Page 2 of 2 Financial reform next for Obama
By Julian Delasantellis
Much like last year's idea from the UK Exchequer to take capital states in
banks rather than buying up toxic assets, this idea has gone viral as well,
infecting the US Treasury.
There's an old saying that goes along the lines of "better the devil you know
than the one you don't", and that's precisely the point here. A large part of
the problem when regulators see a bank or financial institution that becomes
deemed too big too fail is in knowing both how bad, how non-performing, its
assets are, as well as just how punishing the demands to pay off on its debts
will be in the near future.
They're out there somewhere - all the derivatives and collateralized debt
obligations and credit default swaps the bank sold to live high off the fruit
of the land until the time came for their
repayment, after which they would be rolled over to do it again and again into
eternity.
But everybody who bought one of these, in Warren Buffett's words, "financial
weapons of mass destruction", wanted to be able, some day, to cash out of these
investments. Most of the time, it was not a question that the banks on the
other side of a trade with a failing bank, the "counterparties" in bank lingo,
would have liked to have their money back when their trade expired; they had to
have it back, at precisely the time it was due them, in order to pay off other
banks who were redeeming other securities with them.
But merely looking at the facade of a failing big bank just about to tip over
into insolvency does not in and of itself give much insight into just how far
into the marble of the banking system the bad bank has spread its toxic
securities. In March 2008, the US government was not willing to risk finding
out just how far Bear Stearns had spread its poison, but in September, then
Treasury secretary Henry Paulson and Geithner, then at the Federal Reserve,
rolled the dice to let Lehman Brothers fall, and were then thus shocked and
appalled to learn of their error - that Lehman had spread its dross so far and
wide as almost to take the entire financial system down with it.
Wills or financial institution "living wills" address this issue very clearly.
Instead of the clean-up regulator being left to guess just where and how much
bad paper the failed bank had left on the Street, after the bank's demise, the
regulator would find a detailed list with the amounts and locations of all the
bank's debts now probably to be defaulted upon.
Therefore, the senior system regulator, says the Federal Reserve, could perhaps
address special attention and liquidity support to the banks with the most
counterparty risk to the failed bank, since these would be the institutions
most immediately affected by the big bank's insolvency. Also, if, as generally
assumed, the bank regulators had access to the living wills prior to one of the
bankruptcies, the regulator could provide, at the time it was most needed,
valuable informed commentary to the senior system regulator as to whether a
bank in question was indeed too big to fail.
How valuable arrangements such as the living will could be are illustrated by
what is coming to be considered as the most grossly unnecessary profligate
individual episode of autumn 2008's bailout panic, the bailout of AIG.
Speaking of the costs of the Vietnam War, the late senator, Everett Dirksen,
once opined that "a billion dollars here, a billion dollars there - pretty soon
you've got real money". Of course, with 40 years of inflation blowing up the
nominal value of the much greater screw-up (at least in financial terms), the
world financial crisis, the old saw would probably today be to the order of "a
hundred billion dollars here, a hundred billion dollars there, pretty soon
you're buying yourself a financial system bailout". Still, much controversy is
now emerging over just a part of AIG's US$152 billion in bailout authority - a
mere, miserly, relatively inconsequential, piddling $14 billion.
Two days after the checkbooks were slammed shut for Lehman, they were opened
wide for AIG, starting with an $85 billion credit line that was intended to
help the company deal with its credit downgrading.
But in November of last year, it was a specific $14 billion charge that riled
many of the critics of the bailout phenomenon. That was the extra amount that
Geithner, by then moving towards a nomination for Obama's Treasury secretary,
declared that the US would pay for a 100% settlement of credit default swaps
(CDS) that AIG owed to other companies.
For all their convoluted confusion, CDS like those sold by AIG were easy to
understand in the bankruptcy court - they were just another debt, a debt that
could not now be paid in full, that the bankrupt company owed to whoever was on
the other side of the CDS trade, be that another bank, pension or hedge fund.
It is not at all uncommon for the bankruptcy court process to arrange a final
settlement less than the nominal amount of what is owed between the parties -
after all, the court knows you can't get blood from a stone. Many of the
creditors to the auto companies would have been ecstatic with just a 40%
"haircut", or loss on their debt; more than a few of them had to take 80%.
According to information just obtained by a Freedom of Information Act request
by Bloomberg, AIG and its debtors were in final negotiations for a 40% haircut
settlement on its obligations when Geithner intervened to say that AIG, and by
extension the US government, would pay 100% on AIG's debts. According to
Bloomberg, the 100% payouts resulted in even more US government gravy to the
usual suspects of the financial crisis - $14 billion in total for Goldman
Sachs, $16.5 billion for Societe General, $8.5 billion for Deutsche Bank and
$6.2 billion for Merrill Lynch/Bank of America.
Geithner defends his policy in the AIG giveaway by noting that he had no
authority to pay out any less than 100% on the swaps, but all that proved was
that he wasn't willing to have an intern hit the books to find another Section
13c like the one that facilitated the bailout of Bear Stearns.
More and more, it seems as if the real reason for the extra payouts was that
Geithner had no idea just how far and deep into the financial system AIG had
planted its worldwide web of CDS. In not knowing, he had no idea whether making
the creditors take haircuts would have saved US taxpayer money at the cost of
more huge financial system dominoes falling, an event that would have required
even greater federal bailouts to remedy.
A year past the worst of the financial crisis, and, at least in the US, no real
financial reform proposals are even near enactment. Right now that's probably
OK; at present, excessive risk is being disciplined not by legislative fiat but
by the memory of the sight of the guy who used to sit at the mortgage-backed
securities trading desk now washing out the restrooms in the bus station.
But, soon, the appetite for risk will return; it must, for there can be no real
recovery without it. When it does, it is absolutely essential that the issue of
too-big-to-fail banks and other financial institutions be remedied by
prohibiting banks from being allowed to become too big to fail - as I heard in
a conversation at a ball game a while back, too big to fail is too big to live.
In place of these tenebrous cyclops hiding away the strengths, and in a crisis
the weaknesses, of their balance sheets so as to guarantee bailouts by panicky
bureaucrats fearing the worst, what will be needed going forward will be banks
with easy-to-understand business plans, with transparent balance sheets, and in
which the markets can have confidence they will survive the next downturn.
"Transparency" is a big buzzword in financial structure debate and regulation
these days. After all, you've never heard anybody object to it when applied to
Anna Nicole Smith or Ms Fifi La Voosh, have you?
Note
1. Anna Nicole Smith, the stage name of Vickie Lynn Marshall, (November 28,
1967-February 8, 2007), was 26 when she married oil executive J Howard Marshall
(89). Thirteen months later, Marshall died. Smith subsequently claimed half of
her late husband's US$1.6 billion estate, claiming he had orally promised her
half of his estate if she married him. The case went to the Supreme Court,
which affirmed her right to pursue a share of her late husband's estate in
federal court. Smith's death in 2007 was ruled an accidental overdose of a
sedative.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
(Copyright 2009 Asia Times Online (Holdings) Ltd. All rights reserved. Please
contact us about
sales, syndication and
republishing.)
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
