Thursday, February 05, 2009

Too big to Fail

There is some fuzzy thinking in Congress and government at large. The aspect of a super bank like Citi or Bank of America being too big to fail is a rather ridiculous assumption. When an institution starts out, growing in size usually means better efficiency through organization and utilization of resources. The company can double in size and probably handle three times as much business. This increased efficiency is what keeps organizations growing. There comes a point where this sort of return will fail to materialize. The returns will start to diminish with increased size.

Once we exceed certain limits, the benefits decrease with increasing size. General Motors increased in size, the item here that did them in was retirement benefits. Now they can’t sell cars and pay what they promised in benefits.

It’s rather irritating to see a super bank that has receive TARP funds declare that the money spent on the trip to Las Vegas or what ever, was not TARP money. What it tells one, is that the government lent them too much money. Take away the TARP money and let them collapse. Of course if the bank collapses, we don’t have to worry about setting maximum payout for upper management to 500K per year. We don’t have to worry about the money being spent on office furniture or corporate jets.

If a company has money coming in, their priorities don’t have to change. If they are broke, they have to change their lifestyle. Toys are not free. They have been removed as a consumer.

These companies are too big to compete on a realistic level, they need to fail. The reason they need to be allowed to fail is to show the world, you screw up, you’re toast. There is no reward for incompetence (I could be wrong, ask your Congressman). The one problem I have is that Congress seems to think that they are going to solve our problem with some legislation. They repealed the laws that allowed this to happen for a second time. Don’t expect the new administration to be our “White Knight.” It reminds me of a Will Rogers quip, “If stupidity got us into this mess, why can’t it get us out of it.

23 comments:

Anonymous said...

You're right Jim. The label needs to be revised so that it parallels the true reality of our circumstances...

"Too big not to fail".

Joseph Oppenheim said...

Sorry, but that's like closing the barn door after the horses are out.

Yes, especially the banks, were allowed to get too big. But to let them go bankrupt creates an even bigger problem, during this situation.

For example, these banks, through SIVs, CMOs, etc created all kinds of assets which became part of money market funds, etc which businesses and organizations of all kinds, large and small, used to park money needed for everyday needs like paying salaries, paying for goods they purchased, etc.

So, if these banks would just be allowed to go bankrupt, it would set off a whole string of bankruptcies for organizations of all kinds, companies, people, governments, etc, etc which reasonably thought these were safe investments because they received AAA ratings from thought to be respected ratings agencies.

Plus, if you want one year, more critical than most, where deregulation went amuck, was 2004, when Paulson, then CEO of Goldman was the main pusher, and the SEC approving, eased regulations allowing non-bank financial institutions to use leverage above 15:1 to as much as 30:1 or so. So, then these megabanks moved much of their lending to the investment divisions of their banks to issue less capitalized loans.

There are more details which made these banks undercapitalized even more, like being allowed to use their cash (or even borrow) to buy back stock, reducing their capitalization, etc. Mark to market is another factor, though that part I think is necessary, but in this perfect storm it may need to be adjusted.

And, letting Paulson dole out TARP funds, when he was a key guy behind this whole mess, was just asking for trouble.

Nationalization may be the only option, because TARP money has been used to get preferred stock of the banks in exchange. All that effected was to essentially increase the banks' debt load. We probably should have been getting equity in exchange for the TARP funds, not preferred stock. So, nationalization, temporarily, at least gives taxpayers equity which sometime will be worth more, when the banks are turned private, likely smaller and with a better regulatory environment.

GM, etc is not exactly the same. They are victims of the freezing up of debt, layoffs, etc, etc, not just pensions. Plus, if bankript, who do you think is obligated by law to pick up a bid part of the pensions? The US goverment, us, through ERISA. Plus, healthcare, most of their competitors have their countries to provide the healthcare.

If you want a simple answer, I'm sorry, it doesn't exist. Fortunately, there are some people who do understand the complexities, yes, now in our government, unfortunately some who still don't. But, whether things will play out for the best, we still don't know, so we should still be prepared for the worst.

