A Chicken Bailout in Every Pot (Monoline Edition)

How did I miss this PM news item? It appears not to have gotten the attention it deserves.

The list of aspirants to gorge themselves at the government feeding trough gets larger with every passing day. The latest addition is the bond insurers.

As far as I am concerned, they are hugely undeserving. The world survived what was supposed to be the End of Finance As We Know It, namely the loss of the monoline AAAs. Now that we are past that point, pray tell what is the systemic need for a monoline guarantee? Yes, I am sure around the margin it would reduce some casualties, but the powers that be need to start doing triage, and this crowd does not pass muster.

The good news is the initial reaction from Treasury appeared to be cool, and since the monolines are a small industry regulated by the states, it is doubtful that they have spent much money in DC cultivating powerful friends over the years. The news story is so far based on an industry wish list and a favorable research note from one analyst.

But the prospect of a monoline handout contributed to the peppy end-of-day stock market rally. And if the monolines do get a backstop, this says there is no discipline in the process in Washington, none.

The logic of these bailouts and emergency measures is simply untenable. Bernanke is trying desperately to stop deleveraging. That is neither a wise nor viable objective. There is too much debt relative to the underlying economies. More has to be written off, and the trick is how to do that without producing a crisis in confidence (oh wait, we are past that point, aren’t we?). But what Bernanke and his fellow central bankers are trying to do is move bad assets over to the government balance sheet AND provide equity to banks so they go make more loans. The problem is that this merely increases aggregate indebtedness, when a signficant rataionalization needs to take place.

Hopefully, Treasury and the Fed are out of panic mode and will be a little less quick to throw money at every problem that arises. But if they continue with their recent pattern, the US is on its way to debt default, either via substantial inflation or an explicit failure to pay.

From Bloomberg:

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, Chief Executive Officer Michael Callen said.

The companies also may present a proposal next week that would allow the insurers to guarantee some assets with government backing, Callen said in an interview today.

“We’re working hard to put together a proposal and it’s got to be an industry proposal,” Callen said. “We don’t have a lot of time.”

The Treasury’s $700 billion program to buy troubled assets may allow the two guarantors to dispose of bonds backing collateralized debt obligations that they guaranteed, Royal Bank of Scotland Plc analyst Michael Cox said in a research report. Banks also may be more willing to cancel credit-default swap contracts they bought from bond insurers if the banks can sell the underlying CDOs to the government, Cox wrote.

Callen said he isn’t asking Treasury to take a stake in Ambac.

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

The Treasury yesterday said it isn’t considering buying equity holdings in bond insurers. “That’s not an idea we’re focused on or pursuing.” Treasury spokeswoman Jennifer Zuccarelli said in an e-mail to Bloomberg News.

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29 comments

  1. Anonymous

    ““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

  2. Anonymous

    another not-to-be-missed article:

    http://www.nytimes.com/2008/10/17/business/17bank.html?hp

    gruesome excerpt:

    The deepening red ink underscores a crucial question about the government’s plan: Will lenders deploy their new-found capital quickly, as the Treasury hopes, and unlock the flow of credit through the economy? Or will they hoard the money to protect themselves?

    John A. Thain, the chief executive of Merrill Lynch, said on Thursday that banks were unlikely to act swiftly. Executives at other banks privately expressed a similar view.

  3. Lune

    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.

  4. Don

    A Banking Addiction?
    From the NY Times:

    http://www.nytimes.com/reuters/business/business-us-usa-fed-discount.html

    “Banks and dealers’ overall direct borrowings from the Fed averaged a record $437.53 billion per day in the week ended October 15, topping the previous week’s $420.16 billion per day.

    Some analysts are concerned that banks’ dependence on Fed lending might become long term and difficult to change.

    “The banking system is going to become addicted to this very cheap money. Unwinding it will be very difficult,” said Howard Simons, strategist with Bianco Research in Chicago.
    “We have effectively allowed the central banks to disintermediate the banking system. Why would I want to borrow from you if I could do it with the central bank, because they can always print it up and say ‘here’…and they are in the business now of making sure I stay in business,” Simons said.”

    I’m glad we considered this problem before doing it. Jeez.

    Don the libertarian Democrat

  5. Don

    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

  6. locust

    All this talk of lending..but who is going to borrow and why? Consumers aren’t buying..they’re too busy being laid off from their jobs. Who is still buying?

  7. Anonymous

    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.

  8. doc holiday

    Re: gorge themselves at the government feeding trough

    >> WTF is going on, is The Fed just handing out kilos of heroin to anyone with tracks in their arms now, or is there any logic to this drug laundering prostitution ring? As for a feeding trough, these dopers will definitely be going the route of subcutaneous injections, for a long, long time.

    Nonetheless, I still think a few things will happen this year, e.g, Ken Lay will be pardoned and then come back to life in Bermuda. George Bush will be granted a third term, to finish "job done", and then, National Bureau of Economic Research will be closed by budget constraints, thus making it unable to publish information on the economy.

  9. Anonymous

    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.

  10. Anonymous

    I run a little corner grocery store and ordered too much bread. It’s in the storage room and has grown moldy. Does anyone have Henry Paulson’s telephone number?

  11. doc holiday

    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.

