Never mind the bailout details – what were they eating?

Bloomberg has a major exclusive:

Nov. 25 (Bloomberg) — The deal to rescue the world’s best- known bank was pieced together by regulators over Domino’s pizza in near-empty offices one block from the White House …

In the middle of the meeting, Paulson called Bernanke, telling him that he and FDIC Chairman Sheila Bair, whose agency guarantees bank deposits and some debt, were still negotiating details, according to the person. Meanwhile, about 20 staffers were working at FDIC offices a block from the White House, subsisting on Domino’s pizza for dinner at around 8 p.m. and working on the deal until about 11:30 p.m., according to a person familiar with the matter.

Eh?  The biggest bank failure yet, and we’re focusing on the food they orderered?  

But wait – isn’t this all slightly familiar?  Rewind back to the start of October, when UK officials were putting together the rescue package for Britain’s high street banks.  Here’s the Guardian at the time on the key points of the deal:

In the Treasury war room overlooking St James’s Park, central London, his chancellor, Alistair Darling, was thrashing out the details of the bail-out with ministers, lawyers and executives from the eight leading banks … 

Anticipating the long and tense night ahead for him and his team, Darling had taken matters in hand at 8.30pm, personally ringing one of his favourite restaurants, Gandhi’s in Kennington, south London, to order £245 worth of rice, karahi lamb, tandoori chicken, vegetable curry and aloo gobi.

What is it with this obsession over what officials or liquidators were munching (and what time they placed the order) as they put together bailout packages late at night?  Well, Lucy Kellaway is on hand to explain:

Newspaper articles in these tumultuous, fatal, not-seen-since-the-Great-Depression times are so tightly packed with cliché it is hard to do anything other than join in.

To get the tone right, one needs to use clichés of four different sorts. First is the geological seam of seismic shifts, landscapes, earthquakes and meltdowns. Second is the newer, more vicious, medical imagery of injected, sharp, toxic, pumped, fatal and reeling. Third is the cliché of banal detail: what time it is, what people are eating, what their complexions look like (but only if pale) followed by another look at the clock. The only mundane cliché not to have been seen once in the last six weeks is “smoke-filled rooms” as that is now illegal. The fourth sort of cliché is to declare everything the worst since 1929 or the worst in living memory.

So there you are.  Sounds like an excellent excuse for a new version of Meeting Bingo

What’s worse than a bad bank?

The Citibank rescue is being described as a ‘good bank/bad bank‘ deal. Not so, says Paul Kedrosky:

Here is the gist:

  • Citi will carve out $300-billion in troubled assets, which will remain on its balance sheet:
    • The first $37-$40-billion in losses on those assets will go to Citi
    • The next $5-billion in losses will hit Treasury
    • The next $10-billion in losses will go to the FDIC
    • Any more losses will go to the Fed
  • There will be no management changes at Citi, because, you know, they are all fine and upstanding people who have done nothing wrong.
  • There will be some compensation limitations, but those have not yet been made clear.

To be clear, this is not a “bad bank” model. Assets are not, apparently, being taken off the Citi balance sheet and put into another entity walled off from the Citi biological host. Instead, they are being left on the Citi balance sheet, but tagged and bagged for eventual disposal via taxpayers.

He dubs it the ‘fucked bank’ model.

Update: John Carney likes the deal (not):

Citi shovels a steaming pile of $306 billion of crap assets into a corner of its balance sheet. It gradually writes down their value. Citi takes the first $29 billion of losses, and taxpayers take the next 90% (about $250 billion). In exchange, taxpayers get $27 billion of Citi preferred stock.

Would Warren Buffett have made that deal? No way.

At the very least, there should be a sliding scale for taxpayer ownership: The more the value of the crap assets deteriorates, the more of the company the taxpayers own (and the government should be assessing the value of these assets, not Citigroup). Because as it is, Citi has an incentive to write the whole pile off tomorrow for a song. (This would actually be good for the economy, but not for the taxpayer’s “investment”).