...Joseph

Anonymous said...

Too big to bail. I'd like to see Goldman Sachs go first, though, devastating our former crook Paulsons small fortune (small by Bill Gates standards). Of course, that would also devastate the small fortunes of almost every US Treasury worker, all of which seem to be on the Goldman dole.

Rob in Nova Scotia said...

Joseph

I wish I had your sense of optimism and faith in our leaders. Sadly I don't share your point of view. There are some hard decisions that need to be made which will not be popular with the masses. I don't see anyone who has the fortitude to lead us right now.

People still think things can be fixed without making any sacrifices. The people who have lost their jobs typically are younger and I doubt they are going to have patience with government policy that my grand-parents had. I do have one question, if these companies are too big too fail who is going to pay for all the losses?


Regards,

Rob

Joseph Oppenheim said...

Rob of Nova Scotia wrote:

I wish I had your sense of optimism and faith in our leaders. Sadly I don't share your point of view. There are some hard decisions that need to be made which will not be popular with the masses. I don't see anyone who has the fortitude to lead us right now.<<<<<<

Reread my previous post. I included a reasonable amount of doubt that things will play out positively.

Yes, I see some obstacles, like the protectionist mood among many in the masses, and that part of the projected stimulus which includes buying only US steel. This is a global problem, and ideally it will take a global solution. Even on this blog, the nonsense about "main street" being so smart.

Heck, I just looked at what I think is called a 4D sonogram of a fetus, and heck, it was really amazing. You could look at the fetus moving around, smiling, grimacing, scratching its face, etc, etc. And, this is from GE. American technology and innovation.

Polls can change dramatically, among the masses, on "main street". I don't know how far this rally in stocks will go, but either now or soon such a rally could generate optimism. In fact, there is a little bit of good news in what BAC's CEO said today. He said Countrywide is booming, on the good side and BAC will be returning TARP funds. Not that the CEO is totally believable, but we have seen a spurt in foreclosed homes being bought.

A lot of people like to write off America, including many in this country, but it is just too soon to do so. Sure, be protected on the down side, but not to build any protection for the upside is just not wise. Some assets are selling at large discounts. Could they go lower? Sure, but the secret is just keep some money in reserve to pick up more if the price gets cheaper. I like buying things at a discount, quality things. It's all about balance.

....Joseph

Anonymous said...

Frankly, I like Will Rogers question. My answer, "we're trying, we're trying".

Anonymous said...

I am a person who like to avoid prejudging people; however, I have come to the conclusion our new president is clueless and corrupt.

I call him the prince of darkness. Not because of his skin tone, which is as beautiful as any skin tone, but because the prince fits right in with his gangster clique from Wall St. and DC.

These people will continue to rob the common man 'til one of two things happen: the common man revolts or dies from the beating.

We can stop looking to our "leaders" to find salvation. If this country is to turn the corner, it will be because of the iron will of its people.

It will probably take a collapse of public benefits to stir the masses to concerted action. Already, confidence in the current system has dropped, as evidence by the increased savings rates.

Enjoy the free fall while it lasts. The bottom lurks somewhere in the abyss. We'll know it once our collective body crashes on it.

Jim in San Marcos said...

Hi Joseph

I think a better analogy is "Locking the barn door with all of the depositors inside and burning it down."

Tarp money is air money. Nobody worked for it and nobody ever will. Everyone that made money on this mess gets to keep it. Everyone that lost money the government is going to make "whole."

There is no real money to fix this mess. The absurdity of printing trillions dollars of dollars is delusional.

90% of the crap the government is buying you wouldn't waste YOUR hard earned money on. You might want to sell it to them, but you certainly wouldn't be buying it.

The SIV's and CMO's are worthless. Why even mess with them? You and I wouldn't buy them, why should the taxpayer have to?

We have a problem. An awful lot of real money was lost and surprisingly no one lost a dime? Talk about a con game!

