Banks, paying your rescuer: Part 1, you *will* do it

October 20, 2008 | GSEs, Policy, Subprime, TARP, US News

It used to be that if you made a fool of yourself in the wilderness, you got rescued for free.  Now, with extreme skiing, orienteering, and other Darwin-Award candidate adventures, if they airlift your frozen self off the peak, once you’re thawed out and after the flashbulbs have popped, you are presented with a bill for your rescue. 


How much did that cost?


Cynic that I am, I take a quiet amusement in imagining the mixed feelings of those who emerge from their sedation to discover to find themselves both unexpectedly alive and unexpectedly in debt.


Last week saw yet another feat of financial legerdemain coupled with high-stakes bluff, pulled off by the financial rescue team – Paulson, Bernanke and Geithner, to whom must now be added the euphoniously named Neel Kashkari. 



We’re from the government and we’re here to invest in you


Like their previous tricks, this one was performed in broad daylight, and understood by only a handful of people beyond those directly affected.  Like its predecessors, it’s a jaw-dropper.




Something akin to the feelings of a now-indebted rescuee must have greeted the major bank CEOs – a Who’s Who of banking – who gathered in Secretary Paulson’s Treasury offices last October 13, as reported in the New York Times:


Among the bankers attending were Kenneth D. Lewis of Bank of America, Jamie Dimon of JPMorgan Chase, Lloyd C. Blankfein of Goldman Sachs, John J. Mack of Morgan Stanley, Vikram S. Pandit of Citigroup, Robert Kelly of Bank of New York Mellon and John A. Thain of Merrill Lynch.


Across the conference table were the architects of banking on value:


The nine chief executives met in a conference room outside Mr. Paulson’s ornate office, people briefed on the meeting said. They were seated across the table from Mr. Paulson; Ben S. Bernanke, chairman of the Federal Reserve; Timothy F. Geithner, president of the Federal Reserve Bank of New York; Federal Reserve Governor Kevin M. Warsh; the chairman of the F.D.I.C., Sheila C. Bair; and the comptroller of the currency, John C. Dugan.


Even more remarkable is that apparently the Secretary, in full Brando, made them an offer they couldn’t refuse:



I want you to do me a service


Bringing together all nine executives and directing them to participate was a way to avoid stigmatizing any one bank that chose to accept the government investment.



How nice, all nine of you together


What was this offer?  Why, to invest in their businesses!


WASHINGTON — The Treasury Department, in its boldest move yet, [announced] a plan on Tuesday to invest up to $250 billion in banks, according to officials.


Of the $250 billion, which will come from the $700 billion bailout approved by Congress, half is to be injected into nine big banks, including Citigroup, Bank of America, Wells Fargo, Goldman Sachs and JPMorgan Chase, officials said. The other half is to go to smaller banks and thrifts. The investments will be structured so that the government can benefit from a rebound in the banks’ fortunes.


The shift – from buying asset bundles to investing in banks – is yet another dramatic tactical shift in Treasury’s thinking. 


Still, Mr. Paulson’s strategy was backed by lawmakers, including Senator Charles E. Schumer, Democrat of New York, who said he preferred capital injections to buying distressed mortgage-related assets — a proposal that Treasury pushed aggressively before its turnabout.


As we’ll see in a moment, Senator Schumer’s right on here. 



From the New York Times: who’s getting what


To understand why, let’s start by hearing directly from the Treasury statement:


Today, there is a lack of confidence in our financial system – a lack of confidence that must be conquered because it poses an enormous threat to our economy. Investors are unwilling to lend to banks, and healthy banks are unwilling to lend to each other and to consumers and businesses.


For those unfamiliar with Wall Street, it’s hard to appreciate just how astonishing that statement was.  The colossi of Wall Street – the world’s biggest banks – were so spooked by their inability to anticipate who might fail next that they had literally stopped lending to each other overnight. 


We are acting with unprecedented speed taking unprecedented measures that we never thought would be necessary. But they are necessary to get our economy back on an even keel, and secure the confidence and future of our markets, our economy and the economic well-being of all Americans.


This is without precedent for seventy years, and if nobody will lend, the entire system is frozen solid.



Desperately needing liquidity


In recent weeks, the American people have felt the effects of a frozen financial system.  … Without confidence that their most basic financial needs will be met, Americans lose confidence in our economy, and this is unacceptable.


Recession is a looming threat, but the financial crisis was more urgent – the equivalent of financial cardiac arrest.



Need to keep the money pumping


President Bush has directed me to consider all necessary steps to restore confidence and stability to our financial markets and get credit flowing again. Ten days ago Congress gave important new tools to the Treasury, the Federal Reserve and the FDIC to meet the challenges posed to our economy.


Ten days that shook the world, indeed.




Today I am announcing that the Treasury will purchase equity stakes in a wide array of banks and thrifts. Government owning a stake in any private U.S. company is objectionable to most Americans – me included. 


As Maynard Keynes said, “When the facts change, sir, I change my mind:” what do you do?

Yet the alternative of leaving businesses and consumers without access to financing is totally unacceptable. 

When financing isn’t available, consumers and businesses shrink their spending, which leads to businesses cutting jobs and even closing up shop. 

Absolutely.  Now hear the secretary purr ….

I ask you to do me this service”


Nine large financial institutions have already agreed to participate in this program. They have agreed to sell preferred shares to the US government, on the same terms that will be available to a broad array of small and medium-sized banks and thrifts across the nation. These are healthy institutions, and they have taken this step for the good of the U.S. economy. As these healthy institutions increase their capital base, they will be able to increase their funding to U.S. consumers and businesses. 

At a time when events naturally make even the most daring investors more risk-averse, the needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it.


You will take this money, says the Cheshire Cat, barbs and all, and you will smile about it.

Smile, bankers – just smile

In a letter to Mr. Paulson on Monday, Mr. Schumer, chairman of the Joint Economic Committee, urged the Treasury to demand that banks receiving capital eliminate their dividends, restrict executive pay and stick to “safe and sustainable, rather than exotic, financial activities.”

“I don’t think making this as easy as possible for the financial institutions is the way to go,” Mr. Schumer said in a call with reporters. “You need some carrots but you also need some sticks.”

Sticks there are:

Institutions that sell shares to the government will accept restrictions on executive compensation, including a clawback provision and a ban on golden parachutes during the period that Treasury holds equity issued through this program.

You want those fat pay packets?  Pay me off with Tier 1 capital.


It’s for the good of the country


[Continued tomorrow in Part 2.]