I was wrong in my FT column on Monday when I said:

Indisputably, an orderly resolution regime is required for all financial institutions, banks and non-banks alike.

To my dismay, this is disputable after all.

The Treasury secretary… released more details on Wednesday on a plan for a legal framework to put a “non-bank” into receivership at the behest of the government. With the backing of Ben Bernanke, Federal Reserve chairman, Mr Geithner wants powers to “resolve’’ ailing companies that are deemed systemically important.

He told legislators on Tuesday that such powers would have allowed the government to handle better the collapse of AIG, the giant insurer now surviving on $173bn of taxpayer funds.

House Republican leader John Boehner said on Tuesday that Mr Geithner’s plan sounded like “an unprecedented grab of power”.

That is the kind of comment that makes me wonder if the Republicans ever intend to be taken seriously on these issues. How can one intelligently oppose an FDIC-like resolution regime for AIG and other systemically significant non-banks?

I’ve heard it said that the FDIC’s pre-bankruptcy powers should be seen as a quid pro quo for deposit insurance, which AIG did not enjoy, since it was not a deposit-taker. Fine, but do you mean to tell me that AIG’s liabilities were not underwritten by taxpayers? Of course they were. See what happened to that $173 billion. Well then, what is wrong with plain bankruptcy in such a case? Perhaps you remember Lehman, an experience nobody cared to repeat. AIG was kept out of ordinary bankruptcy for a reason.

As my column pointed out:

Bankruptcy was tried, of course, in the case of Lehman, and was not a great success: many see that as a catalyst for the worst phase of this crisis. After the Lehman debacle, keeping counterparties whole to avoid systemic collapse was the entire point of coming to the rescue of AIG and the others.

Apparently, the lesson of the Lehman case was drawn too hastily. Do not worry too much about moral hazard, many concluded. Letting banks that took excessive risks fail in order to encourage more prudent behaviour is all very well in theory; in practice, you pull the ceiling down on your head.

Yes, but then one must also understand that the AIG outcome – keep everybody whole but taxpayers – is the alternative, and this no longer looks so good either. It fails the test of fairness, which is what the outcry is all about. It fails the test of efficiency too. The company’s death-wish business model, which involved insuring risks being taken by other financial groups on a literally insupportable scale, had moral hazard written all over its transactions. As James Hamilton of the University of California at San Diego has pointed out, if AIG’s counterparties were betting that the government would stand behind those suicidal credit default swaps, which in turn allowed them to keep rolling the dice, they turned out to be right.

So the question is this: if you cannot let a systemically significant bank or shadow bank collapse, and you cannot keep it whole at taxpayer expense, how do you dispose of it in an orderly way? How do you arrange a fair and efficient sharing of the losses? A template exists for US banks, though not for shadow banks or for hedge funds pretending to be insurance companies, in the resolution procedures of the Federal Deposit Insurance Corporation.

If the best the Republicans can do in opposing this line of thinking is issue all-purpose admonitions against government power, it would be better for everybody including themselves if they just shut up.

To be honest, I’m still trying to understand the Treasury’s new “legacy assets” proposal: Krishna Guha’s account; Treasury fact sheet. Of course it might fail but my instant reaction was not to think that it is “almost certain to”, as Paul Krugman writes with characteristic clarity (and a corresponding refusal to see any merit whatever in the other side’s position).

There are (at least) two programs here, not one. Many critics are failing to distinguish between the loans program and the securities program, though these are intended to work in very different ways. And although the great complication of the overall plan seems to have satisfied most commentators’ appetite for details, at least for now, crucial aspects of how it will work are in fact still unknown. For instance, as Krisha notes:

Pricing will still be difficult. Many toxic securities are complex and backed by fraudulent mortgage loans. Some are highly idiosyncratic, so discovering a price for one may not convey much about others. Banks may not be willing to part with loans that have not been heavily written down at auction prices, though Ms Bair hinted that regulators may force them to do so.

That banks will simply refuse to play at the prices offered by the PPIFs is probably the main risk for the loans part of the plan–though one that goes away if they are forced to sell. Will they be? Krishna continues:

Moreover, unless credit conditions ease considerably, the price levels established under these schemes will be sustained only by continuing access to lower-cost government finance.

Again, details to follow. The full terms of the FDIC’s guarantees under the loans program, and how it proposes to recoup any losses incurred on these guarantees, are not spelt out. The much-expanded TALF will carry the burden of dealing with legacy securities (hitherto regarded by the Treasury as the larger part of the problem) as opposed to legacy loans, but exactly which assets it will cover and the interest rate to be charged by the Fed are also not stated. And so on.