The money has been lost and we cannot print our way out of this mess. Everyone has real losses.

Let the banks collapse and mark everything to market and let the game start over again.

I emphasize you can print money but you cannot print what we want to buy with it. Thats why this will fall apart. You might get away with printing 100 million a year, but this amount is beyond all comprehension.

Letting everything fail that needs to fail doesn't make for a bigger problem. The problem is not going to go away, it will just take longer to fix.

There is no real money to pay for this. To think that these great minds will solve our problems is a travesty and a joke. Real money if we had it, could fix it, but we are broke.

AngryTaxPayer said...

Jim,

You keep mentioning that the government will print the money... I'm not on the inside of course, but I keep hearing that this money must be borrowed. By China and Japan I'm assuming.

Last time I checked the USA's future was looking pretty bleak. If the government goes looking for Trillions to spend and/or to make up in lost revenue, creditors will demand a much larger rate than what the treasury is offering at the moment. Interest rates have got to be on the rise soon... who in their right mind would invest in treasuries with a negative return (after figuring in inflation).

I offer no solutions... as the "Prince of Darkness" (coined by Anon 7:14, LMAO) has everything under control. And if you believe that, well... you know the saying.

Tom

AngryTaxPayer said...

Joseph,

I wish I shared your optimistic outlook on the situation, but the government and banks could collapse tomorrow and I wouldn't shed a tear. The philosophy of Capitalism on the way up and Socialism on the way down does not set well with me. To show my point, lets use the following example...

If the government received revenue only through donations instead of taxation, how many Americans would eagerly open their wallets to them? When Congress waves the wand soon and demands more taxes from us, would you personally be willing to pick up the extra taxes that I do not want to pay?

I'm disgusted with our every aspect of our government. Every time the government does "something" it cost the taxpayers even more money. I have not heard one word from the POTUS about cutting the existing massive abusive overspending and waste by our beloved government. Now their talking about spending Trillions more!

How can the POTUS keep a straight face when he says he'll cap CEO salaries and restrict spending of companies taking taxpayer funds? I say to the POTUS, clean your own house before taking on the neighbors!

All kidding aside Joseph... I'm in a catastrophic financial situation right now. If something is not done soon, I'll die. Can you give me some of your cash? I promise that I will spend every penny of it and come looking for more!

Tom

Anonymous said...

Let's read between the lines:

The big banks are too big to fail because they hsve $6.84T in deposits and $53B in insurance.

The big banks are too big to fail because world war will break out if the Chinese lose $681B in our market.

Those are the two risks facing us right now. If we would save the rest of this money, they would be able to cover at least two of the big banks blowing up and simply void the swaps to stop the systemic damage.

Rob in Nova Scotia said...

Joeseph

I re-read your post. Your argument is the same one that the government is using to prop up all these Zombie banks and Car Companies. I would have to agree that you tone is not as optimistic as some of your previous posts in other threads. I`m with Jim let them all fail otherwise the average taxpayer will be stuck paying for this for rest of lives. We will likely be anyways but at least Hank might be eating beans and weiners like the rest of us.

Jim in San Marcos said...

Hi Tom

When the banks cut off liar loans real estate tanked. The buyers weren't credit worthy. Now the government wants a ninja loan.

We already owe China a Trillion dollars, I don't see that large of a loan coming from any foreign country. Every country in the world is facing the same situation we are. Japan might be an exception.

I think the first place we will see this fall apart is with trade with foreign countries. Gold will become a measure of exchange values. Trading product for paper money won't work. The barter of goods and services will insure survival.

I see China and the rest of the world demanding payment for what they have already loaned us.

Joseph Oppenheim said...

I emphasize you can print money but you cannot print what we want to buy with it.<<<<<<

Apparently, Jim, you don't want to buy a home 40% or so cheaper than it was a couple of years ago.

Plus, with interest rates much lower, such people with top notch credit ratings can even get a mortgage cheaper. Yeah, it isn't a good time to be someone without money or not a worthy credit risk.

