Earlier this month, I discussed a NYT OpEd by Treasury Secretary Tim Geithner (Welcome to My Job Security). Geithner pointed approvingly to the report released by Alan Blinder and Mark Zandi, advisers to President Bill Clinton and Senator John McCain, respectively:

“The combined actions since the fall of 2007 of the Federal Reserve, the White House and Congress helped save 8.5 million jobs and increased gross domestic product by 6.5 percent relative to what would have happened had we done nothing.” (emphasis added).

I did not have cause to disagree with the Blinder/Zandi numbers; they are best guesses using Moody’s econometric modeling. However, I did criticize their overall approach, saying: “That is now our standard — what was done versus doing nothing? That is truly the wrong counter-factual…

David Weidner took issue with that assessment. In his column A Nation That Won’t Be Fooled Again, he noted:

“The financial crisis and stagnant economy have made us bitter. We’ve become a nation of complainers and critics. Nothing is ever good enough for us. The bailouts are misguided. The stimulus didn’t work or wasn’t enough. Reform is too weak or makes matters worse. It’s one thing to call the glass half empty, but these days we deny the existence of tableware.”

I don’t disagree with Weidner’s perspective. Many people have gone off the deep end, obsessing with “recession porn,” seemingly addicted to negative commentary and wild conspiracy theories.

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My disagreement with the Zandi-Blinder report is not its theoretical underpinnings — it is by definition a hypothetical counter-factual. Rather, it is the counter-factual Blinder/Zandi chose to use: “What would the economy look like now if we had done nothing?

Instead, I propose a better counter-factual: “What if we had done the right thing, instead of nothing — or the wrong thing?

A quick definition first: The term “counter-factual” is a term of art often misunderstood. The definition of counter-factual is a “what-if” — counter-factuals explore historical incidents by extrapolating an alternative time line:

-What-if Chrysler was not bailed out in 1980?
-What-if JPM was not guaranteed $29B of Bear’s liabilities?
-What if Citi and BofA were put into reorg/receivership?
-What if AIG’s counter-parties were not made whole 100 cents on the dollar?

We don’t have alternative universe laboratories to run control bailout experiments, but we can imagine the alternative outcomes if different actions were taken.

So let’s do just that. Imagine a nation in the midst of an economic crisis, circa September-December 2008. Only this time, there are key differences: 1) A President who understood Capitalism requires insolvent firms to suffer failure (as opposed to a lame duck running out the clock); 2) A Treasury Secretary who was not a former Goldman Sachs CEO, with a misguided sympathy for Wall Street firms at risk of failure (as opposed to overseeing the greatest wealth transfer in human history);  3) A Federal Reserve Chairman who understood the limits of the Federal Reserve (versus a massive expansion of its power and balance sheet).

In my counter factual, the bailouts did not occur. Instead of the Japanese model, the US government went the Swedish route of banking crises: They stepped in with temporary nationalizations, prepackaged bankruptcies, and financial reorganizations; banks write down all of their bad debt, they sell off the paper. Int he end, the goal is to spin out clean, well financed, toxic-asset-free banks into the public markets.

Thus, Bear Stearns is not bailed out by the Fed. Instead, the FOMC chair tells JP Morgan’s CEO “You have 9 trillion dollars in exposure to Bear derivatives. Instead of guaranteeing you $29 billion for a risk free takeover, we will start preparing a liquidation plan for Bear. And given your exposure to them, we best plan one for JPM too. (and if you don’t like that, you can kiss our ass).”

Tough talk, but the outcome would have been much better: JPM would likely have bought Bear anyway, if for no other reason than to prevent someone else from buying them, and forcing JPM into bankruptcy, to pick up their assets for pennies on the dollar. That would have set a much better tone for future bailout expectations, versus the massive moral hazard the Fed created with the Bear bailout.

Lehman? Prepackaged bankruptcy, less disruptive.

AIG ? There never was an implicit government guarantee that all counter-parties dealing with AIG-Financial Products — a giant leveraged structured finance hedge fund hiding under the skirt of the regulated insurer — would be made whole. But the Bush/Paulson/Bernanke bailout created one. Instead, AIG-FP should have been carved out for dissolution/wind down, while the insurer could have continued to exist on its own. AIG would have had the liability for the government’s costs, but the counter parties? They would have gotten zero. If you go to Vegas and shoot craps in the alley way behind the casino, don’t expect the gaming commission to collect your winnings. But that is what we did with AIG.

Fannie & Freddie: Two more crappy banks that should have been wound down. These were publicly traded companies that were guaranteed lower interest rates — not an infinite backing from taxpayers. They should have been wound down like all any insolvent bank. Today, they serve as the mechanism for backdoor bailouts of the rest of the wounded banking sector.

The same approach should have occurred with the rest of the crowd of irresponsible banks, investment houses, monoline insurers, etc. One by one, we should have put each insolvent bank into receivership, cleaned up the balance sheer, sold off the bad debts for 15-50 cents on the dollar, fired the management, wiped out the shareholders, and spun out the proceeds, with the bondholders taking the haircut, and the taxpayers on the hook for precisely zero dollars. Citi, Bank of America, Wamu, Wachovia,  Countrywide, Lehman, Merrill, Morgan, etc. all of them should have been handled this way.

The net result of this would have been more turmoil, lower stock prices, and a sharper, but much shorter economic contraction. It would have been painful and disruptive — like emergency surgery is — but its better than an exploded appendix.

And today, we would have a much healthier economy:

Functioning Banking System: Clean banks not laden with bad paper would be actually making loans to qualified borrowers;

Healthier Housing Sector: An unsubsidized real estate sector — no tax credits to first time buyers, no ultra low interest rates — would have had much lower prices, with far less bad mortgages floating around. We would be much further along in the foreclosure process. More of the folks who bought more house than they could afford would have moved into homes they can afford;

Much Smaller Federal Deficits: The trillions of dollars of bailout costs on the books of Uncle Sam would not exist. Not he Tarp, not the government guarantees, not the GSEs, none of it.

Right-sized Finance Sector: Instead of an outsized banking sector, finance in the US would be more proportional relative to the overall economy. Resources and assets (including programmers, quants, and engineers) would go to more appropriate firms.

Bond holders Lose: Here is an insane idea: If you lend money to a firm that goes out of business, you lose most of that money (You do get a high priority in the liquidation). The US Taxpayer does not step in to guarantee the loss. Crazy, I know, but it is crazy enough that it just might work!

Counter-parties Lose: See above

Managements Lose: It seems that for the most part, most of the upper level bankers who helped bring about the crisis are still working for the same banks. A study found that “92% of the management and directors of the top 17 recipients of TARP funds” are still working for the same banks. Reorg would have caused these people to be fired; perhaps the bankruptcy judges would have clawed back some of the execs ill gotten gains.

Moral Hazard: Bankers expectations that they can behave recklessly because Uncle Sam will bail them out, is dramatically reduced.

While we certainly can compare what was done with doing nothing, the proper counter-factual is to compare what was done with what should have been done.

Throwing trillions of dollars at the crisis, and hoping for the best will provide a short term improvement over doing nothing; trillions of dollars have that sort of power.

The proper comparison, however, should be versus what should have been done. Performing that analysis leads one to a very different set of conclusions . . .

