Tag: bear stearns

US Has Already Been Downgraded

Lost in all the concerns over how Moody’s and S&P will view any deal to raise the debt ceiling and whether such a deal addresses our country’s long term budget imbalances is the fact that at least three rating agencies have already downgraded U.S. government debt.  One of these agencies, Weiss Ratings, treats U.S. government debt as barely better than “junk” or speculative grade.

It would be easy to dismiss these agencies as irrelevant and attempting to simply grab attention, but at least one of these agencies, Egan-Jones, has a track record of correctly predicting problems at such companies as Enron, WorldCom, Global Crossing, Bear Stearns and Lehman Brothers that the major rating agencies missed until it was too late.  Egan-Jones also employs a business model of having investors pay for its services, rather than the debt issuer.

The simple truth is that the U.S. government has made more future promises than it will have the capacity to pay, under almost any circumstances.  The fact that the major rating agencies downplay these long term imbalances is further testament to their entrenched monopoly status.  But then when the government provides you with some regulatory protections, its only natural to assume the government will expect one to return the favor.

For more on the issue, check out Cato’s latest daily podcast.

Exit Interview with Sheila Bair

Sunday’s New York Times Magazine has an interesting exit interview with Sheila Bair, who until this past Friday served as Chair of Federal Deposit Insurance Commission (FDIC). While I haven’t always been her biggest fan, I did find it refreshing to hear a bank regulator state the obvious:  we should have let Bear Stearns fail. As she puts it:

Bear Stearns was a second-tier investment bank, with — what? — around $400 billion in assets? I’m a traditionalist. Banks and bank-holding companies are in the safety net. That’s why they have deposit insurance. Investment banks take higher risks, and they are supposed to be outside the safety net. If they make enough mistakes, they are supposed to fail.

I’d be hard-pressed to say it better. Assisting the sale of Bear to JP Morgan created the expectation that anyone larger, like Lehman, would be assisted as well. Perhaps the most interesting part of the interview is that Bair gets right to the heart of the matter: the treatment of bondholders. ”Why did we do the bailouts?” Bair states “It was all about the bondholders.” Again she couldn’t be more correct. If there was anything Dodd-Frank should have fixed it was this, ending the rescue of bondholders and injecting market discipline back into bank.  It is also refreshing to hear her admit: ”I don’t think regulators can adequately regulate these big banks, we need market discipline. And if we don’t have that, they’re going to get us in trouble again.”

Where I disagree, besides her misguided take on mortgage re-sets, is whether Dodd-Frank will actually impose losses on bondholders. Bair expresses some optimism that such is the case, but there are just too many holes in Dodd-Frank to make that believable. Plus you pretty much have the same set of rules in place for Fannie Mae and Freddie Mac, yet the last time I checked the bondholders are still being protected at the expense of the taxpayer. If we don’t impose losses on Fannie creditors, even now after the panic, what makes anyone think we will do so to Citibank. Section 204 of Dodd-Frank is quite clear that the FDIC indeed retains the power to rescue creditors. Something that Bair was willing to do during the crisis, even if pushed to do so by Tim Geithner. Despite some errors, the interview is really a worthwhile read and has some real lessons for avoiding the next financial crisis.

Bill Daley and ‘Too Big To Fail’

MIT Professor Simon Johnson recently argued that Bill Daley’s appointment as Obama’s Chief of Staff signals that “too big to fail,” as it relates to our largest financial institutions, is here to stay.  Personally I never thought it was in doubt.  With Geithner at Treasury and Dodd-Frank further codifiying “too big to fail,” its been clear for some time that the bailout net is larger than it’s ever been, and is not being pulled back. 

