I've been traveling a lot in recent weeks and had the pleasure of meeting policymakers in a number of countries. Perhaps the most interesting of those meetings occurred in a small workshop attended by a couple of policymakers who had worked with Timothy Geithner to bail-out Wall Street. Let me just say that these were intelligent guys with their hearts in the right places. While they probably did not think they were doing “God's work” (as the Vampire Blood Sucking Squid put it), they certainly did think they were operating in the public interest.
They shared a view that what we experienced back in 2008 was the mother of all liquidity crises. As one of them put it, the crisis boiled down to this: the world missed a payment, then all hell broke loose. To summarize this view, we had a highly leveraged and interdependent financial system that relied on extremely short-term borrowing (overnight) to finance positions in assets.
A key link in the liquidity chain was the money market mutual fund, which essentially promised close substitutes for bank deposits, but without the government guarantee. MMMFs purchased very short term debt issued by the shadow banking system (held as assets). When it looked like forces would “break the buck” there was a massive run on the money markets which made it impossible for the MMMF's to continue to provide overnight funding to the shadow banks. This is a $3 trillion uninsured “deposit-like” market that the government had to guarantee dollar-for dollar. All told, the bailout of Wall Street amounted to more than $29 trillion (that is the “flow” number; the outstanding stock maxed at perhaps $8 trillion—still a very big number). That is what happens when the world “misses a payment”.
While this is not the topic for this blog, just think about the possibilities if $8 trillion (leaving to the side $29 trillion) had been devoted to bailing out Main Street rather than Wall Street. We'd be fully employed, driving brand new SUVs, and making payments on our overpriced MacMansions. All that is too obvious to require any explication. Now, I think these guys are wrong. Dangerously so. What we actually had (and have) were massively insolvent Wall Street shadow banks, so their short term liabilities were trash. The run on MMMFs was not an irrational liquidity run, but rather a rational run on institutions that were holding garbage as assets. The federal government made that garbage as sweet smelling as roses, by intervening in the biggest bailout in human history, by several orders of magnitude. And it did not have to be that way.
Let us instead deal with a “what if”. Suppose we had decided not to bailout the MMMFs and let the insolvent shadow banks go down. What if we had not handed bank charters to Goldman Sachs and Morgan Stanley (the last two investment banks standing)? What if we had simply closed down what my colleague Bill Black calls “systemically dangerous institutions”? What if we had let the market “work”—in its wisdom it wanted to close down the biggest financial institutions and to rid the world of shadow banking. What if we had let that happen?
We know the view at the Treasury: from Rubin to Paulson to Geithner the view is that we'd have no economy at all. Forget about a financial system—we'd be back to bartering coconuts for fish. That was the claim made by Paulson when he went to Congress and demanded nearly a trillion dollars to bailout his Wall Street buds, with a gun to his head and threatening to pull the trigger. What if we had borrowed a line from Clint Eastwood: “go ahead, make my day”? Blow your own stupid head off.
Here's a hypothesis. We'd be MUCH better off today. The banksters would all be gone—retired to their offshore islands with whatever riches they had been able to hide away. We'd still have, oh, about 4000 banks, mostly honest, mostly making loans to firms and households, and with reasonable compensation and no special power over Washington. This ain't just my hypothesis. In a very interesting (and to my mind, convincing) article, Robert G. Wilmers, chairman and chief executive officer of M&T Bank Corp. (MTB) made the case for me. Indeed, his piece is so good that I cannot possibly improve upon it. Let me provide a few key (and somewhat long) excerpts. The whole piece is here: Small Banks, Big Banks, Giant Differences: Robert G. Wilmers
First, Mr. Wilmers rightly notes the long term transformation of banking away from lending and to trading:
Community banks have given way to big banks and excessive industry concentration; profits are increasingly driven by risky trading; leverage is taking precedence over prudent lending; compensation is out of control. This toxic combination leads to continued taxpayer risk and threatens long-term U.S. prosperity. To understand the change, first consider history. Banking once was a community-based enterprise, relying on local knowledge to guide the process of gathering customer deposits and extending credit. Done well, this arrangement ensures that deposits are deployed into a diversified pool of investments, while providing depositors with liquidity and a return on their savings. Over the past generation, however, the financial services industry changed dramatically. In 1990, the six largest financial institutions accounted for 9 percent of all U.S. domestic deposits. As of Dec. 31, 2010, the six biggest banks accounted for 36 percent of deposits.
