WHEN DOES A COMPANY QUALIFY FOR A BAILOUT?
http://www.newsweek.com/id/158615
Wall Street is consumed with the subject of bailouts. As analysts chewed over the implications of the government's decision to assume the debt of ailing mortgage giants Fannie Mae and Freddie Mac, traders (and their real-estate brokers) wondered whether erstwhile titans Lehman Brothers and Washington Mutual would be next in line for government assistance. Meanwhile, lobbyists for the big three automakers were refining their pitches for $25 billion in loan guarantees. It is sure to be another long weekend for Treasury Secretary Henry Paulson.
Bailouts—the government's stepping in and providing financial assistance or credit guarantees to private-sector companies—are a highly confusing subject. As policymakers hasten to save some companies from the ravages of creative destruction, they leave others to fail. Some 5,644 businesses went bankrupt in July, up 80 percent from July 2007. So are there some objective criteria we can use to determine whether the government will toss a lifeline to a particular company?
It's a truism that the bigger you are, and the more you owe, the more forbearance you're likely to get. In 1984, when Continential Illinois, whose reckless lending practices had catapulted it into the ranks of the nation's 10 largest banks, ran into trouble, the government bought some of its loans and provided extraordinary compensation to depositors. "We have a new kind of bank," complained Fernand St. Germain, a congressman from Rhode Island, "It is called too big to fail." (St. Germain, who shepherded the bill that deregulated the savings-and-loan industry, would be blamed in part for the record-setting bailout of S&Ls later that decade).
But these days, size alone doesn't matter. Earlier this decade, Enron, WorldCom, and Global Crossing, three gargantuan companies, went bust while the government looked the other way. Of course, when the aforementioned companies filed for Chapter 11, nobody lost electricity or was unable to make a phone call. "But if the government envisions that a failure will have a serious adverse consequence on the economy, it's going to step in," said Benton Gup, a professor of banking at the University of Alabama and editor of the collection Too Big To Fail: Policies and Practices in Government Bailouts.
For that reason, certain types of financial institutions are much more likely to be helped than others. A bank that lends to people with dodgy credit in California doesn't pose much of a threat to the Davos crowd. But financial intermediaries like Bear Stearns and the FM twins function like the heart of the global financial system. If they go into cardiac arrest, the whole body is in danger. Since Bear Stearns was a counterparty to (and guarantor of) trades and financial arrangements with the world's major financial players, its failure would have triggered a cascade of losses. In the same vein, huge quantities of the $5.4 trillion in debt issued and insured by Fannie Mae and Freddie Mac sit on the balance sheets of central banks and financial institutions around the globe. For the U.S. government simply to let this debt—which it had been implicitly backing for decades—go bad would have meant inflicting severe damage on America's most significant diplomatic and trading partners. Fannie Mae wasn't too big to fail, one Wall Street wag told me this week. It was too Chinese to fail.
To be eligible for a bailout, firms must also demonstrate a particular genius for screwing up. Before it went bust, Bear Stearns had a monstrous $33 of debt for every dollar of capital, and hedge funds it owned destroyed hundreds of millions of dollars of clients' cash. It got a bailout. Lehman Brothers, which has taken painful measures to reduce its risk, is perversely less likely to get direct government help. "The worst Lehman can do is destroy the firm," said Barry Ritholtz, CEO of Wall Street research firm FusionIQ and author of the forthcoming Bailout Nation. "Bear Stearns, on the other hand, set up the firm so that if they screwed up, they could threaten the entire financial system." That may explain why Treasury Secretary Paulson has thus far resisted providing federal succor to Lehman.
Finally, companies seeking the tender mercies of the taxpayer must have good timing. Nearly all the great corporate bailouts of modern times have come in election years. Congress enacted loan guarantees for Chrysler in January 1980, ensuring that a company that employed about 130,000 people, many of them in the swing state of Michigan, would not go bust on the eve of primary season. So, if your company is in trouble, what should you do? Double down. Establish links to other firms. Export your products with abandon. And hustle. There are only seven more weeks until the election.
PERSONAL NARRATIVES AND EMOTIONS IN ELECTION PSYCHOLOGY
http://www.newsweek.com/id/158749
Narratives have been used to attract voters at least since Lincoln's campaign managers cast him as the rugged rail-splitter from the country's frontier, not the prosperous railroad lawyer and sophisticated writer he was, notes historian Michael Beschloss: voters are drawn to someone they can relate to, and the way to make that happen is by offering them stories. (The human brain is wired so that we can follow a chain of events that have people doing things in chronological order more easily than we can follow abstractions.) But the power of the narrative has grown as party identification has weakened—putting more voters in play—and as the culture has changed. Television has made voters expect to, and think they can, "see into people's souls to take their measure," says Beschloss. To do that, "they need clues," and there are few clues so potent as the challenges a person has faced and how he or she has met them. "The feeling that we need to know who these people are has become so enormous that a good part of Sarah Palin's appeal is her life history, the choices she made, things that let voters form a bond with her," says Beschloss.
