Saturday, April 18, 2009

William K. Black is an Idiot

William K. Black has been making the rounds lately, and has been drawing a lot of attention (from people who want to hate the Geithner plan) by claiming that the Obama administration is "refusing to obey the law" by not seizing the major banks. On Bill Moyers' show, Black stated:

I think, first, the policies are substantively bad. Second, I think they completely lack integrity. Third, they violate the rule of law. This is being done just like Secretary Paulson did it. In violation of the law. We adopted a law after the Savings and Loan crisis, called the Prompt Corrective Action Law. And it requires them to close these institutions. And they're refusing to obey the law.
This is patently untrue. Prompt Corrective Action (PCA) does not require the government to close any of the major banks. PCA requires the government to take certain actions as an FDIC-insured bank's capital cushion declines. But even when a bank becomes "critically undercapitalized," PCA requires the government to either place the bank in receivership or "take such other action as the agency determines ... would better achieve the purpose of [PCA], after documenting why the action would better achieve that purpose."So Black is misrepresenting the law. Moreover, none of the major banks' FDIC-insured subsidiaries are even close to "critically undercapitalized" under the Prompt Corrective Action Law. In fact, they're all considered "well capitalized" under PCA. To be considered "well capitalized" under PCA, a bank must have (1) a total risk-based capital ratio of 10% or higher; (2) a Tier 1 risk-based capital ratio of 6% or higher; and (3) a leverage ratio of 5% or greater. A bank isn't considered "critically undercapitalized" until its ratio of tangible equity to total assets falls below 2%. Here are the relevant ratios for the FDIC-insured subsidiaries of Citigroup, BofA, Wells Fargo, and JPMorgan. (Select "Performance and Condition Ratios.") As you can see, all of them have capital ratios well above those required to be considered "well capitalized" under PCA. Now, you can argue that these capital ratios don't represent the true condition of the banks, but that's a different argument. The issue here is whether the Obama administration is "refusing to obey the law" by not seizing the banks under PCA. Clearly they're not. So not only is Black misrepresenting the Prompt Corrective Action Law, he's also badly misrepresenting the condition of the banks under PCA. What a dishonest hack.

22 comments:

Economic Darwinism said...

Hi,

I recently found your blog and like it very much. But as I said last week, I seem to pretty much disagree with everything I read here. That is a good thing! I hope I can learn something. Who knows, you might learn something too.

This post, in particular, I disagree with because I recently nominated William Black a modern-day American hero, which I suspect you'd disagree with. I think you'd also disagree with my previous nomination: Yves Smith.

You said:
But even when a bank becomes "critically undercapitalized," PCA requires the government to either place the bank in receivership or "take such other action as the agency determines ... would better achieve the purpose of [PCA], after documenting why the action would better achieve that purpose."So Black is misrepresenting the law.
How exactly is he misrepresenting the law? I don't see how the government has taken either action.

You said:
Moreover, none of the major banks' FDIC-insured subsidiaries are even close to "critically undercapitalized" under the Prompt Corrective Action Law.I guess that depends on whether you think the numbers the banks are reporting are accurate. Most people on Black's side would argue that the true ratios are much uglier than the reported ratios. That is part of the outrage, i.e. banks not marking assets to reality. Furthermore, bank's capital ratios, especially when it comes to toxic assets, are a function of valuations from risk models, which are also highly suspect (I know because I used to build them).

You said:
Now, you can argue that these capital ratios don't represent the true condition of the banks, but that's a different argument.I disagree. I think this is the issue.

Black argues, correctly I think, that we need to find out the true ratios and by not doing so, we are at odds with the intent of the law.

I also think the stress tests are a shame. What do you think?

Anonymous said...

I find it amazing that you continue to label other people idiots.

Last time I checked, Bank of America was bailed via a taxpayer gift of $118 billion CDS on various mortgage assets.

Now, where would BAC be without the largesse of the taxpayers?

