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What are the remaining pressure points?
Do read up on Arnold Kling before proceeding. From my outsider's vantage point, it seems that commercial bank failures and consolidations are already being handled (see Alex's recent posts) and of course the investment banks are gone. Money market funds are now (mostly) insured. I see three key questions for the next few weeks:
1. Will there be a run on hedge funds?
2. Will the commercial paper market dry up?
3. Will the Fed have to bail out any major foreign banks?
At this point, perhaps the Paulson plan is directed against these contingencies rather than being for the commercial banking sector per se. From this list, it is least clear how the Paulson plan would handle #2, although you could point to a short-run confidence effect. Will that last? #2 is the hardest to handle without implicitly socializing parts of the real economy and if you have good proposals for #2 please let us know. How much can corporations bypass the commercial paper market altogether?
"Recapitalization is a public good" is one key phrase for this crisis; "no natural buyers" is another. So far debate over the plan has focused on the first phrase but not the second.
Addendum: Bruce Bartlett defends the Paulson plan. So does Kudlow.
Posted by Tyler Cowen on September 27, 2008 at 10:55 AM in Economics | Permalink
Comments
Here's my proposal. Let me buy my own mortgage back for 22 cents on the dollar.
Posted by: David at Sep 27, 2008 12:15:50 PM
VRDOs. When the remarketings fail en masse, there will be a few hundred billion in draws on bank and GSE credit enhancement instruments.
Posted by: y81 at Sep 27, 2008 1:00:04 PM
One of the things that has pushed (and been successful) home ownership has been the mortgage interest deduction. I'm wondering if something similar could be done for a 1-2 year period for short-term commercial paper. In other words, could a corporate tax write-off of the interest of short-term loans be put in place for a couple of years?
Posted by: Chris at Sep 27, 2008 1:42:24 PM
Wall Street Executives Made $3 Billion Before Crisis
By Tom Randall and Jamie McGee
Sept. 26 (Bloomberg) -- Wall Street's five biggest firms paid more than $3 billion in the last five years to their top executives, while they presided over the packaging and sale of loans that helped bring down the investment-banking system.
Merrill Lynch & Co. paid its chief executives the most, with Stanley O'Neal taking in $172 million from 2003 to 2007 and John Thain getting $86 million, including a signing bonus, after beginning work in December. The company agreed to be acquired by Bank of America Corp. for about $50 billion on Sept. 15. Bear Stearns Cos.'s James ``Jimmy'' Cayne made $161 million before the company collapsed and was sold to JPMorgan Chase & Co. in June.
Democrats and Republicans in Congress are demanding that limits be placed on executive pay as part of the $700 billion financial rescue plan proposed by U.S. Treasury Secretary Henry Paulson. The former Goldman Sachs Group Inc. CEO, who received about $111 million between 2003 and 2006, said in testimony to Congress on Sept. 24 that he would accept such limits as part of the plan, after initially opposing them.
Posted by: Happy Camper at Sep 27, 2008 2:17:53 PM
Commercial paper is an important market, but all or virtually all non-financial company issuers have back-up lines of credit with a bank to protect them from temporary disruption of the market. This is a lesson learned from the Penn Central crisis.
Can commercial banks provide credit to all the commercial paper issuers? Access to money is no problem. The banks can borrow from the Fed's discount window, and the Fed would be happy to lend to banks for this purpose.
The challenge might be that additional bank lending would balloon bank balance sheets, which would require additional capital. However, non-financial company commercial paper outstandings run about $200 billion, while total banking industry assets are $11 trillion. So no problem.
The real decline recently in commercial paper oustandings is from financial company issuers. These outfits can access Federal Reserve borrowing directly now.
So the bailout bill is not necessary because of the commercial paper market.
Posted by: Bill Conerly at Sep 27, 2008 2:23:48 PM
Bill,
So why aren't they doing it if it is so easy. Honda is paying 300 more basis point for paper for car loans as of this week. Are they stupid or is there more to the story?
Posted by: RobbL at Sep 27, 2008 9:28:40 PM
Drop FAS 157 and adopt innternational accounting standards. THe problem vanishes.
Posted by: kp at Sep 27, 2008 9:35:00 PM
Here's the view of Ken Rogoff, who opposes the Paulson plan: "The idea that the world’s largest economies are merely facing a short-term panic looks increasingly strained. Instead, it is becoming apparent that, after a period of epic profits and growth, the financial industry now needs to undergo a period of consolidation and pruning.... After a period of massive expansion during which the financial services sector nearly doubled in size, some retrenchment is natural and normal. The sub-prime mortgage loan problem triggered a drop in some financial institutions’ key lines of business, particularly their opaque but extremely profitable derivatives businesses. Some shrinkage of the industry is inevitable. Central banks have to start fostering consolidation, rather than indiscriminately extending credit.... Efforts to block a healthy and normal [pruning] dynamic will ultimately only prolong and exacerbate the problem.... The financial industry is undergoing fundamental shifts, and is not simply the victim of speculative panic against housing loans.... Today’s financial firm equity and bond holders must bear the main cost, or there is little hope they will behave more responsibly in the future."
