Tuesday, September 30, 2008

Roubini on the Bailout - Thumbs Down

Mexico, Japan, Bolivia, Czech Republic, Jamaica, Malaysia, Paraguay - the United States of Subprime now joins you. Nouriel Roubini scoffs at this version of a bailout with some nice statistics; I'll defer to him since I'm not a historian but if Roubini says no, I say no! :)
  • Is Purchasing $700 Billion of Toxic Assets the Best Way to Recapitalize the Financial System? No! It is rather a disgrace and rip off benefitting only the shareholders and unsecured creditors of banks.
  • Whenever there is a systemic banking crisis there is a need to recapitalize the banking/financial system to avoid an excessive and destructive credit contraction. But purchasing toxic/illiquid assets of the financial system is not the most effective and efficient way to recapitalize the banking system.
  • Such recapitalization – via the use of public resources – can occur in a number of alternative ways: purchase of bad assets/loans; government injection of preferred shares; government injection of common shares; government purchase of subordinated debt; government issuance of government bonds to be placed on the banks’ balance sheet; government injection of cash; government credit lines extended to the banks; government assumption of government liabilities.
  • A recent IMF study of 42 systemic banking crises across the world provides evidence on how different crises were resolved. First of all only in 32 of the 42 cases there was government financial intervention of any sort; in 10 cases systemic banking crises were resolved without any government financial intervention. Of the 32 cases where the government recapitalized the banking system only seven included a program of purchase of bad assets/loans (like the one proposed by the US Treasury). In 25 other cases there was no government purchase of such toxic assets.
  • Even in cases where bad assets were purchased – as in Chile – dividends were suspended and all profits and recoveries had to be used to repurchase the bad assets. (But in the United States of Goldman Sachs we are told executives won't partake if you hurt their compensation or give away equity! ok ok we'll bend on giving away equity because that only hurts the corporation and not the CEO's personal wealth)
  • But government purchase of bad assets was the exception rather than the rule. It was used only in Mexico, Japan, Bolivia, Czech Republic, Jamaica, Malaysia, and Paraguay. Even in six of these seven cases where the recapitalization of banks occurred via the government purchase of bad assets such recapitalization was a combination of purchase of bad assets together with other forms of recapitalization (such as government purchase of preferred shares or subordinated debt).
  • In the Scandinavian banking crises (Sweden, Norway, Finland) that are a model of how a banking crisis should be resolved there was not government purchase of bad assets; most of the recapitalization occurred through various injections of public capital in the banking system. Purchase of toxic assets instead – in most cases in which it was used – made the fiscal cost of the crisis much higher and expensive (as in Japan and Mexico). (but it enriched the Dept of Treasuries friends the most! Wait, that's just in the U.S.)
  • Thus the claim by the Fed and Treasury that spending $700 billion of public money is the best way to recapitalize banks has absolutely no factual basis or justification. (hmm, why am I getting flashbacks to 2003) This way of recapitalizing financial institutions is a total rip-off that will mostly benefit – at a huge expense for the US taxpayer - the common and preferred shareholders and even unsecured creditors of the banks. Even the late addition of some warrants that the government will get in exchange of this massive injection of public money is only a cosmetic fig leaf of dubious value as the form and size of such warrants is totally vague and fuzzy. (Hammer, don't hurt 'em)
  • So this rescue plan is a huge and massive bailout of the shareholders and the unsecured creditors of the financial firms (not just banks but also other non bank financial institutions); with $700 billion of taxpayer money the pockets of reckless bankers and investors have been made fatter under the fake argument that bailing out Wall Street was necessary to rescue Main Street from a severe recession. Instead, the restoration of the financial health of distressed financial firms could have been achieved with a cheaper and better use of public money.
  • Indeed, the plan also does not address the need to recapitalize those financial institutions that are badly undercapitalized: this could have been achieved by using some of the $700 billion to inject public funds in ways other and more effective than a purchase of toxic assets: via public injections of preferred shares into these firms; via required matching injections of Tier 1 capital by current shareholders to make sure that such shareholders take first tier loss in the presence of public recapitalization; via suspension of dividends payments; via a conversion of some of the unsecured debt into equity (a debt for equity swap). All these actions would have implied a much lower fiscal costs for the government as they would have forced the shareholders and creditors of the banks to contribute to the recapitalization of the banks. (I think this comes next but after our current Treasury Secretary of the United States of Goldman Sachs "retires" after Jan 1 - gotta help his brothers out first)
Conclusion Nouriel i.e. how do you really feel?
  • Thus, the Treasury plan is a disgrace: a bailout of reckless bankers, lenders and investors that provides little direct debt relief to borrowers and financially stressed households and that will come at a very high cost to the US taxpayer. And the plan does nothing to resolve the severe stress in money markets and interbank markets that are now close to a systemic meltdown. It is pathetic that Congress did not consult any of the many professional economists that have presented - many on the RGE Monitor Finance blog forum - alternative plans that were more fair and efficient and less costly ways to resolve this crisis. This is again a case of privatizing the gains and socializing the losses; a bailout and socialism for the rich, the well-connected and Wall Street. (shocker) And it is a scandal that even Congressional Democrats have fallen for this Treasury scam that does little to resolve the debt burden of millions of distressed home owners.
Other than that, he found the plan to be wholesome, fair, and excellent. As I said, expect the government to be coming with hands out (or taking action in their own hands without asking US voters) in the next iteration of the mother of all bailouts v2.0

He does bring up a great point. Where were all the counterpoints and varying views during that 2 day dog and pony show i.e. Congressional hearings?

If you are interested in the Swedish plan, the NYTimes had a solid article here. Just keep in mind we've chosen the Jamaican plan instead ;)

[Sep 15: Nouriel Roubini with a Series of Videos on Yahoo Tech Ticker]
[Aug 20: Nouriel Roubini: "Told you So"]
[Mar 13: Scary Stat of the Day: Roubini Calling for $1 Trillion - $3 Trillion in Losses]

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