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On the Dishonest Sale of the Bailout Bill

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We received this via e-mail from reader Jonathan Bernstein. It makes a point that occurred to us in passing, and we’ve been hugely remiss in not pointing it out, namely, the near-meltdown of the financial system was averted. The urgency about passing a bailout bill is completely phony.

Jonathan makes the case well:

One of the worst things about TARP is the way that Paulson has wrongfully and mendaciously conflated the last week’s money market panic with the need for TARP. They are two separate issues. As you probably know, the short term credit markets got close to seizing up last week. I understand why Paulson injected $105 billion to calm institutional money fund holders and then guaranteed money fund holdings (though the way he did the latter was hamfisted in my opinion).

However, if I understand the NYT article about Paulson’s briefings to Congress to sell TARP, and his other attempts to sell TARP on television, he seems to be saying that TARP will prevent a market Armegeddon. As far as I can see, we got close to Armageddon with the money market panic (which he touched off by letting LEH fail without making sure creditors got a reasonable shot at getting most of their money back). At any rate, money markets won’t seize up while money funds remained guaranteed by the Treasury, so we have time to work out a comprehensive solution and no need to jam through TARP or anything as reckless. We have time to get it right. He is using the money market problems to grab for power, and that seems to me to be both dishonest and under-reported.

As for guaranteeing money funds: I have to remember that they were originally established to get around regulatory strictures of commercial banks. Remember the term, “non-bank bank?” The irony is rich. The FDIC guarantees small and medium sized deposits, presumably for individuals, up to $100,000; now money funds have unlimited insurance for institutions. 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? We need a longterm solution here. Does Paulson believe that things will be fixed in six months when the “temporary” guarantee for money funds expires? I don’t think so. It is momentous that Paulson has guaranteed over a trillion dollars in money funds and turned our deposit insurance system upside down. He has deftly managed to hide that one under a TARP.

Finally, it is hard to escape the political implications of all this. Basically the President is trying almost to nullify the coming election by getting far reaching legislation in place that should have been left to the next Administration. He creates crises and then calls for comprehensive and badly drafted legislation under panic conditions, and the Democrats in Congress give the President what he wants. With both parties on board now these things will be difficult to reverse. The FISA bill was an important example of this, and TARP would be another. With important pieces of very bad policy almost fixed in stone, what will voters have left to decide in November? Other than the very crucial question of Supreme Court nominees, I am drawing a bit of a blank.

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39 comments

  1. Anonymous

    Bernstein has it exactly right. Paulson is proposing a massive bailout totally unrelated to the credit crunch in commercial paper and the money market funds investing in it.

    The NY Post article last week “Almost Armegeddon” caught the crisis dead on, about institutional investors starting to pull money from money market funds, which caused trouble for the companies that wanted to issue commercial paper to them. http://www.nypost.com/seven/09212008/business/almost_armageddon_130110.htm

    The banker who goes to my gym was ecstatic about the commercial paper crunch last week, and how it would help Paulson sell his securitized hybrid instrument transaction (SHIT) bailout.

  2. GoldmanCrook

    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.

  3. Steve Diamond

    I don’t buy this. There is no market for several trillion dollars worth of financial instruments sitting out there.

    Only a long term holder with infinite resources has the ability to enter such a market and pay a price that will both rescue the counter party and enable it over time to make a profit.

    That is, by definition, the state.

    If you want a market test of the idea notice what happened when TARP was announced – huge upswing and recovery of the week’s losses, meaning a floor had been put in. Then compare it to the complete give back over the last two days as political games intruded on the idea. None of these idiots in Congress have a clue as to how today’s financial markets work (with the exception of Rahm Emanuel, perhaps) and they are all playing politics.

    If you want a precedent for what that kind of political game playing can do check out the history around Smoot Hawley tariffs imposed in the 30s by a narrow minded protectionist American congress.

  4. Yves Smith

    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.

  5. MLM

    There is no market for several trillion dollars worth of financial instruments sitting out there.

    I am fed up with hearing this. There damn well is a market. It’s just not a market with prices you like.

    At total debt to GDP of 300%, we are maxed out. The shreds of available credit left to us need to be conserved for dealing with the fallout, not pissed away on a central planning joke like this bailout “plan”.

  6. Anonymous

    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

  7. Anonymous

    http://www.timeinc.net/fortune/conferences/global05/program.html

    GLOBAL FORUM 2005
    China and the New Asian Century
    May 16-18, 2005

    THE NEW ASIAN CENTURY

    Speakers:
    Nobuyuki Idei, Chairman and Group CEO, Sony Corp.
    John B. Menzer, President and CEO, Wal-Mart International
    Henry M. Paulson, Jr., Chairman and CEO, The Goldman Sachs Group, Inc.
    Yang Yuanqing, Chairman, Lenovo Group Ltd.

