13 Responses to Will Summers Push Obama Administration Towards Debt for Equity Swaps for Big Bankrupt Banks?

1. BooRadley April 27th, 2009 at 1:42 am «

   THANK YOU.

   Great job.

   Recommended.

   If you are still within the interval edit, you might want to add Stiglitz’s name to the title. His name might attract more eyeballs.
2. Janushka April 27th, 2009 at 6:38 am «

   Recommended.

   A debt for equity swap would have the effect of wiping out or severely diluting shareholders. Some or all of the current shareholders’ ownership of a bank would be transferred to the creditors (bond-holders) of the bank. Since this would have the affect of reducing the liabilities (debt) of the bank, the bank could then write-down its bad assets; a balance sheet has to balance ( assets == (liabilities + equity)); so if you reduce liabilities (debt) and keep equity the same, you can write down your assets and not be insolvent.

   Bondholders wouldn’t likely be thrilled with this idea; a lot of them are pension plans, insurance companies, etc. They are trading what is supposed to be a “conservative” investment — bonds which pay interest– for more risky equity. But it is the way to handle this situation that is best for the taxpayers.

   My prediction: if they do a debt for equity swap, it will only be for one or more of the large regional banks (for example, Fifth-Third, which Yves Smith has described as a fairly conservative, well-run bank which has been ravaged because it operates mostly in Ohio and Michigan). From what I’ve read, the stress tests are gamed to be harder on the regionals than on the money center banks (for example, Citi and Bank of America); one or more of the regionals will be made the scapegoat(s). Timmeh and Larry can then show that they are using “all policy options”.

   Bondholders and shareholders of the big, politically plugged in, money center institutions will be immune.
3. Hugh April 27th, 2009 at 9:36 am «

   I don’t have the means to listen to the youtubes. My understanding so far has been that it was the government’s stakes in the banks that would be shifted from debt to equity. This would improve the banks’ balance sheets but would leave taxpayers in a worse position. It sort of takes them from being first in line in the event of a bankruptcy to not even being in line. As such it could be used down the road as another justification (albeit like all the others fairly dubious) for further aid to bad banks to keep them out of bankruptcy. IIRC this was part of the last AIG bailout. It is a means for Treasury to futher leverage its resources but at greater risk for taxpayers.

   I don’t see the relation though with what this has to do with marking down the banks’ crap assets. The funds we are talking about are insufficient to make the banks solvent so they have no incentive to be honest about these assets. Also Geithner’s PPIP giveaway is another disincentive for banks to come clean about their crap.

   Now if Summers is talking about non-governmental bondholders having to accept equity for debt, then the real question is how much equity for how much debt, how much control do the bondholders get for the swap, and as janushka points out which banks does this happen to.

   Now just a week or so ago the not very believable story was that the government didn’t have the power short of new legislation to do this. It is difficult to see the PIMCOs of the world going along with this voluntarily. There is no reason that bondholders shouldn’t take a hit. It is just that so far they haven’t been asked to.

   In some ways this is itself a kind of modified bankruptcy. Current shareholders are diluted but not wiped out. Creditors take partial ownership. The same bad players who ran the bank into the ground get to stay on. It has just that quality of keeping the tired failed system going without fixing it that has come to mark the Obama economic team’s approach to the financial crisis.
• Janushka April 27th, 2009 at 10:10 am «

  One thing about the debt for equity swap:

  I am pretty sure that if bond holders were forced to do this (and would get enough equity to control the bank), they would want their own people in there running the show. So the current management would be shown the door.

  But, again, I do not expect this to happen at any money center banks.
• Hugh April 27th, 2009 at 5:21 pm «

  Curiously, a few months ago Gross from PIMCO on a Charlie Rose show suggested putting the banks through bankruptcy, re-organizing them, wiping out the current shareholders, and then turning them over to their creditors. It was of course a very bondholder friendly perspective.

  I really don’t think this is what Summers has in mind. I think he wants to recapitalize banks in part via the debt for equity swap. He wants their money. And for this to have some impact, it would have to be at the big banks, not the small ones. But I don’t see any evidence that he or Geithner want to do anything that replace the current bad managements of the big banks.

  BTW Styve, thanks for the info about Summers’ connection to the Russian mess. It just further confirms that Summers who also promoted derivatives and deregulation of financial markets has had a long history of being wrong.
4. Janushka April 27th, 2009 at 10:04 am «

   The Charlie Rose website has the link up, for those who want to see the whole program

   “http://www.charlierose.com/view/interview/10251″
5. Styve April 27th, 2009 at 11:34 am «

   This seems very much like the Loans for Shares scheme that the oligarchs in Russia used to loot that country, and Summers was a big supporter/fan of Chubais, one of the kingpins involved with Boris Berezovsky.

