naked capitalism

GoldmanCrook says:

Very good point. However if the plan fails is it not likely the TED spread continues to skyrocket along with a perhaps huge drop in the market which should be factoring in the quick stimulus potential of the plan. Bazooka number two if a dud could reignite armageddon fears perhaps. Just throwing out the other side.
These banks should hold these assets until maturity if their true value is substantially above the firesale price. oh wait, many small and medium sized banks probably will just like they got shafted with the fannie and fredie preferred. It is the Goldman’s and whats left of the investment banks who have already marked these assets down and will be the overwhelmingly benefactors of this plan. Other banks simply need to keep the mortgages in their long-term investment section on the balance sheet regardless of current market prices.

Yves Smith says:

Steve,

First, there is a tremendous amount of money ready to pounce on distressed assets. Why is it sitting on the sidelines? Holders of paper unwilling to accept realistic prices. Paulson and Bernanke said in Congressional testimony that they intend to pay above market. This is Japan in fresh packaging. Don’t recognize losses, prop weak institutions up. The most successful model for dealing with a banking crisis, Sweden, did the reverse. They let prices fall to market-clearing levels, took over the banks, stripped out bad assets, sold them, recapitalized them, and later took them public.

Second, the bailout plan is a complete farce. A three page sketch for the biggest fiscal commitment of all time, with the Treasury explicitly put above the law.

Third, there are NO provisions for regulatory reform, any say or veto power at the firms getting their assets liberated, or upside commensurate with the risks being taken.

Anonymous says:

I don;t buy Paulson’s Bailout. I much prefer John Hussman;s proposal which he set forth in an open letter to Congress on 9/22/08

“The appropriate solution is not for the government to replace the bad assets with public money, but rather for the government to execute a receivership of the failed institution and immediately conduct a “whole bank” sale – selling the bank’s assets and liabilities as a package, but ex the debt to bondholders, which preserves the ongoing business without loss to customers and counterparties, wipes out shareholder equity, and gives bondholders partial (perhaps even nearly complete) recovery with the proceeds.

The key is to recognize that for nearly all of the institutions currently at risk of failure, there exists a cushion of bondholder capital sufficient to absorb all probable losses, without any need for the public to bear the cost.”
http://www.hussmanfunds.com/wmc/wmc080922.htm

don says:

I have given thought to the possibility that the threat of an imminent meltdown was exaggerated . . . for tactical purposes, and that it was done so by design to ensure the passage of a bailout bill.

This is not to suggest that something of a meltdown is not underway, but that it has been depicted as an overnight event, rather than a process that takes place over time. The setup was as follows: create the prospect for an meltdown within days unless the bailout is implemented. No doubt the proposal of a bailout itself served a purpose: to ‘calm’ the markets.

But there is more to it than this. The threat of a depression unless swift action was taken has been depicted by no less than Senator Schumer, as well, if I’m not mistaken, by Paulson. So, the situation is such that those who vote against the bailout are essentially voting for a depression. This appears to be no less than a set up, not only for members of Congress who may privately wish to vote any bailout bill down, but perhaps more importantly, for the public at large. It is as if the crisis managers have turned to creating the impression of crisis to subdue crisis, while up until less than a week ago, it was deliberate to play down any such crisis, for fear of encouraging said crisis.

Could it be that the impression of a crisis was building at such a rapid pace . . . assisted of course by all the news media attention, that it was perceived as necessary to jump on the bandwagon (since it was unstoppable), by taking advantage of it?

In some respects, the negotiations now being played out is itself also part of the theater (of the absurd). A ‘compromise’ is inevitable, and it will serve to demonstrate how well the system of legislation works in D.C. We will all be able to breathe easier now that we are confident of our great leaders to lead. A crisis situation has been made out to be a crisis, one of imminent depression even, but has been turned around by our wise leadership, not only in the Bush administration but Congress too.

This seems a larger part of the crisis management now underway, and we have reached a point where maintaining legitimacy, for not only the Bush administration, the Fed, but also the Democrats, is being staged in unison.

I found it a bit ironic that today before Congress Bernancke stated that unless the bill is passed, the country will very likely go into recession. So now we are backtracking. Last week it was a depression, this week its a recession.

