The Bad Bank Assets Proposal: Even Worse Than You Imagined
Naked Capitalism
February 4, 2009

Dear God, let’s just kiss the US economy goodbye. It may take a few years before the loyalists and permabulls throw in the towel, but the handwriting is on the wall.
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.

What we have from Team Obama is a bigger abortion of a :"throw money at bad bank assets" plan that I feared in my worst nightmare. And (when we get to the Post preview), they have the temerity to invoke triage to make what they are doing sound surgical and limited.
Those who remember the origin know that triage means focusing on the middle third of the wounded on the battlefield : leaving the goners to die, leaving those wounded but stable to fend for themselves for the moment (they were in good enough shape to wait to be transported or hold on to be treated later). The middle third, those in immediate danger but who might nevertheless be salvaged, got top priority.

The concept of "triage" recognizes that resources are limited, tough decision need to be made, and some are beyond any hope. But in Team Obama Newspeak, triage means everyone can be saved because resources are presumed to be unlimited:

The basic problem confronting the government is that banks hold large quantities of assets that they value on their books for much more than investors are willing to pay…
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 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.

Instead of taking a single approach, the Obama administration plans to divide assets and other loans into three categories, each with its own solution, according to sources familiar with the discussions, speaking on condition of anonymity because the details are not finalized.

The government would buy and hold on to those assets whose falling prices are putting banks under the most pressure. Officials want to limit these purchases because of the vast expense.

The centerpiece of the plan would be a guarantee to limit losses on a second group of troubled assets that can be kept by the banks because they have more stable prices.

And it would allow banks to retain and profit from their healthiest assets.

Beyond these initiatives, the government also is likely to inject more capital into troubled institutions.
Yves again. This sounds completely arbitrary, despite the pretense of faux science. Do they want to buy the assets most underwater? The assets most at risk of further price declines? The assets with that are the hardest to value (like lower rated CDO tranches?). It may simply be that the Post reporter doesn’t appreciate the issues at work, but I wonder if the extreme vagueness reflects instead failure to come to grips with the real objectives (which means Wall Street will be able to manipulate them) or that they don’t want the public to know what is going on (per the persistent stonewalling of efforts to find out what securities the Fed has bought and taken as collateral).

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.

And what, pray tell, is the point of the guarantee? The loss exposure on a guarantee (versus a purchase) at the same nominal price is the same, although the initial cash outlay is considerably different. Ah, but if the paper is guaranteed, then your friendly bank welfare recipient can bring the junk to the Fed and get nice cash back.

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 show 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 no labor under the delusion that there are cheap or easy ways out of our financial sinkhole. People are suffering, and we are only partway through the process of contraction and writeoffs. I heard of a suicide today, a jewelry dealer who was $400,000 in debt (also owed a lot of money but unable to collect) who threw himself off 10 West 47th Street (from someone else in the building, this is no urban legend). A tragedy, and a visible one, and there is plenty of less acute but no less real trauma afoot.

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. A lot of big financial institutions have been on the ropes for over a year. A security holding is not a marriage. When conditions change, prudent investors reassess and adjust course accordingly. If anyone is long a lot of dodgy bank paper now, they have only themselves to blame. Any why are rank and file bankers still exempt from pay cuts when the workers in another failing US industry, autos, expected to take big hits?

This is the most roundabout and probably the most costly way to not solve this problem. Another warning from the IMF paper:
All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway. Also, closure of a nonviable bank is often delayed for too long, even when there are clear signs of insolvency (Lindgren, 2003). Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the government’s fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.

The most amazing bit is the government acts as if it has no leverage. Look how Paulson sent teams in to inspect the accounts of Fannie and Freddie and put them into conservatorship. The reason it is obvious that this program is a crock is that it has ben cooked up in the complete and utter absence of any serious due diligence on the toxic holdings of the big banks.

As we discuss in a separate post, the one punitive element, executive comp restrictions, are mere window-dressing. Welcome to change you can believe in.

Research related articles:
Wall Street Bank Run
The Destructive World of “Troubled Assets”: Paulson shoots another arrow into the heart of the Economy
Bank bailout could cost $4 trillion
Bank of America to receive additional $20 billion
After Citigroup, is Bank of America next?
Bank Shares Slump, Led by Wachovia
Bank of America to Get Billions More From Treasury
Paulson Says Troubled Assets Will Not Be Purchased
World faces “total” financial meltdown: Bank of Spain chief
Proposed Aggregator Bank is a Trojan Horse for the New “United States Bank”
Bank profits plunge 84 percent in 4Q
Large U.S. bank collapse seen ahead

Cheney warns of new attacks
JOHN F. HARRIS & MIKE ALLEN & JIM VANDEHEI
Politico
February 4, 2009

Former Vice President Dick Cheney warned that there is a “high probability” that terrorists will attempt a catastrophic nuclear or biological attack in coming years, and said he fears the Obama administration’s policies will make it more likely the attempt will succeed.

In an interview Tuesday with Politico, Cheney unyieldingly defended the Bush administration’s support for the Guantanamo Bay prison and coercive interrogation of terrorism suspects.

And he asserted that President Obama will either backtrack on his stated intentions to end those policies or put the country at risk in ways more severe than most Americans — and, he charged, many members of Obama’s own team — understand.