The outsized power of the personal narrative today compared with even a generation ago (in 1980, Ronald Reagan ran not on personal narrative, but on hope and the promise of change) reflects something that has become almost a cliché in political analysis—namely, that emotions, more than a dispassionate and rational analysis of candidates' records and positions, determine many voters' choice on election day. The emotion can be hope or fear, pride or disgust. And don't be too quick to pat yourself on the back for thinking you cast your vote based on a logical parsing of a candidate's positions. For all but the most wonkish wonks, what matters is how the prospect of pulling out of Iraq or expanding oil drilling or any other policy makes you feel, and not a pro-and-con analysis of its pluses and minuses, which few people can figure out.
All of this has been true for decades. What's new is that the circumstances of this election have conspired to push people away from the reason- and knowledge-based system of decision-making and more down the competing emotion-based one. The latter is more ancient and has, throughout the course of human evolution, "assured our survival and brought us to where we are," says neuroscientist Antonio Damasio of the University of Southern California, a pioneer in the study of human emotions and decision-making. ...One of the most salient circumstances of this campaign is the sheer amount of information voters are bombarded with, says Damasio. You can barely pass a screen (TV or computer) or overhear a radio without being pummeled with the latest brouhaha over lipstick-wearing pigs or which candidate was cozier with lobbyists for the failed mortgage giants. When FDR was making radio addresses, "people had the time needed for reflection, to mix emotion with facts and reason," says Damasio. "But now, with 24-hour cable news and the Web, you have a climate in which you don't have time to reflect. The amount and speed of information, combined with less time to analyze every new development, pushes us toward the emotion-based decision pathway." And not even emotions such as hope. Voters are being driven "by pure like and dislike, comfort or discomfort with a personality," says Damasio. "And voters judge that by a candidate's narrative."
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The bailout article is interesting, but to me that's mostly because it shows how shamelessly the media is fanning the flames here. The article implies a substantial moral hazard in finance - that management/employees are rewarded (get money) for doing the wrong thing (blowing up the economy). There's certainly some of that, primarily in compensation paid during the boom and liquidated (i.e. not kept in company stock). That's very hard to resolve post-facto (it would be illegal for the g't to take back money already paid, though they can regulate for future booms). But it's not nearly as bad as the article implies.
The bailouts we've seen this year have not been soft landings for the companies involved. They haven't been quite as "Old Testament" as I'd have liked, but they have done a pretty good job of wiping out management, employee and shareholder value. In the year preceding Fannie Mae's "bailout", the stock lost ~90% of its value (from mid-60's to ~6), and since the g't stepped in it's lost another ~95% (to 0.43); that blows up a lot of the moral hazard, particularly given how much company stock was owned by employees and management. Management was fired (and it's not like people are going to be lining up to hire those folks). AIG's stock took a similar path (from mid-60's a year ago to 2.3 today), management was fired, and the money the g't is loaning them is at 850 basis points over the LIBOR (which is to say, borderline usury). Nobody is intentionally going to drive their firm into the rocks in order to lose 99% of its value and get fired.
In terms of the value of the company and assets, the difference between bankruptcy and bailout seems semantic - I mean, that's roughly what happened to Lehman. The article suggests that companies would somehow *want* to set up their company to be so big and entangled that they would get a bailout. The results when they fail seem pretty similar, though. And the big difference is that Lehman had a much better chance of surviving, exactly because they worked to get untangled. Merrill took a similar approach, and managed to get bought, albeit at firesale prices - not an ideal situation, certainly, but better than either bankruptcy or bailout.
The other bit that seems totally over the top is the assertion that the GSE's were bailed out to help Chinese investors. In calendar year 2008, Fannie Mae and Freddie Mac financed 80% of new mortgage issues. If those two companies suddenly evaporated, it would be dramatically harder for people to get new mortgages ... which means fewer home sales, increased mortgage rates, lower housing prices, and generally a steel-toed kick in the balls for the whole housing market. China benefits as well, but the main beneficiary was the American homeowner. Again, I'm not thrilled about it - it's essentially a generational transfer of wealth, as our parents' generation gets bailed out and mails the bill to you and me 20 years from now, in the form of debt.
