So Is That Really What Republicans Mean By Regulatory Uncertainty?

Someone sent me an article from Alan K. Ota for CQ Roll Call, “GOP: Pimco Sell-Off Signals Need for Federal Cut-a-thon.” It’s online, but you need a special account to get to it, so I can’t link to it. It’s all about how major bondholders, the types that shake hands with the government, after surviving the financial crisis without taking a haircut, want the government to get serious about the short-term deficit through austerity and also some disinflation would be nice. (Remember, high-end inequality is about Oprah being a superstar on a global amount of televisions and not-at-all about rentiers with a government backstop.)

But, whatever. I bring it up only because I sometimes hear that the economy is doing badly because of “regulatory uncertainty.”  President Obama and the Democrats are spooking investors and the market by doing a bunch of things, and investors don’t want to invest.

This story always needs more meat on its bones. When I’m cynical I think saying that certain policies cause “regulatory uncertainty” and “spooking investors” is a dog-whistle that means that the policies “do not explicitly benefit rich people.” After all, the biggest rallying cry for uncertainty was the extension of the high-end Bush-era tax cuts.

So the article features this quote, which has Rep. John Campbell making a reference to an example of the government spooking the markets:

Republicans including Rep. John Campbell, whose California district includes Pimco’s main office, said the GOP was carefully pursuing a tough strategy by providing a showcase for Gross’ bearish advice to pressure Democrats. Campbell said lawmakers need to avoid spooking investors, and recalled the stock market sell-off that followed House rejection of the first version of the financial bailout in September 2008.

!?!? Not passing the first version of TARP is an example of the government irresponsibly spooking of the markets? Good to hear. Is that really the bar now, the level of deference necessary to get back to the a reasonable employment level?

Bonus fun:  John Campbell is the representative who owns the real estate a bunch of auto dealers rent, who then put a loophole in the CFPB for auto dealers, and then voted against it the CFPB. Forgive me if regulatory certainty blurs into the concept of appeasing your rich donors.  I was a guest on NPR’s Planet Money about a year ago, on a show called Attack of the Special Interests.  They asked me about the House’s CFPA exemptions that have been carved out by special interests, and I mention how auto loans have been exempted. I told them that it was put in by a congressman from California who owned a bunch of car dealers, but I wasn’t sure of the congressman’s name.  Their next guest was Rep John Campbell (R – CA), and right before they start the interview their producer figured out it was Campbell who put in the auto loan exemption! It’s a good time, especially when clarifies he owns the land and rents it, but does not own the car dealerships.

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39 Responses to So Is That Really What Republicans Mean By Regulatory Uncertainty?

  1. Tim says:

    I’ve always found the problem always comes back to where the benefits of growth have overwhelmingly gone in the last few decades. If the top does not believe they can in general become even more wealthy from further participation from the economy (and thus absorbing almost all of the benefits of GDP growth) then they simply hold on to what they have, at least investment wise.

    It does surprise me, though, that there is almost no talk about the role of rentiers in our current political discourse. It’s as if they simply don’t exist to popular discourse.

  2. Mike says:

    I think the argument is that the top 1% has enough exposure to the aggregate economy – their wealth is in stocks, in our homes, tied up with our producitivity, etc. – that there’s no conflict that could produce rentier-style dynamics. A similar argument is that recessions hurt the rich as well as the poor in a major way. I’m less certain of that nowadays.

    • Tim says:

      I’d really like to see some data about that second argument. It seems to me that it might be right, in a purely numerical way, but without actually weakening the opportune position the rich have reap later economic gains.

  3. zic says:

    I’ll give you another example of ‘regulatory uncertainty’ — the Gulf oil spill.

    Lot of BP stock holders took a haircut. Stock holders who were depending on a stable regulatory environment — meaning the government was making sure the proper regulation both existed and was enforced — to protect their investments.

    But that’s not the kind of regulatory uncertainty rich folk like to talk about, because it has a tendency to look out for the commons and the little guy who’s retirement account’s invested.

  4. K. Williams says:

    “!?!? Not passing the first version of TARP is an example of the government irresponsibly spooking of the markets? Good to hear. Is that really the bar now, the level of deference necessary to get back to the a reasonable employment level?”

    I really don’t see how anyone can disagree with this. There was no meaningful change between the version of TARP that the House rejected and the version it eventually passed. Not passing the bill was completely irresponsible, and the House’s nay vote froze credit markets and sent the stock market down more than 1000 points in less than a week, while achieving nothing.

    • Mike Easterly says:

      TARP radically changed the government’s relationship to the financial sector–unless, of course, investors had already assumed that the status quo was to bail out financial institutions whenever they got in trouble.

      Come to think of it, you may have a point here.

      • Mike says:

        Right. The whole theory of spooking the market is spooking them off a baseline. Was the baseline that Congress would write a $800 billion check to supplement 13(3) with virtually no debate or no information on how it was spent? Remember the very first Paulson paper? Congress didn’t send the stock market down the stock market the financial sector and credit markets were there already.

        And there were other options – options which the government had an obligation to study.

  5. Howard Wu says:

    Defunding NPR will help contribute to keeping such nasty news from being dispersed. Hear no evil.

  6. K. Williams says:

    “Congress didn’t send the stock market down the stock market the financial sector and credit markets were there already.”

    You can’t actually be making this argument. The stock market had actually held up remarkably well in the wake of Lehman’s failure — in fact, on the morning of the day that the first House vote was taken, the Dow was above where it had been when Lehman went under. When the House killed the bill, the Dow fell 777 points in a couple of hours. That’s not correlation. That’s causation. And I’m not even mentioning that the Dow fell 2500 points in the ten trading days after the House’s vote.