Amazing analysis, from a banker. The big banks have virtually no interest in lending. They use deposits to finance their trading activity; and when the trades go bad they ask Uncle Sam to bail them out.
Such concentration raises the concern that poor decisions at such outsized institutions can lead to systemic risk. But this risk is greatly magnified by the new way in which the major banks, those deemed too big to fail, are doing business today. The largest and most profitable bank holding companies have moved away from traditional lending and come to rely on speculative trading in all types of securities, derivatives, credit default swaps, mortgage-backed securities and other, even more complex and exotic financial instruments -- many of them associated with high leverage. Such trading now is the engine of income. In 2010, the six largest bank holding companies generated $56.1 billion in trading revenue, or 74 percent of their $75.7 billion in pretax income. Trading revenue at these institutions distinguishes them from traditional commercial banks, which aren't typically involved in such speculative endeavors. The Big Six institutions earned more than 93 percent of the trading revenue generated by all American banks during the past two years. To say these large institutions are the same species as traditional commercial banks is akin to describing dinosaurs as reptiles -- true but profoundly misleading.
In reality these institutions are what my colleague Bill Black calls control frauds. Their sole purpose is to enrich top management with outsized bonuses. Trading is the preferred activity. First because they can screw the suckers. But more importantly, because trading profits can be whatever you want them to be. You buy my trash at outlandish prices, and I buy your trash at ridiculous prices. We book profits and pay ourselves bonuses. So long as regulators look the other way, there is quite simply no limit to how much we “earn”. Just ask Hank and Bob—whose rich rewards were due to trading activity.
Consider that in 1929 compensation for employees in the financial-services industry was just 1.5 times that of the average nonfarm U.S. worker. By 2009 employees in the securities and investments sector, which includes investment banks, securities brokerages and commodities dealers, earned 3.4 times as much as an average U.S. worker. The average 2009 investment banking compensation at four of the top banks was at least six times that of an average American worker -- while employees in the traditional commercial bank sector earned just 1.2 times the average nonfarm employee. The chief executive officers at the top six bank holding companies were paid an average of $26 million in 2007, or 516 times the U.S. median household income. Indeed, those bank CEOs are paid 2.3 times the average total CEO compensation of the top Fortune 50 nonbank companies.
The bailout of Wall Street was, by design, an effort to keep those bonuses flowing. Oh, who designed it? Well, Hank, Bob and future Goldman Sachs employee Timothy. And who guaranteed the bonuses? Uncle Sam. What is the consequence? Destruction of the real banks—those that still make loans.
The major Wall Street banks operate under the taxpayer-backed umbrella of the Federal Deposit Insurance Corp. and, as we saw in 2008, the Treasury Department and the Federal Reserve. To pay for the cost of such protection, legislators and regulators have forced thousands of Main Street banks like the one I run to absorb a larger, more expensive set of regulatory costs, including higher capital and liquidity requirements. This threatens to deny small-business owners, entrepreneurs and innovators the credit they need and on which the economy relies.
Such, I fear, are the bitter fruits of a financial services industry unmoored from its traditional role in the commercial economy and a regulatory regime that protects outsized compensation tied to trading. Regulators have failed to distinguish between trading activity and traditional banking, or to recognize that the activity of an institution, not its form, should be the proper focus of oversight.
We know what happened to “reform”—it got captured by Dodd-Frank, legislation overseen by two of the most conflicted legislators the US has ever seen. Worse, President Obama has in recent days renewed his love affair with Wall Street, returning with open arms to rebuild bridges. After all, he wants at least $1 billion to conduct his next campaign. All that drives home the fact that true reform is impossible so long as these “too big to fail”, systemically dangerous institutions are kept on Washington's life support.
Wilmers offers an unassailable agenda for policy makers:
Main Street banks are heavily regulated -- and have been for generations -- to ensure their safety, soundness and transparency. A new generation of regulation must now be applied to what has become a virtual casino. All the players must be included -- Wall Street banks, investment banks and hedge funds. Complex derivatives and credit default swaps must be brought out of the shadows and into public clearinghouses, so that markets can know their magnitude and extent. Those financial institutions that engage in trading should live and die by the pursuit of their fortunes, rather than impose a burden on the whole economy. It's time to disentangle the trading of big financial institutions from their more traditional commercial banking operations and put an end to this unsafe business model.
