bailouts Archives - the patient investor

March 21, 2020March 21, 2020

Bailout time

Boeing has applied to the Federal government for a $60 billion bailout. The troubled aircraft manufacturer is in need of rescuing but has indulged in $54.9 billion of stock buybacks in support of its stock price.

Former UN ambassador and ex-South Carolina governor, Nikki Halley resigned from Boeing’s board, saying that she opposes federal support for Boeing. Smart political move. Public anger is growing.

Twitter post

Many corporations used stock buybacks to boost earnings per share after earnings growth slowed in 2014/15. Boeing was no exception.

Stock Buybacks and LT Debt

The company had a reputation for engineering fine aircraft but in recent years that focus has shifted to financial engineering and cost-cutting to boost earnings per share. Free cash flow was squandered on stock buybacks, dividends and executive bonuses. No reserves were accumulated for a rainy day.

Well, a rainy day finally arrived in 2018. The Boeing 737 MAX airliner, which began service in 2017, was involved in two fatal accidents, Lion Air on October 29, 2018, and Ethiopian Airlines on March 10, 2019, caused by a malfunction of the aircraft’s new MCAS automated control system. The aircraft was grounded by airline authorities around the world and Boeing suspended production in December 2019. After a software bug was discovered in January, the return to service was delayed. Despite an outstanding issue over non-compliant wiring bundles the FAA has indicated that they expect the 737 Max to return to service in the second half of 2020.

The company had to raise almost $10 billion in bonds to help it weather the setback. CEO Dennis Muilenburg was ousted in late 2019 but still walked away with a golden parachute of up to $50 million.

A hit from the 2020 Coronavirus outbreak has put the company into difficulties, with the stock getting pounded. Boeing has been forced to apply for a government bailout.

Stock Buybacks and LT Debt

The company is a strategic asset of the United States and should be protected.

But rewarding bad behavior would promote moral hazard on a wide scale. To give management and stockholders a free ride would encourage risk-taking by other companies — with the expectation that they will be bailed out if something goes wrong.

Support the company but hurt the stockholders

Management and existing stockholders need to feel the pain.

Offer support in the form of $60 billion of convertible bonds or preference shares, ranking behind creditors but ahead of stockholders. Conversion into ordinary shares should be in 10 years time but at the current stock price of $100. Stockholders and management awards will take a huge hit, while taxpayers can look forward to a sizeable gain when the company recovers.

Support should be non-voting (bonds or prefs) to keep political interference to a minimum.

Buybacks

Preventing future buybacks is a completely separate issue that should be addressed on a national basis and not by placing restrictions on individual companies. For the record, we are against buybacks because they can be used to artificially support stock prices. Companies that need to return capital to stockholders should declare a special dividend.

Avoid a Domino-effect

There are a string of companies lining up with bailout requests. It is important to put emotions aside and save those that are still viable businesses and not just strategic assets like Boeing. Millions of jobs are at stake. And disruption to credit markets could have a Lehman-like domino effect.

Just ensure that it is on terms that favor the taxpayer, so that stockholders will think twice about future profligacy.

July 11, 2017

New Bailouts Prove ‘Too Big to Fail’ Is Alive and Well | WSJ

By Neel Kashkari:

Three strikeouts in four at bats would be barely acceptable in baseball. For a policy designed to prevent taxpayer bailouts, it’s an undeniable defeat. In the past few weeks, four European bank failures have demonstrated that a signature feature of the postcrisis regulatory regime simply cannot protect the public. There’s no need for more evidence: “bail-in debt” doesn’t prevent bailouts. It’s time to admit this and move to a simpler solution that will work: more common equity.

