Saturday, February 21, 2009

What to do about the Banks

The more I think about it, the collapsing market value of big US banks may render the brouhaha over nationalization moot.

The government could simply make the following clear

1) There will be no more sweetheart capital injections into the big banks

2) They can be bought by the government at a reasonable premium to current trading price or they can fend for themselves

We can let the shareholders take it from there.

My guess is that they will force management to take the deal. If they don't it is because management can convince the shareholders that the bank can make it own its own.

In this scenario the government probably overpays for Citi for example, since the stock is probably intrinsically worthless and only trades above zero on the possibility of more government injections. However, right now Citi only costs $10B.

While that's not nothing, it may be a small price to pay to avoid a national food fight over whether the government is unjustly seizing private interests.

Once the bank is fully owned by the government it can be recapitalized. Now the government can inject as much money as it wants and all the profit winds up coming back to the government.

In theory we don't even have to change management. We don't have to do anything at all that disrupts the day-to-day operation of the bank. We are merely changing shareholders, something that happens everyday with bank employees or customers thinking much about it.

Thursday, February 19, 2009

Is Obama's Mortgage Subsidy Bad Simply Beause Its Obvious

By now you may have heard that part of the President's plan to deal with the housing crisis is for the government to subsidize subprime mortgage modifications. That is, if the lender will agree to lower the payment to a predetermined affordable amount the government will make up part of the difference.

The goal is to prevent foreclosures. A little know secret is that lenders often, indeed typically, modify loan terms when a payee gets behind. However, this happens only if the payee can show that he or she can make the new payments and not get behind again.

Well, the problem now is that people are so underwater many cannot even make the typical modified payments. So, the administration is stepping in.

This proposal, however, has drawn ire from the financial and economic communities. It is very clearly a subsidy from those who are making their mortgage payments to those who are not. It rewards people who took excessive risk, either by getting a mortgage that was too big or opting for a payment schedule that would including rapidly rising rates.

However, before we get too upset, too quickly shouldn't we wonder whether this isn't simply a more explicit version of the Wall Street bailout that the financial community supported almost universally.

On the one hand, Wall Street firms had to turn over stock and stock options to the government in exchange for their funds, while the these mortgagees will be getting the money with no strings attached.

On the other hand, however, the terms of the Wall Street bailout were much more favorable than anything those firms could have received in the private market. Indeed, that was the point. The government was the investor of last resort.

We favored that plan not because the banks deserved it, but because the consquences of not doing it outweighed the costs. We were risking systemic failure if we did not act and it was not sensible to cut off our nose to spite our face.

So, shouldn't we at least measure the subprime subsidy on those same terms. Will it save taxpayers on average more than $75 Billion? Will it slow the tide of foreclosures, bank writedowns and institutional bailouts enough that the nation as a whole makes it money back?

I don't know the answer to that question, but shouldn't that be basis of our analysis? Desperate times call for clear, rational solutions. We quite simply can't afford to indulge our emotions, whether it is sympathy for those who will loose their homes or anger at those who took on more than they could handle.