Economics focus
Beyond crisis management
Bold ideas for solving America’s financial mess
EVERY financial crisis involves a tug of war between the tacticians and the strategists. The tacticians dash from skirmish to skirmish trying to control a crisis, deciding in each case whether taxpayers should bail out a distressed bank, firm or country. The strategists call for a more comprehensive approach to resolving the mess—often involving new government bodies to recapitalise banks or take over troubled assets.
The present crisis in America conforms to this pattern. So far, the government’s response has been ad hoc and focused on crisis containment. The tacticians at the Federal Reserve and the Treasury have put plenty of taxpayers’ money on the line—whether through the huge expansion in the central bank’s liquidity facilities, the loan to Bear Stearns in March, or the government takeover of Fannie Mae and Freddie Mac, the mortgage giants, and, now, of AIG, a huge insurer. But they have focused on staving off catastrophe one bail-out at a time.
Now the strategists are pushing back. From across the political spectrum people are arguing that it is time for America to shift to a more systematic approach. In the past week Barney Frank, the leading Democrat on financial matters in the House of Representatives, Paul Volcker, a former chairman of the Fed, as well as writers of the editorial pages of the Wall Street Journal, have suggested that Congress may need to create a new agency to deal with the mess. All have pointed to the Resolution Trust Corporation (RTC), a government body set up in 1989 to deal with the fallout of the savings and loan (S&L) bankruptcies.
Americans focus on the RTC because it is the country’s most recent example of a comprehensive government plan to deal with a financial crisis. Between 1980 and 1994 almost 1,300 specialised mortgage lenders, known as thrifts, failed. Their combined assets amounted to more than $600 billion. By 1986 these failures had bankrupted the Federal Savings and Loan Insurance Corporation, the federal insurer for the thrift industry. At first the government tried to muddle through by trying to recapitalise the insurer. But the S&L mess escalated. In 1989 Congress created the RTC, an entirely new organisation, to dispose of the failed thrifts’ assets in a way that minimised downward pressure on financial and property markets.
The RTC is not a perfect parallel for today’s needs. It was set up—years after the S&L crisis began—to deal with the aftermath of widespread bank failures. Those who advocate comprehensive action today want to minimise the mess, not just clean up afterwards. Their proposals vary, but many who cite the RTC envisage an institution that buys troubled mortgage-backed securities (not only from failing institutions), putting a floor under their price. Some propose that the putative new agency should manage and write down the underlying mortgages, in effect combining the functions of the RTC with a Depression-era institution, called the Home Owners’ Loan Corporation, which bought and restructured defaulting mortgages. Details are in short supply, but intellectual momentum is building for a broader solution.
Not a moment too soon, suggest the results of a new study by Luc Laeven and Fabian Valencia, two IMF economists.* They examined all systemically important banking crises between 1970 and 2007, creating a database on how much financial crises cost and how they are resolved. The evidence is clear. Tactical crisis containment is expensive and frequently inadequate. In most financial meltdowns a comprehensive solution was required, and the sooner it was provided the better.
The study looks at 42 crises in all, spanning 37 countries. Like America today, most governments began with ad hoc crisis management. In 74% of cases, for instance, governments pumped emergency loans into failing banks or guaranteed their liabilities. An equally common tactic has been regulatory forbearance. Governments allowed banks to hold less capital than was normally required or softened their rules in other ways. These tactical responses, however, often did not work and ended up increasing the overall bill from a crisis. “All too often”, the economists conclude, “central banks privilege stability over cost in the heat of the containment phase.”
No such thing as a free crunch
Sooner or later most governments realise the need for a comprehensive solution to the crisis, involving public funds. This can take different forms, from bank recapitalisation to forgiveness of all the underlying debts. In three-quarters of the cases, governments shored up bank capital by, for instance, injecting preferred stock. About 60% of the time, governments set up institutions to manage distressed assets.
The evidence from these attempts is sobering for proponents of an RTC II. Some institutions worked well. In the early 1990s, for instance, Sweden successfully set up an asset-management company to take over and sell the bad loans from its biggest banks. But, in general, the paper argues, such government-owned asset-management firms are ineffective—often because politicians try to push them around.
On average, the study finds that government attempts to stanch systemic banking crises over the past three decades have cost 16% of GDP. That average hides enormous variation, much of which depends on how crises were handled. America’s mess, even if it has already led to the demise of famous Wall Street firms, is far from finished. That is why the international lessons are worth taking seriously. Resolving a financial mess is cheaper, quicker and less painful if governments take a rounded approach. For the moment, the bail-out tacticians are in overdrive. But the strategists’ moment is approaching.
Buttonwood
Looking for the bright side
Are there any signs that this could be a buying opportunity?
