Tuesday, September 23, 2008

Finance

UPDATE: below

Blogger bobn, in two comments on an unrelated post yesterday, wants me to condemn "the Paulson Bailout of Swindlers." I mostly decline the offer. Here's what I do know: Reader suggestions welcomed.

MORE:

Gateway Pundit lists 17 times Bush tried to avert the Fannie Mae crisis and was stopped by the Democratic Congress. And Ben Stein says:
The crisis occurred (to greatly oversimplify) because the financial system allowed entities to place bets on whether or not those mortgages would ever be paid. You didn't have to own a mortgage to make the bets. These bets, called Credit Default Swaps, are complex. But in a nutshell, they allow someone to profit immensely - staggeringly - if large numbers of subprime mortgages are not paid off and go into default.

The profit can be wildly out of proportion to the real amount of defaults, because speculators can push down the price of instruments tied to the subprime mortgages far beyond what the real rates of loss have been. As I said, the profits here can be beyond imagining. (In fact, they can be so large that one might well wonder if the whole subprime fiasco was not set up just to allow speculators to profit wildly on its collapse...)

These Credit Default Swaps have been written (as insurance is written) as private contracts. There is nil government regulation of them. Who writes these policies? Banks. Investment banks. Insurance companies. They now owe the buyers of these Credit Default Swaps on junk mortgage debt trillions of dollars. It is this liability that is the bottomless pit of liability for the financial institutions of America.
(via AVI, reader Bob C.)

29 comments:

OBloodyHell said...

I ack the probable need to perform the bailouts in question, despite my own inclination to let companies fail.

As I have noted, I agree with Frank Martin over on VariFrank --
"Too big to fail" means "Too big to allow":

Now, I say this as a complete capitalist, but if a business gets so large that its failure would collapse the market( Like AIG is purported to be), then is it fair to say that the business should be broken up by the government to keep that from happening?

"Too big to fail" should not be "Taxpayers pick up the tab". If you are too big to fail, maybe we need to make you a little smaller.

That goes for you too GM...


We should apply the IC clause for what will probably be the first good use in a century -- and force any and every company we rescue to divest itself into 3 to 4 component parts within 2 years, and to stay that way.

Part of the problem is not just the size of these groups, etc., it's that there is often also limited competition to pick up the slack and detritus of a failure, unlike, say, the "Big 4" when Arthur Anderson went belly up with good reason.

"Too big to fail" == "Too big to exist"

bobn said...

There is probably a need to do something - though we should resist the typical administration fear-mongering that it needs to happen *right now*. Remember a month ago Paulson was saying everything was safe and sound. Take him at his word then.

The original Paulson proposal was utterly and completely wrong. Even with tinkering in Congress to add oversight and equity, I'm still not convinced. (Part of my problem is that Hank Paulson sets my teeth on edge, ever since October 2007 when he tried to orchestrate the M-LEC/SuperSIV thing which only made sense as a means of avoiding asset price discovery. If Paulson came out for oxygen, I'd have to stop breathing.)


Last night on Calculated Risk comments someone linked to this paper from the University of Chicago Graduate School of Business.

It seems to make a lot of sense - unlike what Paulson has proposed - since it makes the people who are holding the toxic sludge eat it, not the taxpayers, and since it invokes prior experience as well agreeing with the basic objection *everyboy* has to this:

The Paulson RTC will buy toxic assets at inflated prices thereby creating a charitable institution that provides welfare to
the rich—at the taxpayers’ expense. If this subsidy is large enough, it will succeed in stopping the crisis. But, again, at what price? The answer: Billions of dollars in taxpayer money and, even worse, the violation of the fundamental capitalist principle that she who reaps the gains also bears the losses.


And this leaves one wondering how much is enough? Paulson says 700,000,000,000 - but we know Paulson is a stupid/evil shit, and should expect that this is just a down-payment.

The fact that Paulson *resists* the taking of equity stakes in the swindlers shows clearly that his intent is to funnel taxpayer money into the Swindlers's companies.

Paulson is *not* an expert at anything except separating people from their money. He is absolutely the wrong person to trust about anything.

bobn said...

OBH said:

We should apply the IC clause for what will probably be the first good use in a century -- and force any and every company we rescue to divest itself into 3 to 4 component parts within 2 years, and to stay that way.

Part of the problem is not just the size of these groups, etc., it's that there is often also limited competition to pick up the slack and detritus of a failure, unlike, say, the "Big 4" when Arthur Anderson went belly up with good reason.

"Too big to fail" == "Too big to exist"


My God, man, if you do that the demons of hell will descend upon us! That's regulation! That's intervention in the market! Don't you understand that bigger is always better?!