Ken Lewis is still in power pratlling about wanting to return the $40 billion in TARP funds. No word on terminating the $118 billion CDS.

Economics of Contempt said...

How exactly is he misrepresenting the law? I don't see how the government has taken either action.

Black is saying that the government is required to place the banks in receivership under the law. But the law doesn't say that. It says that even for banks that fall within the definition of "critically undercapitalized," receivership is only one option, and the government isn't required to use it. Black is claiming that the law says something that it doesn't. That's a misrepresentation.

I guess that depends on whether you think the numbers the banks are reporting are accurate. Most people on Black's side would argue that the true ratios are much uglier than the reported ratios. That is part of the outrage, i.e. banks not marking assets to reality.

The law has well-defined procedures for calculating capital ratios, and the banks are following them. You may disagree with those procedures (like it or not, under GAAP the banks don't have to mark all their assets to market), but that's irrelevant to the issue of whether current law requires the government to place the banks in receivership.

The PCA law provides that if a bank's capital ratio, calculated a certain way, is above a predetermined threshold, then the bank is considered "well capitalized." The capital ratios of all the major banks, calculated in accordance with the law, are above those predetermined thresholds. Thus, for purposes of PCA, the banks are considered "well capitalized."

This isn't an argument about whether the law should force the government to place the major banks in receivership. It's about whether, as Black claims, current law does require the government to use receivership. Current law unambiguously does not require the government to place the major banks in receivership. That makes Black 100% wrong.

I used to like Yves Smith a great deal, but ever since the financial crisis started (i.e., when Lehman failed), her arguments have become borderline delusional. Her bizarre belief that Tim Geithner is corrupt and Goldman secretly controls the government makes her more of a conspiracy theorist than a serious commentator on the financial crisis. I completely agreed with her last summer in the oil bubble debate, but she long ago left fact-based arguments behind. She prefers vague innuendo and "experts" like William Black now.

As for the stress tests, I wasn't involved in them at all, so I don't have nearly enough information to form an informed opinion yet. I don't see how anyone who wasn't involved has enough information about them to have an informed opinion yet.

Economics of Contempt said...

Last time I checked, Bank of America was bailed via a taxpayer gift of $118 billion CDS on various mortgage assets.

Now, where would BAC be without the largesse of the taxpayers?


The PCA law doesn't say that capital ratios have to be calculated based on where a bank would be "without the largesse of the taxpayers." So your point is completely irrelevant. This isn't a morality play, my friend, it's the real world. Why would BofA ignore the government's guarantee on $118bn of mortgage-related assets when calculating its capital ratio? Because you think it's unfair?

The whole point of injecting capital and guaranteeing some of its assets was to improve BofA's capital position, and to make it less likely that BofA will fail. It makes absolutely no sense to guarantee a pool of BofA's assets, and then turn around and ignore that guarantee when calculating BofA's capital ratios.

Sheesh.

Anonymous said...

No offense, but anyone who believes that the calculation agent computes the mark-to-market on a PAUG CDS swap has no business calling anyone else an idiot.

BAC begged the Bush Admin for cash and the Bush Admin obliged them with taxpayer money.

The PCA requires that the FDIC/Tsy explain why BAC wasn't seized. AFIK, the Bush Admin couldn't be bothered to comply with that part of the law.

Economics of Contempt said...

The PCA requires that the FDIC/Tsy explain why BAC wasn't seized. AFIK, the Bush Admin couldn't be bothered to comply with that part of the law.

No, it doesn't. Please go read the law before pretending to have a clue what you're talking about.

The PCA law only requires a written explanation for why receivership wasn't used when a bank has been deemed "critically undercapitalized" for more than 90 days -- that is, when its tangible equity to total assets ratio has been below 2% for more than 90 days. BofA was never deemed "critically undercapitalized" under the PCA's definition, and it was certainly never deemed "critically undercapitalized" for more than 90 days.

This is indisputable.

Anyone who believes that the calculation agent computes the mark-to-market on a PAUG CDS swap has no business calling anyone else an idiot.

