naked capitalism

Anonymous says:

““We’re not going to be asking the government to give us a big gift,” Callen said.”…. hehehe I like that. What exactly is the sale of troubled assets but a gift.

The entertainment value is getting better all the time.

Ralph

Lune says:

Anyone care to add up the money spent by the government so far in its efforts to delay the inevitable?

At this point, the $30 bil spent on bailing out Bear Sterns and that raised such a hue and cry just 6 short months ago will be little more than a rounding error in the final tally.

While it’s bad enough that these toxic assets might lead to the failure of a number of firms — some of them important to the system as a whole, and some of them not — what the Fed doesn’t seem to grasp is that the transfer of these assets wholesale to the U.S. government will eventually lead to its failure, and that will lead to far, far worse systemic disruptions than the failure of any combination of private institutions.

While we are currently experiencing some relief since our friends the Europeans are imploding faster than we are, eventually the world will wise up and realize that most of the Western World’s financial systems are bankrupt, regardless of the Fed’s machinations. By trying to prop up the private world, Bernanke is merely ensuring that the list of failed institutions includes the U.S. treasury.

Don says:

http://www.nytimes.com/2008/10/17/business/17bank.html?pagewanted=1&adxnnl=1&adxnnlx=1224217409-VQRrYXDhRDQm/ZtGavgNzw

“This is the people’s money. They’re giving it out with no rules.”
It doesn't get clearer than this that TARP is off track. Via the NY Times:

"Bank of America said in a statement that the money “will add to our capital, which will increase our capacity to expand our balance sheet and make more loans.” It did not say if it was willing to increase its lending.

Indeed, observers point to the growing well of bank losses, deeper by the quarter, as reason to question whether the government funding will be used as a financial Band-Aid, instead of an engine to move forward.

“It is the government’s responsibility to set the terms and conditions on this money,” said David M. Walker, the former federal comptroller general and now president of the Peter G. Peterson Foundation. “This is the people’s money. They’re giving it out with no rules.”
Bank executives, meanwhile, said on conference calls this week that it was premature to discuss their plans. "

A credit stimulus package without the stimulus. Perfect.

Don the libertarian Democrat

Anonymous says:

The rationale advanced for the bailout of the monolines is that it will restore a AAA rating to local government bond issues and lower their borrowing costs. The scheme is to have the monolines take the first loss and the government backstop them thereafter.

The most under reported story and perhaps the biggest is the absolute disaster that is building with state and local financings. It involves not just current deficits but under funded pension plans that have been further devestated by the market’s implosion.

We are fast approaching a day of reckoning that will be most unpleasant. You mentioned either default or inflation, the two alternatives. Bet on inflation and look for it to be a world wide event. We aren’t the only ones getting backed into the corner.

Anonymous says:

I think Moody’s will need help too. Who else will get relief? Maybe Halliburton, Waste Management, Inc., Exxon, Royal Dutch Shell, Northern Rock, etc.

doc holiday says:

While this could seem off topic, it does fit into the theme of feeding troughs and food related crimes:

FYI: Salad oil scandal

The scandal involved the company Allied Crude Vegetable Oil in New Jersey, led by Tino De Angelis, which discovered that it could obtain loans based upon the inventory of its salad oil.

Ships apparently full of salad oil would arrive at the docks, and inspectors would confirm that the ships were indeed full of oil, allowing the company to obtain millions in loans. In reality, the ships were mostly filled with water, with a only a few feet of salad oil on top. Since the oil floated on top of the water, it appeared to inspectors that these ships were loaded with oil. The company even transferred oil between different tanks while entertaining the inspectors at lunch.

Once the scandal was exposed, American Express was one of the biggest casualties. Its stock dropped more than 50% as a result of the scandal, which cost the company nearly $58 million. Famed investor Warren Buffet took advantage of American Express’ bad fortune by investing 40% of his partnership’s assets in the pummeled company in the 1960’s, reaping a huge windfall as the company recovered. Tino De Angelis was convicted of fraud and conspiracy charges in connection with the scandal and served seven years in prison, gaining his release in 1972.

* The scandal’s ability to push otherwise cautious and conservative lenders into increasingly risky practices has prompted some comparisons to recent financial crises including the 2007 subprime mortgage financial crisis.

john bougearel says:

Yves,
Callen is a likeable enough guy when we see him interviewed on TV and all.

