My post from Friday June 26 contained the first part of this discussion. Today I would like to continue the discussion and there are two reasons for doing so. The first reason is to understand just what the Federal Reserve has been doing over these last nine months. The second is to understand how likely it might be for the Federal Reserve to “unwind” what it has done over the past nine months and reduce a part of the fear of future inflation. Note, I am not including any discussion of future government deficits and the probability that they will be “monetized.”
There is no doubt in my mind that the Federal Reserve has “printed” a lot of money since early September 2008, most of it before January 2009. The Monetary Base (Non-seasonally adjusted, NSA) rose from $847 billion in August 2008 to $1,712 billion in January 2009, an increase of $865 billion. Between January and May 2009, the Monetary Base only rose $63 billion.
Total Reserves (NSA) in the banking system increased by $817 billion from September 2008 to January 2009, but only increased by $42 billion since January. The most interesting thing is that Excess Reserves (NSA) in the banking system rose by almost $800 billion in the earlier period and increased by $46 billion in the January to May period.
The Federal Reserve put a lot on money into the banking system over the last nine months and the VAST MAJORITY of the funds went into Excess Reserves. The Fed “printed” a lot of money (or, created a lot of deposits at the Fed) but these monies did not find their way into the economy!
These two periods need to be separated in order to get a better picture of what the Fed has done and for some implications about what might occur in the future. My basic argument is that the Fed has put a tremendous amount of money into the world banking system and has ultimately underwritten the Treasury’s TARP program and provided much more money to the banking system than Congress authorized.
The underlying effort has two goals: first, to keep financial markets liquid; and second, to protect against the insolvency of the banking system. The first goal has basically been accomplished. The second is still playing itself out. The crucial thing to understand is that the way the Fed has acted has given the system a chance to get healthy and yet provide a net to catch insolvent banks so as to avoid a precipitous collapse of the banking system.
In the September 2008 to January 2009, the crisis period, the Fed basically ceased using the normal tools of monetary policy: open market operations consisting of outright purchases of government securities and repurchase agreements. In the fall, the Federal Reserve basically picked and choose what parts of the financial markets needed liquidity and created facilities to support these ill-liquid sub-markets. The major ways that it supplied funds or saw funds withdrawn in the September 2008 through January 2009 period and in the January 2009 through May 2009 period.
Change (billions) from Sept/08 to Jan/09: Term Auction Credit $257; Other Loans $166; Commercial Paper LLC $334; Other Fed Reserve Assets $506; for a total of $1,263. The change (billions) from Jan/09 through May 2009: Term Auction Credit (-$124); Other Loans (-$62); Commercial Paper LLC (-$206); Other Fed Reserve Assets (-$411); for a total of minus $803.
The Term Auction Credit Facility (TAF) helped to get reserves to the commercial banks that needed reserves, an effort the Fed believed was more efficient than open market operations. TAF peaked at $300 billion increase on 12/31/08. Other loans include increased borrowings from the Fed’s discount window, a facility for asset-backed commercial paper (which reached a peak increase of $152 billion on 10/8/08), a facility for primary government security dealers (which reached a peak increase of $147 billion on 10/1/08), and a facility for AIG. The commercial paper LLC was a limited liability facility that bought 3-month paper from eligible issuers (which reached its peak of $334 billion on 12/31/08). The increase in Other Fed Reserve assets was primarily Central Bank Liquidity swaps (which reached a peak of $682 billion on 12/17/08).
However, the Fed’s efforts reported here resulted in almost a $1.3 trillion increase in its assets and an $865 billion increase in the Monetary Base. Thus, almost the entire monetization ended up as excess reserves held at Federal Reserve Banks. Bank reserves at Federal Reserve Banks increased steadily throughout the fall, peaking at $856 million on December 31, 2008. Whew! The Federal Reserve had made it through this period of financial market illiquidity which accompanied the entire Thanksgiving/Christmas seasonal need for cash.
What happened in 2009? As mentioned above, the needs of specific market makers retreated, but now the solvency of the banking system came to the fore. In terms of the special facilities, as can be seen from the figures given above, a total of $803 billion was removed during the first five months of the year. Then the Fed began to conduct open market operations again. Throughout this time, securities bought outright by the Fed increased by $712 bullion. This included a program to buy government securities on a regular basis which contributed $177 billion to the Fed’s portfolio. It also added $70 billion of Federal Agency issues. Furthermore, the Fed initiated a very important program in 2009 and bought $465 billion of Mortgage-backed securities.
