Tracking Loans Through a Firm That Holds Millions
By MIKE McINTIRE www.nytimes.com 4/24/2009
Judge Walt Logan had seen enough. As a county judge in Florida, he had 28 cases pending in which an entity called MERS wanted to foreclose on homeowners even though it had never lent them any money.
MERS, a tiny data-management company, claimed the right to foreclose, but would not explain how it came to possess the mortgage notes originally issued by banks. Judge Logan summoned a MERS lawyer to the Pinellas County courthouse and insisted that that fundamental question be answered before he permitted the drastic step of seizing someone’s home.
“You don’t think that’s reasonable?” the judge asked.
“I don’t,” the lawyer replied. “And in fact, not only do I think it’s not reasonable, often that’s going to be impossible.”
Judge Logan had entered the murky realm of MERS. Although the average person has never heard of it, MERS — short for Mortgage Electronic Registration Systems — holds 60 million mortgages on American homes, through a legal maneuver that has saved banks more than $1 billion over the last decade but made life maddeningly difficult for some troubled homeowners.
Created by lenders seeking to save millions of dollars on paperwork and public recording fees every time a loan changes hands, MERS is a confidential computer registry for trading mortgage loans. From an office in the Washington suburbs, it played an integral, if unsung, role in the proliferation of mortgage-backed securities that fueled the housing boom. But with the collapse of the housing market, the name of MERS has been popping up on foreclosure notices and on court dockets across the country, raising many questions about the way this controversial but legal process obscures the tortuous paths of mortgage ownership.
If MERS began as a convenience, it has, in effect, become a corporate cloak: no matter how many times a mortgage is bundled, sliced up or resold, the public record often begins and ends with MERS. In the last few years, banks have initiated tens of thousands of foreclosures in the name of MERS — about 13,000 in the New York region alone since 2005 — confounding homeowners seeking relief directly from lenders and judges trying to help borrowers untangle loan ownership. What is more, the way MERS obscures loan ownership makes it difficult for communities to identify predatory lenders whose practices led to the high foreclosure rates that have blighted some neighborhoods.
In Brooklyn, an elderly homeowner pursuing fraud claims had to go to court to learn the identity of the bank holding his mortgage note, which was concealed in the MERS system. In distressed neighborhoods of Atlanta, where MERS appeared as the most frequent filer of foreclosures, advocates wanting to engage lenders “face a challenge even finding someone with whom to begin the conversation,” according to a reportby NeighborWorks America, a community development group.
To a number of critics, MERS has served to cushion banks from the fallout of their reckless lending practices.
“I’m convinced that part of the scheme here is to exhaust the resources of consumers and their advocates,” said Marie McDonnell, a mortgage analyst in Orleans, Mass., who is a consultant for lawyers suing lenders. “This system removes transparency over what’s happening to these mortgage obligations and sows confusion, which can only benefit the banks.”
A recent visitor to the MERS offices in Reston, Va., found the receptionist answering a telephone call from a befuddled borrower: “I’m sorry, ma’am, we can’t help you with your loan.” MERS officials say they frequently get such calls, and they offer a phone line and Web page where homeowners can look up the actual servicer of their mortgage.
In an interview, the president of MERS, R. K. Arnold, said that his company had benefited not only banks, but also millions of borrowers who could not have obtained loans without the money-saving efficiencies it brought to the mortgage trade. He said that far from posing a hurdle for homeowners, MERS had helped reduce mortgage fraud and imposed order on a sprawling industry where, in the past, lenders might have gone out of business and left no contact information for borrowers seeking assistance.
“We’re not this big bad animal,” Mr. Arnold said. “This crisis that we’ve had in the mortgage business would have been a lot worse without MERS.”
About 3,000 financial services firms pay annual fees for access to MERS, which has 44 employees and is owned by two dozen of the nation’s largest lenders, including Citigroup, JPMorgan Chase and Wells Fargo. It was the brainchild of the Mortgage Bankers Association, along with Fannie Mae, Freddie Mac and Ginnie Mae, the mortgage finance giants, who produced a white paper in 1993 on the need to modernize the trading of mortgages.
At the time, the secondary market was gaining momentum, and Wall Street banks and institutional investors were making millions of dollars from the creative bundling and reselling of loans. But unlike common stocks, whose ownership has traditionally been hidden, mortgage-backed securities are based on loans whose details were long available in public land records kept by county clerks, who collect fees for each filing. The “tyranny of these forms,” the white paper said, was costing the industry $164 million a year.
“Before MERS,” said John A. Courson, president of the Mortgage Bankers Association, “the problem was that every time those documents or a file changed hands, you had to file a paper assignment, and that becomes terribly debilitating.”
Although several courts have raised questions over the years about the secrecy afforded mortgage owners by MERS, the legality has ultimately been upheld. The issue has surfaced again because so many homeowners facing foreclosure are dealing with MERS.
Advocates for borrowers complain that the system’s secrecy makes it impossible to seek help from the unidentified investors who own their loans. Avi Shenkar, whose company, the GMA Modification Corporation in North Miami Beach, Fla., helps homeowners renegotiate mortgages, said loan servicers frequently argued that “investor guidelines” prevented them from modifying loan terms.
“But when you ask what those guidelines are, or who the investor is so you can talk to them directly, you can’t find out,” he said.
MERS has considered making information about secondary ownership of mortgages available to borrowers, Mr. Arnold said, but he expressed doubts that it would be useful. Banks appoint a servicer to manage individual mortgages so “investors are not in the business of dealing with borrowers,” he said. “It seems like anything that bypasses the servicer is counterproductive,” he added.
When foreclosures do occur, MERS becomes responsible for initiating them as the mortgage holder of record. But because MERS occupies that role in name only, the bank actually servicing the loan deputizes its employees to act for MERS and has its lawyers file foreclosures in the name of MERS.
The potential for confusion is multiplied when the high-tech MERS system collides with the paper-driven foreclosure process. Banks using MERS to consummate mortgage trades with “electronic handshakes” must later prove their legal standing to foreclose. But without the chain of title that MERS removed from the public record, banks sometimes recreate paper assignments long after the fact or try to replace mortgage notes lost in the securitization process.
This maneuvering has been attacked by judges, who say it reflects a cavalier attitude toward legal safeguards for property owners, and exploited by borrowers hoping to delay foreclosure. Judge Logan in Florida, among the first to raise questions about the role of MERS, stopped accepting MERS foreclosures in 2005 after his colloquy with the company lawyer. MERS appealed and won two years later, although it has asked banks not to foreclose in its name in Florida because of lingering concerns.
Last February, a State Supreme Court justice in Brooklyn, Arthur M. Schack, rejected a foreclosure based on a document in which a Bank of New York executive identified herself as a vice president of MERS. Calling her “a milliner’s delight by virtue of the number of hats she wears,” Judge Schack wondered if the banker was “engaged in a subterfuge.”
In Seattle, Ms. McDonnell has raised similar questions about bankers with dual identities and sloppily prepared documents, helping to delay foreclosure on the home of Darlene and Robert Blendheim, whose subprime lender went out of business and left a confusing paper trail.
“I had never heard of MERS until this happened,” Mrs. Blendheim said. “It became an issue with us, because the bank didn’t have the paperwork to prove they owned the mortgage and basically recreated what they needed.”
The avalanche of foreclosures — three million last year, up 81 percent from 2007 — has also caused unforeseen problems for the people who run MERS, who take obvious pride in their unheralded role as a fulcrum of the American mortgage industry.
In Delaware, MERS is facing a class-action lawsuit by homeowners who contend it should be held accountable for fraudulent fees charged by banks that foreclose in MERS’s name.
Sometimes, banks have held title to foreclosed homes in the name of MERS, rather than their own. When local officials call and complain about vacant properties falling into disrepair, MERS tries to track down the lender for them, and has also created a registry to locate property managers responsible for foreclosed homes.
“But at the end of the day,” said Mr. Arnold, president of MERS, “if that lawn is not getting mowed and we cannot find the party who’s responsible for that, I have to get out there and mow that lawn.”