You Communist, you!

bobn said...

In particular, I'm mystified by McCain's critique of SEC Chair Chris Cox--the SEC being mainly designed to ensure transparency, as opposed to substantive regulation.

Part of transparency is that risk is accurately known to all. The mechanism is allegedly ratings agencies. The SEC has been irresponsible in it's management of the NRSROs.

Had the toxic sludge been rated as toxic sludge - instead of AAA - this would not be happening.

bobn said...

From 14 Questions for Paulson & Bernanke

"8. In 2004, your former firm, Goldman Sachs, along with 4 other brokers, received a waiver of the net capitalization rules, allowing these firms to dramatically exceed the 12-to-1 leverage rules. How much was this waiver responsible for the current situation? "

Leverage for these firms is reportedly as high as 30 or even 40-1.

Yep. More of that great Bush de-regulation at work.

Bob Combs said...

Someone besides bobn needs to comment on this thread -- and I have something to say:

1. The bailout size is ~$700B
2. The mortgage default size is ~$250B

So why is the bill three times the size of bad mortgages in this country?

Read Ben Stein for an answer.

http://finance.yahoo.com/expert/article/yourlife/109609;_ylt=AihYXGa_2tf9PJDeCl.2G0S7YWsA

OBloodyHell said...

.

> You Communist, you!

I've certainly in a divestive spirit.

And as far as this goes, it's easy to avoid the regulation:

Don't accept gummint handouts.

That way companies will only reach for it if they really, really are going under.

Think closely -- This doesn't force such intervention on ANY company which thinks it can remain solvent on its own. Only those which ack that they have lost that ability through what, in one way or another, is mismanagement (making yourself vulnerable to the failure of another company isn't egregiously bad management, but it is still bad management).

Sorry, bob, this is not inconsistency on my part -- I've never been a proponent of no regulation at all. I just grasp that most regulation is micromanagement by incompetents lacking skill or talent in the markets in question.

Regulation should be limited to general topicality and oversight, not specific rules for operation.

One of the more brilliant examples of this I've ever heard of dealt with the way one scandinavian country dealt with pollution -- All factories had to place their discharge UPSTREAM of their intake. Hence, the factories tended to be self-correcting as far as pollution went.

When creators have to "eat their own dogfood", they tend to be more cautious about the quality of said dogfood.

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

I'm sorry, though -- I also see how the mark-to-market notion inevitably leads to a market death-spiral. I think it's obvious that BOTH measures are relevant to examining the status of a company. If assets which need not be liquidated are valued at whatever the current price is, regardless of the fact that there really, really is no reason to liquidate them, in a severely down market, then it's absurd to force the company to consider them only at that value. It's quite clear how a company which is not in trouble can suddenly wind up in trouble through no action or error on its part, by being forced to re-value its assets at firesale prices in a bad market that it has no reason to be selling in in the first place.


.

bobn said...

And as far as this goes, it's easy to avoid the regulation:

Don't accept gummint handouts.

That way companies will only reach for it if they really, really are going under.


But the original version of the Paulson plan was for him to hand out money with no equity or regulations apparent.

I just grasp that most regulation is micromanagement by incompetents lacking skill or talent in the markets in question.

That would cover Paulson and Bernanke, who have both been utterly clueless every step of the way.

I also see how the mark-to-market notion inevitably leads to a market death-spiral

This "illiquid market" is a myth. There are no illiquid markets. Markets clear when buyers are able and willing to buy at prices the seller is willing to accept. Just as in the housing market, the owners of these MBS are asking too much. The assets are not "troubled" because the market is "illiquid". The market is unwilling because the assets are crap relative to the price being asked.

The various tranches of an RMBS are differentiated by the order in which cash from the repayment of the mortgages flows to the tranches. It's lowest tranche last. So a seemingly small default rate is massively magnified - especially when the deal was structured assuming virtually *no defaults* because "real estate always goes up" - to the extent that the lower tranches are completely worthless. (See here for way more information on RMBS.) And the banks in many cases kept the lowest tranches. They drank their own Koolade and now they should have some of the hangover.

See here and here for 2 examples of just how spectacularly crappy much of this stuff is.


We (taxpayers) need to protect aouselves. We should do the minimum needed and extract the maximum amount of pain from our "beneficiaries". We are under no obligation to do anything more than necessary for the Swindlers and Pigmen.

OBloodyHell said...

> The market is unwilling because the assets are crap relative to the price being asked.

If the asset in question would never have been offered for sale at the price in question, it doesn't matter.

