Isn't it funny how they call them the "toxic assets"? OK, a lot of them aren't worth very much. But would it not be better to speak of the "toxic liabilities"? This may sound like a semantic point, but the toxic assets terminology breeds the idea that the mere creation of a "bad bank," built from these assets, will boost the financial system. It won't.
Overpaying for the toxic assets is another matter entirely. Yves Smith, by the way, has a good critique of current bank aid proposals and of course Paul Krugman has been making related arguments. The frightening thing is that many brilliant people — such as those on the Obama team — think this is the best we can do, all constraints taken into account. We'll see, as they say.
The other development is the proposal to limit executive pay to $500,000 for any bank taking "large amounts" of bailout funds; maybe that is the secret plan for keeping the bailout plan affordable. The drawback is that it discourages relatively healthy banks from using the funds to buy out the sick banks which, although it sounds inappropriate, is actually one of the better chances for making the program work.
Two options that I don’t hear much about, perhaps because they are terrible ideas:
1) Expedited bankruptcy for insolvent banks
2) Relaxing Basel II capital requirements, with a firm schedule for re-tightening over the next 5 years.
Any merit to either of those?
Is there not some proposal which deals with the bank size problem?
Part of the problem is that banks get “too big to fail”. But having relatively healthy banks (BofA … healthhy … really???) buy financial institutions perceived to be weaker means those banks get even bigger, which makes the problem worse.
There are a lot of economists out there. Are there any credible ideas for dealing with this crisis by making banks “small enough to fail”, although ideally not too many of them failing right now?
“toxic liabilities”?
Seems inverted.
The primary reason why commercial banks, otherwise contaminated by their existing “toxic assets”, have going concern franchise value apart from these assets is the value of their deposit bases.
MK how about expedited forclosures so that the homes and be quickly resold at lower prices.
“Why would moving assets of any sort off the books of a bank help their solvency?”
From what I understand, there are two problems with these assets:
(1) Nobody knows that they are really worth (or, won’t believe the market when the market says the assets are worth so little)
(2) Learning what they are really worth will likely result in realizing a massive loss
A bank’s goal would be to move the toxic assets off its books, eliminating the uncertianty in its assets’ values, while receiving a price for the toxic assets that doesn’t involving realizing a massive loss. Of course, someone needs to realize these losses. So, if it isn’t the banks, who should it be?
what never seems to be mentioned is that the losses were made when the securities were created and the deals were done. nobody knows how big the loss is at point.
part of the problem is that all the players who usually would deal with these securities have major losses themselves and are teetering on insolvency, and so there is a market failure as well. but the main point is that someone has to eat the losses here.
as for toxic securities vs liabilities, no, these securities have a positive value but they were paid for via debt.
I get a little worried about the cap on executive pay. Of course, $500,000 seems like a big number, and it is at a smaller regional bank. But for the big guys, it is far below what the revenue generators are making and will just provide a disincentive to step up to the plate; the risk / reward tradeoff is being messed with here. That is part of what got us here to begin with. Why do politicians believe they can mess with incentive structures without consequence?
There’s nothing particularly odd about the nomenclature: from the point of view of the bank, the mortgage-backed securities are assets, not liabilities.
The reason they call them assets is that they are on the left hand or asset side of a balance sheet.
Do economists have to take bookkeeping? It seems like a knowledge of elementary accounting would be useful.
Anyway toxic means hard to price, not bad. Non performing loans are worth almost nothing. Performing assets are worth about par until or unless they tank.
Toxic — which is an awful word but the best we have — are definitely valuable but the range of reasonable prices is so high that they are impossible to deal with. If you sell them, you are broke. If you hold them, you are ok, except because of mark to market rules, you have to report losses every quarter.
This is based on the so called paradox of deleveraging, where it is impossible for institutions to improve their financial position by selling.
clarification.
per the above comment, I was referring to loans with respect to performing/non performing.
toxic assets aren’t and can’t be loans, they have to be asset backed securities including mortgaged backed securities.
