The Moral Hazard of the “Bad Bank”

I’ve been closely following the various (new & improved!) bailout plans for the big banks — from the modified TARP to the recapitalizations to the “bad bank” plan.I’ve noticed something I find a bit disturbing about our new Treasury Secretary: He has not yet fully come to terms with his new job, role — and boss. Granted, he’s been in the job for only two days. But given the extraordinary circumstances the financial sector and the economy is in, it is important for the Treasury Secretary to get up to speed as soon as possible.

Consider this statement from Geithner, who said that Treasury  is considering a “range of options” for its financial rescue plan, with the goal of preserving the private banking system.  “We have a financial system that is run by private shareholders, managed by private institutions, and we’d like to do our best to preserve that system.”

No! Defending these idiots was your old gig. In the new job, you no longer work for the cretins responsible for bringing down the global economy. Please stop rationalizing their behavior, and preserving the status quo!

Yesterday’s 13% surge in bank stocks is a clue as to what an obscene taxpayer giveaway this “bad bank” plan is — its free money for the firms that caused the problems, many of whom still have the same incompetent  management in place that caused the problem. Purging toxic assets from bank balance sheets, without punishing the management, shareholders and creditors of these institutions for their horrific judgment will only encourage more of the same in the future. Its moral hazard writ large.

A few reminders for Geithner that are of the utmost importance:

  • ▪ You no longer work for the Banks: The NY Fed is a private corporation, doing the bidding of the FOMC and its private sector owners — primarily, the primary dealers. In other words, the President of the NY Fed works for the biggest commercial and investment banks in New York. That is no longer operational for you.
  • ▪ As Treasury Secretary, your immediate boss is the President, and your ultimate charge are the citizens of the United States, and the finances of the country.
  • ▪ When any conflict comes into play between the nation and the banks, you as Treasury Secretary are on the side of the Nation.
  • ▪ You cannot serve two masters, especially when they are in direct conflict with each other.

When the post-script to this era gets written, I suspect we will learn all sorts of unsavory facts about the former Treasury Secretary, and how he unfortunately had a tendency to believe he was working for the benefit of Goldman Sachs.

The new Treasury Secretary has that mental muscle memory of who his former employers were. He needs to concentrate on the new job, and who he works for. Unfortunately, the early signs suggest that he has yet to figure this out. Let’s hope that changes. Fast.


UPDATE:  January 29, 2009 at 11:45 am

I was just on the radio with Mike Norman, who insisted that the NY Fed is not a private company owned by the primary dealers.

Um, wrong:

Article IV – stock of the bank

Ownership of stock of the Bank, issued to member depository institutions in accordance with law, may be evidenced by advices signed by the President or his/her designate, or by certificates bearing the seal of the Bank and the signature of the Corporate Secretary or an Assistant Corporate Secretary.


Sources: Geithner Says ‘Range of Options’ Considered for Banks Robert Schmidt and Rebecca Christie Bloomberg, Jan. 28 2009

Geithner Says Plan for Banks Is in the Works STEPHEN LABATON and EDMUND L. ANDREWS NYT, January 28, 2009

Bylaws, Board of Directors Federal Reserve Bank of New York December 20, 2007

Originally published at The Big Picture blog and reproduced here with the author’s permission.

6 Responses to "The Moral Hazard of the “Bad Bank”"

  1. Guest   January 30, 2009 at 5:43 am

    Nice! Finally, someone to tell it like it is – thank you. We, the people, don’t want to play the ‘debt game’ any longer

  2. Guest   January 31, 2009 at 3:14 pm

    Obama and Geithner will go down in history as the 2 most responsible people who had that last moment to save this country, yet served anyone else, but the American people.How could we expect anything else from a guy who intentionally “forgot” to pay his taxes, and a president who is “American Idol cool” and voted in by sheeple, but is utterly clueless, or simply doesnt care what happens to us.Maybe we ought to have a “task force” about it so we can “talk” and not DO anything.

