Guest Post: Rationality of Banks

Note: This post originally appeared, in slightly different form, at the author’s personal blog, Diogenes of Brooklyn. It appears here with that blogger’s kind permission.

He does talk in the third person sometimes.

by Diogenes of Brooklyn

Like most Americans, Diogenes knows nothing of economics and finance. But quite a lot about the ways that banks work, or don’t work, has become public knowledge.

Remember when we were taught that economics was about rational markets. Milton Friedman, patron saint of Republican economists, used to say on TV that everything is rational. Keynes thought markets were more or less rational, except when they went nuts, the government had to step in. Mr. Romney still says it in public: Just a little private enterprise competency in the White House and everything will be hunky-dory, or however they say that in the language of the Harvard Business School. It will get to be as good as it was the lasts time we had a President with a Harvard MBA (irony alert).

Nowadays there is not so much rationality. Especially about the toxic assets. The whole economy is in pretty bad shape, but the colossal failure started with the Real Estate Bubble. A little of it was about Fannie and Freddie and the very powerful and very evil Barney Frank, but over 80 per cent of the problem was The Banks and Wall Street and good old private capital. Wall Street had access to billions and billions of dollars that were not usefully employed. Most of the stock market in the doldrums, and the owners of the biggest chuck of money, the Chinese Government, could not invest the money at home for fear of distorting their very productive but fragile economy. That enormous pile of money was invested in MBS’s and CDO’s and all the rest. And that money in the mortgage market allowed the most enormous bubble in USA real estate. You know the stories, whole towns in California where nobody lives, and nobody will ever live. People who bought houses at inflated prices. Standard and Poors said when they rated the derivatives, that Real Estate prices had always gone up, they could not go down. A lot of people lost their jobs in the Great Republican Recession, and could not sell their houses at any amount, let alone an amount that would cover the mortgage, even if they had put up 20%. It was a mess, and it remains a mess.

For a while Diogenes was associated with a company who told the world they had $10 billion from overseas investors, and that these investors wanted to buy the toxic assets of US Banks, at 26 cents on the dollar.

Seemed like a pretty straightforward assignment, just call some large number of banks, talk to the people responsible for unloading the things, and arrange a deal. Not one bank that wanted to do a deal. For a while people said this was because we let them know the price in advance. It really was no secret how they came to the price of 26%: When Merrill Lynch had to unload a ton of these assets in order for Bank of America to take them over, the assets sold in a hurry at that price.

It was not about price. It turns out that all of the banks preferred to let the assets get picked up by FDIC for 16%, instead of selling them privately for 26%. HSBC turned over the assets that my associates wanted to buy at 26 cents, and gave them them up to the government at a lower price, 16%.

Seemed pretty stupid to me. And some of the banks lied to me. The VP at IndyMac told Diogenes they were selling these assets (actual foreclosed houses) one by one at 90 cents on the dollar, and would not entertain any bulk sales of any kind. And that they were working the portfolio down at a rate that was acceptable to the regulators. Turned out not to be true. David Letterman should someday be as funny as the guy from IndyMac.

In order to actually make a deal with investors, someone at the bank would have to take responsibility for de-valuing assets, in writing. That is, the bank officer would have to make a decision to sell assets that were on the books for a billion dollars, and make the bank lose 740 million dollars, before the sale could take place at 260 million. That guy would immediately lose his job and he would never be able to work in the banking business again. Let it go to FDIC, nobody has to sign off on it. As we say here in Brooklyn, Poi-fict.

The whole banking fiasco was based on an interlocking network of stupid rules and irrational markets. It is no wonder that if failed in a spectacular way. It’s a good thing the Republicans have decided to end the Dodd-Frank bill, and get Big Government out of the way of the bankers who really know how to operate the money markets. The collapse of the world economy has been so much fun, that we really ought to give them another go at it (irony alert).