Readers may recall that we were early to deride the Paulson Master Liquidity Enhancement Conduit, and its different in name, same in intent and basic form successors.
Every one of these had the same premise: find a way for banks to offload their dreck. But the only way the banks would do that voluntarily was to sell it at the simply ridiculous prices at which they held it on their books. And as the crisis has progressed, the gap between optimistic marks and real world prices has grown only greater.
The cover story has always been. “Oooh, this stuff is really hard to value and doesn’t trade.” That has been true only for an itty bitty subset of the damaged goods. The vast majority of it is readily salable. The banks just don’t like the prices.
We have said from the first sighting of this idea that it works only if the banks fetch at least the carrying value of the rubbish on their books. Even that isn’t a clear boon. Many banks are now plenty liquid, so as long as they can preserve the fantasy marks for the nuclear waste, they have no compelling reason to clear up the bad assets. They’d need to realize at least carrying value prices so as not to lower their equity levels (a loss on sale is a direct hit to their book value), or better yet above, to bolster their capital.
So this has every and always been an indirect and opaque subsidy to the banks. We have said it would never get done unless the powers that be found a way to manufacture at least carrying value sales prices for the dreck, since those sales prices would serve as market prices. If banks took a loss on any sales, they’d have to mark similar paper down too.
The New York Times after what, more than 18 months of the officialdom trying to wedge this square peg into a round hole, says in a pretty straightforward fashion for the MSM that the premise is flawed:
The Federal Deposit Insurance Corporation indefinitely postponed a central element of the Obama administration’s bank rescue plan on Wednesday, acknowledging that it could not persuade enough banks to sell off their bad assets.
In a move that confirmed the suspicions of many analysts, the agency called off plans to start a $1 billion pilot program this month that was intended to help banks clean up their balance sheets and eventually sell off hundreds of billions of dollars worth of troubled mortgages and other loans.
Many banks have refused to sell their loans, in part because doing so would force them to mark down the value of those loans and book big losses. Even though the government was prepared to prop up prices by offering cheap financing to investors, the prices that banks were demanding have remained far higher than the prices that investors were willing to pay.
Yves here. Of course, this being America, we still have to give credence to official face-saving:
In a statement, the F.D.I.C. acknowledged that it had not been able to get banks interested in its so-called Legacy Loans Program….
F.D.I.C. officials portrayed the change as a sign that banks were returning to health on their own.
“Banks have been able to raise capital without having to sell bad assets through the L.L.P., which reflects renewed investor confidence in our banking system,” said Sheila C. Bair, chairwoman of the F.D.I.C.
Yves here, With commercial real estate losses expected to mount drastically and residential real estate and credit card losses not past their peak? If you believe this, I have a bridge I’d like to sell you. Back to the story:
But some analysts said the banks’ reluctance to clean up their balance sheets meant they were merely postponing their day of reckoning. Indeed, some analysts said government policies had made it easier for banks to gloss over their bad loans.
“What’s happened is that the government’s programs have addressed the symptoms of the financial crisis, but not the cause,” said Frederick Cannon, chief equity strategist at Keefe, Bruyette & Woods, which analyzes the industry. “The patient feels better, but the underlying cause of the problem is still unaddressed.”
Our financial crisis was, and remains, a solvency crisis. Nothing about that subzero status has changed. What has changed is the sovereign creditworthiness of the nation trying to pretend that certain oligopolitan banks aren't dead, dead, dead. Boom Boom Nihon Redux, anyone? Except they had a deep pool of domestic savings to use to finance their fakery and endless stimulus, whereas the US only has the continuing credulity of the international investment community . . . which would seem to be on the wane.
MoLEC most die that the many might breathe free.
The important point, I think, is that the banks' ability to raise capital recently depended in large part on expectations that PPIP would magically cleanse balance sheets, starting this quarter. Bair's view that recent equity sales makes PPIP unnecessary frightens me. PPIP was objectionable to everyone except investors in financials. Once investors comprehend that they, rather than Uncle, will be absorbing losses over a very long time horizon, things could quickly get ugly again.
I agree with Steve. The start of the current market "turnaround" coincided with the feeling that the PPIP was gaining traction. Has the market just not been paying attention to what's been happening (or not happening) with PPIP lately? Or did they just forget about the toxic loans for a moment? It feels like one of those Wil E Coyote moments, where he ran off a cliff and is just hovering for a moment. BEEP BEEP.
Of course they're in bed together! If they were not, these taxpayer-funded giveaway programs would have had the “sell the trash to get the cash” covenant.
They're ALL a bunch of crooks!
I'm in line with Steve and RTD. Investors have put money into the financial system thinking that everything would be okay. If trouble hits yet again, which is entirely possible because of Alt-A recasts, increasing credit card defaults, HELOCs going unpaid and jumbo loans turning sour, then things could get really nasty again. I also think Congress will finally turn off the cash spigot in this case given how much hatred there was over bailout money going to pay bonuses. If this happens, and investors (or should I say, dupes) end up holding the bag, I think we could see something along the lines of Lehman or worse. I'm hoping such an event happens though, because I think it's needed something like this is needed before we can finally start a real recovery.
“What’s happened is that the government’s programs have addressed the symptoms of the financial crisis, but not the cause"
The only quibble I have with this statement is that it should read causes. Otherwise this is what some of us have been saying since last year. The fundamentals of this crisis are not being addressed: bank insolvency, the casino culture of the financial industry, distressed homeowners, distressed creditors in general, and having and enforcing strong regulation. Indeed the government's poor response has led to the misallocation of trillions from productive sectors of the economy to those which are the most wealth destroying. It has failed to preserve the rule of law by leaving massive law breaking in the financial industry uninvestigated and unprosecuted. It has exacerbated recession to the point of depression, and as we keep hearing, the worst is yet likely to come.
