Just Say No to Zombie Banks!

The market seems to have stabilized for awhile as Ben Bernanke has been giving speeches and making appearances every where he can.  For those of you  that really want to take on empirical studies in Economics (econometrics and all), this is a part of a strategy he outlined in  Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment.  (Bernanke and Reinhardt 2001).  It’s 113 pages long so be prepared to spend some time with it like I did last year.  However, my guess is you can read the front parts and the back parts and skip the methodology and findings and be just as happy.  It is basically the Chairman’s take on the Japanese Lost Decade and monetary policy at the time.  It talks about quantitative easing which is the new approach that even the Bank of England is using now.  That is when the Central Bank uses its balance sheet to buy and sale various financial assets to try to unclog lending channels. Since this is the first time the acting Chairman of the Federal Reserve Bank has ever appeared on any major news channel to have a fire side chat as in last night’s appearance on Sixty Minutes, I thought I’d point you to the motive behind the method.  It’s outlined in that academic paper.  Bernanke and Reinhard argue that Federal Open Market Committee (FOMC) announcements of policy and other announcements by the Fed shape market expectations and results. (Yes, I know El Presidente told us we shouldn’t care about the DJ but the FED chair still does because he knows IT MATTERS.)

Has the Federal Reserve’s policymaking body, the Federal Open Market Committee, historically exerted any influence on investors’ expectations about the future course of policy? Although members of the FOMC communicate to the public through a variety of channels, including speeches and Congressional testimonies, official communications from the Committee as an official body (ex cathedra, one might say) are confined principally to the statements that the FOMC releases with its policy decisions.

…

The FOMC has moved significantly in the direction of greater transparency over the past decade. Before 1994, no policy statements or description of the target for the federal funds rate were released after FOMC meetings. Instead, except when changes in the federal funds rate coincided with changes in the discount rate (which were announced by a press release of the Federal Reserve Board), the Committee only signaled its policy decisions to the financial markets indirectly through the Desk’s open market operations, typically on the day following the policy decision. In February 1994, the FOMC began
to release statements to note changes in its target for the federal funds rate but continued to remain silent following meetings with no policy changes. Since May 1999, however, the Committee has released a statement after every policy meeting.

The FOMC statements have evolved considerably. In their most recent form, they provide a brief description of the current state of the economy and, in some cases, some hints about the near-term outlook for policy. They also contain a formulaic description of the so-called “balance of risks” with respect to the outlook for output growth and inflation. A consecutive reading of the statements reveals continual tinkering by the Committee to improve its communications. For example, the balance-of-risks portion of the statement replaced an earlier formulation, the so-called “policy tilt”, which characterized the likely future direction of the federal funds rate. Much like the “tilt”statement, the balance of risks statement hints about the likely evolution of policy, but it does so more indirectly by focusing on the Committee’s assessment of the potential risks to its dual objectives rather than on the policy rate. The relative weights of “forward looking”and “backward-looking” characterizations of the data and of policy have also changed over time, with the Committee taking a relatively more forward-looking stance in 2003 and 2004.

Of course, investors read the statements carefully to try to divine the Committee’s views on the economy and its policy inclinations. Investors’ careful attention to the statements is prima facie evidence that what the Committee says, as well as what it does,matters for asset pricing.

I’ve highlighted that last paragraph because it is extremely important in explaining both the Chairman’s sudden interest in TV appearances and the market’s relief rally recently.  Bernanke has been out there saying that the Fed will not let major banks fail, he dislikes then entire AIG thing and wants to ensure it never happens again,  he’s been asking the senate committees he visits for more regulation, and he’s repeatedly said that the FED expects the recession to experience the trough later this year.  We’ve not seen any meaningful discussion about the type of recovery to expect (L shaped or otherwise).  We have however, seen more upbeat statements geared to appease the markets and their role in asset pricing.