Bail-in debt was envisioned as an elegant solution to the “too big to fail” problem. When a bank ran into trouble, regulators could trigger a conversion of debt to equity. Bondholders would take the losses. The firm would be recapitalized. Taxpayers would be spared……

The problem is that it rarely works this way in real life. On June 1, the Italian government and European Union agreed to bail out Banca Monte dei Paschi di Siena with a €6.6 billion infusion, while protecting some bondholders who should have taken losses. Then on June 24, Italy decided to use public funds to protect bondholders of two more banks, Banca Popolare di Vicenza and Veneto Banca, with up to €17 billion of capital and guarantees. The one recent case in which taxpayers were spared was in Spain, when Banco Popular failed on June 6……

The Minneapolis Fed President has hit the nail on the head. Conversion of bondholders to equity may be legally plausible but psychologically damaging. Similar to money market funds “breaking the buck’, conversion of bondholders to equity in a troubled bank would traumatize markets. Causing widespread panic and damage far in excess of the initial loss. Actions of Italian authorities show how impractical conversion is. Especially when one considers that the affected banks were less than one-tenth the size of behemoths like JPMorgan [JPM].

Banks need to raise more equity capital.

Source: New Bailouts Prove ‘Too Big to Fail’ Is Alive and Well – WSJ

August 19, 2013

Bloated business of banking | The Australian

Adam Creighton discusses the likelihood of taxpayers being asked to bail out too-big-to-fail banks.

In Australia that probability is now 100 per cent. Standard & Poor’s, a ratings agency, gives Australia’s biggest four banks a AA rating explicitly because taxpayers will provide “extraordinary support” to their creditors in any crisis, an implicit guarantee worth more than one-quarter of the four’s annual profits.

Since 1995, the big four Australian banks’ assets, reflecting a global trend, have ballooned from 94 per cent of Australia’s national income to $2.86 trillion, or 190 per cent.

March 26, 2013

The Dijsselbloem Principle | Felix Salmon

Felix Salmon makes this succinct observation:

If a gaffe is what happens when a politician accidentally tells the truth, what’s the word for when a politician deliberately tells the truth? Dutch finance minister Jeroen Dijsselbloem, the current head of the Eurogroup, held a formal, on-the-record joint interview with Reuters and the FT today, saying that the messy and chaotic Cyprus solution is a model for future bailouts.

Those comments are now being walked back, because it’s generally not a good idea for high-ranking policymakers to say the kind of things which could precipitate bank runs across much of the Eurozone. But that doesn’t mean Dijsselbloem’s initial comments weren’t true; indeed, it’s notable that no one’s denying them outright…..

October 29, 2012

Five steps to fix Wall Street

Some more thoughts on the five steps former FDIC chair Sheila Bair suggested to reform the financial system.

Break up the “too big to fail” banks
My take is that breaking up may be difficult to achieve politically, but raising capital ratios for banks above a certain threshold would discourage further growth and encourage splintering over time.
Publicly commit to end bailouts
Just because the bailouts were profitable isn’t a good reason to give Wall Street an indefinite option to “put” its losses to the Treasury and to taxpayers.

As Joseph Stiglitz points out: the UK did a far better job of making shareholders and management suffer the consequences of their actions. Sweden in the early 1990s, similarly demanded large equity stakes in return for rescuing banks from the financial, leading some to raise capital through the markets rather than accept onerous bailout conditions.
Cap leverage at large financial institutions
I support Barry Ritholz’ call for a maximum leverage ratio of 10. That should include off-balance sheet and derivative exposure. Currently the Fed only requires a leverage ratio of 20 (5%) for well-capitalized banks — and that excludes off-balance-sheet assets.
End speculation in the credit derivatives market
Bair pointed out that we don’t get to buy fire insurance on someone else’s house, for a very good reason. How is speculating using credit derivatives any different?

Again Ritholz makes a good suggestion: regulate credit default swaps (CDS) as insurance products, where buyers are required to demonstrate an insurable interest.
End the revolving door between regulators and banks
When regulators are conscious that, with one push of the door, they could end up working for the organizations they are today regulating – or vice versa – “it corrupts the mindset”

A similar revolving door corrupts the relationship between politicians and lobbyists. Enforcing lengthy “restraint of trade” periods between the two roles would restrict this.

via 5 Steps Obama or Romney Must Take to Fix Wall Street.

