Mortgaging the poor to bail out the rich

Irish and American banks took huge risks with their clients money. For slightly different reasons they are all now pretty much insolvent, and require external agencies to make good their huge losses. Unfortunately, those ‘external agencies’ look like being me and you! In effect Irish taxpayers, many already losers of the great Irish property bubble boom and bust, are now being asked to purchase the bad assets owned by Irish banks at current market values – which are well above anything resembling fair value.

David McWilliams argues that the government’s current plan is a bad deal for taxpayers, and asks no cash for trash please? His alternative involves asking for European financial support in order to run a bad asset management company. The banks would pay €6bn for this service, which would dispose of their dodgy assets over time. Similarly, Karl Whelan put forward arguments for nationalisation instead of the bad bank solution. While the maths of Whelan’s solution are clear in his article (although he assumes much smaller bad debts than McWilliams), it’s not clear at all exactly who picks up the reminder of the tab in David McWilliams solution (God bless the ECB?).

Stateside, nobel prize winner, Joseph Stiglitz argues against the ersatz capitalism, of privatizing the gains and socializing the losses in the New York Times. He regards Obama’s / Geithner’s plan as a win-win-lose solution: the banks win, investors win — and taxpayers lose.

One thing is for sure, it is deeply unfair that ordinary taxpayers have to pay twice for the mistakes of the incompetent bankers who made out like bandits at their expense during the boom.

  • Blinding

    I thought that was/is Capitalism.

  • Karl Whelan’s proposal is nonsense. He says “so the relevant issue here is not whether a “bad bank” is introduced, but how.”

    That is false. We already have bad banks, they are the current banks that exist. We don’t need to create new bad banks. We just need to remove the good assets from the existing bad banks, or at least keep their hands off them.

    Willem Buiter, former external member of the Bank of England’s Monetary Policy Committee, has the the correct solution. You simply split the existing banks in two. Create a new bank from the easy-to-value assets and liabilities, including the branch network, of the existing bank. The old bank will then own the new bank but will not be able to manage it nor will it be allowed to do any banking itself any more. The existing management and shareholders will form the ‘asset management company’ that Whelan wants to see. It will live or die by itself without any help or hindrance from outside.

    The new bank, being a boring bank with boring assets should be able to borrow from the government for any shortfall in capital. And being a boring bank it’d be fairly safe and therefore the loan wouldn’t constitute a subsidy.

    Allowing the existing banks to go bankrupt, wiping out the idiot shareholders and the criminal management, isn’t such a bad idea. Buiter’s plan is merely a much tidier way to allow the market to take its natural course. This reorganisation could happen at the stroke of a pen, and then the new bank wouldn’t even notice if its parent company went bankrupt a few months later. And even better, the reorganisation can be undone in future for any of the bad banks that survive.

    Why in the name of all that is holy should one cent of taxpayer money be used to buy shares or bail out creditors of banks? It’s trivial for a non-corrupt government to ensure a revitalised and active banking system, protecting conventional depositors, without any need to ‘lend’ (i.e. lose) money to black holes.

    Even the US might be finally realising that the existing management and shareholders need to be mercilessly wiped out, or whatever course the free market deems for them. Unfortunately, I wouldn’t be surprised if we of the Republic of Ireland are so myopic and stupid that it allows the FF elite to continue its looting. Socialist my arse. We’re being offered a false dichotomy. Both Whelan and Bacon are wrong. Only the Germans can save us from ourselves. Hopefully, they’ll refuse to give a single cent to anything but the soundest of boring new banks.

  • Dave

    “The Irish state could set up an asset management company to manage the distressed debts of the bank. This ‘financial skip’ would take over all the management of the debts but, crucially, the banks would still own the debts, because the new asset management company would simply be working out the debts and trying to get the best price. This is the first crucial difference between this plan and the government’s preferred plan.

    The banks would pay a set figure of around €6 billion to the state over the ten years of the asset management company’s life. This could go to build hospitals and roads.” – David McWilliams

    This is nonsense. The debts are best managed by those bank managers who have familiarity and a working relationship with the business concerned, with its model, history, directors, track record, etc.

