First Bad Bank of the United States

Congress and banking have never been good working partners. Alexander Hamilton conceived the First Bank of the United States to handle the colossal government debt created by the Revolutionary War. Congress drafted and George Washington signed the bank’s charter in 1791. Twenty years later Congress voted to abandon both the charter and the bank. Today the government faces another colossal debt that is being created by the US banking system itself because the system is becoming insolvent. Saving the system may well require Congress to nationalize it. They may draft a charter for Barack Obama to sign creating the First Bad Bank of the United States.

Right now the nation's largest banks are carrying half a trillion dollars in bad debt. According to Nobel Prize Winner Paul Krugman, of the New York Times and Princeton University, the idea of temporary bank nationalization has “moved from the fringe to mainstream acceptance.” Krugman championed the cause for nationalization before the Bush Administration began its bungling government-intervention. "The chances of your being able to do this without nationalizing at least a couple of really troubled banks are not too good," Krugman told ABC.

Nor is he alone in that assessment. Economists Matthew Richardson and Nouriel Roubini may not be names that non-economics types recognize but they are of guru status and in agreement with Krugman that nationalization is the only way out of the out of the current financial crisis. The $1.2 trillion subprime mortgage mess is only the beginning of the problem. “Another $7 trillion -- including commercial real estate loans, consumer credit-card debt and high-yield bonds and leveraged loans -- is at risk of losing much of its value,” Richardson and Roubini wrote in the Washington Post.

How big of a hole are the banks in? It is huge, about $400 billion. This includes losses on loans and the drop in market value of the assets they hold but not the federal bailout funds that they got last fall. Nationalization appears to be the only option that would permit solving the bad asset problem on the banks balance sheets and allow lending to resume.

I use the word bad instead of toxic to describe assets with unknown value. Toxic is a buzz word that pertains to poison. Bad means bad and assets are at the core of this nationalizing business.

Here is the way nationalizing the banks would work. The government takes over running the banks. The bank assets are separated into two piles, good and bad. The good assets would again go private for sale to a buyer or to many buyers through stock offering to the public, such as an IPO. The bad assets would be valued, depressed as that might be, then either sold at their new value to investors or held by the government until the value comes back up to be sold at a profit in the future. In either case, first depositors and then debt-holders would share in the proceeds of the sold assets, with a fee going to the government. The idea is that in time the depositors are paid off and the government breaks even.

Bank nationalization means giving the U.S. government the power to control banks. The government could then choose and install new boards of directors and management as well as set corporate strategy. However, without creating a mega-fund to absorb the bad assets and remove them from the banks’ books, nationalization by itself would do nothing to solve the banking problem.

This is where the Bad Bank comes into the picture. The Bad Bank would be the mega-fund to take a trillion or more dollars of troubled loans and securities off the banks’ books so that credit could get moving again. In other words, the banks could loan money again because they would know what their inventory of money really is. Right now, they do not.

“A bad bank, perhaps run by the Federal Deposit Insurance Corp., would be a big step toward patching up the financial system,” Michael Mandel wrote in Business Week. “However, a bad bank would not eliminate the toughest choices that need to be made. In particular, Treasury Secretary Timothy F. Geithner, FDIC head Sheila C. Bair, and other regulators would still have to decide which banks are insolvent and need to be closed, partly nationalized, or completely taken over.”

What about the government running the banks? It would not make much difference, really. The government would not do a bad job at running the banks since clearly no one has done a good job at it. The problem is the borrowing. The federal government already borrows over a trillion dollars a year. Nationalizing our banks would add trillions of dollars more.

It is not that the government is not already in the banking business, either. Last September Uncle Sam stepped in and effectively nationalized two of the largest mortgage buyers in the country. The government placed Fannie May and Freddie Mac into conservatorship. It could because it backed both of those companies, which had federal charters.

It might have been hard to imagine before the election, but even Republicans such as Senator Lindsey Graham (R-SC) concede that nationalization may be necessary. “To me, banking and housing are the root cause of this problem. I'm very much afraid any program to salvage the banks is going to require the government . . . I would not take off [of the table] the idea of nationalizing the banks."

The president opposes it. "This administration continues to strongly believe that a privately held banking system is the correct way to go, ensuring that they are regulated sufficiently by this government," White House press secretary Robert Gibbs said when asked about nationalizing the banks. I am suspicious whenever a White House press secretary says anything because that is how it launches trial balloons.

Lawmakers already semi-nationalized the banking sector after the first rumbles of the credit crisis last fall. The Bush/Paulson treasury forked over $350 billion in government aid to more than 300 institutions in turn for some of those firms’ shares and other securities. Bank nationalization worked in Sweden with its five banks while we have thousands of banks here, but that does not mean nationalization cannot work here. To say “no” to nationalizing US banks because that is not the way we do things in the good old USA does not make much sense. The First Bad Bank of the United States is an idea whose time has come.

