Bankers LIE

Lots of smart people from different cages in the political zoo are commenting lately about banks and how they work, or don't. Apart from the stimulus package the administration has another slush fund from which to draw water for a thirsty economy, the bailout money remaining in TARP. It's fair to say that money is not burning a hole in anyone's pocket, but everyone agrees that in this case time is "of the essence." The sooner lighter fluid gets squirted on the fire, the sooner the charcoal starts to burn.

Mr. Geitner the Treasury Secretary, decided that since heaping big amounts into a few big banks proved to be a failed effort, it is better to parcel out smaller amounts to a greater number of banks in hopes that by doing so he can get things moving faster. Problem is that the whole banking system is shot through with bad accounting which the financial community likes to call "under stress."

Call it what you want, it all cooks down to carrying outstanding obligations on their books, some of which are more unlikely than others to be worthless. If what I have been reading is close to reality, the next few months will witness a bloodbath in the world of banking that will look like a scene from a Bruce Lee film. Here are a few links for further reading.

Reader advisory: This stuff is by wonks, for wonks and about wonks. Very dry, indeed. Some of it long and boring. Wade in at your own risk and don't complain you weren't warned.

The Stress Test: Time for Transparency by James Kwak

The stress test is supposed to indicate which banks are healthy and which aren’t (so they can be fixed or closed). We need this for the reason most of you already know: nobody thinks the banks (meaning, mainly, the big ones) are healthy. The New York Times has a good summary of the situation. Nouriel Roubini thinks U.S. banks are facing another $1 trillion in write-downs. The IMF thinks it’s more like $500 billion. The only people who think the banks are healthy are the bankers themselves...

Remember that last bit as you read. This next link is not directly about about banking and finance but it pertains to the intended result if money once again gets moving.

"Hurry Up and Waste" by Mark Thoma

...by emphasizing the worthiness of his spending proposals, Obama has allowed the debate to revolve around the merits of each project. Normal spending is judged on those terms--whether the goods or services justify their cost. The point of stimulus spending, by contrast, is simply to spend money--on something useful if possible, wasteful if necessary. Keynes proposed burying money in mineshafts, so that workers would be hired to dig it out. (Imagine what the GOP could do with material like that.) World War II was an effective stimulus that, economically speaking, consisted of 100 percent waste. If war hadn't broken out, we could have enjoyed the same economic benefit by building all those tanks and planes and dumping them into the ocean.

William Black: "There Are No Real Stress Tests Going On" by Yves Smith

By way of background, William Black is a former senior bank regulator, best known for his thwarted but later vindicated efforts to prosecute S&L crisis fraudster Charles Keating. He is currently an Associate Professor of Economics and Law at the University of Missouri - Kansas City.

More germane for the purpose of this post, Black held a variety of senior regulatory positions during the S&L crisis.He managed investigations with teams of examiners reporting to him, redesigned how exams were conducted, and trained examiners.

...it is more likely that the banks will get scorecards that show them to be in various stages of peril, but none will be found to be terminal. (They can't be given a clean bill of health, that would call the whole rationale of the TARP and its various injections into question, and also would put Geithner at considerable risk if any bank declared OK fell over in less than 12 months).

But even the designation of "sick but not ready to be hospitalized" carries with it risk to the Administration. If the banks get sicker than anticipated, how can they explain it? They can't say, "oh, things got worse than we contemplated". The whole point of a stress test is to anticipate worst case scenarios. And it is pretty certain a fair number of the big banks will be on such large-scale life support by year end that it will be hard to make a case not to put them in receivership.

...You can't conduct a meaningful stress test without reviewing (sampling) the underlying loan files and it seems likely that the purchasers of securitized instruments (not just mortgages) do not even have the loan file data. Moreover, loss ratios vary enormously depending on the issuer, so even a bank that originates (or has purchased a bank that originates) similar product cannot simply take its own loss rate and extrapolate it to the measure the risk on the value of securitized credit instruments.

...it takes examiners with experience, care, courage, and investigative instincts and abilities. Very few folks earning $60K are willing to get in the face of the CEO and CFO making $25 million annually and tell them that they are running a fraudulent bank and they are liars.

...Black is not using the fraud word lightly. He believe that we have Enron-level accounting fraud happening, now, in the financial services industry. And we have asked repeatedly, why has there been no investigation of fraud at Lehman? There was a $100 billion plus hole in its balance sheet, meaning a substantial negative net worth, when its financial statements presented a completely different picture.

