Clean Banks and the Best Deal for Taxpayers

Yesterday I linked to Glenn Greenwalds post – Larry Summers, Tim Geithner and Wall Street’s Ownership of Government in which there was this exchange between William K. Black (Associate Professor of Economics and Law) and Bill Moyer,

Black:  Geithner is charging, is covering up. Just like Paulson did before him. Geithner is publicly saying that it’s going to take $2 trillion — a trillion is a thousand billion — $2 trillion taxpayer dollars to deal with this problem. But they’re allowing all the banks to report that they’re not only solvent, but fully capitalized. Both statements can’t be true. It can’t be that they need $2 trillion, because they have masses losses, and that they’re fine.

These are all people who have failed. Paulson failed, Geithner failed. They were all promoted because they failed, not because…

Moyers:  What do you mean?

Black: Well, Geithner has, was one of our nation’s top regulators, during the entire subprime scandal, that I just described. He took absolutely no effective action. He gave no warning. He did nothing in response to the FBI warning that there was an epidemic of fraud. All this pig in the poke stuff happened under him. So, in his phrase about legacy assets. Well he’s a failed legacy regulator. . . .

The Great Depression, we said, “Hey, we have to learn the facts. What caused this disaster, so that we can take steps, like pass the Glass-Steagall law, that will prevent future disasters?” Where’s our investigation?

Black might be a little hyperbolic in regards to accusing the current Treasury Secretary as someone who “gave no warning”. That is not exactly true – see this pretty balanced piece at Pro Publica, As Crisis Loomed, Geithner Pressed But Fell Short. Though Black’s assertion that the current private-public and how Obama-Geithner should be using “Prompt Corrective Action” (PCA) law (adopted in 1991) has some merits. William K. Black on The Prompt Corrective Action Law

WILLIAM K. BLACK: Well, certainly in the financial sphere, I am. I think, first, the policies are substantively bad. Second, I think they completely lack integrity. Third, they violate the rule of law. This is being done just like Secretary Paulson did it. In violation of the law. We adopted a law after the Savings and Loan crisis, called the Prompt Corrective Action Law. And it requires them to close these institutions. And they’re refusing to obey the law.

BILL MOYERS: In other words, they could have closed these banks without nationalizing them?

WILLIAM K. BLACK: Well, you do a receivership. No one — Ronald Reagan did receiverships. Nobody called it nationalization.

It gets a little confusing because some f what people are thinking of as banks are holding companies which are not banks, but own banks. Those holding companies are generally what many commentators mean when they say large financial institutions. Many, including myself, wonder why we should save have the holding companies, which the Geithner plan does. My reasons are not ideological, they are purely practical. Saving the company that owns the bank is more expensive then seizing the bank and as Black suggests, reorganizing it and have it reemerge as a healthier private entity with assets and the ability to take reasonable risks, like loaning money to a small business.

The commentator’s primary concern can be answered briefly because it criticizes a claim I never made. S(he) notes that banking holding companies and insurance companies are not subject to PCA. I did not say that they were. As the interview excerpt shows, we were talking about “[savings] institutions” and “banks” that can be put into “receivership” (I’m going to use “bank” here to refer to any FDIC-insured depository institution.) The FDIC (and if it lacks the funds, the U.S. Treasury) is only legally obligated to pay depositors of FDIC-insured banks up to the deposit insurance limits. The federal banking regulators have receivership powers only over federally insured depository institutions. The FDIC and the U.S. Treasury have no obligation to pay the debts of bank holding companies or insurance companies – and shouldn’t be paying those debts.

The commentator uses this strawman argument (refuting a claim no one made) to imply that the fact that PCA doesn’t apply to bank holding companies means that the federal financial regulators did not have to comply with the PCA law. S(he) lists a series of companies, primarily large bank holding companies (BHCs) and declares that their existence means: “So, pretty much all of the really big players don’t fall under the PCA in the first place.” Bank holding companies, of course, are called that because they own banks – and the U.S. banks they own are subject to PCA. The fact that a bank is owned by a holding company is irrelevant to the PCA’s requirements; it provides no immunity from the PCA. BHCs are “really big players” because they own massive banks subject to the PCA. The banks are the “really big players” and they are subject to the PCA law. When we put insolvent banks into receivership their BHCs and affiliates lose all control of the bank. The FDIC has sole control of it.

PCA does not apply to the corporate owners of banks or their non-bank affiliates.
However, the bank subsidiaries are the dominant assets of almost all holding companies that own banks. As such, the failure of the banking within the group is likely to trigger the failure of the holding company.

To sum up the first point: banks are the issue. U.S. banks have FDIC insurance and are subject to the PCA law, regardless of whether they are owned by a BHC. Deposit insurance covers only insured banks, not BHCs, so the FDIC, the Treasury and the taxpayers do not owe any obligation to pay their creditors. If the commentator is worried that BHCs will escape receivership, s(he) need not fear. BHCs and insurance companies such as AIG are subject to the bankruptcy laws, which can be used to block and even “claw back” excessive and fraudulent executive compensation. (Treasury is also requesting Congress to grant it authority to place BHCs and some insurers into receivership.)