   Will find some material I sent Thom Harmann a while ago on this, which I put together while reading “Godfather of the Kremlin”, by Paul Klebnikov.
6. Styve April 27th, 2009 at 11:36 am «

   Here is the Wikipedia piece on the Loans for Shares ruse…

   The “loans for shares” scheme and the rise of the “oligarchs”
   Main articles: Privatization in Russia and Russian oligarch

   The new capitalist opportunities presented by the opening of the Russian economy in the late 1980s and early 1990s affected many people’s interests. As the Soviet system was being dismantled, well-placed bosses and technocrats in the Communist Party, KGB, and Komsomol (Soviet Youth League) were cashing in on their Soviet-era power and privileges. Some quietly liquidated the assets of their organization and secreted the proceeds in overseas accounts and investments.[10] Others created banks and business in Russia, taking advantage of their insider positions to win exclusive government contracts and licenses and to acquire financial credits and supplies at artificially low, state-subsidized prices in order to transact business at high, market-value prices. Great fortunes were made almost overnight.

   At the same time, a few young people, without much social status, but with lots of entrepreneurial spirit, saw opportunity in the economic and legal confusion of the transition. Between 1987 and 1992, trading of natural resources and foreign currencies, as well as imports of highly demanded consumer goods and then domestic production of their rudimentary substitutes, rapidly enabled these pioneering entrepreneurs to accumulate considerable wealth. In turn, the emerging cash-based, highly opaque markets provided a breeding ground for a large number of racket gangs.

   By the mid 1990s, the best-connected former nomenklatura leaders accumulated considerable financial resources, while on the other hand, the most successful entrepreneurs became acquainted with government officials and public politicians. The privatization of state enterprises was a unique opportunity, because it gave many of those who had gained wealth in the early 1990s a chance to convert it into shares of privatized enterprises.

   The Yeltsin government hoped to use privatization to spread ownership of shares in former state enterprises as widely as possible to create political support for his government and his reforms. The government used a system of free vouchers as a way to give mass privatization a jump-start. But it also allowed people to purchase shares of stock in privatized enterprises with cash. Even though initially each citizen received a voucher of equal face value, within months most of the vouchers converged in the hands of intermediaries who were ready to buy them for cash right away.

   As the government ended the voucher privatization phase and launched cash privatization, it devised a program that it thought would simultaneously speed up privatization and yield the government a much-needed infusion of cash for its operating needs. Under the scheme, which quickly became known in the West as “loans for shares,” the Yeltsin regime auctioned off substantial packages of stock shares in some of its most desirable enterprises, such as energy, telecommunications, and metallurgical firms, as collateral for bank loans.

   In exchange for the loans, the state handed over assets worth many times as much. Under the terms of the deals, if the Yeltsin government did not repay the loans by September 1996, the lender acquired title to the stock and could then resell it or take an equity position in the enterprise. The first auctions were held in the fall of 1995. The auctions themselves were usually held in such a way so to limit the number of banks bidding for shares and thus to keep the auction prices extremely low. By summer 1996, major packages of shares in some of Russia’s largest firms had been transferred to a small number of major banks, thus allowing a handful of powerful banks to acquire substantial ownership shares over major firms at shockingly low prices. These deals were effectively giveaways of valuable state assets to a few powerful, well-connected, and wealthy financial groups.

   The concentration of immense financial and industrial power, which loans for shares had assisted, extended to the mass media. One of the most prominent of the financial barons Boris Berezovsky, who controlled major stakes in several banks and companies, exerted an extensive influence over state television programming for a while. Berezovsky and other ultra-wealthy, well-connected tycoons who controlled these great empires of finance, industry, energy, telecommunications, and media became known as the “Russian oligarchs.” Along with Berezovsky, Mikhail Khodorkovsky, Roman Abramovich, Vladimir Potanin, Vladimir Bogdanov, Rem Viakhirev, Vagit Alekperov, Viktor Chernomyrdin, Viktor Vekselberg, and Mikhail Fridman emerged as Russia’s most powerful and prominent oligarchs.

   A tiny clique who used their connections built up during the last days of the Soviet years to appropriate Russia’s vast resources during the rampant privatizations of the Yeltsin years, the oligarchs emerged as the most hated men in the nation. The Western world generally advocated a quick dismantling of the Soviet planned economy to make way for “free-market reforms,” but later expressed disappointment over the newfound power and corruption of the “oligarchs.”
7. Styve April 27th, 2009 at 1:20 pm «

   Though the Russian loans for shares scheme isn’t identical to the proposed debt for equity scheme, Summers’ involvement in the former and crafting of the latter, sorta stinks to high heaven…

   http://iskran.iip.net/review/september/la1.html

   Los Angeles Times
   How the Chubais clan, Harvard fed corruption
   by Janine R. Wedel

   Janine R. Wedel, associate professor at the Graduate School of Public and International Affairs at the University of Pittsburgh, is the author of Collision and Collusion: The Strange Case of Western Aid to Eastern Europe.

   As more becomes known about Western participation in the laundering of Russian money, the Washington establishment likely will try to hide behind stories of faraway organized crime and distance itself from any culpability.

