Banking Expert: Bailout Not Necessary, Industry Can Take Losses

One of the premises of the bailout bill is that the banking industry must have government help to get back on its feet.

A banking industry expert, Bert Ely, who has a stellar track record in predicting crises and calling false alarms says that the banking industry can handle this mess internally and does not need subsidies.

The comments from Bert come in an interview at Institutional Risk Analytics (the entire newsletter is wide-ranging and very much worth reading), First, IRA’s recap of Ely’s qualifications:

To get some perspective on the evolution of the last remaining large investment banks into commercial banks, we now turn to Bert Ely, one of the leading experts on banking and finance in the Washington policy community. An accountant by training, Ely has specialized in deposit insurance and banking structure issues since 1981. In 1986, he became an early predictor of the S&L crisis and a taxpayer bailout of the FSLIC. In 1991, he was the first person to correctly predict the non crisis in commercial banking. In 1992, he predicted an eventual taxpayer bailout of the Japanese banking system.

Here are the excerpts that relate to whether the banks need government intervention:

The IRA: And if our internal estimates at IRA are correct about the magnitude of the losses facing the industry, then the banks may not have the resources to deal with the problems alone. What then?

Ely: That is of course the trillion dollar question. I have run the numbers looking at the capacity of the industry to pay the tab. Assuming that bank insolvency losses don’t get way out of line, which I don’t think they will, then the industry can handle it. It’s not going to be cheap, but the banks can handle it and clean up their own mess. The losses will feed back through the industry to depositors and borrowers in the form of lower rates on deposits and higher cost of loans….

The IRA: So you oppose the idea of the government putting preferred equity into solvent but troubled banks that cannot raise capital on reasonable terms?

Ely: Yes, it is not necessary, even now. There is absolutely no need for the Treasury to have the authority, as you suggested, to “inject capital into solvent banks that are temporarily unable to raise new capital.” If a bank truly is solvent, it can raise additional capital or sell itself, if its present owners are realistic about what their bank is worth. The reason solvent banks have a problem raising capital, or selling themselves to a stronger bank, is that they set their price too high, as did AIG. As an aside, I am glad to see AIG’s shareholders getting whacked by the warrants associated with the Fed’s taxpayer’s loan to AIG. There is absolutely no need for the taxpayer to subsidize banks so they can stay independent, provided no barriers are erected to prevent new entrants into bank or specific banking markets.

The IRA: Agreed. We were referring to banks that could not be recapitalized or sold. A sale is obviously the first, best choice. So you would let the banks resolve their problems privately. Would you agree with Ernie Patrikis (‘A Change in Bank Control: Interview With Ernest Patrikis’, July 9, 2008′) that the Fed needs to loosen the restrictions on bank ownership in order to facilitate this process?

Ely: I fully agree that restrictions limiting investors from taking significant positions in banks should be lifted. Not only is the belief in separating banking from commerce invalid in an open, competitive economy, but we need to get ruthless investors inside troubled banks to get these banks and their bad assets cleaned up and/or sold. That is what should have happened at AIG, but unfortunately did not.

The IRA: Precisely. We want to see the bad assets remain in private hands, not in a government warehouse for toxic waste. But why then should anyone support Paulson’s proposal to place these toxic assets in the hands of the government? Chairman Frank seems to want to declare the jubilee and engage in mass loan forgiveness in order to ensure his permanent re-election. Maybe we can just all stay home instead of going to work and Barney Frank will just mail everyone a check.

Ely: Look, all of the fallout we are seeing in the markets today is part of clearing the detritus from the last speculative bubble. The housing bubble has to be allowed to collapse in order to clear the markets. We have a very necessary correction process underway. But this process creates a lot of pain and loss. I don’t like that, but we have to clean up the mess and take the pain in order to get the economy back into balance. In collapsing bubbles you have collapsing companies. Japan tried to muddle through and they had a lost decade. I hope we are not going to do that…

The IRA: But that is precisely the point. Why should Washington use taxpayer funds to rescue people who deliberately made bad business decisions?

Ely: This is the question that comes up frequently about Dick Fuld at Lehman and Kerry Killinger at WM. When these guys were contemplating life, did they have any second thoughts, any doubts about these decisions? Did hushed discussions among the top folks in their organizations, with the senior managers and directors, include deliberations such as these or were they too arrogant, too isolated from reality?…

The IRA: How do you see the Paulson plan unfolding? What should the markets expect in the next couple of weeks and months?

Ely: It is likely that Congress will not pass the Paulson bailout legislation this week. However, whenever it is passed, it will be much more complex, and incorporate unwise punitive terms and conditions that will seriously impede the intent of the Paulson plan. Further, I believe the process of pricing the assets purchased under the legislation will be much more complex and contentious than many appreciate at this time, which means that this program will get off to a much slower start than many anticipate, just as the RTC started quite slowly. If the Paulson plan starts slowly, market forces may sweep past the plan. It will be extremely interesting to see how this plan evolves over the next year, particularly given that a new Administration will come to power on January 20.