At risk of sounding like I am suggesting a conspiracy (the poor man’s theory), I have even entertained the possibility that our great leaders have had designs for some time to take us down this direction. Perhaps they have been of the opinion all along that some kind of government/taxpayers bailout was inevitable, and even desirable.

While many have suggested that the bailout is a form of socializing risk (and I understand this perspective entirely), it also be that something more devious is at play: lock the taxpayer into ’saving’ the financial system, and in so doing, the Bush administration and its supporters have made it all the more likely that the funding of social programs will in the future be cut back, and that we may in fact be looking at the eventual privatization of social security as a result of the bailout. Consequently, the bailout ultimately serves the purpose of advancing more privatization, not less.

(This comment was, by mistake, also placed on the most previous post comment section. I have correctly placed it here as well.)

rboltuck says:

“. . . over a trillion dollars in money funds . . .” The WSJ reported the volume at $3.4-trillion.

Walt French says:

It’d be wonderful, as Bernanke hoped (!) this morning, if creating an artificial market for derivative instruments somehow stabilized trading in them. But the only trading will be at artificial prices, and $700 billion will only be enough to save Wall Street. The solution to Akerlof’s Lemons is NOT, IIRC, for the government to subsidize each seller with $3000 so buyers don’t worry about the quality of what they’re buying. The mortgages are toxic because they are full of risk from the US economy: income, housing prices that will implode who-knows-how-much, and who knows what the Fed will do to interest rates and inflation. None of the money goes into the underlying asset and it’ll continue to be unmarketable.

The banks that hold mortgages will be stuck; they’re toast. Even prime mortgages, based on inadequate income that’s falling and prices in free-fall, can’t be priced until we see some stability in the underlying economy — which the stopgap will not do a thing to help.

So the $$$ go to Wall Street; we’ll own negative yield, 10-year-lockup mortgages. If Sen. Dodd gets his way, we’ll take over a couple of depopulated Wall Street shells, while the party will take its capital down the elevators and over to Greenwich.

We’ll “invest” $700 billion in the second-least-productive industry (after McMansions) and our economy will be in worse shape, with our pockets emptied.

But somewhere in the Wall Street Hall of Greats, Hank Paulson will be revered as Beyond The Best. Ever.

This is maybe one to write your congresscritters about. We’re on the precipice, but not in the way that Hank tells us.

(PS: don’t forget that Paulson is said to have held off on pushing this program until he could expect Congress to be frightened into enacting it. And still no long-term solution, just a misguided stopgap that looks like your typical paste-over-the-problem approach.)

Anonymous says:

Yves,

Regarding your comment: “This is Japan in fresh packaging”,

My knowledge of Japan is limited but I believe the problem was that their banks sat on their loans rather than recognize losses, and did not make enough new loans.

But our banks have already recognized many losses and raised significant capital. Almost all of the major US banks has done so.

The issue now is whether these banks sell to hedge funds and vulture funds at 5 or 10 cents on the dollar what they have already written down to 50 or 40 or 30 or 20.

The problem Bernanke and Paulson perceive is that most bank CEOs will not sell into this type of market, but will instead sit on these loans and not make new ones and not roll over their more liquid existing loans (exactly like what happened in Japan). The solution they are proposing directly addresses this.

Your Japan analogy does not support, but rather undercuts, your opposition.

Anonymous says:

anon 12:40:

The problem Bernanke and Paulson perceive is that most bank CEOs will not sell into this type of market, but will instead sit on these loans and not make new ones and not roll over their more liquid existing loans (exactly like what happened in Japan). The solution they are proposing directly addresses this.

