Citi Weekend' Shows Too-Big-to-Fail Endures: Simon Johnson
By Simon Johnson - Jan 18, 2011

`Citi Weekend' Shows Too-Big-to-Fail Endures: Simon Johnson - Bloomberg

Democrats like to say that the Dodd- Frank financial overhaul legislation ended the problem of too big to fail because large failing financial institutions can now be wound down in an orderly manner.

Republicans, including those now running the House Financial Services Committee, dispute that the Dodd-Frank resolution framework is workable and insist that if big banks get into trouble on their watch that they will be allowed to go bankrupt.

Last week’s report by Neil Barofsky, the special inspector general for the Troubled Asset Relief Program, suggests that the views of both sides are likely at odds with future financial realities.

The report, titled “Extraordinary Financial Assistance Provided to Citigroup Inc.,” focuses on the “Citi weekend” in November 2008 when the bank received additional financial assistance from the government -- just weeks after the U.S. had injected capital into all the big banks in the first wave of TARP bailouts. The report reveals fresh details about who made the key decisions and on what basis.

The most interesting quotes are from Tim Geithner, who was both president of the Federal Reserve Bank of New York and President Barack Obama’s pick as Treasury Secretary (his nomination, announced that Monday, was leaked to the market the previous Friday.)

Geithner is refreshingly frank that too big to fail hasn’t necessarily been ended.

‘Just Don’t Know’

“In the future we may have to do exceptional things again if we face a shock that large,” he said, according to the report. “You just don’t know what’s systemic and what’s not until you know the nature of the shock.”

Dodd-Frank supposedly gives any administration better tools but if you look closely at the details -- highlighted in the Treasury letter attached to the report -- you see most of the emphasis is on the resolution authority that allows the government to close financial institutions.

But this doesn’t apply to our largest global banks; there is nothing in the Dodd-Frank authority that applies to the overseas operations of a Citigroup, JPMorgan Chase or Goldman Sachs. So if a big global bank were to fail, it would set off a scramble for assets today just like it did when Lehman Brothers collapsed in September 2008 -- or would have if Citigroup had gone under the following November.

‘Gut Instinct’

This is also a major problem for the “just let ‘em go bankrupt” philosophy [That one is for Fredfredson and his cohort of economic gurus who want a cleansing fire to destroy us all as badly as religious moralists used to pray for God to unleash heavenly mayhem on sinful cities]. There is no framework for cross-border bankruptcy, in the sense of clear rules about who gets compensated with what kind of assets. The courts can presumably sort it out, but it would take many years and cost billions of dollars in legal and other fees. As a result, if a large bank is on the brink of failing, everyone will assume the worst around the world and run for the doors.

Barofsky’s report points out that government decision making on the Citigroup bailout was ad hoc and largely motivated by “gut instinct” about what the consequences might be. Then- Treasury Secretary Henry Paulson was characteristically blunt at the time: “If Citi isn’t systemic, I don’t know what is.”

Sheila Bair, head of the Federal Deposit Insurance Corp., and other FDIC officials deferred to the judgment of Geithner and his team.

In a crisis there are no objective criteria, thus no way to know the full consequences; just a great deal of fear about what the failure of a large financial institution would do.

Like Physics

Size isn’t paramount, but it does matter a lot. If someone tells you that Earth is about to be hit by a meteor, and also tells you its density, impact velocity and impact angle, you then should have one question: How big is it? (You can plug in the parameters online to see for yourself.)

In this scenario, bigger isn’t better; it’s worse. It’s the same with banks -- as seen during the Citigroup weekend. The bank was huge. It was very highly leveraged. It was profoundly global. There was no legal authority that could handle orderly resolution. All of this is still true today, as the report makes clear.

Or perhaps the situation is worse.

“The government’s actions with respect to Citigroup undoubtedly contributed to the increased moral hazard that has been a direct byproduct of TARP,” Barofsky wrote.

As of last January, a senior New York Fed official still viewed Citigroup as too big to fail, and told the special inspector general that if history repeats itself, there is “no question we would do it again (with) a similar or different program,” according to the report.