    Paulson has personally built close relations with China during his career at Goldman Sachs. In July 2008 it was reported by The Daily Telegraph that: “Treasury Secretary Hank Paulson has intimate relations with the Chinese elite, dating from his days at Goldman Sachs when he visited the country over 70 times.”

    Paulson has been described as an avid nature lover.[11] He has been a member of The Nature Conservancy for decades and was the organization’s board chairman and co-chair of its Asia-Pacific Council.[7] In that capacity, Paulson worked with former President of the People’s Republic of China Jiang Zemin to preserve the Tiger Leaping Gorge in Yunnan province.

    Paulson is also on the Board of Directors of the Peregrine Fund; was the founding Chairman of the Advisory Board of the School of Economics and Management of Tsinghua University in Beijing; and, previously served as chairman of the influential trade group, the Financial Services Forum.

    Conflict of interest anyone?

  8. don

    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.)

  9. darkmatter

    i am amazed at how similar the call to stop the “nuclear armegeddon” of saddam sounds so similar to the new mantra of “stop the financial wmd” that is posited to exist.

    maybe it does, but this administration has no shame in playing the “fear card.”

    none

  10. El Cid

    Maybe Paulson & co. saw how easy they got the $100 billion last week and just figured that if they screamed louder and waved their hands a lot, they could get $700 billion without much trouble either.

  11. Walt French

    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.)

  12. Anonymous

    The invasion of Normandy was planned for three years. This Mother of All Bailouts was planned for three days.

  13. Anonymous

    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.

  14. Anonymous

    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.

  15. Anonymous

    Sen Bunning (R-KY) in his questions at todays hearings mentioned that Greenspan was on the hill earlier today saying that 700B was not nearly enough. Funny that there was no coverage of him when he was out talking to his senator buddies this morning pre hearing, apparently being contrary to the Paulson spin.

  16. jest

    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.

  17. Yves Smith

    Japanese banks did recognize losses until it hit the point when it was inconvenient to do so.

    We have banks not foreclosing on homeowners because they don’t want to show the losses, the same was Japanese banks refused to call the loans on mid-sized corporations that were duds (actually, the motivation was somewhat different, the banks were also concerned about forcing businesses to close). Even the supposedly conservative Wells Fargo changed its accounting rules so as to show fewer bad loans (they pushed I believe the threshold for being in default from 120 to 180 days).

    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.

  18. doc holiday

    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!

  19. Anonymous

    I believe Yves is correct speaking of banks not wanting to recognize their losses. I deal with this everyday, as I represent many borrowers with little chance to pay back their C&D loans, but the bank keeps trying to kick the can down the road in the hope that the market will turn. It is a large charade. The bank pretends to play tough with the borrower, but this is mostly so that they can show the regulator that they are "tough" and that the loan shouldn't be written down. There is little doubt in my mind that the banks would be better served to foreclose now and take their medicine rather than kicking the can down the road in some misguided hope for a rebound. Their recovery rate will simply be much lower in six to nine months.

  20. Juan

    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.

  21. eh

    …and the Democrats in Congress give the President what he wants. With both parties on board now…

    Yeah, so much for adversarial/opposition party democracy.

    …political games intruded on the idea.

    In the case of those in Congress with the guts to voice opposition or reservations about this, I hope there’s more than that behind it.

  22. Blissex

    «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.

  23. jumco

    Not Enough Money In The World

    …The government is arguing that there is not enough money in the world to save the economy. If this is the case, than the economy must get smaller. To print enough money to fill the void does not provide clear solutions to any of the markets’ problems. Especially if said money comes with higher interest rates. The problem of over-leveraging is not solved. The problem of lax regulation and limited transparency is not solved. The problem of mortgage borrower default / failure is barely addressed, never-mind solved. So, at the end of the day, there are many questions:

    1. What is this bailout getting the American people that the market is incapable of providing?
    2. What are taxpayers getting that the market doesn’t want?
    3. Why should taxpayers be willing to take what is being sold, if no one else is interested?
    4. If no one else is interested (severely limited demand), why is there such an enormous price tag for these undesirable assets?

    The answers, if honest, are likely to be mendacious. I’m interested to know what is thought by you.

  24. Matthew

    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.

