The Unspoken Macro of the Citibank Saga

I’m writing this because it’s how it is and I haven’t seen it written elsewhere.

Let’s assume, for simplicity of the math, Citibank pre crisis had $100 billion private capital, $900 billion in FDIC insured deposits, and $1trillion in loans (assets), which is a capital ratio of 10%. (The sub debt is part of capital. And notice this makes banks public/private partnerships, 10% private and 90% public. Ring a bell?)

This means once Citibank loses more than $100 billion, the FDIC has to write the check for any and all losses.
So if all the remaining loans go bad and become worthless, the FDIC writes the check for the entire $900 billion.

Then the crisis hits, and, again for simplicity of the math, lets assume Citibank has to realize $50 billion in losses. Now their private capital is down to only $50 billion from the original $100 billion.

This drops Citibank’s capital ratio to just over 5%, as they now have only $50 billion in private capital and 950 billion in loan value remaining as assets. So now if Citibank loses only $50 billion more the FDIC has to start writing checks, up to the same max of $900 billion.

But now Citibank’s capital ratio is below the prescribed legal limit. The FDIC needs a larger amount of private capital to give it a larger cushion against possible future losses before it has to write the check. So it’s supposed to declare Citibank insolvent, take it over, reorganize it, sell it, liquidate the pieces, etc. as it sees fit under current banking law. But the Congress and the administration don’t want that to happen, so Treasury Secretary Paulson comes up with a plan. The Treasury, under the proposed TARP program, will ‘inject’ $50 billion of capital in various forms, with punitive terms and conditions, into Citibank to restore its 10% capital ratio.

So Obama flies in, McCain flies in, they have the votes, they don’t have the votes, the Dow is moving hundreds of a points up and down with the possible vote, millions are losing their jobs as America heads for the sidelines to see if Congress can save the world. Finally the TARP passes, hundreds of billions of dollars are approved and added to the federal deficit, with everyone believing we are borrowing the funds from China for our grand children to pay back. And the Treasury bought $50 billion in Citibank stock, with punitive terms and conditions, to restore their capital ratio and save the world.

So then how does Citibank’s capital structure look? They still have the same $50 billion in capital which takes any additional losses first. Then, should additional losses exceed that $50 billion, the Treasury starts writing checks, instead of the FDIC. What’s the difference??? It’s all government, and the FDIC is legally backstopped by the treasury, and taxes banks to try to stay in the black. (riddle, what begins with g and is authorized to tax?)

57 Responses

  1. What would be the alternate solutions (except shutting Citibank down)? Relaxing the capital ratio?

  2. Yes, they should have just allowed them to run with lower capital with the same terms and conditions they set on the TARP funds if that’s what they wanted to accomplish.

    Not easy to say just what they were trying to accomplish.

  3. The difference is, Paulson’s corporate welfare plan left in place the management that ran Citibank into the ground, the FDIC wouldn’t have been so benevolent. The TARP bill should have used to fund the FDIC. Instead, it overrode the “prompt corrective action” law that Bill Black has mentioned repeatedly.—o000-.html

    I just read Mark Halperin’s and John Heilemann’s new campaign book, Game Change. Chapter 21, September Surprise, is all about how the campaigns dealt with the ultimate campaign game changer. McCain was actually up in the polls till Lehman declared Chapter 11 on Sept. 15. He was blindsided by the news and his campaign never recovered (it didn’t help that his chief economic adviser, Douglas Holz-Eakin, was giving him Hoover-league advice, “not to talk down the economy… its underlying strength its workers, its factories was intact.”).

    its a pity none of the money guys of either party went to their campaign’s management team with the Mosler Plan (or if they did, I’m wondering if Warren’s heard any feedback of the response they got).

  4. I think part of the problem was the perceived impossibility of doing a normal FDIC liquidation on someplace like Citi or BofA. I remember seeing on 60 Minutes last year a story where they follwed the FDIC as it closed some little podunk bank with 3 or 4 branches – they had a huge number of staff who went to every branch simultaneously, walked the employees in to count all the money and go over the books, etc. etc. If you think about trying to do the same thing with a Bank with thousnads of branches, you see that it would be immpossible to organize.

    The question I have: is such a massive operation really necessary? Why can’t the FDIC just show up at BofA HQ, declare that it now belongs to the government, the current senior managers are fired, and declare that operations will continue to run as before until decided otherwise? Sure, it would be a mess and some things would probably be lost in the shuffle, but why the need for one fell swoop?