WHEN Winston Churchill lost the 1945 election, his wife remarked that the defeat might be a blessing in disguise. “At the moment”, replied the great man, “it seems quite effectively disguised.”
It is possible, when investors view recent events in retrospect, they will see them as a turning point for markets. But if there are immediately bullish implications, they seem to be quite effectively disguised. The American authorities sacrificed Lehman Brothers “to encourage the others”, only to find the others were simply encouraged to deny funding to weak-looking institutions.
Risk aversion reached extremes this week as the money markets froze. Overnight dollar rates doubled in the interbank market while the rate paid by the American government for three-month money fell to its lowest in more than 50 years. In addition, the caning the authorities gave to shareholders in Fannie Mae, Freddie Mac and AIG, however hard to argue with, will make it tough for financial institutions to raise new equity. Wall Street did not even bother to rally after the AIG deal as it had after previous government interventions.
Bad news seems to be coming from all sides, leaving Hank Paulson, America’s treasury secretary, increasingly resembling a one-armed wallpaper hanger as he valiantly seeks to cope with the mess. Another problem emerged this week; a $65 billion money-market fund, Reserve Primary, suspended redemptions and warned that it would “break the buck”, ie, repay investors at less than face value. That could cause a flight out of other money-market funds. Meanwhile, credit spreads over risk-free rates have widened sharply and emerging markets have taken a hammering.
The “great deleveraging” is working its way through the markets, as institutions, unable to roll over their debts, are forced to sell assets. The resulting fall in prices raises doubts about the solvency of other businesses, giving the spiral another downward lurch.
So what good news can be found in the midst of all this gloom? The first, curiously enough, is that sentiment is very depressed. The latest poll of global fund managers by Merrill Lynch found that risk appetite is at its lowest level in over a decade. Such extremes are normally a bullish sign.
The second is that the government is not the only buyer. After Merrill Lynch’s sale to Bank of America, HBOS, a British mortgage lender, has also sought refuge within a bank, Lloyds TSB. That suggests executives see value in today’s prices. Whether this is out of shrewd bargain-hunting, state arm-twisting or over-ambitious empire-building remains to be seen.
The third is that the inflation threat has receded, thanks to the sharp fall in commodity prices. Eventually, that will allow central banks to cut interest rates. In addition, it will relieve the pressure on consumer demand and corporate profit margins.
The fourth factor is that central banks are also willing to undertake quite extraordinary market-support measures, including the Fed’s decision to accept equities as collateral against lending at its discount window. That would have been unthinkable 18 months ago.
The fifth issue is that valuations in equity markets have improved substantially. In Britain on September 17th, the yield on the FTSE All-Share index was higher than the yield on ten-year gilts. This has happened only once before since the late 1950s—in March 2003, which proved to be the start of a long rally.
However, it would be a brave investor that acted on those bullish signals today. Those who believed that the Bear Stearns collapse in March marked a turning point in the credit crunch were disappointed. The Vix, or volatility index, a measure of market preparedness for shocks, has been lower than in past peaks—though it shot up on September 17th.
While the money markets are frozen, other financial institutions may get into trouble. Buyers will be tempted to wait until asset prices fall further, a strategy that worked for Barclays, which was able to choose the slice of Lehman Brothers it desired. And the economy will surely have been harmed by this week’s turmoil; consumer sentiment will have been hit and banks will inevitably prove even more cautious about their lending. A recession seems more likely than it did at the start of the month.
Perhaps there will be no climactic sell-off to signal the end of the bear market. Instead share prices may simply bounce around in a choppy range near today’s values. It is quite plausible that those who buy shares today will look smart in five years’ time. It is much less certain they will look smart six months from now.
Japan
Aso steps up
Taro Aso is poised to take over as prime minister in Japan
NOW that he has handily won the nomination to lead the Liberal Democratic Party (LDP), Taro Aso, a 68-year-old former foreign minister, will on Wednesday September 24th become Japan’s third (unelected) prime minister in two years. Mr Aso, the grandson of another prime minister, Shigeru Yoshida, a chief architect of post-war Japan, is reasonably popular for his straight-talking style and upbeat countenance, in contrast to his morose predecessor, Yasuo Fukuda. He seems to have reassured colleagues that his hawkish views will not jeopardise recent improvements in Japan’s ties with China and South Korea.
He will act swiftly to pull together a party in disarray after Mr Fukuda’s abrupt resignation, and facing obstruction from the opposition Democratic Party of Japan (DPJ), which controls the upper house of Japan’s Diet (parliament). Mr Aso’s own standing in the country, as well as the possibility that he will bring some of his beaten opponents into his new cabinet, will almost certainly produce a bounce in popularity for a government unloved by the public.