There is a lot of meaty stuff in this article.

Note that this analysis, even if correct, does not conclusively disprove the need for a bailout bill. The Paulson proposal, as revised over the weekend, now extends to foreign banks and hedge funds. A hedge fund crisis, which Nouriel Roubiini says is the next shoe to fall, would hit prime brokers like Goldman and Morgan Stanley particularly hard. The Lehman bankruptcy nearly deep-sixed the financial system. Goldman and Morgan are bigger firms. If either were to look wobbly, even after their pending capital infusions, it would roil the markets.


Originally published at Naked Capitalism and reproduced here with the author’s permission.

19 Responses to "Banking Expert: Bailout Not Necessary, Industry Can Take Losses"

  1. Guest   September 24, 2008 at 9:21 am

    Exactly the con job with this bailout plan is an insult to the american people. There is nothing FEDERAL about the private bank Federal Reserve who are pulling the strings and want to screw the american people out of 700 billion dollars

  2. Euro   September 24, 2008 at 9:24 am

    ha ha If that bailout package passes I will pack my bags and leave the U.S.

  3. Anonymous   September 24, 2008 at 9:24 am

    $700 bn could buy the whole banking system except JP Morgan and BofAmerica or top 11 banks!Thanks for your service to our country. Why don’t we buy equity in banks that are troubled and put it into the social security trust fund?My colleague put this information together:”I continue to urge you to vote against the current Treasury Dept. plan to buy assets from U.S. banks. For $700 billion, the Treasury could purchase the top 11 banks in the country holding some $7.9 trillion of assets. (source Bloomberg) I would be happy to send you the data. Why does the American public need to buy just the bad assets? Or the Treasury could buy ALL of the public ally traded banks except Bank of America and JP Morgan! Alternatively, the Treasury could purchase new issued shares of any bank in either group willing to participate, effectively doubling the equity capital in the banking system. As $1 of new equity supports $10 of assets this would be a much more effective method of reliquifying the banking system.Thank you for your consideration. “”For $700 Billion, the Treasury Dept. could buy all the outstanding shares of the top 11 banks BAC, JPM, WFC, C, USB, WB, PNC, BBT, STI, NTRS and NCC representing total assets of some $7.9 trillion, over 70% of the total assets in the banking system. Or the government could buy all the publically traded banks except JPM and BAC! (source Bloomberg). Nobody is asking why not buy the banks outright instead of just the bad assets. “This whole plan is just a handout for the rich and connected and does not address the core issues of the crisis–recapitalization of the banking system and credit default swaps that magnify losses.

  4. Guest   September 24, 2008 at 9:56 am

    Better yet have the owners of THE FED pick up the tab for the bailout because they are all trillionaires. But naturally they believe there is a sucker born every minute who should pick up the tab.

  5. Anonymous   September 24, 2008 at 11:49 am

    Does the USA stand for equality for all or not? If you want a bailout, then bailout everyone including the 3 million people who have already lost their home and the 2 million more who are on their way!Or bailout no one and let all the highly leveraged financial institutions FAIL and start over with safer and fairer regulations. Isn’t this what we are indoctrinated with from our educational as well as criminal justice system: if you don’t pass the test or if you break the law-you FAIL and there are serious consequences for those actions!To proceed forward without equality and fairness as the primary criteria of any plan is unAmerican (or is it?!)

  6. Guest   September 24, 2008 at 11:53 am

    In the USSA it is standard practice for the proles to pay for the lifestyle and perks of the ruling class. This crisis is just another piece of it. One can’t say that the masters don’t know their Marx, while we the proles get fed Adam Smith.

    • ComicPro   September 24, 2008 at 4:40 pm

      Maybe its time to change that way of thinking. Its like Pavlovs dog: if they know certain behaviors will illicit a certain response then they will continue to do what they are doing and expect the same result. doing the same thing over and over again and expecting a different result is the definition of insanity. I am not bailing them out and I have written all my Congressional and Senat eleaders 9 I say leaders with a smirk). NO BAILOUT!!!

  7. Guest   September 24, 2008 at 12:32 pm

    In the USSA it is standard practice for the proles to pay for the lifestyle and perks of the ruling class. This crisis is just another piece of it. One can’t say that the masters don’t know their Marx, while we the proles get fed Adam Smith.

  8. Guest   September 24, 2008 at 1:15 pm

    The American Dream has become the American Nightmarewith deep seeded corruption on Wall Street and Washington D.C. This attempted robbery of 700 billion dollars will go down in history as a turning point and the total mockery of the free market system and the constitution. The founding fathers will curse those responsible.