    1. Exactly, replace the board of directors and CEO with a FDIC-appointed team and leave the rest of the bank staff in place.

      Send an FBI agent into every department and branch for just long enough to explain to every bank officer and branch manager that they were personally responsible for providing accurate reports to the (federally appointed) CEO. They would be immune from any prosecution if they answered truthfully, but if FDIC auditors discovered they had not… they would be prosecuted under the Martha Stewart law (providing false information to a federal official is punishable by 5 year in prison). FBI agent goes back to his office, leaving the branch manager feeling very motivated to provide accurate data.

      1. Actually, this would give every branch manager motivation to secure another place of employment.

      2. JCD, fair point, if they had other employment options. The downside of a systemic bank crash is that the FDIC can’t grow fast enough to provide staff for every failed bank. The upside of a systemic bank crash is… its not like the current bank employees are going anywhere.

        Other than the FDIC itself, can’t imagine many employers in banking were looking to hire anyone in the fall of 200

      3. Well, the possibility of prosecution is a real deterrent for continuing to work at a job. Even if you really need that paycheck, you’re probably only going to do that which is necessary to keep the job and stay clear of the law. I wouldn’t expect many branch managers to be too excited about making new loans, hiring or firing, or making any other decisions that could get them in trouble.

        And as soon as they found another job, I would expect them to be gone.

        I think you have to be realistic, and understand that a government owned and run bank is unlikely to either serve the public good, or be profitable.

        Finally, out of curiosity, are you imagining FBI agents sitting in Citibank’s branches in London, Dubai, and Shanghai?

      4. I wouldn’t want or expect the bank to publically run for very long. But the current model for the FDIC seems to be a sort of “big bang” which seizes the bank and divvies up the assets virtually simultaneously, with no intervening government ownership. I just think a few months of “status quo” ownership while an orderly selloff takes place would not be the end of the world.

        But then again, seeing how quickly our Distinguished Congressmen started strongarming GM with every odd piece of political hackery after it was bailed out, maybe a few months would be too much…

      5. The current model for the FDIC is to try to sell the bank to another buyer. The FDIC juices the deal by letting the buyer cherry pick the assets (eg performing loans only) or by writing loss sharing agreements that leave the major liability for poorly performing assets with the FDIC, while the buyer holds on to any upside.

        They rarely seize the bank outright (shut branches, mail checks to depositors) because even poorly run banks are usually worth more as going concerns. This is because most banks would gladly assume the deposit liabilities of another bank for less than their face value in cash.

      6. Jim, what might you are you referring to specifically?

        But then again, seeing how quickly our Distinguished Congressmen started strongarming GM with every odd piece of political hackery after it was bailed out, maybe a few months would be too much…

      7. For JCD,
        this here bank near me was recently closed and I noticed that FDIC let people transfer for 30 days and then sent checks if someone had not transfered at the end of that period. I had never seen this done before, as you say they usually find a buyer, in this case they did not.

      8. Yup, that’s what it looks like when they fail to find a buyer.

        Keep in mind that they won’t sell to just anyone, because when you buy the bank, you get a banking license. They can’t let just anyone buy that.

        So because they have a very narrow market to sell to, they get a bad price, or sometimes just close the whole thing down.

      9. Tom –

        I was thinking especially of all the calls congressmen were making to GM’s new management on behalf of the dealers in their districts that were to be closed down (and that should have been closed down years before).

        I’m no Randite know-nothing, but I am extremely leary of decisions over who gets what loans being determined by who is politically favored (and ultimately that’s what would happen in a public bank, no matter what firewalls were in place). It starts to look an awful lot like fascism.

      10. Jim, fascism is statism of the right, and communism is statism of the left. The US is very close to corporate statism presently and that has me concerned.

        This is due largely to the costs associated with political campaigns, which necessitate politicians to be fundraisers first and foremost if they wish to win elections, and the big contributions come from large corporations, wealthy donors, and their lobbyists. Add to this the revolving door between business, lobbying, and government and the result is capture of the apparatus of the state by money and influence — a plutocratic oligarchy based on cronyism.

        To the degree that this is directed toward nationalistic goals it approaches fascism. In my view, the so-called global war on terror was a thinly veiled facade for this, which the Obama administration seems to have assumed. Of course, it didn’t begin with G. W. Bush. I was radicalized during my service as a naval officer during the Vietnam era, when I realized what was really going on.