By the way, there is no guarantee that this taxpayer largesse will save Citigroup. $306 billion of assets sounds like a lot, but it’s only about 15% of Citi’s massive asset pile (10% if you count the stuff that was so hideous that Citi shoveled it off the balance sheet long ago). Presumably Citi could keep having to take writedowns on assets outside of the bailout’s $306 billion, weakening the company’s capital and eventually possibly forcing yet another bailout.

So taxpayers may get yet another chance to get hosed.

Update II: This from the WSJ is ominous:

In addition to $2 trillion in assets Citigroup has on its balance sheet, it has another $1.23 trillion in entities that aren’t reflected there… Among the off-balance-sheet assets are $667 billion in mortgage-related securities.

So there’s many more toxic assets still to be owned up to (read Felix Salmon’s take). Meanwhile, the Economist points out the obvious:

One thing that we know will be fun is watching Mr Paulson defend the purchase of $100 billion of Citi’s junk, while simultaneously arguing that Detroit shouldn’t get a dime from TARP.

Update III: Shareholders like the deal – initially at least. Commentators from left and right think the US government got ripped off: Krugman:

A bailout was necessary — but this bailout is an outrage: a lousy deal for the taxpayers, no accountability for management, and just to make things perfect, quite possibly inadequate, so that Citi will be back for more. Amazing how much damage the lame ducks can do in the time remaining.

Arnold Kling:

The one sector that definitely needs to contract is the financial sector. Maintaining Citi as a zombie bank is not really constructive. I would feel better if it were carved up, with the viable pieces sold to other firms and the remainder wound down by government. In my view, getting the financial sector down to the right size ought to be done sooner, rather than later.

My questions: (i) How long before another bank wants the same kind of deal? (ii) Is there anything Paulson can now do to rescue his credibility? (iii) How long before the scale of Citi’s problems are fully understood?

Some answers/guesses: (i) Two weeks. (ii) No – he’s changed direction too many times. (iii) Between 2 and 5 years.

The long road

In our paper on Bretton Woods II (pdf), Alex and I provide rather a gloomy assessment of financial crisis – which we suggest is going to last longer than many think…

Given that we now face what Gordon Brown has described as “the first truly global financial crisis of the modern world”, our bet would be that it takes as long as a decade to bring it fully under control.

Let’s unpack the assumptions behind our pessimism. We start from the premise that, six months back, experts were overly optimistic about how far-reaching the meltdown would be. This is based, in part, on April’s Progressive Governance summit, where heads of state were (a) clearly freaked out; (b) fairly sure they grasped the problem, if not the solutions; (c) not acting as if they expected any further big surprises.

Consider, too, what the IMF’s Dominique Strauss Kahn was saying at the time. He was as worried by inflation, as he was by economic slowdown. Although he was forecasting a “rather important, serious slowdown in economic growth” – the expected pain wasn’t really that bad:

Something around 0.5 percent as a rate of growth for the United States in 2008 and a slight recovery during 2009-an average of 0.6 percent for 2009, which is both linked to the financial turmoil, of course, but also the business cycle. 

Next, we look at the lessons of earlier banking crises that, in developed countries, have tended to take four or five years to unravel, cost around 12% of GDP to resolve, and lead to a cumulative loss in output equal to almost a quarter of GDP. The figures are drawn from this useful chart prepared by PIMCO’s Michael Gomez:

Then add in what we know about the banking crisis that gripped Japan in the 1990s, which the IMF ascribes to “accelerated deregulation and deepening of capital markets without an appropriate adjustment in the regulatory framework”. Hiroshi Nakaso’s account is worth reading in full – seven years of crisis management and fire fighting as a senior manager at the Bank of Japan.

“When the bubble burst in the early 1990s, no one expected it was going to usher in such a prolonged period of weak growth in Japan,” he writes. Policy makers underestimated the seriousness of the problem, while banks lacked the ‘foresight and courage’ to confront their predicament head on.