    Mortgaged assets may be written-down, showing negative equity to the mortgage holder, but that only becomes a problem for the bank if that mortgage holder decides to hand back the keys and emigrates. Unlike previous busts (where interest rates skyrocketed for the mortgage holder), emigration is more problematical for the rogue defaulter, so the emphasis should be on making the mortgage holder retain his asset (or whopping great debt) rather than making it easy for him to shift his burden onto taxpayers. The ECB has set interest rates at their lowest level ever, so that is helpful as it keeps mortgage payments manageable.

    If you actually intend to have an economy at the end of this process, then you have to recognise that business – not mortgage holders – are where the limited financial support of the state must be directed. Any ‘plan’ that lumps two dynamically diverse groups like mortgage and business assets together is fatally flawed from the start.

    By the way, how exactly does a bank that is making massive losses generate the profit that is required to pay dividends to the state?

  • Mack

    Blinding

    Captialism is a system that enforces the property rights of individuals. It’s got nothing to do with protecting the rich over the poor. In fact, the most important force for progress – creative destruction, destroys the wealth of the encumbents – favouring new leaner competitors.

    The problem is politically, while everyone welcomes the rise in living standards when (for example) central heating replaced the traditional fireplace – no-one wants to be the chimney sweep that lost his job as a result. So, like the General Motors workers and owners in the US today, they appeal to the government to use other people’s (taxpayers) money to bail them out and foresetall the inevitable.

    The worst thing is, our bankers did as they pleased with our money, they were happy to take the profits associated with their massive risks while the going was good. Now they face even larger losses, they want us to bail them out.

    It’s not capitalism, it’s socialism for rich people.

  • Comrade Stalin

    Mack,

    The rhetoric is all very well, but surely by nationalizing these large institutions, the theory is that the taxpayer, having taken the risk, will reap a large profit later on when the now-fixed institutions are sold back to the private sector.

    In the UK that process is well under way with Northern Rock which is making pretty good progress paying down it’s loan from the government. The government has not had to invest as heavily in Lloyd’s Banking Group as had been expected and remains a minority shareholder. The backup loans and insurance schemes being made to these institutions ultimately mean that the taxpayer gets paid back. It could take 10 years. So what ? There will be a nice payoff which the government can use to pay down the national debt, with some nice profits left over which can be put towards worthwhile public projects (or tax giveaways). The losses fall, as they rightly should, on the shareholders who elected these bankers into place and who never lifted a finger to put a stop to their risky activities.

    In regulatory terms the banking system will have to change. That change will, I would hope, mean that institutions which choose to invest in risky assets do not get the benefit of the government’s deposit protection scheme, and are required by law to say so, so that investors can make up their own mind. The lesson of this bust is that institutions which cannot fail need to be restricted in terms of what they can do.

    I won’t pretend that there haven’t been problems, such as the issues of payoffs and bonuses for the bankers who initiated the screwups; and the weird decision of the government to give away the profitable part of Bradford and Bingley to Santander while keeping the loss-making part under state ownership. But overall, this is not a process of giving money away to bankers. The “bankers” – which surely means the owners of the banks ie shareholders, not the people they employed – have lost massively and it will be a decade before they break even again.

  • The problem is that bankers did not gamble with their own money but with that of their depositors and shareholders. Most of the bailout money really protects the depositors from the irresponsibility of the banks. If there is no bailout it is the depositors and the economy at large that suffers, not the bankers.

  • Mack

    Comrade Stalin – In this case the taxpayer won’t be paid back – it isn’t an investment undetaken by a hardnosed government on behalf their taxpayers, it’s a bail out among friends. AFAIK, there are no plans to nationalise the Irish banks (which is why Karl Whelan is arguing for it).

    There isn’t really much we can do about it, but it is still disgraceful that their gambling debts are being pinned on the population at large.

    Aldamir – Possibly. There were supposed to be depositor protection schemes in place – funded by the banks. My understanding was that in Ireland they were underfunded.

    To big to fail = Moral Hazard – with the disasterous consequences we see today (or will see soon.)