Addendum: I was opposed to the Paulson plan, and now the news that Larry Kudlow is in favor has made me more confident in my opposition.
Posted by: phineas at Sep 27, 2008 9:53:08 PM
It's worth considering the position on this of BB&T bank:
http://media.gatewaync.com/wsj/pdfs/2008/09/allison.pdf.
See CEO/Chairman John Allison's letter to Congress. I think this bailout is less necessary than suggested by some in DC and on Wall STreet.
Posted by: lgs at Sep 27, 2008 9:56:11 PM
I'm not an expert on these things, but until today I too was under the impression that MM's were "insured" by the Fed. I now believe this is NOT the case. I'll quote from deep in another forum's comments:
http://www.nakedcapitalism.com/2008/09/bailout-scare-mongering-another-bank.html
September 27, 2008 11:24 PM
Anonymous said...
The Treasury took all the teeth out of the MMF plan almost immediately because it started a run on the banks. Had they kept it in place, the same thing was about to happen in reverse -- the banks flooding the markets with paper to meet withdrawals. The FDIC couldn't carry the weight of the failures that would line up, and the Treasury has (rightfully) taken the plan down, down, down ever since. Last update I heard - which was not publicized by anyone other than the ABA - is that the plan is subject to a 90 day trial period, to be continued if successful. No major fund company is going to take the gov't up on the offer. They'll cut deep into their own fees with the premium, and they'll kill one of their best tools - the bank channel. None of these firms have the capacity to run individual accounts on a retail / commercial level, nor are they going to want to meet the Patriot Act burdens of the banks even if they could gear up for small accounts.
The commercial paper market is done one way or the other, unless they let AAAs borrow right off the Fed facility. I don't know if any of the lawmakers have the stomach for that. If only the $50b were enough to capitalize a new, private sector bank who could pick up the slack.
September 28, 2008 12:04 AM
Yves Smith said...
David,
The Treasury has not implemented the program, merely announced that it was coming and left it hanging. Check the website. They have not provided any details, merely a sketch and a promise more was coming.
Remember, this is a VOLUNTARY program, and participating money market funds must pay a fee of some sort. This is not something the Treasury is doing unilaterally.
The Treasury has not provided any details of what the charges will be and how to participate and thus no money funds appear to have signed up.
This is confirmed by readers who have called their money fund and have been told that they are waiting for details of what the program will be.
September 28, 2008 12:07 AM
Posted by: StewPDX at Sep 28, 2008 1:01:09 AM
First, this is not 1930. We will not see another great depression, no matter how hard the government tries. Otherwise, Bartlett is pretty good.
Bartlett: "The basic problem is that the financial sector faces systemic risk in a way that no other industry does: By its nature, it is a house of cards that can collapse at a moment's notice."
"The second problem with the financial system - again, by its nature - is that banks borrow short and lend long."
Now, those are damning admissions for a mainstream economist in the guise of support. Are we sure the by-line didn't get swapped with the letter from Ron Paul? Someone has been readling Austrian books in their time off. I think the next administration could probably fill all slots with individuals stabbed in the back by this one.
All we really want is to maintain the institutions to the extent that they make the market. All the failures need to go out of business eventually, and bad bets must be sold off.
Ideas (mostly not original):
Suspend mark-to-market accounting rules until they can be rationalized. Imagine if value investors (i.e. the only real investors) had to live by mark-to-market.
Whatever the Fed is doing behind the scenes to push the rapid de-leveraging, stop.
Cut taxes on CDs and anything that provides long-term capital by contract.
Stop auctioning treasuries shorter than 3 years.
Cut all taxes, most regulation and whatever else on home-based businesses.
Fast-track worker visas for educated immigrants that have employer sponsors.
Replace all incumbents and incumbent parties if possible.
Posted by: Andrew at Sep 28, 2008 9:57:16 AM
Replace all incumbents and incumbent parties if possible.
I'm with you on that but there's no way. Not without something like IRV.
At this point we could hardly be worse off if we replaced Democrats and Republicans with Greens and Libertarians. Sheesh.
I didn't believe the guys who said Obama lacked experience. I figured he'd do OK. But now the first time he gets a crisis he goes along with the scammers. No second thoughts, and he gives up his own programs. What will he do when the neocons tell him we have to invade indonesia right away or they'll get nukes? He's going to invade indonesia.
I was planning to vote for Obama but I guess I'll choose a third party candidate who can't win. What a mess.
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