The Government on Steroids Era

Finally, I found a silver lining. A downsized one, of course. Here goes; Unlike in MLB, we know when exactly when the Government on Steroids Era began, September 2008. It began under Bush, crushed McCain and then found it’s anabolic legs under Obama. It even came with a motto: Buy HGH, sell Lowe’s [and everything else in the private sector].

David Brooks points the fickle finger of fate at the challenges facing the Obama administration, and I almost wish I hadn’t read it.

All in all, I can see why the markets are nervous and dropping. And it’s also clear that we’re on the cusp of the biggest political experiment of our lifetimes. If Obama is mostly successful, then the epistemological skepticism natural to conservatives will have been discredited. We will know that highly trained government experts are capable of quickly designing and executing top-down transformational change. If they mostly fail, then liberalism will suffer a grievous blow, and conservatives will be called upon to restore order and sanity.

Not only do I think they can’t do it–neither does Brooks obviously–I don’t think any new Administration is capable of doing anything quickly and well, let alone ‘top-down transformational change.’ But it’s worse than that, Brooks is being polite–just like I’m being polite by not saying he’s sucking up–when he refers to ‘highly trained government experts.’ This Administration, like all others, are staffed based on a combination of job skills and political necessity.

Mrs Clinton is not whom Obama would prefer to represent his foreign policy, the lady who called her a monster is, but he can’t have her because she said it on video. Biden is VP partly because he is male and thoroughly white. Geithner is a compromised political liability, but the learning curve would be too steep for anyone else in these circumstances. [Noting the Commerce Secretary trial and error appointment technique is, like the actor Alan Swann, beneath me]. All these people are new to their roles and bring with them other new people, not because of their expertise, but because they are trusted by their political benefactors. Trust in this case means they would go to jail for them. Finally, our president is one month into his first executive job [the campaign banter about how running a campaign is comparable to the demands of the presidency having mercifully subsided].

It’s one thing to say that we hope the changes contemplated work out for our sake. It is another to view these circumstances objectively and have reasonable expectations as to their success.

Nationalizing Banks – An Example of The Government on Steroids Era

Incredibly, in just the last few weeks, the nationalization of the banking system has seemingly become a done deal. It will take a few weeks to work its way through the political classes. The Administration’s denials of plans to nationalize are very specific so as to allow room for the subsequent backpedaling. Here is what Bernanke said:

… nationalization is when the government seizes the bank and zeros out the shareholders and begins to manage and run the bank. And, we don’t plan anything like that.

So when they do nationalize, we know it won’t be ‘like THAT.’

Check out the who’s who of those in favor of that policy. Everyone stresses that it should only be a short-term solution–the economist’s version of the Seinfeldian ‘not that there’s anything wrong with that.’

The roundtable on the ABC political show, This Week, on Feb 22 was instructive. George Will, Nouriel Roubini and Paul Krugman all agreed that nationalization would happen. Even George Will could not muster an argument against it. I was surprised that Will did not raise any concerns that the nationalization would be temporary or short-term.

But then Tyler Cowen comes along and raises a rather elementary issue which incredibly has been under-addressed. Who or what are we bailing out? Banks or their holding companies?

Turns out that there is a reason that a lot of the initial TARP money never made it to the actual banks and therefore could not have achieved their initially stated purpose; to inject liquidity into the banking system. Their parent holding companies won’t give it to them. An excerpt from a NY Times Op-Ed piece:

While TARP has been generous with bank holding companies, these companies have not been so generous with their banks. Four large holding companies — JP Morgan, Citigroup, Bank of America and Wells Fargo — initially received a total of $90 billion in TARP money in the fall, but by the end of 2008 they had contributed less than $15 billion in equity capital to their subsidiary banks.

The holding companies seem to have invested most of their TARP money in their other businesses or else retained the option to do so by keeping it in deposit accounts, even as the capital of their banks decreased. At the same time the banks, which provide the majority of loans to large corporate borrowers, drastically reduced lending to new borrowers.