October 15, 2012

5 Steps Obama or Romney Must Take to Fix Wall Street

By SUZANNE MCGEE

In [Sheila Bair’s] view ….. we haven’t yet come to grips with many of the problems that produced the crisis.

Too many regulators fall victim to one of several fatal flaws, Bair suggested in a speech to the National Association for Business Economics yesterday. Some of them over or under-regulate (usually at the wrong point in the cycle); they devise impossibly complex rules; they are “closet free-marketeers” proposing convoluted rules to prove it’s impossible to regulate financial institutions, or they are “captive” regulators who, without any corruption or malfeasance involved, have simply subordinated their judgment to those of the organizations they are charged with overseeing.

The former chair of the Federal Deposit Insurance Corporation suggests five steps that presidential candidates should take to fix Wall Street………

via 5 Steps Obama or Romney Must Take to Fix Wall Street.

July 16, 2012

A lack of money isn't the problem: it's time to shrink – The Drum – ABC News

Alan Kohler: Debt was built up through 30 years of current account imbalances after currencies were finally unshackled from the gold standard in 1971, and the depression of the 70s came to an end in 1982.

Central banks, principally the Federal Reserve, complied in the process of debt build-up by holding down interest rates and allowing asset prices to rise, keeping balance sheets in the black.

The credit crisis of 2007-08 brought asset prices down rapidly and rendered banks suddenly insolvent, so they had to be recapitalised by governments. Now the governments of Europe, the US and Japan are insolvent, and the only question is when the central banks will monetise their debt – that is, print more money and buy their debts…..

via A lack of money isn’t the problem: it’s time to shrink – The Drum – ABC News (Australian Broadcasting Corporation).

October 12, 2011

Too-big-to-fail is here to stay

Lehman Brothers’ collapse in 2008 was intended to intended to teach financial markets that they could not rely on an implicit government guarantee for too-big-to-fail (TBTF) banks. What bondholders learned was the opposite: never again would an institution of that size be allowed to collapse because of the de-stabilizing effect on the entire financial system.

Rescue of Dexia by French, Belgium and Luxembourg governments is the latest example. Bond-holders received 100 cents in the dollar/euro. Markets are just too fragile to consider giving bondholders a haircut. Denmark earlier had to back down from forcing haircuts on bondholders when Danish banks found themselves shut out of funding markets. [WSJ]

Frequent calls for TBTF institutions to be broken up have proved ineffective. Instead the problem has grown even larger with post 2008 rescue/take-overs of Countrywide and Merrill Lynch (BofA), Bear Stearns and WaMu (JPM), Lehman (Barclays), and Wachovia (Wells Fargo) reinforcing Willem Buiters’ survival of the fattest observation.

Proposals to reduce systemic risk through adoption of the Volcker Rule, which would prevent banks form trading for their own account, are proving difficult to implement. The 298-page first draft offers few clear definitions of restricted activities, instead calling for suggestions or feedback.[Bloomberg] Drafters should consider turning the rule around, offering a list of approved activities that banks can pursue, rather than attempting to define what they cannot. I have great respect for banks’ ability to find loopholes in any restrictive list.

The Rule on its own, however, cannot protect taxpayers from future bailouts. It does not prevent banks from over-lending if there is another bubble. There is only one solution: increase capital ratios — and apply similar ratios to securitized assets. Increases would have to be gradual, as some banks could respond by shrinking assets rather than raising capital — which would have a deflationary effect on the economy. Changes would also have to be sensitive to the economic cycle. The easiest way may be to set a long-term target (e.g. 20% Tier 1 + 2 capital by 2030) and leave implementation to the central bank as part of its monetary policy.

Together with the Volcker Rule, increased capital ratios are our best defense against a recurrence of the GFC.