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Sources:
Perhaps, It’s Time to Play Offense
DAVID LEONHARDT
NYT: September 16, 2008
http://www.nytimes.com/2008/09/17/business/17leonhardt.html

A Nation That Won’t Be Fooled Again
David Weidner
WSJ, AUGUST 12, 2010
http://online.wsj.com/article/SB10001424052748704901104575424332141218568.html

Previously:
Banking Sector Remains (literally) Unchanged (January 4th, 2010, 10)

Welcome to My Job Security (August 3rd, 2010)

Krugman’s Crisis Responsibility: Reagan or Bush ? (June 12th, 2009)

Grading Financial Regulatory Reform (June 25th, 2010)

Bear Stearns, Lehman Execs Kept Billions . . . (November 23rd, 2009)

Category: Bailout Nation, Bailouts, Financial Press, 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.

90 Responses to “2008 Bailout Counter-Factual”

  1. Mike in Nola says:

    This article (A Nation That Won’t Be Fooled Again) seems to be laying the groundwork for being fooled again: “We can’t really tell that all the giveaways to the banks were bad and shouldn’t criticize them.”

    As real estate turns down again with the expiration of subsidies and the insolvency of the banks is once again revealed, the old boys in government will try the same sh*t.

  2. Evoo Kermartin says:

    I don’t know, Barry. I think it’s more like the bastards infiltrated the body politic like guinea worms:

    http://en.wikipedia.org/wiki/Dracunculiasis

    Requiring a slow, painful “wind down.” So to speak.

  3. countziggenpuss says:

    BR – Geithner is really one of the last people on the planet that I would like to defend, but I think that when he wrote his op-ed, he was writing on behalf of the Obama administration (not himself as Treasury Secretary or as president of the NY Fed). Most of your criticisms here a based on actions taken pre-Obama administration.

    ~~~

    BR: I have not been happy with the Obama administration continuing the same awful Bailout policies of the Bush administration.

    But you raise a valid point, and I will clarify that above.

  4. BR,

    thanks for doing this..
    ~~~
    but, you know, of course, that neither, Blinder, nor Zandi, will ever posit an analysis along the lines of: “…The proper comparison, however, should be versus what should have been done. Performing that analysis leads one to a very different set of conclusions . . .”

    simply, that ain’t why they’re receiving their Paychecks.
    ~~
    LSS: those two are straight from the mold of Lippman and Bernays: “…Propaganda techniques were first codified and applied in a scientific manner by journalist Walter Lippman and psychologist Edward Bernays (nephew of Sigmund Freud) early in the 20th century…”
    ~~~
    “…In a narrower and more common use of the term, propaganda refers to deliberately false or misleading information that supports a political cause or the interests of those in power. The propagandist seeks to change the way people understand an issue or situation, for the purpose of changing their actions and expectations in ways that are desirable to the interest group. In this sense, propaganda serves as a corollary to censorship, in which the same purpose is achieved, not by filling people’s heads with false information, but by preventing people from knowing true information. What sets propaganda apart from other forms of advocacy is the willingness of the propagandist to change people’s understanding through deception and confusion, rather than persuasion and understanding. The leaders of an organization know the information to be one sided or untrue but this may not be true for the rank and file members who help to disseminate the propaganda…”
    ~~
    “5) Disinformation as weakness: weakness is indicated by reaction, reaction is induced by misinformation and disinformation. Strength is manifest in action to which an adjunct may be the supply of misinformation or disinformation. Individuals must not be allowed to act or think independently, and individuals must not be permitted to act in the face of government coercion. By forcing people to react to disinformation and misinformation individuals in power can pursue their own private agenda…”
    http://www.sourcewatch.org/index.php?title=Propaganda

  5. super_trooper says:

    So, in your scenario what would the inflation, unemployment and GDP be?

  6. Super trooper

    Initally, they would have been worse — deeper contraction, weaker retail sales, more foreclosures, higher unemployment.

    However, by now, we’d already be on the path to improvement. Instead of looking at a Japanese like lost decade (or 2) we be seeing improving hiring, better spending, stronger GDP …

  7. JET55118 says:

    Wow- great post. “It would have been painful and disruptive — like emergency surgery is – but its better than an exploded appendix.” Brilliant! Why aren’t people like you in the government?!

    I am going to buy your book today.

  8. ByteMe says:

    You may have missed a piece of the puzzle, Barry. Your tonic for what ailed us is good, except…

    Except who were the big shareholders of the bonds and preferreds of the big financial firms?

    A lot of other smaller banks. Pensions and pensioners. As we got to watch our parents’ nest egg go to 0, who would have had to step in? As pensions go belly-up, who is required by law to step in? As other banks would be suddenly insolvent, who would have been required by law to step in? Where was the money for all this going to come from? What would all this have done to government spending and the economy?

    As satisfying as it would have been to do what you say, we might have not liked the outcome from what you propose either.

  9. ByteMe says:

    P.S.: Personally, I’d rather get some good perp walks of CEOs and heads of trading desks wearing expensive tailored suits.

  10. ByteMe

    Yes, that is correct. The people who invested in banks that were insolvent would have lost that slice of their money in those shares. THAT IS HOW INVESTING WORKS.

    We don’t reward those who made bad bets; the taxpayers aren’t guarantors of every 401k in the country. Are you saying these bailouts should also rescue the pensions that invested poorly? Why should anyone ever invest wisely if the govt will over their bad decision making?

    Nobody’s next egg goes to zero (unless you were foolish enough to have a crappy bank only portfolio of LEH, BSC, AIG, FNM, etc.) Pensions would not go belly-up, but they would take losses.

    ~~~

    Allan Meltzer noted, “Capitalism without failure is like religion without sin — it just doesn’t work.”

  11. FLECK says:

    brilliant barry-bravo for doing this….cheers,bill

  12. dead hobo says:

    I don’t know, man.

    You first demean those with ‘wild conspiracy theories’, and then you outline a series of transactions that stream cash from the government to wall street and banks in general, bailing out insolvent and incompetently managed businesses. As a result, ginormous bonuses are paid to wall street execs while main street declines.

    Are you describing extreme naive activities from people in govt who all had nothing but the most altruistic intentions? Or might some of the above be clever crooks who saw their opportunity and took it and, amazingly, it was all legal? When the Fed injected $1.5T into the economy with $300B as liquid nitro in the form of UST monetization, of course it was done in such a way as to not influence the stock market in asset bubbly ways. If such a thing happened, it was only a coincidence.

    I think you’re right. Nothing to see here about that. It’s all on the up and up. No secret stuff on any kind by government employees. Anything that looked pumpy in the stock markets was only a coincidence. The markets are still places of honest transactions and only a conspiracy nut might connect the bailout trillions with unsavory market activities. Anyway, the crooks are all gone now and the one C level exec responsible for it all will possibly be in big trouble within the next 18 months thanks to the unicorns at the SEC.

    ~~~

    BR: As noted, most execs are still working for the same banks.

  13. wally says:

    Lost in all this, in my opinion, is the real movement; a shift in income distribution.

    Everybody wants to compare this to recessions, but it is really a structural change simultaneous with a bubble that disguised that change for a period of time. We’ve shipped a lot of jobs away permanently; we’ve redefined the positions of banking and corporate management in fundamental ways that make those roles a sort of aristocratic upper class. We’ve decreased financial mobility. Those things aren’t going to ‘return’ to where they were and, in consequence, neither will a number of other measures.

  14. phanimukkamala says:

    excellent post! As long as Geithner is there, nothing would change.

  15. Petey Wheatstraw says:

    They bailed the flooded town out, right back into the river, and charged us a hefty premium for their efforts. We should have fixed the levy, and jailed those who built and/or destroyed it.

    We’ll continue the hard times until we acknowledge that our rescuers are actually responsible for this mess, remove them from the disaster area, and get down to the business of fixing the structural problems they created.

  16. AGORACOM says:

    @dead hobo

    “Or might some of the above be clever crooks who saw their opportunity and took it and, amazingly, it was all legal? ”

    You are dead right. There is no reason to believe Wall Street wasn’t simply continuing to criminally act in its self interest. They nailed the public on the way up and nailed them again on the way down.

