Chart of the day: Banks too big to fail

As the global economy came crashing down and we all learnt the phrase "too big to fail," I had fun with it by threading this into athletics and academics:

The entire football team signed for a macroeconomics course, and none of them did any work at all, and didn't even show up for the tests.
The professor warned them that this could seriously affect their grades and, therefore, the eligibility to play, to which the quarterback answered .... "But, we are too big to fail" :)

But, that is a joke that didn't cost anybody any nickel.

The banks that were too big to fail cost us a whole lot.

This (ht) is how we got to the situation where:

The nation's 10 largest financial institutions hold 54 percent of our total financial assets; in 1990, they held 20 percent.

The banks win. White flag and surrender :(

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Larry Summers unites the left and the right :)

In graduate school, a professor once remarked that on some issues, if you go far enough, the left and the right will agree.  Yet again, he was proven right--in this case with Larry Summers.  Both the leftist Nation and the libertarian Reason have labeled Summers a liar, and for the same stuff he said.
The context is this PBS interview with Summers

According to the Nation: " Larry Summers is a clumsy public liar."  There, as simple as that!  Well, there is more than that:

Summers's claims about what caused the banking crisis were, likewise, aggressively misleading to plain deceitful. "Regulators didn't have the specific mandate for the consumer." Wrong. The Federal Reserve and other agencies had plenty of legal authority to protect consumers. They chose not to use it. Their dereliction actually occurred on Summers's watch, when he himself was Treasury secretary under Bill Clinton.
"Regulators didn't have authority in a comprehensive way to monitor the derivatives market." This is a flaming lie. The principal regulatory agency--the Commodity Futures Regulatory Commission--was actually preparing to impose stricter oversight on derivatives in the late 1990s when Larry Summers stopped it. Summers and Republican allies intervened in 2000 with legislation that castrated that agency and prohibited it from acting further. Derivatives exploded thereafter.
When Summers was finally asked about his own responsibility for encouraging the dangerous financial instruments, he responded with a mouthful of double talk. "You know, the situation's changed hugely.... So people were actually focused on a very different set of issues." Summers even tried to make it sound like he personally had wanted to tighten the oversight, but was blocked by "Congressional opposition."
Liar, liar, pants on fire.

Ok, that is from the left.  Next up, from the libertarian perspective, here is Reason:

More serious than Summers' well established habit of citing a fake consensus of experts to support his claims is that these comments embarrass an administration that is trying to promote the fiction that it is seriously interested in ending bailouts for gigantic banks. It might make intuitive sense that regulators would rather deal with a few big, identical institutions than with many diverse ones, but that's not the story the Democrats are using to sell their financial reform plan. So between Thursday and yesterday, somebody must have found a woodshed big enough to take Summers out to. Here's what he had to say on one of the Sunday talk shows:

"We must end too big to fail," he said on Face the Nation. "There is no one associated with the White House who believes "too big to fail" is acceptable, or that it's acceptable for financial institutions to rely on a bailout."

Glad that's squared away.

You can understand why I like these: After all, I identify myself as a libertarian Democrat :)

Geithner explains the bank stress test results

So, it was really a surprise that by and large banks passed the test?
Robert Reich was concerned about the tests even before the results came out:

[Banks] needing extra capital will get it from the Treasury. But where will the money come from, now that the TARP fund is almost exhausted and Congress is dead set against providing more bank bailout money? The Treasury will simply swap debt for equity – turning what the banks owe the government into shares of stock in the banks. Presto. Ailing banks will get more capital, and Tim Geithner won’t have to go back to Congress to ask for it.

But by this sleight-of-hand, the public takes on more risk. Much of the money we originally gave Wall Street took the form of senior debt. We were preferred creditors, meaning that in the event of bankruptcy (or some form of it) we’d get repaid first. But as shareholders, we’d get nothing. As we’ve seen time and again during this economic crisis, shareholders lose big.

But, on with the test results, you say? Sure. Here is the treasury sec. explaining the test results:



thanks to GM for the tip

Iceland. Bankers. Photos. Urinals.

Yes, that is the plot outline. (click here if you want some background on Iceland's problems). And, the result? (thanks to Krugman's blog for this link; looks like he had way too much fun with the title of his post!!!)


Photographs of bankers who left Iceland after the financial crisis have a new use in the restroom of a bar in Reykjavik, the capital.

The importance of saving money. Or not!

Nationalizing banks? Please, NO!

