First, want to make everyone aware of the event in DC on January 28, 2009, at American Enterprise Institute.  Co-sponsored by the DC Chapter of Professional Risk Managers International Association (PRMIA), we have an excellent panel of observers (excluding me of course) to examine the Paulson Bailout to date, including Barry Ritholtz our gracious host on BP.  Should be a lot of fun and I am particularly delighted to see Walker Todd back in Washington joined by Barry, Josh Rosner, Tim Bitsberger, myself and our moderator and host Alex Pollock.

Click here for more details

BTW, for those of you who have not already seen it, read our comment this week in the Institutional Risk Analyst, we discuss the role of the Federal Home Loan Banks in causing nearly three quarters of the $9 billion loss to the FDIC in the IndyMac resolution.  We then turn to the roots of the 2008 bailout of Bear Stearns and AIG, and discuss the little-noticed 1991 amendment to the Federal Deposit Insurance Corporation Improvement Act which allowed non-banks to borrow from the Fed.

The FDICIA anecdote also provides my view of the ugly back story on how my friend Walker was driven out of the Federal Reserve System by the pro-bailout forces who are running the show today.  This vicious act of censorship against Todd (and other reserve bank researchers) apparently was conducted by the Board’s staff and with the knowledge and assent of Alan Greenspan.

http://us1.institutionalriskanalytics.com/pub/IRAstory.asp?tag=333

Final thought.  I just got to see the draft paper by Pietro Veronesi, University of Chicago, NBER & CEPR
and Luigi Zingales*, University of Chicago, NBER & CEPR:

http://faculty.chicagogsb.edu/luigi.zingales/research/PSpapers/paulsons_gift.pdf

Abstract
“We calculate the costs and benefits of the largest ever U.S. Government intervention in
the financial system. We estimate that the revised Paulson plan increased the value of
banks’ financial claims by $109 billion at a taxpayers’ cost of $112 -135 billions, creating
no value in the banking sector. We compare the cost of Paulson’s plan with the costs of
alternative solutions that would have achieved the same objective in term of solvency of
the banking system. We find that the revised Paulson plan is the most expensive for the
taxpayers, second only to the original Paulson plan. The biggest beneficiaries of this
massive redistribution were the debtholders of financial institutions, especially those of
the three former investment banks and of Citigroup. The equity holders just broke even.”

Here is part of a statement by Eugene Fama also of U Chicago on bank debt overhang problem and how to get rid of it that relates directly to the issues addressed by Veronesi and Zingales:

“Suppose no private buyer steps up to buy a failed bank, and suppose, for whatever reason, the Fed and the Treasury decide they want to inject equity to allow the bank to meet its capital requirement. The FDIC approach can still be used to solve the debt overhang problem, so taxpayers get their money’s worth, that is, so equity financing ends up as equity financing rather than as a shift of taxpayer wealth to the bank’s debt holders. To achieve this goal, the FDIC can draw a line in the bank’s liability structure, with debt holders and stockholders below the line getting nothing. The line should be drawn so that the market value of the bank’s assets covers the liabilities above the line. (This is what the FDIC does when the new equity comes from a private investor.)”
“When this prescription is followed, the bad news is that the failed bank has been nationalized (I hate nationalization), but the good news is that nationalization is accomplished without a taxpayer subsidy to the bank’s debt holders. I suspect the Fed and the Treasury think they avoid nationalization (or at least perception of it) if they inject equity capital into a bank without solving the debt overhang problem. This is an illusion. The bank has been nationalized, but in a more expensive way. The additional expense is the subsidy to the old debt holders because of the debt overhang problem.”

“The FDIC’s powers are written so that taxpayers should not have to pay when a bank goes bad. The logic is that the bank’s stockholders and its lower priority debt holders get the benefits when the bank does well so they should pay the costs when it does poorly. Stockholders and lower priority debt holders should be pushed out of the game until the value of the bank’s assets are sufficient to cover its remaining liabilities. My view is that this blueprint should be followed when the subsequent injection of equity capital that a failed bank needs to survive comes from the public sector (the Treasury or the Fed), as well as when it comes from the private sector. It produces all the benefits of a recapitalization without a taxpayer subsidy. ”

Best,

Chris

Category: Bailouts, BP Cafe

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.

3 Responses to ““PAULSON’S GIFT” ; A Review of the Bailout — What is to be Done Now??”

  1. murph says:

    Minor questions on the Paulson’s Gift paper.

    On page 10 – they are saying that the CDS liabilities of the ten big banks (that received federal cash injections) will not affect their overall conclusions because “as reported by the Controller of the Currency, 97% [of the CDS's] are held by these [same banks].”

    Two questions:
    1) I thought that CDS’s were not disclosed to outside parties (part of the reason the banks were so unsure about who was solvent) – has the Controller of the Currency been compiling a true list of the existing CDS liabilities out there? If they weren’t in the past, are they now?

    2) Is it really possible that 97% of the CDS market is in the hands of ten banks? Is the Controller of the Currency’s listing a sub-set of the domestic CDS market?

    Baffled.

  2. gloppie says:

    @Murph,
    I do not have factual evidence for this, but it seems rather obvious that the Credit Default Swap players would be the same bunch of most over leveraged, risk-taking, me first ya’ll later crooks wouldn’t it ?
    There is a French saying…Apres moi, les mouches. “After me, the flies”. Utter contempt and selfishness, when I’m gone all that is left is rotten and useless.

  3. murph says:

    While I could certainly believe that these ten banks would be major players in the CDS market, I’d be hard pressed to believe that there aren’t dozens of other entities just as eager to buy into CDS’s.

    I just can’t believe that all the other selfish financial types add up to a meager 3% of the CDS market.