New Treasury Plan: This Ain’t Yo’ Momma’s TARP

Treasury officials are considering a new plan, the New York Times reports, to help banks recapitalize: they’d convert their current loans into common stock in the bank, which would translate to actual equity and, perhaps, the accompanying power that comes with being a shareholder.  This would include some power to decide who stays on the board and, yes, would probably be a big step toward nationalization — all without having to ask Congress for any additional money.

The problem is that, for at least some of these banks, we’d be converting not just loans, as the Times leads with, but preferred stock into common stock.  One stock for another? Paul Krugman was quick to call the plan baffling, and he came up with this analogy:

Here’s how I think about it: you started a business with a bunch of borrowed money, but of course had to put some of your own money in. Now, actually some of the money you put in was borrowed from your mother, but the original lenders don’t care about that, since they have prior claim.

Eventually you run into some business difficulties, and your creditworthiness is in doubt — which in turn is making it hard for you to do business. What you need is evidence of ability to repay the money you already owe.

So does it help if your mother converts her loan into a share of the business? Not really, because she won’t get repaid anyway unless all your other creditors get paid first. So the terms of her agreement with you don’t affect their prospects of payment.

And in this case, the TARP is your mother.

OK.  But I think it actually would help me, as a business, survive — and would certainly increase the confidence lenders had in me — if my mother happened to have a GDP of $14 trillion when she became an official part-owner of my business.

No?

If that seems too cute by far, Felix Salmon likes the new plan, too, and says it in actual econo-speak.  I’ll try and translate, but he’s speaking pretty plain English, too (this is me suggesting you scoot over and read him; he’s very good).  Essentially, whether you like the new suggestion or not depends on how you looked at the original preferred stock plan.  If, like Krugman, you considered preferred stock to come with equity, then this plan makes very little sense — it’s a swap of what we have for what we have, only with increased risk of losing everything.  But Salmon makes the argument that preferred shares didn’t automatically confer ownership in the same way that common stock does, which seems to be generally true of preferred stock.  Preferred stockholders are exactly that — preferred — in the case of bankruptcy.  They (usually) get their money back just after bondholders, and certainly always before common stock holders.  In exchange, preferred stock usually doesn’t come with voting rights, and isn’t usually as profitable in the long term as common stock.

The glass-half-empty way to look at this is that, if any of the nation’s 19 largest banks go under, we’re trading stock that would have guaranteed us at least some of our money back for stock where we could very well and easily lose everything.

Glass half full?  We’re trading stock that gave us no say-so for stock that lets us start cleaning house, at least in a few places, and if we really get the house cleaned, we have a better chance of turning a profit.

I’ll just be over here drinking the rest of the glass.  Now that TARP is my mother, I assume my inheritance is going to be huge.

Dear Public Officials: Stop Being Dumb

I’ve been reading a microecon textbook recently, because I am admittedly in over my head every time serious discussions of the topic come up.  Recently, they’ve come up every day.  Since I wax on publicly about economic policy from time to time, I figured I literally needed to do my homework.  (You can do my homework, too — MIT offers free online course materials for a number of their econ classes).  I also read a couple of economics blogs every day, just to see what the people whose econ homework is decades behind them are saying, and I follow this up with the aforementioned dose of the Wall Street Journal.  I present this information not to show that I’m uniquely or even adequately qualified to be talking about this, but to give anyone who reads this an idea of where I’m coming from when I say this:

Some of our public officials are massive idiots.

There are two glaring examples of this right now.  Rachel Maddow has nicely covered the idiocy of Republican Senator Burr (from North Carolina), and here’s a nice one-minute round up (full disclosure: put together by the Democratic Senatorial Campaign Committee) of what he did:

Maddow also nicely, and with a heavy dose of snark, described what’s so troubling about this incident on her show:

OK.  First of all, she can‘t just go in and talk to a teller?

Second of all, the FDIC insures your freaking deposit, Senator Genius.  Third of all, you think it‘s worth making a “run on the bank” anyway because of what you‘ve learned in Washington about what‘s going on in the financial sector but you don‘t tell your constituents.  You instead just use that information you‘ve got because of your position as a senator to protect your own family?

And fourth, what kind of a genius admits to having done this and suggesting a “run on the banks” in public?  What kind of a genius?  A genius named United States senator from North Carolina Richard Burr, that‘s who.  If you‘ve never heard of him, it‘s probably because he‘s vying with the likes of Senators Barrasso and Crapo to be the most anonymous member of the United States Senate.

Well, he was.  Now he’s a little better known, thanks in part to an angry response he sent to Maddow that she tore apart on air later in the week.  (She also described Burr’s actions in much less snark-tastic terms during last Friday’s show).

So we have a Senator who thinks bank runs are a prudent, All-American response to a financial disaster.  Excellent.  Who can top that?

How about a Detroit City Councilman who decided to walk away from his dream home this week — not because he was about to be foreclosed on, but because he was underwater in his mortgage?  City Council member and probably mayoral candidate Kwame Kenyatta (a Democrat) and his wife, a former city commissioner, saw their home value fall from $225,000 to $100,000 this year, and faced a $1,000 increase on their $2,600 mortgage payments.  So they walked away in December and rented a condo instead:

Walking away from a mortgage isn’t illegal; the bank takes possession and tries to sell the house. But “it just puts more properties in foreclosures, and that’s the last thing we need right now. That’s just pulling the median sales price down,” said Karen Kage, who runs a real estate listing service in suburban Detroit.

In Detroit, the median sales price for a home is now a pathetic $5,800, down more than $66,000 from seven years ago. An estimated 16,000 foreclosed homes are on the market in the city of about 920,000 residents. Detroit also has one of the highest unemployment rates in the nation, at around 20 percent.

Kenyatta’s former neighborhood, North Rosedale Park, is unlike most of the rest of Detroit. Stately, well-kept brick homes line quiet, winding streets. It fights to hold off blight from surrounding northwest side neighborhoods.

Kenyatta’s former home is the ugly duckling on its block. Dead grass spreads gray across the lawn. Withered advertising circulars are strewn about the porch and the hedges.

I am sympathetic to the Kenyattas’ problem, particularly the upcoming mortgage-rate adjustment — but my sympathy lies more strongly with their neighbors.  “‘If I’m going to follow you, you need to be a leader,’ said Patricia Dixon, a former neighbor of Kenyatta’s. ‘You don’t show leadership by walking away from your home in the city of Detroit. You have vandalism where they find out the houses are vacant. You have people stealing fireplaces.'”

If you are going to be in government, you must be focused on and capable of real leadership.  Maybe Kenyatta and Burr both consider themselves leaders — maybe other people do, too.  But the direction both are leading people toward is a very dangerous, irresponsible direction.  Our financial system — and our financial recovery — hinges upon people doing the right things, on people doing things like leaving their money in the banks, paying their taxes, staying in their homes and making their payments, and generally contributing to an overall return to financial health that will require, at times, moves that seem against an indvidual’s short term interest — but which have long-term dividends to offer in the form of a functioning, expanding economy.

The financial issues facing us at every level — local, statewide, nationally, and internationally — are terribly complex.  Most of us, and I include these men, do not have the time to understand every aspect.  But if you’re going to take a job where you’ll be charged at some point with making decisions about these complex issues, you should at least be familiar enough to understand how your own actions figure into overall economic health.  (And if not — you should find a staff member, or an online course, or a nearby community college, to help you figure this stuff out, particularly if you’re being paid for it).

I hope, I truly hope, that both of these men made their decisions based simply on ignorance of the issues, and not upon some idea that it’s OK to put personal interests ahead of those of the public, but my suspicion runs in the other direction.