I mean, I'm not suggesting things are working well. I think the government should have gone further in fully nationalizing the GSE's and then made clear they were going to be completely dismantled and sold for parts. I think the government should also be more transparent in making these determinations. And I think Wall Street compensation should have a large component of long-term results so some of those financial profits could be pulled out of those folks' pockets as we discover years later just how they earned their money (being leveraged 33 times over, for example). At the same time, Paulson and Bernanke have an incredibly hard job which would be challenging to do even if they could see the future.
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Well, I don't think the article was suggesting that these companies deliberately screwed up huge in order to "merit" a bailout. I think the author was being facetious to say that ironically, the biggest greedy morons get more help than those who admitted fault and really tried to help themselves. Like the Prodigal's Son story.
I'm not quite sure what you mean by: They haven't been quite as "Old Testament" as I'd have liked, but they have done a pretty good job of wiping out management, employee and shareholder value.
Definitely upper management played a large role in the crisis, and they should be punished accordingly. Maybe they lost a lot of their assets when the stock's value tanked, but they have plenty of diversified savings left and will recover from this mess, much better than their underlings at least. They will also get hired again, despite this black mark on their CV (maybe not as officers, but definitely into powerful positions). There is plenty of historical precedent for that. But for the ordinary workers, this is a killer, like the telecom and energy trading meltdowns before. Especially because it wasn't really their fault, unless they could have "blown the whistle" to alert others to the unwise business practices taking place, but no one was listening anyway during the housing boom when people were blind with greed. As you said, their savings in company stock has evaporated, and it will be hard to get re-hired quickly, because competing companies are in similar messes, and suddenly thousands of desperate, qualified workers have just entered the job pool. 100,000 financial sector jobs have been lost (maybe only 5-10% of that is management?), so that's 1/6 of total US new unemployment in 2008. So yeah, it wasn't any leader's intent to destroy his or her company, but their decisions contributed to the crisis so they should be held accountable. I don't think companies structure their business plans to make them more desirable for bailout (I hope not at least). But like in law enforcement, it's more efficient and socially preferrable if we can discourage bad behavior before we have to punish it after the damage was done. I don't know how DC can do that effectively though, without major political-economic backlash and accusations of interference in the free market.
How do we mitigate problems so they don't have to reach the bankruptcy/bailout stage? In America, people and companies are free to succeed or fail. Companies can, do, and must fail at times. Even dominant companies like Standard Oil, AOL, and PanAm were destroyed, either by the government, world/economic events, or their own mistakes. So when is a company "too important" to fail? I agree with you that Fannie & Freddie qualify - without them the housing sector grinds to a halt. The American Dream was made possible to millions over the years because of the 30-year-fixed, which no other nation can provide to the masses (so then why the hell did so many people take variable-rate loans instead!?!). However, maybe America doesn't have to have a mortgage-based home ownership system. Other modern nations like South Korea don't give home loans. People pay for apartments and homes with cash. It's a huge upfront cost, but then it's your asset 100% and no more hassles. But America is a borrow & spend culture, so probably we could never accept a change.
Maybe it's in the government's interests to prevent companies in critical sectors from qualifying to be too big to fail. It's horrible precedent to bail out companies with tax dollars, or force rivals to "take one for the team" and absorb another company's debt. Freddie was only created to give Fannie some competition. So maybe more competition/customer choice will keep these companies more honest and risk conservative? There are 5 major i-banks (well, 2 now). Is that too many or too few? Who knows, but I'm leaning towards too few. Other industries like wireless, oil, and airlines are heading down that path with merger-mania.
Regarding the China comments, of course Washington doesn't base its bail-out decisions chiefly on foreign considerations. But at the same time, economic turmoil abroad hurts us at home in this globalized commercial system. It would be bad for everyone if our mortage/financial crisis spread to other continents, and it already has (Asian markets down 5% this week, Europe 3%). The housing bubble also burst in Spain and the UK. European banks have folded or needed rescue too (UK's biggest mortgage bank was just bailed out this week), since they bought up so many American SIVs too. Foreigners must be pissed at us because through no fault of their own, their savings have shrunk because too many dumb Yanks and dumb banks engaged in bad loans.
So a large, troubled American company with significant foreign investment is probably more qualifying of assistance than one without. I think it makes sense. Countrywide wasn't bailed out (unless BofA was "persuaded" to do so by the Feds), and neither were smaller, more regional mortgage banks like IndyMac.
Yeah I agree with you that Paulson, Bernanke, and president 44 will have a hell of a time cleaning up this mess. You really need balls of steel for those jobs, and as you said, even a crystal ball may not save you. That's why it's so idiotic and repugnant for the presidential candidates to claim that they "understand" the economy and know how to "fix" it.
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I guess the problem, is, though, how do you legislate that? Being incompetent isn't (generally) a crime - it's only clear that they were incompetent post-facto (as in, after they were awarded their bonuses, which is an incentive problem I wrote at earlier), so by what mechanism do you decide to take their money away? And how can you make it so that they can't get a well-paying job again? By throwing them in jail?