He goes on the describe how the complexity of the challenge of assessing the financial health of any bank is greater than can be determined by a few outside examiners. In the end, the only people who know the truth are employees of the banks themselves. And if they haven't been doing a good job, it certainly is not in thier interests to rat out themselves.

I've saved the best for last. Unfortunately, this one is also the longest. I printed it off to carry it to the loo, but once you get going, it's not hard reading. However, the reader needs to have done a little background reading to appreciate what is said. I got the link via Cassandra Does Tokyo.

Bank solvency and the "Geithner Plan" by John Hempton

...I used to be an (Australian and New Zealand) Treasury official and thought I gave up policy analysis when I ceased being a bureaucrat.

But the analysis of banks got intertwined with the analysis of politics. You can’t possibly decide what bank to invest (or for that matter short) without an understanding of where the politics is. If the government is going to keep giving money to banks (as per the Citigroup bailout) then you just have to own them. If the government is going to be harsh (as per the AIG bailout) then you want to run a mile. And they could be harsher than that. There are lots of possible outcomes – and the outcomes seem uncorrelated to the solvency of the institution. WaMu was probably solvent (subject to definitions below) and was confiscated – certainly – according to the FDIC – it had enough capital when it was confiscated. Wachovia was forced to sell itself when solvent (and when Wells happily purchased them later proving the point). AIG was shockingly insolvent and the shareholders were 80% diluted. Citigroup was in much bigger trouble than WaMu (it was actually illiquid) and the shareholders were given a big kiss (lots of very cheap government money and guarantees) and told to go on their way.

The government policy is very hard to determine. Under the Bush administration there was no policy. Each financial institution in crisis was handled a different way – think Bear, Lehman, AIG, Fannie and Freddie, WaMu, Wachovia, Citigroup. No two deals were even close to similar. Ad-hoc – thy name is Hank Paulson.

We have gone from an administration which demonstrated that it had no plan to the “Geithner Plan”. The “scare quotes” around “Geithner Plan” are because it is unfair to even call the “Geithner Plan” a “Plan”. As far as I can see there is no detail – and if you don’t have detail you don’t have a plan. I will remove the scare quotes when I think the Obama administration has a plan.

That said – lets put some framework around “the plan” – such as it is

There is no way for me to parse what follows.

Just know that my post title "Banks LIE" is not the punch line. It is the theme. I always knew my suspicions about banks and banking were as poisoned as my attitude about insurance but in recent years, thanks to having banked with some very well-run big banks I almost changed my mind.

The food business taught me that size is the enemy of service. But we were never so big to discover another obvious reality, that size is also the mother of corruption. The bigger the institution, the easier it is for immoral people to escape detection and the greater the temptation to steal.

Robert Reich offers a cliff notes version of what's going on that covers all one really needs to know in a few short paragraphs.

The only way to make sense of Tim Geithner’s “stress test” for banks is to assume a kind of triage. Banks that are reasonably healthy right now -- whose assets are fully adequate to fund their liabilities, and can make new loans -- don't need a bailout. And banks that are too far gone to save –- whose loans when realistically valued won’t make them solvent even when the economy recovers -- shouldn't be bailed out. They should be put under receivership that pays off depositors, wipes out shareholders, and then closes the bank.

This leaves a third category of bank that could be salvaged -- whose assets are likely to be enough to make them solvent when the economy turns up again -- but that need bailouts in the meantime. Money from the Treasury and Fed will be used to lure outside investors to buy up these banks' bad loans and clear up their balance sheets so they can make new, responsible loans.

At least, that's the only sense I can make of it.

But how much of our financial system falls into the “too-far-gone-to save” category, and how much into the “might be saved with taxpayer help?” And how will Geithner and his colleagues at the Treasury be able to tell? After all, we got into this mess because banks were fiddling with their numbers and making bets off their balance sheets. And most still aren’t willing to write down their bad loans to realistic market values.

It would be far cheaper, quicker, and safer for the government to just take over every questionable bank. This is the only way we can get the truth about which should be shut down. And the way taxpayers who will be bailing out salvagable banks can ever recoup our costs. Why should any upside gains go to private shareholders who made bad bets or to bank executives and directors who got us into this mess in the first place?

Meanwhile, the rest of America could stand a stress test on a much bigger scale. No need to worry about families with adequate assets to get them through the storm. And the stimulus will help many others. But families that have lost their savings and are within a few years of retirement, or whose breadwinners have been out of work for months and have exhausted their unemployment benefits, or have no health insurance, or who are on the verge of losing their homes – may not make it. Instead of rewarding executives of insolvent banks that would otherwise fail, we should be helping insolvent families for whom failure spells disaster.