"Nationalizing" the Banks
February 8, 2009
"Nationalizing" the banks doesn't mean anything in itself. It is a term that could be applied to so many specific situations that it is almost meaningless. When Hanky Panky "recapitalized" Citigroup, which then had a market cap of $20 billion, with an additional $20 billion of government funds, the government should have received roughly 50% of the equity in the bank. For example, if there were 4 billion shares outstanding at $5, then Citi would sell the government another 4 billion shares at $5 for $20 billion, so the government would own 4 billion of the 8 billion shares outstanding. This is how it's supposed to work. (Actually, the new capital is supposed to get a discount to the market, or at the very least some bells and whistles like warrants.) Thus, Citi would already be 50%+ owned by the government, which is pretty close to "nationalization" if you ask me. Remember, what really happened was that the government spent $20 billion for a 7.8% stake, or more like $47 a share -- while it was $5 share in the open market -- which is how Wall Street steals from stupid people and the government. We were given this moronic story in the media about how Hanky Panky got all the bankers in a room and "forced" them to take the governments money and give almost nothing in return (a puny 7.8% stake), and how the bankers were so reluctant and all that to steal from the taxpayer instead of going bust the following Monday morning.
Whether the government got 50% or 7.8% of the equity, the end result would have been the same: namely, that Citi is a dead duck. This is because its losses are vastly in excess of $20 billion -- more like $400 billion I'd expect, on its $2,100 billion of assets, which is to say a 19% loss on its assets. As for its off-balance-sheet losses, such as derivatives or SIVs or whatnot -- well, who the hell knows really. Could be a lot, a whole lot considering that Citi is a major CDS dealer.
Usually, "nationalizing" just means who is in charge. The real question is: once the government is in charge, what do they do? Typically, the answer is: all the debt holders are bailed out, and often there is some poor management of assets such as selling assets at ridiculous firesale prices to well-connected insiders (see RTC). In short, it is yet another way to fleece the taxpayer. (Actually, other governments such as those in Asia seem to be rather better behaed about this.) Unfortunately, potential losses (especially considering derivatives) are so large at U.S. banks that even the U.S. government might not be able to bail everyone out. This will cause conflict -- the entire system, and everyone in it, is aligned toward sucking resources from the government. But, if the government is unable to deliver, then someone is going to have to take a hit. I suggest the derivatives counterparties, first, and the debt holders second. That is sensible, but it would be interesting to see what happens in real life.
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"Getting bad assets off the books." Let's say you have a mortgage. Your bank may be servicing the mortgage, but who owns it? It is probably packaged into some sort of securitized layer cake, and even those bits and pieces may change hands regularly. The point is, who owns your mortgage is irrelevant. This is true of loans in general: changing the ownership of the loan has no real economic effect, except perhaps profit and loss among those doing the trading.
So, why is it that we are always bombarded with this "we need to the get the bad assets of the books or the economy will implode" nonsense? Well, I think you've figured most of it out already -- it is a good justification for banks to stuff the government with their failures without having to pay the price. Socializing the losses. Politicians either believe the hooey or they don't really care. It's not their money. Their money comes from -- bankers' political contributions, and maybe inclusion in some super-sweet can't-lose deals (do you think the Clintons really knew anything about cattle trading?).
Also, we see that if you sell an asset for a price that represents a fair value for the asset, it doesn't make banks' losses go away. It merely turns an assumed loss -- the impaired future cashflow from a non-performing loan -- into a realized loss. In many ways, this is worse! And, if the bank can only sell an asset for a price that is well below the likely present value of future cashflows, then the bank is much better off not selling the asset.
I bring this up because I've seen all this "we need to get the bad assets off the books" nonsense before -- during the 1998-2001 period in Japan and elsewhere in Asia. This idea was, as usual, flogged endlessly by the big Western banks like JP Morgan and Goldman Sachs, and repeated in the major Western media outlets like the Wall Street Journal. However, in those days there was a little twist. Today, U.S. banks are saying "we need to stuff the government with our crap paper because the market prices are way too low!!!!" In those days, they used to say "Japanese/Asian banks need to sell their assets on the open market (at super-low prices)!!!" Note that these are completely contradictory. Of course, the Japanese and Asian bankers said: "Screw that. No way I'm going to sell my asset, which I think is worth $400, to some sleazy Goldman Sachs guy for $100." As I explained last week, they can just sit on it and get their $400 through the normal debt workout process, which is bankers' business (especially in Asia where they usually hold onto their loans to maturity).
