Monday, December 22, 2008

Bailout money - no accounting ?!

WASHINGTON – It's something any bank would demand to know before handing out a loan: Where's the money going? But after receiving billions in aid from U.S. taxpayers, the nation's largest banks say they can't track exactly how they're spending the money or they simply refuse to discuss it.

"We've lent some of it. We've not lent some of it. We've not given any accounting of, 'Here's how we're doing it,'" said Thomas Kelly, a spokesman for JPMorgan Chase, which received $25 billion in emergency bailout money. "We have not disclosed that to the public. We're declining to."

The Associated Press contacted 21 banks that received at least $1 billion in government money and asked four questions: How much has been spent? What was it spent on? How much is being held in savings, and what's the plan for the rest?

None of the banks provided specific answers.

"We're not providing dollar-in, dollar-out tracking," said Barry Koling, a spokesman for Atlanta, Ga.-based SunTrust Banks Inc., which got $3.5 billion in taxpayer dollars. Some banks said they simply didn't know where the money was going.[...]


  1. "It's a Wonderful Life's" James Stewart's explanation of the banking system is famous. The movie should be on now and IMO it is worth watching if only to understand the current economic crisis, its causes and potential ramifications.

    Forgive me if I am too wordy as I try again to explain a few economic concepts:

    Recession is generally caused by banking panics. The Great Depression contained several banking crises consisting of runs on multiple banks from 1929 to 1933. Much of the Depression's economic damage was caused directly by bank runs, and institutions put into place after the Depression have prevented runs on U.S. commercial banks since the 1930s even under conditions such as the U.S. savings and loan crisis of the 1980s and 1990s.The Depression's bank runs left a lasting scar on the American psyche, and our government will do anything in an attempt to prevent another Great Depression.

    A bank run occurs when a large number of bank customers withdraw their deposits because they believe the bank might become insolvent. As a bank run progresses, it generates its own momentum, in a kind of self-fulfilling prophecy: as more people withdraw their deposits, the likelihood of default increases, and this encourages further withdrawals. This can destabilize the bank to the point where it faces bankruptcy.

    A banking panic is a financial crisis that occurs when many banks suffer runs at the same time. A systemic banking crisis is one where all or almost all of the banking capital in a country is wiped out. The resulting chain of bankruptcies can cause a long economic recession. Much of the Great Depression's economic damage was caused directly by bank runs. This is what started to happen in the US beginning in August of 2007 when Countrywide suffered a bank run as a consequence of the subprime mortgage crisis. In Sept, 2007 it was British banking giant Northern Rock. In March 2008 it was Bear Stearns' 17 billion. In July 2008 it was Indy Mac. In September 2008 it was Washington Mutual.

    Governments attempt to stabilize banking in the face of a crisis in several ways:

    One is the temporary suspension of withdrawals which tends to cause greater panic as people do not have access to their money. This is what caused the economic collapse in Argentina 1999-2002.

    Another tactic is the organization of central banks that act as a lender of last resort. This is what is happening now with the bailout.

    The protection of deposit insurance systems such as the U.S. Federal Deposit Insurance Corporation can usually prevent some bank crises but the FDIC currently cannot begin to cover the losses due to the drop in real estate values which is the reason why the bailout is necessary.

    These techniques do not always work to prevent deep recession. Even with deposit insurance and bailouts, as we have seen, depositors still lack confidence in the banking system and have failed to invest again. (This was discussed in response to another post).

    This further fuels economic crisis because banks retain only a fraction of their demand deposits as cash (lookup fractional-reserve banking). The remainder is invested in securities and loans which in turn finance industry and housing (and create jobs and put more capital into the economy). No bank has enough reserves on hand to cope with more than the fraction of deposits being taken out at once.

    If only a few depositors withdraw at any given time, fractional reserve banking works well. Depositors' unpredictable needs for cash are unlikely to occur at the same time; that is, by the law of large numbers banks can expect only a small percentage of accounts withdrawn on any one day because individual expenditure needs are largely uncorrelated.

    If many depositors withdraw all at once, the bank itself may run short of liquidity, and depositors will rush to withdraw their money, forcing the bank to liquidate many of its assets at a loss, and eventually to fail. If such a bank calls in its loans early, this may force businesses to disrupt their production, or individuals to sell their homes, causing further losses to the larger economy, which is what is happening right now fueling massive shut downs and widespread unemployment. This naturally exacerbates the banking crisis as more people rush to withdraw funds and businesses are unable to invest due to a lack of capital or the ability to borrow money.

    In a systemic banking crisis, all or almost all of the banking capital in a country is wiped out. Systemic banking crises are associated with substantial fiscal costs and large output losses. Frequently, emergency liquidity support and blanket guarantees have been used to contain these crises, though not always successfully.

    Some measures used in attempting to contain economic fallout and restore the banking system after a systemic crisis include targeted debt relief programs and government capitalization of banks, which is what the bailout was all about. Anyone with a background in accounting or finance does not need an accounting of "where the money went" because it is obvious.