Obama/Geithner have provided for the possibility of acting pretty much as Black suggests, but quite a few of us are wondering why we’re taking these interim public-private steps. Analogies in this situation are tricky, but its not too dissimilar from a family financial crisis. You want to do two things simultaneously – save money on your necessities and straighten out your revenue flow as quickly as possible. banks per se have always been a quasi-public private business. Walk in customers think of them as private, but all banks are connected to insurance and monitor policy. One provided by the government in the public interest (FDIC and PCA) and regulated in the nation’s interest. Unfortunately nationalization is a loaded term politically. Looked at from another angle, banks operate as private entities in the sense they can hire managers and operate in an entrepreneurial manner, but when those private actors act in a way that causes undue risks for us by by of the FDIC and good business practices, it is not unreasonable for the Treasury to step in and take action on our behalf, up to and including showing some executives the door. Geithner Says Government Would Remove Bank Chiefs if Needed.

Both the auto and financial industries have received financial help from the government, but the Obama administration has come under criticism for taking a harder line with the auto industry than with Wall Street. Last month, administration officials pushed out former General Motors Corp. chief executive Rick Wagoner, after a federal auto restructuring task force determined he wasn’t restructuring the auto company fast or deep enough.

Mr. Geithner pointed to the Bush administration’s treatment of executives and board members at Fannie Mae, Freddie Mac, and American International Group Inc., to which the government gave major financial assistance over the last several months. Top executives and board members at those companies were replaced.

Top executives at Citigroup Inc. and Bank of America Corp., which have also received large government capital injections, haven’t been replaced, however. That has led to growing criticism on Capitol Hill that the White House was going easy on Wall Street.

Wagoner could have stayed. GM just would have had to go ahead without further assistance from the government. It was irresponsible to let Wagoner stay the first round, just as it is probably irresponsible not to clean house at Citigroup and BOAC. How to Clean a Dirty Bank

There is a simpler, sounder and fairer way to recapitalize an insolvent bank. The government should seize it, as it is already authorized — indeed, compelled — to do. Then it could inject cash (in the form of Treasury notes) as equity in the bank and, at the same time, remove the toxic assets the bank holds. Bank regulators might perhaps swap Treasury securities for toxic assets “at par” — that is, in an amount equal to the original purchase price of the assets removed. This would be a fair transaction, and it would cost nothing, because the government would own both the bank and the bonds. The toxic assets could then be placed in the basement of the Treasury building while we wait to see what they turn out to be worth.

The government could then quickly — say within a month — auction off the bank. Speed would be critical: If Treasury were to hold a large bank for a long time, it would be difficult to retain the most talented employees, and it is the people, along with a clean balance sheet, that make a bank valuable.

If markets work at all (and if they don’t, Treasury’s new plan is doomed to fail), such an auction would produce a new privately owned “clean” bank, with ample capital to lend. It would also generate proceeds from the sale that would be at least as great as the value of the securities injected into the bank as equity — and likely greater.

Here again, Geither and company are betting that those toxic assets will be worth something, but at current value they are a loss or a modest profit.  In the public-private plan taxpayers will share in any profits, but that is the sticking point. Will there be any appreciable profits for all the risk to tax payers. One of the reasons there would be little advantage to the tax payer is that the auctioning off of assets also has the costs of carrying shareholder and debt holder ownership of banks that have all these toxic assets. Going back to Professor Black. His accusation that some of this smacks of criminality is that we’re giving bail-out money to entities like AIG who are in turn paying out to banks who give chunks of those funds to shareholders. Most tax payers do not want, nor should they, to bail-out shareholders,

Black: Absolutely, because they are scared to death. . . . What we’re doing with — no, Treasury and both administrations. The Bush administration and now the Obama administration kept secret from us what was being done with AIG. AIG was being used secretly to bail out favored banks like UBS and like Goldman Sachs. Secretary Paulson’s firm, that he had come from being CEO. It got the largest amount of money. $12.9 billion. And they didn’t want us to know that. And it was only Congressional pressure, and not Congressional pressure, by the way, on Geithner, but Congressional pressure on AIG.

Maybe there is some shady slight of hand going on here or maybe Obama’s economic advisors genuinely believe their way is the best way. Geithner’s plan might work, but it will cost more and take longer. Since they are making moves to clear nationalization with Congress and are talking about dumping some bank executives, they must have discussed the possibility of going with something like Black and Andrew Rosenfield suggest. Non-economists like me are crossing their fingers that the White House does not end up being bad shoppers, buying the big glossy advertised item that also happens to benefits a lot of their old friends on Wall St, rather then shopping around for the best deal.

Ed Morrissey, hired genuflector for Malkin’s Hot Air, desperate as usual to find some minuscule and sometimes non-existent gaffe by President Obama, jumps on this story from Bloomberg,

“There’s a lot of — I don’t know what the term is in Austrian — wheeling and dealing, and people are pursuing their interests, and everybody has their own particular issues and their own particular politics,” he said in response to an Austrian reporter’s question.

Ed ruined a perfectly good Popsicle rushing to the keyboard to explain,

Austrians speak German and Italian primarily, as well as French — and I’m sure some Austrians speak languages ranging from Albanian to Swahili, being an intelligent and cultured people. However, none of the speak Austrian, because it doesn’t exist.

Actually the Austrians predominant language is Austrian German. Not completely distinct from German, but different enough to warrant a distinction. Austrians also speak Slovene, Croatian and Hungarian. Considering Austria is such a multilingual country, in diplomatic terms Obama’s descriptive use of Austrian is spot on ( Austrians like to think they have their own national identity and are not a suburb of Germany). Its amazing what the Right gets wound up about. They’re like a child that gets excited because they found something shiny. Out of a possible five right-wing Morrissidiocies, I’m giving him three.

This is from his posts so it is fair play. If you have noticed any other Morrissidiocies at Hot Air you can e-mail him at