The Calc Agent calculates the asset value of the underlying for purposes of Implied Writedowns. I was asked who determines the mark for purposes of collateralizing a PAUG CDS on ABS/CDOs. Since Floating Amount Events are what make PAUG CDS on ABS/CDOs "collateralized," and since Implied Writedowns are Floating Amount Events, the correct answer is the Calculation Agent. I'm not new at this.

I call people idiots when they say truly idiotic things. William Black, who is a law professor, has repeatedly claimed that the law says something that it plainly does not say. And this is an area of law on which he claims to be an expert. That makes him an idiot. I just call 'em like I see 'em.

Anonymous said...

I'm trying to be polite here and but you would fit your definition of an idiot.

The U. S. Government gave BAC $118 billion in taxpayer money (close to their market cap) on or about January 15th. In addition there was direct capital infusion of $20 billion.

Why, pray tell, would the U. S. government do such a thing if BAC was not seriously undercapitalized. Ken Lewis has himself stated that the BAC could not absorb the billiios in MER losses without govt help. BAC had to suspend its dividend (okay it is $0.01) by taking this money.

While I agree even a well capitalized bank would be foolish not to take $118 billion in free money, the dividend restriction would suggest that not all way rosy.

Common sense tells us what happened. BAC found themselves in dire straits. Under PCA, the govt should have either seized BAC or provided documentation as to why they weren't being seized.

If BAC is such a healthy instituiton and Ken Lewis thinks the dividend and bonus limits are onerous, he can return the $118 PAUG CDS to the taxapayer, payback the $40 billion in TARP funds, and payback the cost of FDIC insurance on the debt they've issued since October.

The spirit of the PCA is clear -- protect taxpayer interests. The spirit of Paulson/Geithner is equally clear -- protect bank shareholders.

Black may not be 100%, but he is about 95% correct -- hardly making him an idiot.

You, on the other hand, also use words without understanding their meaning. How is a floating event on a PAUG CDS in any way 'collateralized'?

In the common meaning of the term 'collatealized', the seller of the CDS wuld have to have cash or securities posted to cover the floating payment. On a $100MM CDS, the floating event can be as high as $100MM. Are you saying the CDS seller has put up $100MM in cash somewhere in anticipation of this amount?

I suggest that you look at the bailout of UBS by the Swiss National Bank before you post anymore about PAUG swaps being 'collateralized'.

The misinformation on this blog is staggering.

Economic Darwinism said...

Let's say, for example, that you lived in a country where it happened to be illegal to kill someone. If it was determined that someone had been killed, then the police were required to perform an investigation.

One day Mr Big was overheard yelling and screaming at Mr Small in Mr Small's office. A loud *bang* was heard and Mr Big emerged pale faced with a gun in his hands. Mr Big proceeds to close the door behind him and commands that Mr Small's secretary never let anyone into Mr Small's office. Not even the police.

A week goes by, and Mr Small's office door remains closed and no one has seen him emerge. In addition, a disturbingly bad smell is emanating from Mr Small's office.

Mrs Small has notified the police that her husband is missing. The police show up at Mr Small's office and ask to be let in. By this time, the stench is horrible. The secretary regretfully notifies the police that she has been ordered to not let anyone into Mr Small's office. The police shrug their shoulders and say, "Ok." They leave and the case is closed.

Have the police violated the law? They would have violated the law if they opened the door and saw that Mr Small had been shot, but since they did not open the door, the determination of murder was not made. So no investigation was started and no law was broken.

I'm sure that you are quite accurate when you saw that no law has been broken regarding PCA, but that carries about as much relevance to me (and William Black) as the police report coming from the officers who showed up at Mr Small's office. They SHOULD have opened the door. If they did, it would become clear a crime had been committed.

Economics of Contempt said...

Common sense tells us what happened. BAC found themselves in dire straits. Under PCA, the govt should have either seized BAC or provided documentation as to why they weren't being seized.

