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Unfairly Rewarding Greedy Bankers, and Why It Works
By Steven Pearlstein
Wednesday, January 14, 2009; Page D01
There's been a lot of grousing lately about the Treasury's $700 billion bailout program, which, according to its many critics, has accomplished nothing other than line the pockets of undeserving bankers and their shareholders.
Maybe I'm missing something, but I don't see how it's possible to rescue the banking system without rescuing banks. That's not because anyone thought banks or bankers were particularly deserving of public charity or even sympathy -- clearly they weren't. But by last summer, with investors, lenders and depositors running for the exits, there was a genuine fear that the banking system could collapse and bring the whole global economy down with it. To prevent that outcome, the Treasury asked for $700 billion that it could use not only to mount rescues of individual institutions, but also to try to get ahead of the crisis by taking proactive steps to shore up the financial system.
Sure, you can question how the money was used -- many of us have -- but you can't quarrel with the fact that a financial meltdown has been avoided as a direct result of the government's extraordinary interventions. Fannie Mae and Freddie Mac are providing much-needed support to a mortgage market that would be shuttered without them. The orderly wind-down of AIG's book of credit-default swaps prevented the collapse of an enormous financial house of cards. Citigroup was prevented from becoming the next Lehman Brothers, while the balance sheets of the other big banks have been fortified with additional capital in expectation of further significant write-offs.
Who has benefited from all this? Every investor, every household and every business in the United States. You may not like the fact that, as a result of these actions, overpaid bankers were allowed to hang on to their jobs or preserve the value of their stock holdings. And you may be unhappy that the financial system remains in such fragile shape that it is still hard for some people and businesses to get loans they think they deserve. But let me assure you that things would have been a whole lot worse if these actions had not been taken.
One of the more specious criticisms is that the government "gave" $250 billion to big banks that are now just "sitting" on the money or using it to feather their own nests.
First off, we didn't "give" money to anyone. We invested money in banks in exchange for preferred stock, which is now earning a 5 percent annual dividend. Unless the banks go under, taxpayers will eventually get that money back, along with a modest profit.
One big reason banks got into the trouble they're in is because they were allowed to hold too little capital, or reserves, relative to the volume of loans they had made. To get themselves back into a more healthy balance, banks needed to either raise additional private capital, which under the circumstances was next to impossible, or reduce the size of their loan books. By increasing bank capital, the Treasury has made it possible for banks to "deleverage" without significantly shrinking their book of outstanding loans, or shrinking them less than they would otherwise have.
Moreover, if banks are finally increasing their capital ratios and tightening lending standards after a period of extravagantly loose credit, it's fair to ask whether that's bad for the economy or whether it's a long-overdue correction.
Of course, because money is fungible, critics can always say that the Treasury money is now being used to pay excessive salaries or dividends, or finance unnecessary acquisitions -- or, for that matter, to clean the toilets or support local Little League teams. But unless the government wants to get into the business of making every spending, lending and investment decision at every major bank, then we have to pretty much have faith that, in a free-market system, banks will use the new capital to run their operations and maximize their profits. The way banks maximize profits is to lend out as much money as they can attract at a price higher than they pay for it. "Sitting" on it is hardly a winning strategy.
The reason there is still a credit crunch isn't primarily because bankers are too greedy or even that they are too cautious, although they may be both. The better explanation is that banks can no longer can sell their loans into the secondary market, where loans have long been packaged into bonds and sold to investors. This giant "shadow banking system" has been effectively shut down for the past year after investors lost confidence in the quality of the loans within the packages. The Federal Reserve is hoping to jump-start those secondary markets by buying those packages of consumer and small-business loans directly, as has already been done with some success for home mortgages and commercial paper. That effort, however, may well require additional funds from the Treasury, which is one reason the Obama team has asked Congress to release the second round of bailout money.
There is, however, an even bigger reason why the Obama team needs the next $350 billion. In the next few weeks, banks and other financial institutions will report their latest quarterly results, and they are likely to contain another round of multibillion-dollar losses. Without additional bailout funds at their disposal, the Treasury and the Federal Reserve may find themselves unable to rescue the next Citigroup or the next AIG.
There is plenty to dislike about the Treasury's bailout program, and no doubt there are lots of ways it can be improved, but it is simply unfair to call it a failure. Given the size of the credit bubble and the excessive leverage that banks were allowed to take on, there was no way to rescue the financial system without injecting new capital, shrinking loan portfolios and shielding bankers from the full consequences of their misjudgments. The standard by which it should be judged is not whether it is fair, which it is not, or whether it has magically prevented foreclosures and restored the normal flow of capital, which it could not, but whether it has sufficiently stabilized the financial system to allow for an orderly restructuring.