In essence, Total Federal Reserve Bank credit declined by about $200 billion during the first five months of the year but, as was reported earlier, the monetary base increased by $63 billion and total reserves and excess reserves in the banking system increase by more than $40 billion. In essence, the Fed operated in 2009 to keep the banking system very liquid and replaced the reserves that had been supplied to different parts of the financial markets in 2008 by interjecting funds directly into the banking system. The new twist? Directly helping banks sell their mortgage-backed securities, thereby reducing pressure on the banks to clean up their balance sheets. This was the original purpose of the Treasury’s TARP program.
The banking system faces three problems going forward: existing bad assets; bad assets that will appear over the next 18 months or so; and refinancing needs as the banks may not always be able to roll over existing liabilities.(See my post of June 15, “What Banks Aren’t Telling Us”, http://seekingalpha.com/article/143276-what-aren-t-banks-telling-us, for more on these factors.) The huge amount of excess reserves will help the banks face these problems. In terms of financing needs, the banks have the cash to pay off maturing liabilities without needing to roll the debt over. In terms of bad debts, this is where the TARP program comes in because the Treasury has provided preferred stock to banks with warrants attached. Charge offs can go against existing capital and the preferred stock and warrants can be transformed into new capital owned by the government to keep these banks afloat until something can be done with them.
Some banks have repaid the TARP funds that they had received. Several well-known large banks returned $68.25 billion this month to reduce Federal Government oversight. Still there have been 633 banks that have directly received about $200 billion in TARP funds and a total of 32 banks have now repaid about $70 billion. (On this see “Small Banks Not Shying From TARP” in June 27 Wall Street Journal, http://online.wsj.com/article/SB124606040026463617.html.) So, of the roughly $800 billion that banks are now holding in excess reserves, one could argue that approximately $130 billion of them have been supplied through the Treasury program and are held, mostly, by smaller banks and $670 billion of them has been supplied by the Federal Reserve, the total of the two being the money “printed “ to get us out of the current financial crisis.
The hope is that as the banking system works through its problems, TARP funds will be returned and the mortgage-backed securities will mature or be sold back into the market allowing the balance sheet of the Federal Reserve to contract back to where it was in the summer of 2008. The banking system is apparently holding onto reserves to protect itself and that is why they are really not lending. The idea is that if they don’t need these excess reserves they will return them. This is what the Federal Reserve is planning to happen. Let’s hope that they are correct!
Showing posts with label Troubled Asset Relief Program. Show all posts
Showing posts with label Troubled Asset Relief Program. Show all posts
Sunday, June 28, 2009
Thursday, June 25, 2009
Treasury's TARP Debt Already Monetized?
Where does all the TARP money show up? TARP, of course, stands for the Troubled Asset Relief Program that became law on October 3, 2008, a program aimed at providing support for the banking system. The program was initially intended to provide liquidity-help for the troubled assets that were on the balance sheets of banks but it soon morphed into a program to support troubled banks in their capital needs as funds were made available to purchase senior preferred stock and warrants from commercial banks and other troubled financial institutions.
The first $350 billion of funds was authorized to be released on October 3, 2008 and Congress approved the release of the next $350 billion on January 15, 2009. Part of the concern with the program was that the government deficit would have to increase by $700 billion in order to create the funds. Concerns arose about how the Treasury Department would finance these payments?
One quick answer was “let the Federal Reserve monetize the debt?”
What if the Federal Reserve has already monetized the debt related to TARP? If this is the case, then two questions that have been puzzling me have answers to them. The first question relates to the increase in excess reserves in the banking system. The second question relates to the concern about how the Federal Reserve will reverse out all of the reserves that it pumped into the banking system last fall. Let’s look at both in turn.
Federal Reserve Bank Credit has increased by $1.2 trillion since just before the financial meltdown in September 2008. What has increased the most in the banking system? Excess reserves in the commercial banking system have risen by about $800 billion. Excess reserves in the WHOLE banking system had run about $2 billion before September 2008. Something unprecedented obviously took place!
