Here is another excerpt — part II — of the all consuming OpEd of the Sunday New York Times by Michael Lewis and David Einhorn:

Excerpt:

When Bear Stearns failed, the government induced JPMorgan Chase to buy it by offering a knockdown price and guaranteeing Bear Stearns’s shakiest assets. Bear Stearns bondholders were made whole and its stockholders lost most of their money.

Then came the collapse of the government-sponsored entities, Fannie Mae and Freddie Mac, both promptly nationalized. Management was replaced, shareholders badly diluted, creditors left intact but with some uncertainty. Next came Lehman Brothers, which was, of course, allowed to go bankrupt. At first, the Treasury and the Federal Reserve claimed they had allowed Lehman to fail in order to signal that recklessly managed Wall Street firms did not all come with government guarantees; but then, when chaos ensued, and people started saying that letting Lehman fail was a dumb thing to have done, they changed their story and claimed they lacked the legal authority to rescue the firm.

But then a few days later A.I.G. failed, or tried to, yet was given the gift of life with enormous government loans. Washington Mutual and Wachovia promptly followed: the first was unceremoniously seized by the Treasury, wiping out both its creditors and shareholders; the second was batted around for a bit. Initially, the Treasury tried to persuade Citigroup to buy it — again at a knockdown price and with a guarantee of the bad assets. (The Bear Stearns model.) Eventually, Wachovia went to Wells Fargo, after the Internal Revenue Service jumped in and sweetened the pot with a tax subsidy.

In the middle of all this, Treasury Secretary Henry M. Paulson Jr. persuaded Congress that he needed $700 billion to buy distressed assets from banks — telling the senators and representatives that if they didn’t give him the money the stock market would collapse. Once handed the money, he abandoned his promised strategy, and instead of buying assets at market prices, began to overpay for preferred stocks in the banks themselves. Which is to say that he essentially began giving away billions of dollars to Citigroup, Morgan Stanley, Goldman Sachs and a few others unnaturally selected for survival. The stock market fell anyway.

It’s hard to know what Mr. Paulson was thinking as he never really had to explain himself, at least not in public. But the general idea appears to be that if you give the banks capital they will in turn use it to make loans in order to stimulate the economy. Never mind that if you want banks to make smart, prudent loans, you probably shouldn’t give money to bankers who sunk themselves by making a lot of stupid, imprudent ones. If you want banks to re-lend the money, you need to provide them not with preferred stock, which is essentially a loan, but with tangible common equity — so that they might write off their losses, resolve their troubled assets and then begin to make new loans, something they won’t be able to do until they’re confident in their own balance sheets. But as it happened, the banks took the taxpayer money and just sat on it.

>

Source:
The End of the Financial World As We Know It
MICHAEL LEWIS and DAVID EINHORN
NYT, January 3, 2009

http://www.nytimes.com/2009/01/04/opinion/04lewiseinhorn.html

How to Repair a Broken Financial World
MICHAEL LEWIS and DAVID EINHORN
NYT, January 3, 2009

http://www.nytimes.com/2009/01/04/opinion/04lewiseinhornb.html

Category: Bailouts, Credit, Derivatives, Legal, Markets, Really, really bad calls, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

22 Responses to “How to Repair a Broken Financial World”

  1. Al Czervik says:

    One of the best suggestions from the articles was “don’t let financial institutions get too big to fail”. We have anti-trust laws to prevent any corporation from controlling too much of a market. Wouldn’t it make sense to do this for financial companies?

    For me, the most troublsome aspect of the bailout so far is that we are placing all of our eggs into a smaller number of ever-larger baskets. This creates a less resilient financial system and also raises some serious concerns about the closeness of the government and the people who handle our money.

  2. This really has all come down to protecting creditors and lenders. If they can get past that mental block they won’t have a problem hitting flush. This will come down to who has power on the credit side of the ledger to keep this from happening but as time goes by more of those who were stuck behind the credit 8 ball behind the scenes are probably sneaking out the back door. As the p0litically connected to bagholder creditor ratio gets into favorable territory expect the possibility of flushing out the deadwood to grow

  3. Al Czervik Says: January 4th, 2009 at 11:56 am

    “We have anti-trust laws to prevent any corporation from controlling too much of a market. Wouldn’t it make sense to do this for financial companies?”

    “…the most troublsome aspect //of the bailout–(which one?)// so far is that we are placing all of our eggs into a smaller number of ever-larger baskets. This creates a less resilient financial system and also raises some serious concerns about the closeness of the government and the people who handle our money.”

    Al,

    kindly, though, Have you ever heard of The Federal Reserve?–how it’s Structured, and What is does?

  4. ottovbvs says:

    Al Czervik Says:

    January 4th, 2009 at 11:56 am
    One of the best suggestions from the articles was “don’t let financial institutions get too big to fail”. We have anti-trust laws to prevent any corporation from controlling too much of a market. Wouldn’t it make sense to do this for financial companies?