Standing back from the trees, Steve Pearlstein has a good piece making the case for guarded optimism. It would be educational to see Paul respond to some of his points.

Paul is certainly right that this is really just a new improved TARP. But an improvement is an improvement, not to be dismissed out of hand. Especially if it moves the scheme in the direction of an RTC-type resolution, which is something many critics singing from Paul’s hymn-sheet have been calling for. Gillian Tett writes:

Mr Geithner’s plan essentially tries to fix this problem [the breakdown in the market for securities] by handing government money to private investors so they can purchase the toxic debt. The basic idea is a rehash of the formula successfully adopted 15 years ago by the Resolution Trust Corporation, the body that resolved the Savings and Loans crisis.

Back then, the RTC extended up to 85 per cent non-recourse loans to private investors to kickstart a market for trading S&L assets. This time, the Geithner plan will also offer large dollops of government debt to investors wanting to buy toxic assets (and kick in some equity capital too.)

Moreover, just as the RTC tried to depoliticise the pricing of these assets by conducting open firesales and competitive bids, Mr Geithner’s plan aims to use free competition to establish a price for these planned sales. That way nobody can claim that the price has been “fixed” to the benefit of either banks or investors, or so it is hoped.

“This is RTC II,” enthuses Tim Ryan, the former head of RTC. “I have been crying out for something like this for seven months – now we have it at last.”

Paul is also right that everything depends, as it has from the beginning,  on the degree to which this is a liquidity problem (implying that the toxic assets are fundamentally underpriced in the current market) and a solvency problem (implying that they are are worth no more than the existing market, such as it is, says). The plan is as awful as Paul says only if lack of liquidity has nothing to do with it. To defend Geithner’s plan, you don’t have to argue that the banks would be fine if only the market for these securities could be made to work–this is expressly not the government’s position–only that the market is impaired and that this is adding a lot to the problem. Paul’s view seems to be that the toxic assets are more or less worthless under any plausible scenario. That seems to be putting a lot of faith in the efficiency of the market for toxic assets.

An outstanding and indispensable piece on the White House economics team. Mr Heilemann, I doff my hat.

Tim Geithner boarded the 6 a.m. US Airways shuttle to Washington last Wednesday at La Guardia, slid his rail-thin frame into seat 5C, then stared into the middle distance. Geithner is invariably described as boyish, but that morning he looked every one of his 47 years—and then some. He wore a dapper blue suit, a spread-collar shirt, and dark circles under his eyes. For days, Geithner had been consumed in the unfolding AIG fiasco. He’d been running nonstop, laboring to contain the fallout, to explain how this bonus-related abomination had occurred, what he knew, when he knew it, why he seemed so impotent. But Geithner was too smart to harbor any illusions about the efficacy of those efforts. He knew that what awaited him in Washington was going to be ugly. When the plane touched down, he gathered his things and walked silently toward the jetway. He had the look of a man about to enter a burning building in a suit soaked with gasoline.

Read on here.

The outcry in the US over bonuses paid by AIG, the stricken insurer, has been astonishing. By recent standards the sums involved are tiny but the story refuses to die down. Its implications could be, and should be, far-reaching.

Responding to an onslaught of popular protest, the House of Representatives has passed an atrocious and probably unconstitutional law, using the tax system to void contracts that its own recent stimulus bill sought to protect. Tim Geithner, the Treasury secretary, is implicated in the scandal and may yet be driven from office. The surge of anger may also cripple the long-awaited financial stability plan that Mr Geithner is about to reveal.

This plan will give an important role to private investors acting alongside the government in acquiring toxic assets. Good luck with that: the shredding of contracts and the use of the Internal Revenue Service as a bankers’ punishment squad are hardly conducive to the “partnership” the administration of Barack Obama seeks. Moreover, the government may be unable to take up the slack. The Treasury devised this scheme in the first place because taxpayers were so opposed to spending hundreds of billions more dollars to prop up the banks.

The remainder of the column can be read here. Please post comments below.

I recommend this editorial in the FT: the rage over AIG is understandable but not thought through, and the House bill is an abdication of responsibility.

In AIG’s case, the US government is now the de facto owner. As such it has rights and responsibilities, and it should attend more conscientiously to both. The Treasury should decide whether the bonuses are necessary to retain people essential to the success of its stabilisation plan. If they are, much as one may recoil at the idea, the bonuses should be paid: the cost pales in comparison to the vastly larger sums at stake. If not, the people who received them – those who have not already left, that is – should be told to return them or be fired. The government is within its rights as a new owner to set new terms for its employees.

