Full disclosure: I love Andrew Ross Sorkin’s Too Big To Fail and think everyone should read it. But having said that, Sorkin has spent a bit too much time running with the big dogs.
In today’s piece in the New York Times, he hones in on an amendment added to the Paul/Grayson bill passed last week that is admittedly problematic (I was asked by a Congressional staffer about it, I said I thought it was badly thought out and gave the reasons why). But Sorkin comes off as if he has become a mouthpiece for the aggrieved officialdom (in this case, the Fed) when there is more to the story than meets they eye.
First, let’s start with the eyesore. From Sorkin:
Representative Brad Miller, Democrat of North Carolina, and Representative Dennis Moore, Democrat of Kansas, added their own bell-ringer for voters still outraged over bailouts: the next time the government has to step in and rescue a company, secured creditors will take a hit, too.
That would be a huge shift in the way bondholders are treated. Up to now, they’ve been kept whole, even as others have been asked to share the pain. Otherwise, some feared, creditors might get spooked, and lending might seize up.
Yves here. On this level of abstraction, Sorkin is dead wrong. As we saw with the SIGTARP analysis of the the AIG non-negotiations with the banks who had credit default swaps exposures to the failed insurers, the banks should have taken haircuts on their CDS. If AIG had gone into bankruptcy, who knows how little they would have gotten (even assuming their companies survived the fallout, a very big if) and how long it would have taken. But given the need to move fast, the Fed just went ahead and did the rescue, and didn’t bother with costly details like getting the best deal (and frankly, the Fed is not in the negotiation business, so the idea that they lost ground in the “shape of the table” stage never occurred to them).
But the point here is more general. Creditors take hits in bankruptcy. If a bankruptcy is untenable (as in it might pose a systemic risk), why should the taxpayer get a worse deal? There should have been an explicit reference to the notion that the objective was to create an outcome that was comparable to what might result via a bankruptcy process to help guide action.
So the problem is NOT with creditors taking a hit. Creditors ARE risk capital, if they made bad decisions, they should take their lumps before innocent bystanders like taxpayers. That is a perfectly sensible idea.
What is wrong is this PARTICULAR amendment was just lame. But before we get to that, we have what amounts to ad homimem attacks on those who want to rein in the Fed. Revisit his language:
…. the next time the government has to step in and rescue a company, secured creditors will take a hit, too.
Yves here. Again, Sorkin is wrong-headed. He needs to bone up on bankruptcy law. In commercial bankruptcies (and that is what we are talking about here), secured loans are written down to the value of the collateral. Again, secured creditors are not as sacred as he thinks they are. In fact, one can argue that the bill is too liberal. It allows loans to secured creditors to be cut only by 20%. What if the collateral is worth only 50% of its face value? Even a 20% reduction would be too low. Back to the article:
That would be a huge shift in the way bondholders are treated. Up to now, they’ve been kept whole, even as others have been asked to share the pain. Otherwise, some feared, creditors might get spooked, and lending might seize up.
Yves again. Um, per above, no, this is NOT a huge change, the idea that bondholders could not be messed with is a very new phenomenon that took hold in the bailouts made in this crisis. And now is the time to undo that. Back again to the story:
One other amendment was added, as well. Representative Paul E. Kanjorski of Pennsylvania proposed giving regulators power to undo firms deemed to be too big to fail.
All of these amendments, which are part of a 300-page bill to reform the financial industry that is making its way around the House of Representatives, are intended to help quiet some of the outrage over the bailout.
Yves here. As we noted last week and as further discussed in a post by Ed Harrison, the Kanjorski moves are charades at best and actually in important respects make it harder to corral banksters.
But the key bit is in the next sentence: the accusation that the reforms measures are merely efforts to appease voters. First, that implies that the only reason for reform measures is to appease the angry public. Gee, the banking industry just drove the economy off the cliff, and the Fed and Treasury just stood by and watched. I’d say that is prima facie evidence of a need for a change.
Second, it suggests that everyone in Congress is just out to play to the lowest common denominator. While I would say that that is very often true, it is quite another thing to say that that is universally true. One of the big problems now is the artificial time pressure. The perception is that if reform measures are not passed now, they will not be passed after the Christmas recess (as in they will drag on into March-April, lose momentum, and never get done, because the longer they drag out, the closer they get to mid-term elections). So in the interest of trying to seize what may be the only window until the next train wreck, a lot of stuff is being pushed through. Some of the bad drafting may reflect sheer cynicism, but it may also be the result of the nutty timetable.