Oh my God. First of all, the PCA law only applies to FDIC-insured depository institutions. So the losses from Merrill's investment banking division are irrelevant for purposes of the PCA law.

More importantly, "critically undercapitalized" has a specific meaning under the PCA law. It has nothing at all to do with what you think "common sense" would tell us. Under the PCA law, "critically undercapitalized" means that "the insured depository institution has a ratio of tangible equity to total assets that is equal to or less than 2.0 percent." There is no other definition. So the only way the PCA law would have required a written explanation for why receivership wasn't used would have been if BofA's tangible equity to total assets ratio had been under 2 percent for more than 90 days prior to the January bailout. If William Black can't prove that this was the case, then he's 100% wrong.

What's more, I can prove that this wasn't the case. On December 31, 2008, FFIEC and OTS Call Reports (which are what matters for computing capital ratios under the PCA law) show that BofA's FDIC-insured subsidiaries had a tangible equity to total assets ratio of -- wait for it -- 10.44 percent. This was 15 days before the government's second capital infusion.

Look it up. Search for Bank of America under "Bank Holding Cos." This is irrefutable proof that both you and William Black are 100% wrong. I accept apologies in the form of cash and/or personal checks.

Economics of Contempt said...

How is a floating event on a PAUG CDS in any way 'collateralized'?

I didn't say that. I said that Floating Amount Events are what make PAUG CDS on CDOs "collateralized." Instead of making one lump-sum payment at the legal final maturity, the protection seller pays reversible Floating Amounts -- the equivalent of dynamic collateral posting -- over the life of the contract.

That is the common meaning of "collateralization" of a CDS. That's why Goldman keeps saying that its exposure to AIG was "fully collateralized and hedged."

That's why ISDA says that Implied Writedowns affect the "collateralization" of CDS on CDOs:

"[T]he CDS on CDO template addresses implied write-downs, whereby a drop in the asset value of the underlying necessitates an adjustment in the collateralization."

And that's why Morgan Stanley's handbook says that an "implied writedown is an amount equal to the amount by which the reference obligation is under-collateralized."

So whatever you may think the common meaning of "collateralization" is, it's not the common meaning in the CDS market. I don't know how I could make it any clearer than that.

Anonymous said...

Seriously, do you work for S&P or the risk area of Soc Gen?

1) Who cares what the BAC call report says on 12/31? The capital infusion equivalent to 100% of the capital took place on 1/15.

2) Is it your opinion that we should assume that the Tsy made an emergency capital infusion of nearly $140 billion to BAC because they were healthy institution with sound capital ratios because that is what is on the 12/31 call report? I don't even think S&P is that naive.

3) Here's some news for you --- just because someone from GS says something a press release doesn't make it true. Also, GS simply says that it's exposure to AIG was collateralized and hedged. Nothing about fully collateralized. They could have had collateral on 10% on their exposure. You are a lawyer, surely you've learned how to parse a respondents answer!

4)"Collateral" in the ISDA protocol refers to the assets in the CDO structure -- it says absolutley nothing about the collateral put up the CDS seller.

Here is a simple example. A CDO starts off with $10 billion in assets (collateral) and has 2 classes, A for $7 billion and B for $3 billion.

Class B also buys a PAUG CDS from AIG as insurance on the $3 billion.

The trustee/calc agent reports that defaults of $1 billion have occurred on the collaterl in the CDO. There is now only $9 billion in collateral in the CDO. That is the reference to collateral in the ISDA agreement.

The loss is allocated to the classes based on the terms of the CDO. Let us say the loss is 100% allocated to Class B (NB: we have said nothing about the CDS yet).

Class B has writedown of $1 billion. They claim a floating event of $1 billion from AIG. How one earth is the owner of Class B protected by in the event AIG can't make payment? The ability of AIG to make a payment has nothing to do with the collateral in the CDO.

Collateral has two meanings and you obviously don't understand the distinction. This has been explained to you on several occasions and you still don't seem to grasp the concept.