        But as far as congress people making calls goes, that’s the least of it. Now, habeas corpus is gone, anyone can be disappeared by dictate, torture is OK, and so on. The financial industry is a crime scene and no one is being held to accounting. The list goes on. Especially concerning is the push to replace a civilian defense a professional military and then to substitute a mercenary force run by corporations. It’s pretty easy to see where that is heading if it isn’t stopped.

        The Tea Party is protesting “socialism” while the corporate state solidifies its grip on the country. The protestors have it backwards.

        The political issue is how to apportion real resources between the public and private sectors, so that the private sector can see growth and the public sector can promote public purpose and the general welfare. Presently, the upper echelon of the private sector is controlling and manipulating the debate in its interests and influencing both elections and government, and thereby domestic and foreign policy.

        This arrangement is essentially parasitic. It is inefficient, ineffective, unsustainable, non-consiilient, and disintegrative for society and the individuals that constitute it. It may benefit a particular group for a while, but in the longer run, all are harmed by loss of opportunity that undercuts security and prosperity, both nationally and globally.

  5. Warren,

    I’m writing this because it’s how it is and I haven’t seen it written elsewhere.

    You haven’t seen this line of reasoning elsewhere because that’s not how it is, and anyone with rudimentary balance sheet reading skills can detect the snowjob.

    To wit:

    Let’s assume, for simplicity of the math, Citibank pre crisis had $100 billion private capital, $900 billion in FDIC insured deposits, and $1trillion in loans (assets), which is a capital ratio of 10%.

    “Capital” is not something that appears on a balance sheet. For banks, regulatory capital is a numerical construct, not a balance sheet liability. Tier 1 capital is only equity and retained earnings. Tier 2 capital can contain sub. debt, but only 50% of sub. debt. counts towards tier 2 capital and most bank debt is not subordinated. This means that the majority of banks liabilities — 50% of sub. debt and 100% regular debt, are missing from your example. And yet these are the creditors at risk, and these are the ones being bailed out. By pretending that these creditors don’t exist, you are pulling a snowjob, arguing that it is only regulator forbearance, when in reality it is bondholders being made whole by the government.

    A simple bank balance sheet would look like this:

    10% Equity
    50% Bonds
    40% Deposits

    The government is on the hook for the 40% Deposits only, and in the case of Citi, less than this, as Citi has many overseas deposits that are not gov. insured. Gov. is not on the hook for anything else.

    This means that it is the role of bondholders to absorb the losses of banks once the 10% Equity is exhausted, and there are plenty of risk assets so that bank losses need not touch the FDIC insured deposits at all, even in the current crisis. The FDIC only steps in once Debt and Equity have both been set to zero.

    As an aside, the belief that FDIC guarantees bank bondholders is one that you’ve expressed numerous times before. Publicly going on the record arguing that 90% of bank’s liabilities are FDIC insured wont help your credibility.

    It would be good, for the record, if you stated that

    1) bonds are not “deposit accounts”, so that
    2) the FDIC insures deposit accounts and not bonds.
    3) FDIC insured instruments are typically about half or less of bank liabilities

    It would be even better if these principles were internalized.

    1. RSJ,
      Are the banks bonds the FDIC (via TLGP) is insuring cited in this article here a separate issue from what you are talking about here?

      “Bank of America Corp., Goldman Sachs Group Inc. and the financing arm of General Electric Co. led $29.8 billion of FDIC- backed bond sales since the meeting, making this the second- busiest week since companies began using the FDIC’s Temporary Liquidity Guarantee Program on Nov. 25, according to data compiled by Bloomberg.”


    2. Agreed, i was using number to keep the math simple.

      the ‘terms and conditions’ included protection for the bond holders who are senior to capital.

      The reasoning was probably that, in theory, the FDIC’s capital calculation indicated that there was value for the bond holders to have come out whole in a sale/liquidation scenario. bondholders are above the equity holders in the pecking order, but below the FDIC.

      If you go back on this site, i’ve said more than once that either the banks do have positive capital or the FDIC is wrong in its calculation for whatever reason. In fact some are still saying the banks are still insolvent due to mis marked positions which is again a statement that the FDIC is wrong.

