The House of Representatives voted down the $700B Wall Street bailout package earlier today.
Good! Congressmen felt the wrath of the American voters they are about to face on November 4th, and that's a very healthy impulse. This bill was a rotten turkey, opposed by nearly all professional economists, with some saying it could do more harm than good.
The Fed, Treasury, and FDIC have ample tools at their disposal. (Paulson begrudgingly conceded as much.) It's ridiculous for political leaders to try to ram this turkey through without a fully transparent process, including public hearings, expert testimony, committee votes and review, open amendments, and open debate. The American financial system is suffering due to a lack of transparency, so why would anyone think that a closed political process could solve that?
Japan faced similar problems with their real estate market several years ago, and the government took a similar path to the one in the Wall Street bailout package. Experts now understand that the Japanese government deepened and lengthened the economic downturn, and Japan still has not recovered. (In fact, Japan is falling into another serious recession now.) Bad companies must fail, wiping out their shareholders and (hopefully) executives. The faster that happens, the more quickly the economy can recover. Otherwise financial companies will pause, waiting for government handouts and not taking the necessary steps promptly to correct their structural problems.
Some politicians seem to think that "painless" is still an option. It's not. This process will be painful. (It will be personally painful, too.) But let's get this process going, now, so we can recover more quickly. The Treasury, Fed, and FDIC still have awesome powers to provide liquidity, together with their central bank allies around the world, but solvency issues must be allowed to correct themselves. The rest of the U.S. Government can take a few simple steps: increasing unemployment insurance benefits, adopting the Obama tax plan (which would be highly stimulative since it is progressive), raising FDIC insurance limits to $250,000 and providing 90% coverage up to $1,000,000, indexing capital gains and equalizing the rate with ordinary income, and a few other, noncontroversial steps.
Tuesday, September 30, 2008
Sunday, September 14, 2008
Lehman Brothers' Government Bailout?
Over this weekend a group of Wall Street executives and U.S. Federal Reserve leaders are meeting to discuss what to do about troubled Lehman Brothers. Lehman could declare bankruptcy any moment now. Lots of "experts" claim that Lehman is too big to fail and that its collapse could cause widespread financial panic.
Oh really?
For perspective, stockholders currently value Lehman (at the close of trading on Friday) at a paltry $2.53B. Another company with the same market value is Thomas & Betts Corporation (who?), Memphis-based manufacturer of electrical, steel structural, and HVAC equipment. In other words, stockholders have already discounted Lehman, so those losses are already reflected in world markets. Investors are already giving high odds that Lehman will collapse, and that assessment is also already reflected in global financial company stock prices.
Lehman is a brokerage. Would investors holding brokerage accounts lose money? Probably not. Lehman participates in the Securities Investor Protection Corporation (SIPC). It's a bit complicated, but let's suppose you have a 401(k) retirement account with Lehman valued at $3M. (You're doing well!) That account consists of various stock and bond holdings, and SIPC rules require Lehman to keep your account and others separate from their own assets. That rule should protect you automatically, but in the unlikely event it doesn't you still have an extra $500K of protection. That is, if Lehman's assets are liquidated and the money available doesn't quite cover the value of the underlying assets in your account, SIPC protects you against $500K of such "gap" losses. Since 1970, SIPC has protected over 99 percent of investors in brokerage bankruptcies, so very few people have lost anything.
In 2007, Lehman had $282B of assets under management according to their annual report. That's a reasonably big number, but those assets don't disappear in a bankruptcy. They are stocks, bonds, cash, etc. Some of those assets (about $60B) are mortgage-related assets, and some percentage of those are nonperforming. Lehman wanted to spin off these bad assets into a separate publicly traded company, selling those assets at a big discount to new investors to raise cash and write them off for good. Wall Street nixed that idea, probably because it would highlight problems at other firms even while saving Lehman. The biggest problem, but still small compared to the size of global markets, is the number of employees suddenly out of jobs, many of them high income employees with lavish lifestyles. Like the Arthur Andersen collapse in Chicago, their losses will be felt locally in New York to some extent. (Expect further declines in the local housing market as employees downsize and relocate.) Worldwide there are about 28,000 Lehman employees. Many of them (but certainly not all), especially the biggest earning (i.e. most "successful") individuals, will be offered employment to continue running whatever is left of Lehman. Secretaries and other junior employees will bear the brunt of the collapse both because they are more likely to lose their jobs and because they do not have as much financial cushion. No, life is not fair.