    Amazingly, it happened in plain sight while American masses were mesmerized by Lindsay Lohan, Perez Hilton, the Bachelor, Jersey Shore, Brangelina, ………..

    We are witnessing the financial matrix. I just can’t figure out if Barry is Morpheus or Neo

    Regards,
    George from Canada

  17. Petey Wheatstraw says:

    Barry Ritholtz Says:
    August 17th, 2010 at 8:56 am

    “However, by now, we’d already be on the path to improvement.”
    ______________

    Maybe. Probably not.

    There are two, and only two, options for fixing this freekin’ mess (same as there ever were): Inflate (applied to the starved segment of our economy — the middle class, over-indebted consumer), or default (personal<banking<government). This is not a tangled fishing line, it’s a Gordian knot — it cannot be unwound or untangled, it must be cut.

  18. dead hobo says:

    Barry Ritholtz Says:
    August 17th, 2010 at 9:05 am

    Byteme

    Yes, that is correct. The people who invested in banks that were insolvent would have lost that slice of their money in those shares. THAT IS HOW INVESTING WORKS.

    reply:
    ————–
    I love history but the better question is “where do we go from here?” The bailout and the consequences are old news, but problems remain. Your analysis is quite good, but not relevant to the solution required to fix the problems that are here now. So, looking forward, how are the mistakes of the last solution overridden and put right? What steps need to be taken to fix the problems created by the last fix and make the economy a better place on top of that? Nostalgia is cool, but the only people it feeds are historians.

  19. gregh says:

    Love this post and questions it poses.

    Side-question: the Housing / stock-prices could have massively over-corrected (big mean reversion overshoot right?) how close would the this have put us towards bunker-living and Cormac McCarthy’s “The Road”? Worse housing/stocks would’ve meant even less consumer spending and jobs…. and housing seems so slow to adjust. Just curious.

  20. George,

    re: “They nailed the public on the way up and nailed them again on the way down.”

    see this i-view w/ Susan Wachter, Wharton School professor, discussing “Saving Fannie & Freddie”

    http://www.cnbc.com/id/15840232?video=1568086771&play=1 (~3:00 mark)

    and, Know that the ‘Cained Peep should be hearing the BOHICA-klaxon..

    http://www.thefreedictionary.com/klaxon

  21. Adyt says:

    The taxpayers seemed to love the same financial system they now hate. Why else would they have borrowed so much? So, I think these bailouts were very much in the taxpayers’ interest too, unless they wanted to go back to growing their own food.

    Indeed, there’s some moral hazzard, they probably could have been done better, but I do not see the bailouts as encouraging bad investment practices. The administration would encourage bad investment practices if they didn’t punish the banks now, after the system was saved.

  22. dead hobo says:

    dead hobo Says:
    August 17th, 2010 at 9:11 am

    What steps need to be taken to fix the problems created by the last fix and make the economy a better place on top of that? Nostalgia is cool, but the only people it feeds are historians.

    reply:
    —————-
    Oops, my bad. I forgot about FINREG. It’s all good now. Case closed. Everyone: Back to work!

  23. Everything you said, BR. Now there’s really no turning back from this slow, tortuous decline. Absent a revolution. And why would people revolt so long as they believe in the fantasy that their government can save them?

  24. JusTryinTaMakeIt says:

    One question; In Barry’s scenario most of the major banks would be out of business. Who would have taken over the failed banks’ business? What would the banking industry look like today?

  25. JusTryinTaMakeIt

    The bond holders (and then, the Preferred shareholders) end up owning most of the insolvent banks following org — they are the highest priority (after employees) in a liquidation or reorg.

    The banks would have been cleaned up and reissued as new companies. The government would have spun them back out (think of the Swedish Crisis and how that was resolved)

    The banking industry would look like it does today, only with more competition, cleaner balance sdheerts –a nd actual lending.

  26. Jeff M says:

    Amen, brother.

    Well said.

    JM

  27. Bruman says:

    Barry, I like your analysis, and I think that these are good lessons for doing it better next time. At the same time – I’m sure you have a response to my criticism, because it’s an obvious one – but hindsight is 20/20 vision, and we don’t have a good view of what the unintended consequences of “doing the right thing” would have been, so it’s only one scenario that should be considered along with “doing nothing.”

    Remember that the actions that were taken had to be taken quickly, with imperfect information (we know more about the situation now than we did back then), and had to be politically feasible given the reality of the time. We also don’t have a good sense of exactly what a sharper, deeper, recession would have done to the economy and polity. Very likely many many non-bank businesses would have shut doors, along with the banks, unemployment through the roof, and we would STILL need taxpayer money to recapitalize banks so that the unemployed workers and executives could try starting new businesses.

    It’s like looking at a stock chart and asking why you didn’t buy at the lowest tick and sell at the highest tick. We can see the price action, but the chart doesn’t reveal the risk we perceive at the time, and memory can be selective.

    That doesn’t mean that counterfactuals aren’t useful and it doesn’t mean that “doing the right thing” isn’t a good standard to measure ourselves against. It’s just that it’s a range of scenarios, and we have to evaluate decisions by what is known at the time.

    That’s my friendly criticism of your points, which, basically, I like…

    When I read John Hussman’s work, I’m struck by his complaint that we are bailing out bondholders at the expense of taxpayers, and this is similar to your complaint that bondholders that make bad investment decisions should bear the burden of their bad choices. I agree 100% with this point, and there are two issues raised:

    First is the issue of privatized gains and socialized losses for the highest paid members of society. When asked why investment professionals should be in the top 1% of income earners, most will say “we manage risk… we’re paid well because if we make bad decisions, we suffer.” But if “suffering” means that your bonus is only $250k instead of $1MM, when the median annual family income for the rest of us, is around $55k, that isn’t really suffering. It’s just heads-I-win-tails-you-lose-a-little-less.

    More interestingly is the question of WHY BAIL OUT THE BONDHOLDERS? What is it about bondholders that makes them so special that they need to be made whole? And I think the answer has to do with the fact that enormous numbers of pension funds have their assets in these bonds. To let them take a loss would mean that pension funds become even more underfunded than they already are, with pressure on the US Government to insure or make up those losses. So part of this may have been to stem off a panic of pensioneers.

    Whether this was a good or bad decision is something I don’t really know yet. In general, I prefer when markets reward or penalize people for bad decisions on their own. But extreme dislocations tend to have strong positive feedback loops, and so I am more tolerant of intervention in these cases, provided that there are some kind of sunset provisions or structural changes to reduce the chances of future extreme dislocations.

  28. Greg0658 says:

    I gotta get a new hobby .. a hobby that gets things off the shelf – so that paper pushers can have a life … that’s this post – saving Chrysler circa 1980 – besides a best seller and some jobs for Americans (over those better built BMWs) – so says NYCs Madison Ave & WS .. excuse me but I gotta go save you guys by putting some muscle into something … ya right – the fabric is stained – old and shreading …. the paper pushers need a fast bandaid pulloff – of this slow motion train wreck – otherwise is just doesn’t work out .. aw :-( …….. my next step – whats the next big thing ? PetRocks p. dux

  29. franklin411 says:

    I take issue with Wiedner’s assertion that bailouts made us into overgrown babies. It wasn’t bailout that did that–we were already that way. I point to the Baby Boomer generation, which grew up in the 1950s and 1960s without the benefit of the good parenting practices that had produced earlier generations. Look at the ethos of the Baby Boomers: Nothing matters except yourself, all values are relative, duty/honor/respect are stupid old ideas, etc…

    You didn’t see this kind of whining and moaning in the 1930s, which was a far worse economic situation than we see today. People complained, of course, but they were a lot more willing to tolerate imperfect solutions as long as someone was trying. Today, it’s the whiny Boomer generation that is causing all the political gridlock because they demand absolute perfection and it doesn’t matter how hard you tried to move the ball forward.

