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Sunday, September 28, 2008

A Tally of Federal Rescues: A Legacy for Your Children

Click to enlarge... this one going to be HUGE.

Breakthrough Reached in Negotiations on Bailout: "Congressional leaders and the Bush administration reached a tentative agreement early Sunday on what may become the largest financial bailout in American history, authorizing the Treasury to purchase $700 billion in troubled debt from ailing firms in an extraordinary intervention to prevent widespread economic collapse.

Speaker Nancy Pelosi, left, Treasury Secretary Henry M. Paulson Jr., center, and Senator Harry Reid, the majority leader, early Sunday.

Officials said that Congressional staff members would work through the night to finalize the language of the agreement and draft a bill, and that the bill would be brought to the House floor for a vote on Monday."

I've noticed a lot of talk about "protecting" and "paying back" the taxpayer. I've even heard about the taxpayer "sharing in the upside".

All such talk is absolute fantasy. Out of 42 systematic banking crises across 37 countries, despite the implementation of a wide range of policies, all resulted in the re-allocation of wealth AWAY from taxpayers and towards debtors (banks). None avoided recessions and all recessions were SEVERE.

Not a single bailout resulted in anything but losses.

*** All Data Sourced from the IMF working paper: Systemic Banking Crises: A New Database ***

via New N Economics: The Real Costs of the Banking Crisis Will Be High! " According to the paper, banking crisis can be broken down into its three phases, which I have summarized, and then comment on below:

(1) Initial conditions – macroeconomic conditions are usually weak before a banking crisis.

Fiscal balances are usually negative (-2.1% of GDP on average); current accounts are usually negative (-3.9% on average); inflation is high (137% on average); GDP growth is average (2.4% on average); non-performing loans – bank loans that are not earning interest and the borrower is likely to default - tend to be high (25% of total loans on average).

RW: In 2007, the annual fiscal balances as a % of GDP were negative in the U.K. (-0.29%) and the U.S. (-1.36%); the current account as a % of GDP was negative in the U.K. (-4.32%) and in the U.S. (-5.30%); GDP growth was 3.06% in the U.K. and 2.03% in the U.S. The macroeconomic statistics satisfied some of the average initial conditions for a banking crisis, with the exceptions of high inflation and a non-performing loans (4.8% in the U.S.).

(2) Crisis Containment – emergency liquidity support and blanket guarantees are commonly used. In the 42 banking crises, 71% were complimented by new liquidity measures, while 29% included blanket guarantees on deposits.

RW: The U.S. Federal Reserve Bank (Fed) has extended its liquidity facilities since December 2007 when the first Treasury Auction Facility (TAF) was announced. In addition, the Fed has opened additional funding measures, the Term Securities Lending Facilities (TSLF) and the Primary Dealer Credit Facility (PDCF); both facilities accept a wide range of collateral from Depository Institutions (regulated by the Fed) and Primary Dealers in exchange for Treasury bills or direct funding.

The Bank of England (BoE), the U.K. central bank, also extended its lending facilities in April 2008. Like the Fed, and under the Special Liquidity Scheme, the BoE now accepts a wide range of collateral, including mortgage-backed securities in exchange for government bills and bonds for a one year term. Further, the government offered a guarantee on deposits at Northern Rock (mortgage lender in the U.K.) during its collapse.

(3) Crisis resolution – reduced regulation is often a theme in the resolution phase, but strict regulatory standards follow the resolution. This does not usually solve the problem, and often, a restructuring of the banking system occurs.
In 86% of the 42 crises, despite regulatory forbearance, governments were forced to intervene directly by closing banks, facilitating mergers, or nationalizations.

RW: Sound familiar? In an effort to avoid marking illiquid assets at their current market values, regulators have turned a blind eye to potentially insolvent balance sheets. A quote from Naked Capitalism:

“So rather than follow the course of action that has been shown to work in Sweden and to a lesser degree in the US S&L crisis, namely, let asset prices fall, strip out bad assets and sell them, combine and recapitalize the good pieces, and sell those to the public too, we have clearly decided to go down the Japan path, of maintaining phony asset prices to keep institutions that would otherwise fail alive.”

RW: I agree, why not force the assets to be marked down to current market values (which is nothing), and let the banking system work it out; history has shown that regulatory forbearance doesn’t work! Eventually, banks will fail. WaMu?