In terms of policy making the creation of TARP and the response of the Federal Reserve are closely tied together. (See my post of November 16, 2008, “The Bailout Plan: Did Bernanke Panic?: http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic.) As mentioned above, the first round of TARP was released in October. But, the Federal Reserve could not wait. It began pumping reserves into the banking system in the latter part of September increasing Reserve Bank Credit outstanding from about $890 billion on September 10, 2008 to $1.5 trillion on October 8, $1.9 trillion on October 29, and $2.2 trillion on November 19.
In all this action, what happened to reserve balances at the Federal Reserve? They went from around $8 billion on September 10, to $175 billion, to $420 billion, to $624 billion, respectively, on the same dates as above. Excess reserves in the banking system averaged $2 billion in August, $60 billion in September, $268 billion in October, $559 billion in November, and $767 billion in December.
Excess reserves in the banking system averaged $844 billion in May and are averaging around $800 in June. Clearly a lot of money!
The question is “Why are the banks sitting on such large amounts of basically idle cash?”
My response is that they are sitting on this cash because it is connected with the receipt of TARP monies and the banks are hoping, as some of the larger and stronger institutions have done, to repay the funds as soon as possible.
Let’s look a little closer at the data. I am using information from the H.8 release put out by the Federal Reserve System on assets and liabilities of all commercial banks in the United States. Year-over-year, through May 2009, total assets in the banking system increased by 9.7% or about $1.1 trillion. Cash assets in the banking system increased a whopping $731 billion or at a year-over-year rate of 236%. This is comparable to the year-over-year increase in excess reserves observed on the H.3 release of the Federal Reserve providing data on bank reserves.
Given my post of last June 15, 2009, “What Aren’t Banks Telling Us?”, (http://seekingalpha.com/article/143276-what-aren-t-banks-telling-us) I was interested in looking a little deeper into this information to see how these excess reserves were distributed within the banking system. Roughly the division is this. The increase in cash assets at large commercial banks was $371billion, at small banks the increase was $143 billion, and at Foreign-related Institutions in the United States, $217 billion. The increase at the larger institutions, the large banks and the foreign-related institutions, was $588 billion and this represented the immediate problem to the policy makers. The problems of the smaller banks could be dealt with later.
The reason I am interested in looking into this distribution is the claim made in the above-mentioned post that commercial banks had not been fully open with the public on the problems they were still facing. In that post I mentioned three areas of concern: the bad assets now on the books of the banks; the anticipated increase in the bad assets in the upcoming months; and finally, the needs of the banks to be able to fund themselves in the future in the face of liabilities that were maturing and would not be rolled over. The build up in cash assets, it was argued, was a precaution the banks were taking to handle the uncertainty they faced as either asset values fell or a run off of liabilities forced the banks to dispose of assets.
Here is where the TARP money comes into play. If TARP money went into preferred stock and warrants, then these monies could be used to provide capital to the banks as the banks needed to write off bad loans and securities. The stock could even be converted into capital if the funds were needed to keep the banks solvent. Otherwise the banks could use the TARP funds to pay off maturing debt that could not be rolled over in the financial markets. (See Gretchen Morgenson, “Debts Coming Due At The Wrong Time,”
http://www.nytimes.com/2009/06/14/business/14gret.html?_r=1&scp=1&sq=gretchen%20morgenson/June%2014,%202009&st=cse.) Thus, monetizing the TARP debt makes a lot of sense in that it helps to protect the banking system from either bad assets that have to be written off or from financing problems resulting from the inability of the banks to roll over maturing liabilities.
What does this have to do with the Federal Reserve being able to unwind all the Reserve Bank Credit that it has pumped into the system? Well, when the banking system gets its act in order and charges off the loans and securities that it needs to and when its refinancing needs are satisfied, banks can then repay the TARP money to the Treasury as have the large financial institutions that have already repaid the TARP funds that they received. And, as the TARP monies are repaid, Reserve Bank Credit will decline so as to reduce the concern over the Fed monetizing the federal deficit.
Nice trick! The policy makers have provided a net under the banking system if the situation gets too bad in order to protect it against things falling apart and parallelizing the financial system. And, they have built into the system the means of reducing reserves as the financial system strengthens so as to avoid concerns over possible future inflation.