    This creates a situation where there is no incentive to make a real effort to try to fix problems–you’ll just get your head chopped off unless it’s a “perfect” solution, and, of course, there’s no such thing as a “perfect solution.”

    You know, I’m going to start telling my students that this nation will be great once again, someday. That day will come sometime around 2030 or 2040, when the abominable Baby Boomer generation is dead and buried.

  30. dad29 says:

    By the way, if Government spending is logged as part of GDP, then perhaps a better measure would be “GDP net of Government spending”–both before and after the ‘remedies.’

    Otherwise, the increase in GDP is tautological.

  31. d4winds says:

    This made my day:

    “Instead, the FOMC chair tells JP Morgan’s CEO ‘You have 9 trillion dollars in exposure to Bear derivatives…, we will start preparing a liquidation plan for Bear. And given your exposure to them, we best plan one for JPM too. (and if you don’t like that, you can kiss our ass).’”

    Entire post:
    fantastic!

  32. ByteMe says:

    Barry, it’s not that I want the pensions to get bailed out, but there’s the little matter of the PBGC that — like the FDIC — does not have the money to fund all the insured pensions that will go bust. And then there’s the annoying problem of Congresscritters who will vote money to constituents in need if there were suddenly millions of grandmas showing up on CNN/FOX/etc. who no longer have a nest egg and have to move out of their homes and apartments to find less expensive digs or talk about having to eat dog food.

    Basically, it’s easy to solve this as a theoretical economic problem provided you ignore the politics of it… but the problem is more of a political one anyway. And, as a country, we’ll look for the easiest answer regardless of long-term costs… until there are no more easy answers.

  33. dad29 says:

    More:

    If GM had been allowed to go BK, I will bet a gentleman’s quarter (25 cents US) that the esteemed B. Ritholtz would have gone MasterCardLimit to purchase the Chevy spare-parts tools and dies.

    And I would have been in there right behind him with the 25 cents I would have made on the bet.

    GM “out of business”?? Get real.

  34. WFTA says:

    BR,

    Can’t agree more about the AIG counterparties and that doing bad business should be rewarded with going bust. But one question haunts me:

    The process sounds like a Friday evening FDIC intervention, which is as it should be (should have been.) But were there healthy institutions or investors available to spin the cleaned up operations to such that Main Street could still finance its operations?

  35. Adyt says:

    franklin411,

    I think you are right.

    However, I think that by 2030 – 2040 the Americans will be like the French today: always on strike.

  36. wildebeest says:

    #mark e hoffer

    “but, you know, of course, that neither, Blinder, nor Zandi, will ever posit an analysis along the lines of: “…The proper comparison, however, should be versus what should have been done. Performing that analysis leads one to a very different set of conclusions . . .”

    simply, that ain’t why they’re receiving their Paychecks.”

    True but someone needs to. Is there some economists out there, not dependent on banks or government for paychecks, maybe emeritus professors, that could prepare this sort of counter factual? Basically what BR has outlined but put some numbers to it.

  37. Nice post BR.
    I’d love if you talked about clawbacks more. How about a weekly post about who should be disgorged and why and every post could start off with “Besides Robert Rubin, this fellow here….”

  38. Clawbacks?

    Look at all of these discussions.

  39. DeDude says:

    I have no problem discussing all the alternative options of what could have been done instead, or taking apart each individual component of what was done and debating its effectiveness or lack thereof. Indeed, one of the things Obama demanded was that each part of the stimulus plan should be carefully measured to obtain better insights of what works and what doesn’t. But ultimately the political reality in this democracy is that a “sausage” of a legislative package is brought up for a vote in the Senate and the choice is this or nothing (vote yes or no). I wish there would have been a vote on going “Swedish” on the banking crisis, although I have no doubt that it would have failed (to much soci@lism for our GOPsters and blue dog “democrats”). But remember in the real Swedish solution it took about 5 years to slowly dismantle and rebuild so today we would not even be half way through the unsocialisation process.

    I don’t agree with the first points in your outcome scenario, and believe that the overall loses are much less traumatic to society if you drag them out so that institutions and markets have time to deal with them (a real Swedish solution, not a speeded up done in less than 2 years version). If you are selling an asset at 5 cent that a few years later could have been sold for 50 cent on the dollar, you have a winner and a loser from that forced speeding up of the process. I understand the psychological attraction of “getting it over with” and “punishing the reckless” but the winners of the speeded up process would mostly be rich hedge-fund vultures with cash in hand and the losers would mostly be hard working people’s pensions funds (who ended up mal-investing because they trusted the system). Furthermore, if you had allowed all the banks to fail at once, a good chunk of the loss from failing banks would end up with the taxpayers anyway via FDIC. So I doubt the federal deficits would have been any better, it would just have been called FDIC bailout rather than bank bailouts. The reason banks are not making loans to qualified borrowers is not a lack of funds, but a lack of borrowers that fits the much tighter definitions of “qualified”. Neither the banks licking their wounds nor those that were not wounded have any appetite for risk.

    ~~~

    BR: “overall loses are much less traumatic to society if you drag them out”

    Perhaps you might care to ask the Japanese if they agree, seeing how their long recession began in 1989, and is still ongoing . . .

  40. ashpelham2 says:

    I don’t think I’m qualified to predict what WOULD have happened had the bailouts been done as Mr. Ritholtz suggests, as I’m not a fortune teller. If I were, I would not be reading stuff on the internets, because I’d already know what the future holds.

    What I can hypothesize is that we would be in a much worse situation right now, with small business essentially a thing of the past. Even more importantly, BIG finance, which lends it’s name and it’s dollars to so many things, both for profit and not, would be crippled. We would have failed auto manufacturers, failed money center banks, probably failed insurers and thus, failed hospitals and medical practices, failed secondary education institutions, failed labor unions, so on and so forth.

    So, as much as we complain about the way things were done, what option REALLY existed? Stand by and watch it all go down the drain? I really don’t believe failure of all of these firms is permissable, if it can be avoided.

    We pretty much have a landscape that looks the same as it did 2 years ago. We still have elections, we still don’t see armed military in the streets, we still shop at Target for diapers.

    Seems like the right things were done in the short term. And I can’t predict what the long-term will hold.

  41. Greg0658 says:

    pss – further on housing for us now Neanderthals … without stable housing we fall back into hunter gatherers – lite on the feet is paramount – which takes me to it really does take a community .. and these days communities of communities .. becareful world at large what you wish for

    psss – just watched via library checkout Dr. Seuss “Butter Battle Book” the movie – 1of 3fer The Best of Dr. Seuss
    http://www.imdb.com/title/tt0213536/
    http://en.wikipedia.org/wiki/The_Butter_Battle_Book
    um .. in your heads for change …. pssss gotta go do something – really I’m going … hang in there – guess what it is and short the right stuff and long the right stuff

  42. ByteMe,

    with:
    “…but there’s the little matter of the PBGC that — like the FDIC — does not have the money to fund all the insured pensions that will go bust…”
    +
    “…but the problem is more of a political one anyway…”

    keep it simple, the “Political Problem” is that there are (way) too many, still, believing in “Promises” (Financial, Political, & other) that will never be kept– in any semblance of their, current, expectation..
    ~~
    with that in mind, understand that that *Reality, merely, underscores the beauty of this facet–”…AIG ? There never was an implicit government guarantee that all counter-parties dealing with AIG-Financial Products — a giant leveraged structured finance hedge fund hiding under the skirt of the regulated insurer — would be made whole. But the Bush/Paulson/Bernanke bailout created one. Instead, AIG-FP should have been carved out for dissolution/wind down, while the insurer could have continued to exist on its own. AIG would have had the liability for the government’s costs, but the counter parties? They would have gotten zero. If you go to Vegas and shoot craps in the alley way behind the casino, don’t expect the gaming commission to collect your winnings. But that is what we did with AIG…”

    of the ‘Banker Takeover’…

    ‘Hard Cash’ for Dead Paper ~ “You gotta love it, When a Plan comes together.”