The question is what such momentum will achieve. Two legislative challenges face Mr Aso. The ruling coalition says that the global financial crisis makes it more pressing than ever to pass a stimulus package worth ¥11.5 trillion ($106 billion, though only a fifth of it amounts to new spending). A second task is to renew the navy’s refuelling operation in the Indian Ocean, part of the international effort in Afghanistan. Continuing this operation, which expires in January, has come to be seen as main symbol of Japan’s willingness to play a bigger part in the world.
The opposition DPJ vows to oppose both measures. It says that the fiscal package benefits the LDP’s traditional interests while not helping the old and the poor. And it—or rather its leader, Ichiro Ozawa, who has strong views on the matter—claims that the Indian Ocean mission breaches the pacifist constitution; Mr Ozawa wants UN backing before Japan’s armed services are sent overseas.
Even though Mr Aso is not bound to call a general election until next September, the opposition’s obstruction raises the odds of a snap poll, which the ruling coalition’s junior party, New Komeito, also favours. Much is at stake for the LDP, which for half a century has been in near-continuous power. To set against Mr Aso’s relative popularity is a whole list of grievances directed at a party (and its allies in the bureaucracy) that is seen as incompetent and out of touch. On top of the welfare ministry’s gross mismanagement of the country’s pensions system comes a growing scandal over tainted rice that on September 19th forced the resignation of the agriculture minister.
Mr Ozawa is now urging his forces to bring about an upheaval in Japanese politics: he speaks of the coming election as “the last battle”. There is little that is noble in his approach, which aims to bring together the disaffected from every quarter. Though supposedly a party of reform, the DPJ has attempted to forge an alliance with a reactionary group, the New People’s Party, whose members broke with the LDP because they opposed the privatisation of the postal system. Socialists and Communists also form part of the DPJ’ s ragbag alliance.
Mr Ozawa promises to restore the pension system, help the working poor and the old, and revitalise the countryside. The DPJ’s proposals for paying for this are not credible, but while the opposition is on the attack, that hardly matters. In a policy address on Sunday Mr Ozawa aimed squarely at a rotten target: the murky national budget. In it, special accounts for infrastructure and other spending sit unscrutinised, serving powerful ministries and semi-public corporations. Over the coming weeks Mr Ozawa will travel the country trying to convince voters that the LDP and its allies in the bureaucracy are congenitally incapable of revamping the way taxpayers’ money is taken in and spent in unaccountable ways. Many voters will sit up and listen. Others will think that to return the LDP to the lower house would be to continue the mess of a hung Diet. Mr Ozawa’s hopes for an upheaval look entirely plausible.
Commentary by Amity Shlaes
Sept. 19 (Bloomberg) -- Recovery without federal bailout? Impossible.
That's what we think as we watch the Federal Reserve and the Treasury move to rescue Bear Stearns Cos., Fannie Mae and Freddie Mac, and now, American International Group Inc.
Bailout was the rule in preceding slumps as well. From the New Deal to the Chrysler bailout of 1979, to Long-Term Capital Management LP to today, bailouts are what America does.
So the only thing remaining to think about is exactly when the next bailout will come -- when, say, General Motors Corp. and the other automakers will get more cash. Or whether Robert Willumstad deserves that exit package of $7 million for his three-month tenure as chief executive officer of AIG. Or if Federal Reserve Chairman Ben Bernanke struck a smart deal on behalf of the taxpayer.
In fact, recovery is possible without bailout. It happened right here in the U.S. back in the early 1920s.
In 1919, as in 2007, the country was on a roll. Unemployment was 1.4 percent. The Dow Jones Industrial Average hit 119, almost double what it had been in 1917. The young Fed and the Treasury had been inflating the money supply in order to pay off World War I debt.
Then the Fed began raising the discount rate. Also, gold was leaving the U.S., another contractionary force.
The recession was sharp. Unemployment moved up to 5.2 percent in 1920 and 11 percent in 1921. The Dow lost almost half its value. Political anxiety was part of the story. A wave of strikes was hitting the country. Attorney General Alexander Mitchell Palmer was conducting a series of raids across the country to root out suspected radicals. There was a sense that the revolution in Russia might replicate itself here. Progressives were gaining a great following.
Not So Lucky
Companies ran into trouble, even some in forward-looking industries such as autos. One such company, Kissel Motor Car Co., had thrived during the war, when it had made trucks for the U.S. Army.
Another was GM, which in 1920 saw its stock plummet to 12 7/8 in November from 42 earlier in the year. GM's business had been ``substantially curtailed during recent weeks in view of the falling off of demand of automobiles,'' the New York Times reported at the time. Then, as now, GM was emblematic.