    You can try to say that the markets shouldn’t have been spooked by what lawmakers did, but there’s no question that they were spooked, and given that everyone from Krugman to Pelosi to Bernanke to Obama supported passing the bill, and given that the bill that eventually passed was identical to the one that was voted down, it was utterly irresponsible of Congress to vote against it and it absolutely did send the stock market down.

    • csissoko says:

      The markets were “spooked” because they were worried that the financiers would lose the gamble that the government would step in to protect the value of private sector investments at immense cost to the taxpayer. (We’re still paying in the form an unreformed and virtually uncontrollable banking sector, that is highly likely to generate yet another crisis within the next five years.)

      The markets recovered when they were given the right to draw on public funds to the tune of $700 billion and Paulson/Bernanke engineered the cover up of Citibank’s (and probably BoA’s) financial collapse by “forcing” them to take TARP money.

      If you think that this is one of government’s legitimate roles in the economy, I beg to differ. I would have been okay with TARP if it were a short-run plan that allowed the government to figure out how to resolve Citibank and BoA, but as things have worked out it was just a way of keeping zombie banks alive so they can wreck their destruction again in the future.

  7. Mike says:

    This is a technicality argument but I think it is important. The market assumed that the House would pass a bill. It also assumed Pets.com was worth a ton of money. The House didn’t pass the bill. I’m arguing that the market then, because I think for this conversation it is weak-form efficient, turned to a new equilibrium, which was a death spiral in the money market funds.

    Your argument is predicated on the idea that markets priced in that Congress would do whatever it takes to keep the shadow banking system from imploding. Which is fine, but its just a guess, and it was wrong the first time. That the markets wanted it and even assumed they would get it doesn’t mean that Congress has a responsibility to do it.

    Also, the market rallied because the original rumored plan was to buy $800bn of worthless securitizations. We went with a different plan. Is that equally irresponsible?

    And I’m not sure what you mean that the stock market was doing fine. I remember that summer checking the TED spread every morning, wondering when the other shoe was going to drop.

  8. K. Williams says:

    “Your argument is predicated on the idea that markets priced in that Congress would do whatever it takes to keep the shadow banking system from imploding. Which is fine, but its just a guess, and it was wrong the first time. That the markets wanted it and even assumed they would get it doesn’t mean that Congress has a responsibility to do it.

    “Also, the market rallied because the original rumored plan was to buy $800bn of worthless securitizations. We went with a different plan. Is that equally irresponsible?”

    I really don’t understand the argument you’re making, because you seem to be suggesting that somehow the original vote to kill TARP resulted in Congress adopting “a different plan” from the proposal to buy $700 billion in toxic assets. It didn’t — after the House voted down the bill, sending the markets spiraling down, there were minor revisions to the bill, but the EESA that was passed still authorized Treasury to buy toxic assets. The only thing that changed was that Congress’ failure to do what was necessary freaked investors out, because it made it seem like Washington was feckless and unreliable in a crisis. That’s completely irresponsible.

    I’m simiilarly mystified by the idea that this bailout came “at immense cost to the taxpayer.” On the contrary, as many of us predicted at the time, the bank bailout part of TARP has ended up being profitable for taxpayers. I know, I know, there were all these other ways in which the Fed, et.al., helped out the banks. But those would have occurred regardless of whether or not TARP was passed. The reality is that TARP worked, in the end, exactly as promised. It stabilized the banking system while costing taxpayers nothing — in sharp contrast to what any (at the time legally impossible) attempt to nationalize Citi or BoA would have cost.

    To go back to where this whole discussion started, the point is that Campbell was perfectly accurate in saying that the failure to pass TARP did spook investors, and that it injected an enormous amount of uncertainty into the market that vaporized a couple trillion dollars in equity values in about a week. Now, you can certainly screw investors. But pretending that Congress’ actions didn’t, in fact, make investors much less willing to invest in US equity markets is willfully wrong.

    • Mike Easterly says:

      The nominal cost of TARP is just the tip of the iceberg when it comes to bailout’s price to American taxpayers. It also must include the massive subsidy that banks are currently receiving from being presumed Too Big to Fail. If you don’t think this subsidy is real, consider the resolution costs of Fannie and Freddie once their implicit guarantee became real. The idea that government guarantees are costless because they are “off balance sheet” is part of the thinking that led to the financial crisis.

      TARP didn’t save the taxpayer money so much as it kicked the can down the road. If nothing changes, it’s only a matter of time before another financial crisis causes further damage to the economy and provokes calls for yet another taxpayer bailout.

      This may be a little off-topic, but I also don’t understand your repeated assertions that the two bailout bills were the same and that not passing the first was “irresponsible.” If memory serves, the first bill was three pages long and explicitly ruled out any accountability or oversight.

    • Tim says:

      Capital injections were not a minor addition. It may have only been a few words, but it certainly justifies claiming a difference between toxic asset purchase and the final result.

  9. csissoko says:

    “it injected an enormous amount of uncertainty into the market”

    What the passage of TARP injected into our economy was uncertainty as to whether failed businesses will be allowed to fail. If any uncertainty is damaging the economy right now, it is almost certainly the uncertainty that taxpayers’ money will be used as a slush fund to bail out private investors again in the future. This promotes outrageous levels of risk taking in the financial sector.

    Your claim that “TARP has ended up being profitable for taxpayers” ignores the fact that taxpayers were not in any way compensated for the measure of risk they were taking on. In other words, TARP was profitable in the same way that investing in subprime MBS was profitable up through 2006. Unfortunately, this crisis is not over yet, so it’s far too early to count our returns.

  10. Mike says:

    K. Williams,

    “But pretending that Congress’ actions didn’t, in fact, make investors much less willing to invest in US equity markets is willfully wrong.”