  43. wally says:

    “That day will come sometime around 2030 or 2040, when the abominable Baby Boomer generation is dead and buried.”

    Hey – I resent that.

  44. Bokolis says:

    Not buying that, with the securitization pathway closed off, that banks would be making loans sufficient to keep this taco stand running.

    That the method of treatment is to keep asset prices from collapsing indicates that, for statistics as well as to feed the tapeworm, the priority is to preserve the concentration of wealth.

    As you intimate with Chrysler, the problem was letting them turn into monsters in the first place. This shitstorm was inevitable.

    Ultimately, I don’t believe that a populace that solves its problems with a pill and an app could handle your prescription.

  45. RobertB says:

    Kudos! This well written article is why I read your blog!

  46. b_thunder says:

    Brilliant, Brilliant, Brilliant post. imho, easily in Barry’s all-time top-5.

    I wish Barry would mention this lifetime career-bureaucrat, Bob Rubin’s protege’, Beavis-look-alike putz Geithner and his role in all this.

    Special thanks for mentioning JPM/Bear story: many people are convinced that in reality it was a bailout of JPM, because The Fed/Treasury didn’t care a bit about Bear’s failure (as Lehman proved later, the Fed/Treasury didn’t worry about i-Bank failures – morons!) but the couldn’t let JPM go under… and instead of playing hardball, they surrendered to Dimon’s demands.

  47. super_trooper says:

    @BR,
    “iInitally, they would have been worse — deeper contraction, weaker retail sales, more foreclosures, higher unemployment. However, by now, we’d already be on the path to improvement. Instead of looking at a Japanese like lost decade (or 2) we be seeing improving hiring, better spending, stronger GDP ….”
    If Sweden would be the example for this (yes there are gigantic dfferences), yes GDP went up but unemployment stayed high for almost a decade (started to slowly go down in 1997)
    http://www.indexmundi.com/sweden/unemployment_rate.html
    and never returned to the level before 1990. House prices took 5-10 years until they started going up again. Sweden was pulled up by the strong emphasis on export due to numerous international companies (and growth of Ericsson, similar effect that Nokia had on Finland’s economy after Soviet’s collapse) . Fortunately the global economy was growing in the 2nd half of the 90′s and 00′s. Clearly the situation in the US is different.
    So yes, your path would result in better economic prospect for the country in the long run. It would, however, take much longer and still have tremendous long term effect on the average citizen (loooong term unemployment) than I think you can imagine.

  48. AHodge says:

    this is splendid!
    Push the debt argument even further? If the debt written down, the interest service will not strangle the system. Like now. Meaning way beyond the worlds cashflow ability to service it. Capitalism requires periodic shakouts and losses after booms.

    the counterfactual is;
    whether $1.5 trillion of of tax cutting — infrastucture spending would be doing more than that amount of bondholder bailing. if you think that is too high you havent added Fannie Freddie FHA AIG other. i talk to Mark, and used to be in that business. He has little idea of the accounting issues related to the bondholder bailouts. Apparently neither does Blinder.

  49. TakBak04 says:

    @ BR on “Clawbacks Discussion”

    BR: I had high hope for Kenneth Feinberg doing “Claw Backs” when he was appointed. But, I didn’t really know his background. When I read this in July, it certainly makes the possibility of substantial “Clawbacks” seem remote. With a “fixer” of his background we who hoped for accountability would seem to be set up for disappointments.
    ———————————
    Who is Kenneth Feinberg?by Tom Eley
    2 July 2010
    Agent Orange Product Liability Litigation, The Dalkon Shield case, September 11th Victim Compensation Fund, Obama Administration “Pay Czar” and now to head “20 BL Independent Claims for BP’s Victims”

    BP Claims Administrator:

    The selection of Feinberg to head the $20 billion Independent Claims Facility was approved by BP executives, and with good reason. He has been repeatedly called upon to protect the interests of the wealthy and the powerful. Most notably, he was selected to chair a similar escrow account set up to compensate victims of the September, 11, 2001 terrorist attacks in the US. Later he was chosen as the Obama administration’s “pay czar” for bailed out banks and corporations.

    Feinberg’s task has been to present the image of objectivity and concern while pursuing the interests of the state and big corporations.

    An attorney by training, Feinberg emerged as a political figure in the late 1970s, when Massachusetts Senator Ted Kennedy made him chief of his Senate staff. From there, Feinberg joined or helped establish two politically connected Washington law firms. His specialization was mediation and “alternative dispute resolution.”

    In a number of high-profile disputes since the 1980s, Feinberg has repeatedly proven himself a reliable “fixer” for the ruling class:

    Obama administration “Pay Czar”

    Feinberg’s most prominent job came with his selection by Obama to “oversee” executive pay at financial institutions and corporations that had received a large portion of the $750 billion Troubled Asset Relief Program (TARP). The appointment was largely a public relations stunt designed to defuse popular anger over Wall Street pay.

    Feinberg did nothing to curb executive compensation at the firms, personally approving multi-million dollar pay packages for numerous executives. In 2009, Feinberg declared he was limiting cash salaries for top executives to $500,000. This figure—ten times the median pay for US workers—was in fact no limit. Firms could simply increase stock options and other forms of compensation. In the end, the top 138 executives at the TARP bailed out firms averaged $2.5 million in compensation in 2009.

    At the financial wing of General Motors, GMAC, Feinberg approved a $7.7 million salary for senior risk officer Samuel Ramsey and $4.9 million in compensation for Chief Financial Officer Robert Hull in 2009. CEO Fritz Henderson saw his 2009 compensation more than double from 2008, to $5.5 million. This while the Obama administration’s Auto Task Force gutted the wages and benefits of autoworkers and retirees.

    More of the article at:
    http://www.wsws.org/articles/2010/jul2010/fein-j02.shtml

  50. IS_LM says:

    Back then I wrote:

    Macroeconomic counterfactuals are interesting, but they require an analytic framework to do any type quantification. My preference is a macroeconometric framework, which has admittedly fallen out of favor. Most central banks now rely on dynamic stochastic general equilibrium (DGSE) models. (Even neo-Keynesian Krugman uses a DGSE framework to justify his call for greater fiscal stimulus.) Given a framework, one needs to specify the counterfactual. The more stark is the counterfactual, the looser the analytical framework can be. Blinder and Zandi have a loose framework, so their counterfactual must be stark: what happened (given the bailouts, TARP, ARRA, etc) v. none of those things. Krugman’s framework is highly structural, so he can be looser in his counterfactual: what happened v. more government spending of any kind.

    Because I enjoy this site so much, I look forward to learning what BR sees as the “correct” counterfactual, and, in particular, the framework in which he will quantify the counterfactual outcomes.

    BR has combined a loose framework with a loose counterfactual, as a result he can’t quantify. At best, he can characterize. I think I’ll stick with Blinder and Zandi on this one.

