It’s becoming apparent that several of the large institutions that are in the vortex of bailoutdom are teetering: namely AIG and Citi. They were deemed too big to fail, bit now we are wondering if they are too far beyond saving.
I am struggling with this concept and am rambling here, but now is the time to fix things for the long term benefit. I am sick of quick fixes.
The Too Big to Fail policy is the idea that in American banking regulation the largest and most powerful banks are “too big to (let) fail.” This means that it might encourage recklessness since the government would pick up the pieces in the event it was about to go out of business. The phrase has also been more broadly applied to refer to a government’s policy to bail out any corporation. It raises the issue of moral hazard in business operations.
Citibank, Bank of America, HSBC Bank USA, Wells Fargo Bank and J.P. Morgan Chase reported that their “current” net loss risks from derivatives â€” insurance-like bets tied to a loan or other underlying asset â€” surged to $587 billion as of Dec. 31. Buried in end-of-the-year regulatory reports that McClatchy has reviewed, the figures reflect a jump of 49 percent in just 90 days.
The industry never thought macro enough to consider systemic risk – as in “What happens if it all goes wrong?” Seems pretty basic.
The Federal Reserve appears to be trying to reform its ways and perhaps even the concept of too big to fail. Fed Chairman Bernanke just spoke to the Council on Foreign Relations…
Until we stabilize the financial system, a sustainable economic recovery will remain out of reach. In particular, the continued viability of systemically important financial institutions is vital to this effort. In that regard, the Federal Reserve, other federal regulators, and the Treasury Department have stated that they will take any necessary and appropriate steps to ensure that our banking institutions have the capital and liquidity necessary to function well in even a severe economic downturn. Moreover, we have reiterated the U.S. government’s determination to ensure that systemically important financial institutions continue to be able to meet their commitments.
…while former Fed Chairman Greenspan has been attempting to re-write history.
David Leonhardt, in his piece “The Looting of Americaâ€™s Coffers” said:
The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.
In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer said, would have operated in a completely different manner. The investors displayed a â€œtotal disregard for even the most basic principles of lending,â€ failing to verify standard information about their borrowers or, in some cases, even to ask for that information.
The investors â€œacted as if future losses were somebody elseâ€™s problem,â€ the economists wrote. â€œThey were right.â€
Last week, Sheila Bair of FDIC told 60 Minutes she would like to see Congress attempt to set boundaries for banks to remain as banks. In other words, they grow beyond a certain level, they become some other entity but can’t be bailed out if something goes wrong. Perhaps this implies a higher risk which is understood by investors, forcing the institution to decide whether it can afford to be bigger.
Let’s get our act together real quick or we also too big to fail?
Make a payment a few days late on a HELOC today and the bank may term it out without your approval. You may have a very high credit score, never been late on a payment or pay above the minimum every month and still the bank may pull the HELOC. We are in a credit crunch, and that means some lenders are getting out of the lending business. Someone I know experienced this very same situation last week and they were in shock.
Across the U.S., sellers with good credit who have never been late on a mortgage payment are getting their home equity lines of credit (HELOCs) frozen or downgraded. Major lenders like Bank of America, Citibank, Countrywide Financial Corp., Washington Mutual Bank and USAA have announced that they’re cutting back HELOCs in areas where home prices have taken a hit.
The lower savings rate has been tolerable (or caused by) the ease at which homeowners could withdraw equity from their homes over the past decade. But we still feel guilty about not saving enough.
The ability to spend or feel comfortable with spending has been enabled by housing.
George Will, in his WaPo Alice in Housing Land piece provides perspective about this:
Although Earth’s temperature has risen and fallen through many millennia, the temperature was exactly right when, in the 1960s, Al Gore became interested in the subject. Are we to assume that last year, when housing prices were, say, 10 percent higher than they are now, they were exactly right? If so, why is that so? Because the market had set those prices, therefore they were where they belonged? But if the market was the proper arbiter of value then, why is it not the proper arbiter now? Whatever happened to the belief, way back in 2007, that there was a housing “bubble”?
and how little we now save.
Seventy percent of economic activity is personal consumption, which recently has been fueled by the “wealth effect” — people spending because they feel wealthier due to the appreciation of their largest asset, their house. So “stabilizing” — i.e., putting an artificial floor under — housing prices may be necessary to fuel consumption by a public that in the 1980s saved almost 10 cents of every dollar it earned, and in the 1990s saved a nickel, but recently has had a negative savings rate.
I suspect the savings rate will eventually rise, at great cost to the economy. He rightfully concludes:
Everyone knows that there is only one commodity the price of which always rises — major league pitchers. Concerning the market for them, Congress should do something.
A few years ago, I was amazed at how profitable sub-prime lending was and how national banks were flocking to buy them. The first danger sign for me was when Citibank ran into problems when they purchased The Associates and subsequently assumed their legal woes and eventually settled. But it didn’t end there. In addition to large national retail lenders, International banks got into the game, including HSBC.
Daniel gross wrote a witty piece on HSBC called Hey Sucker Banking Corporation: How a British bank blew it in America [Slate]:
HSBC’s woes are the most highly visible evidence that the real estate-credit orgy of recent years is coming to an unhappy end.
Other names for the acronym HSBC other than its actual Hong Kong Shanghai Banking Corporation have been proposed but HSBC has become the posterchild for all that is wrong with subprime lending.
Don’t get me wrong, subprime serves a need. However, the search for quick profits and lapses in ethical standards associated with subprime lending has begun to take its toll on the lending sector of the economy. Sub-prime lending comprises 20% of all mortgages [MW] so its not an insignificant sector. It doesn’t mean that all sub-prime is predatory but its significant.
In a recent staff report by the New York Fed called Defining and Detecting Predatory Lending explores this topic:
We define predatory lending as a welfare-reducing provision of credit. Using a textbook model, we show that lenders profit if they can tempt households into “debt traps,” that is, overborrowing and delinquency.
This is all scary since those that borrow in this sector are the least likely to afford outside advice.