One final question: have the actions of the Federal Reserve had any impact on bank lending? The answer is “Not Really!” Year-over-year, loans and leases at all commercial banks increased by a tepid $182 billion or at a 2.6% annual rate. And, where were these increases located? Generally in home equity loans, consumer loans, and other residential loans (primarily mortgages) satisfying consumers needs for ready cash through consumer credit or the refinancing of homes. And, these loans were pretty evenly spread throughout the banking system.
Bottom line, however, is that the banks aren’t lending! Especially in the areas of commercial and industrial loans and commercial mortgages. Does that tell you something?
The first $350 billion of funds was authorized to be released on October 3, 2008 and Congress approved the release of the next $350 billion on January 15, 2009. Part of the concern with the program was that the government deficit would have to increase by $700 billion in order to create the funds. Concerns arose about how the Treasury Department would finance these payments?
One quick answer was “let the Federal Reserve monetize the debt?”
What if the Federal Reserve has already monetized the debt related to TARP? If this is the case, then two questions that have been puzzling me have answers to them. The first question relates to the increase in excess reserves in the banking system. The second question relates to the concern about how the Federal Reserve will reverse out all of the reserves that it pumped into the banking system last fall. Let’s look at both in turn.
Federal Reserve Bank Credit has increased by $1.2 trillion since just before the financial meltdown in September 2008. What has increased the most in the banking system? Excess reserves in the commercial banking system have risen by about $800 billion. Excess reserves in the WHOLE banking system had run about $2 billion before September 2008. Something unprecedented obviously took place!
In terms of policy making the creation of TARP and the response of the Federal Reserve are closely tied together. (See my post of November 16, 2008, “The Bailout Plan: Did Bernanke Panic?: http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic.) As mentioned above, the first round of TARP was released in October. But, the Federal Reserve could not wait. It began pumping reserves into the banking system in the latter part of September increasing Reserve Bank Credit outstanding from about $890 billion on September 10, 2008 to $1.5 trillion on October 8, $1.9 trillion on October 29, and $2.2 trillion on November 19.
In all this action, what happened to reserve balances at the Federal Reserve? They went from around $8 billion on September 10, to $175 billion, to $420 billion, to $624 billion, respectively, on the same dates as above. Excess reserves in the banking system averaged $2 billion in August, $60 billion in September, $268 billion in October, $559 billion in November, and $767 billion in December.
Excess reserves in the banking system averaged $844 billion in May and are averaging around $800 in June. Clearly a lot of money!
The question is “Why are the banks sitting on such large amounts of basically idle cash?”
My response is that they are sitting on this cash because it is connected with the receipt of TARP monies and the banks are hoping, as some of the larger and stronger institutions have done, to repay the funds as soon as possible.
Let’s look a little closer at the data. I am using information from the H.8 release put out by the Federal Reserve System on assets and liabilities of all commercial banks in the United States. Year-over-year, through May 2009, total assets in the banking system increased by 9.7% or about $1.1 trillion. Cash assets in the banking system increased a whopping $731 billion or at a year-over-year rate of 236%. This is comparable to the year-over-year increase in excess reserves observed on the H.3 release of the Federal Reserve providing data on bank reserves.
Given my post of last June 15, 2009, “What Aren’t Banks Telling Us?”, (http://seekingalpha.com/article/143276-what-aren-t-banks-telling-us) I was interested in looking a little deeper into this information to see how these excess reserves were distributed within the banking system. Roughly the division is this. The increase in cash assets at large commercial banks was $371billion, at small banks the increase was $143 billion, and at Foreign-related Institutions in the United States, $217 billion. The increase at the larger institutions, the large banks and the foreign-related institutions, was $588 billion and this represented the immediate problem to the policy makers. The problems of the smaller banks could be dealt with later.
The reason I am interested in looking into this distribution is the claim made in the above-mentioned post that commercial banks had not been fully open with the public on the problems they were still facing. In that post I mentioned three areas of concern: the bad assets now on the books of the banks; the anticipated increase in the bad assets in the upcoming months; and finally, the needs of the banks to be able to fund themselves in the future in the face of liabilities that were maturing and would not be rolled over. The build up in cash assets, it was argued, was a precaution the banks were taking to handle the uncertainty they faced as either asset values fell or a run off of liabilities forced the banks to dispose of assets.