Unfortunately, I am not optimistic. First we will need another global financial collapse—probably one bigger than what we experienced in 2008—to make this policy politically feasible. Second, we must close all the big, systemically dangerous institutions. They control policy-making and they have an unfair advantage over community banks. The subsidy offered to Goldman alone (in the form of insured deposits plus an obvious backstop that will prevent Goldman from failing no matter how bad its trades go) is worth tens of billions of dollars. Community banks cannot compete with that. There is no hope so long as Goldman et al remain in business.
Sometimes the best answer is “TINA”: there is no alternative. To shutting down the biggest banks. The next crisis—which could come any day now—will offer that opportunity. It would be foolish to waste another crisis.
L. Randall Wray is a Professor of Economics, University of Missouri—Kansas City. A student of Hyman Minsky, his research focuses on monetary and fiscal policy as well as unemployment and job creation. He writes a weekly column for Benzinga every Tuesday. He also blogs at New Economic Perspectives, and is a BrainTruster at New Deal 2.0. He is a senior scholar at the Levy Economics Institute, and has been a visiting professor at the University of Rome (La Sapienza), UNAM (Mexico City), University of Paris (South), and the University of Bologna (Italy).
From Peter Tchir of TF Market Advisors
The Countdown to Sovereign Debt Write-offs Has Started
Don’t be fooled by the IMF’s announcement that Greece will get a new round of money. This bailout is merely to give a couple of months for the parties to seriously negotiate what haircuts and debt extensions investors need to take in Greece, and Ireland and Portugal. Virtually all the comments made by the parties involved fit in with the view that we are now in a phase where people are negotiating how much they will write off and what else they will do. Almost none of the comments indicate that anyone is really trying to put together a plan that is going kick the can down the road for a long time. I am fading this rally as only the most optimistic investor can believe that this problem doesn’t lead to real default/restructuring with haircuts in the next couple of months.
Why do banks waive covenants?
It looks like Greece has failed to meet the criteria the IMF had set out to provide more money, yet the IMF seems intent on releasing the next tranche. Banks typically waive covenants and release more money only when they truly believe the borrower will turn around, or when they extract enough value from the borrower that they feel safe making the new loan, or when they aren’t prepared to deal forcing the borrower into default.
Does anyone really believe that Greece is going to get turned around? I don’t. In fact I am highly confident that Greece will still not meet the criteria the IMF has set out when it is time for the next tranche. That will be the deadline for the default/restructuring. The IMF can waive the covenants this time because shortly they get to review the progress again and can fail them at that time.
The IMF, which allegedly has some collateral for the loans it is making, be receiving even more collateral on this latest tranche? Could they have perfected their security interests making their own loans extremely safe? That is a real possibility. If this next tranche only includes IMF money, or lending that is collateralized very specifically it would be another clear sign that the game has changed and the lenders are protecting their new loans at expense of existing bondholders.
Are the IMF, or the EU, or the ECB, or the banks prepared to deal with a default or real restructuring right now? The answer clearly seems to be no, but it is also clear that over the past month, the EU in particular has realized restructuring, possibly with losses needs to occur. Talk about the ‘Vienna accord’ and ‘voluntary private restructuring’ has become louder. That will take time. How do you easily pressure a bank into taking a loss, particularly while were still hopeful for a painless solution just a few weeks ago. These ‘voluntary’ decisions won’t be so voluntary, but it will take time for the governments to convince their banks en masse to reach an agreement.
Waiving the covenants and providing the next tranche of IMF money, particularly if fully secured, is completely consistent with the idea that we have entered a relatively short period of negotiations leading to real restructuring.
Germany is laying the groundwork for real write-offs.
Germany was the first EU member to suggest private sector haircuts. It has seemed more open to private sector losses than any other
government. Not only has the German Finance Minister been outspoken on his desire to include the private sector in any package, but the Bundesbank issued a statement that it is confident that the Euro can withstand Greek default. That was the first time in this crisis that a statement has come out trying to prepare the markets for a potential default. As statement start to come out stating that the banking system is strong enough to withstand a default, you know someone is seriously considering a default. I believe that this statement, which has been largely ignored, is a tell. It is the first step in the process of trying to soften the market.
Against this, the ECB continues to lash out that restructuring/default is not an option. At least that is how it seems on the surface. A little below the surface and it seems like they are starting to take some steps to soften their stance. First, and most importantly, Draghi seems to be the main spokesman. Trichet seems to be quiet on the subject now. Many people (at least me) blame Trichet for making the situation worse through the ECB’s wanton purchase of Greek (and Irish and Portuguese) bonds in the open market. By bringing Draghi to the front line are they starting to distance themselves from ECB policy under Trichet? Are they setting him up as a scapegoat? It is plausible to me. Then even looking more closely at what Draghi says also indicates a potential softening. He says “The cost of a real default…” What does he mean by real? Is that to make it easier to wiggle out down the road and say whatever happens wasn’t a “real” default?