    Again, what’s your baseline. Is it really that stock investors should invest assuming Congress would always be willing to pony up TARP levels of cash with no debate, no studies, no conferences, giving huge amounts of discretion to the Treasury secretary on very short notice to stabilize a shadow banking system? That’s what you need to say in order to believe that Congress made investors not want to invest in U.S. equities.

    My statement is simply that the financial system itself screwed up and that caused the panic and the run and the lack of confidence and the vaporizing a couple trillion dollars in equity – we as a people then had to step in to decide whether or not to bailout, and if we need more time to debate that is our prerogative as a democracy. If investors misjudged how likely TARP was to pass – which is what we are talking about here – that’s a their problem not a democracy problem. Investors can vote for new representatives if they so choose, because that is how representative democracy works.

  11. Tim says:

    From K. Williams, my emphasis:

    “The only thing that changed was that Congress’ failure to do what was NECESSARY freaked investors out, because it made it seem like Washington was feckless and unreliable in a crisis.”

    It was necessary for Washington to decide to make up for the collective failure of the market to appropriately safeguard itself from risks that each of these firms and investors willingly took on without the effective oversight of those who were expected to bail them out?

  12. K. Williams says:

    “It was necessary for Washington to decide to make up for the collective failure of the market to appropriately safeguard itself from risks that each of these firms and investors willingly took on without the effective oversight of those who were expected to bail them out?”

    Yes. That’s precisely what it means to have a lender of last resort — that in the last resort (which is certainly where we were in late September 2008), the lender will step in. Normally, that lender would be the Fed, but in this case it was Treasury. In the middle of a run on the banking system, it’s the government’s responsibility to stop the run.

    As for the supposed changes that happened after the bill was voted down, people in this thread are imagining things. Paulson’s original three-page version was rejected by Congress long before the first vote took place, and the lines about capital injections were in the bill that the House rejected. This is precisely the point: the House on Sept. 29, 2008 voted down a bill that in all material respects was the same bill it eventually passed, after it realized how much its nay vote had screwed things up. That’s pure irresponsibility, as far as I’m concerned.

    • Tim says:

      “Yes. That’s precisely what it means to have a lender of last resort — that in the last resort (which is certainly where we were in late September 2008), the lender will step in. Normally, that lender would be the Fed, but in this case it was Treasury. In the middle of a run on the banking system, it’s the government’s responsibility to stop the run.”

      Uh, you seem to be implying that there is a formalized agreement of the government as a backstop for the ENTIRE financial sector, and then saying that the government wouldn’t acquiesce to this formalized but obviously not legalized agreement, given that they had to pass a bill in order to do what “was necessary”. These two positions are irreconcilable; either the government is the backstop and there is no further legal action required, or the government isn’t really the backstop, and there is a consequent push for government to actually do more than it did before.

      “and the lines about capital injections were in the bill that the House rejected.”

      In the timeline I’ve seen, Paulson opposed capital injections until after it’s passage, and that capital injections were an option, not a requirement. If you’ve got information contrary to this I’d like to see it, but I’m inclined to believe PBS’ timeline.

  13. Mike says:

    Could you point me to where it says the government is the lender of last resort to the shadow banking system, especially in 2008? I’ve never actually heard that before. That’s why people call it the shadow banking system, because it was detached from the normal banking mechanism that the government provides a backstop for.

  14. K. Williams says:

    “Could you point me to where it says the government is the lender of last resort to the shadow banking system, especially in 2008”

    To begin with, TARP didn’t bail out “shadow banks.” For the most part, it bailed out banks, banks that collectively held most of the country’s bank deposits. Here’s the list: http://www.foxnews.com/politics/2009/02/05/raw-data-list-banks-receiving-funds-b-tarp/. How many of these institutions are shadow banks? A handful? The crisis may have begun in the shadow banking system, but by September 2008 it had engulfed the entire banking system. Letting hundreds of banks go under — as would have happened had Treasury not stepped in — was not an option any reasonable person, especially not any person with a knowledge of the history of the Great Depression, could endorse.

    Secondly, yes, by fall of 2008 the government had to be lender of last resort to the shadow banking system, too, because we saw the havoc wreaked when it failed to play that role — that is, when Lehman failed. It’s certainly true that regulators should have done more to prevent the metastasis of the shadow banking system beforehand, but by September 2008 that had already happened. It was utterly irresponsible to try to remake the system in the middle of a crisis. The job of the government after Lehman failed was to restore confidence and stability to the financial system and prevent the panic that was engulfing markets from spreading. By voting down TARP, what the House did instead was foster panic. It was pure infantile acting out.

    • csissoko says:

      I think a little data on TARP will improve the conversation.
      http://projects.propublica.org/bailout/main/summary
      http://www.cepr.net/index.php/blogs/beat-the-press/buffett-tells-country-tarp-gave-over-1-billion-to-goldman-sachs

      TARP was designed to ensure that the government was not compensated for the risk it took on and to ensure that it did not act as a lender of last resort — that is as a central bank that lends at a punitive rate to banks desperately in need of funds in a credit crisis, but demonstrably ex post solvent, because they can afford to pay the punitive rate. Instead of acting as a lender of last resort, the Fed is subsidizing incompetent bankers by keeping interest rates at zero — and it should be noted that Bagehot himself warned against subsidizing such banks.

      Do you consider the bailout of AIG, which consumed a full 12% of the total funds disbursed by TARP irrelevant to this conversation? How about the bailout of the GSEs which have deliberately been used to support the banks and give them the opportunity to offload a lot of not so healthy mortgages?

      You may believe that a “command and control” financial system that is unwritten by the government and disciplined only by the dictates of regulators is a good one, many of us would like to see a return to a financial system that faces market discipline.