In fact, the dollar is much, much more valuable than it was almost a year ago. Just look at currency charts. Gas prices, etc are cheaper.

...Joseph

Jim in San Marcos said...

HI Joseph

When you double the amount of money in circulation and the total amount of goods and servics remains the same, prices have to increase and most probably double.

Housing is a special issue. They built too many houses. You won't hear anyone point that out, I wonder why? If you buy one today you could see your investment drop another 40% this year. The interest rates are artifically low because no one wants to borrow any any money. Plus you can still get a no money down REO if you have a job and get repair money back at closing.

Inflation is through the roof, just go price a bag of potato chips or some hamburger, prices have doubled. Four bucks for a 11oz bag of chips is outragous. McDee's dollar double cheeseburger is now a buck and a quarter and only one slice of cheese.

Present interest rates don't even come close to reflecting the current risk in the market. Of course there isn't any risk with all of the government guarantees. The last two sentences contradict each other. Just maybe, government guarantees aren't what they appear to be.

I have more faith in my religion than I do in government promises.

I am tempted to buy a home as a hedge against the coming inflation.

We both may come out of this alright by going in different directions

Thank you for your comments.

Joseph Oppenheim said...

Housing is a special issue.<<<<<

Sorry, Jim, try cars, airline tickets, blue chip stocks, gasoline, and many other things people/businesses want to unload as they need to raise cash. Heck, look at Circuit City - going-out-of-business sales, etc, etc.

As for food, it is so easy to economize. In fact, America is overweight. Stay away from chips. Bake a potato at home. Or else, buy Pepsi, the stock is way down from its highs, and makes tons of money on Lays chips, Doritos, Fritos, Cheetos, etc, plus the stock pays over 3% dividend - raises it annually - has little debt - and the government taxes dividends lower than most other forms of income - plus favorable cap gains tax rates unless you think the stock will never go higher - plus one can't lose everything because the government even allows cap gain losses to be written off against other income. Sure, PEP could go lower, but just another opportunity to pick up more.

The term is "cash is king", at least for now, while this window is open.

...Joseph

Jim in San Marcos said...

Hi Joseph

I spent about a half hour composing an answer to your previous post. I try to respond to everyone on a level that shows I value their comments. I don't want to sound mean, or pick on you, but I don't think you read what I wrote from reading your response.

Your reply to me was not on the topic being discussed. You took one item out of context "Housing is a special issue," and made statements without backing them up with any facts.

Then on my discussion on the issue of inflation citing food prices I got

"As for food, it is so easy to economize. In fact, America is overweight. Stay away from chips. Bake a potato at home."

I consider your remark "half baked."

I did read all of what you wrote and even though it didn't really follow topic of this thread (in the least), let me enlighten you on two points.

Circuit City is closing and their close out sales are for suckers, they are not giving anything away. Don't even waste your time driving over (I did).

Second if you have capital losses you cannot deduct them from your earnings if you have none (unemployed)

Take care my friend. Thank you for your post.

Joseph Oppenheim said...

Circuit City is closing and their close out sales are for suckers, they are not giving anything away. Don't even waste your time driving over (I did).

Second if you have capital losses you cannot deduct them from your earnings if you have none (unemployed)<<<<<

Sure, Jim, I have no intention of checking out Circuit City(there is nothing I need from them), but sooner or later the prices will drop to whatever level someone wants them, even if they end up being bought up by some outlet organization and they end up at swap meets or the equivalent of Big Lots stores for electronics. Bankruptcy is a stepwise process, as for disposing of inventory. But, my experience with Circuit City in the past has been that they can be negotiated with, over price. I have negotiated with them several times in the past. Whether they are negotiatable one day or the next depends a lot on the person you talk with and the skill one has at negotiating. Plus, if not price, something else. One time a bought a notebook computer from them and got them to throw in a $40 carrying case for free.

