April 9, 2009

Elizabeth Warren Offers a Clear, Comprehensive Review of the Situation with Banks

The author (co-author) of the great "The Two Income Trap", which explains one of the key facts and seeming contradictions of the modern American economy -- how a two-earner family can become less secure than a one-earner family through competitive bidding with other families to buy expensive homes in neighborhoods with good schools -- brings us more of her clear, insightful thinking below. This is a great overview of the entire banking situation and our options in a scant 8 minutes. Warren shows why she was chosen as a key public watchdog to report to Congress on this entire mess, and I recommend this video for anyone interested in this subject, from experts to those wanting to digest a well-explained summary in a few minutes. (Also see interesting excerpts from the full report and my comments after the video.)

The report is here.

Two highlights of many:
In addition to drawing on the $700 billion allocated to Treasury under the EESA, economic stabilization efforts have depended heavily on the use of the Federal Reserve Board’s balance sheet. This approach has permitted Treasury to leverage TARP funds well beyond the funds appropriated by Congress. Thus, while Treasury has spent or committed $590.4 billion of TARP funds, according to Panel estimates, the Federal Reserve Board has expanded its balance sheet by more than $1.5 trillion in loans and purchases of government-sponsored enterprise (GSE) securities. The total value of all direct spending, loans and guarantees provided to date in conjunction with the federal government’s financial stability efforts (including those of the Federal Deposit Insurance Corporation (FDIC) as well as Treasury and the Federal Reserve Board) now exceeds $4 trillion.
What this is saying: The Treasury Dept. is working in tandem with the Federal Reserve, and using the Federal Reserve's ability to create new money by just printing more of it and buying bonds and securities to effectively double down and triple down and quadruple down (well...etc., you get the idea) on their bet -- the uncertain gamble that bailing out various types of lending, from auto loans to credit cards, will work out for the best.

If it doesn't work out, if the loans go bad en masse, then the Federal Reserve could lose considerable capital. But that capital value is stored ultimately in the value of the dollar itself, what you and I rely on to conduct our economic lives. In other words, if the Fed loses, you and I are the actual ones that lose.


The second highlight:

[One of several questions from the oversight panel to Sec. of the Treasury:]
2. The thrust of the TALF [the Fed's latest way to lend more money] appears to be to attract investors with large enough pools of capital, such as hedge funds, to the ABS [Asset-Backed Securities, or basically all sorts of lending packaged into a type of bond] market by allowing them to purchase ABS on a highly leveraged basis with risk of loss largely transferred to the taxpayer directly or, through the Federal Reserve System, indirectly, in a manner that confers substantial benefits on these private investors who have little at stake. Please explain in detail the rationale for such a transfer of risk to the taxpayer with so much of the benefit transferred to private investors and please provide the facts and figures that support this rationale.

[Geithner's response:]
"...Because the questions you have raised pertain primarily to the structure and operation of the FRBNY [Fed. Reserve Bank of NewYork] lending facility [TALF], FRBNY staff has taken the lead in responding...." [Note Treasury Sec. Geithner was the FRBNY president previous to his current post.]

The detailed response by the FRBNY below points out the risk capital (private investors' money) which those taking TALF loans put up (and if their gamble goes bad due to bad loans, they lose part or all of their risk capital; this is referred to as a "haircut" in the response), the risk-premium interest rate such TALF loans carry, and...this notable, perhaps hopeful, bullet point:

[excerpt from FRBNY response:]
"The current economic situation is extraordinary and the outlook is therefore especially uncertain. We accounted for that uncertainty by making very conservative assumptions when calibrating the haircuts. The haircuts are designed so that, even if the economy evolves in a manner significantly worse than we currently expect, all credit costs will be more than covered by the haircuts and the excess interest rate spread paid by investors, resulting in no credit losses for the Treasury or Federal Reserve."


Let's hope so.

This is as well designed as can be, no doubt.

It's a gamble though.

A reasonable gamble. A double or triple-down.

In the end, it's reasonable to try to save the old system, to try to make it as easy as possible to get a car loan or a credit card for those that want to buy on credit. The only primary danger in the wide range of governmental efforts to prop up parts of the old status-quo I see is maintaining semi-dead corporations (including banks) that can't really flourish long-term without real restructuring, and thus crowding out better competition (such as better-managed banks) that might replace the subsidized corporations with something much better if they had the open space and opportunity.

But...too much household debt (vs. income) was and is the problem (see here, here, here and here.) We still need to reduce consumer (personal) debt, and the faster this finishes the better, and here's how to speed this up.


  1. I'm impressed by this woman. I'm just concerned that her obvious competence is wasted in a job of Congressional watchdog; I'd like to see her actually running something. On the other hand, it's good to see someone reporting to Congress who can explain things in simple English...

  2. Yes, she is clearly competent in seeing the real picture and pulling out what matters, even in complex situations. I think that she can do some good as a watchdog, if paid attention to, though I admit whether she is widely followed is an open question. I think her book "Two Income Trap" is unusually valuable. Perhaps even if a relatively small audience takes in what she says, her infludence is multiplied if that audience includes writers, as I think it does.

  3. this is just what I needed to support my position while presenting it to my politcally opposite partner thank you!