Peter Cohan, head of Peter S. Cohan & Associate, a management consulting and venture capital firm, based in the Boston area, doubts about the efficiency of the present financial US Federal strategy and thinks Uncle Sam would do better if helping the zombies die a good death. How much more US taxpayer bucks will be injected to keep those financial institutions alive? One trillion? Five trillion?
President Obama’s first budget submission to Capitol Hill calls for a reserve fund of $250 billion that could be used to leverage another $750 b in bank bailouts should the need arise this year or next year. This vast sum will add to the existing inherited $700 b TARP (Troubled Asset Relief Program) fund.
How far the Dow Jones will keep falling to convince politicians and opinion makers (like Nobel Paul Krugman) that temporary nationalization of zombies is a failed strategy? The carnage at Wall Street pushed DJIA in February to 7,000 points (a 50 pct drop from the peak in October 2007) and March just begins below that line.
Opinion makers and spin doctors refer as a best practice the Swedish strategy in the 1990s but fail to understand the differences between then and the present global mess.
INTERVIEW by Jorge Nascimento Rodrigues
Q: How you evaluate Obama’s anti-crisis strategy so far?
A: I think the Obama stimulus plan is 64% stimulus, 36% wasteful tax cuts. The plan to keep throwing money into zombie banks is a waste of money. We are forgetting the purpose which is two fold: get lending going (for which I would create new banks) and clean up toxic waste (which I would fix by letting the FDIC buy the, say 15%, of bad mortgages within a typical mortgage-backed security).
Q: Why new banks? Why not reengineering those in place?
A: If $350 billion in TARP money went into new banks it would create $3.5 trillion in lending capacity (at a conservative asset/equity ratio of 8:1). If the FDIC buy plan I mentioned was put into effect, the toxic mortgages would trade freely because they would consist only of paying mortgages. And the FDIC could restructure the bad loans to keep more houses off the foreclosure market.
COHAN ADVICE: «The new banks would be formed through a blend of public and private investment. The more private capital, the better – but I imagine it might take at least 50% of the government capital to make this work for private firms to invest.»
Q: You say “create new banks”. What you mean exactly? – Helping private people to found new banks with Federal help from TARP money? – Or Federal government taking initiative to create new banks, let’s assume by a public-private partnership (FED Ben Bernanke recently talked about “partnerships”)?
A: Ideally the new banks would be formed through a blend of public and private investment. The more private capital, the better – but I imagine it might take at least 50% of the government capital to make this work for private firms to invest. To start new banks would require fresh capital, new management, outsourced computer systems, and rented empty buildings from failed companies. These new banks would have no toxic waste on their balance sheets and would have a powerful profit incentive to lend out their capital and attract new deposits. The new banks would be able to provide credit which the zombie banks have chosen not to provide. Since those zombie banks get taxpayer money and are not lending it out, the taxpayer money is being wasted.
Q: Do you think the Administration will enforce temporary nationalizations particularly regarding the biggest banks on market capitalization considered zombies, like Citigroup and BofA?
A: It will probably end up with less than a 50% stake in the zombies which will be de facto nationalization if not following the formal definition of nationalization.
COHAN ABOUT ZOMBIES GOOD DEATH: «What I am talking about is to use the money that’s been invested so far to provide some time to plan the failure of the zombie institutions so that the consequences are not as disastrous when they fail.»
Q: You refer recently that probably you would prefer to focusing on assisting the zombies die a good death. How? People say that Lehman Brothers’ case – one of the too big to fail – was the trigger of a worse crash and depression?
A: The problem with the Lehman bankruptcy is that it happened so suddenly that it caused unexpected and widespread consequences to the financial system around the world. What I am talking about is to use the money that’s been invested so far to provide some time to plan the failure of the zombie institutions so that the consequences are not as disastrous when they fail.
Q: How you figure out that assisted death management?
A: These zombies are very complex institutions so it is hard to describe exactly how they would die a good death. The relatively easy part is to separate the profitable business units that would be valuable to an investor from the unprofitable ones that need to be fixed before they can be sold. The unprofitable businesses include Credit Default Swaps (CDS) – which is a form of bond insurance — and Level 3 assets – which have no market value and include mortgage-backed securities (MBSs) – which contain thousands of mortgages. To fix the first, it would be good to set up an exchange – like a stock exchange – for trading CDSs. This would help because thanks to their being deregulated in 1999, CDSs were written in the shadows with no capital requirements, little documentation, and no comprehensive knowledge of who had written which contracts. A CDS exchange would make it easier to settle these and would help put a number on the cost of settling them. As for Level 3 assets, I would follow the plan I mentioned above regarding letting the FDIC buy the 15% of bad mortgages within the MBSs – this would cut out the cancer from the MBSs and then they could trade freely – turning them into Level 1 assets which are worth more and are easy to value because traders put a market price on them.