      In any case, the FDIC acts as if it’s right as does the rest of govt. and moves on from there. and the investors putting in the new private capital probably feel the FDIC is understating capital, which is also very possible, as i’ve also mentioned before. In fact, there’s a pretty big ongoing scandal about WAMU being undervalued by some 30 billion, if i recall correctly? And the FDIC has my bank marking several of our securities well below market values, for example.

      Anyway, bond holders do count as ‘capital’ for FDIC protection as you stated. But the banks can, at any time, fund however much they want with FDIC insured deposits. They used bonds at the time (not the sub debt) due to lower all in costs of funds if, again, i recall correctly. The cost of raising large volumes of fdic insured deposits can be libor plus 100, for example.

      bottom line, tarp was regulatory forbearance with terms and condition, including terms and conditions for bond holders, which all could have been done with regulatory forbearance and not ‘spending tarp money’

      nor does using tarp money to fund the fdic make any sense. the fdic is already fully funded by tsy on an as needed basis. better to reinforce that notion than to pretend otherwise with with ‘special’ funding arrangements like tarp.

      1. Warren:

        When you say banks can fund themselves with FDIC-insured desposits whenever they want (assuming they will pay) do you mean brokered deposits?

      2. yes. and of course the fdic insured debt thing they created during the crisis which is an expedited version of the same thing.

        liquidity isn’t instant or cheap but it’s always there

      3. The issue is that the math is different. Imagine a simple bank:

        $100 loans | $10 Equity, $45 Debt, $45 deposits

        Suppose that the loans are actually worth $70. That bank can be placed into receivership, and the new balance sheet would be:

        $70 loans | $25 Debt, $45 Deposits

        Then, the bank could be sold off to new management:

        $70 loans | $7 equity | $18 Debt | $45 Deposits

        None of that requires that the government write a check for anything. But you are saying that as soon as the equity is exhausted the government writes a check — big difference. That is the point of your essay, but the point I am making is that the government is not on the hook for anything here — there is plenty of bank debt available to absorb all the bad loans, even if there isn’t plenty of regulatory capital. The government doesn’t need to write any checks, it needs to coordinate these types of operations, where coordinate means 1) force them to happen, and 2) provide coordination so that they happen in an orderly manner.

        Moreover, we have the legal authority to place every bank into receivership and perform this type of balance sheet surgery with the current framework. This is what we did with the automakers, btw.

  6. RSJ has a valid point.

    Also, even in a simplified capital structure, without non-capital debt, I’m sceptical that government capital injections equate to “regulatory forbearance”.

    The purpose of government capital injections is to provide additional capital support prior to an FDIC wind up event. It is illogical then for the loss of any of that newly injected capital to trigger such an event. If that’s the case, capital injections can only increase the loss cushion that if breached will trigger such a wind up event. Thus, the injected capital will be in addition to any alternative forbearance, not instead of it. That means the risk profile of the bank as a viable entity has changed. And that’s what ultimately attracts private capital.

  7. Matt: I think RSJ is talking about all the non-FDIC insured liability the banks are carrying. There was plenty of tis long before TLGP.

    JKH: If the regulatory rule is “any entity which falls below its required capital ratio is wound down” then there has certainly been plenty of regulatory forbearance recently! In this instance, public capital was put in first loss position before private capital (and yes, this would attract private capital). It also put the firm at its required capital ratio. Why do you think these two are so distinct?

  8. JCD: “I think you have to be realistic, and understand that a government owned and run bank is unlikely to either serve the public good, or be profitable.”

    Presently, there are a lot of people who don’t think so and are actively working for public banking.

    Here is an interesting quote from Bill MItchell on the subject embedded in a comment I made at billy blog here:

    The essence of a progressive agenda is reform, and where reforming an existing system is either impossible or impractical, replacement. This is what progressives should be pushing:

    Bill MItchell: …If we were to include the massive losses and public bailouts that were required to prevent the entire world financial system from collapsing then the risk-weighted returns would be negative by a long way. A public banking system can deliver financial stability and durable returns (social) with much less risk overall….

    It is grossly unfair for the Fed to target inflation using unemployment as a tool and to act as lender of last resort, when government does not act as employer of last resort and uses bank regulation and government intervention in markets to protect equity holders and bond holders from their own imprudence, not to mention a double standard in the application of the law. Moreover, the downside is not merely quantitative but also qualitative. This isn’t just about numbers, it’s about lives.

