Too Big To Fail

Breaking Down Bernie's Bill

Its evolved from a catchy phrase, to a mantra, then policy ordoxody, and now to a proposed law in Congress.

The "Too Big to Fail" legislation is just two pages. BTW, which Treasury secretary was derided for being too vague and brazen in his two page proposal on TARP? And, as reported previously, it was introduced by (socialist) Senator Sanders who couldn't contradict itself more if it wanted:

Section 2: "The Secretary of the Treasury shall submit to Congress a list of all commerical banks, investment banks, hedge funds, and insurance companies that are too big to fail."

Section 3: One year later..."the Secretary of the Treasury shall break up entities included on the Too Big to Fail List..."

Ok, fair enough. At least give him credit for being honest. But wait...

Section 4: "For purposes of this Act, the term "Too Big to Fail" means any entity that has grown so large that its failure would have a catastrophic effect..."

So which is it Bernie? Do you want to break up just financial institutions? Or do you expect us to entrust Treasury and you to responsibly expropriate (which might be an oxymoron) anything you deem "too big to exist?"

When I first read the bill I thought to myself how foolish is this guy? Well, after some sleuthing I realized I'm the dumby. Sanders telegraphed his intentions shortly after TARP was introduced in Sept. 2008:

"Finally, we need to protect ourselves from being at the mercy of giant companies that are "too big to fail," that is, companies who are so large that their failure would cause systemic harm to the economy. We need to assess which companies fall into this category and insist they are broken up."

Expect this bill to end up in the paper shredder. The Frank bill, while in need of major revisions, is at least representative of a free and stable economy, and worthy of debate. Unlike this one which is - dare I say it - something only the Bolksheviks would rubber stamp.

Guerrilla News Video #2

God Bless Canada

Sometimes the world makes no sense in very amusing ways. France's president called ours "naive" and "ill-prepared" to handle evil regimes and terrorism. When the French are lecturing our overtly timid leader, something's awry. And now the Canadians - yes the Canadians - are (politely) telling Gordon Brown to throw his global bank tax idea over a bridge.

First it was Tax Cheat (pardon, Treasury Secretary) Geithner who rightfully dismissed any notion that the U.S. would support a financial transaction tax to finance a global bank bailout fund: "The idea has been around for a long time...I think frankly the experiences are mixed," expressing an American view that there was no widespread backing for such a tax, Reuters reported Sunday.

And then there was Canadian Finance Minister Jim Flaherty: "It (the tax) is not particularly attractive to me as finance minister of Canada. We have been a government that has been reducing taxes," he said according to Reuters.

We should heed Flaherty's ideas. Limit government's ability to wastefully expropriate resources. Let all people keep more of their owns assets so they can create the next million jobs.

What an absurd socialistic fantasy that there is, to adapt John Lennon's dream, a "brotherhood of banks" that will cooperate to spread wealth and risk among all nations, irrespective of their visions or responsibilities.

  

Gordon Brown: Global Tax to Fund Bailouts

British Prime Minister Gordon Brown seems like a well meaning fellow. But like our nobel - er, noble intentioned president, he's sadly naive. 

In a meeting with G20 central bankers and finance ministers Saturday, Mr. Brown said: "I believe we should discuss whether we need a better economic and social contract to reflect the global responsibilities of financial institutions to society."

Hey in theory that's fine and dandy, but how does it work in practicality?

It seems to me, which media reports confirm, that he's insinuating a global FDIC-like tax on cross-border financial institutions. That pool of money would then fund international bailouts, so as to avoid using public funds to finance them.

Under no circumstance do I want American banks (which are owned by virtually all of us in one way in our 401k's) to cut away from the bottom line for bailouts in any country, let alone Russia, China, Mexico, etc...I would imagine the feeling is pretty mutual in the other direction. Think how many times the United States was demeaned as the sole greedy culprit in the credit crisis.

We can be concerned about the world. We can want and encourage others to succeed. We can offer consultation and avenues (like the IMF) for help. But each nation is sovereign. Each nation, especially outside of Europe, is independent. Each nation is responsible to itself. I care about other nations, but I would never sign a 'social contract' to force American firms to finance what should be the responsibility of someone else.

Moral Hazard: A Self-Fulfilling Prophesy

Two new bills were put forth this week - one by Rep. Barney Frank (D.Mass) and the other Sen. Bernard Sanders (I.VI) to tackle the issue of 'too big to fail' institutions. Both of them have it wrong and one is so inane it's hard to imagine it will ever make it through committee.

Let's start with the worst bill first. If passed, Sen. Sanders's proposal would give Treasury three months to compile a list of systemically risky financial or "any entity that has grown so large that its failure would have a catastrophic effect on the stability of either the financial system or the United States economy without substantial government assistance." And then here's the kicker: within 1-year the bill would make Treasury break-up those very same institutions.

This gives politicians an uncomfortable amount of wiggle-room - any entity? Further, do we really think politicians are smart and prudent enough to delineate where the line is between 'too big to fail' and not?

"If an institution is too big to fail, it is too big to exist," Sanders said in a statement this week. I spidey senses tell me this is a clever justification for the Senate's only self-described socialist to expropriate any firm he wishes.  