It’s easy to see why holding companies would withhold capital from their troubled banks. If a bank is insolvent — as many are now believed to be — and the government has to take it over, the holding company loses any capital it gave to the bank. Rather than take that risk, the holding company can opt to spend its money elsewhere, perhaps on trading of its own.

But this is not a good use of scarce capital. We might end up with too much of this proprietary trading and too little lending. It also means that when it comes time to recapitalize banks there is a bigger hole to fill, and when banks fail there is less capital available to meet the government’s obligations to insured depositors and other creditors. Keeping money at the holding company may benefit its shareholders, but it is costly for taxpayers.

Oh well, maybe the rookie–I mean Obama, not Cameron Maybin, in whom we do not doubt–will work out. But honestly, do you think the people who voted for Obama fully contemplated the ‘biggest political experiment of our lifetimes.’

Articles referenced are copied in full at end of post.

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The Big Test – By DAVID BROOKS

February 24, 2009 – Op-Ed Columnist

“We cannot successfully address any of our problems without addressing all of them.”

Barack Obama, Feb. 21, 2009

When I was a freshman in college, I was assigned “Reflections on the Revolution in France” by Edmund Burke. I loathed the book. Burke argued that each individual’s private stock of reason is small and that political decisions should be guided by the accumulated wisdom of the ages. Change is necessary, Burke continued, but it should be gradual, not disruptive. For a young democratic socialist, hoping to help begin the world anew, this seemed like a reactionary retreat into passivity.

Over the years, I have come to see that Burke had a point. The political history of the 20th century is the history of social-engineering projects executed by well-intentioned people that began well and ended badly. There were big errors like communism, but also lesser ones, like a Vietnam War designed by the best and the brightest, urban renewal efforts that decimated neighborhoods, welfare policies that had the unintended effect of weakening families and development programs that left a string of white elephant projects across the world.

These experiences drove me toward the crooked timber school of public philosophy: Michael Oakeshott, Isaiah Berlin, Edward Banfield, Reinhold Niebuhr, Friedrich Hayek, Clinton Rossiter and George Orwell. These writers — some left, some right — had a sense of epistemological modesty. They knew how little we can know. They understood that we are strangers to ourselves and society is an immeasurably complex organism. They tended to be skeptical of technocratic, rationalist planning and suspicious of schemes to reorganize society from the top down.

Before long, I was no longer a liberal. Liberals are more optimistic about the capacity of individual reason and the government’s ability to execute transformational change. They have more faith in the power of social science, macroeconomic models and 10-point programs.

Readers of this column know that I am a great admirer of Barack Obama and those around him. And yet the gap between my epistemological modesty and their liberal worldviews has been evident over the past few weeks. The people in the administration are surrounded by a galaxy of unknowns, and yet they see this economic crisis as an opportunity to expand their reach, to take bigger risks and, as Obama said on Saturday, to tackle every major problem at once.

President Obama has concentrated enormous power on a few aides in the West Wing of the White House. These aides are unrolling a rapid string of plans: to create three million jobs, to redesign the health care system, to save the auto industry, to revive the housing industry, to reinvent the energy sector, to revitalize the banks, to reform the schools — and to do it all while cutting the deficit in half.

If ever this kind of domestic revolution were possible, this is the time and these are the people to do it. The crisis demands a large response. The people around Obama are smart and sober. Their plans are bold but seem supple and chastened by a realistic sensibility.

Yet they set off my Burkean alarm bells. I fear that in trying to do everything at once, they will do nothing well. I fear that we have a group of people who haven’t even learned to use their new phone system trying to redesign half the U.S. economy. I fear they are going to try to undertake the biggest administrative challenge in American history while refusing to hire the people who can help the most: agency veterans who are registered lobbyists.

I worry that we’re operating far beyond our economic knowledge. Every time the administration releases an initiative, I read 20 different economists with 20 different opinions. I worry that we lack the political structures to regain fiscal control. Deficits are exploding, and the president clearly wants to restrain them. But there’s no evidence that Democrats and Republicans in Congress have the courage or the mutual trust required to share the blame when taxes have to rise and benefits have to be cut.

