Topic: Finance, Banking & Monetary Policy

Bailouts Make Money, If You Ignore Losses

Just when you think the headlines could not get any more absurd, the Wall Street Journal declares today that the “Bailouts Yield Returns Amid Risk.” while yesteday’s Financial Times lets us know that the Federal Reserve is turning a profit on its lending programs.

What is missing from these headlines is that while some loans and investments have provided a positive return to taxpayers, the overall programs themselves are estimated to cost the taxpayers hundreds of billions.  Overall the government has received about $30 billion in dividends, premiums for guarantees, and interest payments:  $7 billion in TARP dividends from banks, $14 billion for the Federal Reserve from purchases of mortgage-backed securities and other investments, and $9 from the FDIC’s bank debt guarantee program.

While $30 billion may sound like a substantial amount of money, it is less than a tenth of the $356 billion that the Congressional Budget Office tells us we will never see back from TARP.  And the Fed’s income from purchasing Fannie and Freddie securities will also amount to about a tenth of the ultimate losses we are likely to suffer from bailing out those entities.  In regard to the FDIC’s debt guarantee program, premiums are paid up front, making that look like income, while the guarantees will remain outstanding for several years.  Given that there is currently almost $340 billion in FDIC guaranteed bank debt outstanding, all it would take is a loss rate of 2.6% on that debt to wipe out any premiums collected so far.

Before Washington starts to spend all its newfound earnings, we should all stop and remember that these bailouts continue to leave the taxpayer in a pretty big hole.

When Governments Are Forced to Compete, the Result Is Better Policy and More Liberty

A story in USA Today is a perfect illustration of the liberalizing power of tax competition. In an effort to attract more jobs and investment, states are competing with each - even taking the aggressive step of advertising in high-tax states. This does not guarantee that states will always use the best approach since states sometimes try to lure companies with special handouts, but tax competition generally encourages states to lower tax rates and control fiscal and regulatory burdens. The same process works internationally, which is precisely why international bureaucracies controlled by high-tax nations are seeking to thwart fiscal competition between nations:

Las Vegas is running ads in California warning businesses they can “kiss their assets goodbye” if they stay in the Golden State. In New Hampshire, economic development officials pick up Massachusetts business owners at the border in a limousine and give them VIP treatment and a pitch about why they should relocate there. Indiana officials, using billboards at the borders and direct appeals to businesses in neighboring states, are inviting them to ‘Come on IN for lower taxes, business and housing costs.’ As states struggle to keep jobs in a continuing recession, they are no longer hoping businesses in other states happen to notice their lower taxes, cheaper office space and less-stringent regulations. They are taking the message directly to them and taking shots at their neighbor’s shortcomings. …No one does it more unapologetically than the Nevada Development Authority. The agency has picked on California before, but its $1 million campaign, launched this month, ratchets up the mockery of California’s budget deficits and IOU paychecks. ‘It’s all done tongue-in-cheek. But the underlying deal is, we want this business,’ Nevada Development Authority President and CEO Somer Hollingsworth said. …’They do mask the nastiness of their message with humor, but this time, their ads are over the top,’ said [California Assemblyman] Solorio, a Democrat from Santa Ana.

HUD Helps to Set the Ground for Next Round of Mortgage Fraud

Just when you were thinking it was safe to go back into the mortgage market, today’s Wall Street Journal  is highlighting the next source of mortgage fraud, the Federal Housing Administration’s (FHA) reserve mortgage program.  In a typical reverse mortgage, the bank sends the borrower a monthly check (or a lump sum payment at the beginning of the loan).

It seems that some creative individuals have figured they could deed a run-down house to an elderly individual, and then get a reserve mortgage on that property; leaving them with the cash and the government with the run-down worthless property.  Of course, this requires getting an appraiser to go along with the value of the home, but since the Clinton HUD decided to do away with FHA control of appraisers and let the lender pick the appraiser, that sadly hasn’t been much of an obstacle.

The great thing for lenders is that if the loan goes bad, or the value of the house falls below the mortgage amount, FHA - backed by the taxpayer - picks up the tab.  Of course, the borrower is required to pay an insurance premium to cover any potential shortfalls.  But just like in any other federal insurance program, when these’s a shortfall beyond funds collected via premiums, we taxpayers are left on the hook.  I could go on about what a great job Washington does running insurance programs; suffice to say, Washington does a pretty poor job.

