February 17, 2009

Obama Taking Cues From Sweden, Really?

Posted by John Wilson at 4:12PM

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Word out of D.C. is that the Obama administration is looking to glean some insight from Sweden's nationalization of their banks some 30 odd years ago. Not that nationalization is the demonic word it used to be considering even Senator Lindsey Graham (R) of South Carolina mentioned it as a possible option this past weekend. And we certainly do need a fresh approach to the housing/banking/credit situation (at this point they are certainly interwoven). But why should we take cues from an ocean away when we have our very own recent history to learn from?

The Savings & Loan debacle of the 80's, that the Reagan administration was able to salvage from financial damnation was scarier than Sarah Palin appearing on Jeopardy: between '86 -'95 1,043 savings and loans institutions failed, with over 500 billion in assets at risk and losses totaled 152.9 billion, of which taxpayers were on the hook for 123.8 billion, according to the Federal Reserve. And, just like now, the initial estimates of the costs were much lower than the final tab because the ultra-conservative accounting. In addition, there were some similar causes for the crisis, namely: riskier loan markets and products (think subprime borrowers and adjustable rate mortagages - ARMS), ineffective regulatory climate (think the securitization of loans, where lenders have bundled loans together, done a poor job of assessing whether homeowners can afford payments and sold the bundle off to an unsuspecting investor) and poor economic regional conditions.

This list is far from exhaustive, and Federal Reserve regulation Q changes in the early 80's, which led to lower industry profitability and capital, along with the withdrawal of tax deductions for commercial investments in '86 were particularly pernicious. Looking back at the crisis, three big lessons include:

• Cost - the Bush 41 administration struggled with a cost estimate. No one inside or outside D.C. had a handle on the amount needed to recapitalize banks and for good reason - inability to estimate how many banks did what. Hence, no consensus in Congress and weakened consumer confidence. The Obama administration should avoid this scenario by not talking about overall cost. Be clear about objectives and parse funds based solely on them, whether it's easing credit liquidity, stemming foreclosures, or buying "toxic" assets.
• Resolution Trust Corporation was created to manage all insolvent banks placed in receivership or conversatorship. Assets were apportioned based on a new risk ratio that reflected the recessionary economic environment. The private sector was encouraged to invest through limited partnerships in various funds that assets were allocated in. This sounds similar to Secretary of the Treasury Geithner's plan (PDF). Only problem is that when Geithner spoke about his plan he was vague and looked like a man who had been told it was his last day on the job. RTC worked. Reestablish it and finally rid the market of "toxic" assets.
• What Bailout? The Obama administration must remind people that TARP (while I don't agree with how it was written) is an investment in the banks. The Bush administration purchased shares in various banks to assist them in their capitalization. Uncle Sam is going to get it back with interest.

In sum, there is much to be learned from the S&L crisis that we can put to good use during these harrowing times. Partial nationalization must be on the table if we are to rid "toxic" assets from the market swiftly with least amount of injury to homeowners, credit markets and investors.