Next Time

Or we could also make the biggest banks smaller -- ideally, small enough to fail. This was the proposal of the Brown-Kaufman amendment to Dodd-Frank, which died on the Senate floor, largely because of opposition from Geithner and the Treasury Department. So we’ll do nothing, it seems, except let these massive banks become bigger and even less well managed.

Until next time, the people who run the country will again face the same choice as in November 2008: provide an unsavory bailout for management, shareholders and creditors that rewards failure and stupidity, or run the risk of causing a second Great Depression.

If the big banks get large enough, we’ll become like Ireland today -- saving those institutions will ruin us fiscally, destroy the dollar as a haven currency, and end financial life as we know it.

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I cannot say that I disagree. My preferred solution would rather be to separate lending banks from investment ones and limit/adapt their authorised leverage depending on the stage of the cycle we're in but, either way, it'd work better than what we have now...

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Quote:

This is also a major problem for the “just let ‘em go bankrupt” philosophy [That one is for Fredfredson and his cohort of economic gurus who want a cleansing fire to destroy us all as badly as religious moralists used to pray for God to unleash heavenly mayhem on sinful cities]. There is no framework for cross-border bankruptcy, in the sense of clear rules about who gets compensated with what kind of assets. The courts can presumably sort it out, but it would take many years and cost billions of dollars in legal and other fees. As a result, if a large bank is on the brink of failing, everyone will assume the worst around the world and run for the doors.

Heh...

What follows in this article is precisely why it would have been better to have had that collapse two years ago! And why the longer we wait to resolve the problem the worse the collapse WILL BE.

Essentially this article agrees with me that things are getting more dangerous as we go along.

While we may disagree as to how bad the collapse in 2008 would have been if allowed to proceed as it looked like it was going to, increasingly it is becoming apparent that the situation is getting much worse the longer it takes to resolve the imbalances.

Quote:

So we’ll do nothing, it seems, except let these massive banks become bigger and even less well managed. Until next time, the people who run the country will again face the same choice as in November 2008: provide an unsavory bailout for management, shareholders and creditors that rewards failure and stupidity, or run the risk of causing a second Great Depression. If the big banks get large enough, we’ll become like Ireland today -- saving those institutions will ruin us fiscally, destroy the dollar as a haven currency, and end financial life as we know it.

Yeah that is a better solution to be sure

F

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"Patriotism means being loyal to your country all the time and to its government when it deserves it."-- Mark Twain

"Inter arma silent Musae"--when the weapons speak, the muses fall silent.

An't nanum hearm deth, doth hwaet ye willath.

It is forbidden to kill; therefore all murderers are punished
unless they kill in large numbers and to the sound of trumpets. -Voltaire

Economic Left/Right: -3.88
Authoritarian/Libertarian: -4.36

January 12, 2011
2011 - Another Year of Living Dangerously
By Brady Willett

http://www.fallstreet.com/jan1211.htm

“If the crisis has a single lesson, it is that the too-big-to-fail problem must be solved”Ben Bernanke. September 2, 1010

“It is unconscionable that the fate of the world economy should be so closely tied to the fortunes of a relatively small number of giant financial firms. If we achieve nothing else in the wake of the crisis, we must ensure that we never again face such a situation.” Ben Bernanke. March 20, 2010



Unconscionable or not, the statistics released by the Fed in December speak for themselves: $3.3 trillion (at its peak) in emergency lending to primarily large financial firms. As for Mr. Bernanke’s March 2010 epiphany, at the same time he was decrying ‘too-big-to-fail’ the Fed’s emergency TAF program was dolling out more than $3.5 billion to U.S. banks and the Fed’s emergency TALF scheme was kicking out billions more to numerous LLC’s. Remember, these and other activities were taking place when the Fed was supposedly focused on an exit strategy (from unprecedented monetary interventions), and Bernanke was giving a speech entitled “The Economics of Happiness”. In this speech Mr. Bernanke claimed, rather prematurely, that with regards to the 1930s, the ‘lesson has been learned”.