That said, Professor Johnson’s focus on Daley distracts from the real issue, which is changing our bank regulatory structure to end bailouts.  The focus on Daley has the potential to lead us down that path of “if we just had the right people in government…”  We shouldn’t be designing our regulatory structures with the “right” people in mind, but rather with the rule of law in mind.  In fact, one of the benefits of the Obama administration is that it serves as a great test of the “right people” hypothesis of government.  One is unlikely to see a more left-leaning White House than this one, so if this one gets captured by special interests, including Wall Street, than it’s a safe bet that any future administration will as well. 

Since I believe most of us actually want to end “too big to fail,” the real question is how to do it.  It strikes me that we have three options:  regulate the largest institutions to death (or competitive disadvantage), break them up, or credibly impose losses on their creditors.  Ultimately I think the regulation approach is bound to fail, if for no other reason than regulatory capture.   (Even Elizabeth Warren seems to get this: “Regulations, over time, fail. I want to see Congress focus more on a credible system for liquidating the banks that are considered too big to fail.”)  Breaking them up might sound attractive in theory, but I have a hard time seeing how it truly works in practice.  After all, few in Washington viewed Bear Stearns as “too big to fail.”  Accordingly, I believe the best approach would be to force creditors to take losses or be converted into equity.  To make this credible, we must bind the hands of the regulators.  As long as the Fed, Treasury, or the FDIC can inject money, then bailouts are always on the table.    

Sadly, what the Daley appointment reminds us is that any attempt to end “too big to fail” will likely have to wait until the next administration.  Not only is this one wed to bailouts, the President would likely veto any bill that really tied the hands of the Fed.

Reform Needed, but Obama Plan Would Result in More Financial Crises, not Less

Today President Obama took his financial reform plan to the airwaves.  While there is no doubt our financial system is in need of financial reform, the President’s plan would make bailouts a permanent feature of the regulatory landscape.  Rather than ending “too big to fail” – the President wants us to believe that with additional discretion and power, the same Federal Reserve that missed the boat last time will save us next time.

The truth is that the President’s plan will result in a small number of companies being viewed by debtholders as “too big to fail”.  These companies would see their funding costs decline, allowing them to gain market-share at the expense of their rivals, making these firms even larger.  Greater concentration in our financial services industry is the last thing we need, yet the Obama plan all but guarantees it.

Obama also chooses myth’s over facts.  The President claims that de-regulation and competition among regulators caused the crisis.  The facts could not be more different.  Those institutions at the center of the crisis – Fannie Mae, Freddie Mac, Bear Stearns, Lehman –could not choose their regulator.

The President’s plan chooses convenient targets and protects entrenched interests, rather than address the true underlying causes of the crisis.  At no time have we heard the President discuss the expansionary monetary policies that helped fuel the bubble.  Nor has the President talked about the global imbalances – the global savings glut that poured surplus savings from the rest of the world into the US.  But then the President appears to hope that loose monetary policy and continued American consumption funded by China will get him out of his own political problems with the economy.  It is especially striking that the President makes little mention of the housing bubble, as if it was only the bust that was the problem.

The President continues to say he inherited this crisis.  While true, he did not inherit the same individuals – Tim Geithner and Ben Bernanke – who were at the center of creating the crisis.  All Obama needs to do is find a position for Hank Paulson and he will have completely re-assembled the Bush financial team.

Without real reform – fixing Fannie and Freddie, scaling back the massive subsidies for leverage in our tax code, loose monetary policy – it will only be a matter of time before the next crisis hits.  If we implement the President’s plan, we will, however, guarantee that the next crisis will be even larger and severe than the current one.

Embracing Bushonomics, Obama Re-appoints Bernanke

bernanke1In re-appointing Bernanke to another four year term as Fed chairman, President Obama completes his embrace of bailouts, easy money and deficits as the defining characteristics of his economic agenda.