      As I said before if TARP had been a plan to buy time, so that banks like Citibank and BoA could be resolved, I would have said it was a good idea. Since it has clearly been used to keep zombie banks alive, it’s very likely to turn out to be just as costly a policy as regulatory forbearance in the Savings and Loan Crisis. Unfortunately now the escalating losses are denominated in billions, not millions.

    • csissoko says:

      (It looks like my initial reply isn’t going to post. I’ve taken out the links.)

      A lender of last resort supports the credit system by lending to solvent banks against good collateral at a punitive rate. TARP money was not lent against collateral, was not lent at a punitive rate and most likely did not go to solvent banks.

      You can make the argument that TARP was “necessary,” but calling it a lender of last resort action requires that you indicate what novel definition you are using of that term.

      TARP was clearly designed to bail out the shadow banking system. More than 12% of the funds expended went to AIG because of its involvement in shadow banking. The banks that got the TARP money were granted explicit exceptions to normal bank/holding company barriers by the Fed so that they could use their TARP-augmented capital to support money market funds and tri party repo securities.

      Furthermore TARP was accompanied by the extremely costly GSE bailout that deliberately supported banks by creating a government underwritten mortgage market and taking many not so solid loans off of bank balance sheets and out of the securities the banks had invested in.

      You may think that what we need is a “command and control” financial system with a government backstop that is disciplined only by the dictates of regulators (at least that’s how I understand your novel use of the term lender of last resort), but many of us think that the discipline of market forces is necessary to ensure that we have a reasonably safe and sound financial system.

      As I said before if TARP had been used to buy time to resolve Citibank and BoA, then I would have said it was a good idea. However, we know now that it was just a policy to support zombie banks, and as such is essentially just a repeat of the Savings and Loan crisis’s regulatory forbearance, and will most likely have equally costly results. Unfortunately now the losses being multiplied are denominated in the billions, not the millions.

  15. K. Williams says:

    “A lender of last resort supports the credit system by lending to solvent banks against good collateral at a punitive rate. TARP money was not lent against collateral, was not lent at a punitive rate and most likely did not go to solvent banks.”

    No, this is your definition of what a lender of last resort should do. My definition is much less specific: a lender of last resort steps in to provide liquidity to net-present-value-positive institutions during times of market panic. In times of genuine systemic crisis, it is foolish for the government to be scholastic about the quality of the collateral it is lending against, or the rates at which it is lending, since a massive breakdown of the banking system will inflict huge costs and necessarily devalue even the “good” collateral.

    This is, as it happens, exactly the position the Bank of England (the original lender of last resort) took during the banking crisis of 1825. As Bank director Jeremiah Harman put it:

    “We lent… by every possible means, and in modes that we never had adopted
    before; we took in stock of security, we purchased Exchequer bills, we made
    advances on Exchequer bills, we not only discounted outright, but we made
    advances on deposits of bills to an immense amount; in short, by every
    possible means consistent with the safety of the Bank;… seeing the dreadful
    state in which the public were, we rendered every assistance in our power.”

    This is what it means to be a lender of last resort — to act creatively and innovatively in the face of crisis, with the only constraint being that one’s actions should not put the government itself in jeopardy. This is what Bernanke did, and what TARP enabled Treasury to do, and it was the right thing to do, given “the dreadful state in which the public were.” I’m all for market discipline. But in a fractional-reserve banking system, banks are by definition always at risk of a panic-driven run, one that ends up threatening the health of the system as a whole. For the government to sit idly by at those times is outrageously irresponsible.

    Look, we tried it your way — we let the market work its magic and send Lehman under. If you want to argue that not rescuing Lehman made the system stronger, or less subject to moral hazard, or that it didn’t end up imperiling financial institutions whose balance sheets were in reasonable shape before the panic, go ahead. But we ran your experiment, and it failed.

    • csissoko says:

      (i) In 1825 the Bank of England lent at a minimum of 5% interest. If “Bank Rate” was already the policy (and I have to admit I don’t remember when it started) the rate in this crisis would have been much higher. The Bank of England considered it dangerous throughout the 19th century to lend at rates below 2%. (‘John Bull can stand many things, but he cannot stand two per cent.’ as they used to say.)

      (ii) Bagehot’s comment on the aggressive lending of 1825 that you reference was:
      “No advances indeed need to made by which the Bank will ultimately lose. The amount of bad business in commercial countries is an infinitesimal small fraction of the whole business. That in a panic the bank, or banks, holding the ultimate reserve should refuse bad bills or bad securities will not make the panic really worse; the ‘unsound’ people are a feeble minority, and they are afraid even to look frightened for fear their unsoundness may be detected.”

      This environment, where bad credit was an “infinitesimal” part of the whole grew out of an environment where every banker and financier had his own house and personal assets on the line, because

      (iii) In 1825 their were no limited liability banks (except for the bank of England itself). When a bank failed, the personal assets of the banker of of the joint stock holders were sold off to make good all the banks debts. Look up what happened when Overend and Gurney failed (which was the 19th century equivalent of Lehman and convinced Bagehot to write Lombard Street).

      (iv) In fact Overend and Gurney is an example of what an effective lender of last resort does: It lets the bad banks fail and supports the financial system through their dissolution.

      Because Bagehot recognized that it would be a disaster to support a bad bank, he approved of the Bank of England’s decision to let Overend fail.

      He considered Overend a bad bank:

      “The case of Overend, Gurney and Co., the model instance of all evil in business, is a most alarming example of [the] evil [of a hereditary business of great magnitude]. No cleverer men of business probably … could well be found than the founders and first managers of that house. But in a very few years the rule in it passed to a generation whose folly surpassed the usual limit of imaginable incapacity. In a short time they substituted ruin for prosperity and changed opulence into insolvency.”

      But did not fault the Bank of England for allowing it to fail:

      “In 1866 undoubtedly a panic occurred, but I do not think that the Bank of England can be blamed for it.”