    This is why sensationalist stories such as the one posted here have not been published in the Wall Street Journal whose readership generally understands all too well the fallout and widespread consequences of the crisis.

    As more depositors and investors begin to doubt whether the government can support the country's banking system, the silent run on the banking system will gather steam, causing zombie banks (with a net worth which is less than zero, but which continue to operate because of government backing) to sell some of their assets to cover losses. The remaining assets will then contain a larger fraction of unbooked losses. If the bank rolls over its liabilities at increased interest rates (which is what has been happening), it squeezes healthy banks and business concerns. The longer the silent run goes on, the more benefits are transferred from healthy banks and taxpayers to the zombie banks. I hope that this will explain some of the reasoning behind the bailout.

    The cost of cleaning up such a widespread economic crisis is huge. In systemically important banking crises in the world from 1970 to 2007, the average net recapitalization cost to the government was 6% of GDP, fiscal costs associated with crisis management averaged 13% of GDP (16% of GDP if expense recoveries are ignored), and economic output losses averaged about 20% of GDP during the first four years of the crisis. Laeven L, Valencia F (2008). "Systemic banking crises: a new database".

    In other words our government chooses to spread the losses over future earnings rather than allow a total collapse of our economy as occurred during the Great Depression which saw a quarter of Americans out of work, the failure of 40% of American banks which caused the loss of 2 billion in deposits, a 31 percent contraction of the money supply, a drop in Capital growth investments from $16.2 billion to 1/3 of one billion, and a 53% drop in farm prices.

    The US began to emerge from the Great Depression with the Fed's expansion of the money supply in 1932, the creation of the Reconstruction Finance Corporation and the raising of the top tax rate from 25 to 63 percent (to encourage investing rather than hoarding capital due to tax savings). During the Great Depression, it 1935 before unemployment began to dip to 20%.

    This is the nature of the crisis that our lawmakers are trying to avoid.

    I hope that this might be a starting point for further reading and understanding.

  2. Wall Street Journal
    December 10, 2008
    The panel's top official, Harvard Law School professor Elizabeth Warren, is scheduled to describe her findings to the House Financial Services Committee today. Among other things, a draft of the report posed 10 questions to Treasury relating to the program's strategy, accountability and why it hasn't done more to help prevent foreclosures.

    The roughly 30-page report is also expected to press Treasury to describe whether the money used to inject capital into the banking sector is a "giveaway" or a "fair deal," according to one person familiar with the report.

  3. The "bailout" is an act of desperate attempt to avoid the complete collapse of our economy, banks, currency and our country's descent into Great Depression Era unemployment and widespread hunger. Whether or not it is working is not a question; we can still go to the bank to withdraw our savings, cash our paychecks and use our Visa cards at the grocery store. It IS working. But obviously, an infusion of cash into the banking system is not the cure for our economic woes any more than stuffing newspapers and buckets of tar into the ceiling will fix a leaking roof. Sooner rather than later, you are going to have to borrow (and pay it off for many years), the money needed to rip off the whole roof and rebuild it properly. If you don't, pretty soon the house with collapse and you will be homeless, cold and wet.

    There are many more things that need to be done to fix the economy but preventing the immediate collapse of our banking system was number one. The bailout was the bucket of tar that temporarily prevented the immediate collapse of our banks and currency, but the roof has been leaking for more than twenty years and it is going to take a LOT to rebuild it from scratch.

    Officially unemployment is about 7%, which is terrible, but still a far cry from the 25% unemployment caused by the bank failures and currency runs of the Great Depression.

    The next step will most likely be to stabilize mortgages via government programs and stimulate spending via government intervention.

    These are the lessons learned from the Great Depression. Yes, obviously we will pay for this "borrowing" against our future GDP as we did during the post WWII era, incidentally the most prosperous era in our nation's history as monetary policies put in place during the Depression (ie high taxes) stimulated capital investment.

    If we do not take these desperate and seemingly socialist measures (see the charges leveled against Roosevelt in the 30s), we will surely see widespread unemployment, homelessness and hunger as banks fail one by one as happened in the 1930s.

    In today's WSJ Opinion Journal- Robert Lucas, 1995 Nobel Prize Winner in Economics explains (quite nicely IMO):

    The Federal Reserve's lowering of interest rates last Tuesday was welcome, but it was also received with skepticism. Once the federal-funds rate is reduced to zero, or near zero, doesn't this mean that monetary policy has gone as far as it can go? This widely held view was appealed to in the 1930s to rationalize the Fed's passive role as the U.S. economy slid into deep depression.

    It was used again by the Bank of Japan to rationalize its unwillingness to counteract the deflation and recession of the 1990s. In both cases, constructive monetary policies were in fact available but remained unused. Fed Chairman Ben Bernanke's statement last Tuesday made it clear that he does not share this view and intends to continue to take actions to stimulate spending.

