Mercury Rising 鳯女

Politics, life, and other things that matter

Somehow This Doesn’t Surprise Me

Posted by Phoenix Woman on April 5, 2009

Oh noes! Somebody (William Black) went on Bill Moyers and said that Obama is breaking the law by not nationalizing stricken banks!

Um, except that he isn’t:

Again, let me repeat.  This is a lie.

And quite a lie it is.  It is a lie on at least two levels.

First, the Prompt Corrective Action (“PCA”) law does not give the FDIC (or OCC or Federal Reserve) the ability to take over any Bank Holding Company (“BHC”).  BHC’s are regulated and governed by the Federal Reserve, pursuant to The Bank Holding Act of 1956. The PCA applies to insured depository institutions, i.e. the retail bank operation as opposed to the investment bank and bond trading desk.

Amongst the financial institutions that are thus not subject to the PCA are:

JP Morgan Chase

Citigroup

Bank of America

Wells Fargo

HSBC

Goldman Sachs

Morgan Stanley

And, of course, the PCA also does not apply to AIG, which is an insurance company and not involved in banking at all.  So, pretty much all of the really big players don’t fall under the PCA in the first place.  Their commercial banking subsidiaries very well may, but your local Bank of America branch is not at the root of this crisis.  We can seize the banking units that aren’t the problem, but we can’t seize the banking units that are the problem.  (See the UPDATE regarding the horror show that could result from plucking a retail bank out of a conglomerate like Citi).  And we won’t even get into the whole problem of international banks like Citi, CSFB, or UBS.

Second, the diary is a blatantly inaccurate because it states an impossibility.  What?  It claims that Obama is breaking the law by not nationalizing a bunch of banks, when the language of the statute explicitly gives the government considerable discretion in deciding whether to do . The PCA does not mandate that the FDIC take over any bank .

And Sheila Bair has more (h/t white widow):

While the depository institution could be resolved under existing authorities, the resolution would cause the holding company to fail and its activities would be unwound through the normal corporate bankruptcy process. Without a system that provides for the orderly resolution of activities outside of the depository institution, the failure of a systemically important holding company or non-bank financial entity will create additional instability as claims outside the depository institution become completely illiquid under the current system.

In the case of a bank holding company, the FDIC has the authority to take control of only the failing banking subsidiary, protecting the insured depositors. However, many of the essential services in other portions of the holding company are left outside of the FDIC’s control, making it difficult to operate the bank and impossible to continue funding the organization’s activities that are outside the bank. In such a situation, where the holding company structure includes many bank and non-bank subsidiaries, taking control of just the bank is not a practical solution.

If a bank holding company or non-bank financial holding company is forced into or chooses to enter bankruptcy for any reason, the following is likely to occur. In a Chapter 11 bankruptcy, there is an automatic stay on most creditor claims, with the exception of specified financial contracts (futures and options contracts and certain types of derivatives) that are subject to termination and netting provisions, creating illiquidity for the affected creditors. The consequences of a large financial firm filing for bankruptcy protection are aptly demonstrated by the Lehman Brothers experience. As a result, neither taking control of the banking subsidiary or a bankruptcy filing of the parent organization is currently a viable means of resolving a large, systemically important financial institution, such as a bank holding company. This has forced the government to improvise actions to address individual situations, making it difficult to address systemic problems in a coordinated manner and raising serious issues of fairness.

UPDATE: Geekesque has updated his diary:

UPDATE: Big Tent Democrat misapprehends, or perhaps I have failed to explain, a crucial point.

Let’s step back and take Bank of America as an example.  A great deal of its toxic garbage is concentrated not in its retail and consumer banking divisions, but in its investment banking and securities trading divisions, especially after the acquisition of Merrill Lynch.  In other words, its chartered depository bank is doing just fine and is no danger of missing capitalization requirements.  However, its other divisions are struggling under the weight of the toxic assets and could fail.  But, no one can touch those.

Or, let’s take Citi as an example.  Per Time’s excellent Justin Fox.

