The Question Geithner Refuses To Answer

[girl gone mad]

The Question Geithner Refuses To Answer
http://www.businessinsider.com/henry-blodget-the-elephant-in-the-bailout-room-2009-3">The Business Insider

Tim Geithner did a good job on the Sunday talk-show circuit. He has survived his near-death experience of two weeks ago, and the betting odds that he'll be ousted by June have fallen back to 10%.

But there's one question he still refuses to answer. Why is he bailing out the people who lent trillions of dollars to our now-insolvent banks?

Each of the bailed-out institutions has tens or hundreds of billions of dollars that could be used to cover losses before the taxpayer had to cough up a dime. And with the exception of Lehman Brothers (and, now, General Motors), these gigantic pools of money have been protected to the tune of 100 cents on the dollar.

Who are these people?

The bondholders.

In any fair world, the bondholders would lose everything before any taxpayer money was put on the line. Ever since Lehman Brothers, however, Tim Geithner & Co. have been so afraid of a Lehman-repeat that they refuse to even publicly discuss the possibility of making bondholders share the pain. Whenever anyone suggests this idea, moreover, Geithner & Co. immediately dismiss it by saying it would lead to another Lehman.

At best, this is wrong. At worst, it's disingenuous.

The folks who lent money to AIG, Citi, etc., knew exactly what risks they were taking. It's time to at least discuss the possibility that they should have to answer for this.

[MarjorieG]

1. The scary part of all this is how much is still unknown about the assets worth, repercussions.

We aren't go to bailout again like we did last Fall, however much it's fun to beat up Geithner.

[girl gone mad]

2. You should read fund manager John Hussman's letter:

From the beginning of the recent crisis, starting with Bear Stearns, I have emphasized that nearly all of the financial institutions at risk of insolvency have enough liabilities to their own bondholders to fully absorb all probable losses without any loss to customers or the American public. The sum total of the policy responses to this crisis has been to defend the bondholders of distressed financial institutions at public expense.

Note that in the example balance sheet above [http://www.hussmanfunds.com/wmc/wmc090330.htm">click here to read the full post], 30% of the liabilities of the institution represent debt to the company's own bondholders. It is these individuals – not homeowners, not the American public – that are being defended by the promise of trillions of dollars in public money.

For example, while Citigroup has approximately $2 trillion in assets, those assets are financed not only by customer deposits, but also by nearly $600 billion in debt to Citigroup's own bondholders. It is these private bondholders who provided the funds for Citigroup to acquire questionable assets.

The bondholders of distressed financial institutions – not the American public – should bear responsibility for the losses of those institutions. This can be accomplished, without harm to customers or the broader financial system, in one of two ways:

1) The bondholders could voluntarily agree to move a portion of their claims lower down in the capital structure, swapping debt for equity (preferred or common), allowing the bank to have a larger cushion of Tier-1 capital, avoiding insolvency, and hopefully allowing the bank to recover by its own bootstraps, preferably assisted by debt restructuring on the borrower side (via property appreciation rights and the like). Alternatively;

2) The U.S. government could take receivership of the financial institution, defend the customer assets, change the management, wipe out the stockholders and a chunk of the bondholders claims entirely, continue the operation of the institution in receivership, and eventually sell or reissue the company to private ownership, leaving the bondholders with the residual. Indeed, this is how the largest bank failure in history – Washington Mutual – was handled so seamlessly last year that it was almost forgettable. This is not Argentina-style “nationalization,” but receivership – a form of “pre-packaged bankruptcy” that protects the customers and allows the institution to continue to operate, followed by re-privatization. This would fully protect all of the customers and depositors at no probable expense to the public.

What should not be done is what was allowed in the case of Lehman Brothers – a disorderly failure, by which the company was allowed to fail with no conservatorship of the existing business. It was not the failure of Lehman per se, but the disorder resulting from its piecemeal liquidation, that caused distress to the financial markets.

[many a good man]

4. The big question is WHO are the bondholders. Maybe not who you think.

It's not rich Americans. As Americans went a buying binge with the cheap credit most of this money came from foreign investors seeking safe investments. Our financial system swore they were safe. If we refuse to pay up America's spot at the top of the rung will be over for good. You really have to think through the ramifications of that, and the worldwide wreckage that would ensue.

http://www.businessweek.com/the_thread/economicsunbound/archives/2009/03/a_simple_guide.html?chan=top+news_top+news+index+-+temp_news+++analysis

[girl gone mad]

5. Bank bonds have never had the implicit safety of Treasury Bills..

and I don't believe the bondholders (even foreign ones) were naive enough to make such a crazy assumption. It's not our national obligation to treat the bonds as if they were T-bills just because some foreigners may not have been sufficiently hedged.

You mention the ramifications of forcing bondholders to take a haircut but that's something that's always been written into the contract. Insolvency and bankruptcy is a known potential outcome. I see the risk of treating bonds like T-bills as a much greater threat since there could never be an explicit guarantee (barring permanent nationalization), but the mere assumption would bring a deficient rate of return which would threaten the ability to raise capital. Why buy low yielding bank bonds which may or may not be backed by the US government when you can just buy treasuries, which are? This is an unknown potential outcome, much more dangerous.

Bank holding company CDS spreads are reaching new highs, so I'm guessing the market thinks Geithner is seeking resolution authority because he wants to go this route and the bondholders are going to take a hit.

[many a good man]

10. Triple A ratings are supposed to be safe

It's pretty rare to go from AAA to haircut in a single bound. Investors around the world are losing faith and confidence in what used to be rock solid. Americans don't earn enough or save enough on our own to meet our current obligations.

It's not right and it isn't fair. Obama must think that these guys are wearing suicide belts and have their thumbs on the detonator. How do we get from here to there without melting down the entire world?

[GeorgeGist]

11. The world will be wrecked if Americans don't remain at the top of the rung.

A greedy thought for any bad man.

[many a good man]

12. There would be a very painful transition period

I don't say this out of greed. There can be a severe economic dislocation around the world for a generation or more if there is a major change in the international economic system. Lots and lots of innocent people will suffer and die before a new system is stabilized.

It is quite possible that whatever comes out in the end would be vastly superior to the American-led system we have now but there are no guarantees. Would you prefer to live in a system dominated by China?

[tbyg52]

9. I wish I'd had *all* my money in his two funds

Strategic Growth only lost about 10% and Strategic Total Return made money last year. Not many funds you can say that about.

[MannyGoldstein]

3. Who's This Geithner You Speak Of?

All I saw was Paulson with a wig.

[wildbilln864]

6. k&r! nt

:hi:

[OhioChick]

7. K&R

:kick:

[TexasObserver]

8. Yes, it's an outrageous misuse of public money.

This is why federal funds should have been earmarked for certain uses only, and all other uses prohibited. Saving the equity of shareholders or saving the losing bettors from their bad bets should be the last priority of Treasury.

[omega minimo]

13. and that would be why the plan is to pretend that the toxic assets and bogus products

are valid and need to be kept in play to get the system moving again?

Validating the bogus products keep the focus off of who knew what when.

[Badlands Democrat]

14. Tim Geithner may be horrible in public,

but he's an economic genius. Like President Obama, give him time.
8 years of George W. Bush - don't forget that.

[ihavenobias]

15. K & R. I'll side with Krguman, Stiglitz, Galbraith & Reich, not Fox, the WSJ & Paulson. n/t