Bernanke, along with Secretary Geithner (then New York Fed president) were the prime movers behind the bailouts of AIG and Bear Stearns. Rather than “saving capitalism,” these bailouts only spread panic at considerable cost to the taxpayer. As evidenced in his “financial reform” proposal, Obama does not see bailouts as the problem, but instead believes an expanded Fed is the solution to all that is wrong with the financial sector. Bernanke also played a central role as the Fed governor most in favor of easy money in the aftermath of the dot-com bubble – a policy that directly contributed to the housing bubble. And rather than take steps to offset the “global savings glut” forcing down rates, Bernanke used it as a rationale for inaction.

Perhaps worse than Bush and Obama’s rewarding of failure in the private sector via bailouts is the continued rewarding of failure in the public sector. The actors at institutions such as the Federal Reserve bear considerable responsibility for the current state of the economy. Re-appointing Bernanke sends the worst possible message to both the American public and to government in general: not only will failure be tolerated, it will be rewarded.

Don’t Bail Out Bernanke

Here is the message members of Congress should send to Ben Bernanke during the Fed chief’s annual Capitol Hill testimony this week: He is fighting for his job. With his term up in January of next year, Bernanke needs to be called to account for the Fed’s many questionable actions during the financial turmoil of the past year.

Even while correctly identifying the “global savings glut,” Bernanke sat by and did nothing about the unsustainable build-up of leverage in the housing market—the “bubble” which famously burst in late 2008. Bernanke also used Fed financing to bail out Bear Stearns and AIG—hotly political moves which should rightfully have been left to Congress—and oversaw the massive expansion of the Fed’s balance sheet from about $900 billion to over $2 trillion. Under Bernanke, the Fed has transcended monetary policy and bank supervision into the world of fiscal policy.

While thus politicizing the Fed on one hand, Bernanke has sought to insulate the bank from congressional pressures by appeasing majority Democrats with various new credit regulations. Both the recently proposed credit card and mortgage rules unnecessarily restrict credit and increase the litigation risk facing banks, while doing nothing to roll back some of the irresponsible lending policies that exacerbated the housing bubble.

Bernanke’s pandering to the Left on misguided “consumer protections,” and the absence of any debate over the Fed’s role in the housing bubble, raise serious questions as to whether Bernanke understands the causes of the current financial crisis. We cannot hope to avoid the next financial crisis without a Fed chairman who understands the current one.

Bachus Plan a Good Start toward Ending Bailouts

Today Congressman Spencer Bachus, along with several of the Republican members of the House Financial Services Committee, offered a plan for reforming our financial system and ending future government bailouts of the financial sector

At the heart of the financial crisis has been the Federal Reserve’s willingness to invoke its powers under Paragraph 13-3 of the Federal Reserve Act to bail out firms like Bear Stearns and AIG — all without a single vote from Congress or any form of public debate. Almost 10 months after the initial AIG bailout by the Fed, there is still no plan for resolving that firm, and no strategy for recovering the taxpayers investment.

While some might pretend that the Fed puts no taxpayer funds at risk under the use its 13-3 powers, it is the American taxpayer who ultimately stands behind any Federal Reserve actions. In focusing on 13-3, the Bachus proposal rightly targets the largest, and least accountable, source of the bailouts. The Bachus proposal would require the Treasury secretary to approve any 13-3 actions and allow Congress the ability to disapprove such actions. While a complete repeal of 13-3 would be preferred, the presented reforms are a step in the right direction.

Another feature of the Bachus plan is to require large, non-financial firms to be resolved under the bankruptcy code, and not under a regime of continuing bailouts or political manipulation. Despite whatever flaws it may have, the bankruptcy process is one that is separated from politics. As we have witnessed in the recent government restructuring of U.S. auto companies, allowing Washington to resolve firms is an invitation for violating contracts and rewarding political constituencies.

The Bachus plan also addresses the two institutions at the center of our mortgage crisis: Fannie Mae and Freddie Mac. Their model of private profits and public losses has become an expensive one, with little public benefit. Any reform proposal that does not deal with Fannie and Freddie does not merit being called reform. The Bachus plan would rightly begin phasing out the privileged status of Fannie and Freddie.