The legislative blunderbuss about to be discharged by Congress, on the other hand, is likely to blow up in taxpayers’ faces. It forbids the case-by-case judgments on pay which are necessary to ensure that the stabilisation plan succeeds. And it expresses the tyrannical principle that Congress can use the tax code to void contracts that the executive branch has consented to, after the fact and with retrospective force. The measure is constitutionally dubious, as Congress well knows. All these considerations have been set aside for the purpose of venting the country’s anger. It is an abdication of responsibility.

I was interested to see EJ Dionne take a different line. He thinks that blind rage is a good thing, and economic populism a force for social justice if only it is intelligently directed. Continue reading "The rage over AIG"

A reader has asked me to explain the term “big girl’s blouse“. It resists exact translation. The nearest I can come to it is “daft apeth” (or haporth, or even halfpenny-worth, if you’re not into that whole short-form thing). Does that help?

My mother often calls me a daft apeth. It’s an affectionate rebuke. Big girl’s blouse, admittedly, adds intimations of being a sissy–either that or of coming from Bury (pronounced to rhyme with hurry), insofar as one can make this distinction. It appears that Kate Winslet called Leonardo DiCaprio a big girl’s blouse during the filming of “Titanic”, which is a bit strange because our Kate is not a northern lass.

Sorry for the confusion, chuck.

National Journal’s Charlie Cook, doyen of political rune-readers, on the latest numbers:

Just as the economic news was relentlessly negative until the last few days, poll numbers for Republicans were horrific for months. So the GOP should be heartened by the first encouraging polling news it has received perhaps since Lehman Brothers defaulted in mid-September: Republicans have pulled even with Democrats on the generic congressional ballot test, according to a survey by a respected pair of firms.

In the new National Public Radio poll conducted by the Democratic polling company Greenberg Quinlan Rosner Research and its Republican counterpart, Public Opinion Strategies, 42 percent of the 800 likely voters surveyed March 10 to 14 said that if the next congressional election were held today they would vote for the Republican candidate; an identical percentage of respondents said they would vote for the Democratic one. For several years, Democrats held a substantial lead on this question…

Many Democratic congressional leaders shake their heads with disdain or in disbelief over what they see as the Obama White House’s preoccupation or even obsession with pleasing independent voters by promoting bipartisanship, but reaching across party lines is critical to Obama’s success. Independent voters do not like partisanship, whether it is practiced by Democrats or Republicans. If Republicans really have pulled even or slightly ahead among independent voters, that is a very ominous sign for Democrats, an indication that Obama’s talking the talk of bipartisanship isn’t sufficient and that he and the Democratic majorities on Capitol Hill have to walk the walk.

My new column for National Journal defends the administration’s reluctance to nationalise banks outright, but argues that a straightforward RTC-type bad bank would be better than the proposed “public-private investment fund”.

Few things about the banking crisis are clear even to the experts, and sadly the things that do seem clear, taken together, only compound the problem. One is that hundreds of billions of dollars of further taxpayer support, at least, are going to be needed to revive the financial system. Another is that taxpayers are deeply reluctant to pay one more cent. The gap between those facts is very wide, and fury over American International Group’s bonuses has made it even more difficult to bridge.

Remembering what is at stake, it is surprising what a big role mere words can play. “Bonus,” for instance. If the contracts offered to the financial engineers of AIG had simply promised so much cash in return for so many months of work, they might have aroused little controversy, even if the sums involved had been as large. What ignited the outrage was the idea that taxpayers should finance a bonus — a special reward, as if in recognition of exceptional performance — for the very people who helped destroy the firm in the first place. It does not matter that the promised payments were never intended to be bonuses of that sort. The word added insult to injury.

Another nuisance word that arouses irrationally strong feelings even though nobody seems to know quite what it means is “nationalization.” One prominent school of thought holds that the administration’s dithering over its financial rescue plan comes down to reluctance to use that dreaded term. The country’s big insolvent banks need to be taken into immediate, outright, and temporary public ownership, in this view. Shareholders would lose everything, management would be replaced, and government would call the shots on lending policy, pay, and everything else until new private owners could be found.

In the long run, this would cost taxpayers far less than the present muddle, many argue. But much as voters hate bailing out banks with cash that promptly leaks abroad, or into bonuses, or who knows where, President Obama’s Treasury Department apparently assumes that Americans hate “nationalization” even more.

Read on here [link expires in two weeks].