Time to bite the bullet over bankrupt banks

South China Morning Post  |  Feb 26, 2009

By Sin-ming Shaw

There are two overriding economic issues the Obama administration must resolve quickly.

First is what to do with the major banks that are, in effect, bankrupt. The second is whether publicly funded bailouts can be fair to taxpayers.

If, for instance, the US government were to overpay for Citigroup in the anticipated buyout, President Barack Obama will be watched closely to see how the government makes amends in some other way. Overpaying for Wall Street's damaged goods, as it were, effectively robs the working class to help the kleptomaniac captains of Wall Street.

US Treasury Secretary Timothy Geithner was correctly criticised two weeks ago for failing to take a clear stand on how best to bail out the banks. After a muddled rationalisation of his vague rescue plan, he appears to be on the verge of nationalising Citigroup, a step that is as inevitable as it was unnecessarily late. The world is watching with baited breath to see how he will execute this.

The issue with the banks is straightforward. They have, on their books, a large cache of toxic assets. The banks have been playing hide and seek with the public with tacit approval from Henry Paulson, the previous Treasury secretary, as to what these assets, and by extension their banks, are really worth.

Most astute financial professionals believe some of the world's major lenders are largely worthless.

Financier George Soros, a man of great intellectual and moral integrity, insists that assets with no actual market price at which transactions of a meaningful size can be done, should be written down to zero.

This is theoretically correct because if no one can demonstrate an asset has an actual tradeable price, it is worthless. Maybe such a price will emerge at some future date. But that's not good enough to justify keeping it at a cost based on a hope and a prayer.

More important, when such non-tradeable assets are carried at their original cost, or are insufficiently marked down, the managers of such assets - whose incomes are derived from the size of the assets - are dishonestly compensated.

Bank chief executives have been reluctant to mark down assets in the Soros fashion because to do so would immediately reveal to the world that their liabilities are larger than their assets: in short, they are bankrupt.

Bank managements have been procrastinating in the hope that markets will improve enough to mask the worthlessness of their assets and the extent of their incompetence.

They are also holding governments hostage; they have created the impression that, without them, the financial system will collapse, bringing down the whole economy. That being so, then the government must fork over ever larger sums to keep them and their firms afloat.

GM, Citigroup and AIG are the three most prominent examples. Others are waiting in the wing for more bailout money. These firms have spotted a weakness in this inexperienced Obama administration, which does not want to be seen as responsible for an economic free fall.

Mr Geithner, now increasingly viewed as weak, appears fearful of upsetting the status quo. Many existing board members of bankrupt Wall Street banks have strong political and personal ties to the senior members of the administration.

If, in the nationalisation of Citigroup, the government paid too much for its assets, existing shareholders would benefit but voters would be alienated. It would also show that Mr Obama's economic advice is inadequate for the challenges ahead.

If Mr Geithner were to do the right thing, by paying a nominal price for Citigroup as a bankrupt company, shareholder fallout would trigger

"regime change" among management. The rest of Wall Street may take heart and engineer its own less-dramatic changes at the top. If and when that happens, it would be reason to hope for a speedier recovery of the US economy.
Sin-ming Shaw is a private investor


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