So the process is defective. But we also have a Fed that has performed very badly. Yet the scaremongering is decidedly one-sided:
But consider these words of caution from Senator Judd Gregg, Republican of New Hampshire: “Congress has demonstrated time and again its inability to manage the nation’s fiscal policy, illustrated by our staggering national debt in excess of $12 trillion. So how can anyone think that its involvement in monetary policy would be good for the country?”
So any unintended consequences of the amendment — what Senator Gregg calls “a dangerous move by this Congress to pander to the populist anger” — could indeed lead to less independence for the Federal Reserve, and the result ultimately may not be good for the economy.
That has been Fed Chairman Ben Bernanke’s line all along. He does not want the Fed to be a puppet of Congress. And on that score, he is probably right. Could Paul Volcker have raised interest rates in the early 1980s to nosebleed levels if Congress were pulling strings? What would happen in an election year? Interest rates would invariably go down, only to go up again later.
Yves here. Ahem. Who proposes budgets? It’s the executive branch. The deficits can hardly be pinned solely on Congress (as I dimly recall, it was Bush who gave us the combo plate of tax cuts and very costly Middle Eastern misadventure. And we’ve had 40 years of imperial Presidents, with Congressional power slowly eroded. Lyndon Johnson would be spinning in his grave if he could see what goes on now.
And look at the rhetorical tricks. Some checks on the Fed suddenly becomes the Fed turning into a puppet of Congress. Huh? The Fed has abused its role and the pushback is long overdue. The Fed lost its vaunted independence in the Greenspan era, when he started throwing his weight behind various Administration initiatives. That was a huge break from the past. And it got vastly worse under Bernanke, with the Fed operating as an off-balance sheet entity of the Treasury to evade normal Constitutional budgetary processes. This is simply heinous, but you’d think the Fed was completely innocent and undeserving of such rough treatment if you read only this article.
This article is badly one-sided and reads like a PR plant from friends of the Fed. I’m the first to admit the proposed legislation has problems, but it is quite another thing to depicts its objectives as illegitimate, and to create the impression that any measures along these lines would be damaging.
Update 11/25/09, 1:30 AM: Apologies for not updating this sooner. I have been on mission this week, and not spending much time on the blog.
Brad Miller weighed in in comments, and clarified a key issue that I had wrong in the post. While his amendment does provide for fully secured creditors to take an up to 20% haircut, there is already a provision in the bill for collateralized loans to be written down to the value of the collateral. Thus the up to 20% haircut is in addition to that.
This is the rationale for this measure:
The creditors to whom the amendment would most likely apply would be existing creditors who see the collapse coming and are in a position to demand more and more collateral. Only a desperate management agrees to tie up all of the firm’s liquid assets as collateral for short term debt. In those cases, the FDIC should probably not wait until Friday night to knock on the door. The resolution would certainly be easier, and cheaper, if the firm still has some assets that aren’t pledged as collateral.
If the amendment deters short term lending to collapsing companies that allows some creditors to grab enough collateral to cut in line ahead of taxpayers on resolution, that’s okay. That’s an intended consequence.
I’m not certain I like this idea either, and I need to ponder it further. I’ll be elaborating in another post.
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“That would be a huge shift in the way bondholders are treated”
Well, I would hope so. Now I know Mr. Sorkin is only in the 9th grade, but waaaaay back in the ninties, and before that, we had what was known as “profit and LOSS.” That is, you took RISKS, and you got rewards. Higher the risk, higher the rewards. Somewhere when we got the idea of all borrowing, all the time, and it became unpatriotic to pay cash, I guess the idea took hold that the number one industry of American is finance – and finance depends on bondholders – so if we make sure they never, ever lose money, all will be well.
As the song says in the other posting, RISKLESS Christmas to all!
This article (regarding which I began drafting my own post which I’ll have up later this morning) is another case study in the Status Quo Fraud.
The status quo, however extreme, aggressive, unnatural, ideological, and politicized, is represented as the normal, moderate, rational, natural, nonpartisan baseline.
Meanwhile any call to change, however reasonable, responsible, democratic, however much it would tend toward moderation, accountability, the public interest, is represented as extremist, irrational, demagogic, an affront to nature and god, lese majestie.