    There should be no mystery about what he has in mind. Over the past four months the Fed has put more than $600 billion of new reserves into the private sector, using them to discount -- lend against -- a wide variety of securities held by a variety of financial institutions. (The addition is to be weighed against September 2007's total outstanding level of reserves of about $50 billion.)

    This action has been the boldest exercise of the Fed's lender-of-last-resort function in the history of the Federal Reserve System. Mr. Bernanke said that he is prepared to continue or expand this discounting activity as long as the situation dictates.

    Why do I describe this as an action to stimulate spending? Financial markets are in the grip of a "flight to quality" that is very much analogous to the "flight to currency" that crippled the economy in the 1930s. Everyone wants to get into government-issued and government-insured assets, for reasons of both liquidity and safety. Individuals have tried to do this by selling other securities, but without an increase in the supply of "quality" securities these attempts do nothing but drive down the prices of other assets. The only other action people can take as individuals is to build up their stock of cash and government-issued claims to cash by reducing spending. This reduction is a main factor in inducing or worsening the recession. Adding directly to reserves -- the ultimate liquid, safe asset -- adds to supply of "quality" and relieves the perceived need to reduce spending.

    When the Fed wants to stimulate spending in normal times, it uses reserves to buy Treasury bills in the federal-funds market, reducing the funds' rate. But as the rate nears zero, Treasury bills become equivalent to cash, and such open-market operations have no more effect than trading a $20 bill for two $10s. There is no effect on the total supply of "quality" assets.

    A dead end? Not at all. The Fed can satisfy the demand for quality by using reserves -- or "printing money" -- to buy securities other than Treasury bills. This is the way the $600 billion got out into the private sector.

    This expansion of Fed lending has not violated the constraint that "the" interest rate cannot be less than zero, nor will it do so in the future. There are thousands of different interest rates out there and the yield differences among them have grown dramatically in recent months. The yield on short-term governments is now about the same as the yield on cash: zero. But the spreads between governments and privately-issued bonds are large at all maturities. The flight to quality means exactly that many are eager to trade private paper for non-interest bearing (or low-interest bearing) reserves and with the Fed's help they are doing so every day.

    Could the $600 billion in new reserves be called a bailout? In a sense, yes: The Fed is lending on terms that private banks are not willing to offer. They are not searching for underpriced "bargains" on behalf of the public, nor is it their mission to do so. Their mission is to provide liquidity to the system by acting as lender-of-last-resort. We don't care about the quality of the assets the Fed acquires in doing this. We care about the quantity of its liabilities.

    There are many ways to stimulate spending, and many of these methods are now under serious consideration. How could it be otherwise? But monetary policy as Mr. Bernanke implements it has been the most helpful counter-recession action taken to date, in my opinion, and it will continue to have many advantages in future months. It is fast and flexible. There is no other way that so much cash could have been put into the system as fast as this $600 billion was, and if necessary it can be taken out just as quickly. The cash comes in the form of loans. It entails no new government enterprises, no government equity positions in private enterprises, no price fixing or other controls on the operation of individual businesses, and no government role in the allocation of capital across different activities. These seem to me important virtues.

  4. Today's "more on where the money is going".

    Treasury Will Invest Billions in AmEx, CIT

    The U.S. Treasury will invest a total of nearly $6 billion of the $700 billion bank bailout fund in business and consumer lender CIT Group Inc. and credit-card giant American Express Co.

    Becoming a bank holding company allows firms such as American Express additional avenues of financing.

    AmEx will receive a capital infusion of $3.39 billion from the Treasury in return for warrants and preferred stock, while CIT will get $2.33 billion. AmEx became a bank-holding company last month and was seeking as much as $3.5 billion in aid. CIT, whose application was approved Monday by the Federal Reserve, was seeking as much as $2.5 billion.

    The two companies are part of the growing ranks of newly formed bank-holding companies, which include investment banks Morgan Stanley and Goldman Sachs Group Inc. Another company seeking that status is GMAC LLC, the financing arm owned by private-equity group Cerberus Capital Management and General Motors Corp.

    Becoming a bank-holding company gives companies access to additional stable avenues of financing besides the Treasury's rescue program. Those include the Fed's discount window, where banks can borrow funds for 90 days at a current 0.5%. AmEx has also raised $5.5 billion in debt backed by the Federal Deposit Insurance Corp.

    Both CIT and AmEx need stable funding sources to make loans to businesses and consumers, but the credit crunch has made raising funds in public markets expensive.

    CIT's access to funding evaporated in March, prompting the century-old firm to drain a $7.3 billion credit line. Since then, CIT had been looking to slim down, and it unloaded its home-lending business in July. CIT also plans to raise at least $1.4 billion of regulatory capital through a note exchange, set to be completed by Wednesday.

    Write to Kevin Kingsbury at


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