  3. Paul Fraser   February 1, 2009 at 5:29 pm

    RBC Bank President Gordon Nixon – Salary $11.73 Million$100,000 – MISTAKE (FISHERMEN’S LOAN)I’m a commercial fisherman fighting the Royal Bank of Canada (RBC Bank) over a $100,000 loan mistake. I lost my home, fishing vessel and equipment. Help me fight this corporate bully by closing your RBC Bank account.There was no monthly interest payment date or amount of interest payable per month on my loan agreement. Date of first installment payment (Principal + interest) is approximately 1 year from the signing of my contract.Demand loan agreements signed by other fishermen around the same time disclosed monthly interest payment dates and interest amounts payable per month.The lending policy for fishermen did change at RBC from one payment (principal + interest) per year for fishing loans to principal paid yearly with interest paid monthly. This lending practice was in place when I approached RBC.Only problem is the loans officer was a replacement who wasn’t familiar with these type of loans. She never informed me verbally or in writing about this new criteria.Phone or e-mail:RBC President, Gordon Nixon, Toronto (416)974-6415RBC Vice President, Sales, Anne Lockie, Toronto (416)974-6821RBC President, Atlantic Provinces, Greg Grice (902)421-8112 mail to:greg.grice@rbc.comRBC Manager, Cape Breton/Eastern Nova Scotia, Jerry Rankin (902)567-8600RBC Vice President, Atlantic Provinces, Brian Conway (902)491-4302 mail to:brian.conway@rbc.comRBC Vice President, Halifax Region, Tammy Holland (902)421-8112 mail to:tammy.holland@rbc.comRBC Senior Manager, Media & Public Relations, Beja Rodeck (416)974-5506 mail to:beja.rodeck@rbc.comRBC Ombudsman, Wendy Knight, Toronto, Ontario 1-800-769-2542 mail to:ombudsman@rbc.comOmbudsman for Banking Services & Investments, JoAnne Olafson, Toronto, 1-888-451-4519 mail to:ombudsman@obsi.cahttp://www.pfraser.blogspot.comhttp://www.corporatebully.ca″Fighting the Royal Bank of Canada (RBC Bank) one customer at a time”[8o|]

  4. Anonymous   February 2, 2009 at 1:54 pm

    Don’t you think Germany has the right idea. Separate each banks bad assets from good assets and set up two sections of each bank individually so that the bad assets are attached to the banks that have them.

    • Nick Marshall   February 3, 2009 at 9:56 pm

      The only good thing about the German idea is that it would allow insolvent banks to be wound up in an orderly fashion. Bad assets are still bad assets. Time may repair some value – that is they may be worth more than firesale value. But that is only an assumption. The fact is that values of everything (except moral values) were driven sky high over the last decade by credit inflation. So what solution are governments offering? More credit inflation. This will not work. The problem is that after 20 odd years of spendthrift behaviour no-one wants to borrow or lend. Optimism is out and caution is in. People are beginning to save again. The result is that the $52 trillion pool of credit is shrinking faster than central banks can inflate. This is not all bad debt but it is all subject to deflating collateral values and thus all that debt is being re-priced downwards. That is deflation. At one time, in the 60s, every new dollar of credit could bring nearly $5 of added GDP. Now it is less than one for one. Credit will contract until it can be supported by new production. By the time it is over our perception of values will be radically altered. It may well be that fire sale values offered now will be the best that is ever going to be available. No one wants to believe that, of course. The history of markets shows that hope prevails over reality until the final sellout. So you can expect politicians aided by the very people who were at the epicentre of this catastophe (eg Timothy Geithner) to pour good money after bad. Instead of giving money to the banks, the government would be better off buying up houses across the US. At $250,000 a pop, $1 trillion buys 4 million houses. Perhaps it would take $3 or $4 trillion but it would put a stop to foreclosure and the vicious circle of plummeting house prices. The problem is, though, that short of confiscating houses and paying out compensation such a program would be exploited by every real estate shark in the business. The government would end up over-paying just as it will when it takes the bad assets off the banks. Perhaps such draconian leadership is necessary. It could be argued that FDR showed such leadership by confiscating gold in the 30s. The New Deal is often criticised for prolonging the depression. Perhaps there is no other way.

  5. Guest   February 3, 2009 at 7:45 am

    Thanks for telling it the way it is. Just yesterday I read that Dick Fuld, of all people, is acting as a consultant for Lehman. Someone who had such a poor understanding of the business that he was running that it collapsed is somehow seen as offering value in managing the break-up of that business. From my perspective, the man was criminally negligent and should be as far removed from the corpus as possible.