By that standard, it has been a qualified success.
washingtonpost.com
By Steven Pearlstein
Wednesday, January 14, 2009; Page D01
There's been a lot of grousing lately about the Treasury's $700 billion bailout program, which, according to its many critics, has accomplished nothing other than line the pockets of undeserving bankers and their shareholders.
Maybe I'm missing something, but I don't see how it's possible to rescue the banking system without rescuing banks. That's not because anyone thought banks or bankers were particularly deserving of public charity or even sympathy -- clearly they weren't. But by last summer, with investors, lenders and depositors running for the exits, there was a genuine fear that the banking system could collapse and bring the whole global economy down with it. To prevent that outcome, the Treasury asked for $700 billion that it could use not only to mount rescues of individual institutions, but also to try to get ahead of the crisis by taking proactive steps to shore up the financial system.
Sure, you can question how the money was used -- many of us have -- but you can't quarrel with the fact that a financial meltdown has been avoided as a direct result of the government's extraordinary interventions. Fannie Mae and Freddie Mac are providing much-needed support to a mortgage market that would be shuttered without them. The orderly wind-down of AIG's book of credit-default swaps prevented the collapse of an enormous financial house of cards. Citigroup was prevented from becoming the next Lehman Brothers, while the balance sheets of the other big banks have been fortified with additional capital in expectation of further significant write-offs.
Who has benefited from all this? Every investor, every household and every business in the United States. You may not like the fact that, as a result of these actions, overpaid bankers were allowed to hang on to their jobs or preserve the value of their stock holdings. And you may be unhappy that the financial system remains in such fragile shape that it is still hard for some people and businesses to get loans they think they deserve. But let me assure you that things would have been a whole lot worse if these actions had not been taken.
One of the more specious criticisms is that the government "gave" $250 billion to big banks that are now just "sitting" on the money or using it to feather their own nests.
First off, we didn't "give" money to anyone. We invested money in banks in exchange for preferred stock, which is now earning a 5 percent annual dividend. Unless the banks go under, taxpayers will eventually get that money back, along with a modest profit.
One big reason banks got into the trouble they're in is because they were allowed to hold too little capital, or reserves, relative to the volume of loans they had made. To get themselves back into a more healthy balance, banks needed to either raise additional private capital, which under the circumstances was next to impossible, or reduce the size of their loan books. By increasing bank capital, the Treasury has made it possible for banks to "deleverage" without significantly shrinking their book of outstanding loans, or shrinking them less than they would otherwise have.
Moreover, if banks are finally increasing their capital ratios and tightening lending standards after a period of extravagantly loose credit, it's fair to ask whether that's bad for the economy or whether it's a long-overdue correction.
Of course, because money is fungible, critics can always say that the Treasury money is now being used to pay excessive salaries or dividends, or finance unnecessary acquisitions -- or, for that matter, to clean the toilets or support local Little League teams. But unless the government wants to get into the business of making every spending, lending and investment decision at every major bank, then we have to pretty much have faith that, in a free-market system, banks will use the new capital to run their operations and maximize their profits. The way banks maximize profits is to lend out as much money as they can attract at a price higher than they pay for it. "Sitting" on it is hardly a winning strategy.
The reason there is still a credit crunch isn't primarily because bankers are too greedy or even that they are too cautious, although they may be both. The better explanation is that banks can no longer can sell their loans into the secondary market, where loans have long been packaged into bonds and sold to investors. This giant "shadow banking system" has been effectively shut down for the past year after investors lost confidence in the quality of the loans within the packages. The Federal Reserve is hoping to jump-start those secondary markets by buying those packages of consumer and small-business loans directly, as has already been done with some success for home mortgages and commercial paper. That effort, however, may well require additional funds from the Treasury, which is one reason the Obama team has asked Congress to release the second round of bailout money.
There is, however, an even bigger reason why the Obama team needs the next $350 billion. In the next few weeks, banks and other financial institutions will report their latest quarterly results, and they are likely to contain another round of multibillion-dollar losses. Without additional bailout funds at their disposal, the Treasury and the Federal Reserve may find themselves unable to rescue the next Citigroup or the next AIG.
There is plenty to dislike about the Treasury's bailout program, and no doubt there are lots of ways it can be improved, but it is simply unfair to call it a failure. Given the size of the credit bubble and the excessive leverage that banks were allowed to take on, there was no way to rescue the financial system without injecting new capital, shrinking loan portfolios and shielding bankers from the full consequences of their misjudgments. The standard by which it should be judged is not whether it is fair, which it is not, or whether it has magically prevented foreclosures and restored the normal flow of capital, which it could not, but whether it has sufficiently stabilized the financial system to allow for an orderly restructuring.
By that standard, it has been a qualified success.
washingtonpost.com