Here is where the TARP money comes into play. If TARP money went into preferred stock and warrants, then these monies could be used to provide capital to the banks as the banks needed to write off bad loans and securities. The stock could even be converted into capital if the funds were needed to keep the banks solvent. Otherwise the banks could use the TARP funds to pay off maturing debt that could not be rolled over in the financial markets. (See Gretchen Morgenson, “Debts Coming Due At The Wrong Time,”
http://www.nytimes.com/2009/06/14/business/14gret.html?_r=1&scp=1&sq=gretchen%20morgenson/June%2014,%202009&st=cse.) Thus, monetizing the TARP debt makes a lot of sense in that it helps to protect the banking system from either bad assets that have to be written off or from financing problems resulting from the inability of the banks to roll over maturing liabilities.
What does this have to do with the Federal Reserve being able to unwind all the Reserve Bank Credit that it has pumped into the system? Well, when the banking system gets its act in order and charges off the loans and securities that it needs to and when its refinancing needs are satisfied, banks can then repay the TARP money to the Treasury as have the large financial institutions that have already repaid the TARP funds that they received. And, as the TARP monies are repaid, Reserve Bank Credit will decline so as to reduce the concern over the Fed monetizing the federal deficit.
Nice trick! The policy makers have provided a net under the banking system if the situation gets too bad in order to protect it against things falling apart and parallelizing the financial system. And, they have built into the system the means of reducing reserves as the financial system strengthens so as to avoid concerns over possible future inflation.
One final question: have the actions of the Federal Reserve had any impact on bank lending? The answer is “Not Really!” Year-over-year, loans and leases at all commercial banks increased by a tepid $182 billion or at a 2.6% annual rate. And, where were these increases located? Generally in home equity loans, consumer loans, and other residential loans (primarily mortgages) satisfying consumers needs for ready cash through consumer credit or the refinancing of homes. And, these loans were pretty evenly spread throughout the banking system.
Bottom line, however, is that the banks aren’t lending! Especially in the areas of commercial and industrial loans and commercial mortgages. Does that tell you something?
Monday, April 13, 2009
Are Banks Telling the Truth?
On the front page of the Financial Times this morning we read the disconcerting headlines, “’Tarp cop’ to investigate whether banks have ‘cooked their books.’” (See http://www.ft.com/cms/s/0/163c85c4-2789-11de-9b77-00144feabdc0.html.) Neil Barofsky, special investigator-general for the Troubled Asset Relief Program (TARP), is “seeking evidence of wrongdoing on the part of banks receiving help from the fund.”
The game—“institutions applying for TARP money had to show they were fundamentally sound, potentially prompting them to misstate assets and liabilities.” Barofsky is quoted as saying, “I hope we don’t find a single bank that’s cooked its books to try to get money but I don’t think that’s going to be the case.”
Mr. Barofsky also said the Treasury’s expanded Term Asset-Backed Securities Loan Facility (TALF) was ripe for fraud.
The potential—fraudsters would be receiving indictments!
Two thoughts cross my mind when reading this. First, bankers in deteriorating situations tend to hide their heads in the sand when it comes to bad assets because they keep hoping that things will get better and the assets will recover their value. Having (successfully) completed several bank turnarounds I have found that this is one of the first things that becomes obvious when you initially investigate the loans and other assets of a troubled institution. Bankers, lenders, or portfolio managers continually think that ‘the economy will turn around’ or that ‘the company is getting its act in order’ or that some other event will come along that will result in the ‘asset gone bad’ becoming the ‘asset has become good again.’ And, so the asset is carried along but never comes back to life.
The problem with this is that these bad assets continually undermine the ability of the financial institution to right itself and become profitable again. The example is always there on the books of the banks and whether the executives or officers admit the fact, internally they know that things are not right and this drains efforts to instill a healthy culture to “do the right thing.” Managements that allow this unhealthy culture to continue are just perpetrating a bad situation, one that very rarely ever turns itself around.