I grew up in India, when most of the banks were government owned. The few private banks were way smaller than these government entities. While India is seeking to make these large public-sector banks more efficient, here in the US there are loud calls to nationalize major banks.
Granted that we are in a serious crisis .... but, nationalize? and, yes, I have no expertise in this topic, but I don't think I am that significantly less smart than the elected officials who are expected to make this decision. So, ....

Yet, I was waiting for a real expert to articulate in simple terms the kinds of apprehensions I have on this topic. And, here is Alan Blinder on why nationalizing is not a good idea, even though it worked well for Sweden:

WHERE TO DRAW THE LINE? First and foremost, the Swedish government had to deal with only a handful of banks; we have more than 8,300. Numbers matter, because deciding where to draw the nationalization line isn’t easy. Presumably, no one wants to nationalize all the banks, thousands of which are healthy. But where do you stop, once you start?

Suppose we nationalized four banks. Bank Five would then find itself at a severe disadvantage in competing for funds with the government-backed quartet. Forced to pay higher interest rates to attract depositors and other creditors, its profitability would suffer. Soon, Bank Five might start looking like a candidate for nationalization, too — followed by Banks Six, Seven and so on.

THE DOMINO EFFECT As stock traders began to contemplate the nationalization of Banks Five, Six and Seven, their share prices would tank, and short-sellers might consign the companies to an early grave.

THE MANAGEMENT CHALLENGE The Swedes had a relatively simple task. They never had to deal with institutions of the size and complexity of our banking behemoths.

Mr. Geithner has emphasized that governments are ill-suited to manage businesses. I’d take the point a step further: Overseeing the management of dozens, or hundreds, or maybe even thousands of nationalized banks is a daunting task.

POLITICAL OBSTACLES The process of nationalization and reprivatization went amazingly well in Sweden partly because it was remarkably free of political interference. Would that happen here? You decide. My bet is no.

THE CONFIDENCE QUESTION Finally, because nationalization runs counter to deeply ingrained American traditions and attitudes, there is a danger that it might undermine rather than bolster confidence.

To which Paul Krugman responds:

1. I just don’t understand a lot of what my colleague Alan Blinder wrote. In particular, I don’t understand how the good bank/bad bank solution is possible unless you pump in large amounts of public funds.

You might say, why can’t a bank just split itself, giving the bad stuff to one piece and the good stuff to the other? Because it has to divvy up the liabilities as well as the assets. And if it gives the bad bank (which isn’t solvent) a bunch of the liabilities, this amounts to defaulting on its debts — and the bondholders will sue. So the good bank-bad bank thing seems to implicitly carry the assumption that someone, namely you and me in our capacity as taxpayers, guarantees the bad bank’s liabilities. In which case we are in fact nationalizing the losses, but privatizing the gains.

Well, here is what I think: the bottom line is essentially how much we (taxpayers) absorb the losses, and allow private interests walk away with profits. That is the bullet we need to bite. I am ready to let go of the gains that will flow towards private interests (and see if we can somehow tax them), and just take over the bad debts and get moving. The zombie status will otherwise continue on forever, and make economic recovery that much more a challenge.

So, Obama and Geithner, do what Alexander did to untie the Gordian Knot--take a sword and slice it. In this case, into "good bank" and "bad bank". Don't listen to economics professors for ever--we faculty, in any discipline--love to debate, and we can go on and on without reaching a conclusion.

Iceland is a hedge fund. That sounds right.

Iceland was entirely new to his experience: a nation of extremely well-to-do (No. 1 in the United Nations’ 2008 Human Development Index), well-educated, historically rational human beings who had organized themselves to commit one of the single greatest acts of madness in financial history. “You have to understand,” he told me, “Iceland is no longer a country. It is a hedge fund.”

Isn't that a wonderful description of Iceland during its go-go-years between 2002 and 2008? That quote was from this lengthy piece in Vanity Fair.

The article seems so surreal--could such things have really happened? How could the global economy have become such a grand ponzi scheme? I mean, take this excerpt, for instance:

On February 3, Tony Shearer, the former C.E.O. of a British merchant bank called Singer and Friedlander, offered a glimpse of the inside, when he appeared before a House of Commons committee to describe his bizarre experience of being acquired by an Icelandic bank.