Originally published in Blogcritics Magazine, February 10, 2009

Broke Banks Mounting

I would like to write the story that is published beneath the headline “Banks and Credit Card Companies Lead Country to Prosperity.” It should be clear that there are things bankers do not know how to do, such as lead. I am also troubled that bankers do not know what to do with the tax dollars they have received from the Troubled Asset Relief Program (TARP), such as lend. Since I cannot write that story, please accept this one.

If ever there was an industry that needs some positive public relations, it is banking. Bank failures have become common place. In Georgia, for example, there have been five bank failures in the last five months and the hits just keep on coming. Another fifteen banks are expected to go under this year, more than twice the number that collapsed there during the savings and loan crisis twenty years ago.

Until last year, California had seen only 3 bank failures during the previous decade – in 1999, 2000 and 2003. According to the FDIC, California suffered 5 bank failures in 2008 alone.

· PFF Bank and Trust, Pomona, California, closed.
· Downey Savings and Loan Association, F.A., Newport Beach, California, closed.
· Security Pacific Bank, Los Angeles, California, closed.
· First Heritage Bank N.A., Newport Beach, California, closed.
· IndyMac Bank, F.S.B., Pasadena, California, closed. (The FDIC was named Conservator.)

Banking is a highly regulated business. Despite news commentaries that bankers got greedy as banks were deregulated and became corrupt, bank consumers have protection. In the case of IndyMac Bank, the third-largest bank to fail in American history, a run on deposits and rising defaults made Federal regulators seize it.

The mortgage loan portion of the banking business earned derision for being lax and, in some cases, predatory in its lending practices. Federal Reserve Chairman Ben Bernanke says that a sustained economic recovery may require additional bailouts of financial institutions. However, the business loan portion of banking has become the collateral casualty that threatens the country’s economic recovery.

As a business management consultant experienced in dealing with bankers on behalf of my clients, it is clear to me that business loan criteria are in flux. Even clients with excellent credit, strong assets and positive history are being denied new loans and are incurring decreased credit lines. New financing does not seem to be happening. Does that mean banks are not lending money to small businesses? They say that they are but that assertion is inconsistent with my clients’ are experiences.

Banks make money by selling the use of money, right? “If the borrower provides the bank with both a belt and a pair of suspenders,” Joe Nocera wrote in the New York Times, “the loan is being granted.” However, “[i]n addition to not making new loans, the banks are systematically withdrawing commitments and capital from the economy.”

So what about the Economic Stimulus Package of 2008? It is about tax breaks for businesses that spent money on property and vehicles last year while their credit lines were getting trashed. According to the Packages press release, “This new legislation will not only benefit small businesses in a variety of ways, but it will also provide an economic boost to the entire nation.” Bold words in that generalization do not change the fact that “there are exceptions and additional requirements.” Tax credits for small businesses that create jobs sound fine, but it takes money to make the payroll to pay for the jobs to qualify for the tax credits.

Consider this: it is not that bankers are greedy, they are just not thinking of anything except their bank as directed from the home office. They do not make informed decisions, they just react. That is not greedy, that is stupid. Additionally, from the previous bailout round of the dying days of the Bush Administration, there is no mechanism to hold the banks accountable for putting bailout money into circulation.

Bank accountability is about to change with the new administration. Specifically, the government might force banks to make loans they would otherwise avoid. It is certain that the Obama administration wants to avoid more stupidity, such as those of the Bush Treasury secretary, Henry Paulson “who sold Congress on an elaborate strategy for shoring up banks and then shifted to an entirely different approach before he even got started.”

A retreat is in order. Banking and bank shareholders have no choice but to go along with a change that will mean making less money by taking less risk.

Meanwhile, forces for the benefit of small business—the largest aggregate employer in the United States -- are seeking the administration’s ear. The National Development Council wants a $75 billion small business stimulus package and a Cabinet-level position to coordinate federal resources for small businesses. Additionally, the National Small Business Association is seeking congress’s ear, asking for 25 percent of TARP funds to be aimed at small business lending and a mandate that 23 percent of stimulus infrastructure funds be contracted out to small businesses. Both are debatable requests.

Another debatable move is that of credit card companies like American Express. In November the Federal Reserve granted a request by American Express to become a bank holding company and access to low-cost financing from the Fed. Just like the banks, Amex also cuts back credit lines regardless of business or personal credit worthiness or history. The credit card business is a trillion dollar a year industry, cunning, predatory and greedy.

At the top of the banking food chain are some serious minded criminals who got away with being sharks in the Bush Administration’s pool. While the former president may avoid prison, I hope that those lesser crooks at the top serve time. Nor do I believe that bank shareholders, whom the crooks served, should prosper at taxpayer expense while the banking system undergoes its overhaul.

Small business needs direct financial help to grow our pillaged economy and to create the jobs promised by the new administration. Tax credits alone cannot make job growth happen. The new congress and administration need to hear from us. We will have to make prosperity happen. They will have to help us.

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Originally published in Blogcritics Magazine, January 22, 2009