Noted Economist Nouriel Roubini's opinion and advice on the Wall Street bailout

Is Purchasing $700 billion of Toxic Assets the Best Way to Recapitalize the Financial System? No! It is Rather a Disgrace and Rip-Off Benefitting only the Shareholders and Unsecured Creditors of Banks

Nouriel Roubini | Sep 28, 2008

Whenever there is a systemic banking crisis there is a need to recapitalize the banking/financial system to avoid an excessive and destructive credit contraction. But purchasing toxic/illiquid assets of the financial system is not the most effective and efficient way to recapitalize the banking system. Such recapitalization – via the use of public resources – can occur in a number of alternative ways: purchase of bad assets/loans; government injection of preferred shares; government injection of common shares; government purchase of subordinated debt; government issuance of government bonds to be placed on the banks’ balance sheet; government injection of cash; government credit lines extended to the banks; government assumption of government liabilities.

A recent IMF study of 42 systemic banking crises across the world provides evidence on how different crises were resolved. First of all only in 32 of the 42 cases there was government financial intervention of any sort; in 10 cases systemic banking crises were resolved without any government financial intervention. Of the 32 cases where the government recapitalized the banking system only seven included a program of purchase of bad assets/loans (like the one proposed by the US Treasury). In 25 other cases there was no government purchase of such toxic assets. In 6 cases the government purchased preferred shares; in 4 cases the government purchased common shares; in 11 cases the government purchased subordinated debt; in 12 cases the government injected cash in the banks; in 2 cases credit was extended to the banks; and in 3 cases the government assumed bank liabilities. Even in cases where bad assets were purchased – as in Chile – dividends were suspended and all profits and recoveries had to be used to repurchase the bad assets. Of course in most cases multiple forms of government recapitalization of banks were used.

But government purchase of bad assets was the exception rather than the rule. It was used only in Mexico, Japan, Bolivia, Czech Republic, Jamaica, Malaysia, and Paraguay. Even in six of these seven cases where the recapitalization of banks occurred via the government purchase of bad assets such recapitalization was a combination of purchase of bad assets together with other forms of recapitalization (such as government purchase of preferred shares or subordinated debt).

In the Scandinavian banking crises (Sweden, Norway, Finland) that are a model of how a banking crisis should be resolved there was not government purchase of bad assets; most of the recapitalization occurred through various injections of public capital in the banking system. Purchase of toxic assets instead – in most cases in which it was used – made the fiscal cost of the crisis much higher and expensive (as in Japan and Mexico).

Thus the claim by the Fed and Treasury that spending $700 billion of public money is the best way to recapitalize banks has absolutely no factual basis or justification. This way of recapitalizing financial institutions is a total rip-off that will mostly benefit – at a huge expense for the US taxpayer - the common and preferred shareholders and even unsecured creditors of the banks. Even the late addition of some warrants that the government will get in exchange of this massive injection of public money is only a cosmetic fig leaf of dubious value as the form and size of such warrants is totally vague and fuzzy.

So this rescue plan is a huge and massive bailout of the shareholders and the unsecured creditors of the financial firms (not just banks but also other non bank financial institutions); with $700 billion of taxpayer money the pockets of reckless bankers and investors have been made fatter under the fake argument that bailing out Wall Street was necessary to rescue Main Street from a severe recession. Instead, the restoration of the financial health of distressed financial firms could have been achieved with a cheaper and better use of public money.

Indeed, the plan also does not address the need to recapitalize those financial institutions that are badly undercapitalized: this could have been achieved by using some of the $700 billion to inject public funds in ways other and more effective than a purchase of toxic assets: via public injections of preferred shares into these firms; via required matching injections of Tier 1 capital by current shareholders to make sure that such shareholders take first tier loss in the presence of public recapitalization; via suspension of dividends payments; via a conversion of some of the unsecured debt into equity (a debt for equity swap). All these actions would have implied a much lower fiscal costs for the government as they would have forced the shareholders and creditors of the banks to contribute to the recapitalization of the banks. So less than $700 billion of public money could have been spent if the private shareholders and creditors had been forced to contribute to the recapitalization; and whatever the size of the public contribution were to be its distribution between purchases of bad assets and more efficient and fair forms of recapitalization (preferred shares, common shares, sub debt) should have been different. For example if the private sector had done its fair matching share only $350 billion of public money could have been used; and of this $350 billion half could have taken the form of purchase of bad assets and the other half should have taken the form of injection of public capital in these financial institutions. So instead of purchasing – most likely at an excessive price - $700 billion of toxic assets the government could have achieved the same result – or a better result of recapitalizing the banks – by spending only $175 billion in the direct purchase of toxic assets. And even after the government will waste $700 billion buying toxic assets many banks that have not yet provisioned for such losses/writedowns will be even more undercapitalized than before. So this plan does not even achieve the basic objective of recapitalizing undercapitalized banks.

The Treasury plan also does not explicitly include an HOLC-style program to reduce across the board the debt burden of the distressed household sector; without such a component the debt overhang of the household sector will continue to depress consumption spending and will exacerbate the current economic recession.