Germany seems to be moving further into private losses and preparing the markets for how contained those losses will be and the ECB is softening a bit and making it easier to blame its original stance on Trichet if they change their mind.
What about contagion risk?
There is real risk of contagion. That is another reason that the EU/IMF/ECB need to buy a few more months because not only do they have to restructure Ireland and Portugal. When the next plan is announced it will be comprehensive and Greece, Ireland, and Portugal will be included. I had been surprised how quiet Ireland has been. Other than being mentioned in general terms as part of a contagion argument, relatively few new specifics were being talked about. Suddenly this week, here they are. Allied Irish sub debt had a credit Event. Noonan is speaking about haircuts for senior Allied Irish bondholders. He is commenting on Greece. It is not a coincidence in my mind that suddenly he is speaking out, as he is likely involved in this next phase of negotiations. In fact, it seems that the number of finance ministers and ECB officials who are hitting the airwaves is expanding. I assume if that many people feel the need to comment, something serious is going on behind the scenes.
Contagion risk is there, but it is being addressed so Greece, Ireland and Portugal can be sorted out at once, and the banks that would be in biggest trouble can get help if they need it.
The Government Changes in Greece Point to Default
You could argue that the changes to the Greek parliament are an attempt to get approval to jam another round of austerity on its people. That could be, but I think it is more likely that Prime Minister Papandreou does not want to be labeled as the man who put Greece in default or who crushed the Euro, so he is trying to escape that role, or drag others into a group to share the blame. He is clearly politically savvy, he was an MD at Goldman, and prime minister. If I was him I would be trying to do things so that my name doesn’t go down in history as the person who broke the Euro.
Banks Can’t Handle the Defaults
I really think most banks can handle the defaults. The most likely outcome, in my opinion, is there is some amount of permanent debt reduction and any remaining debt has its maturity extended for a long time. The banks that aren’t mark to market would have to take a loss on any permanent reduction in principal but there is no reason they have to take a loss on any debt that they extend the maturity. So if a bank took 100 million of 2 year bonds, and exchanged them for 80 million of 10 year bonds, they would take a write off of 20 million. That seems manageable for most banks (and the governments can directly support any bank that can’t handle it). From a stock price perspective, no one is buying the stocks of banks with big exposure to Greece, Ireland, and Portugal, on the basis that they don’t have impairments in the portfolio. Given where debt is currently trading, and how much of the write off is permanent, and the trading price of new bonds, bank stocks may rally. I occasionally read articles about banks trading below book value as being cheap. I usually stop there because I believe smart investors try to figure out the value of the banks holdings are not easily fooled by non mark to market accounting. If I am correct, the banks will have some big losses, their share prices may not react much, and the various EU countries can bailout their own banks directly if they choose to.
CDS?
A subject that will get its own write-up, but from the data available from the DTCC, concerns about CDS on sovereigns seems overblown, even if there is a Credit Event. Of all the subjects written about, the only that seems to get the least accurate treatment is the potential impact of CDS on the outcome. The problem is a debt problem. The bulk of all losses will result from poor lending and bond buying decisions. CDS will spread some gains and losses around, but will not in itself have a meaningful impact on the market. Trying to compare AIG is wrong as AIG had almost nothing to do with single name CDS and had ridiculously loose collateral terms even by the 2007 standards, let alone today. Lehman, with massive amounts of debt saw its CDS settle with little confusion, and the market dealt pretty well with the loss of Lehman as counterparty on so many CDS trades. There were more surprising losses from things as simple as repo agreements than from its role as CDS market maker.
Among the many shocking facts that have emerged from the News of the World hacking crisis, it is the revelations about News International's dysfunctional leadership and the NoW's brutal organizational culture that have ...
<b>News</b> International's Leadership Crisis - Gill Corkindale - Harvard <b>...</b>The company's stock price has dropped since the revelations of a wider phone hacking scandal at News of the World.
<b>News</b> Corporation Looks to Bolster Stock With Buyback Plan <b>...</b>We already know that the News of the World hacked the phones of virtually everyone in England, including dead people and the prime minister and, probably, you. But with the latest revelation, the scandal has actually ...
