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A whole new sort of moral hazard?
So now federal regulators are in a bit of a bind. If they let Wells Fargo ride in and snatch Wachovia out from under Citigroup, they get a better deal for taxpayers—an industry-on-industry solution with no government backstop.
But that might send a dangerous signal to the market. Setting aside the issue of whether or not a Wachovia-Wells deal would be illegal under the terms of the agreement Wachovia made with Citi, we're still left with the situation where deals made under the direct supervision of the feds are subject to change. Citi came to the rescue of Wachovia in the middle of the night. If the deal they reached is allowed to be shoved aside, what happens the next time Citi, or another potential white knight, gets the call for help?
I've already been having some shaky feelings about how comfortable we are at changing the rules of the game these days—short selling bans, mark-to-market accounting rule rewrites, discussion about letting judges adjust first mortgages in bankruptcy court.
Desperate times call for desperate measures, I know. But when it comes to something like the enforceability of contracts, isn't that bedrock to the whole notion of capitalism?
Barbara!
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Point taken, Barbara. But if the Feds do not pursue the best deal for the taxpayers, who by the end of the day will probably have about a trillion dollars of skin in the game themselves (I haven't really been counting, since it's all play money to me), aren't they violating another, and arguably more important, fiduciary responsibility?
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Exactly. I'm reminded of all the talk around how Fannie and Freddie never really worked because they had to answer to two divergent masters. I'd be interested to hear about the entity that clearly only has one constituency.
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"--short selling bans, mark-to-market accounting rule rewrites--"
it's amazing to think we have our first MBA president when this happens as well. From my MBA classes, all the profs are pretty much free-marketeers. I wonder if wherever he got it is going to rescind his degree.
" discussion about letting judges adjust first mortgages in bankruptcy court."
this one bothers me less. given that judges have this ability with all other debts for vacation homes, farms, investment properties -- it seems like a strange exception for them not to be able too...
and as far as the moral hazard - shouldn't this kind of judicial power help tighten up credit standards some more which was part of the problem..
(source link:http://www.washingtonpost.com/wp-dyn/content/article/2007/11/19/AR2007111901327_pf.html)
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@TAD: Yeah, I feel that one is a lot less black-and-white, too. Thanks for the WaPo article. This is my favorite paragraph:
Allowing judges to change the loan terms would create uncertainty about that asset's value. To offset the risks, lenders would demand larger down payments, charge higher interest rates and get more picky about borrowers, said Kurt Pfotenhauer of the Mortgage Bankers Association.
Downpayments and lending only to people who should be lent to—perish the thought.
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"Desperate times call for desperate measures, I know. But when it comes to something like the enforceability of contracts, isn't that bedrock to the whole notion of capitalism?"
Indeed. And shouldn't somebody have worried about enforceability when 53 trillion dollars worth of CDOs and CDSs were being written? The bedrock of capitalism, it seems to me, has been eroding for a while now.
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Citi will get its pound of flesh in due course. They have a binding exclusivity agreement that has been breached, that is unless this is North Korea, Cuba or the good old U.S.S.R.
We shall soon see what kinds of pieces of paper CDS's are. I believe they are valid and binding agreements executed with soon to be insolvent hedge funds.
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Doesn't the insistence from the FDIC and CitiCorp make you think that this was less a rescue of Wachovia and more a double secret reverse rescue of CitiCorp?
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@Joe4Pack: I like the way you think. Only thing is, the FDIC hasn't exactly been 100% on-message. Last Thursday night, FDIC chief Sheila Bair rang up Bob Steel, the head of Wachovia, and told him Wells Fargo would be calling. According to an affidavit of Steel, filed over the weekend: "On October 2, 2008 at approximately 7:15pm, I received an unexpected call from Chairman Bair. She asked if I had heard from Mr Kovacevich [the head of Wells]. I assured her I had not spoken to him since the initiation of the negotiations with Citi. She advised me that it was her understanding that he would be calling me to propose a merger transaction that would result in Wachovia shareholders receiving $7.00 per share of Wells Fargo common stock and encouraged me to give serious consideration to that offer." (Thanks to Felix Salmon for posting the entire paragraph.)
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