    Just as the preferred means of reforming healthcare is eliminating the inefficiency of the middleman through single-payer, e.g., Medicare-for-all, so too, reforming the financial system would be best accomplished by public banking and outlawing all financial activity that detracts from public purpose.
    The debate needs to be reframed. The burden should be on the private sector to show why and how it can provide for public utilities, such as health care and money creation, in a way that is more efficient and effective than public provision.

    The question is whether the country is going to have a government of the people, by the people, and for the people, or be ruled by plutocratic oligarchy in which an aristocracy of wealth and power is privileged.”

    Government is already massively involved in public necessities and utilities, including public education, healthcare (Medicare, Medicaid, VA, military), infrastructure, basic research, real estate (parks, public lands), insurance (FEMA, safety net), etc., and doing what the private sector is either unable or unwilling to do efficiently and effectively for a reward commensurate with the risk. As Bill Mitchell observes, when the true price of risk is figured in, private banking is not profitable either under the current framework if the role of the government as a backstop were to be compensated adequately or removed.

    When true cost is computed by including externalities, the picture looks very different for so-called free markets. Then, “free” becomes charge the externality to the public IAW the adage, “Privatize the gains and socialize the losses.” Time to refigure and renegotiate. Right now, the public is getting the short end of the stick in the name of “freedom and democracy” equated with laissez-faire.

    1. Over 100 years ago, many people thought public ownership and management of the k-12 education system would serve the public good, and be efficient. How’s that working out?

      Perhaps the solution to the inherent conflicts in banking as it is currently structured (a public-private partnership) would be best served by reducing government’s role, rather than increasing it. Without government standing by the banks with a shovel ready to bail them out, do you really believe they could get this big and this levered?

      1. Over 100 years ago, many people thought public ownership and management of the k-12 education system would serve the public good, and be efficient. How’s that working out?

        In middle class suburbs, it’s working just fine, like it generally has. The upper class has always had a private educational system of its own from nanny to PhD and always will. That’s not where the problems lie, and the problem is not reducible to government involvement. Do you think that there would be an enthusiastic response from the private sector to take over inner city schools to make a profit? Really?

        Perhaps the solution to the inherent conflicts in banking as it is currently structured (a public-private partnership) would be best served by reducing government’s role, rather than increasing it. Without government standing by the banks with a shovel ready to bail them out, do you really believe they could get this big and this levered?

        In my view, there should be a separation between public and private in banking and finance. A public banking system would take care of what government takes on its shoulders now through guarantees and subsidies. This segment is not all that big a deal to the private financial sector since it’s not where the money is to be made. So public banking would take care of consumer banking, including residential mortgage loans, in which Fannie and Freddie are the major players anyway. Government is always going to back up this level regardless when push comes to shove. That is just political reality.

        The private sector can deal with commercial lending, investment banking, and prop trading with the understanding that they are on their own. I would them require that all private banking and financial dealing to be partnerships in which the principals were personally responsible instead of allowing for a corporate veil in the case of fiduciary responsibility and prop trading. That would solve most of the problems. Regulation and oversight, including criminal sanctions, would also be needed to some degree to minimize gaming the system and creating systemic risk. All those dealing in the US would be required to abide by these rules of engagement.

      2. My view of government’s effects on k-12 education are a little less sanguine than yours. But I’ll put the question back to you. Do you really think the private sector would do a worse job of running k-12 schools than the government has? Really?

        As far as banks go, why not simply remove the FDIC guarantee of deposits? Why does the government have to run banks? If depositors don’t want to take exposure to non guaranteed banks, they can put their money in Treasury backed Money market accounts.

      3. But I’ll put the question back to you. Do you really think the private sector would do a worse job of running k-12 schools than the government has? Really?

        I don’t think that they would do it at what the government is now spending. If they did, they would have to cut services. People think that there is a lot of waste in public education. That is a myth. Cost it out. For example, special ed, which is a requirement, is a huge cost. Where are the savings? Cut teachers’ salaries and benefits. Larger classes?

        Oh, I know. Fire all the “bad teachers” and replace them with good ones. Uh huh.

        As far as banks go, why not simply remove the FDIC guarantee of deposits? Why does the government have to run banks? If depositors don’t want to take exposure to non guaranteed banks, they can put their money in Treasury backed Money market accounts.