The managements that participate in such a charade tend to be desperate and susceptible to moving to the next step when they are thrown a life boat like many financial institutions received in the past nine months or so.
Before following up on this point, let me just say that, historically, the bank either brings in someone to turn the institution around, or, a regulatory agency steps in and dissolves the organization. The American banking system has worked very well in the past with respect to “sick” banks. Contagion has been avoided through quick action connected with the swift resolution of problem assets. Financial institutions that were in trouble were taken care of—period!
But, that is not the case in the current situation. We have had a bailout. The banks have been tossed a life boat. However, financial institutions were supposed to be “fundamentally sound” in order to obtain TARP money. Here we get into the muddy waters of conducting a “general” bailout.
Let me just say that I have been suspicious from the start when government officials claimed that the need for the TARP funds was because the banks were facing “a liquidity problem” with respect to their troubled assets.
Again, my experience in doing bank turnaround’s is that the officers of the bank that claimed their assets were in trouble because of liquidity problems were attempting to cover up the real difficulties connected with the assets which were almost always associated with the issue of solvency.
It would not be much of a surprise to me to hear that the banks justified to the government that they were “fundamentally sound” because their asset problems were associated with liquidity issues rather than ones of solvency. This assessment could perhaps be supported if government officials only took a cursory glance at the assets. But, one could argue that this is the conclusion that government officials wanted to hear at that time.
Is this fraud? That is what Mr. Barofsky is going to have to find out.
Other than outright “cooking of the books”, in many cases the distinction between liquidity and solvency may fall back on an argument about “judgment”, about the “eye of the beholder.” Thus, Mr. Barofsky is going to have his problems proving his case.
In my opinion, many of the banks that received bailout relief had and still have a solvency problem and until the situation is handled that way the dislocations associated with the banking industry and the financial markets are going to continue. Consequently, I believe that Mr. Barofsky and others are going to find evidence that all along the issue has been solvency and not liquidity. If so, then there is a real issue of whether or not that these institutions that received TARP money were “fundamentally sound.”
My second thought on this issue is a very simple one. If people inside the banks covered up the real issues related to solvency heads should roll. Those that committed fraud should be indicted! Those that knowingly misled should be dismissed!
And, top executives, even though they were not directly involved in fraud or in a cover up, should be removed from their positions as well. They have proven that they cannot manage their institutions with sufficient control to justify their ability to move those institutions on into the future. The “buck stops with the top position” and the argument that they didn’t know what was going on is insufficient. It was their responsibility to know what was going on!
Risk management, the other “bug-in-the-coffee”, and financial control are not glamorous pursuits, especially when compared with the “jet pilots” of finance that were tossing around all sorts of money chasing narrow spreads with lots and lots of leverage. Performance over time, however, is closely related to an institution’s ability to successfully exert risk management and financial control.
We have to know what is going on in the banks and other financial institutions. The pressure needs to be stepped up to find out where things are. And, the sooner this pressure is exerted the sooner we will be able to find ways out of the mess we are in.
And this brings me to one final point. The Financial Times also had another headline on its front page that I found disturbing. The article cried out “AIG in derivatives spotlight.” (See http://www.ft.com/cms/s/0/cb2ddafc-278c-11de-9b77-00144feabdc0.html.) “The unit that all but destroyed AIG has failed to sign up for the overhaul of the global derivatives market, which was given added impetus by the troubles at the US insurance group.” The government is involved with AIG—the government owns most of AIG. It is mind boggling to me that a government that supposedly wants to bring greater openness and transparency to the financial markets allowed this to happen!
The game—“institutions applying for TARP money had to show they were fundamentally sound, potentially prompting them to misstate assets and liabilities.” Barofsky is quoted as saying, “I hope we don’t find a single bank that’s cooked its books to try to get money but I don’t think that’s going to be the case.”
Mr. Barofsky also said the Treasury’s expanded Term Asset-Backed Securities Loan Facility (TALF) was ripe for fraud.
The potential—fraudsters would be receiving indictments!