Saturday, April 25, 2009
Friday, April 24, 2009
Checking Obama's Balance
By Stephen Sestanovich, www.washingtonpost.com
Friday, April 24, 2009
Last week, 30 Columbia University graduate students and I spent two long days in meetings with senior officials at the State Department and National Security Council; on Capitol Hill; and with experienced Washington journalists, economists, consultants and lobbyists. Most of us probably expected to come away wondering whether, in its overhaul of American foreign policy, the Obama administration has found a winning strategy for dealing with tough problems such as Iran or North Korea. By the end my conclusion was different. What the president and his team really need is a strategy for dealing with Congress
Our field trip came three days after President Obama announced his refashioning of Cuba policy. Not surprisingly, my students asked why the changes were so limited, especially since -- as we were frequently told -- the administration believes the U.S. embargo has been "a total failure for decades." Ah, we heard, anything more far-reaching would require action by Congress.
The week before, in Prague, Obama had announced his vision of a world without nuclear weapons. As a crucial first step, he said he would "immediately and aggressively" seek ratification of the Comprehensive Nuclear Test Ban Treaty to bolster American credibility in trying to keep other states from going nuclear. But on the Hill we heard that the votes aren't there for ratification, that key senators who voted down the treaty 10 years ago may be even more dubious now. Pressed on this, administration officials conceded that "immediate" and "aggressive" action doesn't actually mean "soon" -- not this year, and maybe not in the first half of next year.
Perhaps no Obama policy has excited more enthusiasm abroad than the administration's readiness to negotiate a binding treaty on climate change. My students were reminded, however, that Congress intends to define the new standards that will restrict greenhouse-gas emissions, and the desire to maintain congressional control crosses party lines. Last month almost half of the Senate's Democrats voted to give their Republican colleagues more say in the process -- by agreeing to require a 60-vote supermajority on climate legislation.
The list of issues pitting the president against Congress could be extended. While in Europe, Obama promised Russian President Dmitry Medvedev to "graduate" Russia from the restrictions of the Jackson-Vanik amendment, the Cold War law that tied trade relations to free emigration from the Soviet Union. Although emigration has not been restricted for years, many senators believe that Jackson-Vanik should remain in place until the United States gets something in return -- trade concessions, perhaps, or gestures on human rights.
The budget that Defense Secretary Robert Gates introduced this month may face similar trouble. My students heard a senior official of the previous administration praise Gates for trying to focus the Pentagon on current counterinsurgency operations -- and away from the much smaller risk of war with another major power. But congressional committee chairmen are clearly less happy about the change. The old strategy meant more spending on big weapons systems -- and more manufacturing jobs in their districts.
Administration strategists understand all this, and they think that once they begin to make their case, issue by issue, they'll pick up more support. Surely they will. Even so, despite Democratic majorities in both houses, each issue on which Obama is seeking to change long-standing policy will be a tough battle. In no case -- not climate change, defense spending or even Cuba -- is existing policy held in place simply by Republican obstinacy. What the president really needs is more support than he can now count on from industrial-state Democrats. And on nuclear testing, not even unanimous Democratic support will be enough.
Treaty ratification requires a two-thirds majority, and the Comprehensive Nuclear Test Ban Treaty will go nowhere unless influential Republican senators support it. The administration's task is further complicated by the fact that, having called for change on so many issues, it can't treat them all as matters of hair-on-fire urgency. The president's floor managers and backroom dealmakers know they will have to resort to the logrolling that defines Congress's daily business. They are probably beginning to wonder whether, even with today's vast federal budget, there's enough pork to go around for all the votes they're going to have to buy.
But if the Obama administration ends up relying on a give-a-little-here, get-a-little-there strategy to move its foreign policy agenda through Congress, it will probably fail. New presidents who want to push for big changes usually conclude that they need more power to make them work. They challenge Congress to defy them by treating it as an out-of-date institution, slow in its ways, poorly adapted to new realities and overly influenced by parochial interests.
There is already a not-so-gentle hint of this approach in the administration's suggestion that if Congress can't reach consensus on sound climate policy, it will exercise its own regulatory authority to achieve the same result. It's not hard to imagine a more aggressive approach on other issues, particularly defense spending. (Richard Nixon, remember, called his defiance of the congressional budget process "sequestration" -- the Obama administration may simply need a fresher term.)
It would be ironic if Barack Obama, following a president whom he scorned for abusing executive power, concluded that he can't reorient foreign policy in the ways he wants without more unhampered authority. But deferring to Congress too often carries a high price. If the president really wants a new foreign policy, he won't want to pay it.
Friday, April 24, 2009
Last week, 30 Columbia University graduate students and I spent two long days in meetings with senior officials at the State Department and National Security Council; on Capitol Hill; and with experienced Washington journalists, economists, consultants and lobbyists. Most of us probably expected to come away wondering whether, in its overhaul of American foreign policy, the Obama administration has found a winning strategy for dealing with tough problems such as Iran or North Korea. By the end my conclusion was different. What the president and his team really need is a strategy for dealing with Congress
Our field trip came three days after President Obama announced his refashioning of Cuba policy. Not surprisingly, my students asked why the changes were so limited, especially since -- as we were frequently told -- the administration believes the U.S. embargo has been "a total failure for decades." Ah, we heard, anything more far-reaching would require action by Congress.
The week before, in Prague, Obama had announced his vision of a world without nuclear weapons. As a crucial first step, he said he would "immediately and aggressively" seek ratification of the Comprehensive Nuclear Test Ban Treaty to bolster American credibility in trying to keep other states from going nuclear. But on the Hill we heard that the votes aren't there for ratification, that key senators who voted down the treaty 10 years ago may be even more dubious now. Pressed on this, administration officials conceded that "immediate" and "aggressive" action doesn't actually mean "soon" -- not this year, and maybe not in the first half of next year.
Perhaps no Obama policy has excited more enthusiasm abroad than the administration's readiness to negotiate a binding treaty on climate change. My students were reminded, however, that Congress intends to define the new standards that will restrict greenhouse-gas emissions, and the desire to maintain congressional control crosses party lines. Last month almost half of the Senate's Democrats voted to give their Republican colleagues more say in the process -- by agreeing to require a 60-vote supermajority on climate legislation.
The list of issues pitting the president against Congress could be extended. While in Europe, Obama promised Russian President Dmitry Medvedev to "graduate" Russia from the restrictions of the Jackson-Vanik amendment, the Cold War law that tied trade relations to free emigration from the Soviet Union. Although emigration has not been restricted for years, many senators believe that Jackson-Vanik should remain in place until the United States gets something in return -- trade concessions, perhaps, or gestures on human rights.
The budget that Defense Secretary Robert Gates introduced this month may face similar trouble. My students heard a senior official of the previous administration praise Gates for trying to focus the Pentagon on current counterinsurgency operations -- and away from the much smaller risk of war with another major power. But congressional committee chairmen are clearly less happy about the change. The old strategy meant more spending on big weapons systems -- and more manufacturing jobs in their districts.
Administration strategists understand all this, and they think that once they begin to make their case, issue by issue, they'll pick up more support. Surely they will. Even so, despite Democratic majorities in both houses, each issue on which Obama is seeking to change long-standing policy will be a tough battle. In no case -- not climate change, defense spending or even Cuba -- is existing policy held in place simply by Republican obstinacy. What the president really needs is more support than he can now count on from industrial-state Democrats. And on nuclear testing, not even unanimous Democratic support will be enough.
Treaty ratification requires a two-thirds majority, and the Comprehensive Nuclear Test Ban Treaty will go nowhere unless influential Republican senators support it. The administration's task is further complicated by the fact that, having called for change on so many issues, it can't treat them all as matters of hair-on-fire urgency. The president's floor managers and backroom dealmakers know they will have to resort to the logrolling that defines Congress's daily business. They are probably beginning to wonder whether, even with today's vast federal budget, there's enough pork to go around for all the votes they're going to have to buy.
But if the Obama administration ends up relying on a give-a-little-here, get-a-little-there strategy to move its foreign policy agenda through Congress, it will probably fail. New presidents who want to push for big changes usually conclude that they need more power to make them work. They challenge Congress to defy them by treating it as an out-of-date institution, slow in its ways, poorly adapted to new realities and overly influenced by parochial interests.
There is already a not-so-gentle hint of this approach in the administration's suggestion that if Congress can't reach consensus on sound climate policy, it will exercise its own regulatory authority to achieve the same result. It's not hard to imagine a more aggressive approach on other issues, particularly defense spending. (Richard Nixon, remember, called his defiance of the congressional budget process "sequestration" -- the Obama administration may simply need a fresher term.)