The first striking thing there that Citi’s U.S. banking operation just isn’t all that big: J.P. Morgan Chase has $722 billion in U.S. deposits (and $287 billion outside the country). Washington Mutual, which was not deemed by regulators to be too big too fail, had $182 billion in deposits, in the same territory as Citi’s U.S. bank.

The second is that if Citibank’s overall business breaks down along domestic/foreign lines pretty much as deposits do (which probably isn’t quite the case, but close enough), that gets you to $392 billion in assets and $365 billion in liabilities. That’s the part of Citigroup that the FDIC has the authority to take over. I bet the FDIC could handle it, at least if it gets the new $500 billion credit line it wants from Congress. But this would leave an entity (or entities) with about $1.5 trillion in assets and $1.4 trillion in liabilities to be taken over by foreign governments or fail in pretty much the same unruly manner that Lehman Brothers did.

To repeat: Citigroup has liabilities of $1.797 trillion. The deposits that the FDIC has some responsibility for (up to $250,000 per depositor) add up to $241 billion. So we have this reasonably sensible system for winding down troubled banks, but when it comes to the most troubled big banking company in the country, said system only covers a fraction of the overall operation. Which leads to a couple of conclusions:

  1. I get why the administration is so reluctant to take over Citi completely.
  1. I don’t get why we all (I’m including myself in this) thought it was okay to allow the creation and growth of gigantic financial companies for which we had absolutely no plan for winding down in case of trouble.

This is all getting lost in the shrieking, I’m afraid.

10 Responses to “Somehow This Doesn’t Surprise Me”

  1. RCATexas said

    Why does this not surprise me, that people are still out there givingout inaccurate information. Thank you for letting us know. Croosk and Liars has a piece also, but I don’t think they explained the difference. I’m surprised Bill Moyers didn’t do some of his due diligence on this stuff. The Obama administration, it seems can’t do anything right (per wingnuttery’s)
    Roberta

  2. Charles II said

    PW, I would not jump too hard on Geekesque’s conclusions. Black is not someone to dismiss as G does.

    I am certainly no legal expert. However, while it is my understanding that the power of receivership is limited to depository institutions, (a) several investment banks became despository institutions in order to receive federal assistance, and (b)it is possible for the federal government to make the determination that even if a bank holding company isn’t formally a depository institution that the line between the DI and the bank holding company has been breached.

    Black may be oversimplifying or even exaggerating. But I don’t think he’s wrong in saying that the Feds have the power and duty to act.

  3. tsisageya said

    Okay, here’s the transcript from the horse’s mouth: http://www.pbs.org/moyers/journal/04032009/transcript1.html
    BILL MOYERS: To hear you say this is unusual because you supported Barack Obama, during the campaign. But you’re seeming disillusioned now.

    WILLIAM K. BLACK: Well, certainly in the financial sphere, I am. I think, first, the policies are substantively bad. Second, I think they completely lack integrity. Third, they violate the rule of law. This is being done just like Secretary Paulson did it. In violation of the law. We adopted a law after the Savings and Loan crisis, called the Prompt Corrective Action Law. And it requires them to close these institutions. And they’re refusing to obey the law.

    BILL MOYERS: In other words, they could have closed these banks without nationalizing them?

    WILLIAM K. BLACK: Well, you do a receivership. No one — Ronald Reagan did receiverships. Nobody called it nationalization.

    BILL MOYERS: And that’s a law?

    WILLIAM K. BLACK: That’s the law.

    BILL MOYERS: So, Paulson could have done this? Geithner could do this?

    WILLIAM K. BLACK: Not could. Was mandated–

    BILL MOYERS: By the law.

    WILLIAM K. BLACK: By the law.

    BILL MOYERS: This law, you’re talking about.

    WILLIAM K. BLACK: Yes.

    BILL MOYERS: What the reason they give for not doing it?

    WILLIAM K. BLACK: They ignore it. And nobody calls them on it.