What to do? Herbert Hoover, then Commerce secretary, argued that employers must not cut wages and called for collective bargaining.
What about the companies? A bailout did come for GM -- but not from the government. Pierre S. Du Pont and J.P. Morgan took control, buying until they held more than 51 percent of the company. ``Deal embraces move to stabilize the nation's entire automobile industry,'' the Times wrote. Many automakers, including Kissel, weren't as lucky.
No Bailing
Washington, for its part, didn't do much bailing. Nor did it attack Wall Street, as Democratic House Speaker Nancy Pelosi and, for that matter, Republican presidential candidate John McCain, are doing.
To Hoover's displeasure, government didn't manage to persuade companies to sustain wages. Wages were cut by more than 5 percent even ``before business had reached a dangerous position,'' as scholar Don Lescohier has noted. At the Treasury, meanwhile, Andrew Mellon hacked away at tax rates.
Recovery arrived as suddenly as recession had. By 1923, unemployment was down again, to 2.4 percent. The Dow climbed back, although taking longer to do so. The economy spent the rest of the decade growing in exemplary fashion. What had been good for GM proved good for America.
Size Adjustment
Why? As always in crashes, the economy needed to readjust to its new smaller base, says W. Gene Smiley, the author of the primer ``Rethinking the Great Depression.'' In the early 1920s, that adjustment was the right kind. Prices came down.
Forcing the adjustment by attacking companies or getting them to share the wealth just slows the recovery, Smiley says. It's better to allow an adjustment to the new, smaller world through prices, including wages.
A decade later Hoover, and then Franklin Roosevelt, did prop up wages and bash companies. Both men blamed Wall Street as well; Roosevelt, of course, expanded the government. Recovery eluded the country for another decade.
Smiley makes a subtle, crucial point: The sharper the downward movement -- think of Wednesday's 449-point loss in the Dow -- the more people believe a bailout is necessary. But that 60 percent decline in the Dow of the early 1920s was a good thing, reflecting an economy able to adjust.
New Rules
It is possible to write new rules that provide incentives to make investment banks act the way J.P. Morgan and Du Pont did in the GM case. One change, put forward by Charles Calomiris of Columbia University and others, would allow government bailouts. But in such instances, government would make other investment banks share the cost by bearing the first tier of losses before taxpayers.
Such a rule would discourage unnecessary bailouts, since banks would lobby against them, and therefore reduce overall taxpayer risk. Commercial banks already have a similar regime under the Federal Deposition Insurance Corp. Improvement Act of 1991.
Economic history these days is becoming news, so badly do we all desire context for the week's events. Senator Barack Obama, the Democratic presidential candidate, is already positioning himself as the heir to Roosevelt, ready to offer a New New Deal. And Americans tend to believe that a Rooseveltian program represents the most successful form of crash management. But as the 1920s show, there's more than one way to get to recovery.
Commentary by William Pesek
Sept. 22 (Bloomberg) -- There's something fitting about Timothy Geithner being on America's financial fire brigade.
First, here's a memo that the U.S. Treasury team, of which the New York Federal Reserve president was a member, might have written a decade ago.
To: Asian Finance Officials From: U.S. Treasury Subject: Worsening Regional Crisis
As economies reel amid instability and as investors flee, it's important that Asian policy makers heed this 10-point plan:
1. Raise interest rates to support currencies; 2. Cut government spending and debt; 3. Don't blame speculators and hedge funds; 4. Let property prices slide. It's a correction, not a crash; 5. Don't save those who made bad decisions. Moral hazard is bad; 6. Increase transparency in the corporate sector; 7. Subsidies of any kind are always and everywhere bad; 8. Get banks to write down bad loans immediately; 9. Avoid blaming the media for your problems; 10. Follow the free-market policies that drive U.S. prosperity.
Now for the message emanating from the U.S. Treasury these days: Disregard all of the above.
``The shifts in strategy are taking a lot of getting used to,'' Marshall Mays, director of Emerging Alpha Advisors and a longtime Asia investor, told me in Manila last week.
Tectonic Shifts
Other financial shifts are looking nothing less than tectonic. Just ask Lee Chol Hwi, chief executive officer of Korea Asset Management Corp. Known as Kamco, the state-run outfit helped liquidate distressed assets in South Korea after the 1997 financial crisis. It's now seeking to buy as much as $900 million of bad loans in the U.S.
Plenty of U.S. companies are lobbying for Korean money. Lehman Brothers Holdings Inc. seeking investment from state-owned Korea Development Bank is but one example. ``So much has changed in the world in the last 10 years,'' Lee says.
