Neel Kashkari Is the Zombie Master...
CNN Death Spiral Watch

Brad Setser and Felix Salmon Fear the Zombie Banks

Ogoun Badagis--St. Jacques Majeur--Neel Kashkari, guard us!

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From Felix Salmon:

The Weakness of the Treasury's New Bailout Plan: The scorpion, it seems, is staying as true as he can to his nature. And although I'm the first to admit that this is no time to worry overmuch about moral hazard concerns, the slowly-emerging shape of Treasury's plan to recapitalize the banking system worries me.... [T]he broad-brush approach of the proposed plan, with no voting rights and seemingly very little due diligence, worries me. Pricing the Treasury's preferred stock will be a bugger; I have a feeling they might just make all the banks pay them a nice round 10% and leave it at that, with the banks having a call option after say three years. But that one-size-fits-all approach, especially when it's combined with the present bank management which got us all into this mess to begin with, is a recipe for hail-mary passes and other forms of counterproductive risk taking.

If you're running an insolvent bank, and you get a slug of equity from Treasury, your shareholders will thank you if you use that equity to take some very large risks. If they pay off and you make lots of money, then their shares are really worth something; if they fail and you lose even more money, well, there was never really any money for them to begin with anyway. Brad Setser has it right, I think:

A world where the government guarantees the ability of privately owned banks with potentially troubled balance sheets to raise wholesale funding is neither desirable nor necessarily stable for long.... If the guarantee is credible then an institution with little or no equity has the capacity to raise wholesale funds to gamble for redemption. And those bets are a potential source of instability. Regulation theoretically can limit this risk, and right now there is enough fear that I am not sure that it is most immediate risk -- but conceptually, the incentive to make big bets with the government's guaranteed money is there.

This is a real risk, I think, especially when you're talking about banks like Morgan Stanley whose books are very opaque and which can lever up substantially within minutes....

[I]f you go the UK route and insist on board seats and the ouster of failed executives, it helps.... I'm quite sure that Paulson hates the fact that he's semi-nationalizing the banking system. But he needs to get real and accept it, rather than trying to brush it under the carpet. Otherwise he's putting hundreds of billions of taxpayer dollars at unnecessary risk.