It would be ironic if Barack Obama, following a president whom he scorned for abusing executive power, concluded that he can't reorient foreign policy in the ways he wants without more unhampered authority. But deferring to Congress too often carries a high price. If the president really wants a new foreign policy, he won't want to pay it.
Thursday, April 16, 2009
Wells Fargo’s "Profit": Too Good to Be True
Commentary by Jonathan Weil
April 16 (Bloomberg) -- Wells Fargo & Co. stunned the world last week by proclaiming it had just finished its most profitable quarter ever. This will go down as the moment when lots of investors decided it was safe again to place blind faith in a big bank’s earnings.
What sent Wells shares soaring on April 9 was a three-page press release in which the San Francisco-based bank said it expected to report first-quarter net income of about $3 billion. Wells disclosed few details of what was in that figure. And by pushing the stock up 32 percent that day to $19.61, investors sent a clear message: They didn’t care.
Dig below the surface of Wells’s numbers, though, and there are reasons to be wary. Here are four gimmicks to look out for when the company releases its first-quarter results on April 22:
Gimmick No. 1: Cookie-jar reserves.
Wells’s earnings may have gotten a boost from an accounting maneuver, since banned, that it used last year as part of its $12.5 billion purchase of Wachovia Corp. Specifically, Wells carried over a $7.5 billion loan-loss allowance from Wachovia’s balance sheet onto its own books -- the effect of which I’ll explain in a moment.
First, a quick tutorial: Loan-loss allowances are the reserves lenders set up on their balance sheets in anticipation of future credit losses. The expenses that lenders record to boost their loan-loss allowances are called provisions. As loans are written off, lenders record charge-offs, reducing their allowance.
Free to Dip
Once it took control of the reserve from Wachovia, Wells was free to start dipping into it to absorb new credit losses on all sorts of loans, including loans Wells had originated itself. (Think of a child raiding a cookie jar.)
The upshot is that Wells could get by with reduced provisions until the $7.5 billion is used up, boosting net income.
Another quirk: The reserve was related to $352.2 billion of Wachovia loans for which Wells was not forecasting any future credit losses, according to Wells’s annual report.
Small Losses
All this may help explain Wells’s surprisingly small loan losses. For the first quarter, Wells said net charge-offs were $3.3 billion, compared with $6.1 billion at Wells and Wachovia combined for the fourth quarter. Provisions were $4.6 billion, bringing Wells’s allowance to $23 billion, as of March 31.
Wells, which completed its purchase of Wachovia on Dec. 31, wouldn’t have been allowed to carry over the allowance had it completed the acquisition a day later. On Jan. 1, new rules by the Financial Accounting Standards Board took effect prohibiting such transfers. A Wells spokeswoman, Janis Smith, declined to comment.
Gimmick No. 2: Cooked capital.
The most closely watched measure of a bank’s capital these days is a bare-bones metric called tangible common equity. While the term doesn’t have a standardized definition under generally accepted accounting principles, it typically means a company’s shareholder equity, excluding preferred stock and intangible assets, such as goodwill leftover from past acquisitions.
Measured this way, Wells had $13.5 billion of tangible common equity as of Dec. 31, or 1.1 percent of tangible assets. Yet in a March 6 press release, Wells said its year-end tangible common equity was $36 billion. Wells didn’t say how it arrived at that figure. Nor could I figure out from the disclosures in Wells’s annual report how it got a number so high.
Shouldn’t Be Guessing
Investors shouldn’t have to guess. Under a Securities and Exchange Commission rule called Regulation G, companies that release non-GAAP financial measures are required to disclose “a reconciliation of the disclosed non-GAAP financial measure to the most directly comparable GAAP financial measure.” (The rule applies to press releases, as well as formal SEC filings.) That way, anyone can see how the numbers were calculated.
Wells didn’t do this in its March 6 release. A spokeswoman, Julia Tunis Bernard, declined to tell me the math Wells used. Silly me -- I thought the SEC’s rules apply to Wells Fargo, too.
Gimmick No. 3: Otherworldly assets.
Look at Wells’s Dec. 31 balance sheet, and you’ll see a $109.8 billion line item called “other assets.” What’s in that number? For that breakdown, you need to go to a footnote in Wells’s financial statements. And here’s where it gets comical.
The footnote says the largest component was a $44.2 billion bucket that Wells labeled as “other.” Yes, that’s right: The biggest portion of “other assets” was “other.” And what did this include? The disclosure didn’t say. Neither would Bernard.
Talk about a black box. That $44.2 billion is more than Wells’s tangible common equity, even using the bank’s dodgy number. And we don’t have a clue what’s in there.
Gimmick No. 4: Buried losses.
How quickly investors forget. One week before Wells’s earnings news, the FASB caved to pressure by the banking industry and passed new rules that let companies ignore large, long-term losses on the debt securities they own when reporting net income.
Wells didn’t say what its first-quarter earnings would have been without the rule change, which companies can apply to their latest quarterly results. As of Dec. 31, though, Wells had $12.2 billion of gross losses on securities held for sale that weren’t included in earnings. Of those, $4.2 billion were on securities that had been worth less than their cost for more than a year.
The bottom line: Net income isn’t necessarily income. And it means nothing without complete financial statements.
Investors should have learned this lesson by now.
(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: Jonathan Weil in New York at jweil6@bloomberg.net
April 16 (Bloomberg) -- Wells Fargo & Co. stunned the world last week by proclaiming it had just finished its most profitable quarter ever. This will go down as the moment when lots of investors decided it was safe again to place blind faith in a big bank’s earnings.
What sent Wells shares soaring on April 9 was a three-page press release in which the San Francisco-based bank said it expected to report first-quarter net income of about $3 billion. Wells disclosed few details of what was in that figure. And by pushing the stock up 32 percent that day to $19.61, investors sent a clear message: They didn’t care.
Dig below the surface of Wells’s numbers, though, and there are reasons to be wary. Here are four gimmicks to look out for when the company releases its first-quarter results on April 22:
Gimmick No. 1: Cookie-jar reserves.
Wells’s earnings may have gotten a boost from an accounting maneuver, since banned, that it used last year as part of its $12.5 billion purchase of Wachovia Corp. Specifically, Wells carried over a $7.5 billion loan-loss allowance from Wachovia’s balance sheet onto its own books -- the effect of which I’ll explain in a moment.
First, a quick tutorial: Loan-loss allowances are the reserves lenders set up on their balance sheets in anticipation of future credit losses. The expenses that lenders record to boost their loan-loss allowances are called provisions. As loans are written off, lenders record charge-offs, reducing their allowance.
Free to Dip
Once it took control of the reserve from Wachovia, Wells was free to start dipping into it to absorb new credit losses on all sorts of loans, including loans Wells had originated itself. (Think of a child raiding a cookie jar.)
The upshot is that Wells could get by with reduced provisions until the $7.5 billion is used up, boosting net income.
Another quirk: The reserve was related to $352.2 billion of Wachovia loans for which Wells was not forecasting any future credit losses, according to Wells’s annual report.
Small Losses
All this may help explain Wells’s surprisingly small loan losses. For the first quarter, Wells said net charge-offs were $3.3 billion, compared with $6.1 billion at Wells and Wachovia combined for the fourth quarter. Provisions were $4.6 billion, bringing Wells’s allowance to $23 billion, as of March 31.
Wells, which completed its purchase of Wachovia on Dec. 31, wouldn’t have been allowed to carry over the allowance had it completed the acquisition a day later. On Jan. 1, new rules by the Financial Accounting Standards Board took effect prohibiting such transfers. A Wells spokeswoman, Janis Smith, declined to comment.
Gimmick No. 2: Cooked capital.
The most closely watched measure of a bank’s capital these days is a bare-bones metric called tangible common equity. While the term doesn’t have a standardized definition under generally accepted accounting principles, it typically means a company’s shareholder equity, excluding preferred stock and intangible assets, such as goodwill leftover from past acquisitions.
Measured this way, Wells had $13.5 billion of tangible common equity as of Dec. 31, or 1.1 percent of tangible assets. Yet in a March 6 press release, Wells said its year-end tangible common equity was $36 billion. Wells didn’t say how it arrived at that figure. Nor could I figure out from the disclosures in Wells’s annual report how it got a number so high.