But, I want to thank you for making note that there are many undeserving entities, such as the monolines, of treasury handouts.

Many undeserving entities will surely get the handouts. To a certain extent, it is up to folks like us who follow these outrages to remonstrate against them.

That aside, we are a moribund debt-driven society, seeking to revive the same debt driven society with capital injections to spur more lending and debt obligations at the very time we need to shrink all that.

Our Keynesian regulators simply can not stand a contraction in the business cycle. They have for the past 75 years been trying to smooth out the business cycle so that we never have to experience the ills associated with a bust.

The fears they have regarding a contraction are not well-founded, and has contributed to the overall panic sparked by the Lehman mistake. When the sky-is-falling, it’s “no bank or business too big or too small to be left behind. Same as the RFC saw to it in the 1930’s.

“Our practice of rushing field agents into afflicted areas was both arduous and expensive, but the needs were nearly always urgent. In some communities the distress was almost universal.

Heck, Jesse Jones had the RFC loan $20 to a barber. To the RFC’s credit there were loans that they did not make. The news, radio, and auto auto industry. So were churches, which had the audacity to seek relief. Representatives from the Protestant, Catholic and Jewish communities petitioned both FDR and the RFC to take over their debts to the banks, cut them in half, and then lend to the churches at 2%. Church representatives went to capitol hill with the egregious slogan, “Ask largely that your joy may be full.” Thank god the bill authorized the RFC to ake loans to churches died in committee.

To a large extent, the interventionist element of Keynesian economics, when pushed to its logical extremes, must by definition lead to default, if there is no mechanism to regulate the amount of intervention. The only mechanism we have is in the legislation and apparently, as we saw earlier this month, that mechanism is easily overcome with $150 billion or so of pork.

Unfortunately, this is the slow road to china the country has been traveling down ever since the Great Depression.

Lune ~ the Fed and our regulators certainly and fully understand that the road they travel can lead to govt credit rating downgrades and defaults. They are gambling as they always have that they can engineer their way through this and avoid default.

They are risk-takers in the final analysis.

David Habakkuk says:

It has been evident for some time that if there was any prospect of containing the eventual financial burden of rescuing the U.S. financial system, this depended upon some very brutal triage. Absent this, as Yves points out, the logic points to an eventual repudiation of the burden, either by inflation or by straight default.

If as Yves suggests there is still little indication that either Bernanke or Paulson have faced up to the need for triage, then if foreign holders of Treasuries are remotely rational, they should surely be contemplating the possibility that the eventual value of their holdings may very well be devalued to a degree which would have been absolutely unthinkable only weeks ago.

At the moment, one suspects that a lot of people throughout the world are in a kind of intellectual shell-shock — desperately trying to get their heads around the fact that the premises on which their strategic calculations had been based have collapsed. But I still think it eminently possible not simply that Treasuries are just one more in the long succession of bubbles — but that it may burst much more quickly than people expect.

eh says:

“We’re not going to be asking the government to give us a big gift,”Callen said.

But:

Ambac Financial Group Inc. and other bond insurers are working on a plan to send to the U.S. Treasury that would enable them to sell troubled assets to the government,…

At what price? At the “troubled” price? Or another, higher price?

You have to love the rhetoric of this crisis. If you weren’t a cynic before, you really almost have to be one now.

Richard Smith says:

David Habakkuk,

That is all too plausible, and would be a far larger and more disruptive bust than anything we have seen so far. I can’t really grasp the implications, but do you have any thoughts on what they might be?

We will have to listen out for what the big Treasury holders are saying. Not much until after the election, I would have thought, but then – watch out!

Forgive mny inane curiosity: are you anything to do with Hrothgar? You seem to like economic history too (except in near real-time).

fresno dan says:

Thanks “Doc Holiday”
I never quite understood the defintion of that finanacial term “float”
Now I know!!!

maynardGKeynes says:

It’s important to distinguish the municipal side of the business from the other bad part. Until the monolines collapsed, municipal bond insurance provided positive externalities to taxpayers by lowering the cost of municipal borrowing for the many small municipal entities that provide important public services, and the collapse of the monolines has really hurt taxpayers. It makes perfect sense for the federal government to step in to support municipalities, and arguably the most direct and low cost way would simply be for the federal government to reinsure municipal debt. Unlike most of the bailouts that have been discussed, the federal government is likely to make money on this, because the municipal insurance business was always quite profitable for the monolines. The other side of the business should simply be allowed to go into runoff — – it no longer plays any role in minimizing systemic risk.

david.habakkuk says:

Richard Smith,

I can’t begin to grasp the potential implications either.