I think the government did about the best it could, in wiping out nearly 90-95% of many of these company executives' personal wealth, without getting into punishments that would deviate from due-process and legal-based actions. I think it's a generalized problem of American life where well-connected people "fail-upward," as President Bush did, but no amount of legislating, unfortunately, is ever going to stop that problem (short of a total makeover of how society works). It's the same reason that all these political retreads get cushy jobs as political commentators spouting stuff that any idiot on the internet could come up with.
But I think that we do need to come up with, as Obama put it, a way to help out people on Main Street as well as Wall Street. A package that extends unemployment benefits, increases availability of food stamps, extends COBRA programs for those who recently lost their jobs, etc. Krugman and other economists have made the point that average citizens generally aren't as susceptible to the moral hazard problem - after all, most people only buy a few houses in their lifetime and bailing them out once isn't going to radically change their behavior, as it might with banks.
So I hope that the new rescue plan put forward is sufficiently draconian on companies and their executives; some people are actually speculating that the government might make money off of all of this (because no one has the money to buy these assets, many of them have fallen well below their long-term price. So the government, with a good source of capital, can now snatch them up). Hopefully they can use that money to repay the costs of helping out those on Mainstreet...
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Thanks for the comments A, and I agree it's a sticky situation for the government to decide how much to intervene on these economic matters. As you said, it's difficult and controversial for a government to punish business incompetence after the fact, and probably a company's own board is better equipped to punish poorly performing executives instead (unless the executives appointed the board). What do you mean by the government took away 90-95% of the executives' wealth? Because they lost their bonuses and the value of the company stock tanked? Can the government revoke private sector pay for poor performance?
In terms of helping out Main Street, it's clear that economic stimulus checks aren't the long-term answer. Bush's recent effort had only a minor impact for about 2 months at best; a drop in the bucket at the cost of billions borrowed. Unemployment assistance is a good step, but I think Senate Republicans and Bush, while he's around, may try to block it at every turn (they said it was excessive spending, yet they spend 100s of billions on Wall Street "welfare"?). Finally the Dems had to attach unemployment assistance to a war supplemental for Bush to accept it. But maybe now the situation has gotten more dire, and with the election approaching, the GOP should try to shed the stereotype that they don't care about the troubles of the Average Joe (unless it's true).
http://seattletimes.nwsource.com/html/politics/2004469503_apjoblessbenefits.html
http://www.military.com/news/article/bush-threatens-veto-over-gi-bill-adds.html
Unemployment insurance, COBRA, etc. can keep some people afloat for a few more months, but I don't know how we can go about creating over 1M new jobs in the next 12 months (what would be needed to bring unemployment back down to 5%). And minimum-wage service jobs with scant benefits won't cut it. The new jobs from the "green economy" won't materialize as long as this recession persists, lending is tight, and government spending is curtailed by the wars and tax cuts. Gas and food will not get significantly cheaper, even if there is a global economic slowdown (which causes other problems too). GM and some airlines are so deep in the red they might ask for bailouts too (but won't get them). The dollar's gains in int'l money markets may mean that exports slow somewhat. Even China is showing signs of economic cool-off. I don't know how we can get people back to work quickly. It seems like companies are laying low, besides the financial sector snatching up bargains of course, as you said of government takeovers too (that raises another interesting question - what will the Feds do with these companies once they start becoming profitable again?). Everyone is waiting for peak foreclosures to pass and home prices to adjust to rock-bottom (for this cycle at least), so the growth curve can re-commence with restored lending fluidity and market confidence. But who knows when that will be? 6, 12, 24 months or longer?
I agree that citizens are not exposed to the moral hazard like company officers, but nevertheless they can and do make decisions to hurt themselves. In many cases, predatory lenders didn't even need to persuade customers to enter into suicidal mortgages. And some of the same people who didn't learn their lesson after the dot-bomb made the same greedy mistakes in the housing bubble. And they will F up again during the next boom/bust. It's endemic in this greedy society to a certain extent. Some people are just predisposed to gambling, ignoring warnings, and screwing themselves. What do we do about them? I know we can enact some laws to protect citizens from themselves, but how do we do that without adding a new layer of bureaucracy to the already unjust and convoluted lending industry? And it's not like Washington has had a good track record of regulating anything intelligently. What completely sucks is that some speculators obviously got away with it if their timing was right. And the people who played it safe and played by the rules still get screwed by the reckless to some degree, yet they are the ones who get the least reward/assistance for their good behavior, because their situations may not be as dire as the gamblers. Well, I guess "being good" is its own reward, and I doubt they would want to trade places with the desperate.