Of course that’s not surprising coming from Sorkin, who for me will always be the errand boy delivering the stickup message from AIG thugs demanding their “bonuses” last spring, “pay up or else”.
(Too Big to Fail does sound like a good book, though, and I look forward to reading it. Maybe he thought he needed to take a different ideological tack writing for a general audience rather than the NYT biz page corporatists.)
Sorry, I screwed up my http address there.
I don’t know why I need to keep retyping it every time. Other wordpress blogs don’t have that problem.
Your description of the Status Quo fraud is a keeper. I am so saving that, attribution included, of course. :-D
Allow me to correct one thing: “lèse majesté” would be the correct spelling, as in the famous expression “un crime de lèse majesté”.
Thanks! I think it’s a useful concept, given how omnipresent the phenomenon is in today’s media coverage and political framing.
Thanks for the correction. (I knew about the marks over the vowels, though I need to look up how to type those.)
The “Bair-Miller-Moore haircut” amendment fits into the bill right after a paragraph that provides that secured debt is written down to the value of the collateral, and the amount of the debt in excess of that is treated as unsecured. In other words, the rule of bankruptcy that applies to all secured debt (other than homes in which families actually live)applies to the secured debt of the systemically significant financial firm. The amendment only applies to “fully secured” creditors. There may be some ambiquity about whether less than fully secured creditors will have their secured debt reduced to the amount of the value of the collateral, and then get a haircut, but that’s fixable.
More fundamentally, we’re not talking about bondholders here, nor are we talking about firms that teeter over into insolvency with liabilities slightly exceeding assets. Bondholders are generally unsecured creditors. Shareholders and bondholders would lose everything before secured creditors would lose anything. Also, general unsecured creditors would lose everything (except to the extent they get paid something as part of keeping the firm going to avoid systemic collapse) before secured creditors lose anything. When shareholders, bondholders, and unsecured creditors lose everything and taxpayers (or the insurance fund) still don’t get made whole, there was almost certainly a spectacular, catastrophic, Hindenberg-like collapse.
The creditors to whom the amendment would most likely apply would be existing creditors who see the collapse coming and are in a position to demand more and more collateral. Only a desperate management agrees to tie up all of the firm’s liquid assets as collateral for short term debt. In those cases, the FDIC should probably not wait until Friday night to knock on the door. The resolution would certainly be easier, and cheaper, if the firm still has some assets that aren’t pledged as collateral.
If the amendment deters short term lending to collapsing companies that allows some creditors to grab enough collateral to cut in line ahead of taxpayers on resolution, that’s okay. That’s an intended consequence.
Oh, I still planning to read Too Big To Fail, but I’m going to check it out of the library instead of buying it.
Yes I fully agree I’m not paying for the book after this piece.
In the sense that Sorkin is a mouthpiece, it was probably a quid-pro-quo for the access needed to write the book. Hes no different to rating agency payola
There seems to be a running misconception that debt is different from equity. It isn’t, except for tax treatment (and I’d like to see that away too).
Debt is only a different name for super-senior redeemable preference shares (and stands somewhere between voting and non-voting ones, as it large debtors can influence a company more than a board of directors. Just ask a small business how much their bank controls their life).
If a company has no assets, its debt has no value – the same as equity. Anyone who believes differently is deluding themselves.
Unfortunately, this delusion is widely shared. The first step to remove the delusion is to remove different tax treatment for debt and equity.
Two points we must all remember: 1. The Fed is not independent. Their member banks spend untold millions on lobbying the Congress and the Senate; that is not independence. Conversely, independence should not mean unaccountable, particularly to the sovereign people of the U.S. 2. The Fed must be politicized; our vote is the only tool for accountability that the sovereign people hold over them. We have to maintain the ability to vote the Congress and the Senate out of office, and to vote the Fed out of existence if they become unaccountable. Do not fall for the independence or politicizing of the Fed propaganda.
Please do some editing on this piece.
Collateral doesn’t get lost or tied up in these arrangements. It gets sold since it’s held by the counterparty (like Goldman).
Maybe AIG was bailed out because it was about to file for bankruptcy. Apparently Moodys and AMBAC weren’t.
Thank you Yves for debunking that piece of garbage by Sorkin.