Shouldn’t Be Guessing
Investors shouldn’t have to guess. Under a Securities and Exchange Commission rule called Regulation G, companies that release non-GAAP financial measures are required to disclose “a reconciliation of the disclosed non-GAAP financial measure to the most directly comparable GAAP financial measure.” (The rule applies to press releases, as well as formal SEC filings.) That way, anyone can see how the numbers were calculated.
Wells didn’t do this in its March 6 release. A spokeswoman, Julia Tunis Bernard, declined to tell me the math Wells used. Silly me -- I thought the SEC’s rules apply to Wells Fargo, too.
Gimmick No. 3: Otherworldly assets.
Look at Wells’s Dec. 31 balance sheet, and you’ll see a $109.8 billion line item called “other assets.” What’s in that number? For that breakdown, you need to go to a footnote in Wells’s financial statements. And here’s where it gets comical.
The footnote says the largest component was a $44.2 billion bucket that Wells labeled as “other.” Yes, that’s right: The biggest portion of “other assets” was “other.” And what did this include? The disclosure didn’t say. Neither would Bernard.
Talk about a black box. That $44.2 billion is more than Wells’s tangible common equity, even using the bank’s dodgy number. And we don’t have a clue what’s in there.
Gimmick No. 4: Buried losses.
How quickly investors forget. One week before Wells’s earnings news, the FASB caved to pressure by the banking industry and passed new rules that let companies ignore large, long-term losses on the debt securities they own when reporting net income.
Wells didn’t say what its first-quarter earnings would have been without the rule change, which companies can apply to their latest quarterly results. As of Dec. 31, though, Wells had $12.2 billion of gross losses on securities held for sale that weren’t included in earnings. Of those, $4.2 billion were on securities that had been worth less than their cost for more than a year.
The bottom line: Net income isn’t necessarily income. And it means nothing without complete financial statements.
Investors should have learned this lesson by now.
(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: Jonathan Weil in New York at jweil6@bloomberg.net
Saturday, April 04, 2009
Problem: How and When to Stop the Goose from Laying More Golden Eggs?
By Scott Lanman and Craig Torres
April 4 (Bloomberg) -- The Federal Reserve’s top two officials assured that they will pull back their emergency- credit programs once the crisis fades, even as they prepare to flood the system further with an excess of $1 trillion.
Chairman Ben S. Bernanke said yesterday in Charlotte, North Carolina that the Fed must retain the flexibility to withdraw its record cash injections to restrain prices. Vice Chairman Donald Kohn said in Wooster, Ohio, “the trick will be unwinding this balance sheet in a timely way to avoid inflation.”
The remarks followed calls by current and former officials for an exit strategy from the central bank’s record accumulation of assets, from corporate debt to mortgage bonds. Concern that political pressure may delay the start of an anti-inflation fight drove the Fed to forge an accord with the Treasury Department last month.
“They have two significant challenges -- one is figuring out when to unwind,” said Christopher Low, chief economist at FTN Financial in New York, referring to U.S. central bankers. The second challenge is how, and that’s made tougher by “so many unwieldy positions. Nothing is as liquid as it used to be” on the Fed’s balance sheet, he said.
The U.S. central bank has effectively printed money to buy or lend against a range of assets to alleviate the credit crunch and revive the economy. Bernanke’s speech yesterday detailed steps that the Fed can take to remove that liquidity, including soaking up cash by the issuance of special bills.
Harder to Sell
The Fed normally raises interest rates by selling Treasuries on its balance sheet, draining reserves from the banking system. That task is tougher with the Fed’s commitment last month to buy more than $1 trillion in mortgage-backed securities, which are harder to sell quickly without roiling markets or potentially attracting political scrutiny.
Bernanke, 55, speaking at a conference hosted by the Richmond Fed bank, hailed last month’s joint statement with the Treasury that spelled out the principles underlying the central bank’s work with the Treasury to revive credit.
While the Fed has implemented “unconventional” measures and taken some “extremely uncomfortable” steps, it’s critical that the efforts “do not interfere with the independent conduct of monetary policy,” Bernanke said.
The joint statement was the culmination of a behind-the- scenes, two-month long debate involving the Fed’s Open Market Committee, as well as the Treasury.
Unemployment Concern
Fueling the debate is the concern that policy makers will have a tough time if they try to end their emergency-lending programs as soon as next year while the unemployment rate, now at quarter-century high 8.5 percent, remains elevated.
A Labor Department report yesterday showed the U.S. lost 663,000 jobs in March, bringing to 5.1 million the drop in payrolls since the start of the recession in December 2007.
The central bank has expanded its balance sheet by $1.2 trillion over the past year, taking on assets including mortgage securities, corporate debt and now long-term Treasuries under the Fed’s latest policy decision last month. The Fed’s total assets stood at $2.08 trillion as of April 1.
The FOMC’s March 18 decision commits the Fed to buy as much as $750 billion of additional mortgage debt, $100 billion of federal agency debt and $300 billion of Treasuries. Separately, the Fed last month began a lending program to restart markets for consumer and business lending. That plan, the Term Asset- Backed Securities Loan Facility, may reach $1 trillion, though the Fed is struggling to persuade investors to participate.
How to ‘Get Out’
“We can’t go into this without knowing how we are going to get out again,” Kohn, 66, who’s worked for the Fed almost four decades, said in response to a question after a speech at the College of Wooster, where he received a bachelor’s degree in economics.
The Fed’s tools for raising short-term rates once the crisis wanes include unwinding the emergency-loan programs, conducting reverse repurchase agreements against long-term securities holdings and increasing the rate the Fed pays on bank reserves, Bernanke said. The emergency facilities were designed to be “unwound as markets and the economy revive,” he said.
Kohn said the Fed and Treasury are seeking “other tools” from Congress to help mop up excess cash. One possibility is that the Fed issue its own securities, or “Fed bills,” or the Treasury could issue special bills, and put the cash on deposit at the Fed.
“It is important to get either of those tools exempt from the debt ceiling so that the Fed could have the power to absorb all the reserves it wanted to,” Kohn said in response to a question.
Bernanke said that “the large volume of reserve balances outstanding must be monitored carefully, as -- if not carefully managed -- they could complicate the Fed’s task of raising short-term interest rates when the economy begins to recover or if inflation expectations were to begin to move higher.”
April 4 (Bloomberg) -- The Federal Reserve’s top two officials assured that they will pull back their emergency- credit programs once the crisis fades, even as they prepare to flood the system further with an excess of $1 trillion.
Chairman Ben S. Bernanke said yesterday in Charlotte, North Carolina that the Fed must retain the flexibility to withdraw its record cash injections to restrain prices. Vice Chairman Donald Kohn said in Wooster, Ohio, “the trick will be unwinding this balance sheet in a timely way to avoid inflation.”
The remarks followed calls by current and former officials for an exit strategy from the central bank’s record accumulation of assets, from corporate debt to mortgage bonds. Concern that political pressure may delay the start of an anti-inflation fight drove the Fed to forge an accord with the Treasury Department last month.
“They have two significant challenges -- one is figuring out when to unwind,” said Christopher Low, chief economist at FTN Financial in New York, referring to U.S. central bankers. The second challenge is how, and that’s made tougher by “so many unwieldy positions. Nothing is as liquid as it used to be” on the Fed’s balance sheet, he said.
The U.S. central bank has effectively printed money to buy or lend against a range of assets to alleviate the credit crunch and revive the economy. Bernanke’s speech yesterday detailed steps that the Fed can take to remove that liquidity, including soaking up cash by the issuance of special bills.
Harder to Sell
The Fed normally raises interest rates by selling Treasuries on its balance sheet, draining reserves from the banking system. That task is tougher with the Fed’s commitment last month to buy more than $1 trillion in mortgage-backed securities, which are harder to sell quickly without roiling markets or potentially attracting political scrutiny.
Bernanke, 55, speaking at a conference hosted by the Richmond Fed bank, hailed last month’s joint statement with the Treasury that spelled out the principles underlying the central bank’s work with the Treasury to revive credit.
While the Fed has implemented “unconventional” measures and taken some “extremely uncomfortable” steps, it’s critical that the efforts “do not interfere with the independent conduct of monetary policy,” Bernanke said.