   But U.S. policy toward Russia has contributed to that country’s sorry conditions. Russian “reformers,” including many under investigation for allegedly laundering billions of dollars through the Bank of New York, have long been embraced by the Clinton administration and international financial institutions. Among them are current and former members of Russian President Boris N. Yeltsin’s government, to which the West pinned its hopes for a new relationship with Moscow and entrusted hundreds of millions of dollars in aid. For years, despite accounts of massive capital flight, money laundering and Russians buying up the French Riviera, the money kept flowing. Yet, no Russian dollar can be deposited in a Western bank account without the knowledge and participation of a Western institution.

   Among those under investigation in the West for money laundering is longtime Yeltsin aide Anatoly B. Chubais, the chief architect of Russia’s economic reforms. While under investigation in Russia for matters ranging from suspect banking deals to bribery, Chubais and his clique of political and financial powerbrokers, known as the “Chubais Clan,” were the darlings of the U.S. Treasury and international financial institutions. With Treasury Secretary Lawrence H. Summers the key architect of U.S. economic policy toward Russia since 1993, the administration gave the Chubais Clan much control over hundreds of million of dollars in aid.

   The Clan worked closely with the Harvard Institute for International Development, whose Russia project was headed by economist Andrei Shleifer, Summers’s co-author and protege. Citing “foreign policy considerations,” Clinton administration policymakers largely bypassed the usual public bidding for foreign aid contracts. Harvard principals with ties to the Chubais Clan were given “substantial control of the U.S. assistance program,” according to a 1996 report by the U.S. General Accounting Office. Since 1997, Shleifer and another Harvard principal have been under investigation by the U.S. Justice Department for misuse of funds.

   The Harvard Institute, together with the Chubais “dream team,” as Summers called it, presided over Russia’s economic “reforms,” many of them U.S.-funded, including privatization. But the reforms were more about wealth confiscation than wealth creation. The first stage of privatization, which had substantial input from U.S.-paid Harvard advisers, fostered the concentration of property in a few Russian hands and opened the door to widespread corruption.

   Then Chubais approved the “loans-for-shares” program, which was masterminded by his associate, Vladimir O. Potanin, a onetime deputy prime minister for economic affairs who also is named in the current money-laundering investigations. It was under this scheme that insider deals and coziness between government and Russia’s oligarchs became crystallized for all to see. But the Clinton administration continued its support for its favored “reformers.”

   continued at link above~~
8. wesgpc April 27th, 2009 at 1:59 pm «

   thanks to commenters above for the info and notification that the whole show is up at the Charlie Rose site.

   I wish Rose were a bit better at focusing discussion. He tends to let things wander before points are nailed down; and he sometimes tries to demonstrate he understands things (when I do not think he does in fact understand) -maybe he should just ask a damn question to get things settled more often.

   But… my understanding of the interview is that Summers may be advocating that bondholders of the big bankrupt banks be forced to trade their debt for equity. This would be in effect, a kind of financial reorganization, and a way to recapitalize the banks, and force private investors to take some of the risk and cost, rather than laying it all on taxpayers.

   As for effects of bondholders in large pension plans and insurance companies, Stiglitz, Roubini, and Galbraith, and some others (Simon Johnson, I think) are all on the record as saying that, as far as effects on pensions, etc., it is better to face truth and deal with their problems directly. And, I think news reports have strongly suggested that little of the bailout dollars have gone to these kinds of asset holders anyway. So, for the commenters who brought up pensions, I would need to hear in some detail how the current approach will definintely work better for them -seems to me that they are not seeing the money now anyway, and will face the music anyway, if the banks are still limping along in a couple of months, or years, from now, and no more money can be sprung from Congress or the Fed.
• Janushka April 27th, 2009 at 2:40 pm «

  I agree with what the people you cited say about dealing directly with pension plans’ problems. I don’t think that the fact that pension plans will be negatively affected is a good reason to do the Summers-Geithner type bailout of the banks.

  However, it is incorrect that they “are not seeing the money now”. Debt issued by banks are among the largest holdings of pension plans and insurance companies (and money market accounts). Except for a few instances (Lehman and WAMU come to mind) there have been no debt defaults by big financial institutions. Citigroup, Bank of American, Morgan Stanley, Wells Fargo, JPMorgan — none of them have defaulted on their debt. The pension plans that hold this debt have been getting their interest payments (and principal payments in cases where the bonds have matured) without interruption; thanks to TARP., etc. So, of course, everyone involved would just like to keep things this way.
• wesgpc April 27th, 2009 at 5:10 pm «

  You have a good point, many parties are getting their interest paid right now.

  I was under the impression from some stories that some of the TARP money was used to buy the assets held by some big banks at face value, so they do not even have to worry about interest any more. But I may very well be wrong.

  I think we are agreed that the problem comes when the TARP, and other bailout money is gone, cannot be replenished and then what happens to those who will still need interest payments after that.
9. Hugh April 27th, 2009 at 5:25 pm «

   Pensions have been chronically underfunded. Their inflows are decreasing due to the depression. Their outflows remain fixed. They are burning through a lot of assets which they have to sell at low prices because there is so little market for them. They together with the hedge funds are one of the last major shoes left to drop.

   Naked Capitalism has been following this story.