Baseline Scenario

The Baseline Scenario
The Two Sides of the Balance Sheet
Benefits of Size?
The Cost of Life
The Two Sides of the Balance Sheet
Posted: 30 Jun 2009 02:30 PM PDT
Noam Scheiber at The New Republic has the inside scoop (hat tip Ezra Klein) on why Treasury is letting the Public-Private Investment Program die a quiet death (although at this point the legacy securities component may still go ahead). In short, the argument is that the point of PPIP was to help banks raise capital by cleaning up their balance sheets; since they have been able to raise capital themselves, there is no need for PPIP. According to one person Scheiber spoke to: “If you had asked–I don’t want to speak for the secretary–what’s problem number one? I think he’d say capital. Problem two? Capital. Problem three? Capital.”
This represents the latest swing of the pendulum between the two sides of the balance sheet. As anyone still reading about the financial crisis is probably aware, a balance sheet has two sides. On the left there are assets; on the right there are liabilities and equity; equity = assets minus liabilities. (There are different definitions of capital, depending on what subset of equity you use.)
The goal has always been to provide confidence that there is enough capital to withstand the impact of market and economic turmoil – in particular, its impact on the toxic assets that litter banks’ balance sheets. However, there are two alternative approaches to doing this. One is to add more equity to the right side by issuing new stock (preferred or common). (This would add cash to the left side to keep them in balance.) The other is to reduce the uncertainty of the left (asset) side by helping banks sell toxic assets; even if the banks have to sell them for a little less cash than their current balance sheet value, this would have the salutary effect of reducing vulnerability, since cash does not lose value (at least not in an accounting sense). Alternatively, you could achieve the same effect by insuring the value of the assets while leaving them on bank balance sheets, because then the risk transfers to the insurer.
The initial Paulson Plan last September focused on the left side; the idea was to buy toxic assets off of bank balance sheets. Then in October Treasury did an about-face and switched to the right side, recapitalizing banks by buying preferred stock from them (TARP). In November and January, Treasury and the Fed did combined bailouts of Citigroup and Bank of America, in which they both provided fresh capital and guaranteed certain assets against falls in value. In February and March, Treasury shifted all the way over to the left (asset) side with the PPIP, which was hailed (by its supporters, at least) as a way to cleanse bank balance sheets – something that had not been accomplished by TARP. Now, it seems, we are back to the right side; as long as banks can raise more capital, everything is fine, no matter how many toxic assets they may hold.
One key to the financial crisis has been nervousness about toxic assets on bank balance sheets. It’s nice that people aren’t so nervous anymore. But as Raghuram Rajan said to Klein, “if we reenter the downturn, and the banks begin to look shakier – we’ll wish we had moved the assets when the market was calm and stable, rather than leaving them to create uncertainty and volatility at the center of the banking system.”
By James Kwak

Benefits of Size?
Posted: 29 Jun 2009 09:13 PM PDT
Felix Salmon points out that Bank of America can now charge customers overdraft fees ten times a day (up from five). (Read the original Washington Post article if you want to be aggravated.) Well, I can do one better.
I recently had to track down some past bank records. Local banks? No problem, no fee. At Bank of America, however, they insisted on charging me $5 per page – even though they were breaking a state law forbidding them from charging a fee. (All I’ll say is that they weren’t allowed to charge a fee because of the characteristics of the person I was getting the records for and the purpose for which he needed the records.) I pointed out to the drone at the bank that she was breaking the law, but she insisted she couldn’t do anything about it and we would have to sue them to get the money back. And I believe her; the problem is almost certainly that requests go from the local branch to some central processing center, and there is no way for the local branch to tell the central processing center not to deduct the fee from your account.
Now perhaps this central processing center setup reduces costs for Bank of America. But do they charge lower mortgage rates? No. Do they offer higher savings rates? No. Are they too big to fail? Absolutely. Do things have to be this way?
By James Kwak

The Cost of Life
Posted: 29 Jun 2009 08:59 PM PDT
Mark Thoma links to a medical paper that brings up the issue that few people want to talk about: at what point is the cost of medical care to extend life not justified? Like Thoma, I don’t have a great answer, except to point out that in a world of scarce resources, the answer cannot be that any effort to extend life by any small amount is always a good idea. (And as David Leonhardt explained, our health care system is certainly constrained by scarce resources, whether we like it or not.)
I just have one observation and one recommendation.
The observation is that our political and legal systems already put price tags on life routinely. If you die on the job, the workers’ compensation system calculates how much your life was worth; if you are killed as a result of someone else’s negligence, the tort system does the same. In either case, the calculation is primarily based on your expected earnings for the rest of the life; in other words, young high-earners are worth more than old poor people. And for virtually everyone, the number you end up with is much less than the value implied by the cancer treatment discussed in the paper Thoma cites.
I’m no fan of that system. I’m just surprised that as a society we can be so brutal and inegalitarian in one sphere and so touchy in another (health care, where the thought that any life-extending treatment might be too expensive is probably considered morally abhorrent by most people).
The recommendation is that if you are interested in this issue, you should listen to Dr. Robert Martensen on Fresh Air. Martensen is not only a doctor and a bioethicist, but at the time of the interview I believe (my memory might be failing me) he was dealing with the imminent death of one of his parents, and the medical choices involved.
By James Kwak