  12. Anonymous

    They could have fixed this problem a lot easier and probably with the same inflation we are going to get anyway by just giving ever US citizen as of 3/1/07 over the age of 18 in the lower 80% income group a flat million with a couple of strings attached. 1. All money must be used to pay off debt, home loans, student loans, auto loans and credit cards made before 3/1/07 then any monies would go back to the government. 2. If you had less then 10k in debt as of 3/1/07 the million would invested in 10 year US treasuries which you would be entitled to annual interest payments upon reaching age 70. Makes more sense then the crap they are doing now. A lot of the debtors would be out of debt with a clean balance sheet, the creditors would be paid off for the most part and the money that went back into the treasury market would almost be a wash. I’m just a bum and it’s a great time to be a bum though.

  13. john bougearel

    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.

  14. Anonymous

    It is becoming more obvious to people now that more of the same will delay the inevitable, but also increase the consequences after shifting the burden to the masses who are stuck with a defaulting government.

    The only question which still remains, since this is more of the same, is where will this cash go? Meaning effectively what will the last of the great excessive money supply induced bubbles be?

    I think the answer will be the things needed by you and me. I heard one person say that to him the definition of stagflation was that everything you want is really cheap and everything you really need is expensive.

    So here is a toast to the coming bubble of high food prices, fuel, and consumer staples, (not to mention gold for wealth storage) only this time when the bubble pops those things will still be expensive because our hard earned wages will not go very far since our wages will be low as a function of our devalued currency.

    In those days us Americans will call a man going to work in Asia
    “lucky.”

    We DO live in interesting times. Damn it.

  15. David Habakkuk

    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.

  16. Anonymous

    Once a crisis of confidence reaches state-to-state levels i.e. treasuries, things will worsen I’m afraid.

    Iceland defaulting on its debt payments should be a warning example.

    If there is no one buying bonds and treasuries, states can no longer rely on outside help to solve the situation.

    It is correct for a state government to intervene in terms of crisis. But any money should be spent worthwile, so foreign investors do not loose confidence in a states ability to meet its obligations.

    I don’t think the financial system can be saved. It is the states duty to make sure, the rest of the world keeps spinning nevertheless. So take over key players completely. The rest has to be on its own. Then the country and economy is financed by state banking. Instead of being the lone player in the interbanking market, a state government should be the lone player in the state economy until the dust settles.

    I would buy a state bond for financing main street activities. I would not buy a state bond covering the potential losses of toxic investment portfolios.

    Moving the toxic assets around does not make them disappear. They only spread the lack of trust and confidence.

  17. eh

    “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.

  18. Jojo

    And then there is:
    ==================
    Shady Sheets
    By jonathan.weil
    Created 10/16/2008 – 11:24am

    The trouble with throwing a lifeline to dying banks is they keep trying to pull the rest of us into the drink.

    Here we have the Treasury Department injecting $250 billion of fresh capital into U.S. banks in exchange for preferred stock, which should present the perfect opportunity for them to sell or write down all their toxic holdings.

    And how do the banks return the favor? By trying even harder to gut the rules that say they can’t lie to investors about the values of their crummy assets.

    What investors need now is a good reason to believe corporate balance sheets. Otherwise, it won’t matter how much taxpayer money gets pumped into ailing financial institutions. We’ll still be risking systemic meltdown because nobody, especially the banks, will be able to trust anyone else’s books.

    ….

    Full article”

    ============================

  19. Richard Smith

    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).

  20. wintermute

    I have been watching the monoline meltdown since last year when doubts about their AAA rating were being raised in earnest. Yves is 100% right – at the time it seemed the the End of the World – but now they are almost a footnote in this financial disaster.

    Why is there talk of saving them now? The subtext is important. US muncipalities are creaking under the stress of higher interest rates. Is this a flawed plan to somehow put confidence back into bond insurance – to save hundreds of bond-issuers from direct federal bailout?

    If so – this is like telling a house-owner, after a fire, that the burnt-out shell would be quite habitable with a lick of white paint.

  21. fresno dan

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

  22. Anonymous

    “By trying to prop up the private world, Bernanke is merely ensuring that the list of failed institutions includes the U.S. treasury.” Lune at 12:10 AM.

    It would be more accurate to say that the failed institution will be the Federal government. The only way out of this mess likely will be scrapping the Federal Reserve Note, instituting a commodity based currency, switching the financial center of the country to Chicago (go Obama). It is certainly not too soon to begin thinking about currency reform. However, the initiative for this will probably end up having to come from the heartland, probably Texas. The progressive coasts are exhausted as the Zeitgeist is dead.

  23. maynardGKeynes

    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.

  24. wintermute

    mgk – agreed. However it would be far more efficient for the Treasury to invest directly in Berkshire’s muni insurance (for example) than absorb the dross present in MBIA/Ambac to achieve the desired result of supporting municipalities.

  25. david.habakkuk

    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.

  26. ccm

    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.

  27. ccm

    I should have noted that when a super senior CDO counterparty fails, the CDO needs to find another counterparty (impossible in the current climate) or go into immediate liquidation — which in the current climate is likely to wipe out all junior tranches of the CDO and result in a partial or complete default on the insurance buyer who is on the other side of the hybrid/synthetic CDO deal. Who are these insurance buyers: investment banks, hedge funds? Your guess is as good as mine.

  28. ASav

    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.

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