Friday, October 10, 2008

Let's Buy Us Some Banks

An apparent trend in the various bail-out plans in the US, UK, and Europe: whatever one country does, all of the other ones have to do. Ireland, for example, was one of the first to start guaranteeing all bank deposits, and their move started to pull cash away from the UK. In the end, every country will have to adopt the strongest safety net of any country to prevent a flight to safety.

It also looks like the US will actually buy some banks. This is a good thing for three reasons:
  • How much do we pay for a toxic MBS? No one knows. There is no market for them. How much do you pay for a bank? That's easy, there is a stock price. (It's not real high, but it does exist.)
  • If we are going to give the banks some money, what do we get in return? If we buy a piece of the bank, we get a piece of their profits should they survive. No taxation without representation, so to speak.
  • The only way a bank gets more capital to invest when we buy an MBS is if we pay too much! (If we pay the amount they have "on the book", then the buy-out looks like a net change of zero for them.) So when we buy toxic assets we have to overpay or hurt the bank. By buying the bank itself, the bank can do better.
Of course, this sort of sucks for current bank management and current bank investors. We should not care! The bank lobby hates the idea of tax payers having equity, and that alone is an endorsement in my mind.

The bank lobby, in trying to claim that buying the banks is a bad idea, say that this would scare away outside private investment. George Soros, who is the kind of outside investor we need, disagrees:

And of course I reiterate what I've said before...besides the problem of over-paying for toxic assets and not knowing what to pay for toxic assets, the government shouldn't own mortgages that are in high default - too much political pressure to not liquidate the houses by foreclosing. I hate to be in favor of foreclosures, but there is no light at the end of the tunnel until we work the sub-prime crud out of our system - delaying that process only makes it hurt longer.

Other ranty points:
  • McCain is crazy to want to lower corporate taxes - they just had record profits for years...why would they need lower taxes? Money doesn't grow on trees! They're not going to do more business with lower taxes, they're just going to pay less taxes.
  • I can't tell what McCain plans to do about houses from his web site. The devil is in the details: buying mortgages at face value is a terrible idea - it's a cash give-away to banks, just like TARP if TARP buys assets. (It appears that TARP will let the treasury buy assets or equity.) Buying the mortgages at face value is a bail-out to banks with poor lending discipline and, by artificially propping up home prices, stops the market from clearing to sane price levels.
The government does need to provide mortgage financing at good interest rates to credit-worthy borrowers, but banks need to eat the loss on their loans.


Anonymous said...

Interesting reading.

In the long run the government would make money buying subprime mortgages at a hefty discount. It would make money by buying shares in the banks too and selling them when appropriate.

What bothers me is the provocative nature of the attacks by the Rep. candidates and McCain referring to certain websites - no doubt, extreme - in an interview, as well as the constant replaying of attack ads by Faux News in the name of news. Instigating fear added spook value in foreign markets at a time when the world needed reassurance that Uncle Sam could get its house in order.

The outside world doesn't see the NRA ads in Michigan and other places showing a rifle range target captioned "Defeat Obama," but I know that many fear such an outcome and are appalled by the whole spectacle. The constant drumming about Ayres and Acorn smell like a setup of sorts.

Americans mightn't care about how this election is viewed by the outside world, but in my eyes at least, anything short of a landslide result would diminish the standing and influence of the most powerful nation on earth, if not confirm its declining superpower status.


Benjamin Supnik said...


Hefty discount is the key. The problem with buying toxic assets is that it sets up a zero sum payers can only make money by buying the assets at a discount, but this act forces a write-down, further weakening bank balance sheets.

At a time when the government is trying to un-freeze credit markets, weakening lenders isn't so good...that's what makes equity a better choice - no zero sum game between tax payers and lenders. (It's not good for share-holders, but if they don't eat the risk of their investments, it creates a moral hazard.)

As for McCain vs. Obama, the country is really divided - no matter who wins I fear that the issues separating the left and right don't really lend themselves to compromise. We've had a lot of division since 1992.