All in all, I can see why the markets are nervous and dropping. And it’s also clear that we’re on the cusp of the biggest political experiment of our lifetimes. If Obama is mostly successful, then the epistemological skepticism natural to conservatives will have been discredited. We will know that highly trained government experts are capable of quickly designing and executing top-down transformational change. If they mostly fail, then liberalism will suffer a grievous blow, and conservatives will be called upon to restore order and sanity.

It’ll be interesting to see who’s right. But I can’t even root for my own vindication. The costs are too high. I have to go to the keyboard each morning hoping Barack Obama is going to prove me wrong.
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Banks vs. bank holding companies – Tyler Cowen

I continue to see many bloggers suggesting that bank nationalization is a fait accompli and that anyone who isn’t on board right now is in denial. It is far less common that bloggers give serious consideration to the difference between a bank and a bank holding company. In fact I usually don’t see that critical distinction mentioned at all.

If the government nationalized (or “pre-privatized”…whatever) Citibank, Citicorp would go bankrupt and we would be back at a Lehman Brothers scenario again. So the government would have to take over Citicorp too. That goes way, way beyond anything the Swedes did or for that matter it goes well beyond WaMu. Shall I turn the mike over to Wikipedia?

Citigroup was formed from one of the world’s largest mergers in history by combining the banking giant Citicorp and financial conglomerate Travelers Group on April 7, 1998. Citigroup Inc. has the world’s largest financial services network, spanning 107 countries with approximately 12,000 offices worldwide. The company employs approximately 300,000 staff around the world, and holds over 200 million customer accounts in more than 100 countries. It is the world’s largest bank by revenues as of 2008.

Thinking through the implications of said nationalization for the counterparty positions of a bank holding company, or its role in the commercial paper market, is mind-boggling. Neither the FDIC (which generally does an OK job) nor any other government agency is in any way prepared for this kind of management task. It has very little to do with standard FDIC procedures. All I hear about is “bank” this, “bank” that, etc. but again little or no talk of the bank holding company.

Of course this is only a problem for the five or six biggest financial institutions but those are precisely the issue at hand.

On nationalization, Bernanke is very much on the ball. He said this:

Federal Reserve Chairman Ben Bernanke said this week, is “that you tend to lose the franchise value, that the counterparties and others don’t want to deal with you because they don’t know your future.”

I usually don’t like to speak so negatively, but it’s the advocates of nationalization who are in denial. There is a belief that Obama, Bernanke, and/or Geithner are somehow spineless or in the pocket of the banking lobby. The sadder truth is that they understand just how ill-prepared the U.S. government, or the Fed, would be to run such an enterprise.

I do understand that if all the water runs out of the sink, as it may, nationalization will come in some form or another, however disastrous that may be. But the desire to postpone it until the last possible moment, and the desire to pursue even a small chance of avoiding nationalization, are signs of wisdom, not cowardice.

When you read about nationalization, and see only the word “bank,” and not “bank holding company,” be very afraid of the advice on tap.

Addendum: Here is a different but related piece on banks vs. bank holding companies.
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The Bailout Is Robbing the Banks – By JOHN C. COATES and DAVID S. SCHARFSTEIN

February 18, 2009

MANY Americans are angry at banks for taking bailout money while still cutting back on lending. But the government is also to blame. For reasons that remain unclear, the Troubled Asset Relief Program has channeled aid to bank holding companies rather than banks. The Obama administration’s new Financial Stability Plan will have more influence on bank lending if it actually directs its support to banks.

To see why, it’s important to understand the distinction between banks and bank holding companies. Banks take deposits and make loans to consumers and corporations. Bank holding companies own or control these banks. The big holding companies also own other businesses, including ones that execute trades both on their clients’ behalf and for themselves.