    And just to insure that you never take me to goddammed dailykos again (surprise! UGH!), I have deleted you from my bookmarks.

    Thanks for nothing.

  4. Charles II said

    I’m not sure why you’re so upset, T.

    There’s a difference of opinion… both of which, one may say, are on the Great Orange Satan’s website (Daily Kos).

    If we can’t accept that people will have differences of opinion, even sharp differences of opinion, how are we ever going to become any wiser than we already are?

    As far as being surprised… well, there is the mouseover feature. I use that routinely to make sure I won’t end up on a site that does something a lot worse than show me an opinion I disagree with.

  5. tsisageya said

    This is not a matter of OPINION, Charles, so spare me. And now, I will do what I do so very well.

  6. omen said

    william black counters criticism:

    http://www.pbs.org/moyers/journal/blog/2009/04/william_k_black_on_the_prompt.html

    i only did a quick scan, but i didn’t see him counter sheila bair’s point.

  7. Charles II said

    Thanks. That’s a great link, Omen.

    He’s not saying anything different than Sheila Bair.

    1. The banks are the largest portion of many bank holding companies, so receivership of them amounts to receivership of the holding company.

    2. Recapitalization would have come from elsewhere if it could have done. So (neglecting the federal role), recapitalization must come from the bank holding company. This would send the bank holding companies into bankruptcy, as Bair says.

    Also, with respect to Geekesque’s post, which begins the long climb down from his over-the-top accusations against Black, Citi is a very atypical company because of its extreme diversification. To go back to the institutions he named originally, Bank of American and Wells Fargo are mostly banks and therefore would play out very much as Black said. Geekesque assumes that the bad mortgages are held by the investment banking arm, but that’s not at all necessarily true. They could be held as individual mortgages by the bank or even as securitized mortgages (CMOs, CDOs, etc.) on the bank’s books.

    The other institutions… it’s more complicated, and I don’t know the ins and outs of their books (nor of WFC or BAC, for that matter). But I think that Geekesque was out of line and that what Black stated was correct, if a bit over-dramatic.

  8. omen said

    but charles, black is arging geithner is breaking the law by not acting on authority he already has.

    sheila bair is arguing they lack sufficient authority to act in how black is arguing for.

  9. Charles II said

    I would say she’s arguing that PCA should be extended from the banks to the shadow banks (many of which have formed themselves into bank holding companies), Omen.

    Let’s consider two situations regarding a bank and its holding company. (1) Bank net assets >0, bank holding company’s assets < 0 and (2) Bank net assets < 0, holding company’s assets > 0. [Equation fixed 4/7. WordPress swallowed the angle brackets]

    In case #2, the FDIC has the obligation to seize the bank unless the bank holding company recapitalizes it. In case #1, the FDIC has no authority. Geekesque asserts that we are in case #1. Black states that we are in case #2.

    Now, in reality, figuring out which case holds can be difficult. This is particularly the case because banks have minimum capitalization requirements, while other companies just have to keep assets above liabilities. For example, a bank with liquid assets of $100 and outstanding loans of $500 is adequately capitalized and solvent. But a bank holding company with $100 of assets and even as much as $101 of liabilities is bankrupt. Moving assets from one side of the corporate wall to the other can make either company insolvent.

    And then there’s the issue of marking securities to market. A mortgage that is performing is worth money. But if the resident isn’t paying on it, then it’s worth much less. WF did a trick where it stopped recognizing non-performance out to six months after people stopped paying. That allowed it to claim those mortgages as performing assets. If it hadn’t been allowed to play this trick, who knows whether it would be solvent.

    I think Black is arguing that the bank holding companies have created the illusion of solvency, but that a proper accounting which dissolved the corporate veil would expose the insolvency.

  10. […] by Phoenix Woman on April 8, 2009 A few days ago, the possibility that a hero of the lefty part of the blogosphere may have been wrong if not actively engaged in deceit (namely, by falsely claiming that in failing to nationalize the […]

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