        The political reality is that government is going to back consumer banking no matter what. We just aren’t going back to the panics of old. Remember the crisis really started in earnest this time when a money market fund broke the buck.

        Why not just eliminate the superfluous middlemen and increase efficiency when markets are supposed to be about assuming risk and the government is assuming it. Anyway, banks make their money from consumer operations from fees and penalties not service. Let’s go to something like the nonprofit credit union of model of basic consumer service at a fair price, which a lot of people are turning to right now to avoid the rip offs.

      4. Well, as a board member of a charter school, I know it’s possible to run a school in an inner city environment for less money than the local school district does, and get a better result. We have ‘costed’ it out and done it. And there’s a waiting line of parents at the door trying to escape the local public school and get their kids into our charter school. And no, we don’t cherry pick. This isn’t theory speaking, it’s practice.

        As far as the banks go, I guess we have a difference of vision. I’m a libertarian, and I believe you’re a progressive. I like solutions that maximize liberty as a first order objective. I believe that without liberty the fruits of life aren’t worth having, and with liberty life has immeasurable value.

        I believe we both agree that the current order of affairs is inherently corrupt. Banks get a free lunch from the government in deposit insurance, and “too big to fail” insurance. I believe the solution is to take away the free lunch. You believe the solution is to take away their business. You see bankers as ‘superfluous middlemen’ who should be doing something more productive in society. I see them as clever businessmen taking advantage of a free lunch given to them by government.

        That being said, one of the things I like about MMT is that we can both agree about our understanding of the way fiat currencies work, and disagree on what is to be done about it. MMT isn’t inherently political.

      5. JCD, I am a radical, that is to say, a libertarian of the left. I fear the corporate state in the present environment much more than the socialist state, which I see as remote in the US. Right now, the US is a corporate state, i.e., a plutocratic oligarchy masquerading as a representative democracy.

        I really don’t care who runs an operation as long as it is run efficiently and effectively, and in a way that is sustainable, consilient, and integrative. “Efficiency is doing things right,and effectiveness is doing the right things” – Peter F. Drucker.

        Presently, special interests, primarily large corporations are sucking off the public teat and lobbying for policy that is to their advantage at the disadvantage of the people at large. For this reason, I recommend that where government takes the risk, the middlemen should be eliminated.

        As someone who understand the potential of MMT, I can see that a government can fund a great deal of public investment that the private sector is either unable or unwilling to engage itself in, or if it does, arranges to lean on government. In my view, this is where government can step and should step in to promote public purpose and the general welfare. I also see that a lot more can and ought to be done internationally by the international community to promote human and ecological purpose and welfare.

        In an enlightened society and world, government and laws would be unnecessary, but humankind is far from being there yet. So we need to adopt the most efficient and effective means for meeting the ongoing challenges of evolution, or be left behind. Humanity need to use both intelligence and empathy to select the most appropriate means given the data available and the possibilities for survival and progress in a constantly shifting environment.

  9. the public purpose behind having private capital in banking is the notion that the private sector is better able to price risk than the public sector.

    there is no reason that stability can’t be just as easily sustained with the public/private banking model (with activities limited to promoting public purpose as I describe in my proposals).

    Failing need mean only shareholders fail, and not business interruption.

    And firing managers for poor performance is certainly not expedited by public ownership.

    1. Warren, your optimism seems unwarranted to me. What you say may be true in principle, but it hasn’t been true in practice.

      As Simon Johnson, William K. Black and many others have documented:
      (1) risk was systematically mispriced,
      (2) public purpose was undermined,
      (3), capital at risk was shamelessly bailed out,
      (4) almost no one responsible was fired or held to account,
      (5) moral hazard has increased, and
      (6) meaningful reform seems to be dead in the water now that the crisis “appears” to be over.
      (7)The financial system is now more consolidated and the oligarchy more powerful than pre-crisis, and the prediction is that the next crisis is built in.

      I am very skeptical about fixing a system that is controlled by an oligarchy that has captured the apparatus of the state without dismantling that system. We are being set up for another Minsky moment that the usual suspects will make the most of again by holding the country and world hostage.

      This is very far removed from a free market. It’s a rigged game in which government and the people are left holding the bag.

      1. points i’ve made on this issue:

        regulation and supervision is a work in progress.

        as per my proposals ‘if i ran the world’ banks wouldn’t be doing most everything that’s been a problem.

        no one in govt seems to be qualified to do what they are doing- they continuously show they don’t fundamentally understand banking

  10. Winterspeak:

    Case 1:

    Citibank capital falls from $ 100 billion (regulatory requirement) to $ 50 billion.