It would seem obvious that helping banks, not holding companies, would be the most direct way to stimulate bank lending. But when TARP purchased preferred stock and warrants, it bought them from holding companies, not their bank subsidiaries.

While TARP has been generous with bank holding companies, these companies have not been so generous with their banks. Four large holding companies — JP Morgan, Citigroup, Bank of America and Wells Fargo — initially received a total of $90 billion in TARP money in the fall, but by the end of 2008 they had contributed less than $15 billion in equity capital to their subsidiary banks.

Bailouts, at the very least, should reach their target. When Washington wanted to help Chrysler, it gave money to Chrysler. It did not write a blank check to Cerberus, the private equity firm that owns Chrysler, in the hope that the money would somehow find its way to the carmaker and not to the other companies Cerberus owns.

Some politicians, frustrated that the government’s costly interventions have not had their desired effect, have wanted to mandate higher levels of bank lending. Others have tried shaming chief executives of financial institutions into lending more, as when Representative Mike Capuano of Massachusetts admonished eight of them who came before the House Financial Services Committee: “Start loaning the money that we gave you. Get it on the street!”

It would be more effective to simply ensure that the Financial Stability Plan is directed at banks. When the government buys stock, it should buy bank stock. And if it chooses to buy stock in holding companies, it should at least require that the new capital reaches the bank and non-bank subsidiaries that the government wishes to support. If the government chooses to help private investors buy toxic bank assets, as the planned Public-Private Investment Fund is supposed to do, it should not allow the banks to send those investments to their holding companies. And if the government decides to guarantee debt, it should guarantee the debt of banks, not of holding companies.

The Obama administration seems to understand that reviving bank lending is key to economic recovery. Now it needs to make sure that the banks get the money.

John C. Coates is a professor at Harvard Law School. David S. Scharfstein is a professor of finance at Harvard Business School.
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Aside from myself, here are the folks who are in favor of temporarily Nationalizing the banks, and then spinning them back out:

Alan Greenspan
Gordon Brown, UK PM
Senate Banking Committee Chairman Christopher Dodd
Senator Chuck Schumer
Sen. Lindsey Graham
House Speaker Nancy Pelosi
Republicans (some)
Joseph Stiglitz
Paul Krugman
Alan S. Blinder, Princeton
Nassim Taleb
Nouriel Roubini
Greg Mankiw
J. Bradford DeLong
Elizabeth Warren, TARP Oversight Panel
Dennis Gartman
Chris Whalen
Josh Rosner
Jeff Matthews
John Mauldin
Jack McHugh
Bill King
Matthew Richardson
Dylan Ratigan (CNBC, Daily Beast)
Jesse Eisinger, Conde Nast Portfolio
Martin Wolf, FT
Aaron Task (Yahoo Tech Ticker)
Paul Kedrosky (Infectious Greed, CNBC)
Nicholas Kristof (New York Times)
Mark Gongloff (WSJ)
Richard Parker (Newsweek)
Michael Hirsh (Newsweek)
David Reilly (Bloomberg)
Paul Vigna (Dow Jones)
Henry Blodget (Silicon Alley)
Willem Buiter (FT)
Adam Posen (Peterson Institute for International Economics)
Jeff Macke
Todd Harrison
Calculated Risk (Preprivatize the Banks)
Mark Thoma (Economistsview)
Karl Denninger
naked capitalism
Eddy Elfenbein (Crossing Wall Street)
Bronte Capital
Aaron Krowne Mortgage Lender Implode-O-Meter
Prieur du Plessis (investmentpostcards)
Roger Ehrenberg, Information Arbitrage
Felix Salmon
Interfluidity (Nationalize Like Real Capitalists)
Urban Digs

And those opposed:

Ben Bernanke
President Obama
Tim Geithner
Lawrence H. Summers
Financial Services Committee Chairman Barney Frank
Republican Senator Jon Kyl
George Soros
Meredith Whitney, Oppenheimer
Deroy Murdock (NRO)
Larry Kudlow
James Cramer
Hale Stewart
Tyler Cowen
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