<b>News</b> of the World Hacked Cops Investigating <b>News</b> of the World Hacking
providence bobby fergusonAmong the many shocking facts that have emerged from the News of the World hacking crisis, it is the revelations about News International's dysfunctional leadership and the NoW's brutal organizational culture that have ...
<b>News</b> International's Leadership Crisis - Gill Corkindale - Harvard <b>...</b>The company's stock price has dropped since the revelations of a wider phone hacking scandal at News of the World.
<b>News</b> Corporation Looks to Bolster Stock With Buyback Plan <b>...</b>We already know that the News of the World hacked the phones of virtually everyone in England, including dead people and the prime minister and, probably, you. But with the latest revelation, the scandal has actually ...
<b>News</b> of the World Hacked Cops Investigating <b>News</b> of the World HackingI've been traveling a lot in recent weeks and had the pleasure of meeting policymakers in a number of countries. Perhaps the most interesting of those meetings occurred in a small workshop attended by a couple of policymakers who had worked with Timothy Geithner to bail-out Wall Street. Let me just say that these were intelligent guys with their hearts in the right places. While they probably did not think they were doing “God's work” (as the Vampire Blood Sucking Squid put it), they certainly did think they were operating in the public interest.
They shared a view that what we experienced back in 2008 was the mother of all liquidity crises. As one of them put it, the crisis boiled down to this: the world missed a payment, then all hell broke loose. To summarize this view, we had a highly leveraged and interdependent financial system that relied on extremely short-term borrowing (overnight) to finance positions in assets.
A key link in the liquidity chain was the money market mutual fund, which essentially promised close substitutes for bank deposits, but without the government guarantee. MMMFs purchased very short term debt issued by the shadow banking system (held as assets). When it looked like forces would “break the buck” there was a massive run on the money markets which made it impossible for the MMMF's to continue to provide overnight funding to the shadow banks. This is a $3 trillion uninsured “deposit-like” market that the government had to guarantee dollar-for dollar. All told, the bailout of Wall Street amounted to more than $29 trillion (that is the “flow” number; the outstanding stock maxed at perhaps $8 trillion—still a very big number). That is what happens when the world “misses a payment”.
While this is not the topic for this blog, just think about the possibilities if $8 trillion (leaving to the side $29 trillion) had been devoted to bailing out Main Street rather than Wall Street. We'd be fully employed, driving brand new SUVs, and making payments on our overpriced MacMansions. All that is too obvious to require any explication. Now, I think these guys are wrong. Dangerously so. What we actually had (and have) were massively insolvent Wall Street shadow banks, so their short term liabilities were trash. The run on MMMFs was not an irrational liquidity run, but rather a rational run on institutions that were holding garbage as assets. The federal government made that garbage as sweet smelling as roses, by intervening in the biggest bailout in human history, by several orders of magnitude. And it did not have to be that way.
Let us instead deal with a “what if”. Suppose we had decided not to bailout the MMMFs and let the insolvent shadow banks go down. What if we had not handed bank charters to Goldman Sachs and Morgan Stanley (the last two investment banks standing)? What if we had simply closed down what my colleague Bill Black calls “systemically dangerous institutions”? What if we had let the market “work”—in its wisdom it wanted to close down the biggest financial institutions and to rid the world of shadow banking. What if we had let that happen?
We know the view at the Treasury: from Rubin to Paulson to Geithner the view is that we'd have no economy at all. Forget about a financial system—we'd be back to bartering coconuts for fish. That was the claim made by Paulson when he went to Congress and demanded nearly a trillion dollars to bailout his Wall Street buds, with a gun to his head and threatening to pull the trigger. What if we had borrowed a line from Clint Eastwood: “go ahead, make my day”? Blow your own stupid head off.
Here's a hypothesis. We'd be MUCH better off today. The banksters would all be gone—retired to their offshore islands with whatever riches they had been able to hide away. We'd still have, oh, about 4000 banks, mostly honest, mostly making loans to firms and households, and with reasonable compensation and no special power over Washington. This ain't just my hypothesis. In a very interesting (and to my mind, convincing) article, Robert G. Wilmers, chairman and chief executive officer of M&T Bank Corp. (MTB) made the case for me. Indeed, his piece is so good that I cannot possibly improve upon it. Let me provide a few key (and somewhat long) excerpts. The whole piece is here: Small Banks, Big Banks, Giant Differences: Robert G. Wilmers
First, Mr. Wilmers rightly notes the long term transformation of banking away from lending and to trading:
Community banks have given way to big banks and excessive industry concentration; profits are increasingly driven by risky trading; leverage is taking precedence over prudent lending; compensation is out of control. This toxic combination leads to continued taxpayer risk and threatens long-term U.S. prosperity. To understand the change, first consider history. Banking once was a community-based enterprise, relying on local knowledge to guide the process of gathering customer deposits and extending credit. Done well, this arrangement ensures that deposits are deployed into a diversified pool of investments, while providing depositors with liquidity and a return on their savings. Over the past generation, however, the financial services industry changed dramatically. In 1990, the six largest financial institutions accounted for 9 percent of all U.S. domestic deposits. As of Dec. 31, 2010, the six biggest banks accounted for 36 percent of deposits.