The joint statement was the culmination of a behind-the- scenes, two-month long debate involving the Fed’s Open Market Committee, as well as the Treasury.
Unemployment Concern
Fueling the debate is the concern that policy makers will have a tough time if they try to end their emergency-lending programs as soon as next year while the unemployment rate, now at quarter-century high 8.5 percent, remains elevated.
A Labor Department report yesterday showed the U.S. lost 663,000 jobs in March, bringing to 5.1 million the drop in payrolls since the start of the recession in December 2007.
The central bank has expanded its balance sheet by $1.2 trillion over the past year, taking on assets including mortgage securities, corporate debt and now long-term Treasuries under the Fed’s latest policy decision last month. The Fed’s total assets stood at $2.08 trillion as of April 1.
The FOMC’s March 18 decision commits the Fed to buy as much as $750 billion of additional mortgage debt, $100 billion of federal agency debt and $300 billion of Treasuries. Separately, the Fed last month began a lending program to restart markets for consumer and business lending. That plan, the Term Asset- Backed Securities Loan Facility, may reach $1 trillion, though the Fed is struggling to persuade investors to participate.
How to ‘Get Out’
“We can’t go into this without knowing how we are going to get out again,” Kohn, 66, who’s worked for the Fed almost four decades, said in response to a question after a speech at the College of Wooster, where he received a bachelor’s degree in economics.
The Fed’s tools for raising short-term rates once the crisis wanes include unwinding the emergency-loan programs, conducting reverse repurchase agreements against long-term securities holdings and increasing the rate the Fed pays on bank reserves, Bernanke said. The emergency facilities were designed to be “unwound as markets and the economy revive,” he said.
Kohn said the Fed and Treasury are seeking “other tools” from Congress to help mop up excess cash. One possibility is that the Fed issue its own securities, or “Fed bills,” or the Treasury could issue special bills, and put the cash on deposit at the Fed.
“It is important to get either of those tools exempt from the debt ceiling so that the Fed could have the power to absorb all the reserves it wanted to,” Kohn said in response to a question.
Bernanke said that “the large volume of reserve balances outstanding must be monitored carefully, as -- if not carefully managed -- they could complicate the Fed’s task of raising short-term interest rates when the economy begins to recover or if inflation expectations were to begin to move higher.”
Friday, April 03, 2009
Privatize profit, socialize losses
Bailed-out banks eye toxic asset buys
By Francesco Guerrera in New York and Krishna Guha in Washington for FT.com
US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets to be sold by rivals under the Treasury’s $1,000bn (£680bn) plan to revive the financial system.
The plans proved controversial, with critics charging that the government’s public-private partnership - which provide generous loans to investors - are intended to help banks sell, rather than acquire, troubled securities and loans.
Spencer Bachus, the top Republican on the House financial services committee, vowed after being told of the plans by the FT to introduce legislation to stop financial institutions ”gaming the system to reap taxpayer-subsidised windfalls”.
Mr Bachus added it would mark ”a new level of absurdity” if financial institutions were ”colluding to swap assets at inflated prices using taxpayers’ dollars.”
Participating in the plan as a buyer could be complicated for Citi, which has suffered billions of dollars in writedowns on mortgage-backed assets and is about to cede a 36 per cent stake to the government.
Citi declined to comment. People close to the company said it was considering whether to take part in the plan as a seller, buyer or manager of the assets, but no decision had yet been taken.
Officials want banks to sell risky assets in order to cleanse their balance sheets and attract new investments from private investors, limiting the need for the further government funds.
Many experts think it is essential to take these assets from leveraged institutions such as banks that are responsible for the lion’s share of lending, into the hands of unleveraged financial institutions such as traditional asset managers, where they will have much less impact on the flow of credit to the economy.
Banks have three options if they want to buy toxic assets: apply to become one of four or five fund managers that will purchase troubled securities; bid for packages of bad loans; or buy into funds set up by others. The government plan does not allow banks to buy their own assets, but there is no ban on the purchase of securities and loans sold by others.
“It’s an open programme designed to get markets going,” a Treasury official said. But he added: “It is between a bank and their supervisor whether they are healthy enough to acquire assets,” raising the possibility regulators may prevent weak banks from becoming buyers.
Wall Street executives argue that banks’ asset purchases would help achieve the second main goal of the plan: to establish prices and kick-start the market for illiquid assets.
But public opinion may not tolerate the idea of banks selling each other their bad assets. Critics say that would leave the same amount of toxic assets in the system as before, but with the government now liable for most of the losses through its provision of non-recourse loans.
Administration officials reject the criticism because banking is part of a financial system, in which the owners of bank equity - such as pension funds - are the same entitites that will be investing in toxic assets anyway. Seen this way, the plan simply helps to rearrange the location of these assets in the system in a way that is more transparent and acceptable to markets.
Goldman and Morgan Stanley have large fund management units and have pledged to increase investments in distressed assets.
This week, John Mack, Morgan Stanley’s chief executive, told staff the bank was considering how to become “one of the firms that can buy these assets and package them where your clients will have access to them”.
Goldman and JPMorgan did not comment, but bankers said they were considering buying toxic assets.
By Francesco Guerrera in New York and Krishna Guha in Washington for FT.com
US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets to be sold by rivals under the Treasury’s $1,000bn (£680bn) plan to revive the financial system.
The plans proved controversial, with critics charging that the government’s public-private partnership - which provide generous loans to investors - are intended to help banks sell, rather than acquire, troubled securities and loans.
Spencer Bachus, the top Republican on the House financial services committee, vowed after being told of the plans by the FT to introduce legislation to stop financial institutions ”gaming the system to reap taxpayer-subsidised windfalls”.
Mr Bachus added it would mark ”a new level of absurdity” if financial institutions were ”colluding to swap assets at inflated prices using taxpayers’ dollars.”
Participating in the plan as a buyer could be complicated for Citi, which has suffered billions of dollars in writedowns on mortgage-backed assets and is about to cede a 36 per cent stake to the government.
Citi declined to comment. People close to the company said it was considering whether to take part in the plan as a seller, buyer or manager of the assets, but no decision had yet been taken.
Officials want banks to sell risky assets in order to cleanse their balance sheets and attract new investments from private investors, limiting the need for the further government funds.
Many experts think it is essential to take these assets from leveraged institutions such as banks that are responsible for the lion’s share of lending, into the hands of unleveraged financial institutions such as traditional asset managers, where they will have much less impact on the flow of credit to the economy.
Banks have three options if they want to buy toxic assets: apply to become one of four or five fund managers that will purchase troubled securities; bid for packages of bad loans; or buy into funds set up by others. The government plan does not allow banks to buy their own assets, but there is no ban on the purchase of securities and loans sold by others.
“It’s an open programme designed to get markets going,” a Treasury official said. But he added: “It is between a bank and their supervisor whether they are healthy enough to acquire assets,” raising the possibility regulators may prevent weak banks from becoming buyers.
Wall Street executives argue that banks’ asset purchases would help achieve the second main goal of the plan: to establish prices and kick-start the market for illiquid assets.
But public opinion may not tolerate the idea of banks selling each other their bad assets. Critics say that would leave the same amount of toxic assets in the system as before, but with the government now liable for most of the losses through its provision of non-recourse loans.
Administration officials reject the criticism because banking is part of a financial system, in which the owners of bank equity - such as pension funds - are the same entitites that will be investing in toxic assets anyway. Seen this way, the plan simply helps to rearrange the location of these assets in the system in a way that is more transparent and acceptable to markets.
Goldman and Morgan Stanley have large fund management units and have pledged to increase investments in distressed assets.
This week, John Mack, Morgan Stanley’s chief executive, told staff the bank was considering how to become “one of the firms that can buy these assets and package them where your clients will have access to them”.
Goldman and JPMorgan did not comment, but bankers said they were considering buying toxic assets.
'Twas the Year Before Stagflation
The Radicalization of Ben Bernanke
He is throwing trillions of dollars at the financial crisis. What happens if his gambles don't pay off?
