Tales from Rohan

When you discover that something has gone badly wrong I think it is nice to see if you can easily prevent the same thing from happening again. I noticed that all the banks in Lebanon are flourishing now. Come to find out that they had a rather more minor financial crisis a few years back and the government banned derivatives. Consequently, their banks are rock solid and turning a profit. Digging a little deeper past the knee-jerk reaction “just ban derivatives”, I ask why did banks get in such trouble with derivatives?  Because they didn’t know what they were really worth. There is no standardized accounting method for the derivatives that got all these banks into trouble. Banks get a bunch of special privileges and are regulated at minimum because ordinary deposits in banks are usually government insured. As a trade-off for the special benefit of receiving deposit insurance from the government I think it would be fair to say that banks cannot own or trade in any form of security for which there is a not an industry-wide accounting practice. You could even go so far as to restrict banks trading in securities which have an accounting method approved by a neutral-ish government agency like the very well-respected Government Accountability Office (GAO) in the US.

I am personally very curious what the balance sheet of every US bank would look like if the government just declared that the value of all “toxic securities” was officially zero until further notice and nobody was allowed to trade in them. Would any of the banks look OK if they didn’t have the liability of some of these derivatives? Would some banks look even worse? If there is nominal value still in these securities, the government could declare their ownership illegal, make loans based on the nominal value, and then forgive part of the repayment of these loans in exchange for the nominal value of the seized assets.

I want to shift gears and talk briefly about bankruptcy. The idea of bankruptcy is that it protects someone from their creditors. However this means that if those creditors traded fairly, they get screwed.  Perhaps a useful place for the government to step in and offer money is to offer *creditors* of bankrupt companies a grant or loan (free insurance perhaps) to cover their costs. My idea is that when the economy goes in the crapper, we should reward companies that were still in business doing something useful first. They should not be penalized for selling something to a deadbeat company. I would much rather see my taxpayer dollars go to this kind of creditor payment insurance than to a big bank that did something really dumb, or a big dumb reinsurance company….

I heard today that AIG executives were caught on camera having their second luxury retreat since after they received taxpayer bailout money to the tune of $150 Billion. The previous retreat, just days after the bailout and estimated to cost about half a million, was reported by NPR and ABC among others. Note that AIG currently has a market capitalization under $10 billion, but it needs a $85 billion bailout.

The Fed also said today that they would not use any of the $700 Billion bailout money approved by Congress to buy illiquid derivatives, “toxic” securities allegedly poisoning the financial system (which was the original motivation given for requesting the money). Not a single dollar of this money has been spent buying these “toxic securities”.

Since this brilliant bailout plan is working so well, I am not keen on bailing out US auto makers either. I would love to make sure that the employees still have a good job, but I don’t think these companies are going to do anything with the money other than throw good money after bad.