  51. IS_LM says:

    I would note, however, that economists like Krugman agreed with BR on the idea of temporary nationalization for the large banks as a means to recapitalize. While that may have been possible for Bank of America or JPMorganChase, it was quite clear at the time that the US gov’t, acting alone, did not have the statutory authority to deal with Citi.

  52. DeDude says:

    “Perhaps you might care to ask the Japanese if they agree, seeing how their long recession began in 1989, and is still ongoing”

    Hmmm – are you perhaps committing the same sin you are accusing Geithner of committing? Its not like there are only two choices. There is a difference between dragging out the solution to give the system time to digest looses, and dragging things out forever (Japanese style). I agree with the Swedish approach but just don’t believe in the rushed version that you seem to be advocating. Allowing stressed assets to find a fair price level before they are sold will simply rob the hedge fund vultures of the opportunity to strip value away from the pension funds holding the bonds – and that is a good thing for society. Especially since taxpayers are ultimately on the hook for failing pension funds as well as deposits of failing banks.

  53. IS_LM says:

    Basically what BR has outlined but put some numbers to it.

    For that, you need an actual model.

  54. I think you are taking a bit of leap from “what should have been done” (which things I largely agree with) and suggesting “today we would have a much healthier economy.”

    We are many trillions short of necessary, productivity-enhancing, infrastructure investment (deferred over many decades), the likes of which surviving enterprises likely would be no more wont to finance than presently (save their part in that Mussolini, fascist-Italy-like arrangement otherwise called “Build America Bonds”). Time has come for the resurrection of a Hamiltonian national bank … Lincoln’s “greenbacks” … FDR’s “Reconstruction Finance Corporation” — essentially a bank in which every American taxpayer is a “shareholder,” financing great projects at rates of 1-2% (strictly to pay for administrative costs): projects whose completion effectively stands to serve the long-term wealth of the nation in a manner more viable and enduring, and less susceptible to manipulation and fraud (not to say these things will be eliminated, but rather markedly reduced, putting in check their system-wide, destructive impact).

    Absent such a flanking operation whose long-term objective no bank in the private sector would dare risk (particularly following the past 40 years of “what have you done for me today?” financing), restructuring alone cannot create “a much healthier economy.” Constitutionally, we have power to create such a national bank as will finance, say, the build out of state-of-the-art nuclear power plants (as well as fuel reprocessing facilities) offering to take the nation beyond its dependency on hydrocarbon-based fuels in a manner likewise raising physical productivity by at least an order of magnitude. We simply have no better choice. It must be done now, otherwise we collapse, toxic assets still living on bank balance sheets or not.

  55. obsvr-1 says:

    This is a great exercise, too bad it is not being done at where policy, enforcement and actionable execution takes place — so we are stuck with the big bailout and multiple derivative bailouts as we continue through the slow painful path that we are on.

    @JusTryinTaMakeIt Says: One question; In Barry’s scenario most of the major banks would be out of business. Who would have taken over the failed banks’ business? What would the banking industry look like today?

    –Reply — that was more that one question … The banking system would look like it is today, major money center banks still in place – narrow banking as a utility would never have been compromised due to FDIC and FED guarantee of deposits, but the leveraged assets would have been unwound. Banks would have bad business units shut down or divested. Banks would have shared in much more of the pain than what has transpired under the bailout program. The pre-packaged or outright bankruptcy process would have done what BR described in that the participants in the capital structure would suffer the losses from common through bond holders — the worst companies suffer the most and may not have survived the cleansing.

    ********
    @dad29 Says:

    If GM had been allowed to go BK, I will bet a gentleman’s quarter (25 cents US) that the esteemed B. Ritholtz would have gone MasterCardLimit to purchase the Chevy spare-parts tools and dies.

    And I would have been in there right behind him with the 25 cents I would have made on the bet.

    GM “out of business”?? Get real.

    —- Reply:
    Not sure how you missed this, but GM did go bankrupt – the stockholders were wiped out, the bond holders took a major haircut — The gov’t became the Debtor in Possession creditor and ended up with 61% of the company. We can debate over whether this should have been done and what the structure of the deal different that what was done. Since this game hasn’t ended, pending the IPO and future stock sales, time will tell if the taxpayers will win/lose. Currently the ‘experts’ say there will be a loss. I think the gov’t should have required either a preferred position and/or secured loan position in the ‘newco’ company and held until the taxpayer is made whole.

    *******

    In the end — I think what BR has posited here is a great exercise and should be done by the powers to be as a process to continue to improve post crisis actions (policy, enforcement and structure).
    Since we did not take this we are stuck with the bailout strategy we will never know what would have happened or could have been … Unfortunately the folks making the decisions were more interested in stakeholders other than the taxpayer and the masses (think 1%-ers, elites) to ever consider what BR articulated.

    If the masses took the time to really understand the undercurrents of the bailout there would be a revolution and major changes demaned … but just try to get more than a handful to read the examiners report on the LEH bankruptcy or the reports coming out of the Congressional Oversight Panel, especially the report on the AIG bailout. Instead the 30 sec soundbites feed through the MSM machine drive the masses to distraction— argh !!

  56. rootless cosmopolitan says:

    The proper comparison, however, should be versus what should have been done. Performing that analysis leads one to a very different set of conclusions . . .

    It’s a very idealistic approach. A picture of an ideal world is being drawn and it is imagined how society could be formed (and capitalist economy be controlled) according to the idealized, normative picture, if everyone just did the right thing.

    There is only a slight problem with that approach: Society doesn’t work in this way. And since it doesn’t the idealists complain afterward that is doesn’t and the outcome is different to the wished one. I don’t really call this an “analysis”.

    Now let’s talk about the real world and why it works in the way it actually works.

  57. Evoo Kermartin says:

    Barry said @9:41 am:
    The bond holders (and then, the Preferred shareholders) end up owning most of the insolvent banks following org — they are the highest priority (after employees) in a liquidation or reorg.

    Don’t forget those pesky super-priority swap holders!

  58. rootless cosmopolitan says:

    I also take an issue with the normative approach according to which it should be done what “capitalism requires”. I actually give a damn what “capitalism requires”.

  59. sparrowsfall says:

    Barry, all makes sense, except:

    Could your approach have triggered a (far worse) deflationary cycle? Damn things can be self-perpetuating.

  60. I confused my point, you obviously talk about clawbacks, I mean more, how can some sizzle be added to the clawback/disgorgement meme so that it gets some traction. So that the Rubins of the world act in response to the fear of the public demand for clawbacks rather than the bought off politicians who shield them. I’d just love to see Moral Hazzard walking the streets.

  61. Thor says:

    “However, by now, we’d already be on the path to improvement.”

    I see this stated a lot and frankly think it’s BS. No one has any idea where we’d be today or how bad things would have eventually become. We might be on the path to improvement now, we might still be in collapse. Either outcome was a possibility and to argue that things would have been well on their way to rosy had we don’t nothing is disingenuous.

  62. [...] Barry Ritholtz has an interesting post fantasizing about what the world would look like if bondholders and counterparties hadn’t been bailed out of this and previous financial crises. He’d probably love to know the administration’s answer to Cowen’s question, and so would we. [...]

  63. Steve Hamlin says:

    BR – I agree with your points in principle, but you seem to skip over the scorched-earth environment that would inevitably result. I’ve never seen any discussions go as far as I would like. Paulson/Bernanke said to the public, to the White House, and to Congress “we have to save the banking system or else”. BR says “we should have done this instead.”

    But what about the “or else”? You simply dismiss it entirely.

    Say we did everything you say (which I tend to agree with) – equity of all the big financial institutions goes to zero, bondholders take large losses and have claims to the corpse. Excise the bad debt at creditor expense, as quickly as possible.