    For me, the most troublsome aspect of the bailout so far is that we are placing all of our eggs into a smaller number of ever-larger baskets. This creates a less resilient financial system and also raises some serious concerns about the closeness of the government and the people who handle our money.

    Al, one of the consequences of all this is that there is taking place a a massive consolidation of the US financial industry. BOE+Countrywide+Merrill is just the most visible manifestation. Paradoxically, provided the govt puts in place a really robust regulatory machinery which they are going to do, make no mistake about it, then it reduces the opportunity for the system going off the rails. This will hold good for the next 20 years whoever is in office but then you’ve alway got the chance that a bunch of post Bush/Gingrich idiots get back in power and it’s deja vu all over again.

  5. jmay says:

    I’ve seen it written over and over again that banks were given capital in order to lend and stimulate the economy.

    But couldn’t it be that Paulson gave the banks money in order to cushion their balance sheets for the next wave of defaults? To give them enough cash to meet the leverage requirements, in the hopes that some of these so-called toxic assets might eventually find some value above 5 cents on the dollar?

    I ask the question honestly. I’m not an expert by any means.

  6. Bob_in_MA says:

    From the article: “We should begin by breaking the cycle of deteriorating housing values and resulting foreclosures…”

    This thought is repeated constantly. Why is it that people who otherwise believe in free markets think that they are capable of determining when home prices have reached an equilibrium and then arresting their fall further?

    Any attempt to stabilize home prices at some artificially, and apparently arbitrarily, determined level is doomed to failure.

    What happens when prices fall another 15%? Do we refinance and guarantee new mortgages for these people?

  7. Bruce in Tn says:

    I have a problem this afternoon, and I need someone who speaks economics…..

    http://news.moneycentral.msn.com/provider/providerarticle.aspx?feed=OBR&date=20090104&id=9483804

    Yellen says economy risks “grim outcome”

    Janet Yellen is quoted:

    “With an extended period of abnormally high unemployment in the forecast, it is increasingly likely that inflation will fall to undesirably low levels,” she said.

    Is she trying to say the “D” word?? Are economists forever banned from the brotherhood if the D word is uttered? Is she afraid of having her mouth washed out with soap? Help me out here..

  8. larster says:

    Bob_in_MA

    That’s why job creation is key. Witout some stabilization in employment home values will continue to decline. I think you’re abso;utely right. The cart is before the horse on this one.

    The more I read on the activities of Treasury, my b.s. antennae go into overdrive. It sure looks like a massive transfer of wealth to a few favored parties to me.

  9. Winston Munn says:

    “From the article: “We should begin by breaking the cycle of deteriorating housing values and resulting foreclosures…”

    I have my own take on this. We should begin by breaking the cycle of lies, obfuscation, and resulting bullshit.

    Anyone who believes the solution to the problem of artificially high home prices is to keep the home prices artificially high is either: 1) in complete and total denial that artificial demand created the artificially magnified prices to start – in other words, an idiot or 2) is a thief and liar who knows the truth but continue the lies and thievery anyway – in other words, pathological.

    In either case, neither should be left in charge.

  10. MAL says:

    The senior preferred stock initiative was a superior alternative to the original Treasury plan of buying “distressed” assets.

    It appears to me that David Einhorn may have had a self interest in the original plan of buying these assets.

    The problem is that the U.S. government was neither consistent in implementing their plans nor the best negotiator for the U.S. taxpayer. Regardless of what happened, there were going to be jobs lost, more bankruptcies, higher unemployment, and lower asset prices.

    It is my opinion that had the original plan been implemented things would be worse not to mention the outcome ethically wrong. It would have been a huge unchecked transfer of wealth without a clear mechanism for establishing a fair price, which assets to purchase, and from whom to purchase those assets from. Maybe Einhorn wanted some of his “distressed” assets purchased?

  11. Boo-urns says:

    Recapitalization wasn’t the problem, it was how it was executed. As Einhorn and Lewis note, nationalization of banks in Sweden was widely considered pretty successful. What they don’t mention is that this nationalization was effectively a recapitalization.

    Paulson should have been forcing banks to recapitalize, rather than pleading with them to accept public money. This would be pretty easy to do, you would just have the bank regulators require banks to write down their assets to the appropriate levels (as opposed to what they’ve been doing to date, which is bending over backwards so that banks don’t meet certain undercapitalization triggers; the actions of OTS were extreme but almost certainly not isolated). Undercapitalized banks (which I’m assuming would basically be all the major players) would then need to raise capital, and if they can find sufficient private capital in this market, God bless them. Otherwise, they take public capital on terms dictated by the federal government- executive compensation restrictions, federal management and Board representation, a cessation of dividend payments until they have repaid the federal government and are well capitalized. I.e., exactly what Sweden and the Great Depression-era U.S. did to successfully manage their bank crises.