It’s about time! We are in the red by 15 billion and I’m still going to go out and buy a new jet and fly here and there at the companies expense. What are these guys thinking? For most of us, a 500K salary is only a dream. For those who do make that kind of money (and deserve it) then it’s not a problem. But for the fat cats who have done such a poor job of running things and are now begging for bailout money, they shouldn’t get paid a dime in my opinion) until they are able to turn things around. It’s not like being a weatherman where you can be right 50% of the time and no one cares if they are right or wrong. In this case they have not only destroyed the company, but lives of employees and eroded the customer base as well. Personally, I would like to say to GM – screw you and your greedy unions. Go belly up and restructure and get rid of the losers you sell. Just as the Oldsmobile line disappeared, it’s time for Hummer, Saturn and possibly Pontiac to join the crowd. Have cars made by General Motors Corp and not individual brands. As far as the banking industry is concerned – the same should apply to them. We lost 20 billion on bad home loans – I still need my 300 million bonus. Who do these characters think they are anyway. I didn’t vote for Obama, but I have since changed my mind on how he intends to fix the economy and the steps he is taking are certainly steps in the right direction. Now if we could get him to have a similar plan for the overpaid athletes and Hollywood “stars”. Come on – 8 million a year to play baseball? 5 million to star in a film that may or may not flop? Let them get paid based on PERFORMANCE!!! What a novel idea. I know my bonus is based on personal and company performance. If the company performs – they make money – if it doesnt – sorry Charlie – no raises or bonuses. What a great incentive it would give to all employees to know that if they didnt perform – they were not getting raises or bonuses. I bet the good employees would weed out the bad ones pretty quickly!
I’m not sure what these guys are thinking. I have no problem with $500,000 as a base salary but it should be coupled with stock options or performance-based pay. Based on what the NYT article says, this doesn’t appear to be the case.
If you pay executives with call options that can only be exercised five years from now, that solves the incentive problem from both ends. On the one hand, executives’ chums in the compensation committee who know just how bad things are at the firm won’t be able to extract equity from the shareholders in the form of executive compensation. And on the other hand, the prospect of being a billionaire by turning the firm around would attract the right kinds of people.
Jeff,
Suppose we did suspend mark to market. That would allow banks to value these assets on their balance sheets at a price higher than what they can get on the market. This would increase net equity on paper but wouldn’t change reality. Since these assets cannot sell for anything close to the prices they are valued at on the balance sheet, people would simply discount balance sheet numbers and still refuse to lend to banks that hold certain “toxic” assets since they have dubious value as collateral and cannot be sold for “fair value” in the event of bankruptcy. Suspending mark to market wouldn’t change anything in the real world to make banks better off and would result in people having even less faith in the numbers put out on financial statements.
i suspect ‘toxic assets’ are worth a price that is heavily discounted at what they were bought at. imagine if we were living in a world where this was true. how would you expect banks to try and handle that situation. i think they would act exactly like they are acting now. they would claim that the assets can’t be fairly valued in the market and beg for the government to give them cash because reduced equity is better than no equity. they would claim that asymmetric information prevented buyers from offering a fair price but would make no attempt to try and fix the information problem.
Perhaps there is a simpler solution:
In former times, it was often called a “barrelhead agreement.”
The U.S. should cause the formation of a type of mutual bank (Barrelhead Bank [BB])that would be owned by all the participating banks, but organized along the lines of the FRS.
Each bank wishing to participate in “shedding” some classes of assets would transfer those assets to BB at a tentative valuation set by the participant and would receive a number (subject to future adjustment) of shares in Barrelhead Bank [BB]. In addition, the participant would purchase [i]for cash [/i]an additional number of shares (not subject to adjustment) equal to at least 3% of the valuation initially assigned to assets transferred.
Immediately upon establishment and completion of transfers, the participants would be entitled to claim the BB shares as assets in place of those transferred, but should set a reserve for adjustments. A Board would be established to review and set initial arbitrary prices on the assets received in accord with uniformly standards applied to all transfers.
Upon the establishment of the initial price of assets transferred the number of shares issued will be adjusted (up or down) from those set by the participants valuation. If a participant is dissatisfied with the price, it can withdraw a particular asset and surrender the matching BB shares and reduce the 3% cash purchase proportionately. If any participant is dissatisfied with the prices set for assets contributed by another they may withdraw from the program. All will fall within time schedules.
BB will then issue bonds based upon a percentage of the aggregate prices assigned to the assets retained, which will be either insured or guaranteed by the U.S. as to principal and interest. Percentage of bonds issued will conform to the payment of interest at 4% available from the net earnings (after BB expenses) on the capital raised from the cash purchases of BB shares by participants.
This would not be the fabulous “Bad Bank.” It would be a bank with assets in marketing flux, exempt from “mark to market,” limited in operational scope and period of existence (unless extended). It’s obligations could have “sweeteners” (tax exempt, IRA benefited, etc.). BB shares would be transferrable only amongst participants and their values would be taken at their stated book value for participants balance sheets.
In that fashion the banks can work through their own problem resolutions.
R. Richard Schweitzer
s24rrs@aol.com
I totally agree with this that the part of the problem is that banks get “too big to fail”. But having relatively healthy banks (BofA … healthhy … really???) buy financial institutions perceived to be weaker means those banks get even bigger, which makes the problem worse.
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