Tuesday, February 10, 2009

g.h.kirsch: Not to Big to Fail

The President's dynamic duo, Larry Summers and Tim Geithner, tell us, “governments make poor bank managers.” Geithner, our brand spankin' new Secretary of the Treasury, goes on. “We have a financial system that is run by private shareholders, managed by private institutions, and we’d like to do our best to preserve that system,”

“The worst loan owns the bank.” This was an insight shared with me at the outset of my business career by a Japanese gentleman nearing the end of his. His final post was in Seattle to run the US trading operations of Mitsui & Co. His advice came as I somewhat naively re-lent Mitsui's money to my suppliers.

The worst loan that a banker can make is one they can not afford to call. Or in current jargon, a loan so big the bank can't let the customer fail. If you pick up the echo of recent rationales for various bailouts, then, like me, you are coming to realize we are the bank of all banks.

Recently The Washington Post told readers if the government (that's us) were to buy the junk assets held by banks at prices banks want, the Treasury would take a huge loss when it finds a buyer for the assets. The Post went on to opine, if the Treasury paid the market price, most banks would be bankrupt.

The Post though seems to beg the important question, what price really is fair to the taxpayers? We know what price the holders of these junk assets would like, but that has nothing to do with what they are worth. If they had the money, what would bankers pay their brethren for those assets? Few are willing to discuss simply taking over insolvent banks, a policy which has been advocated by economists across the political spectrum.

How often have we heard them tell us, “it's not the role of government to pick winners and losers.” Well that was before they were the losers. There are few free marketeers in foxholes on the front lines in the battle to save their sorry asses.

And these folks seeking more of the taxpayers' money still can't seem to understand their's is a culture of excess, driven by the wrong incentives. They seem the progeny of a Boesky-Helmsley marriage.

At the heart of our system is the notion that profits are earned by those who invest in activities in which their investment is at risk and could be partially or entirely lost. A sucker is someone who can't measure the risk and makes a deal with little or no upside and substantial downside.

I enjoyed a modicum of levity Saturday morning when the host of an NPR program asked the listeners, “what is it you are looking for from your bank?” My chuckle was prompted by the absurd use of the possessive. Forget about retail banking services. Those are just the money handlers in the temples. Banking takes place upstairs, and is about making loans and investments. I think of bankers as glorified bookies.

When you make a poor bet and lose; when the wheel stops spinning, and the house scrapes your chips across the table; or maybe with a bank, takes your house, you learn three things: they're no longer your chips, it's not your house any more, and it certainly ain't your bank.

So when these bank executives take stupid bets and lose, who loses?

The answer of course is the bookie; the bank owners; the shareholders who invested in the bank. And what if the bank hasn't enough capital to continue? Normally they raise more capital by selling stock to investors who then share in ownership. And the new ownership dilutes the shareholders who backed bad bets.

What if the bank can’t raise more capital? Then they're bankrupt.

Well, the losers just won't admit they're losers and take their losses. And they've still got enough chips to call in favors and slip their losses to us. Bank stocks are worth so little ( Citigroup and Bank of America combined only have a market value of some $52 billion) that given the capital they need to raise, our ownership would be partial but overwhelming. If the taxpayers were to make the banks sound, and received commensurate control, we'd own the banks.

Why should we the people do what private investors wouldn't, that is, provide capital without taking control in return? To outright purchase bad assets for more than they're worth and bailout the losers is a sucker's game. And as hard as they'll work to mask it, anything less than too much means bankruptcy for most banks. That's the whole point of buying their "toxic assets" to begin with.

Getting back to my Japanese mentor; it was the early 1970's. Japan was the go-go economy of the world. Guys like Tom Peters wrote books extolling the virtues of their business savvy and lauding their economic system. When in fact what the Japanese had was largely a bunch of syndicates that survived the war and MacArthur. Some started basically as franchises originally granted Shoguns by the Child of Heaven in feudal times.

These powerful economic groups generally consisted of a financial institution with nearly direct access to the treasury, a number of industrial manufactures, an international shipping and trading arm, and real estate speculators. From their origins, acquiring land in close proximity to the imperial grounds was a critical status symbol.

Central to the rhetoric of the time was how we needed to emulate the Japanese work ethic and their social philosophy. We were even encouraged to read their ancient works on the art of war. And always we were told we needed to create our own banks large enough to compete with the Japanese behemoths.

For my part, having spent countless evenings with young salary men in tatami rooms, sushi bars and soap shops up and down the coast and in Alaska, and having witnessed their excesses at home in Japan, where spending ten thousand dollars entertaining a round eyes, and a half dozen compatriots and their consorts on the company expense account wasn't that unusual, I was more struck by their lack of individualism, acquiescence to their superiors, and the false comfort they took from a paternalistic system and its promise of perpetual employment. It wasn't hard to understand how so many could be turned into kamikazes.