  9. Anonymous   September 24, 2008 at 1:23 pm

    If it passes, its because too many Congressional leaders have been PAID $$$$$$ to pass it.This should be no brainer for the likes of Frank and Dodd and Shelby unless they too are conflicted

  10. rich   September 24, 2008 at 1:55 pm

    Fractional reserve banking is a pyramid scheme when the base is leveraged out the system has to deflate to move forward ofcourse it never really moves forward at all it just performs cycles of inflation followed by deflation. This is a bail out for the elite or anyone who has substantial assets, but it won’t help the economy because there’s no way to inflate something that has no room for inflation. You can only fill a balloon so much.

  11. Guest   September 24, 2008 at 2:19 pm

    Bush is going on TV to talk about the gift he’s trying to give his pals at the expense of the taxpayer before he leaves office.

  12. Citizen   September 24, 2008 at 8:38 pm

    Outrageous! Every American should see this for what it is…a power grad by the executive branch, taxation without representation..a financial coup d’état! How else could you explain the terms of the Plan…no congressional oversight, no judical review, not subject to future laws…In the definition below just replace government with branch of government, military with private enterprise (hedge fungs/private equity)Definition:”A coup d’état (pronounced /kuːdeɪˈtɑː/ AHD: [ko͞o”dā tä]), often simply called a coup, is the sudden overthrow of a government by a part of the state establishment — usually the military — to replace the branch of the stricken government, either with another civil government or with a military government.Definition:The coup d’état succeeds if its opponents fail to thwart the usurpers, allowing them to consolidate their positions, obtain the surrender of the overthrown government or acquiescence of the populace and the surviving armed forces, and thus claim legitimacy. Coups d’état typically use the power of the existing government for the takeover.As Edward Luttwak remarks in Coup d’État: A Practical Handbook: A coup consists of the infiltration of a small, but critical, segment of the state apparatus, which is then used to displace the government from its control of the remainder. In this sense, the use of either military or another organized force is not the defining feature of a coup d’état.

  13. tax payer   September 24, 2008 at 10:48 pm

    If Government really want to bail out they can try this which will really help all of us who are paying taxes and the companies too…for $700 billion it comes to $10,000 per household. Instead of giving the money to companieswhy don’t fed pay the people debt. for 10k /family. They can do it in following way,ask for the people loan numbers of the outstanding debt. like home, auto or credit card loans and directly govt. can transfer money up to $10k in this loans. so that, all individual will be happy and thus companies get their money.And for people who don’t have any sort of debt govt. can propose a timeline like next 6 -12 months where they can avail any type of loan (home/auto) and govt. will pay up to $ 10k for these loan.If govt. can work out a plan for this then it is a win win situation!winner winner Chicken dinner!

    • Guest   September 25, 2008 at 5:40 am

      This would end up hurting the banks because it would pay down a lot of good interest paying accounts. They’re going to use the money to strictly plug the holes on non-performing loans.

  14. Anonymous   September 24, 2008 at 11:19 pm

    If deflating housing bubble causes this crisis. Why not grant foreigners who would buy a forclosed property above certain value a Green card? There are hundreds of thousands of people in other countries with plenty of ca$h in their matresses who would be happy to own a house in the US. Why is this harder to do than to spent $700 Billion that we don’t have.P.S. Bush should go down in the history as the first “president” who wrecked an economy of two countries (USA & Iraq) during the time in office.Great job GW!

  15. Gepay   September 25, 2008 at 12:52 am

    i read John Mauldin’s article ‘this Too Shall Pass’ where he explains how one can make guaranteed money buying marked down MBSs and CDOs. The trick as always is knowing which ones to buy. Who would know better which ones are trash and which ones are cash than the people who structured them to begin with? These are the people that Paulson wants to hire to help buy the toxic trash MBSs with the mortgages bound to fail. Now the government is already on the hook to for AIGs Credit default swaps. This whole financial meltdown is looking more and more like an incredibly large and complicated scam where those in the know (read parts of Goldman Sachs and JP Morgan)take some small losses in order to get giant gains when the government gets saddled with the really bad s^^t. Like for instance, the government is going to make $441 billion of AIGs credit default swaps good. It won’t have to make all of them good but it will have to make many of them good. The taxpyers, the pension funds and investors not in the loop are going to take the fall while the foxes are making out like the bandits they are. Is not Paulson the richest man in Bushes cabinet?

  16. Guest   September 25, 2008 at 2:25 am

    To all this is an attempted FINANCIAL COUP D’ETAT as was mentioned here. THE FEDERAL RESERVE private interests are behind it.

  17. Guest   September 25, 2008 at 3:25 am

    My bailout plan: give us all gov’t issued credit cards with a $100,000 limit. When we default, … you know the rest…