It is the sheer pace of change which seems to me make everything so unpredictable. As I understand it, it was only in mid-September that the Fed’s balance sheet started ballooning out of control. This was not so much of an immediate problem, because the panic meant that the Treasury could sell a vast quantity of very short term paper. But this kind of panic funding will not be available for ever — may not indeed be available for very long.

In an interesting paper reproduced on the FT Alphaville site, John Kemp suggested that it was only China who had the resources to provide the requisite funding. He want on to suggest that ‘while China probably does not want to add to its holdings of dollar assets and its exposure to the United States, the size of its existing holdings, and its need to protect their value, may leave it no choice.’

(See http://ftalphaville.ft.com/blog/2008/10/09/16850/follow-the-money-v/.)

It seems to me that the Chinese would very much want to avoid risking the rapid disintegration of their export-led growth strategy, and possible major political turmoil, by pulling out from dollars while the U.S. financial system is on the life-support machine. But if they once conclude either that the patient is going to expire anyway, or that their holdings are in danger of catastrophic fall in value whatever they do, then they might be deeply reluctant to add to their holdings: which could be enough to precipitate chaotic collapse.

I agree that it is likely that the Chinese and other Treasury holders will want to play for time — until after the election, nobody can take any realistic bets as to the direction of U.S. policy. And they will also want if they can to think through the implications of alternative courses of action before doing anything with irreversible consequences. But — as with so many processes in tightly-coupled systems — if once an initial stability is seriously disrupted, change can follow rapidly and chaotically, and people have to make policy on the hoof.

As to what forms chaotic change might then take, I also have difficulty thinking things through — and in any case chaotic processes are inherently unpredictable. Would Bernanke then make the resort to printing press which he mentioned as the ultimate backstop in 2002? Very likely, I would have thought. A competition in currency trashing would then appear quite likely, with even the Germans being drawn reluctantly in, and inflationary pressures emerging at some point. Would we have an orderly sequence — deflation followed by inflation? Or might the whole sequence unfold much more quickly and chaotically then generally anticipated?

What I would imagine is that the dollar rapidly ceases to be the global reserve currency. But as to what would replace it, I cannot begin to envisage. Is there any reason why one should have a global reserve currency? (On a more detailed point, I am curious as to what oil producers would do. Would they continue pumping heavily at depressed prices, or might they conclude that oil in the ground is a better reserve than any currency? If so, can they afford to run down reserves?)

As regards your other question: my late father was indeed Hrothgar. Not long before he died, back in 2002, he said that this was such an interesting period of economic history, he was sorry he would not live to see how it turned out. But then he was 14 in 1929, and the possibility that apparent stability could suddenly disintegrate was always with him.

ccm says:

My concern with TARP has always been that Paulson’s goal may be to backstop super senior CDOs (=super senior CDS). These are essentially financial insurance contracts that are guaranteed to bankrupt the issuer (e.g. Ambac, MBIA, AIG) when economic circumstances deteriorate. (It’s my understanding that the reason monolines are monolines is precisely because NYS recognized the correlation problem with financial insurance.)

Now, because the valuation of assets on investment bank balance sheets depends on this insurance being worth something, I’m worried Paulson wants the government to backstop it.

Problem 1: the losses on this stuff could run as high as $1 trillion, because quite a bit of it is tied to second tier securitizations that may go to zero.

Problem 2: Since these are CDS contracts, there is a sense in which they are gambling debts. What does it say about the state of finance in the US, if the US Treasury decides to “save” investment banks by taking over the gambling debts of bankrupt counterparties?

The financial press needs to stop playing into the Orwellian doublespeak of investment bankers by calling super senior CDOs (which sound like investment products) what they are: super senior insurance liabilities that were marketed by the insurance buyers as assets. The whole market was built on the assumption that the government would bail it out if (or should that be when) the insurance issuers collapsed.

ASav says:

So if the CDS and ABS longs blow out on this mess, does that mean the shorts i.e. mortgage holders get their houses with no lien attached? That would seem right. Except at that point we’d be so far screwed that the house would have no heat or electricity so that may be a small disincentive.