Sentences to ponder

by on April 20, 2009 at 6:26 am in Economics | Permalink

If you don’t give a bank any more money, it doesn’t have any more money.

Here is much more, worth a read on the latest banking plan.  At the end of the post the author asks:

Is there another way to explain this even more simply?

I believe the answer is no.

Addendum: Paul Krugman says the same.

1 Andrew April 20, 2009 at 6:32 am

I think we have two issues. There is real cash flow and balance sheets and real bankruptcy. Then, because we don’t (usually) allow banks to actually go bankrupt, we abort the process through FDIC, we have the regulatory bankruptcy, a form of euthanasia, that we use to avoid continued waste of resources. We need clear thinking and clear separation of these two issues. Maybe I don’t have it either.

I think there is no reason to euthanize banks that everyone knows are on life support.

2 MichaelG April 20, 2009 at 9:41 am

Aren’t banks businesses, that are supposed to, you know, EARN money?

3 liberty April 20, 2009 at 10:15 am

Its not a “new plan,” they are nationalizing the banks. They pretend that there is some reason that this is “good for the taxpayer” or “will save money in the long run” or create some other justification; but the fact is that they told us they would not nationalize the banks, and now they are nationalizing the banks. They won’t say that, if they don’t have to. They will call it by any other name and give it any number of justifications, because “nationalize” is not a good word in this country.

Have you noticed the trend? They have done it now with several of these plans. They say “Don’t worry we promise we won’t do X, just Y”, they pass Y and then switch it to X afterward.

“While the option appears to be a quick and easy way to avoid a confrontation with Congressional leaders wary of putting more money into the banks, some critics would consider it a back door to nationalization, since [um, since IT WOULD NATIONALIZE THE BANKS].”

4 liberty April 20, 2009 at 10:17 am

sorry for the double post

5 cja April 20, 2009 at 10:49 am

Posted this at Krugman’s blog (still waiting to be approved).

Bank of America is on track to pay almost $6 billion in preferred dividends this year. If you convert the preferred to common, you don’t have to pay the dividend anymore. That’s a lot of capital that BAC gets to save each year (over 25% of their peak annual income). So your not giving them more money, but your saving them a lot of future negative cash flows by converting the preferred.

Another way to look at it: converting preferred to common is straightforwardly dilutive to common shareholders. What is dilutive to the common is usually going to add to the buffer against debt creditors. It’s just as if you took subordinated debt holders and told them they were going to have to exchange their debt for common. No new cash for the bank, but they also have lower future liabilities.

One of the reasons the Fed cares about TCE and not Tier One Capital is that under the bank’s business model, there’s not a huge difference between perpetual preferreds and actual debt (when you borrow debt, with plans to roll it forever, and never pay it back, it’s basically a more senior version of a preferred). You can’t just cut the dividend on a preferred and do nothing to make amends to owners, just like you can’t just cut the interest payment on a loan.

6 babar April 20, 2009 at 11:00 am

@brian o —

‘futile’ as in insufficient?

7 bill April 20, 2009 at 12:18 pm

The crisis has already passed for the major banks and they are now self-healing. If left alone they will grow their way out of this situation in just a few more quarters. This idea of converting preferred to commmon is just a way for the government to show that they are doing something and are helping to fix the problem.

Traditional lending is fine but the shadow banking system is in tatters. If the government does follow through on this crazy preferred conversion idea it will seriously damage any efforts by the TALF to get the securitization markets going. Tier 1 capital has always been the way that banks measured capital ratios. Now in the middle of the crisis the government is trying to change the rules about what sort of method should be used to measure capital ratios. This is after the banks raised tens of billions of capital via preferred share sales in 2008. If the banks had known that TCE would be the ratio used in the future (in contradiction to decades of using Tier 1) they would have raised common equity in 2008.

8 Iain April 20, 2009 at 1:41 pm

“If you don’t give a bank any more money, it doesn’t have any more money.”

This sentence, in isolation, sounds like a description of a ponzi scheme.

Just sayin’

9 infopractical April 20, 2009 at 4:46 pm

My wife and I keep discussing how sad it is that Tyler Cowen quickly evolved from “reasonably intelligent (as far as economists go) bloggist” to “bag boy for Paul Krugman”. Or is “fluffer” the appropriate term? Either way, I’m scratching my head searching for more pathetic personality downgrades.

10 don April 20, 2009 at 10:27 pm

What stock price for the conversion? My guess, if they do this soon, taxpayers will get the stocks at rip off prices – and who do you think will be ripped off?

11 T. Shaw April 21, 2009 at 5:35 pm

As usual, the NYT is nearly 100% wrong.

In the real world of corporation law, finance, and accounting preferred stock IS EQITY.

There is no maturity nor is there interest payable – it’s dividends. They don’t get to vote, either. These are perpetual, noncumulative preferred stock. So, if a div is missed it doesn’t become a liability of the corp. The question as to whether these could be included in Tier 1 capital revolved around the banks’ ability (since taken away!) to repurchase the shares. The powers that be (like they do in Venezuela and other banana republics – that keeps them down and blaming Uncle Sam) decided that they would qualify as Tier 1 capital.

Here’s the problem with the TARP. It was cobbled together by investment bankers not bankers. The problems with Citi and BoA and Wachovia and etc. were not capital-related. No bank could possibly have sufficient capital to cover the losses they incurred. The problems were huge loan losses. When the guv put into Citi the first $25 billion, that accounted for $25 billion of $300+ billion in loan losses. POOF! GONE!!!! The guv then in December(?) put a guaranty on them $300 billion loans, and got nothing in return, and another $20 billion in PS.

I could go on.

The guv can convert the PS at the point of a bayonet. You know what that’s called?


And, you know how well that game is player: FNMA/FHLMC.

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