Suffice to say, the only lesson that has been learned/confirmed is that Bernanke and company have no intentions of ever seriously dealing with the overly interconnected, overly complex, and moral hazard laden circus that is the U.S. financial system. Rather, as 2011 begins the Fed is still making massive interventions into supposedly free markets, the Fed’s balance sheet is still chalk full of toxic assets, and Bernanke is still not ruling out the possibility of QE3. When does the madness stop Mr. Bernanke? When, if ever, does the Fed get down to the difficult business of busting up a financial system that remains, according to your words, the preeminent threat to America?

Before looking into the crystal ball, one quote from an unlikely source highlights just how reckless and obvious the Federal Reserve’s actions have become:

“When Germany, a country that knows a thing or two about the dangers of inflation, warns us to think again, maybe it's time for Chairman Bernanke to cease and desist. We don't want temporary, artificial economic growth bought at the expense of permanently higher inflation which will erode the value of our incomes and our savings.”

The above quote was spoken by one Sarah Palin…


2011 – An Artificial Recovery Is Still A Recovery

Against the backdrop of minimal job creation and the inability of policy makers to remove any of their extraordinary stimulus measures, Mr. Bernanke actually had the audacity to contend that QE2 was ‘already working’ because it helped raise stock prices. Have we not learned that outsized increases in asset prices are unwelcome - that the booms they engender inexorably lead to gigantic busts? As for the debt side of the equation, with the U.S. consumer showing only faint signs of increasing their appetite for debt, leading the charge is the U.S. government, which, according to the Treasury, in fiscal 2010 accrued more than $2 trillion in net liabilities. The U.S. government, by all accounts, is set to embark upon more years of unrepentant borrowing.

In other words, not unlike previous episodes of ‘recovery’, today’s U.S. revival is being supported by cheap money, rising asset prices, and staggering increases in debt. This sorry state of affairs – wherein policy makers are focused solely on short-term growth objectives – comes after decades of dysfunction. Specifically, and as covered in this year’s Wish List (download preview), increases in debt and asset prices beyond gains in wages have produced an insatiable U.S. appetite for imported goods, and this has created a hysterical policy paradox (on the one hand, failing to direct resources at supporting unsustainable consumption would ensure a sharper economic downturn, while on the other efforts to spur short-term consumption is unproductive in that it reduces the focus on strategic investment and saving). A ready example of this predicament can be seen in the trillions already spent trying to stop much needed financial market corrections (which would have negatively impacted short-term consumption and debt accumulation) versus the meager amount ($586 billion) spent by China making things and investing in technology. Today China is overtaking Japan in R&D spending and trying to slow down its overly successful stimulus activities, while the U.S. is still directing massive resources at trying to fix its broken consumption model.

The hazards of conspicuous consumption noted, the expectation that many unsustainable/artificial drivers of growth will, eventually, spark an increase in jobs remains. Howl all you want about how ill-guided U.S. policies are, but if the definition of recovery is quarantined to the idea of growth at any cost there is the potential for short-term success. Quite frankly, given the continued improvement in many of the recent economic statistics and strong advances in many jobs-related stocks, new job creation may be imminent. If so, an extension, albeit unstable, of the ongoing recovery is likely.



This is not to say that the recovery is built to last. After all, remember that all of the 8.1 million U.S. jobs created by rising asset prices and debt from September 2003 to December 2007 quickly vanished during the crisis.

Bears Will Have To Wait!

Along with the improving economic headlines, the problem with being a starving bear is that capital flows and sentiment trends have turned decidedly bullish. We see these trends in the Investor Intelligence and related surveys and complacent readings in the VIX, but also, more anecdotally, by the fact that Abby Joseph Cohen and company are yelling it’s time to “Get Back Into Stocks!” and a jolly Lawrence Kudlow is interviewing a jolly Donald Luskin. Having watched the 1990s mania unfold and the 2003-2007 ‘recovery’ keep rolling along, these episodes of acute optimism have a way of feeding on themselves, often times for longer than common sense would deem possible.

As for those that take a contrarian bent – since no one is bearish now must be the time to be bearish! – this attitude is definitely warranted insofar as a market correction is concerned. However, the sentiment may be misplaced if speculating on an immediate bear market. Quite frankly, in direct contrast to all of the optimism to be found is the fact that equity fund flows have only started to turn positive after more than 7-months of steady outflows. Will, after months of market gains, the average American play the role of sucker once again and return to U.S. equities en masse? There is this possibility.