Thus, the Treasury plan is a disgrace: a bailout of reckless bankers, lenders and investors that provides little direct debt relief to borrowers and financially stressed households and that will come at a very high cost to the US taxpayer. And the plan does nothing to resolve the severe stress in money markets and interbank markets that are now close to a systemic meltdown. It is pathetic that Congress did not consult any of the many professional economists that have presented - many on the RGE Monitor Finance blog forum - alternative plans that were more fair and efficient and less costly ways to resolve this crisis. This is again a case of privatizing the gains and socializing the losses; a bailout and socialism for the rich, the well-connected and Wall Street. And it is a scandal that even Congressional Democrats have fallen for this Treasury scam that does little to resolve the debt burden of millions of distressed home owners.
[link to www.rgemonitor.com]

The credit default swap market is the real problem. And there is absolutely nothing that they can do to fix it...waaaaay beyond their control.

The US and global financial crisis is becoming much more severe in spite of the Treasury rescue plan. The risk of a total systemic meltdown is now as high as ever

Nouriel Roubini | Sep 29, 2008

It is obvious that the current financial crisis is becoming more severe in spite of the Treasury rescue plan (or maybe because of it as this plan it totally flawed). The severe strains in financial markets (money markets, credit markets, stock markets, CDS and derivative markets) are becoming more severe rather than less severe in spite of the nuclear option (after the Fannie and Freddie $200 billion bazooka bailout failed to restore confidence) of a $700 billion package: interbank spreads are widening (TED spread, swap spreads, Libo-OIS spread) and are at level never seen before; credit spreads (such as junk bond yield spreads relative to Treasuries are widening to new peaks; short-term Treasury yields are going back to near zero levels as there is flight to safety; CDS spread for financial institutions are rising to extreme levels (Morgan Stanley ones at 1200 last week) as the ban on shorting of financial stock has moved the pressures on financial firms to the CDS market; and stock markets around the world have reacted very negatively to this rescue package (US market are down about 3% this morning at their opening).

We need a new HOLC - more than a new RTC or RFC- to provide massive debt relief to the household sector. We need to create the HOME (Home Owners’ Mortgage Enterprise)

Nouriel Roubini | Sep 19, 2008

In the last two weeks financial markets reached near panic conditions with almost every day another major financial institution on the verge of collapse (first Fannie and Freddie, then Lehman, then Merrill, then AIG and now Morgan Stanley, Goldman Sachs, WaMu, Wachovia and other banks under pressure), money markets seizing up and interbank spreads spiking like never before, Treasury bills yields plummeting as investors were seeking the safety of near cash instruments, credit spreads surging and stock markets tumbling on Monday and Wednesday. Even the Washington policy makers finally realized that this is the worst financial crisis since the Great Depression and that their ad hoc step-by-step and unsystematic approach to resolving this crisis was not working and the effect of ad hoc and band-aid policies in boosting market confidence was fizzling out. Indeed , after the March bailout of Bear Stearns markets rallied for two months; after the July announcement that Fannie and Freddie may be rescued markets rallied for three weeks; after the announcement of the actual bailout of Fannie and Freddie last week markets rallied for only one day on Monday and went into a tailspin starting on Tuesday with the worries about Lehman and other broker dealers; and after the bailout of AIG stock markets did not even rally: actually they tumbled almost 5% on Wednesday while money markets and credit markets went into a total seizure.

So by Wednesday this week as markets were in total panic (stock prices collapsing, interbank spread surging to levels never seen before, credit spreads reaching new highs and Treasury bill rates practically down to zero as investors rushed to safety) the policy authorities decided that something more radical – that many of us had advocated for a long time – needed to be done. The most important policy action is not the decision of extending the swap lines between central banks (so as to provide dollar liquidity to non-US banks abroad); it is not the re-imposition of limits to short sales (a policy action that is itself a naked attempt to manipulate upward stock prices); it is rather the realization that a generalized debt and solvency problem required a solution that leads to significant debt reduction.

BBC Hardtalk Interview with Roubini: “US Bail-Out Special”
Nouriel Roubini | Oct 1, 2008
US bail-out special

In a HARD talk programme broadcast on 1 October, Stephen Sackur talks to economist Nouriel Roubini and journalist Oliver Kamm about the current economic crisis.

[link to www.bbc.co.uk]

The US House of Representatives' rejection of a $700 billion plan aimed at bailing out Wall Street sent markets plummeting.

None of this is a surprise to critics like economist Professor Nouriel Roubini from New York University.

Roubini predicted the current crisis back in 2006.

He thinks US Treasury Secretary Henry Paulson's rescue package is too late -- and furthermore, it's "totally flawed".

In a special programme, Professor Roubini joins Times columnist Oliver Kamm in the HardTalk studio.

Stephen Sackur asks them if we really are heading for another Great Depression.

[link to www.rgemonitor.com]

CDS is screwed big guys will fall the hardest thus the 700 billion payout from tax payers.