Bank Discipline

"The results of bank stress tests--expected tomorrow--will no doubt prompt calls for further government guarantees and capital injections. But continuing to prop up the banks with government cash is a mistake. There is a better approach. ... Not only is the carrot approach not jump-starting lending, it is also angering the American people. It's hard to justify to taxpayers that we need to reward the same group of people who, rightly or wrongly, are perceived as responsible for the current situation. ... The first step should be an announcement that the FDIC guarantee of short-term debt, set to expire at the end of October, will not be renewed. Insolvent banks--defined not by stress tests, but as those that cannot fund themselves in the private market--will be taken over by the FDIC. Otherwise creditors will play 'chicken' with the government, knowing that at the last minute the government will flinch and fail to remove the guarantees. ... First of all, the FDIC lacks the staff to oversee, let alone run, several large and complex banks which may become insolvent. Second, the FDIC's main approach so far, as with Washington Mutual and IndyMac, has been to restructure the banks for acquisition. ... On the one hand, this split separates the toxic assets, whose value is very uncertain, in an institution that has no insured or guaranteed liabilties and poses no systemic risk. ... One of the major objections to letting banks fail is the argument that they are not really insolvent; they are just facing a temporary dislocation in the marketplace. But if this observation were true, the bad bank would surge in value, and the old shareholders of the banks, who received the shares in the bad bank would gain. If it is false, the bad bank would default and the old shareholders would receive nothing (as they should)", my emphasis, R. Glenn Hubbard, Hal Scott and Luigi Zingales (HS&Z) at the WSJ, 6 May 2009, link: http://www.igmchicago.org/2009/05/14/banks-need-fewer-carrots-and-more-sticks/

Hubbard is a Columbia economics professor, Scott, a Harvard Law professor and Zingales a Chicago economics professor, all big "hitters" here. Disagreeing with them, I prefer simplicity. It's good HS&Z are concerned with the pitchfork brigades' opinion. Make us happy. Have HS&Z an opinion as to who is "responsible for the current situation"? Offer us, the pitchfork brigade, some bank CEOs heads on pikes. No good-bad banks splits. Let the banks fail. Send them to bankruptcy court. I attended a Houston CPA Chapter annual reporting seminar on 7 May. One panelist who talked sense, as opposed to nonsense, was James Leisenring (JL), an IASB member. As JL said, if bank asset impairments are "temporary", let the bank managements resign and buy those assets for themselves. I said this of Citigroup, on 17 July 2008, link: http://skepticaltexascpa.blogspot.com/2008/07/schwartzman-and-mcteer-on-accounting.html. Bret Dooley, a Citigroup employee, and another presenter, flinched at JL's suggestion. First step? Of 12? I disagree with making an announcment. Let the banks twist in the wind. Just don't renew in October. No press release. Creditors "will play 'chicken' with the government" until they see Lloyd Blankfein among others indicted. The "FDIC lacks the staff", absolutely. So why were banks holding FDIC insured deposits permitted to grow to this point? Why were they permitted to hold assets the FDIC examiners can't understand? It's too late for the separation to occur. Let the bank's bondholders pay.