By Simon Johnson and James Kwak
Sunday, April 5, 2009; B01
Timothy Geithner and his predecessor Henry Paulson have been the public faces of the U.S. government's battle against the global economic crisis. But even as the secretaries of the Treasury have garnered the headlines -- as well as popular anger surrounding bank bailouts and corporate bonuses -- another official has quickly amassed great influence by committing trillions of dollars to keep markets afloat, radically redefining his institution and taking on serious risks as he seeks to rescue the American economy. Without a doubt, this crisis is now Ben Bernanke's war.
Bernanke has become the country's economist in chief, the banker for the United States and perhaps the world, and has employed every weapon in the Federal Reserve's arsenal. He has overseen the broadest use of the Fed's powers since World War II, and the regulation proposals working their way through Congress seem likely to empower the institution even further. Although his actions may be justified under today's circumstances, Bernanke's willingness to pump money into the economy risks unleashing the most serious bout of U.S. inflation since the early 1980s, in a nation already battered by rising unemployment and negative growth.
If he succeeds in restarting growth while avoiding high inflation, Bernanke may well become the most revered economist in modern history. But for the moment, he is operating in uncharted territory.
When he first joined the Federal Reserve's Board of Governors in 2002, and later when he became chairman in 2006, there was little reason to expect Bernanke to revolutionize central banking. After all, it was the Age of Greenspan the Triumphant. Almost two decades of sustained growth and low inflation had created the illusion of central banking as a precise science, with the Fed simply reading economic statistics and nudging short-term interest rates up or down to keep the American economy humming and inflation low.
Shortly after succeeding Alan Greenspan as Fed chairman, Bernanke credited his predecessor's monetary policy with helping to reduce wide swings in U.S. economic performance -- the so-called "Great Moderation" -- and revive the productivity of American workers. This apparent success also lent staying power to some of Greenspan's conviction that the Fed should regulate the banking system with a light touch, relying on the free market and private-sector incentives.
Bernanke initially maintained Greenspan's hands-off approach to the emerging housing bubble. As the financial crisis deepened in late 2007 and early 2008, however, the Fed began expanding its lending efforts to financial institutions that couldn't raise money in private markets. This was Bernanke's first departure from the Greenspan school, in which tweaking interest rates was the instrument that mattered.
Then, in 2008, Bernanke became sucked into the firestorms that threatened to engulf the financial sector: Bear Stearns, AIG, the money markets and Citigroup, among others. In these interventions, the Fed brought the money. It extended loans to newly created entities and accepted dodgy collateral in return; lent money directly to non-financial institutions; or guaranteed the value of toxic assets -- a series of reactive, chaotic and non-transparent transactions that seem to have enriched Wall Street and have attracted congressional concern.
The theory at the time was that the financial sector was facing a liquidity crisis, with banks unable to raise enough money to pay off their short-term debts. In response, the Fed would provide enough cash for banks to "deleverage in a more orderly manner," as Bernanke explained last August. By late 2008, the Fed was providing $1.5 trillion of liquidity to the economy through these programs -- an amount roughly equal to half of the 2008 federal budget -- prompting John Cassidy of the New Yorker, in a perceptive essay, to note that Bernanke had begun to "intervene on Wall Street in ways never before contemplated by the Fed."
Since late last year, however, Bernanke has signaled that even these efforts are not enough. In a January speech, Bernanke acknowledged the limits of liquidity and outlined a broader strategy in which the Fed would do everything in its power to increase credit. And last month, in an extraordinary interview on "60 Minutes," Bernanke conveyed a powerful message with his words about the Fed "printing money" and with his body language, as he toured his home town in South Carolina and declared that he cares about Wall Street only because it affects Main Street -- in part attempting to defuse criticism that the Fed lending was mainly benefiting bankers.
Clearly, the Fed chairman recognizes the severity of the problem and has decided to do whatever it takes to prevent anything like the Great Depression from happening again. Given where we are today, that means printing money, even if that runs the risk of creating a serious inflation problem.
Shortly after joining the Fed in 2002, Bernanke gave a speech describing how the Fed could prevent deflation, i.e., a general decline in prices. The key theme was that, in a pinch, the Fed could simply print more dollars -- for example, by buying long-term bonds on the market -- which reduces the value of each dollar in circulation and therefore raises the dollar price of goods and services. "Under a paper-money system," Bernanke explained, "a determined government can always generate higher spending and hence positive inflation." In a time of economic overconfidence, the discussion seemed largely academic. But it is now clear that Bernanke intends to follow through on it.
After the double-digit inflation of the 1970s and early 1980s, why would anyone want to create inflation? Households and companies alike are trying to "deleverage," or pay down their debts. But deflation makes it harder to pay down debts, because debts are fixed in dollars and those dollars are becoming worth more and more. Moderate inflation in the neighborhood of 4 percent, by contrast, makes it easier for borrowers to manage their debt loads, and stimulates the economy.
In the past few months, Bernanke has expanded the central bank's role in two major ways. The Fed has committed over a trillion dollars for buying securities issued by federal housing agencies, and another trillion for other products such as student loans, credit card loans and auto loans. Not only is the Fed devoting enormous funds to restart the flow of credit, but it is deciding where and how to allocate the credit. This is a remarkable shift from the traditional, hands-off approach to central banking. Bernanke is now making the Fed a major banking player in its own right.
Then in March, the Fed said that it will begin buying long-term Treasury bonds on the open market, hoping to push down long-term interest rates (by increasing the amount of money available for long-term lending) and thereby stimulate borrowing. The implication is that the Fed will finance these purchases by creating money. Not only that, but Bernanke wants us to know exactly what the Fed is doing; he hopes to push up our expectations of future inflation, so that wages and prices will nudge upwards, not downwards.
In short, Bernanke is making the biggest bet placed by a U.S. central banker in decades, wagering that he can pull the economy out of a deep crisis by creating money without unleashing high and long-lasting inflation.
Will it work? In a normal advanced economy, creating hundreds of billions of dollars in new money would not foster runaway inflation. As long as the economy is underperforming -- for example, with high unemployment -- stimulating the economy will only cause that "slack" to be taken up, the theory goes. Only when unemployment is low again can workers demand higher wages, forcing companies to raise prices.
But is the United States really a normal advanced economy anymore? We seem to have taken on some features of so-called emerging markets, including a bloated (and contracting) financial sector, overly indebted consumers, and firms that are trying hard to save cash by investing less. In emerging markets there is no meaningful idea of "slack;" there can be high inflation even when the economy is contracting or when growth is considerably lower than in the recent past.
If the United States is indeed behaving more like an emerging market, inflation is far easier to manufacture. People quickly become dubious of the value of money and shift into goods and foreign currencies more readily. Large budget deficits also directly raise inflation expectations. This would help Bernanke avoid deflation, but there is a great danger that unstable inflation expectations will become self-fulfilling. We do not want to become more like Argentina in 2001-2002 or Russia in 1998, when currencies collapsed and inflation soared.
In his prime, former Fed chief Greenspan was considered one of the most powerful men in the world, simply by changing short-term interest rates in response to inflation. But the Great Moderation that he oversaw, it turns out, was an illusion, and Greenspan has admitted that his beliefs in a self-correcting free market were wrong.
Now Bernanke, the soft-spoken but authoritative academic, has redefined the Federal Reserve on the fly and exercised powers that Greenspan never dared touch. Bernanke's strategy is risky, and only time will determine whether he is being brave in averting a larger crisis, or reckless in unleashing inflation that could increase quickly and uncontrollably. Today, Bernanke's gamble looks like the worst possible alternative, apart from all the others.
Simon Johnson, a professor at MIT's Sloan School of Management and the former chief economist of the International Monetary Fund, and James Kwak, a student at Yale Law School, are co-founders of BaselineScenario.com, which tracks the global financial crisis.
He is throwing trillions of dollars at the financial crisis. What happens if his gambles don't pay off?
By Simon Johnson and James Kwak
Sunday, April 5, 2009; B01
Timothy Geithner and his predecessor Henry Paulson have been the public faces of the U.S. government's battle against the global economic crisis. But even as the secretaries of the Treasury have garnered the headlines -- as well as popular anger surrounding bank bailouts and corporate bonuses -- another official has quickly amassed great influence by committing trillions of dollars to keep markets afloat, radically redefining his institution and taking on serious risks as he seeks to rescue the American economy. Without a doubt, this crisis is now Ben Bernanke's war.