As for your other comment about capital losses not being able to be deducted for someone without a job, that is incorrect. 1) the person could still have some capital gains from which to offset the losses against. 2) The person might file a joint return and the spouse might still have a job or capital gains. 3) Most of all, the losses can be carried forward to future years when the person does have some income from which to offset.

You have much to learn about taxes and stocks.

As for me taking one comment of yours, my other posts have followed the crux of your original post. Plus, that statement did show your lack of understanding of a key part of the thrust of your posts on the subject. Prices of lots of things are down from their highs. Some are up, but plenty are down, especially major purchases like homes and cars.

Really, I don't disagree with you too much on the big picture. We do agree that things will get worse, I just think it is too soon to write a doomsday scenario, plus I doubt this mess will get as bad as in the 30's, etc. However, I am not ruling that out, just would put the chances of that at maybe 10% or so, but I will be watching to see if that probability goes higher.

...Joseph

Rob in Nova Scotia said...

Joseph

So if you want to save the banks what do you cut? Social Security, Medicare, Defense, Education. All these promises have to be paid for and it looks like the government is going to just print or borrow the money. The end result either way is inflation. It is true right now that we are in deflationary cycle but this is short term. It is of no use that prices are falling if you have no money. One can borrow the money but this is exactly the wrong thing to do as once inflation takes hold in economy anyone with onerous debt will be crushed.
I just hope the Chinese will be as understanding as you when their money is worth half as much. As for the chance of depression I'd say it's very good as I think we are in one now.


Regards,

Rob

Jim in San Marcos said...

Hi Rob

Todays post has two visuals that are easy to choke on when viewing this mess. It indirectly touches on what you are talking about. The discussions in this thread from everyone help me put it together.

AngryTaxPayer said...

Joseph said...

Really, I don't disagree with you too much on the big picture. <<<<

Translation: I agree somewhat with you, but only at the moment, at which time I reserve the right to change my mind at anytime, but only if its Wednesday. Is it raining right now? I think I left the windows down in my car.


Joseph said...

We do agree that things will get worse, I just think it is too soon to write a doomsday scenario, plus I doubt this mess will get as bad as in the 30's, etc.<<<<<

Translation: Things will get worse, but only when I say. What time is it now? Since I grew up in the 30's, I know what it was like then. Pointing out recent relevant facts of our economy is beside the point. Did someone just call me?

Joseph said...

However, I am not ruling that out, just would put the chances of that at maybe 10% or so, but I will be watching to see if that probability goes higher.<<<<

Translation: I'm 90% sure nothing will happen. Should I wear white or blue today? I would hate to be wrong, my reputation is at stake. Steak, that sounds great for dinner. I'm now 90.5% sure nothing will happen. What time is it now?

Tom

Anonymous said...

We all know how the housing bubble started and burst. Lenders relaxed their criteria for lending. Borrowers with poor credit (or no credit) bought homes. Borrowers defaulted. Banks, shocked at the prospect of owning real estate instead of paper, froze the credit market. Downward spiral.

That to me is the story in a nutshell. Sure there are subplots, but that is the gist.

The problem that lenders did not anticipate is the default rate. They anticipated the same default rate that existed BEFORE the loosening of mortgage lending standards.

Making home loans as easy to get as a car loan or credit card should have made the BANK GENIUSES consider the back end. They apparently did not. Of course mortgage default rates would essentially mirror the default rates in other consumer lending. It was bound to happen.

That alone is not a reason to lend. However, real estate is quite a different animal then a car or dining room set or credit card loan. You can repo a car quite easily, same with furniture. Credit cards lead to judgments and garnishment of wages. Creditors stop the bleeding quite easily and get to recover some of the principal. Forget the interest.

Collecting on a mortgage debt requires a foreclosure and there are 50 different foreclosure laws in the United States. Here in Illinois, you can live "rent free" for about 9 months or more after the foreclosure starts (which is typically 90 days after the first missed payment).

In Missouri, I hear it is much faster. Six months max.