    All of that isn’t going to happen overnight. And if you recall, there was serious concern in October 2008 about payment systems, continuing trade, and payrolls being made. Hell, people were worried about food on supermarket shelves.

    What would have happened to the entire commercial paper market if large financial institution debt is uncertain? If FNM/FRE goes into receivership, and 5,000 small and regional banks are insolvent overnight, with limited ability of the FDIC to manage it? Interbank lending dries up, SWIFT and FedWire systems are worthless?

    Massive inability to meet payroll? Merchants stop taking credit/debit cards, and require currency for all transactions?

    What happens when International Letters of Credit are denied, and international shipments grind to a quick halt? What happens to supermarkets when deliveries slow down, and stop altogether for lots of products?

    Systemic risk isn’t just the risk that a BS or AIG failure causes losses at JPM and GS, and Wall Street overall is hurt. It is that Main Street and almost every facet of the entire developed world depends, at a very core level, upon the financial & economic system in effect in 2008 functioning as designed. And if it stopped, or ground down more that it already did under the factual, this economy would be in absolute chaos. Massively complex and inter-dependent systems don’t just nicely re-adjust overnight.

    I agree with your principle, but while I’ve never seen hard analysis, I do think your suggestions would have created significant financial-leading-to-social chaos that you’re not discussing. The suggested policies & actions would have created massive knock-on effects that matter a lot more now than some future tax increases to pay for federal borrowing.

    I find your counter-factual interesting and a good start, but it is very incomplete for you to call it an improvement over what actually did happen.

  64. zola says:

    “Many people have gone off the deep end, obsessing with “recession porn,” seemingly addicted to negative commentary and wild conspiracy theories.”

    I don’t disagree with this, but I think that it outght to be looked at it from a more psychological perspective. I don’t think it’s unreasonable to assume that a large proportion of the “many people” have lost a great deal due to this recession, be it their retirement accounts, their jobs, or their homes.

    I speculate that most of these people feel cheated, that they feel they played by the rules and that they feel they have been deprived of what was supposed to be the fruits of playing by the rules. As a result, they are very angry and look for someone to blame.

    Finding someone to blame is even more important given that currently, our culture worships the idea of personal responsibility. It’s much easier to dig for conspiracy and fixate on bad news, because that confirms that we aren’t personally responsible for the mess we are in.

    So of course the whining and angst and bitterness proceeds apace.

  65. ashpelham2 says:

    Riskaversealert@12:26

    Quote -” Time has come for the resurrection of a Hamiltonian national bank … Lincoln’s “greenbacks” … FDR’s “Reconstruction Finance Corporation” — essentially a bank in which every American taxpayer is a “shareholder,” financing great projects at rates of 1-2% (strictly to pay for administrative costs”

    This is a good thought, and one that I’ve had a few times myself.
    Roll back the clock to early 2008, when we started to realize the toxic assets sitting on the books of banks were tied strongly to worthless derivatives, underpinned by worthless mortgages on underwater properties. My thought was at that time, rather than just dumping money into banks to help their capital req’s, why not take the bad bets they made, and a lot of American homeowners made, and create a “Investment in America” quasi-bond structure, for anyone and everyone who took on a mortgage or excessive debt, and make us all become shareholders in that. Yes, banks too, yes, other businesses related to the mess too. Underwritten by the Feds, we all would be a part of this debt-bond, and we would all work over a time to pay this back to ourselves. Perhaps you would do it through tax receipts, a new tax, increased taxes, something….It wouldn’t have been popular, but really, where was the win at? The Republicans were losing control/had lost control. And this would have been better for America, I contest.

    Too late now, I suppose.

  66. IS_LM says:

    Actually, macroeconomist and economic historian Brad DeLong has an excellent post on the role of bailouts in his description of three “sects” of modern macro. Paraphrasing BDL paraphrasing Don Kohn:

    … the lender of last resort should act because teaching a few thousand investment bankers a lesson they deserve is not worth doing if the cost is the jobs of millions.

  67. bruerr says:

    Appreciate the counter-factual explanation. And you taking the position what if we had done the right thing, instead of done nothing or the wrong things, and leveraging that into discussion on JPM and AIG shenanigans.

  68. obsvr-1 says:

    IS_LM Says:

    … the lender of last resort should act because teaching a few thousand investment bankers a lesson they deserve is not worth doing if the cost is the jobs of millions.

    —–
    now for the real of the story

    … the lender of last resort should act because teaching a few thousand investment bankers a lesson they deserve is not worth doing if the cost is the LOST of millions in POLITICAL CONTRIBUTIONS

  69. bruerr says:

    Appreciate the counter-factual explanation. And you taking the position what if we had done the right thing, instead of done nothing or the wrong things, and leveraging that into discussion on JPM and AIG shenanigans.

    “Thus, Bear Stearns is not bailed out by the Fed. Instead, the FOMC chair tells JP Morgan’s CEO “You have 9 trillion dollars in exposure to Bear derivatives. Instead of guaranteeing you $29 billion for a risk free takeover, we will start preparing a liquidation plan for Bear. And given your exposure to them, we best plan one for JPM too. (and if you don’t like that, you can kiss my ass).”

    “That would have set a better tone for future bailout expectations, versus the massive moral hazard the Bear bailout created.”

    Can you please elaborate on this more. In this scenario are you debating or upholding the position that JPM due to exposure of 9Trillion, in Bear derivatives, should have gone down with Bear? As in once it was clear JPMorgan had 9Trillion exposure to Bear derivatives, that JPM itself, could have been acquired for pennies or a few bucks per share? …Thus leaving JPMorgan with an executive decision, to buy Bear still, but possibly pay more (the decision to purchase Bear based off desire or desperation to keep knowledge of their exposure to Bear to a limit).

    Can you please elaborate. Possibly provide more info in support of their 9 trillion exposure, when that became generally known on the time line with all the other things.

    Agreeing and re-affirming this is a counter-factual discussion. Conceding you raise some very interesting thought here Barry.

  70. Assassin says:

    “So, I think these bailouts were very much in the taxpayers’ interest too, unless they wanted to go back to growing their own food.”

    but with all the scorched earth, how do you know the land would even be arable?!?!?!

    or seriously, why don’t you provide evidence for your ludicrous claims before fearmongering any more?

  71. Ted Kavadas says:

    BR,

    Excellent post. While I don’t necessarily agree with some of it, it is definitely thought-provoking.

    RE: “Throwing trillions of dollars at the crisis, and hoping for the best will provide a short term improvement over doing nothing; trillions of dollars have that sort of power.”

    Many people think of “the cost” of this solution as simply being the trillion or so spent on stimulus plans. However, as you point out there is also Moral Hazard (extreme IMHO) as well as countless other worrisome conditions.

    As for the Blinder-Zandi paper; it really is quite notable on many fronts. I made some quick comments on it here:

    http://www.economicgreenfield.com/2010/08/01/blinder-and-zandi-paper-my-comments/

  72. Jeff L says:

    I like your ideas Barry and I believe they would have worked pretty well. I’m not convinced however, that what was done will prove to be better than doing nothing at all…let’s wait about 10-20 yrs, then see if we think what Treasury, the Fed and the rest of the players did worked out better than had they done nothing. The painful repercussions of what was done are going to last a long, long time.

  73. ACS says:

    Now the real fun question. Could the government have done it even worse?

  74. obsvr-1 says:

    @ACS Now the real fun question. Could the government have done it even worse?

    we’re talking about the politically charged and lobbyist influenced (controlled ?) gov’t — there is always room for f’ing things up worse

  75. Norm.Conley says:

    Barry:

    I love your writing and I understand your frustration. But I’m not sure I agree with your depiction of the alternative universe that would have resulted had “what should have been done” actually been done.