“When we get people who are more concerned about reading the rights to an Al Qaeda terrorist than they are with protecting the United States against people who are absolutely committed to do anything they can to kill Americans, then I worry,” Cheney said.

Protecting the country’s security is “a tough, mean, dirty, nasty business,” he said. “These are evil people. And we’re not going to win this fight by turning the other cheek.”

Citing intelligence reports, Cheney said at least 61 of the inmates who were released from Guantanamo during the Bush administration — “that’s about 11 or 12 percent” — have “gone back into the business of being terrorists.”

Read full article
Research related articles:
Change? Cheney Backs Obama’s National Security Team
McCain On Whether Cheney Might Serve In His Administration: ‘Hell, Yeah’
Cheney: Bush’s actions legal if not impeached
Brzezinski: Last two US presidents tested early by al Qaeda attacks
Obama team will get crisis training to prepare for terrorist attacks
Hans Blix Would Testify Against Bush-Cheney War Crimes
Flashback: Possible “DC Madam” / Dick Cheney Affair Raises Ire Among Concerned Citizens
India warns all options open with Pakistan after Mumbai attacks
The Cheney Doctrine
FBI warns of revenge attacks by Hezbollah
Bush warns of ‘lasting’ damage
Obama: No Gitmo Closure Anytime Soon

(part 1/6)

Obama Administration Threatened Britain To Suppress Torture Evidence
Paul Joseph Watson
Prison Planet.com
Wednesday, February 4, 2009

The Obama administration has been caught in a fresh torture controversy after it emerged that America threatened to cease all intelligence ties with Britain if it revealed that a British suspect held at Guantanamo Bay had been tortured into confessing to being part of a dirty bomb plot.
“Two senior British judges have expressed their anger and surprise that President Barack Obama’s Government has put pressure on Britain to suppress evidence of torture in US custody,” reports the London Times.

“Lord Justice Thomas and Mr Justice Lloyd Jones said they had been told that America had threatened to stop co-operating with Britain on intelligence matters if evidence were published suggesting that Binyam Mohammed, a British resident held at the US prison camp at Guantánamo Bay, had been tortured into confessing crimes.”

In their ruling, the judges, acting on behalf of the Foreign Office & Commonwealth Office, scorned the hypocrisy behind the Obama administration’s actions.
“We did not consider that a democracy governed by the rule of law would expect a court in another democracy to suppress a summary of the evidence contained in reports by its own officials . . . relevant to allegations of torture and cruel, inhumane, or degrading treatment, politically embarrassing though it might be,” they stated.

“We had no reason . . . to anticipate there would be made a threat of the gravity of the kind made by the United States Government that it would reconsider its intelligence-sharing relationship, when all the considerations in relation to open justice pointed to us providing a limited but important summary of the reports.”

Binyam Mohammed has been held at Guantanamo Bay since September 2004 after being kidnapped at the behest of U.S. authorities in Pakistan in 2002. He claims he was tortured and mistreated into confessing to being part of a dirty bomb plot. Reports written by U.S. intelligence officials apparently confirm Mohammed’s claims.

The British judges declined to publish the reports after America’s threat, but lambasted America for bullying Britain to conceal information that posed no threat to America’s national security.
“Championing the rule of law, not suppressing it, is the cornerstone of a democracy,” said the ruling.
“The suppression of reports of wrongdoing by officials (in circumstances which cannot in any way affect national security) would be inimical to the rule of law and the proper functioning of a democracy.”

The controversy follows the revelation that Obama, despite his superficial moves against torture which have been given much attention by the establishment media, has in fact signed an executive order that will ensure a continuance of the practice of “rendition,” the secret capture, transportation, and imprisonment of so called “enemy combatants” in countries renowned for carrying out torture.
Secret rendition “black sites” hit the headlines in late 2005 when U.S. and foreign intelligence officials blew the whistle on the CIA’s practice of hiding and interrogating “al Qaeda” captives at a Soviet-era compound in Eastern Europe.

The secret facility was revealed to be part of a covert CIA prison system, set up after 9/11, that at various times included sites in eight countries, including Thailand, Afghanistan and several democracies in Eastern Europe, as well as a small center at the Guantanamo Bay prison in Cuba. The Washington Post refused to name the European countries involved after pressure from senior U.S. officials.
Horror stories of brutality and psychological torture of detainees at the secret prisons emerged soon after.

Many on the political left were fast and loose with their praise for Obama after he made moves to shut down Guantanamo Bay, but the real torture black sites and the process by which suspects are kidnapped and taken to them will remain in place thanks to Obama’s executive order.

Research related articles:
British authorities colluded to have man tortured, shipped to Guantanamo, rules judge.
Court gags ex-SAS man who made torture claims
Top Bush Administration officials pressured underlings to use torture tactics at Guantanamo
Former SAS man condemns British role in Iraq and Afghanistan torture
Obama & Biden To Protect Bush Administration Criminals
Duncan Hunter: Torture Provided ‘Enormously Valuable Information That Saved American Lives’
Scalia: “Absurd” to Suggest that the U.S. Shouldn’t Torture Supposed Terrorists
Wikileaks Proffers Photo Evidence of Bizarre U.S. Torture
Obama advisers: Bush era war criminals will walk
Iraqi group files 200 lawsuits against Rumsfeld, US security firms for torture
Bush administration gave nod for CIA waterboarding: report
Obama administration warns public to expect rise in US casualties