Amazing analysis, from a banker. The big banks have virtually no interest in lending. They use deposits to finance their trading activity; and when the trades go bad they ask Uncle Sam to bail them out.
Such concentration raises the concern that poor decisions at such outsized institutions can lead to systemic risk. But this risk is greatly magnified by the new way in which the major banks, those deemed too big to fail, are doing business today. The largest and most profitable bank holding companies have moved away from traditional lending and come to rely on speculative trading in all types of securities, derivatives, credit default swaps, mortgage-backed securities and other, even more complex and exotic financial instruments -- many of them associated with high leverage. Such trading now is the engine of income. In 2010, the six largest bank holding companies generated $56.1 billion in trading revenue, or 74 percent of their $75.7 billion in pretax income. Trading revenue at these institutions distinguishes them from traditional commercial banks, which aren't typically involved in such speculative endeavors. The Big Six institutions earned more than 93 percent of the trading revenue generated by all American banks during the past two years. To say these large institutions are the same species as traditional commercial banks is akin to describing dinosaurs as reptiles -- true but profoundly misleading.
In reality these institutions are what my colleague Bill Black calls control frauds. Their sole purpose is to enrich top management with outsized bonuses. Trading is the preferred activity. First because they can screw the suckers. But more importantly, because trading profits can be whatever you want them to be. You buy my trash at outlandish prices, and I buy your trash at ridiculous prices. We book profits and pay ourselves bonuses. So long as regulators look the other way, there is quite simply no limit to how much we “earn”. Just ask Hank and Bob—whose rich rewards were due to trading activity.
Consider that in 1929 compensation for employees in the financial-services industry was just 1.5 times that of the average nonfarm U.S. worker. By 2009 employees in the securities and investments sector, which includes investment banks, securities brokerages and commodities dealers, earned 3.4 times as much as an average U.S. worker. The average 2009 investment banking compensation at four of the top banks was at least six times that of an average American worker -- while employees in the traditional commercial bank sector earned just 1.2 times the average nonfarm employee. The chief executive officers at the top six bank holding companies were paid an average of $26 million in 2007, or 516 times the U.S. median household income. Indeed, those bank CEOs are paid 2.3 times the average total CEO compensation of the top Fortune 50 nonbank companies.
The bailout of Wall Street was, by design, an effort to keep those bonuses flowing. Oh, who designed it? Well, Hank, Bob and future Goldman Sachs employee Timothy. And who guaranteed the bonuses? Uncle Sam. What is the consequence? Destruction of the real banks—those that still make loans.
The major Wall Street banks operate under the taxpayer-backed umbrella of the Federal Deposit Insurance Corp. and, as we saw in 2008, the Treasury Department and the Federal Reserve. To pay for the cost of such protection, legislators and regulators have forced thousands of Main Street banks like the one I run to absorb a larger, more expensive set of regulatory costs, including higher capital and liquidity requirements. This threatens to deny small-business owners, entrepreneurs and innovators the credit they need and on which the economy relies.
Such, I fear, are the bitter fruits of a financial services industry unmoored from its traditional role in the commercial economy and a regulatory regime that protects outsized compensation tied to trading. Regulators have failed to distinguish between trading activity and traditional banking, or to recognize that the activity of an institution, not its form, should be the proper focus of oversight.
We know what happened to “reform”—it got captured by Dodd-Frank, legislation overseen by two of the most conflicted legislators the US has ever seen. Worse, President Obama has in recent days renewed his love affair with Wall Street, returning with open arms to rebuild bridges. After all, he wants at least $1 billion to conduct his next campaign. All that drives home the fact that true reform is impossible so long as these “too big to fail”, systemically dangerous institutions are kept on Washington's life support.