Finally, beyond the obvious trends sits another, more layered observation in that the world needs the U.S. more than the U.S. needs the rest of the world. As a quick example, the dysfunctional U.S. dollar can catch safe haven flows regardless of its horrendous fundamentals because the Euro is in a more dire state of dysfunction, because China strictly manages its currency, and because numerous countries do not want the dollar to fall (at least not yet). The same story holds for U.S. equities, which if being priced solely on earnings valuation or Fed model view, are attractive compared to other parts of the world.

As for the potential obstacles leading into 2011, they include a more widespread Euro-crisis, a blow-up in China, a global bond market meltdown, a municipal bond crisis, another real estate down-leg, inflationary pressures, a dollar crisis, a commercial real estate crisis, wars, etc. With the possible exception of raging commodity prices – which owe part of their resurgence to Bernanke’s printing press – none of these events is likely to derail the U.S. recovery. Rather, the story is that of U.S. policy makers unleashing waves of stimulus, increasingly risk-enamored investors taking to surf, and global policy makers terrified of rocking the boat. Untenable and dangerous as this situation might seem, unexpected obstacles simply exhume a ‘more of the same!’ response. And while these events may make the next crisis that much larger, they also impart a resolute attitude of recovery that is difficult to ignore.

In an effort to clarify a very complex condition: the U.S. economy will either continue to recover or the financial markets, U.S. dollar, and U.S. government as we know it will completely collapse. This all or nothing outlook is what happens when debt, asset prices, and policy ammunition myopically fixes its gaze on short-term GDP advances…

Conclusions

For the moment the world needs the U.S. more than the U.S. needs the rest of the world. This is what 2011, and beyond, is about. Only when this fact changes or investors reacquire an aversion to risk will the outlook for continued recovery materially change.

In this environment the investment alternatives are few, while the opportunity for speculation is strong. Paying little attention to the latter, the story is that of being extremely selective in equities, weary of mispriced fixed instruments, cognizant of your currency exposures, and maintaining an exposure to precious metals.

As for the dream that one day financial institutions will be stable/strong enough to be broken into smaller pieces, and that these pieces will never again be permitted to hold the Fed and American public ransom, this remains simply a dream. Another year of living dangerously ensures that further obstacles to meaningful reform will be erected in the shadows, and that another financial crisis is preordained.

__________________
"Patriotism means being loyal to your country all the time and to its government when it deserves it."-- Mark Twain

"Inter arma silent Musae"--when the weapons speak, the muses fall silent.

An't nanum hearm deth, doth hwaet ye willath.

It is forbidden to kill; therefore all murderers are punished
unless they kill in large numbers and to the sound of trumpets. -Voltaire

Economic Left/Right: -3.88
Authoritarian/Libertarian: -4.36

Originally Posted by Fredfredson

Essentially this article agrees with me that things are getting more dangerous as we go along. While we may disagree as to how bad the collapse in 2008 would have been if allowed to proceed as it looked like it was going to, increasingly it is becoming apparent that the situation is getting much worse the longer it takes to resolve the imbalances.

Well, that's one way to look at it. But I think the conclusion of the article and my own is more along the lines of "Please, stop wasting time and reform this mess ASAP".

As I said, the various measures are not of the "never done before" variety and it's not like they don't have the support of powerful (the Fed/Bernanke as your article quoted) and smart or ruthless (Paul Volckner) individuals and organisations.

What is missing, again, is someone with courage, authority or viciousness either in the WH or in the Congress to take on the lobbyists and the Wall Street interests. Although, even they aren't as vehement as you might think. Goldman Sachs and other, after arguing against it, have dropped or reduced their prop. desks (i.e. their internal hedge funds). Some say these drops were purely cosmetic (risks were not just located within the prop. desks. It's the structured credit desks which really blew up) but I think it could be made real easily enough. Again, it just seems like some inexplicable inertia or lack of ambition by the politicians...

So, basically, yes, things are getting more dangerous and/or risks are mutating but the solutions are known and they don't have to involve going through a financial and economic holocaust...

OTOH, if nothing ever gets done, I agree with you it'll end in tears... AGAIN.

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