Which brings me back to the sort of recession recovery we might expect when it does occur and the fact that we still haven’t dealt with the problems in the financial system.  This is the best discussion I’ve seen to to date that succinctly covers our options for dealing with the banks and other financial institutions that basically collapsed from overleverage and poor lending practices.  It’s from VOX and is entitled:  “Good Bank vs Bad Bank:  Don’t touch the unsecured creditors!  Clobber the tax payer instead. NOT. ”  This article by European Economist Willem Buiter covers several academic studies and approaches to solving the banking crisis.  The best ones do not include setting up zombie banks which is essentially what we’re beginning to see the de facto policy of the Obama regime become.  (Check that last link because it lists what are now considered by most folks to be ‘zombies’.) The motivation is simple.  It passes the cost of bad decision making by investment bankers, hedge funds, the sovereign wealth funds,  and the biggest of the biggest megainvestors to the tax payer.  Basically, it’s protecting the Obama campaign fund base deeply rooted in folks like Penny Pritzker.  Here’s a money line for you.

The Good Bank solution favours the tax payer. The Bad Bank solution favours the unsecured and non-guaranteed creditors of the zombie banks. ‘Tax payer’ includes those beneficiaries of public spending programmes that may have to be cut to meet the fiscal cost of purchasing or guaranteeing the toxic assets under the Bad Bank solution. It also includes those who lose as a result of future inflation or sovereign default, should either of these two solutions to dealing with the public debt created as a result of the Bad Bank solution eventually be adopted.

The Bad Bank solution also favours the shareholders of the zombie banks, but in the case of RBS, this is mainly the government and therefore the taxpayers. The amount of shareholder equity involved in the zombie banks is, in any case, negligible compared to the exposure of the unsecured and non-guaranteed creditors. The Bad Bank solution also saves the jobs and perks of the top management and the boards of the zombie banks – often the very people responsible for turning a once-healthy bank into a zombie bank.

There can be no doubt that, from a distributional fairness perspective, the Good Bank solution beats the Bad Bank solution hands down.

I’ve been giving much thought about why we’re not seeing Secretary of the Treasury come up with the plan he appeared on the verge of announcing several times.  He’s worked for the FED which is the main regulator of banks.  He’s also worked for the Treasury before.  He has to know about these things.  It must be that lack of political will on the part of congressional leaders and the administration to skewer their best campaign contributors.  That’s the only thing I can deduce at this point. The article cites ‘special interests’ pressures also.

Here’s the basic idea of a ‘good bank’ as explained by the VOX article.

Under the Good Bank approach, the state creates a new bank, the Good Bank, which gets the deposits and the clean assets of the old banks. The old bank gets compensation equal to the difference between the (known) value of the clean assets it loses and the value of the deposits it gives up. The state may also inject additional public capital into the Good Bank, or it may invite in additional private capital. Government financial support is given only to new lending, new investment, and new funding by the Good Bank. The legacy (ex-)bank has its banking license taken away and simply manages the existing stock of toxic assets. The legacy (ex-)bank does not get any further government support.

During the Dubya years, the taxpayers footed a bill to enrich oil companies and the military industrial complex at the taxpayer’s expense. We ignored global warming and transferred dollars to the likes of KRB and Halliburton.  The result has been a complete disaster.  Now, we have a repeat of similar circumstances in dealing with the financial system.  The solutions we’ve seen so far are political at best, self serving at worst.   I have to say I always used to admire Maxine Waters and Barney Frank.  I knew Biden and Dodd were overly friendly with the monopoly banks but I thought Waters was one of the good people That was until this year.  Read this and weep from the WSJ:  Waters Helped Banks Whose Stocks She once Owned.  I also watched her repeatedly say there was no problem with Fannie and Freddie when they were close to bankruptcy and when at least one of the former CEOs was under suspicion of loan churning to increase their merit pay. Even Maxine appears to be knee deep in the problems.

When Rep. Barney Frank was looking to aid a Boston-based lender last fall, the Massachusetts Democrat urged Maxine Waters, a colleague on the House Financial Services Committee, to “stay out of it,” he says.

The reason: Ms. Waters, a longtime congresswoman from California, had close ties to the minority-owned institution, OneUnited Bank.

Ms. Waters and her husband have both held financial stakes in the bank. Until recently, her husband was a director. At the same time, Ms. Waters has publicly boosted OneUnited’s executives and criticized its government regulators during congressional hearings. Last fall, she helped secure the bank a meeting with Treasury officials.

Et tu Maxine? Until congress and the president realize they serve the people and not the creditors of financial institution we are not going to have a real solution to this problem and we will not have a complete economic recovery.  Just remember what the Zombie banks did to Japan.