      Even though he recognized the Lehman like consequences of that failure.

      “no cause is more capable of producing a panic, perhaps none is so capable, as the failure of a first-rate joint stock bank in London. Such an event would have something like the effect of the failure of Overend, Gurney and Co.; scarcely any other event would have an equal effect.”

      Do you really think our modern financial system can be compared to one where every financier had his own house and horses on the line? With the results that almost no bad assets were actually originated?

      A financial system that originates massive quantities of bad assets needs to be purged one way or another, as both Jeremiah Harmon and Walter Bagehot would have recognized in a moment.

      As I have said many times: if the point of TARP had been to buy time to carefully dissolve the bad banks, it would have been acceptable. So no, you didn’t run my experiment, and no it didn’t fail.

  16. Tim says:

    I originally held the position that is was for the good of the average person that we did not allow these irresponsible and insolvent institutions to go under. As time goes on, I’m less and less convinced that it has provided us with positive results. We instead have an extremely long and deep recession, with the near total assurance of another crisis in the near future.

    Doesn’t seem like a policy victory to me.

  17. K. Williams says:

    “Do you really think our modern financial system can be compared to one where every financier had his own house and horses on the line? With the results that almost no bad assets were actually originated?”

    I do not fetishize Bagehot, or take his judgment on Overend — or, for that matter, on the proper lending policy during panics — to be the last word on the matter. The US let plenty of bad banks fail in the early 1930s. I fail to see any evidence that that helped the economy recover more quickly. More to the point, I don’t agree that Citi and BoA were bad banks in the Overend sense, which is to say I don’t think they were ever net-present-value-negative institutiions. From a public-policy perspective, breaking them up might have been beneficial in the sense that huge banks don’t seem to serve any great economic benefit. From the perspective of the economy, forcing them into bankruptcy or nationalizing them would have done more damage and been far more costly to the government than TARP. Nor would it have been, as some have suggested, any more politically popular. We nationalized Fannie and Freddie and AIG and cleaned out their management, yet those moves are as, if not more, unpopular than TARP.

    Finally, I have absolutely no idea what you mean when you write: “Do you really think our modern financial system can be compared to one where every financier had his own house and horses on the line? With the results that almost no bad assets were actually originated?”

    Are you actually trying to argue that “almost no bad assets were originated” by banks i the 19th century? This is patently absurd. Do I really have to walk you through the long history of real-estate bubbles and crashes in the US?

    • csissoko says:

      The comparison you made was to 19th century England (where Jeremiah Harman lived) and England did not have the “wild cat” banks of the US. Of course, in England as everywhere loans went bad, but at no time in 19th century England were loans comparable to 21st century american subprime loans being originated.

      The claim that putting the real and personal property of the people running banks on the line does not change their behavior in regards to loan origination is ridiculous on its face. And I think your problem is that you understand perfectly well what I mean, but know that it defeats your argument entirely.

      The fact that our financiers are not asked to take responsibility for the consequences of their behavior is rotting our financial system. And as long as we refuse to face up to this fact, the situation will just get worse and worse.

  18. csissoko says:

    Since the previous response was a little rushed, let me address some of your substantive points:

    “The US let plenty of bad banks fail in the early 1930s. I fail to see any evidence that that helped the economy recover more quickly.”

    The problem in the early 30s was that the American financial system relied on the assumption that Britain would be able to keep its peg to the gold standard. When Britain went of gold in 1931, it wiped out the asset base of many “good” American banks. Thus, the problem in the 30s was that so many good banks failed, not that bad banks were allowed to fail. Personally, I find comparisons the 30s faulty for this reason. Our financial system simply does not have all the safeguards that existed in the 30s.

    “More to the point, I don’t agree that Citi and BoA were bad banks in the Overend sense, which is to say I don’t think they were ever net-present-value-negative institutiions.”

    As far as I know no one ever claimed that Overend was a net present value negative institution. On the contrary, most observers believed that had the Bank of England allowed it access to the discount window, the bank would have survived. The reason it was a good idea to allow it to fail in 1866 was because saving it would have made a bigger crisis in the future likely. It was simply relying too heavily on the Bank of England’s resources.

    “From the perspective of the economy, forcing them into bankruptcy or nationalizing them would have done more damage and been far more costly to the government than TARP.”

    It’s far from clear to me that the alternatives were bankruptcy or nationalization. I always assumed that the main prospect was an FDIC takeover of the bank and the creation of a bridge bank — just as happened with Continental Illinois, IndyMac, etc. The question was what to do with the holding companies after the FDICIA mandated FDIC takeover — and then I think the main prospect was resolution, not nationalization.

    Whether this would have been more or less costly than TARP, we can never know, because it was a path not taken.

  19. K. Williams says:

    “It’s far from clear to me that the alternatives were bankruptcy or nationalization. I always assumed that the main prospect was an FDIC takeover of the bank and the creation of a bridge bank — just as happened with Continental Illinois, IndyMac, etc. The question was what to do with the holding companies after the FDICIA mandated FDIC takeover — and then I think the main prospect was resolution, not nationalization.”

    As you know, the government had no legal authority to do an FDIC-style takeover of the bank holding companies, while the parts of these banks that the FDIC did have authority over were, by any standard, solvent. (And the FDICIA contained, as you also know, an exception to the least-cost resolution rule for systemically important institutions.) So the only alternatives were bankruptcy or nationalization. In any case, even if we’d somehow managed an FDIC-style resolution of Citi and BoA, there’s no question that it would have been more costly (at least in terms of dollars outlaid) then TARP, because depositors would have fled, bondholders would have had to be paid back, etc. IndyMac had total assets of $32 billion when it was taken over, and its resolution cost the FDIC more than $10 billion. Now, Citi and BoA’s finances were nowhere near as awful as IndyMac’s, but even so, that gives you a sense of how expensive it would have been to resolve institutions with $1 trillion+ in assets.

