Last week brought another outrageous gift to bank stakeholders at the expense of taxpayers: $20 billion and trash-asset guarantees to insolvent Bank of America (BAC). This followed close on the heels of a similar gift to save the stakeholders of insolvent Citigroup (C).
It’s easy to blame these bizarre and undeserved gifts on fear of another Lehman Brothers (Sure, it’s infuriating, but think of the alternative!). But that’s ridiculous: You don’t have to subsidise banks and their stakeholders at taxpayer expense to avoid another Lehman. You just have to fix the banks the right way.
What’s the right way?
* Temporarily seize the banks
* Write their assets down to nuclear-winter levels (or, if desired, put them in a big bad bank, as Sheila Bair wants to do.)
* Convert enough of their debt to equity to put them in a strong capital position.
That’s it. No taxpayer money. No citizen outrage. No comical “Yes, we’re lending” assurances when what the banks are really doing is, sensibly, hoarding everything.
We could do this to Citigroup and Bank of America tomorrow afternoon, and on Wednesday morning, two of our biggest banks would be rock solid (they could also still be publicly traded, under the same ticker symbols, with different shareholders). The banks would have hundreds of billions of dollars of assets on their balance sheets that would be marked at or below market, and they could sell them for gains or hold them as their managers saw fit. They would be liquid and able to lend. They would have no reason not to lend because their assets had already been written down to the worst-case scenario. (Another plus: Management wouldn’t have to lie about the value of their assets anymore). Bank employees would still have jobs. Senior management would now be free to pay themselves whatever massive bonuses they wished–without doing it at taxpayer expense. Sanity and fairness would have been restored.
The drawbacks? It’s hard to even call them drawbacks:
- Today’s common shareholders would get wiped out
- Today’s preferred shareholders would get wiped out
- Today’s debtholders would take a big hit, with unsecured debtholders ending up with equity stakes.
But wait–isn’t that unfair? Arbitrarily deciding that shareholders and debtholders will get dinged? Isn’t that an abandonmnent of free-market capitalism?
Please. These banks have already failed. If it weren’t for our having already abandoned free-market capitalism, they’d all have ended up like Lehman. Adults made bets on these securities on their own free will (on the apparent assumption that they come with implicit taxpayer guarantees). These adults can now, finally, accept responsibility for their decisions.
For some reason, this simple, fair solution doesn’t even seem to be under consideration. Instead, Sheila Bair et al have floated TARP 2: yet another massive gift to bank stakeholders disguised as a huge “bad bank” (a taxpayer funded entity that will intentionally overpay for trash assets under the absurd argument that the government knows better than the market what these assets are worth). Once again, this plan will reward bank stakeholders and managers for their stupid decisions, and it will do it at taxpayer expense.
Why? Why can’t we do this sensibly? What on earth are we so afraid of?
*UPDATE: Several readers immediately suggested that “seizing” the banks would be illegal. No it wouldn’t: Our bank regulations allow regulators to put involvent banks into receivership. This is what the government did last year with IndyMac and the dozens of other failed banks. And it’s basically what it did with Fannie, Freddie, and AIG. This only modification here to the standard “receivership” play is that the banks would remain publicly owned companies. The government would do a horrible job running them, and there’s no reason to go down that road…
(Yes, the banks might disagree with the assessment that they’re insolvent. And, if they wish, they can take that up later, in court–if they can find plaintiffs attorney who stops laughing).
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