Yves Smith on the Bank Bailout plan.
The Bad Bank Assets Proposal: Even Worse Than You Imagined
By Yves Smith at Naked Capitalism.
The Obama Administration, if the Washington Post’s latest report is accurate, is about to embark on a hugely expensive "save the banking industry at all costs" experiment that:
1. Has nothing substantive in common with any of the "deemed as successful" financial crisis programs
2. Has key elements that studies of financial crises have recommended against
3. Consumes considerable resources, thus competing with other, in many cases better, uses of fiscal firepower.
The Obama Administration is as obviously and fully hostage to the interests of the financial services industry as the Bush crowd was. We have no new thinking, no willingness to take measures that are completely defensible (in fact not doing them takes some creative positioning) like wiping out shareholders at obviously dud banks (Citi is top of the list), forcing bondholder haircuts and/or equity swaps, replacing management, writing off and/or restructuring bad loans, and deciding whether and how to reorganize and restructure the company. Instead, the banks are now getting the AIG treatment: every demand is being met, no tough questions asked, no probing of the accounts (or more important, the accounting).
Why is this a bad idea? Let’s turn to a study by the IMF of 124 banking crises. Their conclusion:
Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.
In case you had any doubts, propping up dud asset values is a form of forbearance. Japan had a different way of going about it, but the philosophy was similar, and the last 15 year illustrates how well that worked…
Yves here. The spin is so thick I have to interject after one sentence. Note how the problem is that the investors don’t want to pay enough, not that the assets are in most cases fetid? Back to the [Washington Post] article:
Since the early days of the financial crisis, officials have struggled to unwind that knot. If the government buys the assets at prices that banks consider fair, the Treasury would take a huge loss when it ultimately sells the assets for much less. If, instead, the government insists on paying market prices, the banks may not survive their losses.
Yves here. See how saving the banks in their current form is presumed to be necessary? This is the phony policy constraint that is leading to all the distortions. The savings and loan crisis’ Resolution Trust Corporation is touted as a good "bad bank" model (it’s far from the only one). But guess what? It got those bad assets from banks that died. That little detail seems to be neglected in modern accounts…
As John Paulson pointed out, a lot of poor quality paper is trading. The idea that it is illiquid is a myth.
The problem is not a lack of price discovery, as the discussion above pretends, it’s a lack of investor willingness or ability to take losses. And readers have said if a particular piece of paper doesn’t fetch a bid, that’s because its real value is not materially above zero. But per above, that’s the sort of dreck that Team Obama would buy… 
So we the taxpayers are going to eat a ton of bank losses that should instead be borne first by stockholders and bondholders This program should be labeled the Pimco bailout plan, since the giant bond fund holds a lot of bank debt. That shows what a fiction Obama’s populism is. It’s mere posturing and empty phrases. Look at where the dough goes, and it is going first and foremost to the big money end of town.
Now I do not labor under the delusion that there are cheap or easy ways out of our financial sinkhole…
But Team Obama is taking the cowardly approach of distributing the costs among the most disenfranchised group in the process, namely the taxpayer, when there far more obvious and logical groups to take the hits. Shareholders and bondholders bought securities KNOWING there was the possibility of loss…
Full article here.