If Washington were serious about cracking down on predatory lending and mortgage fraud, Congress should end the practice of allowing lenders to put 100% of their losses to the taxpayer.  Maybe that would provide the correct incentives for the lender to actually make sound loans.

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.

American People to Government: Don’t Mess Up the Economy

The American people get it.  The government is likely to go too far in “fixing” the economy. 

Explains Rasmussen Reports:

Fifty-four percent (54%) of U.S. voters worry more that the federal government will try to do too much to fix the economy rather than not enough. That’s up three points from a month ago and the highest level of concern found on this question since Barack Obama was elected president.

A new Rasmussen Reports national telephone survey finds that just 37% are more worried that the federal government will not do enough in reacting to the nation’s current economic problems. That’s little changed from last month and down from a high of 44% in January.

Last October, as the meltdown of Wall Street dominated the front pages, 63% worried that the government would do too much. By the first week of November, that number had fallen to 46% and it stayed below the 50% level for several months.

Among the nation’s Political Class, (70%) worry that the government will not do enough. As for those who hold populist or Mainstream views, an identical percentage (70%) fear the government will do too much.

Notable is the contrary thinking of the political class.  The vast majority worries that the government won’t do enough.  Unfortunately, this group has far more influence over what government is likely to do than does the general public.

The Pay Czar at Work

Mark Calabria notes how the form of salary scheme at financial institutions played no apparent role in sparking the financial crisis.  But that hasn’t stopped the federal pay czar from boasting about his power, even to regulate compensation set before he took office.

Reports the Martha’s Vineyard Times:

Speaking to a packed house in West Tisbury Sunday night, Kenneth Feinberg rejected the title of “compensation czar,” but he also said said his broad and “binding” authority over executive compensation includes not only the ability to trim 2009 compensation for some top executives but to change pay plans for second tier executives as well.

In addition, Mr. Feinberg said he has the authority to “claw back” money already paid to executives in the seven companies whose pay plans he will review.

And, he said that if companies had signed valid contractual pay agreements before February 11 this year, the legislation creating his “special master” office allowed him to ask that those contracts be renegotiated. If such a request were not honored, Mr. Feinberg explained that he could adjust pay in subsequent years to recapture overpayments that were legally beyond his reach in 2009.

This isn’t the first time that federal money has come with onerous conditions, of course.  But it provides yet another illustration of the perniciousness of today’s bail-out economy.

Did Bank CEO Compensation Cause the Financial Crisis?

Earlier this summer, the House of Representatives approved legislation intended to, as Rep. Frank, put it, “rein in compensation practices that encourage excessive risk-taking at the expense of companies, shareholders, employees, and ultimately the American taxpayer.”

While there are real and legitimate concerns over CEOs using bailout funds to reward themselves and give their employees bonuses, Washington has operated on the premise that excessive risk-taking by bank CEOs, due to mis-aligned incentives, caused, or at least contributed to, the financial crisis.  But does this assertion stand up to close examination, or are we just seeing Congress trying to re-direct the public anger over bailouts away from itself and toward corporations?

As it turns out, a recent research paper by Professors Fahlenbrach (Ecole Polytechnique Federale de Lausanne) and Rene M. Stulz (Ohio State) conclude that “There is no evidence that banks with CEOs whose incentives were better aligned with the interests of their shareholders performed better during the crisis and some evidence that these banks actually performed worse…”

Professors Fahlenbrach and Stulz also find that “banks where CEOs had better incentives in terms of the dollar value of their stake in their bank performed significantly worse than banks where CEOs had poorer incentives.  Stock options had no adverse impact on bank performance during the crisis.”  While clearly many of the bank CEOs made bad bets that cost themselves and their shareholders, the data suggests that CEOs took these bets because they believed they would be profitable for the shareholders.

Of course what might be ex ante profitable for CEOs and bank shareholders might come at the expense of taxpayers.  The solution then is not to further align bank CEOs with the shareholders, since both appear all too happy to gamble at the public expense, but to limit the ability of government to bailout these banks when their bets don’t pay off.