Singer and Friedlander had been around since 1907 and was famous for, among other things, giving George Soros his start. In November 2003, Shearer learned that Kaupthing, of whose existence he was totally unaware, had just taken a 9.5 percent stake in his bank. Normally, when a bank tries to buy another bank, it seeks to learn something about it. Shearer offered to meet with Kaupthing’s chairman, Sigurdur Einarsson; Einarsson had no interest. (Einarsson declined to be interviewed by Vanity Fair.) When Kaupthing raised its stake to 19.5 percent, Shearer finally flew to Reykjavík to see who on earth these Icelanders were. “They were very different,” he told the House of Commons committee. “They ran their business in a very strange way. Everyone there was incredibly young. They were all from the same community in Reykjavík. And they had no idea what they were doing.”

He examined Kaupthing’s annual reports and discovered some amazing facts: This giant international bank had only one board member who was not Icelandic, for instance. Its directors all had four-year contracts, and the bank had lent them £19 million to buy shares in Kaupthing, along with options to sell those shares back to the bank at a guaranteed profit. Virtually the entire bank’s stated profits were caused by its marking up assets it had bought at inflated prices. “The actual amount of profits that were coming from what I’d call banking was less than 10 percent,” said Shearer.

In a sane world the British regulators would have stopped the new Icelandic financiers from devouring the ancient British merchant bank. Instead, the regulators ignored a letter Shearer wrote to them. A year later, in January 2005, he received a phone call from the British takeover panel. “They wanted to know,” says Shearer, “why our share price had risen so rapidly over the past couple of days. So I laughed and said, ‘I think you’ll find the reason is that Mr. Einarsson, the chairman of Kaupthing, said two days ago, like an idiot, that he was going to make a bid for Singer and Friedlander.’” In August 2005, Singer and Friedlander became Kaupthing Singer and Friedlander, and Shearer quit, he said, out of fear of what might happen to his reputation if he stayed. In October 2008, Kaupthing Singer and Friedlander went bust.

In spite of all this, when Tony Shearer was pressed by the House of Commons to characterize the Icelanders as mere street hustlers, he refused. “They were all highly educated people,” he said in a tone of amazement.

And later this on the foreigners who jumped in:

You didn’t need to be Icelandic to join the cult of the Icelandic banker. German banks put $21 billion into Icelandic banks. The Netherlands gave them $305 million, and Sweden kicked in $400 million. U.K. investors, lured by the eye-popping 14 percent annual returns, forked over $30 billion—$28 billion from companies and individuals and the rest from pension funds, hospitals, universities, and other public institutions. Oxford University alone lost $50 million.

Interestingly enough, the latest issue of the New Yorker also has a piece on Iceland and its financial debacle. I wish the two authors and the two magazines had worked together--because they are so much similar, even in the writing styles! One interesting aspect in the New Yorker article, when it discusses the protests:

From the foot of the statue, Edward Huijbens, a geographer who teaches at the University of Akureyri, in northern Iceland, spoke briefly. In his thirties, he was a neatly Bolshevik figure, wearing a black fur hat, a white shirt, and a dark tie.

More power to geographers :-)

Iceland's deep freeze

From the blog at the Economist:
Iceland’s entire banking system is ruined. In addition to the usual domestic credit shock, this financial sector collapse is causing havoc to the import and export sectors, which are crucial to this small open economy. International bank transfers are difficult. Capital controls are in place; a multiple exchange-rate system is operating. Many companies are facing bankruptcy. Others are thinking of moving abroad. Polls show that a third of the population is considering emigration.

The International Monetary Fund has promised aid, but the Dutch and British governments are demanding compensation for citizens that deposited billions in an Icelandic bank’s high-interest saving accounts. Since Iceland’s GDP is down 65% in euro terms, repayment is unlikely—especially if the nation’s best and brightest move abroad to escape the shock and growing tax burdens. This has happened before. The Great Irish Famine triggered a mass emigration shock which tipped the nation into a downward spiral; population fell in most counties from 1840 to 1961, according to O’Grada and O'Rourke (1997).

I learned all this from a fascinating Vox column posted 12 November by Jon Danielsson, who is a Reader (professor, in American English) of finance at the LSE. Here’s the most sobering bit:

In this crisis, the strength of a bank’s balance sheet is of little consequence. What matters is the explicit or implicit guarantee provided by the state to the banks to back up their assets and provide liquidity. Therefore, the size of the state relative to the size of the banks becomes the crucial factor. If the banks become too big to save, their failure becomes a self-fulfilling prophecy.

That’s worth paraphrasing: If banks are too big to save, failure is a self-fulfilling prophecy. There are several European nations with banks their taxpayers could not save.