You really should avoid calling people idiots when your own understanding of elementary concepts appears quite limited.

economicdarwinism said...

I think EoC makes a perfectly valid point that, technically, no law has been broken because the PCA procedures are based on well-defined numbers that have well-defined rules for computing them.

He did say that whether you believed those numbers was another issue, which is fair enough, I supposed.

So instead of going back and forth, maybe we can think about what can be done "legally" to force the government to uncover and reveal publicly the correct numbers. Most of us would probably agree that the correct numbers, i.e. those reflecting reality, would trigger PCA action.

Anonymous said...

How does Black's error, even if egregious, justify calling him "a dishonest hack," and "an idiot" ???

jw

sandorgb said...

A lawyer ought to be more careful with words. Better to refer to Black as disingenuous than an idiot. This is a more meaningful commentary. That is the entire point of this piece -- be more careful with the words you choose to describe people and events. Calling someone an idiot provides no information other than your bias.

We must get beyond emotional outrage to unravel this political mess. We ought to be focused on constructive solutions rather than petty name-calling and side-arguments over trivialities. Black, while technically misrepresenting the letter of the law, makes an argument about the spirit of the law. And that is precisely the problem with our system -- the spirit of the law has been barricaded, tied up, and tortured.

I will go so far as to say that the blogger's attitude of contempt for others is destructive to the ends he proposes to achieve -- discovering truth. Truth is the union of the letter and the spirit.

Anonymous said...

Disingenous implies that Black is intenionally deceiving and is perhaps worse than calling him an idiot.

Anonymous said...

EoC, please disclose if you have any positions in the financials. If you have no positions, please consider going long the shares of the FAS. This will ensure your comfortable early retirement, while the idiots who are long the SKF will be landscaping your estate grounds.

economicdarwinism said...

Ouch. I hope you weren't long FAS today Mr Anonymous (FAS -30.22%). By the way SKF was +20.12%.

Anonymous said...

You said:
Now, you can argue that these capital ratios don't represent the true condition of the banks, but that's a different argument.Well then, if it's a different argument then let's just forget entirely about the bigger picture, shall we? You want to discredit Black - that much is clear from your ad hominem attacks and your attempt to re-frame the debate by focusing narrowly on the issue of whether the Obama administration is violating the PCA.

Here's another couple gems from the comment section, where you wrote:

The law has well-defined procedures for calculating capital ratios, and the banks are following them. You may disagree with those procedures (like it or not, under GAAP the banks don't have to mark all their assets to market), but that's irrelevant to the issue of whether current law requires the government to place the banks in receivership.This isn't an argument about whether the law should force the government to place the major banks in receivership. It's about whether, as Black claims, current law does require the government to use receivership.Oh really? This is what I find most interesting about your post. Not the legal issue - I'll concede there was no violation of the PCA - but rather your thought process in framing the debate. You've decided that "the issue" and "the argument" to be discussed is whether Black erred in alleging a legal violation of the PCA. You dismiss all other issues and concerns as irrelevant.

All you've proven is that you are a good lawyer who knows how to focus on an argument he can win. But what have you accomplished? There is much more at stake in connection with this financial crisis than the narrow question of whether the Obama administration has properly interpreted the statutory definition of "severely undercapitalized." I don't believe for a second that you are not intelligent enough to tackle the critically important normative questions about how the government should be approaching this crisis. You choose not to do so, instead cherry picking arguments offered by Black - a vocal critic of the bailouts - to rebut.

It leaves me to wonder about your motives. Your blog comes across as if you are an apologist for the bailouts, but I don't see a willingness to engage in an honest debate on these issues. You seem more interested in correcting Black's ability to parse statutory language, and in trading insults with finance geeks about who has more expertise regarding the CDS market.