Wilmers offers an unassailable agenda for policy makers:
Main Street banks are heavily regulated -- and have been for generations -- to ensure their safety, soundness and transparency. A new generation of regulation must now be applied to what has become a virtual casino. All the players must be included -- Wall Street banks, investment banks and hedge funds. Complex derivatives and credit default swaps must be brought out of the shadows and into public clearinghouses, so that markets can know their magnitude and extent. Those financial institutions that engage in trading should live and die by the pursuit of their fortunes, rather than impose a burden on the whole economy. It's time to disentangle the trading of big financial institutions from their more traditional commercial banking operations and put an end to this unsafe business model.
Unfortunately, I am not optimistic. First we will need another global financial collapse—probably one bigger than what we experienced in 2008—to make this policy politically feasible. Second, we must close all the big, systemically dangerous institutions. They control policy-making and they have an unfair advantage over community banks. The subsidy offered to Goldman alone (in the form of insured deposits plus an obvious backstop that will prevent Goldman from failing no matter how bad its trades go) is worth tens of billions of dollars. Community banks cannot compete with that. There is no hope so long as Goldman et al remain in business.
Sometimes the best answer is “TINA”: there is no alternative. To shutting down the biggest banks. The next crisis—which could come any day now—will offer that opportunity. It would be foolish to waste another crisis.
L. Randall Wray is a Professor of Economics, University of Missouri—Kansas City. A student of Hyman Minsky, his research focuses on monetary and fiscal policy as well as unemployment and job creation. He writes a weekly column for Benzinga every Tuesday. He also blogs at New Economic Perspectives, and is a BrainTruster at New Deal 2.0. He is a senior scholar at the Levy Economics Institute, and has been a visiting professor at the University of Rome (La Sapienza), UNAM (Mexico City), University of Paris (South), and the University of Bologna (Italy).
From Peter Tchir of TF Market Advisors
The Countdown to Sovereign Debt Write-offs Has Started
Don’t be fooled by the IMF’s announcement that Greece will get a new round of money. This bailout is merely to give a couple of months for the parties to seriously negotiate what haircuts and debt extensions investors need to take in Greece, and Ireland and Portugal. Virtually all the comments made by the parties involved fit in with the view that we are now in a phase where people are negotiating how much they will write off and what else they will do. Almost none of the comments indicate that anyone is really trying to put together a plan that is going kick the can down the road for a long time. I am fading this rally as only the most optimistic investor can believe that this problem doesn’t lead to real default/restructuring with haircuts in the next couple of months.
Why do banks waive covenants?
It looks like Greece has failed to meet the criteria the IMF had set out to provide more money, yet the IMF seems intent on releasing the next tranche. Banks typically waive covenants and release more money only when they truly believe the borrower will turn around, or when they extract enough value from the borrower that they feel safe making the new loan, or when they aren’t prepared to deal forcing the borrower into default.
Does anyone really believe that Greece is going to get turned around? I don’t. In fact I am highly confident that Greece will still not meet the criteria the IMF has set out when it is time for the next tranche. That will be the deadline for the default/restructuring. The IMF can waive the covenants this time because shortly they get to review the progress again and can fail them at that time.
The IMF, which allegedly has some collateral for the loans it is making, be receiving even more collateral on this latest tranche? Could they have perfected their security interests making their own loans extremely safe? That is a real possibility. If this next tranche only includes IMF money, or lending that is collateralized very specifically it would be another clear sign that the game has changed and the lenders are protecting their new loans at expense of existing bondholders.
Are the IMF, or the EU, or the ECB, or the banks prepared to deal with a default or real restructuring right now? The answer clearly seems to be no, but it is also clear that over the past month, the EU in particular has realized restructuring, possibly with losses needs to occur. Talk about the ‘Vienna accord’ and ‘voluntary private restructuring’ has become louder. That will take time. How do you easily pressure a bank into taking a loss, particularly while were still hopeful for a painless solution just a few weeks ago. These ‘voluntary’ decisions won’t be so voluntary, but it will take time for the governments to convince their banks en masse to reach an agreement.
Waiving the covenants and providing the next tranche of IMF money, particularly if fully secured, is completely consistent with the idea that we have entered a relatively short period of negotiations leading to real restructuring.
Germany is laying the groundwork for real write-offs.
Germany was the first EU member to suggest private sector haircuts. It has seemed more open to private sector losses than any other
government. Not only has the German Finance Minister been outspoken on his desire to include the private sector in any package, but the Bundesbank issued a statement that it is confident that the Euro can withstand Greek default. That was the first time in this crisis that a statement has come out trying to prepare the markets for a potential default. As statement start to come out stating that the banking system is strong enough to withstand a default, you know someone is seriously considering a default. I believe that this statement, which has been largely ignored, is a tell. It is the first step in the process of trying to soften the market.