My final thoughts

After reading this paper, it is obvious to me that the current banking crises that are plaguing the U.S. and U.K. are not unusual in the world of banking crises. The difference is: The banking crisis is in developed, rather than developing economies. And in a developed world, a significant amount of capital is at stake. According to the McKinsey Institute, the value of global capital markets in 2006 was $US 167 trillion, where the U.S. held $56.1 trillion and the U.K. held $10 trillion. The current banking crises in the U.S. and U.K. puts $66.1 trillion, 40% of the world’s stock of capital, at stake.

Overall, the fiscal costs and real effects of banking crises are high.

-On average, fiscal costs (RW: net of recoveries, meaning net of the potential profits earned from TARP) average 13.3% of GDP.
-Using an asset management company to manage the portfolio of acquired assets by the government (again, TARP) may lower only slightly the fiscal cost by increasing the recovery rates.
-Output losses (loss in aggregate production) average 20% of GDP during the first 4 years of the crisis.
-RW: In the case of the U.S., there will likely be less output loss and higher fiscal costs, as the two are negatively correlated - higher fiscal costs lower output loss - across the sample of 42 banking crises. The TARP program illustrates a strong desire to go down the fiscal road.

The U.S. banking sector has hit the containment phase of this crisis and moved on toward the resolution phase. However, the banking crisis cannot be fully resolved until the housing market bottoms. I still see that U.S. home sales will bottom this year, followed by a trough in home prices next year, and the start of a healthy recovery in 2010. Once that happens, the mortgage-backed securities will likely assume some positive value, and the U.S. government will finally realize the costs of its interventions.

Overall, the outlook for the U.S. is not good. This paper indicates that ex post (after all is said and done), the costs – fiscal or reduced output – will be high.

Rebecca Wilder"

News N Economics by Rebecca Wilder is an excellent financial blog I visit daily.


kayxyz said...

I won't post the URL, but Nouriel R. on RGE Monitor has a great last paragraph on why the bailout won't work. Even though in other blogs Nouriel has been "reported" as supporting the bailout.

Ben Bittrolff said...


I will:

"Thus, the Treasury plan is a disgrace: a bailout of reckless bankers, lenders and investors that provides little direct debt relief to borrowers and financially stressed households and that will come at a very high cost to the US taxpayer. And the plan does nothing to resolve the severe stress in money markets and interbank markets that are now close to a systemic meltdown. It is pathetic that Congress did not consult any of the many professional economists that have presented - many on the RGE Monitor Finance blog forum - alternative plans that were more fair and efficient and less costly ways to resolve this crisis. This is again a case of privatizing the gains and socializing the losses; a bailout and socialism for the rich, the well-connected and Wall Street. And it is a scandal that even Congressional Democrats have fallen for this Treasury scam that does little to resolve the debt burden of millions of distressed home owners."

Anonymous said...

There is a heart here beating that controls the circulatory system of the derivatives.This heart is literally sucking precious energy and blood at the expense of the brain and other organs of the financial system. It is literally the lynch pin of the whole system. Bringing it down would save the other organs at the expense of a major heart attack. Were we willing to go through with it, it could mean wresting our financial and political future from the brink of hyperfascism. It has its cells in every other organ from the political spectrum to the financial. It holds positions in key areas of government and banking. Maybe if we kill the tyrant we would be free.

This heart is Goldman Sachs.

Charles Butler said...

If I remember right, by the time I left in '99, Torontonians who had bought houses at bubble peaks 10 years earlier were still not above water in equity terms - although the city itself had more or less come back to life.

toddpw said...

Don't look now, but Section 132 of the bill authorizes the SEC to suspend Mark-to-Market accounting rules at their discretion.

Seems to me like you could delete everything else in the bill, and it would work a lot better and with no taxpayer money. But realize-- if this bill passes, it will appear to work but only after everyone they like has been saved and everyone else has gone under!

If you have not pestered your Congress Critter yet, DO IT NOW!

Feinstein's message service keeps claiming it's full. I left messages for Pete Stark and Barbara Boxer tonight after faxing Stark and Barney Frank my own letter as well as the Andrew Jackson post, Denninger's "Make this Viral" and a recent blog post by Peter Schiff. (This is in addition to the one-pager I wrote and faxed a bunch of Senators yesterday.)

Anonymous said...

Ha Ha Ha! Avis Budget Group, Ryder Systems and Group 1 Automotive added to no-shorting list . . . what a farce.

-Mike J said...

I agree, Rebecca Wilder's '' blog is good one, nice hat tip.

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