Those changes were the buzz last week at an Asian Development Bank conference in Manila. The basic take was that the U.S. is proving better at imposing its prescriptions on developing nations than following them.
One can debate the merits of how the U.S. is handling its financial crisis. Is there still too much Milton Friedman in how the Treasury and Fed are acting? Is a bit too much Karl Marx seeping into the mix? Or are the Marx Brothers in charge? Some investors in Asia and economist Nouriel Roubini joke about how the U.S.A. is morphing into the U.S.S.A.: the United Socialist States of America.
Wall Street Burns
There's some hyperbole here. No one wants to be remembered as the Nero of the U.S., fiddling as Wall Street burns. An expert on the Great Depression, Federal Reserve Chairman Ben Bernanke is taking no chances. Neither is Geithner, who saw first-hand how Asian growth stars such as Indonesia, Korea and Thailand were flattened by denial in the halls of power.
Recent events are disorientating for Asia, a region long told that the free-market gospel preached by the U.S. was the ticket to prosperity.
``Since the Asian crisis, we have learned it takes lots of money and trial and error to stabilize things,'' says Nicholas Kwan, head of Asian research at Standard Chartered Plc in Hong Kong. ``The U.S. is just beginning this process.''
What's the model for Asia now? Europe? Is it China's mix of top-down control of economic trends and market openness? Is it a return to Japanese-style financial management?
Political Woes
These aren't just academic questions for a region that is home to many of the world's fastest-growing economies. One of Asia's biggest problems is that political development hasn't kept pace with the opening of markets.
From instability-prone Thailand to control-freak China to politically paralyzed Japan and malaise-plagued Malaysia (Malaise-ia, anyone?), Asia is littered with governments struggling to grow faster. As the U.S. heads back to the drawing board to restore trust in markets, Asia will need to think more for itself than it has in recent decades.
How far the U.S.'s credibility has fallen can best be seen in the wealth dynamics of Washington and Asian capitals. While savings-rich Asia is setting up sovereign wealth funds to prepare for the future, the U.S. is setting up debt funds to repair the past. The U.S. has spent the 2000s fighting al-Qaeda, while China built world-class cities and airports.
Regulatory Changes
Once the dust settles, economic-policy makers must begin finding a ``more appropriate regulatory environment,'' says Asian Development Bank Managing Director-General Ragat Nag.
Ideas are flying in Washington. U.S. Senate Banking Committee Chairman Christopher Dodd says the Fed can act as an ``effective Resolution Trust Fund'' to buy and dispose of bad debt stemming from the subprime-mortgage crisis.
Financial regulators, attorneys general in New York, Texas and Connecticut, and the three largest U.S. pension funds are cracking down on short sellers after the collapse of Lehman and American International Group Inc.
U.S. officials would have been aghast if Asians did that a decade ago. It's a reminder that in times of crisis, it can be hard to take your own medicine.
Commentary by Jonathan Weil
Sept. 22 (Bloomberg) -- Here's the truth about why Treasury Secretary Hank Paulson wants $700 billion of your money to bail out stupid financial companies. It's not about protecting you, the unwitting American. It's about protecting people like him.
Specifically, people like Morgan Stanley Chief Executive Officer John Mack. With his company's shares in a freefall, Mack sent a memo on Sept. 17 to all employees, telling them ``short sellers are driving our stock down.''
Mack offered no facts to support this claim. He also said ``there is no rational basis for the movements in our stock.'' Actually, there was: Investors don't believe Morgan Stanley's numbers.
No matter. Heeding pleas of people such as Mack, U.S. and U.K. regulators raced to ban short sales of all financial companies' shares. They also opened investigations into ``market manipulation'' by shorts, investors who sell borrowed shares, hoping to buy them back at a lower price for a profit.
Then on Sept. 19, Paulson, the former boss of Goldman Sachs Group Inc., unleashed the ultimate market manipulation -- the bailout, although this isn't really the right word. It's more like a needle-exchange program.
Mission accomplished: Stocks soar. Morgan Stanley and Goldman survive. Armageddon is averted. And, here's the important part: People like you stop dreaming of lining people like John Mack up against a wall and shooting them.
For now, at least. The problem with Paulson's plan, on paper, is it shouldn't work, unless Paulson authorizes government-sponsored looting of the Treasury, which seems likely. The only way it will work is if (1) people like you, (2) think other people like you, (3) think other people like you, (4) will think it will work.
Meaning of `Troubled'
Here's why. Since the financial crisis began last year, banks worldwide have disclosed $519 billion of losses from writing down assets. Consequently, many of them don't have enough capital left to absorb more losses. And unless their stock prices go up a lot, they can't raise any more.