  • Comrade Stalin,
    Why do you, like so many others, breathlessly say things like “the taxpayer, having taken the risk, will reap a large profit later on when the now-fixed institutions are sold back to the private sector.”

    The bank shares are relatively low today for a very good reason. That reason being that their loans books are awful. Ergo, the bank will never be worth very much. So the current forms of bailouts will never make a profit. Agree or disagree, but don’t just repeat it as if it’s something obvious that doesn’t need a detailed and robust defence.

    Look at Anglo’s balance sheet on page 33. Barely half of the liabilities are customer deposits, and it is only these that we need be concerned about in any way. All other creditors would, quite properly and in accordance with centuries of capitalism, be wiped out if bankruptcy were allowed to proceed. Therefore, it is clear that the bailout do not increase one iota the safety of deposits. Instead it protects the investments of gamblers. Businesses fail every day, with all investors losing much of their money, so why should investors in bank shares or bonds be special?

  • blinding

    Thanks for the reply Mack

    How does capitalism deal with the well connected that may also be corrupt, powerful and seemingly able to exert their will on goverments to give them free reign and then when they do get it wrong get the poor or relatively poor to bail them out.

    Until Capitalism can offer believable answers to these questions then it certainly deserves the contempt it currently has.

    Perhaps as people we deserve the goverments that we elect.

  • Mack

    Blinding –

    Capitalism is an economic system that provides citizens and legal constructs with rights wrt property.

    Political corruption is a different concern entirely, unfortunately it seems to exist no matter what economic system is adopted (perhaps even more so under socialism / communism as power is concentrated centrally to a much greater degree).

    Our Western societies are quite sophisticated – rule of law, media, democracy and a mix of both state directed and free market economies. I’d hope the corrupt are pursued to the full extent of the law, and if politicians are protecting the corrupt that the people eject them come election time.

    I think this whole crises shows that we need proper banking regulation. As the two big to fail problem creates a Moral Hazard where the bankers were able to gamble our futures away..

  • Blinding

    Mack

    When Capitalism is sailing under a good wind it always urges/coerces goverments to introduce light touch regulation and the cycle starts again.

    It is easy to define what capitalism is but it is probably better to observe what happens in practice.
    For example at the moment the failed banking execs are walking away with fabulous pensions and who knows what benifits that they have already accrued “BUT” there are many people losing their jobs and possibly their homes often through no fault of their own with little or no compensation.

    If Capitalism did what some of these definitions says it does it would be fine but when some are being well rewarded for monumental failure and others with no blame are doing the suffering and footing the bill then Capitalism in practice has failed.

  • Mack

    Blinding –

    Light regulation is a good idea where there is no moral hazard and where creative destruction is given free reign to destroy the wealth of those who would make mistakes. Where this isn’t the case businesses need to be heavily regulated to prevent them taking undue risks at others expense.

    Capitalism is the wrong term for what you are describing. It’s abuse of power, corporatism or cronyism may come close.

    Some of the wealthy and/or powerful will always attempt to act solely in their own interests at others expense. The trick is not to let them.

    If Capitalism did what some of these definitions says it does it would be fine but when some are being well rewarded for monumental failure and others with no blame are doing the suffering and footing the bill then Capitalism in practice has failed.

    Well… no. Socialising business is socialism no matter what way you dress it up (bail outs, subsidies, nationalisation – all the lexicon of socialism). The governments’ lost their nerve in terms of letting the feckers go under – which is capitalism requires. The process of the incompentent going bankrupt letting the competent take over their assets is absolutely essential to capitalism.
    Like I said, capitalism is unpalatable at times because the chimney sweeps must go bust. The meddlers (politicians) don’t like that, and they aid their rich friends at our expense via socialist policies. (Take a look at Michael Taft today – subsidise everything!)

    It’s not fair at all, but in keeping perspective neither is it the end of the world. Are we establishing that you’re a capitalist and not a socialist at heart?

    But even with the current crisis. Living standards are far higher than they would be under a socialist system. And this crisis pales into insignificance by comparison to the disaster that was The Great Leap Forward.