I read some extracts of his books in Vanity Fair or I don’t remember what magazine. He obviously had a lot of access to all those Wall Street bigwigs. That already made him suspicious in my eyes. Why would they trust him? Now we know. He is paying them back with that dirty piece of propaganda.
I certainly will not buy his book. I don’t need to see Wall Street scumbags depicted as heroes scrambling to save our financial system.
Hey man, what do you mean, “Wall Street scumbags”? Didn’t you hear they’re doing god’s work?…lol
Vinny
PS- note the lower case “g” in the word “god” above…
The concept that investing happens without risk is the primary lie of a Ponzi scheme. Financial products have been sold to a generation of ‘unsuspecting savers’ under the guise that markets always return a positive value. Wouldn’t you invest your money in AAA rated securities that always appreciate in value? One would be stupid not to! But that was just the sales lingo. Everyone who sold these products understood that they were “weapons of mass financial destruction.” While I have little simpathy for the “unsuspecting savers” who didn’t learn about the products they purchased, I am more chiefly concerned with Congress allowing the existence of the Federal Reserve System, an inherent farce that only benefits a few “too big to fail” investors/banks at the expense of the greater economy [the rest of us capitalists]. Capitalism works when the rules are applied equally. When a TBTF mega-bank was bankrupt, I expected it to be bankrupt … and I made financial decisions based upon that reasoning. Having been betrayed by the actions the Fed took to circumvent the Rule of Law, I feel that the only solution is to completely dismantle the Federal Reserve System and expose the cronyism of back-door money laundering.
Only in a fair market can I achieve the vaunted American dream. I cannot compete against the Federal Reserve guaranteeing trillions to the banks that I am in direct compeition with. Their implicit guarantee by the existence of the Federal Reserve is the primary threat against the fairness of the capital markets. And coincidently, the primary problem with the job-market.
If you can’t beat them … cheat them. Has become the mantra of Wall Street’s “too big to fail” system of mega-banks.
After viewing the issue through Salmon-colored glasses:
“But neither Yves nor Andrew Ross Sorkin nor just about anybody else seems to be able to get a grip on what exactly the Miller-Moore amendment does, despite the fact that it’s all of 160 words long. Here’s Smith:
‘One can argue that the bill is too liberal. It allows loans to secured creditors to be cut only by 20%. What if the collateral is worth only 50% of its face value? Even a 20% reduction would be too low.’
This isn’t true — in fact secured debt is only secured to the value of the collateral. That’s perfectly standard, and it’s in the original bill, and therefore doesn’t need to be amended by Miller-Moore.”
Response?
Uncle Billy,
You are assuming the lender seizes the collateral, as opposed to gets a cash settlement or has the debts restructured. The bill presupposes case settlement or restructuring.
Look at AIG, and residential mortgages for other examples. The value of the CDS (in AIG’s case) nor the value of the secured loan (in the case of the mortgage) is NOT written down to reflect the impairment. This is regularly discussed in bankruptcy law courses (see Elizabeth Warren). It comes up very often on furniture loans (the principle is called “hostage value” that banks are able to extract more than the collateral is worth). Similarly, in commercial bankruptcies, the value of mortgages is written down to reflect the current value of the property when the mortgage balance is higher than the value of the real estate.
Take that a bit further. The lender either receives the property; or, he receives the net proceeds of the liquidation of the collateral. If the adjudication is in Chapter 11, the loan may be extinguished and the lender receives title to a new loan in a lessor amount. Note, the mortgage and the loan are two separate contracts that are joined at the hip. If the collateral goes poof, the loan continues but the mortgage is moot. This latter event is commonly called a cram-down. What is occuring is that the secured lender is sharing in the losses that are being inflicted on unsecured creditors. This is an event that should only occur in extraordianry circumstances.
Sorry, didn’t make it clear (and forgot to post the link) that this came from here:
http://blogs.reuters.com/felix-salmon/2009/11/24/clearing-up-miller-moore/
Thank you for the clarification.
Why don’t people realize that regardless of what you are investing in there is always risk. Yves, you bring up an important point that so few people ever realize.
Please re-edit this “Scare-Mongering Over Fed Oversight Bill” piece … the quotes from Sorkin’s article seem misplaced and not clarified against your writing.
That being said, excellent points … as always.
Jeff,
I’ve checked the piece and do not see what the problem is. My comment in each case relate to the Sorkin material directly above.