This Lehman situation is really a big game of chicken. To their credit, the Federal Reserve leaders do not seem interested in spending taxpayer money on a Lehman bailout. Wall Street executives, on the other hand, are doing their best to pretend that Lehman's collapse would be the End of the World(TM), in large part because Lehman is highlighting their own asset problems. I think what's going on here is that the Fed is happy to provide a conference room and a pot of coffee, but it's up to the private sector (and the bankruptcy code) to figure out Lehman's fate, and to continue the process of unwinding these bad assets throughout the industry.
Oh really?
For perspective, stockholders currently value Lehman (at the close of trading on Friday) at a paltry $2.53B. Another company with the same market value is Thomas & Betts Corporation (who?), Memphis-based manufacturer of electrical, steel structural, and HVAC equipment. In other words, stockholders have already discounted Lehman, so those losses are already reflected in world markets. Investors are already giving high odds that Lehman will collapse, and that assessment is also already reflected in global financial company stock prices.
Lehman is a brokerage. Would investors holding brokerage accounts lose money? Probably not. Lehman participates in the Securities Investor Protection Corporation (SIPC). It's a bit complicated, but let's suppose you have a 401(k) retirement account with Lehman valued at $3M. (You're doing well!) That account consists of various stock and bond holdings, and SIPC rules require Lehman to keep your account and others separate from their own assets. That rule should protect you automatically, but in the unlikely event it doesn't you still have an extra $500K of protection. That is, if Lehman's assets are liquidated and the money available doesn't quite cover the value of the underlying assets in your account, SIPC protects you against $500K of such "gap" losses. Since 1970, SIPC has protected over 99 percent of investors in brokerage bankruptcies, so very few people have lost anything.
In 2007, Lehman had $282B of assets under management according to their annual report. That's a reasonably big number, but those assets don't disappear in a bankruptcy. They are stocks, bonds, cash, etc. Some of those assets (about $60B) are mortgage-related assets, and some percentage of those are nonperforming. Lehman wanted to spin off these bad assets into a separate publicly traded company, selling those assets at a big discount to new investors to raise cash and write them off for good. Wall Street nixed that idea, probably because it would highlight problems at other firms even while saving Lehman. The biggest problem, but still small compared to the size of global markets, is the number of employees suddenly out of jobs, many of them high income employees with lavish lifestyles. Like the Arthur Andersen collapse in Chicago, their losses will be felt locally in New York to some extent. (Expect further declines in the local housing market as employees downsize and relocate.) Worldwide there are about 28,000 Lehman employees. Many of them (but certainly not all), especially the biggest earning (i.e. most "successful") individuals, will be offered employment to continue running whatever is left of Lehman. Secretaries and other junior employees will bear the brunt of the collapse both because they are more likely to lose their jobs and because they do not have as much financial cushion. No, life is not fair.
This Lehman situation is really a big game of chicken. To their credit, the Federal Reserve leaders do not seem interested in spending taxpayer money on a Lehman bailout. Wall Street executives, on the other hand, are doing their best to pretend that Lehman's collapse would be the End of the World(TM), in large part because Lehman is highlighting their own asset problems. I think what's going on here is that the Fed is happy to provide a conference room and a pot of coffee, but it's up to the private sector (and the bankruptcy code) to figure out Lehman's fate, and to continue the process of unwinding these bad assets throughout the industry.
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