NPR's This American Life came out with the latest installment of their absolutely excellent series about the ongoing US and global financial crisis. Listen and enjoy this latest episode, entitled "Bad Bank."
Here's a cheat sheet on the crisis…
––25% of all the $$$ in the global banking system is held by CitiGroup and Bank of America
-90% of all the $$$ in the global banking system is concentrated in just 20 banks. (See "Too Big to Fail")
-If one of these major banks collapses and runs out of money, it will set off a deadly chain reaction (aka Domino Effect) of bank failures and destroy the world economy. (See "Credit Crunch") Why? Because businesses everywhere need cash to stay alive and who holds their cash? Banks! Since cash is to a business as oxygen is to the human body, when they run out of cash, they die. Banking Collapse = Mass Business Death.
-Reality: CitiGroup and BofA are currently insolvent, i.e. they owe more money than they're worth. They should be dead. However, to prevent the domino effect and subsequent economic collapse that their death would cause, the US government is giving them billions of dollars. (See "Bailout")
-The real debate is whether the government should:
a) buy just the mortgages, credit default swaps, and collateralized debt obligations (see "toxic assets") that have collapsed in value over the last year and a half from the major banks and let them go on their merry way (see "Bad Bank"); or
b) actually invest in the insolvent banks themselves, exchanging cash for ownership and say in how the bank is managed (see "Nationalization").
End goal in either scenario: Give the banks cash. Make them solvent.
-Why a Bad Bank?
a) You believe that the so-called "toxic assets" (mostly home mortgages and their derivative financial products) are actually decent investments whose price will rise again at some point in the future
b) You own stock in an insolvent bank and don't want to lose all your money.
c) You think "nationalization" is a dirty word
a) You think it's unwise to buy mortgage-related "toxic assets" because they're probably still overvalued
b) You're a taxpayer
c) You think that the owners of a business (i.e. stockholders) that makes really bad decisions should actually have to suffer the consequences of said decisions and not receive a windfall from the US taxpayer
d) If the we were someone other than the
United States of America, the International Monetary Fund would step in, tell us to stop whining and (temporarily) nationalize the banking system
In truth, both options suck, but that's where we are. I say we nationalize the banks for a bit then sell them back to the public when the time is right. This graph explains why "toxic assets" are in fact clear losers, courtesy of Robert Shiller and the New York Times:
As you'll notice, housing prices are still inflated! These mortgages and the financial goodies derived from them ain't gonna go up in value anytime soon unless we have another bubble. Thus, the Bad Bank idea = a Bad Deal for the taxpayers. Ironically, this idea––favored, shockingly, by the banks––is premised on the idea that the "efficient market hypothesis" that wrote about yesterday is NOT true, that the market is fundamentally under-valuing the US housing stock. Hmm…
Why? Because, the US govt would be buying these "toxic assets" at price above the current market value. Yes, that's right, the US government would be paying a special premium to private US banks billions of dollars for the right to buy "toxic assets" at a price no private investor in their right mind would pay. This, my friends, is insane, especially since housing prices are still inflated (and falling) relative to their long run average value. (See the chart above.)
At this point, we've got no good options. Nationalization, it seems, is just the least bad option.
Want more info? Listen to NPR's award-winning This American Life explain the Financial Crisis!
The Giant Pool of Money May 2008
Another Frightening Show About the Economy October 2008