****

Banks not wanting to lend is no problem. All the government needs to do is seed new banks with pristine balance sheets to lend. Or have regulators put regulated entities that are insolvent using MTM into a simplified bankruptcy process where enough of their debt is recapitalized into equity to give them adequate capital.

jest says:

here’s a scary thought:

what if the bill does not pass?

since the fed has little oversight, wouldn’t the next logical step be for the fed to print up a few bucks to do what congress wouldn’t do?

i honestly do not know which would be worse.

doc holiday says:

Re: "At the very least Pauslon needs to start imposing regulatory strictures on what money funds can invest in, and how their managements will be replaced if they draw on Government help, but I haven’t heard a peep about such things, have you? "

>> Here, here and bravo! All anyone has to do is look at a money market prospectus to see the toxic waste connected to mutual fund casino playing, like ETF, e.g, Vanguard using VIPERS and repos and derivatives mixed in with crap from Fannie, bankers assurances and a list of shit you do not want to know about — then take that a few steps up the food chain and look at what unregulated pension funds are allowed to get away with, with all the exemptions from prohibited activities by underwriters and hedge funds! Wake The Fu-K up people, it's time to be pissed off and we need to tell our elected mafia that they have no future!

Juan says:

walt french, thank you for remembering there is a deteriorating real economy beneath the financial spectacle, a deterioration not to be stopped but probably exacerbated through handouts to finance. in short, and as had been the case through most of capitalism’s history, price falls to value during crises–or, we are on a deflationary trajectory.

Blissex says:

«Japanese banks also had significant hidden reserves, so initially it didn’t seem that bad for them to play games, but as we know now, the losses were overwhelming.»

To support this, especially the “losses were overwhelming” part.

Quite a lot of people don’t understand that there are two distinct problems, one small and one big:

* The small problem is that a lot of mortgage debtors (subprime) simply cannot afford to pay the mortgage anyhow; they just bought the house to flip it.

* The big problem is that a lot of *prime* customers have borrowed and spent $400k to buy a house that is worth now $200k. Some of they can afford to repay, but won’t. Anyhow, even those who can afford to repay will see a large hit to their disposable income from the payments, driving consumption down.

The aggregate losses, especially from the second, bigger, problem are at least $1 trillion, and probably around $2 trillion.

Some of these losses are not yet in the books of lenders (when the borrower is still paying the instalments on the $400k even if he knows the house is worth $200k), but quite a lot of them are already booked by lenders.

Now the aggregate losses are bigger than the capital of the whole USA financial system, so in the aggregate the whole USA financial system is bankrupt.

Since the bigger problem is that there are a lot of $400k loans for houses that are worth $200k, there are 3 solutions:

* The house prices are goosed up to $400k again.

* Someone gives $200k to the borrower, so both him and the lender are saved.

* Someone gives $200k to the lender, so the lender is saved when the borrower goes bankrupt and they have to write down the loan.

Or of course combinations thereof. The Paulson plan is mostly about giving something like $100k to the lender, and doing so in a way that generates enough inflation that house prices rise by the remaining $100k.

The better option would be to let the borrowers go bankrupt, let the lenders go bankrupt, but then lend new money to keep productive activities going so the borrower at least keeps his/her job even if he/she loses his/her dreams of an easy early retirement thanks to a huge house capital gain.

The reason why it is important to let both lender and borrower go bankrupt is that this draws a line on the past, and prevents a Japanese style financial ice age; the reason why providing funding for productive activities is that the bankruptcies would otherwise trigger a nasty downturn, as both borrowers and lenders hunker down.

It is also important to avoid the situation where it is all solved by house prices going back to $400k from $200k because that means galloping inflation.

Matthew says:

The only mitigating factor I see here relates specifically to mortgage-backed-securities.

Post Frannie bailout, spreads tightened dramatically. Over the next week and a half, much of that stability leaked back out of the mortgage market. Our paper is toxic in the eyes of Asia et. al.

In the same week when a few biggies close up shop, not only do some of the key players de-lever a couple hundred percent, but the Asian bid for our MBS got completely sucker punched.

Given the confluence of events, events not readily perceivable to those who don’t follow the MBS color, we are at least part way to accepting this as “necessary crisis aversion,” despite the fact it looks otherwise. We’ve never seen anything like the last two weeks in the MBS market. Given how things felt on Thursday, a global economic catastrophe was not an inconceivable eventuality by Monday.