Under Paulson's plan, the Treasury will get as much as $700 billion to buy ``troubled assets'' from financial institutions. The word ``troubled'' seems to mean whatever Paulson wants it to mean. As far as I can tell, the only way this would help plug banks' capital holes is if the Treasury pays them much more than the assets are worth.
Even if Treasury pays 100 percent of the assets' balance- sheet value, banks still won't have enough capital. And as the whole world seems to know, the asset values on banks' balance sheets are grotesquely inflated. If Treasury pays only what they're worth, the banks would have to take more writedowns and admit to bigger capital shortfalls.
You Gotta Believe
So, to boost the banks' capital, the Treasury basically has to bribe U.S. banks into staying afloat. As it turns out, Paulson's plan gives him unchecked authority to do just that.
It doesn't matter whether Paulson's plan will work, though. What matters is getting enough people like you to believe it will. If that happens, the banks' stock prices will go up. Then bankers can start raising capital again from people like themselves who, while richer, are no less gullible than people like you.
The government also said it will offer unlimited insurance for money-market mutual funds. This would draw deposits away from the commercial banks supposedly being rescued, where federal insurance is capped at $100,000. It also will inspire money- market fund managers to turn to the needle themselves, taking greater risks in search of higher returns, more assets under management, bigger fees and, in time, bigger bailouts.
Slight Loophole
The supreme lunacy comes from the Securities and Exchange Commission. It passed emergency rules last week to make investment managers disclose their short positions. Now, you might think this would mean someone like Jim Chanos, who runs the world's largest short-only hedge fund, Kynikos Associates, would have to start disclosing his firm's bets. Here's a scoop, though: He doesn't.
Instead, the rules only require short-sale disclosures by funds that held ownership stakes in public companies' securities as of June 30. Kynikos, which has $7 billion under management, doesn't own any securities. It only shorts them. So, the rules don't cover Kynikos.
``It does underscore our concerns about the hastiness of these late-night regulations,'' Chanos told me, after I called to make sure I wasn't imagining the loophole. He says Kynikos will disclose its short positions anyway, to abide by the rules' spirit.
Prosecution Rests
This goes to show: If the government didn't care enough to make sure its rules apply to Chanos, it probably doesn't really care about short-sellers. It just wants to divert attention by creating an enemy for public persecution. Don't take my word for it, though. Check out what President George W. Bushsaid Sept. 19 on national television.
``The SEC is also requiring certain investors to disclose their short selling, and has launched rigorous enforcement actions to detect fraud and manipulation in the market,'' he said. ``Anyone engaging in illegal financial transactions will be caught and persecuted (sic).''
Whatever it takes to save our financial system from descending into oblivion, it will be tried, even if it all but guarantees we'll have a bigger meltdown later. It's not about principle. It's about the money. And it's about people like John Mack protecting themselves from people like you, by whatever means necessary.
Heaven help us all if it doesn't work.
Sept. 22 (Bloomberg) -- Democrats proposed revising a provision in the Bush administration's financial rescue plan that would bar judicial scrutiny of the U.S. Treasury Department's acquisition of up to $700 billion in troubled assets.
``I think that may be illegal, not to be able to challenge things,'' Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, told reporters. ``I'm not sure that would hold up anyway.''
Today, Dodd offered an alternative rescue plan that would let courts step in when they find that a decision about a troubled loan was arbitrary or illegal. Senate Judiciary Chairman Patrick Leahy of Vermont said in a statement he wrote the language, adding that eliminating court review ``invites abuse.''
Judicial bypass provisions are common in statutes and in some cases have been upheld by the U.S. Supreme Court. Congress, nonetheless, may choose to revise the administration plan to permit some independent review. So far, the issue has been overshadowed by Democratic demands to broaden the rescue plan to include a stimulus package for the economy and help for homeowners having difficulty paying their mortgages.
The proposed rescue echoes some of the most momentous presidential actions in U.S. history, including President Franklin Roosevelt's New Deal and President Harry S Truman's seizure of the nation's steel mills.
The Bush plan bars review by administrative agencies, as well as the judiciary, giving the Treasury secretary the final word on transactions.
Frank Proposal
Democratic Representative Barney Frank of Massachusetts, chairman of the House Financial Services Committee, would change that provision by giving oversight authority to the U.S. Comptroller General and the Government Accountability Office, Congress's financial watchdog.
Frank's proposal would address concerns that the Bush plan would be an unconstitutional delegation of congressional spending power, said Walker Todd, a former Cleveland Federal Reserve attorney who is now a research fellow at the American Institute for Economic Research in Great Barrington, Massachusetts.
``The number one thing in play here is the constitutional principle that no money shall be withdrawn from the Treasury except pursuant to appropriations by law,'' Todd said.