Q: With all this paradoxical discussion about nationalizations of pillars of a private capitalist economy, have the politicians and lawmakers got a “socialist drunkenness”?
A: No socialist drunkenness. But I don’t think public ownership will solve the problem. It will just transfer it to the government which probably does not know how to run a bank. Maybe if the governments that take over put in place executives with a background in turning around troubled banks, then they will be able to get a return on their investments.
Q: But does it make sense – even in a crisis situation – to put the Treasury as head of the financial system? Or is it acceptable as a transitory political measure, if we can define the extension of this transitory period?
A: I don’t think the Treasury will be the head of the financial system. It will be a troika – the Fed, the Treasury, and the FDIC with Obama directing all three. It will only be good if they pursue the right policies. And I would give the FDIC $80 billion to buy the bad mortgages at face value out of the mortgage-backed securities. This would free those mortgage-backed securities to trade and make them non-toxic. Meanwhile the FDIC could restructure the mortgages and keep them out of foreclose.
Q: How the Congress must supervise this transitory nationalization, if it occurs?
A: It should set specific benchmarks for when it is time to sell the shares back to investors. For instance, it could set goals for profitability, capital adequacy, and credit quality. Once those goals are achieved, then investors will be ready to buy back the shares. And I hope, the government will sell those at a profit to reimburse the Treasury for the risk taken.
COHAN ABOUT THE SWEDISH CASE STUDY: «The Swedish solution in the 1990s does not apply to the current situation. The current situation is different due to securitization and global interconnectedness.»
Q: Do you think the Swedish solution in the 1990s can be useful today?
A: The Swedish solution in the 1990s does not apply to the current situation. The current situation is different due to securitization and global interconnectedness. In Sweden, nationalizing banks did not shut down the rest of the financial world. If the U.S. shut down its banks, the shut down would have repercussions around the world. Also in Sweden, the problem was too many bad loans of a conventional type which were easier to value. The current toxic waste is much more difficult to value and thus it is harder to gauge where the bottom is.
Q: The DJIA is in its lowest level from the pick of the last bull Wall Street cycle in October 2007. Do you think the crash can went further? Mark J. Lundeen, an independent analyst, forecasts a 60 pct correction until June from the pick in October 2007…
A: Dow can hit 3,000. The Dow lost 90% from its peak after October 1929 and I think it is reasonable to assume a severe drop from the 14,000 high in October 2007.
COHAN ON THE BIG LOGOS IN THE NYSE: « The conglomerates like GE that are really financial companies with a wrapping of product makers will also go below $1.»
Q: If the DJIA bottoms at 3000 points, what will happen to the big names of the DJIA and the NYSE financials?
A: I think the financial stocks that needed government money are all going to be trading at less than $1 a share. And the conglomerates like GE that are really financial companies with a wrapping of product makers will also go below $1.
Q: And with less than $1, do you think these stocks must continue in the NYSE?
A: Under a $1 they should be delisted and trade on the ‘pink sheets’ – but the U.S. will probably make an exception for them because they are ‘too big to fail.’
COHAN ON THE CHINESE ‘UNCLE: ‘« Simply put, China and the U.S. have a kind of economic mutually assured destruction if they disengage from each other.»
Q: With a so huge crash in Wall Street what will be the contagion effect around the world?
A: Well the U.S. is selling treasury bills to finance the bailouts of the sick financial institutions and it depends on other countries to buy these notes. If the other countries buy the notes and the U.S. cannot refinance them when they mature, then the rest of the world will lose its investment. This seems like a slim possibility. Other more conventional global effects could be the continued loss of value of mortgage-backed securities and other asset-backed securities held by investors around the world and the inability of Credit Default Swap parties to fulfill their obligations – thus stiffing global counterparties. And the most conventional global effect would be from the slowdown in U.S. demand for goods made around the world.
Q: Why a slim possibility? You do not think it’s a real political option from China and others if the US does not give some geopolitical gifts in exchange?
A: For the time being, China is very dependent on Western demand for goods that it manufactures. If China does not buy U.S. bonds, then the U.S. will be in even worse economic shape. It will buy even fewer Chinese manufactured goods. And China will have an even bigger political problem of workers who came from the countryside to work in factories and are recently fired from their jobs. However, if China decides to change the composition of its economy – by making itself less dependent on the U.S., then it can afford to let the U.S. go begging elsewhere for a buyer of its bonds. It might take some time for China to achieve this – and since it owns something like $350 billion worth of U.S. bonds, if interest rates rose, the value of those holdings would decline. Simply put, China and the U.S. have a kind of economic mutually assured destruction if they disengage from each other.
© janelanaweb.com, 2009