    But I thought both pieces by Einhorn and Lewis were excellent.

  12. Bruce,

    w/this: “”If ever, in my professional career, there was a time for active, discretionary fiscal stimulus, it is now,” Yellen said in remarks prepared for the American Economics Association’s annual meeting in San Francisco.

    Yellen said she was skeptical about suggestions for broad-based, permanent tax cuts and instead urged “spending on goods and services with higher rather than lower social value.””

    you don’t need someone “who speaks economics”, you need to look a little further to the right, on your Library shelf, to the book on “Elitist”..

    LSS: from their POV: “You don’t know, aren’t able to figure out, what you need; We’ll Tell You.”

    it’s the Bottom-Line of Keynesianism, anywhere found.

    Keynes’ problem was that there was not, and Never will be, ~120% of the Earth, to push into his scheme..

    speaking of schemes, I find it interesting that these ‘people’ always like to return the scenes of their ‘deeds’:

    http://www.icerocket.com/search?tab=web&p=2&q=U.N.+San+Francisco+1945&lng=&

    http://www.ourdocuments.gov/content.php?page=milestone ..a telling list

  13. wunsacon says:

    The whole world is increasingly morphing into a centralized command economy.

    Questions…

    1. – Where can I take my marbles? Agricultural commodities and precious metals?

    Oh, also, let me repost a couple of questions from a less-read thread:
    2. – If bond prices fall, will money managers have to “rebalance” away from equities every month-end?

    3. – Remember Bernanke’s 2002 speech? Doesn’t he say he can purchase Treasuries in order to keep the yields low, as was supposedly done in the 1950’s? Won’t that hurt TBT investors?

    Thoughts?

  14. wunsacon says:

    “Editing”…Sorry, forgot to remove that first, overbroad statement. That was just my reaction to reading some more of the bailout/payout news this morning. (Apparently, someone’s trying to get government money for a newspaper. That runs the risk of allowing the government to sponsor the papers it likes and not the papers it dislikes.)

  15. Che Stadium says:

    @Wunsacon:

    What’s so “overbroad” about that statement?

    I was always very skeptical of the notion that capital injections for banks would increase lending. The only plausible way to make that happen would be to provide the capital to small banks that have meaningful legal lending limit constraints. Those banks would have the highest marginal propensity to lend, but conversely those are the banks where any capital injection would be most potentially dilutive.

  16. wunsa-

    w/this: “That runs the risk of allowing the government to sponsor the papers it likes and not the papers it dislikes.)”

    forget the Fact that they’re Already doing it..

    The MSM will assure you that: “That could Never happen…too many ‘people’ would know, ‘someone’ would talk”, etc., et al., ad infi..

  17. Bruce in Tn says:

    Well, I don’t know what all the fuss is about. Mr. Luskin today says the recession is already over…(see SmartMoney)…so I thought I’d post this little gem from August..

    http://www.smartmoney.com/investing/stocks/Think-Were-in-a-Recession-Head-to-Disneyland-23631/

    Think We’re in a Recession? Head to Disneyland

    (The fellow who played Goofy was sick, and Don was doing a little moonlighting…)

  18. Graphite says:

    “The whole world is increasingly morphing into a centralized command economy.

    Questions…

    1. – Where can I take my marbles? Agricultural commodities and precious metals?”

    Buy a farm in some corner of the world where no army will ever care to fuck with you. Bring lots of guns and carry them with you at all times.

    This is going to be soooooo much better than laissez-faire, you guys!

  19. dunnage says:

    Would you rather be confused and wrong or simply wrong? The CIA did not provide bad info on WMD. They said they did not exist and Iraq was not a problem — then under pressure they lied. Powell lied at the U.N.. I watched him show two grainy pictures and tell a stupid story. What did you see?

    So Paulson — confusing? hell no. He demanded a trillion dollars to give as he pleased — no questions now or later. So he gives a few hundred billion to friends — did he expect them to loan the $. No. Does he expect them to soon loan the money. No. He showed that the gov was behind the Big 9 Sponges. Great for perception cause what the hell else do you do when you know they are totally underwater. Besides his buds could use the cash. Yes, I can imagine the fight they put up. Beyond this, does Paulson know anything we don’t know — hell no, the guy got us into this mess, his job is done. Oh, and look at the new blood in the White House. Who are those guys?

  20. dunnage says:

    As far as Policy. One way has always been used and always will be used: throw public money at the problem. The only question is where. Governments, Kings, Queens, and Dictators have no other tools, or inclinations for that matter.

  21. steward84 says:

    My favorite observation of the entire piece is this quote from the op-ed, referring to government’s attempt at restoring confidence in the system:

    ‘When you shout at people “be confident,” you shouldn’t expect them to be anything but terrified.’

  22. batmando says:

    Wunsacon -
    My questions exactly. Was looking/hoping for responses from some of the more insightful commenters hereon.