Bernanke has become the country's economist in chief, the banker for the United States and perhaps the world, and has employed every weapon in the Federal Reserve's arsenal. He has overseen the broadest use of the Fed's powers since World War II, and the regulation proposals working their way through Congress seem likely to empower the institution even further. Although his actions may be justified under today's circumstances, Bernanke's willingness to pump money into the economy risks unleashing the most serious bout of U.S. inflation since the early 1980s, in a nation already battered by rising unemployment and negative growth.
If he succeeds in restarting growth while avoiding high inflation, Bernanke may well become the most revered economist in modern history. But for the moment, he is operating in uncharted territory.
When he first joined the Federal Reserve's Board of Governors in 2002, and later when he became chairman in 2006, there was little reason to expect Bernanke to revolutionize central banking. After all, it was the Age of Greenspan the Triumphant. Almost two decades of sustained growth and low inflation had created the illusion of central banking as a precise science, with the Fed simply reading economic statistics and nudging short-term interest rates up or down to keep the American economy humming and inflation low.
Shortly after succeeding Alan Greenspan as Fed chairman, Bernanke credited his predecessor's monetary policy with helping to reduce wide swings in U.S. economic performance -- the so-called "Great Moderation" -- and revive the productivity of American workers. This apparent success also lent staying power to some of Greenspan's conviction that the Fed should regulate the banking system with a light touch, relying on the free market and private-sector incentives.
Bernanke initially maintained Greenspan's hands-off approach to the emerging housing bubble. As the financial crisis deepened in late 2007 and early 2008, however, the Fed began expanding its lending efforts to financial institutions that couldn't raise money in private markets. This was Bernanke's first departure from the Greenspan school, in which tweaking interest rates was the instrument that mattered.
Then, in 2008, Bernanke became sucked into the firestorms that threatened to engulf the financial sector: Bear Stearns, AIG, the money markets and Citigroup, among others. In these interventions, the Fed brought the money. It extended loans to newly created entities and accepted dodgy collateral in return; lent money directly to non-financial institutions; or guaranteed the value of toxic assets -- a series of reactive, chaotic and non-transparent transactions that seem to have enriched Wall Street and have attracted congressional concern.
The theory at the time was that the financial sector was facing a liquidity crisis, with banks unable to raise enough money to pay off their short-term debts. In response, the Fed would provide enough cash for banks to "deleverage in a more orderly manner," as Bernanke explained last August. By late 2008, the Fed was providing $1.5 trillion of liquidity to the economy through these programs -- an amount roughly equal to half of the 2008 federal budget -- prompting John Cassidy of the New Yorker, in a perceptive essay, to note that Bernanke had begun to "intervene on Wall Street in ways never before contemplated by the Fed."
Since late last year, however, Bernanke has signaled that even these efforts are not enough. In a January speech, Bernanke acknowledged the limits of liquidity and outlined a broader strategy in which the Fed would do everything in its power to increase credit. And last month, in an extraordinary interview on "60 Minutes," Bernanke conveyed a powerful message with his words about the Fed "printing money" and with his body language, as he toured his home town in South Carolina and declared that he cares about Wall Street only because it affects Main Street -- in part attempting to defuse criticism that the Fed lending was mainly benefiting bankers.
Clearly, the Fed chairman recognizes the severity of the problem and has decided to do whatever it takes to prevent anything like the Great Depression from happening again. Given where we are today, that means printing money, even if that runs the risk of creating a serious inflation problem.
Shortly after joining the Fed in 2002, Bernanke gave a speech describing how the Fed could prevent deflation, i.e., a general decline in prices. The key theme was that, in a pinch, the Fed could simply print more dollars -- for example, by buying long-term bonds on the market -- which reduces the value of each dollar in circulation and therefore raises the dollar price of goods and services. "Under a paper-money system," Bernanke explained, "a determined government can always generate higher spending and hence positive inflation." In a time of economic overconfidence, the discussion seemed largely academic. But it is now clear that Bernanke intends to follow through on it.
After the double-digit inflation of the 1970s and early 1980s, why would anyone want to create inflation? Households and companies alike are trying to "deleverage," or pay down their debts. But deflation makes it harder to pay down debts, because debts are fixed in dollars and those dollars are becoming worth more and more. Moderate inflation in the neighborhood of 4 percent, by contrast, makes it easier for borrowers to manage their debt loads, and stimulates the economy.
In the past few months, Bernanke has expanded the central bank's role in two major ways. The Fed has committed over a trillion dollars for buying securities issued by federal housing agencies, and another trillion for other products such as student loans, credit card loans and auto loans. Not only is the Fed devoting enormous funds to restart the flow of credit, but it is deciding where and how to allocate the credit. This is a remarkable shift from the traditional, hands-off approach to central banking. Bernanke is now making the Fed a major banking player in its own right.
Then in March, the Fed said that it will begin buying long-term Treasury bonds on the open market, hoping to push down long-term interest rates (by increasing the amount of money available for long-term lending) and thereby stimulate borrowing. The implication is that the Fed will finance these purchases by creating money. Not only that, but Bernanke wants us to know exactly what the Fed is doing; he hopes to push up our expectations of future inflation, so that wages and prices will nudge upwards, not downwards.
In short, Bernanke is making the biggest bet placed by a U.S. central banker in decades, wagering that he can pull the economy out of a deep crisis by creating money without unleashing high and long-lasting inflation.
Will it work? In a normal advanced economy, creating hundreds of billions of dollars in new money would not foster runaway inflation. As long as the economy is underperforming -- for example, with high unemployment -- stimulating the economy will only cause that "slack" to be taken up, the theory goes. Only when unemployment is low again can workers demand higher wages, forcing companies to raise prices.
But is the United States really a normal advanced economy anymore? We seem to have taken on some features of so-called emerging markets, including a bloated (and contracting) financial sector, overly indebted consumers, and firms that are trying hard to save cash by investing less. In emerging markets there is no meaningful idea of "slack;" there can be high inflation even when the economy is contracting or when growth is considerably lower than in the recent past.
If the United States is indeed behaving more like an emerging market, inflation is far easier to manufacture. People quickly become dubious of the value of money and shift into goods and foreign currencies more readily. Large budget deficits also directly raise inflation expectations. This would help Bernanke avoid deflation, but there is a great danger that unstable inflation expectations will become self-fulfilling. We do not want to become more like Argentina in 2001-2002 or Russia in 1998, when currencies collapsed and inflation soared.
In his prime, former Fed chief Greenspan was considered one of the most powerful men in the world, simply by changing short-term interest rates in response to inflation. But the Great Moderation that he oversaw, it turns out, was an illusion, and Greenspan has admitted that his beliefs in a self-correcting free market were wrong.
Now Bernanke, the soft-spoken but authoritative academic, has redefined the Federal Reserve on the fly and exercised powers that Greenspan never dared touch. Bernanke's strategy is risky, and only time will determine whether he is being brave in averting a larger crisis, or reckless in unleashing inflation that could increase quickly and uncontrollably. Today, Bernanke's gamble looks like the worst possible alternative, apart from all the others.
Simon Johnson, a professor at MIT's Sloan School of Management and the former chief economist of the International Monetary Fund, and James Kwak, a student at Yale Law School, are co-founders of BaselineScenario.com, which tracks the global financial crisis.
Wednesday, April 01, 2009
The Government Is Not Taking All the Risk on Toxic Assets-- Just 92% Of It
April 1, 2009
Op-Ed Contributor
Obama’s Ersatz Capitalism
By JOSEPH E. STIGLITZ
THE Obama administration’s $500 billion or more proposal to deal with America’s ailing banks has been described by some in the financial markets as a win-win-win proposal. Actually, it is a win-win-lose proposal: the banks win, investors win — and taxpayers lose.
Treasury hopes to get us out of the mess by replicating the flawed system that the private sector used to bring the world crashing down, with a proposal marked by overleveraging in the public sector, excessive complexity, poor incentives and a lack of transparency.
Let’s take a moment to remember what caused this mess in the first place. Banks got themselves, and our economy, into trouble by overleveraging — that is, using relatively little capital of their own, they borrowed heavily to buy extremely risky real estate assets. In the process, they used overly complex instruments like collateralized debt obligations.
The prospect of high compensation gave managers incentives to be shortsighted and undertake excessive risk, rather than lend money prudently. Banks made all these mistakes without anyone knowing, partly because so much of what they were doing was “off balance sheet” financing.