At the time there was considerable schadenfreude in the West about Japan’s failure to get to grips with its crisis. It was eight years or so before its policy makers even found the levers that would begin to inch the crisis towards a solution. Are we right to assume that we’ll now do better? Continue reading

A Bretton Woods II worthy of the name

Ahead of this weekend’s G20 summit, David and I have published a short paper entitled A Bretton Woods II worthy of the name.  Key points:

– The summit is unlikely to be able to live up to its billing.  Leaders do not yet understand the nature of the problem well enough to be able to implement viable solutions.  However, the problem is more fundamental than a simple lack of shared awareness. 

 – History suggests that leaders will only think the unthinkable on institutional reform once the challenge they face has really hit rock bottom. But history also suggests that we are wrong to think that the worst of the crisis is now past, given that many past banking crises have taken five years or more to unravel.

 – Bretton Woods 1 looked across the whole international economic waterfront in 1944, while this weekend’s summit will be much more narrowly focused.  Leaders will make a big mistake if they try and tackle finance in isolation, given the growing impact of resource scarcity, and that 2009 is supposed to see another ambitious global deal – on climate.

 – We need to recalibrate what we expect from globalization through a serious debate about subsidiarity. Where has globalization gone too far, too fast? Where do we need more integration at a global level? These were exactly the questions that preoccupied Keynes in 1933, when he weighed the relative benefits of global versus local across a range of variables.  We need a similar debate today as a precursor to serious international economic reform.

 – Leaders need to extend their horizons in (at least) five directions: onto longer time scales; beyond financial regulation into wider resource scarcity challenges; into other international processes, especially climate; towards grand bargains with emerging powers; and beyond government, to non-governmental networks.

Full version after the jump, or better yet here’s the pdf.

Continue reading

When central banks lose control of interest rates

Just after the Bank of England’s stunning 150 basis point cut yesterday, BBC business editor Robert Peston noticed an alarming signal of problems ahead.  He wrote:

I’ve just had a call from an astonished individual who has several hundred million pounds that he puts on deposit in various banks. As of 10 minutes ago, a leading British bank was offering to pay him almost 7% interest for his cash. That was after the Bank of England’s policy rate had been slashed by 1.5 percentage points to 3% – an unprecedented reduction in the history of the Bank’s Monetary Policy Committee.

Why does it matter that this holder of squillions is still being offered almost 7%? Well, if he’s being paid almost 7%, what chance is there that small businesses will be able to borrow at less than 10, 12, 14% or more (with the actual rate depending on an assessment of their credit-worthiness)?

Peston’s conclusion: “the transmission mechanism from the Bank of England’s policy rate to the interest rates we pay has broken down“.  This morning, the front of the FT confirms the problem:

All but two UK banks snubbed government calls to pass on Thursday’s dramatic interest rate cuts to new customers and more than 20 lenders withdrew deals that would have slashed borrowers’ monthly mortgage repayments … Lloyds TSB and Abbey were the only two lenders to say they would pass on the full rate cut in their standard variable rates.

What’s at stake here is potentially rather larger than simply the question of providing some much-needed relief for mortgage holders and small businesses, or the political issue of whether banks in receipt of taxpayer bailouts have a duty to pass on the rate cut. 

No, the bigger question is about the degree and efficacy of state control over monetary policy – full stop.  Here’s how it’s supposed to work in the words of the Bank of England:

When the Bank of England changes the official interest rate it is attempting to influence the overall level of expenditure in the economy. When the amount of money spent grows more quickly than the volume of output produced, inflation is the result. In this way, changes in interest rates are used to control inflation.

The Bank of England sets an interest rate at which it lends to financial institutions. This interest rate then affects the whole range of interest rates set by commercial banks, building societies and other institutions for their own savers and borrowers.

Well, that’s the theory, anyway.  But what happens if it no longer works?