Still, Todd said that the Supreme Court has been reluctant to overturn laws on those grounds in recent decades. The last time the court declared a law to be an unconstitutional delegation of legislative power was in 1935, when a majority voided parts of Roosevelt's National Industrial Recovery Act.
`Intelligible Principle'
More recently, the court has given Congress broad authority to hand off its responsibilities, requiring only that Congress provide an ``intelligible principle'' for administrators to follow.
``In our increasingly complex society, replete with ever- changing and more technical problems, Congress simply cannot do its job absent an ability to delegate power under broad general directives,'' the high court ruled 8-1 in a 1989 case that upheld federal criminal sentencing guidelines.
The Supreme Court has likewise proven reluctant to strike down measures based on the unavailability of judicial review. University of Michigan securities law Professor Adam Pritchard pointed to a unanimous 1994 Supreme Court decision upholding a ban on judicial review of decisions by the president to close military bases.
``Lots of statutes have those provisions,'' said Gilbert Schwartz, formerly the associate general counsel of the Federal Reserve Board.
Steel Mills
In 1952 the Supreme Court said Truman exceeded his authority by seizing the nation's steel mills to head off a strike. The parallels with that case are limited because it involved a unilateral presidential action, rather than one done with congressional authorization.
In addition, the steel case centered on a government seizure -- not the consensual purchases envisioned under the Bush administration rescue plan.
Should it survive, the judicial-bypass provision likely would prevent a recurrence of the lawsuit flurry that followed the government's 1989 bailout of the troubled savings and loan industry. Investors and thrifts filed more than 120 suits, claiming regulators broke promises of special regulatory treatment.
``One of the reasons they want the nonreviewability provision is they got bogged down in lawsuits for a decade or more after they stepped in to take over the savings and loans that were insolvent,'' Pritchard said.
Tens of Billions
The suits collectively sought tens of billions of dollars in damages from the government.
The rescue plan also could face court challenge as an unconstitutional ``taking'' of property by companies that don't benefit from the bailout, said Stanley Sporkin, a former federal judge who also was enforcement director of the U.S. Securities and Exchange Commission.
Ultimately, the biggest obstacle facing the judicial-bypass provision may be the skepticism it is sparking on Capitol Hill rather than any courtroom problems. Dodd said other lawmakers share his concerns about the legality of the review provision.
``You can't give all this power to any one person, particularly a non-elected person, as much as we respect the secretary, without making sure that conflicts of interest are dealt with, that people are treated fairly,'' Democratic Senator Charles Schumer of New York told reporters.
Sept. 22 (Bloomberg) -- House Financial Services Committee Chairman Barney Frank said lawmakers and Treasury Secretary Henry Paulson narrowed their differences on a $700 billion plan to buy bad investments and agreed the U.S. should get equity in the participating companies.
Lawmakers ``made it clear'' the U.S. should get stock warrants ``so that if the company becomes profitable, we get more than the general share for taking these risks,'' and Paulson agreed, Frank told reporters today in Washington. Negotiators support letting Treasury use the authority while Congress writes oversight rules, Frank said in a Bloomberg Television interview.
Frank and Senate Banking Committee Chairman Christopher Dodd are leading efforts to halt a financial crisis that forced Lehman Brothers Holdings Inc. into bankruptcy and led the U.S. to take over American International Group Inc. Senator Richard Shelby, ranking Republican the banking panel, said the Treasury plan may not work and urged lawmakers to consider alternatives.
The Bush administration is seeking to buy as much as $700 billion in devalued assets from investment firms to unfreeze the financial system. The proposal, sent to Congress during the weekend, would prevent courts from reviewing the Treasury's actions while raising the nation's debt ceiling.
``We understand that bad market choices have put us in a situation where something has to happen,'' Frank said. ``We want it to happen with the best possible chance of it working, of the taxpayers ultimately being made whole.''
Congressional Proposals
Frank and Dodd have proposed changes that include strengthening foreclosure-prevention efforts, curbing executive pay for companies that need the U.S. to buy their assets and expanding oversight of the Treasury program. Paulson has opposed limits on executive pay.
Republican Senator Mel Martinez of Florida said there is bipartisan support for limits on compensation and severance for senior executives of bailed-out firms. ``Some element of that has to be in'' the legislation, he said after a meeting of Senate Banking Committee members.
Martinez said the administration's proposal should only be changed ``on the margins.'' Congress doesn't have time now to debate the issue of whether to alter existing home mortgages to avert foreclosures, he said.
``Hastily Crafted'
Shelby, of Alabama, called on Congress to explore alternatives to the plan proposed by Paulson.