I'm with Richard, this is a solvency issue, not a liquidity issue.
Steve Keen has an interesting post up explaining under what conditions a solvency crisis can masquerade as a liquidity crisis.
This is all borne out by a chart I saw in Dave Rosenberg's June 1st missive that shows the cash reserves on the balance sheets of commercial banks tripling in April 2008, long before the Fed's balance sheet showed a similar explosion.
The "credit crunch" occurred not because of a lack of liquidity but because a fear of insolvency caused the banks to hold onto their cash and build up their reserves.
Great chatter on whether the banksters are crazy as a fox, or just crazy.
Richard says the financial system is insolvent, not illiquid.
I agree of course. Insolvency is the proper name of this situation.
But I disagree that this insolvency ends with the financial system.
The insolvency of the financial system is inevitably based on a more basic insolvency, that of the debt-money system.
The structure of the debt-money system has a "pre-condition" for the viability of that system.
That pre-condition is economic growth. The debt-money system MUST grow faster than the increase in interest payments
on the debt-money already in existence, or, guess what?
Bernanke has floated Trillions in new debt-money at zero interest rates. They're going up.
The debt-money system is broke, broken and insolvent.
We need a brand new money system.
And we should never turn it over to the private bankers.
Wait, I thought the big concern was that they would game the system and bid for far more than the assets were worth, sticking the taxpayers with the losses? Well, at least that didn't happen.
While I agree with you that one failure that led to the current crisis is a fundamental failure to understand the true nature of our money system. Neoclassical economics assumes that money is exogneous, while Post Keynesians have shown that money is typically created endogenously via the extension of credit, making our economy a "credit-money" or "debt-money" system. (I say typically because when banks stop lending, the government can create money through Keynesian fiscal policy; monetarism just doesn't work when the banks don't want to lend because they're insolvent, so the newly printed money never gets into circulation.)
While I have to think it through further, my initial reaction is that the entire money system is not insolvent, that debt deflation is a more likely outcome. (Maybe I'm missing something?) Therefore, I don't think a new money system is required as long as we face the reality of what the money system actually is and put in place limits on credit extension that cannot be circumvented.
And that's one of the things that kills me: the assumption that low interest rates forced or even encouraged such horrendous risk taking by the banks. Even the hidebound Austrian School recognizes, perhaps better than anybody else, that bubbles are typically created by credit expansion. Where the Austrian School, and Mises himself, fell down was in the assumption that private banks have no say in credit expansion, which simply has been proven wrong.
""While I have to think it through further, my initial reaction is that the entire money system is not insolvent, that debt deflation is a more likely outcome. (Maybe I'm missing something?) Therefore, I don't think a new money system is required as long as we face the reality of what the money system actually is…""
I have previously posted and do again this paper by financial linguist Steven Lachance on "How Debt-Money Goes Broke".
When Irving Fisher wrote his book on debt-deflation theory, he was well on his way to becoming the strongest of supporters of full-reserve banking, which would, of course, provide that "brake" that you mention on rational bank lending.
For the most part, banks would lend real money.
To me, that is a new money system.
Fisher, Henry Simons, Douglas, Means and many other leading economists of the day supported the Chicago Plan for Monetary Reform, which was designed to replace our fractional-reserve creation/lending system that plays around with interest rate targets as a means of controlling the amount of money out there.
I believe that if you think about it further, you will find that the definition of insolvency applies to the money system – we cannot create enough new money fast enough to keep up with the additional interest payments coming down the pike.
We cannot do it.
Only a massive contraction, and resultant destruction of the mountain of paper wealth can lead to a point of re-beginning.
That is the debt-deflation phase.
So, if you want to do this all over again, then let's pretend it is not the debt-money system that is the problem.
To me the exit strategy we need is from the debt-money system to the debt-free system outlined in the Chicago Plan legislation.
There appear to be at least three plausible & mutuallly reinforcing reasons for low LLP participation rates by banks:
FASB recently changed the accounting rules to weaken mark-to-market accounting rules, reducing pressure on balance sheets from thase toxic asset s.
Private capital is flowing to the banks because hedge funds see banks as a quasi-guaranteed investment, due to a willingness by Summers & Geithner to support the banks above all else – and by Obama to put up with Summers.
The plan wouldn't have worked the way the banks wanted it to, anyway.
On the latter point – One major feature of the FDIC portion of the program is that the FDIC under Shiela Bair would have run it.
Getting FDIC to take this junk would, under Bair at least, have required that the assets be restructured and revalued. These are assets – predominantly CDO's – having the toxic "legacy" of having been valued, originally, using David X. Li's "gaussian copula" function to give the illusion of a data free prediction of the default rates of different securities.
The Li "function" has been discredited as bad math, and possibly worse. But the CDOs' valuation as carried by the banks is based upon the invalid function. Sale of these instruments, under the supervision of the Bair FDIC, would have (or might have, depending on how you interpret the FDIC intent) required a virtual dissassembly of the CDO packages in order that the mortgage backed securities included in them (the CDOs) might be accurately revalued using data about each of the mortgages incorporated in tthe MBSs.
My feeling is that the data about these mortgages necessary to allow assignment of valid (uncontaminated by the David X. Li gaussian copula function) values either do not exist or are prima facie indicative of fraud. If as true as experienced observers believe it to be, that is apt to be a significant source of resistance to subjecting these instruments to any process under the supervision of a Bair managed FDIC.
I will not speculate on Shiela Bair's future. I will say that whatever it is, it will likely be dispositive information re the integrity and intent of the Obama Administration for a clean up – or not – of our financial system.