Richard Kline says:

Given how markets were seizing up by Thursday, 18 Sep in the Ides of September crisis, Armageddon was possible Friday, and conceivable on Monday. Didn’t happen. We are by no means out of the woods, and further sector meltdowns strike me as highly likely. But I’m with Jonathon Bernstein fundamentally: A threshold collapse has not happened, we have time to craft a real intervention, and will have to live with the results.

But there is, to me, an even more telling point: Nothing in the Paulson Proposal would avert a crisis if that proposal was passed on Monday, this Friday, or at any time. His proposal would take weeks to implement even if he was given absolutely everything he asked for. Most of the crisis moments have had to do with market freeze-ups when institution or sector failures began to shave currently invested funds. These were, and will be, issues which have to be resolved within a day or two, and very specifically, although with later comprehensive programs to follow. Passing the Paulson Proposal on the hurry up WOULD DO NOTHING to avert situational crisis, and hence the entire logic of it has been phony. And I also agree with Bernstein and Yves: this proposal had everything to do with locking in money give away programs which would become ‘critical to confidence’ and so unchangeable when a new, and non-Republican political regime comes into office in January 09. Despicable of the Bushies, and typical in that regard.

Anonymous says:

Frankly, I thought the panic about the fund which “broke the buck” was over-hyped, too.

A 3-percent haircut to 97 cents on the dollar is no fun, but it’s not the end of the freaking world.

Indeed, if I were going to design combined deposit and money-market insurance from scratch, I would offer unlimited coverage (so as to avoid the “too big to fail” exception for big banks), but provide for up to a 5% haircut for depositors if the entity is liquidated at a loss.

After all, the objective of deposit insurance is to protect the system against collapse, not necessarily to “keep depositors from ever losing a penny” (as the FDIC likes to crow). Indeed, the potential of losing up to 5 pennies on the dollar (a year’s interest, more or less) would short circuit the moral hazard which plagues the current system. As in WaMu running saturation radio ads, seeking new business accounts.

fresno dan says:

LOVE this blog – it really helps me to understand the situation.
I would love to ask Paulson one question, “Did you understand how GS made money (or more accurately, lost money)when you worked there?”
OK, I lied… I would also ask, “If not, why did they pay you?” (and even I am not so mean as to ask him if he knows what he is doing now)

Anonymous says:

Did anyone hear Mr. Buffett this morning???? Why not stop the panic and listen to someone with a brain.

Peggy McGilligan says:

When Bill Clinton eased banking restrictions in California, he also dished out $8-billion dollars for “community redevelopment loans.” Of course, the money would never get paid back. Undoing regulations sets a precedent, as does “comping” real estate. With the influx of cheap capital, properties already overvalued at $125,000 inflated to $525,000. Enter, “creative financing.” When the schemes fell through, as they are wont to do whenever 30-million Mexican nationals buy inflated properties in another country and default, it left bankers around the world in the lurch (see global economy). Never mind that the aforementioned demographic is the new face of the Democratic Party; Congress simply cannot determine the worth of the financial instruments, because of rampant “creativity” and subjective prices. It’s a $90-billion bailout at best. But if you want to thank someone, thank Hillary Clinton. She knew all along who’d get the loan giveaways; she knew whose votes she’d buy. So, why should you bail the housing bubble? Let the Dems do it, let those 18-million cracks pass the hat: http://theseedsof9-11.com

Yves Smith says:

First, Buffett is an interested party, having bought a major stake in Goldman, If he thought the financial world was in such peril, would he have made that move? Actions speak louder than words, Breakingviews and other contend this would not be fatal:

He and Bernanke are selling Tarp as banks’ last best hope. But the US Congress is resisting. If the scheme isn’t approved, it would be a serious blow to confidence. But then markets could get on with sorting out their problems, with the ample government help already available.

Second, as we have written elsewhere, at considerable length, this plan is unlikely to succeed. Propping up asset prices at unsustainable levels has NEVER worked, The government lacks enough funds to support markets this massive.

Third, there is TONS of capital on the sidelines ready to bottom fish. If we let prices fall, figured out who to save and how to consolidate the industry, there would be a big influx of funds once we let the market bottom

And once we have blown $700 billion+ plus on a failed exercise, we have no firepower left for better remedies.