You say in your post that there are "people who want to hate the Geithner plan." That's not me. I don't "want" to hate it, but hate it I do. You want me to support the Geithner plan? I'll support Geithner as soon as he acts in the best interests of me and my children (as opposed to the best interests of bank bondholders). This means: (1) full transparency of banks' financial health, honest accounting, REAL stress tests and receivership for those banks that need it; and (2) no more bailouts based on the flawed notion that this is a liquidity crisis, rather than an insolvency crisis. I want Geithner to tell the truth and admit publicly what everyone who has studied the history of speculative manias knows - housing prices are not going to return to peak bubble valuations and these toxic assets are not going to regain value if held to maturity. It is morally wrong to transfer trillions of dollars of private sector liabilities onto the taxpayer balance sheet based on the false promise that they will regain value over time.

Black may be wrong about what the PCA requires, but he is on the right side of the bailout issue. He is drawing attention to the fact our government failed us. it failed to anticipate this crisis and has failed to propose the proper solutions. Black wants to clean up the mess, Geithner wants to cover it up.

What do you want to do, Mr. Economics of Contempt? No more compartmentalized analysis. If you think the Geithner plan might work and we should give it a chance, I'd like to hear your explanation. It's easy to be a critic. It's harder to put your own ideas out there for others to critically analyze. I've got an open mind so we'll see if you bother to reply.

Economics of Contempt said...

Economic Darwinism,

What exactly do you think the Treasury should be doing that it's not already doing? In other words, what would constitute "opening the door to Mr. Small's office" in your mind? Is it just marking the banks' toxic assets to market?

I think you're overly generous when you say that the fact that "no law has been broken regarding PCA ... carries about as much relevance to ... William Black as the police report coming from the officers who showed up at Mr Small's office." If the PCA law were irrelevant to Black, I hardly think he would have gone around explicitly claiming that the Obama administration is refusing to obey the PCA law. He claimed on multiple occasions that the Obama administration was violating the letter of the PCA law (and never made any distinction between the spirit of the law and the letter of the law). So while the letter of the PCA law may be irrelevant to you, I don't think you can honestly claim that it's irrelevant to Black.

Economics of Contempt said...

"I don't believe for a second that you are not intelligent enough to tackle the critically important normative questions about how the government should be approaching this crisis. You choose not to do so, instead cherry picking arguments offered by Black - a vocal critic of the bailouts - to rebut."

Call me old-fashioned, but I think that when a reasonably prominent commentator falsely claims that the current administration is actively violating the law, it's somewhat important to correct the record. Correcting the record requires positive, not normative, analysis of current law. I'm sorry if you don't like that the subject of my post was a narrow legal question.

"All you've proven is that you are a good lawyer who knows how to focus on an argument he can win."

Thanks!

"Your blog comes across as if you are an apologist for the bailouts, but I don't see a willingness to engage in an honest debate on these issues."

I've stated before that I'd like to have an honest debate on the merits of the Geithner plan, but I don't think we have nearly enough information to have that debate yet. For example, regarding the Legacy Securities program, we don't yet know: haircuts, cost of funds, loan maturities, or minimum loan sizes. Hell, we don't even have a final list of eligible securities yet! These details are extremely important to the ultimate effectiveness of the program. Same goes for the stress tests, which we know very little about at this point. I know this will disappoint you, but until we have some basic information on the material terms, I'm reserving judgment on the Geithner plan.

Anonymous said...

Call me old fashioned, but I believe it is better to confront our problems head on rather than pushing them off on to future generations. I also believe the capital structure exists for a reason. Investors in in the stock and bonds of major banks are the ones who should be bearing the risk of loss, not taxpayers.

The banks have made it perfectly clear they do not want to sell these toxic assets at currently prevailing market prices. Therefore, the only way the PPIP can ensure participation by sellers is to overpay. By reserving judgment on the Geithner plan, you imply that some level of overpayment is acceptable, depending on the circumstances.

The government is the sucker stepping in where private capital fears to tread. Taking losses that should be pushed up the capital structure of the banks. The whole thing stinks and I don't need all the details of the Geithner plan to tell you that.

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