Now on to Rep. Frank's bill. Even by MarketWatch's admission, the proposal "raises more questions than it answers." The bill would require banks with assets of $10 billion plus to pay into a 'too big to fail' insurance fund to help finance wind-downs of insolvent institutions during a crisis. If the insurance fund ran dry, taxpayer funds would be lent to pay for the process. It would also authorize the government to provide funds to creditors and counterparties of the failed institution. 

The biggest problem I see with this logic is by explicitly trying to prevent firms from getting too systemically important, the law, if enacted, would encourage banks to grow and take enough risk to become just that. And it would unnecessarily punish the mid-size and smaller regional banks who wouldn't have access to all the government protections. 

Financial Markets Podcast Wednesday, October 28

Download Williams Podcast Kudlow Final Audio 10.30

New Bills on Riskiness and Hedgies

Two regulatory bills are making their way through Congress at the moment -  one on TBTF institutions and the other on hedge funds.

Let's consider the former for today.

With regard to securitization, the bill seems to require two big changes to the originate-to-distribute model. First, originators will be required to have a "skin-in-the-game." If kept to a minimum, I think this COULD potentially help deal with the problems of moral hazard and screening for adverse selection at the beginning of the securitization process. It's also important to keep in mind, however, that by requiring lenders to hold additional capital, originators will have less money to make more loans, thus reducing the availability in credit and making all securitize loans - including student, auto, commercial - more expensive for the borrower (US!). Second, for investment banks that originate and distribute themselves (UBS is a prime example), they will now be required to maintain additional capital to buffer against potential losses. I only like this idea if a certain notional amount is permanently retained or warehoused for, say, longer than 2 months. This "penalty" buffer should be a percentage of the notional amount of securitized assets on the balance sheet. On the final point on TBTF, according to this article in The Atlantic, it seems hedging retained securitized positions will be a thing of the past. Personally, I think this is overdone. The problem in the last crisis was that hedging techniques were implemented, but very poorly. Only about 2-4% of the notional amount would be hedged through CDS (buy protection), and the timeline for proper hedging would take eons (see UBS's mea culpa). I would prefer the bill's language be changed to allow hedging, but to make requirements on the amounts on the products held in-house.

How in the World Could GMAC be TBTF?

Really? We still think a dying auto-lender is too interconnected and poses a systemic risk to markets? I was aghast that GMAC received two bailout rounds constituting $12.5 billion. Treasury now owns about a third of the company.

But now GMAC wants a third infusion of ~ $5.6 billion to tie it over presumably for a few more months. And, to make matters worse, this company with a Ca credit rating (two notches above default mind you) issued 3-year debt this week fully guaranteed under the FDIC's Temporary Liquidity Guarantee Program - making it essentially just another AAA issuer.

Since the Fed/Treasury/FDIC never made (to the best of my knowledge) any material adverse clauses with bailout funds or liquidity programs, this was bound to happen. No specific benchmarks or restructuring for the company to meet, just a cash life preserver. Philosophical arguments about TBTF aside, in pure economic terms GMAC clearly does not fit the loosely-held definition of a firm that poses a systemic risk to the economy. Yes it has 15 million borrowers and relationships with thousands of GM and Chrysler dealerships, but our over the last few decades our economy has significantly waned away from its dependence on manufacturing, specifically American auto makers, to propel our economy. GMAC is insolvent, not illiquid. It is also not interconnected enough to fit what we've been told is TBTF. GMAC perhaps is TBTF for the Democrats, who need AFL-CIO support as much as I need sleep.

Mom - If You're Reading - I Want This for Christmas

Larry Kudlow Speaks @ NYU

Not even a one-hour Obama-induced traffic jam could keep Wall Street's most prolific supply side economist from speaking to NYU students last evening.

CNBC's Larry Kudlow, a harsh critic of the bank bailouts and current fiscal policy, spoke for about 60 minutes to a third-full Schimmel Auditorium. Among the aforementioned topics, Mr. Kudlow covered the following:

1) Health Care

2) The weakening USD

3) Obama's socialistic tendencies + "weird" ties to admitted socialists

4) An inept GOP - most notably in New Jersey

5) The "too big to fail" concept

6) A historical take on the effects of massive tax cuts (Kennedy, Reagan, Bush 43)

I've analyzed most of the above (especially numero cinco ad nauseum), with the exception of Chris Christie's colossal collapse in the polls relative to New Jersey Governor Corzine. So let's focus on that. 

Kudlow and I are in strong agreement that this election is a watershed moment for the GOP heading into 2010 and 2012. And with the way Corzine has jacked-up taxes and spending, driving the Garden State into the same budgetary and economic pits as New York and California, Christie should be a shoe-in for a big W.

Two months ago he was. Now, he's abandoned the free-market and common sense economic principles that the state is dying (almost literally) for. This is much to Corzine's credit. He has shifted the focus of the election to mammograms and childish insinuations to Christie's obesity, and away from the economic failures of the last few years.

On top of that, Corzine used to be a top executive at Goldman Sachs. Given the public's current distaste for bankers, you couldn't serve it up on a better plate for us.

Alas, most polls show a virtual dead-heat. At best Christie has a 2-point lead (used to be ~20).

Putting it another way for Kudlow, the recession, bailouts, and budgetary problems provide the perfect opportunity to flip the economic direction of NJ back to entrepreneurship and low taxes, and remove onerous regulations. The people need them, but it's up to the messenger to heed these sacred principles.

*Note - In about two weeks I will post a 3-minute video of the event supplemented with interviews.