    This is one reason, by the way, why there should have been a pre-authorized resolution fund in Dodd-Frank — while the government does now have the legal authority to resolve these institutions, doing so is still going to require Congress’ willingness to shell out money up-front (which we hope will eventually be paid back).

  20. csissoko says:

    ” there’s no question that it would have been more costly (at least in terms of dollars outlaid) then TARP, because depositors would have fled, bondholders would have had to be paid back, etc. IndyMac had total assets of $32 billion when it was taken over, and its resolution cost the FDIC more than $10 billion.”

    First, the bridge bank is created to prevent depositors from fleeing. Do you have some data on depositors fleeing after an FDIC takeover and government guarantee? Remember that the guarantee was extended to commercial accounts in the crisis.

    The whole point of resolution (or what you prefer to call nationalization) of the holding companies is to make sure that unsecured debt holders including bondholders take the haircut for which they have for years been earning compensation in the form of interest rate spreads. Because of the ability to share losses with bondholders in a bank holding company resolution, the government is likely to face far smaller losses than in an FDIC resolution.

    What you appear to be observing is that Treasury’s dithering through 2008 meant that no resolution authority was drafted over the summer to present to Congress instead of TARP. (That such an authority was clearly necessary after the Bear Stearns failure is well established, see http://www.nytimes.com/2009/09/08/business/economy/08sorkin.html ) The real scandal of TARP is that Treasury had half a year to draft the bill it needed, and what we got was TARP and a government transfer to the financial system that wasn’t senior like DIP financing, FHLB loans or FDIC insurance, but instead actual sat below unsecured creditors. There was simply no excuse for a government intervention of this nature, especially give that this intervention was planned for five months. (See Swagel’s Spring 2009 Brookings Paper for the latter.)

    TARP was an unwise and unprecedented give-away to the financial sector and nothing like the lender of last resort measures that have been taken in the past. It was an effort, not to support the financial system through a liquidity crisis (which would by definition have been completed within a matter of months), but to support the financial system through a solvency crisis. And, in addition to an interest rate policy that is a pure subsidy to the banks, we continue to see regulators bending over backwards to prevent banks from realizing the losses they have earned (see, for example, the servicing agreement currently making the rounds).

    You may find it comforting to think of TARP as a “necessary,” but it is really not hard to think of 101 other policies that could have been tried. And I, for one, am convinced that nothing good can come of coddling the banks and treating them like young children who simply cannot be asked to face the risks they have chose to take.

  21. K. Williams says:

    “First, the bridge bank is created to prevent depositors from fleeing. Do you have some data on depositors fleeing after an FDIC takeover and government guarantee? Remember that the guarantee was extended to commercial accounts in the crisis.”

    IndyMac declared $19 billion in deposits when it was seized. By the time the bank was sold (that is, by the time resolution was done), it had $6.4 billion. That’s a steep decline — half of which was accounted for by running off brokered deposits, but the other half of which was the result of depositors pulling their money out. There were 1000+ plus people lined up outside IndyMac branches early in the morning the day the bridge bank opened, and the branches were crowded with depositors pulling their money out all week long: http://www.americanbanker.com/issues/173_140/-358143-1.html. And those withdrawals just kept coming. That’s why the losses the FDIC took were so much bigger than it had initially projected, because it had to pay out so much to depositors. There’s no reason to think that people would not have similarly pulled their money out of Citi and BoA if the government had taken them over. Indeed, since the level of panic provoked by the takeover of those banks would have been far greater, the withdrawals might plausibly have been greater, too.

    ” to make sure that unsecured debt holders including bondholders take the haircut for which they have for years been earning compensation in the form of interest rate spreads. Because of the ability to share losses with bondholders in a bank holding company resolution, the government is likely to face far smaller losses than in an FDIC resolution.”

    IndyMac’s bondholders got pennies on the dollar. Its losses still totaled about 1/3 of assets. WaMu’s bondholders were wiped out. But had J.P. Morgan not agreed to take over WaMu (an action that, unlike creating a bridge bank, really does keep depositors’ confidence), the FDIC’s losses on WaMu would have been immense.

    What resolution does is turn potential losses — that is to say, mark-to-current-market losses — into real ones. And it amplifies those losses by destroying depositors’ confidence in the institution and by forcing the institution to pay back (however much it chooses to pay them) bondholders, since it’s an occasion of default. There are times when this is a necessary and correct strategy — IndyMac had already lost the confidence of everyone. But if you have reasonably well-run institutions that are not taking additional reckless gambles, that are liquid, and that have the potential to earn themselves back into financial health via their ordinary business (as was true of both Citi and BoA), then the cheapest solution is unquestionably the one that the government followed. The alternative — using panic-driven markets as the sole definer of solvency — would mean that the government would be forced to take over banks all the time.

  22. Tim says:

    Your argument has been predicated on cost- have you ever stopped to ask yourself why you are referring to cost instead of results? Specifically have you thought that maybe spending less money to kick the crisis a little further down the road instead by backstopping the huge and (still) tangled mess that is the financial sector instead of unwinding it and putting it back into the daylight (and reasonable terms of leverage) when there was a chance might not actually be in our best interest long term.

    If you want to take the bet that there will not be a future crisis that stems from the way we handled this one, I’d really like to take that bet.

  23. csissoko says:

    (I wrote a lengthy response and lost it when my computer crashed, so this is a briefer Take II.)

    The FDIC tells us that as of 12-31-2010 IndyMac Federal has $9 billion of “unpaid deposits,” which when added to the fact that the $19 billion figure includes brokered deposits and the $6.4 billion does not probably accounts for the difference. We really do no have the data to conclude that there was a bank run on Indy Mac Federal.