Two thoughts cross my mind when reading this. First, bankers in deteriorating situations tend to hide their heads in the sand when it comes to bad assets because they keep hoping that things will get better and the assets will recover their value. Having (successfully) completed several bank turnarounds I have found that this is one of the first things that becomes obvious when you initially investigate the loans and other assets of a troubled institution. Bankers, lenders, or portfolio managers continually think that ‘the economy will turn around’ or that ‘the company is getting its act in order’ or that some other event will come along that will result in the ‘asset gone bad’ becoming the ‘asset has become good again.’ And, so the asset is carried along but never comes back to life.
The problem with this is that these bad assets continually undermine the ability of the financial institution to right itself and become profitable again. The example is always there on the books of the banks and whether the executives or officers admit the fact, internally they know that things are not right and this drains efforts to instill a healthy culture to “do the right thing.” Managements that allow this unhealthy culture to continue are just perpetrating a bad situation, one that very rarely ever turns itself around.
The managements that participate in such a charade tend to be desperate and susceptible to moving to the next step when they are thrown a life boat like many financial institutions received in the past nine months or so.
Before following up on this point, let me just say that, historically, the bank either brings in someone to turn the institution around, or, a regulatory agency steps in and dissolves the organization. The American banking system has worked very well in the past with respect to “sick” banks. Contagion has been avoided through quick action connected with the swift resolution of problem assets. Financial institutions that were in trouble were taken care of—period!
But, that is not the case in the current situation. We have had a bailout. The banks have been tossed a life boat. However, financial institutions were supposed to be “fundamentally sound” in order to obtain TARP money. Here we get into the muddy waters of conducting a “general” bailout.
Let me just say that I have been suspicious from the start when government officials claimed that the need for the TARP funds was because the banks were facing “a liquidity problem” with respect to their troubled assets.
Again, my experience in doing bank turnaround’s is that the officers of the bank that claimed their assets were in trouble because of liquidity problems were attempting to cover up the real difficulties connected with the assets which were almost always associated with the issue of solvency.
It would not be much of a surprise to me to hear that the banks justified to the government that they were “fundamentally sound” because their asset problems were associated with liquidity issues rather than ones of solvency. This assessment could perhaps be supported if government officials only took a cursory glance at the assets. But, one could argue that this is the conclusion that government officials wanted to hear at that time.
Is this fraud? That is what Mr. Barofsky is going to have to find out.
Other than outright “cooking of the books”, in many cases the distinction between liquidity and solvency may fall back on an argument about “judgment”, about the “eye of the beholder.” Thus, Mr. Barofsky is going to have his problems proving his case.
In my opinion, many of the banks that received bailout relief had and still have a solvency problem and until the situation is handled that way the dislocations associated with the banking industry and the financial markets are going to continue. Consequently, I believe that Mr. Barofsky and others are going to find evidence that all along the issue has been solvency and not liquidity. If so, then there is a real issue of whether or not that these institutions that received TARP money were “fundamentally sound.”
My second thought on this issue is a very simple one. If people inside the banks covered up the real issues related to solvency heads should roll. Those that committed fraud should be indicted! Those that knowingly misled should be dismissed!
And, top executives, even though they were not directly involved in fraud or in a cover up, should be removed from their positions as well. They have proven that they cannot manage their institutions with sufficient control to justify their ability to move those institutions on into the future. The “buck stops with the top position” and the argument that they didn’t know what was going on is insufficient. It was their responsibility to know what was going on!
Risk management, the other “bug-in-the-coffee”, and financial control are not glamorous pursuits, especially when compared with the “jet pilots” of finance that were tossing around all sorts of money chasing narrow spreads with lots and lots of leverage. Performance over time, however, is closely related to an institution’s ability to successfully exert risk management and financial control.
We have to know what is going on in the banks and other financial institutions. The pressure needs to be stepped up to find out where things are. And, the sooner this pressure is exerted the sooner we will be able to find ways out of the mess we are in.
And this brings me to one final point. The Financial Times also had another headline on its front page that I found disturbing. The article cried out “AIG in derivatives spotlight.” (See http://www.ft.com/cms/s/0/cb2ddafc-278c-11de-9b77-00144feabdc0.html.) “The unit that all but destroyed AIG has failed to sign up for the overhaul of the global derivatives market, which was given added impetus by the troubles at the US insurance group.” The government is involved with AIG—the government owns most of AIG. It is mind boggling to me that a government that supposedly wants to bring greater openness and transparency to the financial markets allowed this to happen!
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