    To put a point on it, I’m not at all sure that your suggested “should have” actions would have resulted in simply a more severe (but shorter) economic downturn. Back in bad old days of October ’08, I saw investment-grade bond spreads begin to blow out to Depression-era levels (they eventually surpassed those lofty heights in Dec ’08). Financial debt comprises roughly 40% of the major corporate credit indices, and intermediate maturity A+ rated financial debt traded to the low 60′s. So it is not much of an overstatement to note that that CDS and cash markets in most large or large-ish financial institutions was beginning to reflect a systemic meltdown. Personally, I feel that there were a variety of points during the crisis in which we were days away from global bank holidays being declared. The system itself, in a whole smorgasbord of respects, was teetering. Earlier commenters have noted (and I agree) that we were on the cusp of potentially major social upheaval during the crisis.

    In that environment, uncontrolled collapses of BK’s or liquidations of JPM, C, GS, MS, HSBC, and (fill in the blank with any number of global financial institutions) were perilously close to occurring. Some entity (public or private) had to stop the downward momentum – and quickly. Unfortunately, the entity that in large part watered the roots of the problem – i.e. the government – was, in the end, the only entity big enough to stop the bleeding. The fact that this is sub-optimal does not make it untrue.

    Given all of the above, and it pains me to say it, I think policymakers did the best they could have with the information they had at the time. Had they been better, smarter, more capitalistic, less political, and much faster, they (perhaps) could have done better. But that’s not the world we live in.

  76. algernon says:

    BRAVO, BARRY. ONE OF THE BEST THINGS YOU’VE WRITTEN!

  77. EAR says:

    “I would not say that the future is necessarily less predictable than the past. I think the past was not predictable when it started.” – Donald Rumsfeld

  78. 1. Sweden never put its banks into receivership. Bondholders were made whole. What you’re advocating is most certainly NOT the “Swedish route.”

    2. Receivership wasn’t available for non-commercial banks (i.e., Goldman, MS). And the fact that Goldman and MS converted to BHC status changes nothing, because FDIC receivership doesn’t apply to holding companies; it only applies to the commercial bank subsidiaries. You’re assuming we had different laws.

    3. It was impossible for AIGFP to be separated from the parent company. All of AIGFP’s trades had parent company wraps, as well as cross-default provisions. Surely you know that. If AIGFP’s counterparties were given “zero,” as you advocate, then the AIG parent company would have been in default, and pushed into bankruptcy. Simple as that. There was literally no way to do what you say should have been done.

    I could go on. The point is that this isn’t a legitimate counterfactual, because you’re giving yourself a completely different set of facts to work with. You’re describing a different financial crisis, in a country with different laws, and in which the financial instruments had different terms.

    ~~~

    BR: You are incorrect about Sweden:

    Two of Sweden’s six largest banks, Första Sparbanken and Nordbanken, announced in the fall of 1991 that they could no longer meet the regulatory capital requirements (8 percent of assets). The state guaranteed all their existing liabilities, took full ownership of Nordbanken, and helped Första Sparbanken with a loan guaranty to the owners. Within a year, a third major institution, Gota Bank, became undercapitalized. When its largest owner refused to provide additional funds, the state guaranteed all its liabilities to prevent a meltdown; Gota declared bankruptcy the same month. Once again, the state took ownership of the bank. (Cleveland Fed)

    How can I take the rest of your comments seriously, when your first statement is not only wrong, but so easily verifiable? Please check your facts, and try again.

  79. andrewp111 says:

    Actually, you are wrong. An awful lot of elderly had (and still have) much of their nest egg in AIG annuities. Over 1 trillion dollars worth. For instance, my aunt had 200K in such instruments. If AIG had gone under, all those annuities would be worthless, and so would another trillion in life insurance. (Neither annuities nor life insurance are guaranteed by the FDIC or anyone else.) Especially, since the preferreds and bonds on AIG’s balance sheet would be worth much less also, and would be totally expended on the collateral claims of the credit default swaps. And there is no way that AIG FP could have been separated out from the parent. The parent was directly responsible for all those contracts, and all the collateral claims were against the parent. This is why they had to pay all counterparties 100%, and why Bernanke said in his TV interview that nothing made him more angry than the AIG situation. Essentially, AIG held a gun to the head of the USG, and said bail us out or else we all go down together.

    ” Barry Ritholtz Says:
    ……..
    Nobody’s next egg goes to zero (unless you were foolish enough to have a crappy bank only portfolio of LEH, BSC, AIG, FNM, etc.) Pensions would not go belly-up, but they would take losses. “

  80. Guambat says:

    Great so far: what would you have done with ratings agencies? (You’ve probably done that in a prior post; if so, I missed it. Gomenasai.)

  81. philipat says:

    Thanks for the extremely insightful and comprehensive post barry. I for one truly appreciate your efforts.

    But as a non-American, I just don’t understand why your people can’t see that the whole system is corrupted and broken. What does it take to get back on track? Or does nobody care?

    As my American freind put it, “As long as there are still Cheesy-Twirls in Wal Mart, heck who cares”?

  82. Barry: Do you know what a “receivership” is? I think it’s pretty clear that you don’t. What you describe is NOT a receivership. A receivership describes a liquidation process in which creditors can (and usually do) take losses. The FDIC places failed banks in receivership, for example, and creditors usually take losses, because the FDIC has the avoidance power. As you highlighted, Sweden guaranteed the banks’ liabilities. The state took equity ownership of the banks. It didn’t break contracts, and like I said, bondholders were made whole. That’s not a receivership, champ.

    If “equity ownership” was all you meant when talking about Swedish banks, then fine. But you’re wrong to call it a receivership. Equity ownership and receivership are two very, very different things. I assumed you knew that, so I thought you were asserting that Sweden did something it verifiably didn’t do. It turns out you were just misusing terms. That’s fine, but I’m not the one who needs to get my facts straight.

  83. Economics of Contempt:

    You are technically correct about the definition of Receivership — but that wasn’t the way or the context most people who were discussing alternatives to bailouts were using that term during the Fall of 2008.

    Temporary Receivership — or Nationalization, or Conservatorship or Prepackaged Bankruptcy (I even heard someone reference Probate!) were commonly used phrases. (Search for recievership and Citigroup for example) But all of the references were to finding alternatives to a cash bailout.

    I don’t think disagree with you on this definition, but the common usage was a lot looser than the formal jargon

  84. AHodge says:

    i think this story of bondholders actually poor pensioners we need to help is misplaced. And especially w AIG.
    their annuities were likely in one of their many standalone state insurance regulated subs, most of them are fine. Some are being sold off as the jewels.
    But This is not a reliable company, or an ethical one. Your aunt made a mistake. They own an array of no name insurance companies without AIG label on them, and tend to stiff their customers on claims. In property casualty they often just dont pay claims till sued. cant think of a better company to have made an example of.

  85. Richard L says:

    Nice post

  86. perryair says:

    Late to the party but this in a nutshell is EXACTLY what I believe should have happened back in 07/08. Where is it written or how did it ever become interpreted that investors are never allowed to fail? Because there isn’t enough money in the world to insure everyone’s returns, the government then has to play ‘pick-a-winner’, the most morally corrupting game in existence.

    There was a piece that I read recently about how this is the first time that banks nationalized a country instead of the other way around. How true that was…

    On a crazy tangent, I personally believe this whole entire sequence of events to be an outgrowth of the inane idea that the right to “equality” means equality of outcome instead of equality of opportunity. If we keep on this path, one day we will all equally be broke, penniless and without rights or liberties together… because that’s how it ‘should be’.

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