February 01, 2009
Links to a few items I found interesting on non-residential structure investment, the "bad bank" proposal, and separation of powers.
If there's one thing I've learned in 3-1/2 years of blogging, it's that when Calculated Risk says "watch out," we all better run for cover. Bill offers this assessment with some blunt words:
investment in non-residential structures only declined at a 1.8% annualized rate [in 2008:Q4]. As a percent of GDP, non-residential structure investment actually increased slightly in Q4. This story will change in 2009, and non-residential structure investment will be a significant drag on GDP.
Elsewhere on the web, Michael Mandel considers what will happen if the assets the government purchases to create a new "bad bank" turn out to be, you know, bad:
One straightforward solution is for the government to pay more for the bad assets than their current market price, assuming that values will eventually rebound.... However, this approach could leave taxpayers on the hook, big time. If unemployment and business failures keep rising, the mortgage-default rate will soar. The troubled assets absorbed by the bad bank will fall in value, and the U.S. government-- and by extension, taxpayers-- will become the biggest owner of foreclosed real estate in the world.
A cheaper and better way of solving this problem would be more difficult politically. Regulators can be sent into banks to take a close look at their books and assign a more realistic value to their assets, taking into account that housing prices may not bounce back anytime soon.... If a bank is found to be insolvent, the troubled securities and loans would be taken by the government, and its shareholders and debtholders would be partially or fully wiped out.
Finally, I was very interested to see this item from California Attorney General Jerry Brown. It appears that a receivership ordered by a federal court has declared itself to have the authority to dictate $8 billion in new spending on particular prison health facilities. This is ordered by the court for a state which is already facing what seems to be an unsolvable $42-billion budget shortfall for 2009-10. I agree very much with Brown that a decision of how much money to spend and where to spend it is one that needs to be made by the legislative and executive branches, not the judiciary.
Posted by James Hamilton at February 1, 2009 07:17 AMdigg this | reddit
Nial Ferguson (sp?) said it best when he said that the US already has a bad bank, it is called the Fed. The Fed has taken on bad assets from Bear Stearns, Citi, BofA and a host of others. It has also supplied funding of junk securitization.
Posted by: MikeR at February 1, 2009 08:39 AM
CR does have good taste in graphs (although credit for the "4 Bad Bears" stock market decline chart belongs to Doug Short.)
For the flip side of Doug's chart, here's one showing the trajectory of stock prices after hitting bottom in the worst stock markets on record, which should become pretty relevant beginning this month....
Posted by: Ironman at February 1, 2009 08:53 AM
I'm with MikeR: let the Fed take all the junk.
I've learned from you, Professor, that there is a cost to such: reduced interest income remitted to the U.S. Treasury.
I'm happy to take that 'separation of duties': we the people take reduced interest income, the schmucks and shysters at the Fed take the capital loss.
Posted by: jg at February 1, 2009 11:24 AM
We’ll see if this whole good bank bad bank idea is going to hold up. It looks like things are starting to go towards some other options. On my site, I wrote a piece explaining the good bank/bad bank idea. (linked here) Stop by and read it.
Posted by: elementaryfinance at February 1, 2009 04:47 PM
The problem with California is that the prison guard's union lobbies to put and keep people in jail. Release the marijuana offenders, rehab the drug addicts, and there will be less people in prison.
Posted by: jim at February 1, 2009 10:08 PM
@Jim: fewer people, not "less people". Yes, pendantic, but you posted three times so I could not let it slide. That said, I agree with you; marijuana should be legalized.
Posted by: Expat at February 2, 2009 12:14 AM
The bad bank is a bad idea. As a preliminary, let's agree that assets, toxic or otherwise, are only worth whatever the market will pay for them. Those of you who disagree should start your own hedge funds to buy the assets you think are undervalued. If you're right, you'll get rich. Even better, if you can convince others that you're right, you'll get rich instantly.
Still here? OK, let's suppose that the bad bank, aka the taxpayer, offers to buy assets from, say, Citibank at market value. Actually, there's no reason to do this. If Citi wanted to sell assets at market value, it would have already done so. (I suspect that the reason Citi doesn't do this is that the sales would force accounting recognition of big losses that have already occurred. It may well be that Citi and other major banks are already insolvent.)
So if you see banks selling assets to the taxpayers, you can be sure we're paying too much. But suppose we do so anyway. The taxpayers take big losses, Wall Street continues paying big bonuses, bank managers, stockholders and creditors get bailed out, and everyone lives happily ever after, right? Not likely.
One reason we don't want steroids in sports is that if some players use them, everyone else has to do the same to stay competitive. Gresham's Law applies to the financial industry too. Subsidizing irresponsible lenders forces everyone else to be irresponsible to maintain their market share. This is part of how we got into the current mess. And further rewarding the bad lenders with subsidies and punishing conservative lenders by forcing them to compete on a tilted playing field insures that the next financial crisis will be bigger and occur sooner rather than later.
Over the past decades, the financial industry has gotten unsustainably large relative to the economy, and the same is true of the amount of debt. As Herb Stein used to say, if something can't continue, it won't. One way or another, both are going to shrink. Keeping the bad banks in business will only drive the good banks out. Debt will either shrink in the bankruptcy courts or via high inflation. Maybe both. Anyone for stagflation?
We don't need another bad bank. We have plenty of them already. What we need to do is shut down the bad banks and sell all of their assets, good and bad, to good banks and new entrants, at market value. The FDIC knows how to do this, and it, rather than the bad banks, should get a big capital injection. Then the rest of the government should get out of its way.
The Japanese experience shows what happens when you allow zombie banks to hang on for years. They absorb funding and make only bad loans, because good loans don't pay enough. Or even worse, they loan only to the politically-connected. That way lies banana republichood.
Posted by: Jeff at February 2, 2009 07:51 AM
Do yoy mean you think the stock market begins recovery this month? No way.
Posted by: Name at February 2, 2009 09:19 AM
"Regulators can be sent into banks to take a close look at their books and assign a more realistic value to their assets"
Do you seriously believe the govt can value CDOs of ABS et. al?!
Posted by: MW at February 3, 2009 06:58 AM
Jeff on the third post above this expresses my sentiments exactly. Let the bad banks fail.
Paulson may have been right when he judged back in September 2008 that the world financial system would have frozen if another large bank or insurance firm had been allowed to fail after Lehman brothers. But we have a different situation now. The world has seen that the U.S. is willing to pour public money into the U.S. financial system to keep it operating.
We need an explicit change of policy, to be announced by Obama with proper fanfair, that the U.S. will not allow bank failure to succeed each other in a domino fashion until all big banks or destroyed BUT We will allow the banks that are worse off, that cannot survive without Federal help to go under -= until the surviving banks are not more numberous than the amount needed to serve the current economy.
Posted by: ReformerRay at February 3, 2009 04:39 PM