Against this, the ECB continues to lash out that restructuring/default is not an option. At least that is how it seems on the surface. A little below the surface and it seems like they are starting to take some steps to soften their stance. First, and most importantly, Draghi seems to be the main spokesman. Trichet seems to be quiet on the subject now. Many people (at least me) blame Trichet for making the situation worse through the ECB’s wanton purchase of Greek (and Irish and Portuguese) bonds in the open market. By bringing Draghi to the front line are they starting to distance themselves from ECB policy under Trichet? Are they setting him up as a scapegoat? It is plausible to me. Then even looking more closely at what Draghi says also indicates a potential softening. He says “The cost of a real default…” What does he mean by real? Is that to make it easier to wiggle out down the road and say whatever happens wasn’t a “real” default?
Germany seems to be moving further into private losses and preparing the markets for how contained those losses will be and the ECB is softening a bit and making it easier to blame its original stance on Trichet if they change their mind.
What about contagion risk?
There is real risk of contagion. That is another reason that the EU/IMF/ECB need to buy a few more months because not only do they have to restructure Ireland and Portugal. When the next plan is announced it will be comprehensive and Greece, Ireland, and Portugal will be included. I had been surprised how quiet Ireland has been. Other than being mentioned in general terms as part of a contagion argument, relatively few new specifics were being talked about. Suddenly this week, here they are. Allied Irish sub debt had a credit Event. Noonan is speaking about haircuts for senior Allied Irish bondholders. He is commenting on Greece. It is not a coincidence in my mind that suddenly he is speaking out, as he is likely involved in this next phase of negotiations. In fact, it seems that the number of finance ministers and ECB officials who are hitting the airwaves is expanding. I assume if that many people feel the need to comment, something serious is going on behind the scenes.
Contagion risk is there, but it is being addressed so Greece, Ireland and Portugal can be sorted out at once, and the banks that would be in biggest trouble can get help if they need it.
The Government Changes in Greece Point to Default
You could argue that the changes to the Greek parliament are an attempt to get approval to jam another round of austerity on its people. That could be, but I think it is more likely that Prime Minister Papandreou does not want to be labeled as the man who put Greece in default or who crushed the Euro, so he is trying to escape that role, or drag others into a group to share the blame. He is clearly politically savvy, he was an MD at Goldman, and prime minister. If I was him I would be trying to do things so that my name doesn’t go down in history as the person who broke the Euro.
Banks Can’t Handle the Defaults
I really think most banks can handle the defaults. The most likely outcome, in my opinion, is there is some amount of permanent debt reduction and any remaining debt has its maturity extended for a long time. The banks that aren’t mark to market would have to take a loss on any permanent reduction in principal but there is no reason they have to take a loss on any debt that they extend the maturity. So if a bank took 100 million of 2 year bonds, and exchanged them for 80 million of 10 year bonds, they would take a write off of 20 million. That seems manageable for most banks (and the governments can directly support any bank that can’t handle it). From a stock price perspective, no one is buying the stocks of banks with big exposure to Greece, Ireland, and Portugal, on the basis that they don’t have impairments in the portfolio. Given where debt is currently trading, and how much of the write off is permanent, and the trading price of new bonds, bank stocks may rally. I occasionally read articles about banks trading below book value as being cheap. I usually stop there because I believe smart investors try to figure out the value of the banks holdings are not easily fooled by non mark to market accounting. If I am correct, the banks will have some big losses, their share prices may not react much, and the various EU countries can bailout their own banks directly if they choose to.
CDS?
A subject that will get its own write-up, but from the data available from the DTCC, concerns about CDS on sovereigns seems overblown, even if there is a Credit Event. Of all the subjects written about, the only that seems to get the least accurate treatment is the potential impact of CDS on the outcome. The problem is a debt problem. The bulk of all losses will result from poor lending and bond buying decisions. CDS will spread some gains and losses around, but will not in itself have a meaningful impact on the market. Trying to compare AIG is wrong as AIG had almost nothing to do with single name CDS and had ridiculously loose collateral terms even by the 2007 standards, let alone today. Lehman, with massive amounts of debt saw its CDS settle with little confusion, and the market dealt pretty well with the loss of Lehman as counterparty on so many CDS trades. There were more surprising losses from things as simple as repo agreements than from its role as CDS market maker.
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