    It’s true that people were still showing up at the door on the Monday IndyMac Federal took over, but as your article states most branches “had returned to normal” by Wednesday. This supports my point more than yours. Once the government had stepped in the run tapered off.

    The data we need is the deposits in IndyMac federal in August 2008. As far as I can tell that’s not available.

    “What resolution does is turn potential losses — that is to say, mark-to-current-market losses — into real ones.”

    No. The point of a bridge institution is to carry the assets instead of liquidating them immediately.

    “And it amplifies those losses by destroying depositors’ confidence in the institution and by forcing the institution to pay back (however much it chooses to pay them) bondholders, since it’s an occasion of default.”

    As noted above there’s no evidence that the introduction of a Federal bridge bank adds in any measure to the bank run. And it doesn’t make sense to claim that losses are “amplified” by the decision not to pay bondholders.

    “But if you have reasonably well-run institutions that are not taking additional reckless gambles, that are liquid, and that have the potential to earn themselves back into financial health via their ordinary business (as was true of both Citi and BoA), then the cheapest solution is unquestionably the one that the government followed.”

    Putting Citigroup — the bank that needs a bailout every ten years — in the category of “well-run institutions” is just funny. And any bank that doesn’t have a net zero balance in each sub-category of its derivative holdings (see the OCC report) is clearly taking positions and “additional reckless gambles.”

    But supporting any institution with “the potential to earn themselves back into financial health via their ordinary business” is where I think you’ve completely failed to understand the nature of the support that a lender of last resort (LoLR) provides. The LoLR has to carefully balance the need of the financial system with liquidity support with the adverse incentives created by the existence of that support. This means that it is essential that a lender of last resort make it clear that any bank that has created a situation requiring LoLR intervention or that relies extremely heavily on that support will not be supported the next time. It’s precisely the act of allowing banks that appear to be mismanaged to fail that ensures that banks will be managed conservatively and not take inappropriate risks. Banks need to be scared of the LoLR, not reliant on it — and grateful when the LoLR chooses to help them.

    Your criterion for a bail out encourages banks to negotiate with the LoLR: Just give us a chance, so we can pull through. And even the possibility of such negotiation is sure to trigger inappropriate risk taking.

    “The alternative — using panic-driven markets as the sole definer of solvency — would mean that the government would be forced to take over banks all the time.”

    The is not, of course, just one alternative. I’ve delineated an alternate approach to LoLR lending, which is a reasonable description of the management of the Bank of England which invented the concept of a LoLR. I’m all for supporting the financial system through a liquidity crisis. But a liquidity crisis is by definition a short-run affair, so such intervention is clearly meant to support insolvent institutions if it lasts for more than a year. And as we have seen, the government’s already taking over banks all the time. Just take a look at the FDIC website.

    I am strongly opposed to government support of insolvent institutions. And your criterion of supporting any bank with “the potential to earn themselves back into financial health via their ordinary business” is pretty clearly meant to support such institutions.

  24. K. Williams says:

    “The FDIC tells us that as of 12-31-2010 IndyMac Federal has $9 billion of “unpaid deposits,” which when added to the fact that the $19 billion figure includes brokered deposits and the $6.4 billion does not probably accounts for the difference. We really do no have the data to conclude that there was a bank run on Indy Mac Federal.”

    Yes, we do. The data from 12-31-2010 is irrelevant to what happened to IndyMac after the FDIC took it over, because it’s been privately owned since March 2009, and of course its owners have been adding deposits since then. The relevant number is the $6.4 billion. That’s the total in deposits it had as of 1/31/2009 — http://www.fdic.gov/news/news/press/2009/pr09042.html — down from $19 billion as of 3/31/08. The bank run at the end of June removed about $1.3 billion of those. The FDIC said that brokered deposits totaled around $6 billion. You’re still talking about $5-6 billion that was withdrawn after the bank was seized. Why else do you think the FDIC’s losses went from an estimated $4-6 billion to almost $11 billion?

    Also, on the way resolution turns “potential losses” into real ones, this is precisely the point about cost. If you have to give depositors back their deposits and senior bondholders back their principal today (even if you give unsecured creditors a haircut), you have to sell assets to do that, or else the government needs to foot the bill. The first, if done in the kind of market panic we saw between the summer of 2008 and the spring of 2009, creates losses unnecessarily. The second, if done for institutions the size of Citi and BoA, would force the government to shell out tens, if not hundreds, of billions of dollars that it would have no guarantee of getting back. (There’s no FDIC fund for bondholders.) This would have been more, not less, unpopular than TARP, and there’s no way Congress would ever authorized the expenditure of funds for it.

    Finally, the problem with forcing bondholders to take a haircut is, of course, that among the biggest bondholders of large banks are other, smaller banks, so that taking over the big banks would, in turn, have severely weakened the country’s smaller banks. Again, hardly the strategy you want to pursue in the middle of a financial crisis.

  25. csissoko says:

    “The data from 12-31-2010 is irrelevant to what happened to IndyMac after the FDIC took it over, because it’s been privately owned since March 2009”

    The data I was discussing refers explicitly to IndyMac Federal which is available if you click the “balance sheet” link here: http://www.fdic.gov/bank/individual/failed/IndyMac.html. It does not refer to the new OneWest Bank. You are confused. I don’t know why the FDIC has not yet paid out $9 billion in IndyMac deposits, but I am confident that the FDIC is giving us accurate information.

    “Also, on the way resolution turns “potential losses” into real ones, this is precisely the point about cost. If you have to give depositors back their deposits and senior bondholders back their principal today”

    I don’t believe your claims about the run on deposits of a federally guaranteed bank. Nor do I believe your claims about the bondholders: Unless they’re secured, bondholders don’t need to be paid back in a resolution unless and until the bank has the free resources to do so. You should look up the FDIC’s powers when it comes to resolving a bank.