    No capital injection.

    Capital falls further to $ 49 billion, at which point FDIC “seizes” the bank.

    Implied “forbearance limit” = $ 51 billion.

    Case 2:

    Citibank capital falls from $ 100 billion (regulatory requirement) to $ 50 billion.

    Government injects capital of $ 50 billion, for a revised total of $ 100 billion.

    Capital (total) falls (further) to $ 99 billion, at which point FDIC seizes the bank.

    Implied “forbearance limit” = $ 51 billion, given the presumed equivalence of the capital injection to an equivalent amount of regulatory forbearance.

    Those are the two equivalent cases. The first is an effective simple forbearance limit of $ 51 billion. The second is an equivalent effective forbearance limit of $ 51 billion, acknowledging the capital injection as a forbearance equivalent.

    My point, to repeat, is that the second case is ludicrous as a government strategy outcome. The government would never inject $ 50 billion of “forbearance equivalent capital” only to pull the plug at the next incremental loss. But that’s exactly what’s implied by a simple statement of forbearance equivalence between the two cases.

    A more logical comparison is to pick the same gross number as the forbearance effect in each case. If the number is $ 49 billion in each case, then the effective forbearance limit with capital injection is equivalent to $ 101 billion rather than $ 51 billion. If the number is $ 0 billion in each case, then the forbearance limit with capital injection is $ 150 billion rather than $ 100 billion.

    The underlying point is that you can’t compare forbearance and government capital without defining a numerical forbearance limit. It can’t be infinite; that would be absurd. So there must be a finite line in the sand defined by the difference between the normal regulatory limit and the forbearance adjusted limit. When you attempt to define equivalence between capital and forbearance sans capital with a finite limit, you reach the kind of operational contradiction I’ve depicted. The result is that capital injections always increase effective forbearance compared to forbearance without capital, rather than equating to it.

    The further point is that capital injections change not only the capital structure of the entity but the asset risk profile as well. That doesn’t happen with the straight forbearance alternative. Capital injects cash as a new asset, which is initially risk free. That changes the asset risk structure. Moreover, that cash can be used by the entity while it is viable. That changes the event space for risk outcomes. Also, given the increase in effective total forbearance, there is an expected extension of time over which the bank can attempt to reach full viability. Potential private investors know this. And this time extension brings larger benefits in the form of recapitalizing through normal banking operations over time, including retained earnings.

  11. JKH: I’m not sure if anyone meant anything as precise as what you say. The message around TARP was to put in another $50B, just as a temporary measure to deal with a passing crises of liquidity, and then to get it back with interest. Tax payers would make money on the deal (snicker). Having the TARP money there, plus heroic efforts off-stage, would make the bank whole wrt to capital requirements, but there would be no additional losses.

    We agree that the forbearance event happened when the bank hit $50B in equity and it needed $100B but was not shut down. So what is the real numerical forbearance adjusted limit, particularly when we include suspending mark-to-market accounts? Were the banks in trouble or were they not?

    There is no argument that the risk structure for banks is dramatically different today than it was pre-TARP. I believe that the actual mechanics of TARP only contribute a small fraction of this difference though, more of it is in the revealed regulatory envrinoment.

    1. I don’t disagree with anything you’ve said above, w.

      My point remains otherwise. There’s simply a difference between injecting incremental cash into a live entity, versus using the same amount of money to absorb losses in the event of a declared wind up. The purpose of capital is to absorb unexpected losses, but that’s not the only event that capital facilitates.

  12. if gov understood their risks then they would know that either way they start writing checks after the remaining 50 b of private capital is gone, and act accordingly. FDIC and Tsy are under the control of the same gov.

    but of course they don’t understand the bottom line risks/rewards/public purpose which was the point of my post

  13. So if they don’t even understand the risks of their current financial arrangements in banking, perhaps they should seek to exit the business, as opposed to putting more money at risk.

    1. JCD: First, Gov does not know what it does not know. In either case, the brain of the Gov is in the unniversity, and this is primary failure of academy. failure of Gov is second step.

      Second, Gov can exit business and you have exogenous currency regime (there are lots out there). This does not obviate problems — see Greece! — it just removes solutions.