A moment I've never forgotten found me drinking a hundred dollar cup of coffee topped with foamed milk as my host graciously sprinkled gold dust over the whole thing. That was the night he celebrated moving into a larger, thousand square foot, condominium in central Tokyo that his firm financed for him. I do not remember how many yen it cost, but I do remember it was just a few thousand short of a million dollars given the exchange at the time.

Not only could he rely on being perpetually employed, given the debt he carried it would take more than a lifetime to pay off the loan. His children would be working for the firm and paying it off themselves. Talk about creative financing. But they would be close to the Chrysanthemum Throne with a great view of the Heavenly Light.

So some twenty-five years down the road, with Japan's real estate bust and lost decade in the rear view mirror, it wasn't that hard to recognize the bubble ahead. What Alan Greenspan, Larry Summers and company thought they saw was lost on me. These are the last guys I'd want managing my little girl's inheritance.

On Sunday, Summers criticized the administration's critics saying those who were in power the last eight years, while this debacle unfolded, “don't seem to be in a strong position to lecture about the lessons of history.”

For a guy who always had the front bumper of his Batmobile strategically located at Greenspan's tailpipe, and along with Slick Willy, was there at the birth of more than one bubble of irrational exuberance and the illusion of economic success, maybe he needs to look further back than just the last eight years for his history lesson.

You gotta wonder why he's got the new president's ear. Or maybe this is why the administration seems to speak in riddles. The prince of change appears to be going for more of the same.

It isn't entirely clear whether our newly elected president is just too obsessed with bipartisanship, or whether he actually shares the prejudice for private control expressed by Messrs. Summers and Geithner, even though we the people are putting up all the money.

In either case the administration’s response to the financial crisis is paradoxical and the banking industry presents a real dilemma and a test of principles. HIs advisers continue to speak in riddles. Today, even Paul Krugman characterized Geithner's proposal to banks and taxpayers, "an offer you can’t understand."

"So what is the plan? I really don’t know, at least based on what we’ve seen today. But maybe, maybe, it’s a Trojan horse that smuggles the right policy into place." Or maybe not.

So riddle me this. Why is our government, ostensibly banking incompetents, about to loan more billions to a bunch of folks who've lost trillions of their own money? Is there actually some good reason? Or is our government's willingness to make such a loan just further proof of the incompetence asserted by the dynamic duo?

Economists often remind us of the moral hazard of interfering in free markets to absolve the careless of the consequences of their failures. Sorta like tough love. Investors who put up their money and ignore how it's used have no one to blame but themselves. All the financial planners, brokers, and other schemers they rely on aren't the problem. It's the shareholders stupid. If you give your money to somebody and they don't give it back, who's the sucker? This seems to be a lesson that must be learned and re-learned. “A fool and their money are soon parted.” Who's going to learn if there's no losing?

So this suggests an analogy. We taxpayers are the shareholders in this government. The elected are the executives in this great national enterprise. So, if like me you're laughing just a little at these suckers who've been separated from their money, watch out. We could be about to lose our investment and our children's and grand children's patrimony.

Fellow shareholders, not unlike Bush and his cronies, the prejudice for continuing private control of insolvent banks is alive and well in Washington. The plan afoot is to give our money to these schemers. Fellow shareholders, we own the bank of all banks. It's your money, your future, so wake up. There's nobody going to bail us out.

There's no good reason to preserve the system we have. No good reason to bet on proven failures. Whatever follows the demise of these banks will be better if for no other reason than the little matter of moral hazard will be clear. And understanding that failing really means failing might teach us not to create entities too big to let fail.

And there wouldn't be anything wrong, given the correction in the market, with putting some of the retiring politicians responsible back in stocks.

Stick to the rules. Keep “mark to market” and call bullshit on fantasy accounting practices. Put the shareholders who let their managers run amok in the backseat and tell 'em to shut up.

Take over the insolvent banks. Let Volcker run 'em 'til we can sell 'em. If down the road we move these bankrupt institutions for more than we've sunk in them, maybe their stock will have value again.

But fire the bozos who invested in these Ponzi schemes; don't keep giving them bonuses!

The Japanese lost a decade to deflation and still haven't really come back. It was only new bubbles overseas that allowed them to begin exporting again and somewhat stabilize their economy. Numerous economists attribute the duration of their economic slump to the unwillingness of banks to write off their losses, and the government's unwillingness to admit they'd failed.

Trust me. Let these guys go down and it won't be long until new money comes into the game. While we ponder and pretend these failed banks haven't really failed, who wants to get in a game where you can't tell who's the house, or what the rules are.

Are we again going to follow the Japanese model? If we do, get ready for more than a lost decade. Sayonara suckers.

And lest you haven't realized, we aren't too big to fail.
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