    “severely weakened the country’s smaller banks”
    So did allowing banks to postpone payment on their trust preferred securities — since small banks invested heavily in TRuPS CDOs. But the regulators were willing to do that to improve the capital position of the postponing banks.

    It seems to me that you want to see costs that might not even be there in order to convince yourself of the “necessity” of your preferred policy choice.

  26. K. Williams says:

    “The data I was discussing refers explicitly to IndyMac Federal which is available if you click the “balance sheet” link here: http://www.fdic.gov/bank/individual/failed/IndyMac.html. It does not refer to the new OneWest Bank. You are confused. I don’t know why the FDIC has not yet paid out $9 billion in IndyMac deposits, but I am confident that the FDIC is giving us accurate information.”

    I can’t believe I’m still writing about this, but what the hell: someone (that is, you) is wrong on the Internet.

    You’re misreading the numbers. The $9 billion on that balance sheet — in “proven deposit claims” — aren’t deposits IndyMac FSB has. It’s the money that it owes — and will never be able to pay — the FDIC. The way it works is that when the FDIC pays off the insured depositors, it then in theory creates a claim for that sum against the financial institution (that’s why it says “FDIC subrogated claim”). Ideally, via asset sales, the FDIC would be able to recover all that money. But in this case, it came up about $9 billion short, even after selling the bank to OneWest.

    Look, it’s all right there in the “Introduction” http://www.fdic.gov/bank/individual/failed/IndyMac.html:

    On March 19, 2009, the Federal Deposit Insurance Corporation (FDIC) completed the sale of IndyMac Federal Bank, FSB, Pasadena, California, to OneWest Bank, F.S.B., Pasadena, California. . . . All deposits of IndyMac Federal Bank, FSB have been transferred to OneWest Bank, FSB.

    “On July 11, 2008, IndyMac Bank, F.S.B., Pasadena, CA was closed by the Office of Thrift Supervision (OTS) and the FDIC was named Conservator. All non-brokered insured deposit accounts and substantially all of the assets of IndyMac Bank, F.S.B. have been transferred to IndyMac Federal Bank, F.S.B. (IndyMac Federal Bank), Pasadena, CA “assuming institution”) a newly chartered full-service FDIC-insured institution.”

    On July 11, 2008, that is, all non-brokered deposits of IndyMac Bank went to IndyMac Federal Bank. On March 19, 2009, all the deposits of IndyMac Federal went to OneWest. The second number was $6.4 billion. The first number was at least $9 billion, and probably closer to $11 billion. That difference is the result of the run on the bank after IndyMac was taken over.

    It seems to me that you want to not see costs that are there in order to convince yourself that resolution would not have been expensive and dangerous.

  27. csissoko says:

    I wasn’t misreading the numbers. I was pointing out to you that of IndyMac’s deposits $9 billion were not yet paid out by the FDIC. Presumably the deposits that were transferred to OneWest were paid out, so we’re now at $15.4 billion. You claim that $1.3 billion was withdrawn before the FDIC takeover, while the FDIC website indicates that the number was $1.7 billion. What’s left is $1.9 to $2.3 billion, this may well be accounted for by brokered deposits that were paid out over a period of 18 months as the FDIC deliberately reduced them. (See here: http://www.fdic.gov/news/news/press/2009/pr09001.html “it has restructured funding to focus on more stable core deposits”)

    These numbers provide no evidence whatsoever of a run on IndyMac Federal. You claim that $9 to $11 billion were transferred to IndyMac Federal, but do not give us the source of this information.

    You stated previously that the the deposit run that you claim took place is the only source you can think of for the increase in FDIC loss estimates from up to $8 billion in July 2008 to $10.7 billion in March 2009. This claim ignores what happened to asset values between those months. The FDIC has stated explicitly that $2.6 billion of the increase came from declining real estate values between the two dates (see here: http://www.fdic.gov/news/news/press/2009/pr09042.html )

    There is no evidence on the FDIC website of the deposit run on IndyMac Federal that you claim took place or of the costs that you associate with it.

  28. csissoko says:

    Don’t know whether my previous comment will post, but I wrote it too quickly anyhow. Thank you for explaining the FDIC balance sheet information, which I will admit I misunderstood. I apologize for continuing with my confusion over it. (Trying to get too many things done at once.)

    Two questions remain: how many of the non-brokered deposits fled IndyMac federal? and Did this increase the costs of resolving IndyMac?

    The FDIC website does not gives us enough information to establish the answer to the first question and if you can find a source for the claim that between $9 and $11 billion was transferred to IndyMac Federal I would be interested in it.

    The question raised by the second issue is whether the FDIC faces the same constraints as a private institution in meeting its obligations in a resolution/bankruptcy. Because the FDIC has access to a line of credit from the Treasury, I don’t see how it can be forced into a fire sale of assets. And in fact the balance sheet that you have kindly explained makes this clear: Despite losses of $10 billion on IndyMac the FDIC is carrying $3.3 billion in assets that it is still looking for a good opportunity to lay off. And this is 18 months after the closure of the bank.

    Where is the evidence of the “mark-to-current-market losses” that you claim? Instead this is a government institution with the ability to carry the assets until it has a good opportunity to sell them. Thus, even if the run took place as you claim, there is no reason to believe that it could impose “fire sale” costs on an institution like the FDIC.

    Note that I’m not claiming that there will be no costs, only that costs of continuing to coddle dysfunctional banks will end up being even larger. The disaster I’m worried about is the modern equivalent of the Credit Anstalt failure in 1931 (which was caused by its take over of the bad assets of another bank in a government orchestrated bailout). History shows us that at some point our too big to fail banks become too big to save.

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