      1. Zanon:

        I agree with your assessment. The Government has poor first order knowledge (i.e. it doesn’t know how banking works) and poor second order knowledge (i.e. it is unaware of it’s own ignorance).

        But I think I failed to be clear in my post. I’m suggesting the govt should exit the business of insuring banks (FDIC). I’m not suggesting the government should exit the business of creating a stable fiat currency.

      2. Ah yes, this is favorite solution of many libertarian-leaning commentariat (who also understand nothing) and the basis of so called “narrow banking”.

        I reject it, as it does not solve anything that needs solving.

        Govt does not insure banks via FDIC, it insures deposits. Deposits are a class of liability that are not an investment decision, they are a not-spending decision (a “saving” decision) and to have this backed is prudent and sensible. It is the only thing the Govt does right, and even here it is only right up to $250K.

        Since banks do not lend out deposits, FDIC or otherwise, you do not get any prudence in credit markets by uninsuring this channel

      3. Well I guess I know nothing, but I’m curious without any deposits, what would the banking system lend?

      4. Are you new to this site?

        Banks do not lend out deposits. Bank loans CREATE deposits.

        Please read Mandatory Readings.

  14. the public purpose behind banking with insured deposits is to support the public infrastructure called the payments system.

    otherwise, with strictly private depositories, you’d have to study their financial statements, which will always be impossible and impractical, before opening a checking account, for example It just doesn’t work well over time.

    on the lending side the public purpose is that of being able to lend on credit analysis rather than market value, which also requires liabilities not be used for market discipline.

    and the reason for private capital is the presumption that the private sector can better price risk than the public sector.

    take another look at my proposals, thanks.

    it was suggested to me a while back that there could be two kinds of banks. deposit/transactions servicers and lenders. The lenders would be funded by the fed and nowhere else, and the deposit banks would keep their deposits at the fed and not invest. Not a bad idea, except for lost economies of scale and efficiencies of management by having both under one roof.

    1. I think it is bad idea warren, as splitting banking in this way does not get you improved credit analysis, which is the most important thing in the lending.

      the notion of “narrow banking” comes from belief that FDIC insured deposits are being used to make loans, as since Government is backstopping those deposits the incentives are wrong. This is nonsense of course at every level, so the “solution” is to a problem which is not real.

  15. what it gets you is stability of the payments system, stability of the lending process, and disposable institutions as needed, and all with a substantially reduced total regulatory burden.

    1. I am not following.

      Unlimited FDIC and a rational discount window gets you stable payment system.

      As loans create deposits, what you would have in narrow banking is one type of entity making the loan, which then gets booked as deposit in a second type of entity. The loan-creation entity would need to borrow liability somehow — maybe debt?

      Loans could be good or bad as today. If loans are bad, then loan-creation entity would or would not go belly up depending on political connectedness as today, etc.

      Deposits were never at risk in crises, and payment system was only at risk because Fed rules for IB market are crazy.

  16. my fed funds lending proposal by the fed means liquidity isn’t ever an issue.

    yes, banks can become insolvent, but it doesn’t have to mean business interruption. the fdic takes over and sells he assets to other banks or raises new equity, as it currently does with small banks today

    1. Exactly my point.

      If we have your Federal Funds lending proposal, plus unlimited FDIC insurance, then we get all the benefits from “narrow banking”. These are pretty simple, problem is cognitive, not operational.

      Narrow Banking is complex solution to very simple problem, and ignores the much harder problem of credit quality on asset side. So why bother?

  17. The issue of credit quality on the assets side is dealt with by capital requirements which means shareholder money is at risk, and therefore management has a profit incentive, and regulation wherein govt. makes sure it’s happy with the assets as well, including concentration risk, interest risk, etc.

    And is there is a loss, of any size, there is no systemic risk, as liquidity is always there and the FDIC has the tools to deal with insolvency.

    1. Totally agree.

      But why bother with splitting banking sector into two, a “narrow” to deal with deposits and another to deal with loans?

      Have FDIC cover all deposits, have discount window lend unsecured, and have capital requirements etc. on asset side. You can do this with current system, in fact, they ARE doing some of this with current system.

      The whole “narrow banking” idea is based on fallacy that Govt insured deposits are being loaned out, creating Original Moral Hazard. You should not be supporting this nonsense.

  18. agreed. i wasn’t suggesting the two types of banks system, just using it for illustration.

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