So, the JP Morgan and Goldman guys ganged up on the politicians. "If you don't get the 'bad assets off the books,' all the most horrible things you can imagine will happen!!! Oh yes I promise!!! And, you definitely won't get a job at JP Morgan/Goldman Sachs once you get thrown out of office for your terrible management of the economy." And so the politicians forced the banks -- with all their legal powers of compulsion -- to sell their assets "on the open market," which consisted of JP Morgan and Goldman Sachs (and some U.S. hedge funds) because all the Asian banks couldn't buy these assets -- they were being forced to sell them. As you can imagine, the selling prices were super-low. This caused a brand new problem at the Asian banks -- because, when they took an asset with a face value of $1000 (let's say) and now worth $400, and sold it for $100, they had to take another $300 loss, on top of all the other losses from economic reasons. In short, it made the banks that much weaker, which is exactly the opposite of what the program was supposedly going to do ("save our economic bacon"). The additional loss taken by the Asian banks was exactly equivalent to the profit enjoyed by JP Morgan and Goldman Sachs. The profit that results from buying a loan at $100 and working it out -- exactly the same as if the banks had just sat on them and worked them out themselves -- and eventually getting a $400 recovery.
This was wonderful for JP Morgan and Goldman Sachs, because not only did they make a $300 profit on a $100 investment, they managed to weaken/destroy their foreign competitors, and use the foreign governments to do so!
What an absolutely brilliant assfucking they gave those stupid Asian dweebs! And nobody noticed!
Now, the same JP Morgan/Goldman Sachs guys say that "If we don't stuff the government with our losses, then all the most horrible things you can imagine will happen!!! Oh yes I promise!!!" It's all crap. "Getting bad assets off the books" is fantasy. It just moves them to someone elses books, which is totally irrelevant in broad economic terms.
The U.S. bankers are all liars and thieves. I've been saying this over and over, and maybe now, after the events of the last six months, you are starting to understand what I mean. I know because I've been doing this not only for six months, but for over ten years, and it has been the same every time. The bankers elsewhere -- in Asia and also Europe -- are not quite so evil. They are more like the CEOs of industrial corporations. Eagle Scout types.
The end point of this is: just put a wooden stake in the "bad bank/TARP/Super SIV" nonsense. It has no economic purpose. And send JP Morgan and Goldman Sachs to the liquidator. See ya.
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Henry Blodget (???) is on board: Can we please just fix the banks the right way?
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More on the debt/equity swap. We compared the value of bank debt to the value of a mortgage for an underwater homeowner. Actually, it's a little more complicated. Consider a house with a senior mortgage holder and a junior mortgage holder. So, the house was bought for $300,000 with $30,000 of equity (down payment), a $100,000 junior mortgage, and a $170,000 senior mortgage. Then, the house is foreclosed and sold for $200,000. The equity ($30,000) is gone. The $170,000 senior mortgage is paid in full. The remaining $30,000 goes to the junior mortgage.
The senior mortgage is like the insured deposits of a bank (and the uninsured deposits, if we are going to protect those.) The junior mortgage is the bank's debt. As noted last week, we don't want to liquidate these institutions. Rather, they should continue as a going concern, pretty much the same as they are today. The only change is who owns the bank. Instead of the old equity shareholders, the new owners are the old bond holders. The ownership of a bank changes all the time anyway (via the stock market), so this is really not that much different.
In our mortgage example, we can see that the value of the junior mortgage turned out to be $30,000. Thus, if the junior mortgage was "converted to equity," then the value of the equity would be $30,000. If it traded on a stock market, it should have a market cap of $30,000. This is easy enough in a liquidation situation. However, as mentioned previously, these would be going concerns.