  25. Anonymous

    Price inflation doesn’t cause houses to sell. Wage income would have to outstrip housing prices to cause buying. Don’t hold your breathe waiting for that to happen.

    Of course you want to hide your losses by keeping them off the balance sheets esp. RE with banks. That’s what is causing some of the mistrust between bank and the resulting lockup in credit. No bank knows if the other banks are good for repayment.

    The credit lockup is real just on the RE cause and affect. The situation is worsening as banks unload REO driving prices down with more forecloses ready to come online. A housing glut with no buyers and sales that do occur are markdowns of 40%+ from the original mortgage. Everybody is underwater including the buyer if RE pricing continues to slide. (and it will)

    The US Treasury pleads for money but with no accountability is very strange even though the Federal Reserve, SEC and the Treasury agree oversight is a good thing. What do you expect from a bunch of bankers?

    Prefect time to take bailout funds and open an US Treasury bank and let the Federal Reserve die on the vine.

  26. Richard Kline

    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.

  27. alphabetzoo

    @ Don:

    Yes I’m no fan of conspiracy theorists but I’ve long believed the ‘neo-Rockefellers’ such as Cheney have encouraged this whole process as a means of bankrupting Medicare and Social Security.

  28. Anonymous

    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.

  29. Anonymous

    We’ve had multiple waves of trouble: last August, January (Kerviel), March (Bear Stearns), July (Fannie/Freddie stock price collapse and the first short-selling ban), and now September. Each wave is worse than the last; each was supposed to be the last.

    Premature sighs of relief and lack of urgency are asking for trouble. If the next wave comes in late October while the bloviating gasbags are campaigning full-time, it will surely be too late to do anything.

  30. fresno dan

    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)

  31. Matthew Dubuque

    Matthew Dubuque

    Now that Dick Cheney has become intimately involved in the process, we need to increase our scrutiny.

    The 700 billion will likely be broken up into 50 billion dollar tranches whose management will be OUTSOURCED.

    In the tradition of KBR and Halliburton, will these management contracts be no-bid contracts?

    Will Goldman Sachs receive 1.5 billion for managing a tranche of early 2006 RBMS about which they are already extraordinarily familiar because they already have this vintage on their books?

    Matthew Dubuque
    mdubuque@yahoo.com

  32. Anonymous

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

  33. Don Milton

    It seems likely that Congress will do something — no officeholder can allow constituents to suffer great pain from a financial meltdown without at least appearing to try to prevent it. And, it will make people feel good to try and limit personal compensation of the people who made the bad decisions as part of the deal. But, that does not address the worst part of this mess; ‘Paulson’s Folly’ will soak up government assets that should be going toward things in the real economy that will keep the US competitive, infrastructure improvements and maintenance, and health care. (Little attention is being given to how many of the mortgage defaults that underlie the housing crisis derive from the inability of people to make mortgage payments when they become ill.) A more effective way to both control executive compensation and to finance the bailout as well as other needed programs is to go back to a truly progressive income tax – a modern version of this might keep the current tax brackets as they are or slightly reduce the rates in the current brackets, but add a new one at the upper end, starting at $3 million and applying a 50% or higher rate. The government should probably not be trying to dictate what companies pay their leadership — but it should be requiring that the executives with outrageous compensation carry a proportionately large part of the tax burden. Taxation may also be a more effective way to discourage behavior we don’t like, in this cases, than regulation. If this were combined with relatively low very long term capital gains taxes (for assets held for years), then executive compensation might more effectively be directed toward true performance, and the results of this crisis could be a stronger American – rather than just richer investment bankers.

  34. Peggy McGilligan

    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

  35. Anonymous

    Yves,

    “We have banks not foreclosing on homeowners…”..

    Are you serious? Do you really think that there is a lack of foreclosure activity?

    Not so. Banks are foreclosing, they have taken their writedowns, and they have raised capital.

    The only question now is whether the stuff they have written down sits on their balance sheet for years (exactly like Japan) while they call in the working capital lines and other loans critical to productive economic activity.

    To the poster who suggests letting everyone go bankrupt and then starting over, how long and drawn out a process do you think this will be? And how costly? And wouldn’t your new banks seeded with federal money recreate many of the conflicts and ambiguities that haunted us in the form of FNM and FRE??

    For what it’s worth, I believe Buffett himself came out this morning and said the bailout is necessary and the last worst of many bad options.

  36. Yves Smith

    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.

  37. Juan

    anon, this self-cannibalizing system is already bankrupt, what we’ve been seeing is only the most recent evidence.

    buffett? special preferreds paying a 10% coupon might lead one to wonder about gs.

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