The point is that Lenders needed a national foreclosure law to assist them in the recovery of collateral. They could stop the bleeding and the quickly get a recovery of their capital (or most of it).

Now they have to carry the houses for months and months, incurring taxes, attorney fees, insurance...it's got to be a nightmare for them.

I submit that a NATIONAL FORECLOSURE LAW would help solve the problem. Armed with such a law, lenders could again LEND without the downside risks they currently have. Most loans are Federally backed somehow anyway, so there is a rationale for imposing Federal control on the process.

If LENDERS started LENDING again (o.k. not quite like they did before, but made loans attainable to poor credit or no down payment borrowers), the housing market might just correct itself in a year or two.

And it you default. You're out in 6 months tops. NATIONAL FORECLOSURE LAW...and idea whose time has come.

AR

Allen Charles Report said...

A better plan to stabilize the financial markets is to simply let the Federal Deposit Insurance Corporation take over the insolvent companies and form a holding company and reopen as one large institution. Just as when the FDIC takes over smaller banks the same rules should apply here. The new holding company can then operate the new banks keeping the good accounts and spinning the bad ones to a second operating company to work through them eventually restoring some of them and liquidating the rest. If any legitimate debt holders are established then stock could be issued to these legitimate debt holders ( likely bond holders). After a period of time this new company could do a stock offer selling the entire company back into the private sector. Problems solved, seven hundred billion of tax payers money would be saved. The cost of the new company would be returned back to the taxpayers from proceeds of the sell of the stock at the return to the private sector from government operation. The fat cats on Wall Street could be returned to work for the new company but like all reorganizations at a lower cost to the new company allowing it to return to health much faster.


Both Wachovia and Washington Mutual as well as all the community and regional banks that are or become distressed should be included in the new Holding Company thus making a network of bank outlets available to allow loans between banks to be unfrozen and allow the system to do a restart with these outlets being secure and adding the desperately needed stability to the entire banking system. If a bank becomes weak it needs to be added very quickly keeping the system calm.

The changeover could be done over a weekend without any disruption of any kind. Each of the banks taken over would continue to operate under it's present name and corporate structure except that the boards would become advisory only with the final authority being held with the new holding company. Over time most of the banks could be either spun off or several combined under a new corporate configuration and then spun off or sold. The stability of the entire banking system would be the most important goal.

The Federal Reserve System looks at all the deposits at all the banks as one total, so this new bank would not alter the loan patterns from what it would be with if all these various banks that would be part of the new holding company were operating separately. All the bad things being claimed by Mr. Paulson would be avoided with this plan and the best part of this plan are NO TAXPAYER costs beyond the administrative cost of the new bank holding company.

This plan takes a second look at the way the taxpayer’s money is used and avoids benefitting those that caused the problem to begin with. They took unnecessary risk and have lost so the bailout should take the control of the future out of these either corrupt or incompetent executives hands and allow a time out for our banking system to stabilize and get back on track.

The one caveat I have for the new Holding Company, which plans to put these bad debt mortgages in, is that a provision in the restructuring should provide a way for people that are in these mortgages to be able to stay in the home. One idea would be to renegotiate the value of the property back to an equity position with the caveat that they could not sell their home, for eight to ten years or some other appropriate time frame. The reason that I would like to see this put into the terms for use of this agency to stabilize the mortgage market is that if something isn’t done the power structure that will be controlling this new agency will likely sell off these homes at a larger loss than leaving people in the homes or working out something for them. If this doesn’t happen many insiders, the money crowd, Wall Street types you know the folks that got us in this mess to start with will come in and buy these properties up for pennies to the dollar at leaving the homeowner homeless the taxpayer on the hook for the costs and the rest us no better off than we are now. There could be a deed restriction on these homes that required them to pay the proceeds of the write-down out of the home or of the equity of the home as a penalty for moving too fast. The whole idea for this bailout is to stabilize the mortgage market, financial market, and the economy.