February 1, 2008: Let's Take a Trip to the English Village (scroll down)
So, the value of the equity -- which would trade on the stock market -- in this case would be a market estimate of the real value of the assets of the bank, minus the liabilities of the bank (mostly insured deposits), plus some franchise value. The point is, we don't have to do this "what's the real value" nonsense because we could leave it up to the market. The stock market would determine the amount of "haircut" the debt holders would take. (I expect this is already happening in the debt market.) Indeed, it is possible that the debt holders could actually make a profit! I showed how this was possible even in the case of Citi taking a whopping $300 billion writedown of its assets:
October 12, 2008: Effective Bank Recapitalization 2: Three Examples
I still think that you're not going to get anywhere unless off-balance-sheet liabilities such as derivatives -- junior to the debt in the case of bankruptcy -- get wiped out, as is normal business practice in these situations. That could be very disruptive to the counterparties of these agreements. However, most of the counterparties are pretty much bust themselves at this point (other banks), so nothing new there.
Have you noticed that most of the people involved in this process -- journalists, politicians, pundits, bureaucrats, economists, pretty much everyone besides the bankers themselves, stock analysts and some buy-side sharpies -- don't know how banks work? Toldya so.
February 3, 2008: How Banks Work
February 10, 2008: How Banks Work 2: Shitting Like an Elephant
February 17, 2008: How Banks Work 3: More Elephant Poop
February 24, 2008: How Banks Work 4: Banks and the Economy
March 9, 2008: How Banks Work 5: Selling Loans
March 16, 2008: How Banks Work 6: Liquidity Crises and Bank Runs
March 23, 2008: How Banks Work 7: the Lender of Last Resort
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Worse than the Depression Watch: Okay, we've done "worst since the Depression" to death. Time for a new theme ... worse THAN the Depression! Here's our first contendah, courtesy of Frank Veneroso:
THERE HAS NEVER BEEN DATA THIS BAD FOR ANY MAJOR ECONOMY – EVEN IN THE GREAT DEPRESSION.
December industrial production came in down 9.6%, worse than the METI forecast. It is now down almost 21% year over year. METI forecasts a further 4.7% decline in February. The inventory to production ratio soared again. Maybe METI will be correct. (Veneroso’s emphasis)
If it is, Japan industrial production will have fallen 28% (non annualized) in four months. It will have fallen by a third in about a year. Nothing in the history of major nations compares. A 28% decline in four months would be more than half of the entire decline in U.S. industrial production over the 3 years and nine months of the U.S. Great Depression.
It would be a greater decline in four months than in any 12 month period in the Great Depression in the U.S. We are literally looking at the unimaginable
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Gold Standard Watch: I've said for years that the next gold standard would be in Dubai, and -- I was right! Well, we'll see. I think they don't quite know what they're doing, and are probably aware of that. This makes them hesitant -- as it should, because if you don't know what you're doing, you can blow things up. Probably they will fail, or not even start for fear of failure. That would really be too bad, but it's the way things usually work out, so don't be too disappointed.
A problem today is that, even if a government decided that it wanted a gold standard, it would probably start asking "experts" about how to implement one. Maybe someone would tell them exactly what they need to know. But, then they'd talk to someone else, who would probably give them some sort of cocked-up nonsense that would probably not make it past the first week ("Federal Reserve Gold Certificate Ratio"; "Pure/100% Gold Standard" etc. etc.). They would notice the discrepancy. Then, they would have to find a way to resolve the discrepancy. It takes a special insight to be able to say: "yes, this is the right path, and this is the wrong one." Usually, they just go by consensus. Indeed, I think I have never seen a government official, anywhere in the world, that has that special insight, at least regarding monetary affairs. What this probably means is that: a) things need to get bad enough that someone actually tries to implement a gold standard; b) it blows up in their face; c) they learn from the experience; d) someone else actually tries it again, despite the earlier failure; e) b-d are repeated as often as necessary, until; f) they actually get it right.
Like I said, don't get your hopes up.
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Guerrilla Gardening: Seed sellers report that interest in backyard gardens is soaring. Hey, it kept the Russians alive!
This year might see some food issues, but 2010 is when things might get really tight. 2009 is practice.