The narrative (at least the only one I've been hearing) from lawmakers
and the media is oversimplified: Bailout vs. No Bailout, "It sucks
that taxpayers will have to shoulder the burden of the excesses of
Wall Street but it's unfortunately necessary to stabilize the
economy."--in other words, that "The Bailout" is in our best interests
in the long run, even though it sucks. What's missing from the
discourse is an examination of the terms of The Bailout and mention of
the many possible alternatives (to taxpayers buying outright the
assets of a failed bank).
The following article delineates the various ways in which a
government can intervene to recapitalize a failing banking system, and
then EXAMINES THE HISTORICAL RECORD of countries that have done so.
Pardon my caps.
[About the author: http://en.wikipedia.org/wiki/Nouriel_Roubini]
Nouriel Roubini | Sep 28, 2008
Whenever there is a systemic banking crisis there is a need to
recapitalize the banking/financial system to avoid an excessive and
destructive credit contraction. But purchasing toxic/illiquid assets
of the financial system is not the most effective and efficient way to
recapitalize the banking system. Such recapitalization – via the use
of public resources – can occur in a number of alternative ways:
purchase of bad assets/loans; government injection of preferred
shares; government injection of common shares; government purchase of
subordinated debt; government issuance of government bonds to be
placed on the banks' balance sheet; government injection of cash;
government credit lines extended to the banks; government assumption
of government liabilities.
A recent IMF study of 42 systemic banking crises across the world
provides evidence on how different crises were resolved. First of all
only in 32 of the 42 cases there was government financial intervention
of any sort; in 10 cases systemic banking crises were resolved without
any government financial intervention. Of the 32 cases where the
government recapitalized the banking system only seven included a
program of purchase of bad assets/loans (like the one proposed by the
US Treasury). In 25 other cases there was no government purchase of
such toxic assets. In 6 cases the government purchased preferred
shares; in 4 cases the government purchased common shares; in 11 cases
the government purchased subordinated debt; in 12 cases the government
injected cash in the banks; in 2 cases credit was extended to the
banks; and in 3 cases the government assumed bank liabilities. Even in
cases where bad assets were purchased – as in Chile – dividends were
suspended and all profits and recoveries had to be used to repurchase
the bad assets. Of course in most cases multiple forms of government
recapitalization of banks were used.
But government purchase of bad assets was the exception rather than
the rule. It was used only in Mexico, Japan, Bolivia, Czech Republic,
Jamaica, Malaysia, and Paraguay. Even in six of these seven cases
where the recapitalization of banks occurred via the government
purchase of bad assets such recapitalization was a combination of
purchase of bad assets together with other forms of recapitalization
(such as government purchase of preferred shares or subordinated
debt).
In the Scandinavian banking crises (Sweden, Norway, Finland) that are
a model of how a banking crisis should be resolved there was not
government purchase of bad assets; most of the recapitalization
occurred through various injections of public capital in the banking
system. Purchase of toxic assets instead – in most cases in which it
was used – made the fiscal cost of the crisis much higher and
expensive (as in Japan and Mexico).
Thus the claim by the Fed and Treasury that spending $700 billion of
public money is the best way to recapitalize banks has absolutely no
factual basis or justification. This way of recapitalizing financial
institutions is a total rip-off that will mostly benefit – at a huge
expense for the US taxpayer - the common and preferred shareholders
and even unsecured creditors of the banks. Even the late addition of
some warrants that the government will get in exchange of this massive
injection of public money is only a cosmetic fig leaf of dubious value
as the form and size of such warrants is totally vague and fuzzy.
So this rescue plan is a huge and massive bailout of the shareholders
and the unsecured creditors of the financial firms (not just banks but
also other non bank financial institutions); with $700 billion of
taxpayer money the pockets of reckless bankers and investors have been
made fatter under the fake argument that bailing out Wall Street was
necessary to rescue Main Street from a severe recession. Instead, the
restoration of the financial health of distressed financial firms
could have been achieved with a cheaper and better use of public
money.
Indeed, the plan also does not address the need to recapitalize those
financial institutions that are badly undercapitalized: this could
have been achieved by using some of the $700 billion to inject public
funds in ways other and more effective than a purchase of toxic
assets: via public injections of preferred shares into these firms;
via required matching injections of Tier 1 capital by current
shareholders to make sure that such shareholders take first tier loss
in the presence of public recapitalization; via suspension of
dividends payments; via a conversion of some of the unsecured debt
into equity (a debt for equity swap). All these actions would have
implied a much lower fiscal costs for the government as they would
have forced the shareholders and creditors of the banks to contribute
to the recapitalization of the banks. So less than $700 billion of
public money could have been spent if the private shareholders and
creditors had been forced to contribute to the recapitalization; and
whatever the size of the public contribution were to be its
distribution between purchases of bad assets and more efficient and
fair forms of recapitalization (preferred shares, common shares, sub
debt) should have been different. For example if the private sector
had done its fair matching share only $350 billion of public money
could have been used; and of this $350 billion half could have taken
the form of purchase of bad assets and the other half should have
taken the form of injection of public capital in these financial
institutions. So instead of purchasing – most likely at an excessive
price - $700 billion of toxic assets the government could have
achieved the same result – or a better result of recapitalizing the
banks – by spending only $175 billion in the direct purchase of toxic
assets. And even after the government will waste $700 billion buying
toxic assets many banks that have not yet provisioned for such
losses/writedowns will be even more undercapitalized than before. So
this plan does not even achieve the basic objective of recapitalizing
undercapitalized banks.
The Treasury plan also does not explicitly include an HOLC-style
program to reduce across the board the debt burden of the distressed
household sector; without such a component the debt overhang of the
household sector will continue to depress consumption spending and
will exacerbate the current economic recession.
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.