In theory, the administration’s plan is based on letting the market determine the prices of the banks’ “toxic assets” — including outstanding house loans and securities based on those loans. The reality, though, is that the market will not be pricing the toxic assets themselves, but options on those assets.
The two have little to do with each other. The government plan in effect involves insuring almost all losses. Since the private investors are spared most losses, then they primarily “value” their potential gains. This is exactly the same as being given an option.
Consider an asset that has a 50-50 chance of being worth either zero or $200 in a year’s time. The average “value” of the asset is $100. Ignoring interest, this is what the asset would sell for in a competitive market. It is what the asset is “worth.” Under the plan by Treasury Secretary Timothy Geithner, the government would provide about 92 percent of the money to buy the asset but would stand to receive only 50 percent of any gains, and would absorb almost all of the losses. Some partnership!
Assume that one of the public-private partnerships the Treasury has promised to create is willing to pay $150 for the asset. That’s 50 percent more than its true value, and the bank is more than happy to sell. So the private partner puts up $12, and the government supplies the rest — $12 in “equity” plus $126 in the form of a guaranteed loan.
If, in a year’s time, it turns out that the true value of the asset is zero, the private partner loses the $12, and the government loses $138. If the true value is $200, the government and the private partner split the $74 that’s left over after paying back the $126 loan. In that rosy scenario, the private partner more than triples his $12 investment. But the taxpayer, having risked $138, gains a mere $37.
Even in an imperfect market, one shouldn’t confuse the value of an asset with the value of the upside option on that asset.
But Americans are likely to lose even more than these calculations suggest, because of an effect called adverse selection. The banks get to choose the loans and securities that they want to sell. They will want to sell the worst assets, and especially the assets that they think the market overestimates (and thus is willing to pay too much for).
But the market is likely to recognize this, which will drive down the price that it is willing to pay. Only the government’s picking up enough of the losses overcomes this “adverse selection” effect. With the government absorbing the losses, the market doesn’t care if the banks are “cheating” them by selling their lousiest assets, because the government bears the cost.
The main problem is not a lack of liquidity. If it were, then a far simpler program would work: just provide the funds without loan guarantees. The real issue is that the banks made bad loans in a bubble and were highly leveraged. They have lost their capital, and this capital has to be replaced.
Paying fair market values for the assets will not work. Only by overpaying for the assets will the banks be adequately recapitalized. But overpaying for the assets simply shifts the losses to the government. In other words, the Geithner plan works only if and when the taxpayer loses big time.
Some Americans are afraid that the government might temporarily “nationalize” the banks, but that option would be preferable to the Geithner plan. After all, the F.D.I.C. has taken control of failing banks before, and done it well. It has even nationalized large institutions like Continental Illinois (taken over in 1984, back in private hands a few years later), and Washington Mutual (seized last September, and immediately resold).
What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses. It is a “partnership” in which one partner robs the other. And such partnerships — with the private sector in control — have perverse incentives, worse even than the ones that got us into the mess.
So what is the appeal of a proposal like this? Perhaps it’s the kind of Rube Goldberg device that Wall Street loves — clever, complex and nontransparent, allowing huge transfers of wealth to the financial markets. It has allowed the administration to avoid going back to Congress to ask for the money needed to fix our banks, and it provided a way to avoid nationalization.
But we are already suffering from a crisis of confidence. When the high costs of the administration’s plan become apparent, confidence will be eroded further. At that point the task of recreating a vibrant financial sector, and resuscitating the economy, will be even harder.
Joseph E. Stiglitz, a professor of economics at Columbia who was chairman of the Council of Economic Advisers from 1995 to 1997, was awarded the Nobel prize in economics in 2001.
Op-Ed Contributor
Obama’s Ersatz Capitalism
By JOSEPH E. STIGLITZ
THE Obama administration’s $500 billion or more proposal to deal with America’s ailing banks has been described by some in the financial markets as a win-win-win proposal. Actually, it is a win-win-lose proposal: the banks win, investors win — and taxpayers lose.
Treasury hopes to get us out of the mess by replicating the flawed system that the private sector used to bring the world crashing down, with a proposal marked by overleveraging in the public sector, excessive complexity, poor incentives and a lack of transparency.
Let’s take a moment to remember what caused this mess in the first place. Banks got themselves, and our economy, into trouble by overleveraging — that is, using relatively little capital of their own, they borrowed heavily to buy extremely risky real estate assets. In the process, they used overly complex instruments like collateralized debt obligations.
The prospect of high compensation gave managers incentives to be shortsighted and undertake excessive risk, rather than lend money prudently. Banks made all these mistakes without anyone knowing, partly because so much of what they were doing was “off balance sheet” financing.
In theory, the administration’s plan is based on letting the market determine the prices of the banks’ “toxic assets” — including outstanding house loans and securities based on those loans. The reality, though, is that the market will not be pricing the toxic assets themselves, but options on those assets.
The two have little to do with each other. The government plan in effect involves insuring almost all losses. Since the private investors are spared most losses, then they primarily “value” their potential gains. This is exactly the same as being given an option.
Consider an asset that has a 50-50 chance of being worth either zero or $200 in a year’s time. The average “value” of the asset is $100. Ignoring interest, this is what the asset would sell for in a competitive market. It is what the asset is “worth.” Under the plan by Treasury Secretary Timothy Geithner, the government would provide about 92 percent of the money to buy the asset but would stand to receive only 50 percent of any gains, and would absorb almost all of the losses. Some partnership!
Assume that one of the public-private partnerships the Treasury has promised to create is willing to pay $150 for the asset. That’s 50 percent more than its true value, and the bank is more than happy to sell. So the private partner puts up $12, and the government supplies the rest — $12 in “equity” plus $126 in the form of a guaranteed loan.
If, in a year’s time, it turns out that the true value of the asset is zero, the private partner loses the $12, and the government loses $138. If the true value is $200, the government and the private partner split the $74 that’s left over after paying back the $126 loan. In that rosy scenario, the private partner more than triples his $12 investment. But the taxpayer, having risked $138, gains a mere $37.
Even in an imperfect market, one shouldn’t confuse the value of an asset with the value of the upside option on that asset.
But Americans are likely to lose even more than these calculations suggest, because of an effect called adverse selection. The banks get to choose the loans and securities that they want to sell. They will want to sell the worst assets, and especially the assets that they think the market overestimates (and thus is willing to pay too much for).
But the market is likely to recognize this, which will drive down the price that it is willing to pay. Only the government’s picking up enough of the losses overcomes this “adverse selection” effect. With the government absorbing the losses, the market doesn’t care if the banks are “cheating” them by selling their lousiest assets, because the government bears the cost.
The main problem is not a lack of liquidity. If it were, then a far simpler program would work: just provide the funds without loan guarantees. The real issue is that the banks made bad loans in a bubble and were highly leveraged. They have lost their capital, and this capital has to be replaced.
Paying fair market values for the assets will not work. Only by overpaying for the assets will the banks be adequately recapitalized. But overpaying for the assets simply shifts the losses to the government. In other words, the Geithner plan works only if and when the taxpayer loses big time.
Some Americans are afraid that the government might temporarily “nationalize” the banks, but that option would be preferable to the Geithner plan. After all, the F.D.I.C. has taken control of failing banks before, and done it well. It has even nationalized large institutions like Continental Illinois (taken over in 1984, back in private hands a few years later), and Washington Mutual (seized last September, and immediately resold).
What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses. It is a “partnership” in which one partner robs the other. And such partnerships — with the private sector in control — have perverse incentives, worse even than the ones that got us into the mess.
So what is the appeal of a proposal like this? Perhaps it’s the kind of Rube Goldberg device that Wall Street loves — clever, complex and nontransparent, allowing huge transfers of wealth to the financial markets. It has allowed the administration to avoid going back to Congress to ask for the money needed to fix our banks, and it provided a way to avoid nationalization.
But we are already suffering from a crisis of confidence. When the high costs of the administration’s plan become apparent, confidence will be eroded further. At that point the task of recreating a vibrant financial sector, and resuscitating the economy, will be even harder.
Joseph E. Stiglitz, a professor of economics at Columbia who was chairman of the Council of Economic Advisers from 1995 to 1997, was awarded the Nobel prize in economics in 2001.
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