Games of Chance: TALF, PPIP, TARP, FDIC, FASB
Posted by Larry Doyle on April 7, 2009 2:40 PM |
In thinking about the economy, markets, and our banking system, my memory brings me back to my early days in New York. While working my way along 8th Avenue back to my apartment in Hell’s Kitchen, I would happen upon numerous versions of the classic NYC “hustle.” The shell game (also 3 card monte) was rampant in NYC in the ’80s. Mayor Giuliani cleared out this game, along with a host of other street scenes. For those not familiar with this game, there was a constant need for new players with new money to keep the game alive.
Why do these games remind me of our current banking system? The similarities are scary. Let’s access the most recent piece from John Mauldin’s site to “view the games.”
Mauldin’s guest, John Hussman, comments on these various “games” (TALF, PPIP, TARP, FDIC, FASB), in which taxpayers bear the brunt of the risk in the government’s engagement with financial institutions. Hussman writes of the PPIP:
this is a recipe for the insolvency of the FDIC and an attempt to bail out bank bondholders using funds that have not even been allocated by Congress. The whole plan is a bureaucratic abuse of the FDIC’s balance sheet, which exists to protect ordinary depositors, not bank bondholders.
In regard to the FASB’s relaxation of the mark-to-market accounting rule for financial institutions:
the irresponsibly rosy assumptions built into these models have been a large contributor to this near-insolvency, because they virtually ignored foreclosure risks.
Whether via the TALF, PPIP, or FDIC sales, the transferral of toxic assets to private investors will ultimately only have one outcome and that will be :
the public will suffer the losses that would otherwise have been properly taken by the banks’ own bondholders. You can tinker with the accounting rules all you want, and it won’t make the banks solvent. It may improve “reported” earnings for a spell, but as investors who care about the stream of future cash flows that will actually be delivered to us over time, it is clear that modifying the accounting rules doesn’t create value. It simply increases the likelihood that financial institutions will quietly go insolvent. I recognize that the accounting changes may reduce the immediate need for regulatory action, since banks will be able to pad their Tier 1 capital with false hope. But we have done nothing to abate foreclosures, and we are just about to begin a huge reset cycle for Alt-A’s and option-ARMs. As the underlying mortgages go into foreclosure, it will ultimately become impossible to argue that the toxic assets would be worth much even in an “orderly transaction.”
In a slightly different version of the game – and in attempt to attract more players, if not necessarily truly new money – the government is considering allowing the sellers of toxic assets to also be buyers. How does that version of the game work? The sellers (Citi, BofA, JP Morgan, et al):
can put up a few percent of their own money, and swap each other’s toxic assets financed by a bewildered public suddenly bearing more than 90% of the downside risk. The “investors” in this happy “public-private partnership” keep half the upside while ordinary Americans take the downside off of their hands. Some partnership.
The NYC sidewalk games of chance are best played outside so we need to make sure the weather is good. In a similar fashion, for the government’s games to work it helps if the weather, that being the economy, is improving. Well, the difference between partly cloudy and partly sunny is all in how you look at it. In a similar fashion, regarding consumer spending:
analysts have noted that year-over-year consumer spending has only declined very slightly, hailing this as evidence that economic concerns are overblown. The difficulty is that consumer spending has never declined on a year-over-year basis, except in this downturn, so that slight decline is actually the worst showing for consumer spending in the available data.
Games of chance can be fun; however, if an individual is spending money he does not have, the risks grow exponentially. To wit, Hussman summarizes:
I have no idea how long investors will remain enthusiastic about trillion dollar band-aids and eroding the integrity of our accounting rules. I do know that at the end of the day, what matters is the long-term stream of deliverable cash flows that investors can actually expect to reach their hands. It’s exactly that consideration that makes it clear that we will sink deeper into this crisis until we observe debt restructuring on a large scale. If we don’t restructure the debt, the debt will fail, because for many borrowers, the cash flows aren’t there, and it is not possible to service the debt on existing terms.
When my “old man” encouraged me to “hustle” and “take some chances,” I am not so sure this is what he had in mind.