  • blinding

    Mack

    I am probably a “fair for all Capitalist” but it does not exist and probably never will.

    Capitalism probably suits the human condition better than any other that has been tried here to fore.

    My next view is probably a bit extreme but I fear also suitable to the human condition.

    We as the ordinary people have not found an effective way of controlling the power brokers whether they be the Bankers or the politicians.

    Historically when the people running the system got things disasterously wrong the people rose up and certainly made their feelings known.This may have ended with the deaths of the “leaders”
    of the power brokers.

    This extreme action chastened and educated the next leaders for a while at least.

    Now when our Leaders whether financial or political fail us more than likely through corruption the worst that happens is they walk away with lucrative pensions.

    This rewarding of failure does not suit the human condition and will possibly lead to a violent backlash against the failures

    Maybe capitalism can work but we must come up with a way of making failed politicians/bankers do a “fair” penetence.

  • blinding,
    There are many ways in which even the most ardent capitalist does support state involvement in banking. The state, at a minimum, should enforce contracts and debts. Hence, if the state allows deflation or rampant inflation, it has failed in this most important duty. If I owe you €100, then it’s not fair on either of us if the debt magically goes up or down because of unexpected inflation/deflation rates.

    Similarly, bank deposits are protected by the state. If an employer owes me money, then there is no moral justification for that money to disappear after payday just because a third party (a bank) has gone bust.

    For these reasons, the state quite rightly is involved in and is responsible for the enforcement of and transfer of debts. And it would only be some anarchists who would reject this.

    Given this appropriate involvement by the state, the consequences are that the state has a duty to heavily regulate the banks, banning some activities if it so chooses. Splitting investment and retail banking are one such option. Strict capital requirements. Ensure all assets are tradeable, and regularly traded, on markets. Any new type of derivative must be tested and approved and be designed to be traded in utter transparency. No unregulated markets. No sane capitalist would advogate deregulating the stock market (believe me, it’s all very heavily regulated), so why were CDOs allowed to invade the banks’ balance sheet without any regulation or transparency? Banks should never be allowed to grow too big to fail; simply split them or stunt their growth. Banks should not be allowed to be cross-border; for any given bank it should be clear to the world which central bank and which fiscal authority is responsible for it (this raises questions for the EU). Regulate pay and bonuses to ensure incentives for long term stability. The state, representing the depositors, is in effect entitled to the full ownership and control of any bank. No sane individual would guarantee another’s debts without getting detailed control over their lives, why does the state often fail in this basic responsibility.

    Enforcing of contracts and debts is the most important responsibility of the state, according to the most extreme anarchists/capitalists, and thus the state has a duty to heavily regulate banking in all its forms.

    The casino capitalism of the last decade or two, and its equivalent in the 1920s, are just temporary blips. Between the 1930s and 1970s, banking was regulated heavily and it was boring and banking salaries were low; as a result the world economy had the most sustained growth ever seen. Unfortunately this temporary blip will probably last a decade or so and there will be plenty of looting by the criminal banksters, aided and abetted by cheerleaders of ‘pseudo-free-markets’.

  • Blinding

    Aaron M

    Read your interesting post

    Thanks for taking the time to reply.

  • blinding,
    You might find these graphs from Paul Krugman, the most recent Nobel Economics Prize winner, an interesting appendix to my final paragraph.

  • Comrade Stalin

    Aaron:

    The bank shares are relatively low today for a very good reason. That reason being that their loans books are awful. Ergo, the bank will never be worth very much. So the current forms of bailouts will never make a profit. Agree or disagree, but don’t just repeat it as if it’s something obvious that doesn’t need a detailed and robust defence.

    Sorry Aaron. I kind of jumped in using an argument that probably applies to the UK banks, but as you note it’s not at all so clear cut with the Irish institutions.

    Agreed on your most recent post. If the state is guaranteeing deposits (by implication or otherwise), clearly it has a right to ensure the risk it is taking is insurable. It’s like breakdown insurance – it isn’t valid if you don’t maintain your car.