``Treasury's proposal is neither workable nor comprehensive, despite its enormous price tag,'' Shelby said in an e-mailed statement. ``In my judgment, it would be foolish to waste massive sums of taxpayer funds testing an idea that has been hastily crafted, and may actually cause the government to revert to an inadequate strategy of ad hoc bailouts.''
Congress should ``immediately undertake a comprehensive, public examination of the problem'' and explore ``alternative solutions rather than swiftly pass the current plan with minimal changes or discussion,'' Shelby said.
The Treasury proposal gave Paulson ``much too much authority,'' Frank said. ``We have restored the notion of judicial review and accountability.''
Frank proposed the U.S. comptroller general ``commence ongoing oversight of the activities and performance'' of the plan, according to legislative language his office presented to Treasury officials yesterday.
Oversight Plans
The comptroller general, who is director of the Government Accountability Office, and other GAO officials would have access to financial records, have audit powers and would report findings to Congress under Frank's proposal. The GAO is Congress' financial watchdog.
Dodd's proposal would give the Treasury an equity stake when it helps companies and create a five-member oversight board to supervise the purchase and sale of distressed mortgage debt. Frank said he and the Senate ``are pretty close'' on the plan.
Democrats proposed revising a provision in the plan that would bar judicial scrutiny of any acquisition of assets and Dodd offered a plan that would let courts step in when they find that a decision about a troubled loan was arbitrary or illegal.
``I think that may be illegal, not to be able to challenge things,'' Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, told reporters. ``I'm not sure that would hold up anyway.''
Frank said Democrats and Treasury are still at odds over the Democrats' executive-pay proposal and a provision to allow judges to modify loan terms for struggling borrowers in bankruptcy proceedings.
``Without some limitations on CEO compensation and compensation for the other top executives, this bill is going to be rejected not just by the Congress but by the country,'' Frank said today in an interview with Bloomberg Television.
The bankruptcy provision is ``one of the things that we'll see how hard they fight,'' Frank said. ``It's something we care about.''
Sept. 22 (Bloomberg) -- Citigroup Inc. said wealth- management head Sallie Krawcheck, who was recruited in 2002 by former Chief Executive Officer Sanford ``Sandy'' Weill to burnish the bank's image, is leaving the firm.
Krawcheck, 43, will ``pursue other opportunities,'' New York-based Citigroup said today in a statement. She will remain ``through the end of the year to ensure an orderly transition,'' Citigroup said. Michael Corbat, 48, who for the past four years has overseen lending to large corporations, will succeed her, the bank said. Edward ``Ned'' Kelly, hired this year to oversee hedge funds and other alternative investments, will add Corbat's duties to his current role, the bank said.
Krawcheck departs nine months after the bank named a new CEO, Vikram Pandit, to replace Charles O. ``Chuck'' Prince, Weill's successor. Prince was ousted last year as mortgage-bond writedowns saddled the New York-based bank with a record fourth- quarter loss of almost $10 billion.
``She was clearly a part of Chuck Prince's team,'' Tanya Styblo-Beder, chairwoman of risk-management adviser SBCC Group and former head of Citigroup's Tribeca hedge-fund unit, said in an interview. ``When you look at what Citi's been through as an organization it's not surprising that everyone who was part of that management team would ultimately be ousted.''
Citigroup fell 64 cents to $20.01 as of 4:15 p.m. today in New York Stock Exchange composite trading. It has declined 32 percent this year.
A call to Krawcheck's office was referred to Citigroup spokeswoman Susan Thomson, who declined to comment.
Krawcheck's Career
Krawcheck joined Citigroup from Sanford C. Bernstein & Co. in October 2002 as head of the Smith Barney brokerage and stock- analysis department. Weill was responding to suggestions the bank's analysts misled investors by publishing biased research to win investment-banking assignments.
She was chief financial officer from November 2004 through early 2007, when she returned to overseeing the bank's wealth management-businesses, including Smith Barney.
During Krawcheck's tenure as CFO, Citigroup was criticized by shareholders, including the Saudi billionaire Prince Alwaleed bin Talal, who said costs were rising faster than revenue. Citigroup's earnings climbed 7 percent in 2006, compared with 70 percent growth at rival JPMorgan Chase & Co.
Citigroup's Prince recruited Gary Crittenden from American Express Co. to replace Krawcheck as CFO. Since then, she has overseen Citigroup's private bank and the Smith Barney network of 14,983 financial advisers. Total revenue climbed 10 percent during the first half of the year to $6.59 billion, compared with a 29 percent decrease for Citigroup overall.
``She's very talented and she clearly rose to a very senior position,'' said Jeanne Branthover, managing director at Boyden Global Executive Search Ltd. in New York.
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