage), and the shakier the enterprises to which they lend (at higher interest), the higher their rate of return during the credit expansion (inflation) phase of the cycle. The name of the game is to grow your balance sheet as fast as possible, with little concern as to reserve ratios or collateralization.

The Opportunity

Once the bust arrives, bank executives have already collected so much in salary and bonuses and sold so much stock to an ever-credulous public, that it isn’t very painful for them if their bank fails, since they have become rich. But once a bank gets big enough (remember, the name of the game is to expand your balance sheet), it is easy for its now powerful executives to ‘convince’ politicians that failure would be so damaging that the Treasury (i.e., public) must assume its debts for the greater good.  At critical times, it may be desirable to cut out the middle man and place a trusted member of the cartel directly in the federal executive.

The Fed is Just an Accomplice

In the meantime, the Federal Reserve is called upon to extend cheap credit to banks in general, which often entails the printing of new paper or digital money. The lower base rates that ensue help banks to get off their feet again by encouraging the public to borrow more than is warranted by economic conditions. (Note: The above is how things worked before we reached Peak Credit last year, and the bankers and Fed are trying with all their might to inflate again, but they will be continually confounded. The game is now over, because nobody wants or can afford any more debt, and banks are finally so impaired by defaults that they cannot lend. Also, at $50 trillion in total private debt, the entire mess is now too big to bail, given the Fed’s mere $900 billion balance sheet.)

A Long History of Offense

So that is it in a nutshell: a completely corrupt monetary system. It is nothing new. We have had episodes like this since before Andrew Jackson abolished the first national bank. So long as a national bank has a monopoly on money creation and legal tender laws obligate the public to use fiat currency and not an alternative such as gold, bankers will retain a lock on the economy and the boom-bust cycle will continue, at great expense to our security and quality of life.

Can They Help it? Isn’t it Just Human Nature?

The credit cycle is a natural phenomenon, yes, but so is war. And just as right-thinking people oppose that other means by which the public is exploited by the oligarchy, so they should oppose fractional reserve lending and the institutions that support it: the Federal Reserve system, the FDIC, and legal tender laws.