Using M2M, you put a business in a position where they effectively MUST sell regardless of an intention to wait for the market to improve, because they have no explicit need to sell it.

THEN that sets a new, lower price for that item, and the NEXT business which owns that item gets ITS prices radically lowered.

The system is a blatant variation of the DEATH SPIRAL.

If I buy something which I realize, after the fact, is overpriced, then one option for me is to hold onto that thing until the overall market improves enough that it's no longer overpriced. This happens all the time. Errors are made, but the nature of the market can allow time to "fix" them. M2M is certainly of relevance to those investing in a company, but I can certainly look at those assets, realize the market is way down, and that that company could be in very very good shape when the markets move back up again. The current system clearly has the power to destroy a company by forcing them into bankruptcy based on a ruinous valuation of assets during a sharp downswing of the market. Which then forces the next business into an even MORE ruinous valuation of THEIR assets.

You would have to be blind not to see the obviousness of these ripples, as one after the other gets knocked over, throwing market prices further and further down, until ALL leverage is gone, and the companies' assets are 1-1 with its debts, because only "then" are you not nominally bankrupt.

If you are going to allow leveraging at all (and I have yet to hear anyone sane claim that leverage is itself inherently bad), then M2M has to have limits in its application. It may be listed as part of the company information, but there also needs to be a rational valuation of assets, too. People -- and companies -- don't usually sell in the middle of a very down market. The proper response is obviously to hunker down and squat on it.

bobn said...

If anybody actually believed that this crap was going to improve with time, they would buy it.

Most people - and everybody with any sense that I've seen - believe that the housing market has further to fall. That means these "assets" have further to fall. For most of the lower tranches, being held in Level 3 obscurity by the swindlers, the train has long since left the station. They are already at zero, based on defaults that have *already* occurred.

If somebody would advocate pricing these things based on the near certainty of another 15-20% decline in the housing market, I could be persuaded. But I'm not hearing anybody say that - except the "invisible hand" of the market which, suddenly, you no longer trust.

OBloodyHell said...

P.S., bob -- One of your links includes this money quote:

It gets even hinkier. Some 58% of the loans were no-documentation or low-documentation.

That is a clear and direct growth out of the CRA. Such stuff did not happen before the CRA. CRA-inspired loans are a huge chunk of the first domino.

OBloodyHell said...

Another thing -- I distinctly remember advertising for FM investments being sold on the fact that they were "government backed" -- that is, that the government guaranteed them.

I'm curious (long after the fact) if it was claiming this, since, theoretically, it appears to be fraudulent, though the Fed has indeed taken them up.

bobn said...

That is a clear and direct growth out of the CRA.

Absolutely wrong once again. These things were called "liar loans", and exploded during the bubble, because they were yet another way to lie up an acceptable DTI ratio.

Anybody who talks about CRA as having anything to do with the current crisis just betrays profound ignorance. And since you were following the blog where I produced the evidence that the timing, locations, numbers of loans made under CRA and types of institions controlled by CRA, were all *wrong* to have any sort opf meaningful contribution to this crisis, you are displaying willful ignorance of facts in favor of your bias.

OBloodyHell said...

> Absolutely wrong once again.

Yes, bob.

**58%*, bob.

Absolutely nothing to do with it!!

Pay no attention to that loan behind the curtain.

I said, "Pay *NO* attention, damn you!!!"


Also:
Ace makes his point.

OBloodyHell said...

> If anybody actually believed that this crap was going to improve with time, they would buy it.

bob, there is a HUGE difference between HAVING a bad investment, and OBTAINING a known bad investment.

To claim otherwise is clearly either brain damaged or blatantly disingenuous.

Which are you being? Stupid, or a liar?

As a matter of fact, unless I am recollecting wrongly, didn't you comment somewhere that YOU made a bad investment? That YOUR own house is overpriced?

Why aren't you dumping it, bob?

You don't voluntarily enter into a bad investment. But, once in one, it is not always the wrong choice to hunker down and bear the expense than it is to walk away, tossing out anything and everything you've put into it.

That doesn't mean that ALL these are such, but it doesn't change that fact.

Further, with the current prices in a death spiral, who knows where the bottom lies? Is house 'x', priced at 'y'. even close to how low it can go? The smart person isn't going to buy NOW even if all rational sense says it's already a good buy -- because if it keeps going down you could wind up stuck with a "bad" investment that all rational sense says is a good one, but markey hysteria drives into a falsely valued "bad" one.

Until the market has shown that the curve has bottomed out, most people in their right minds won't buy unless they are really, really liquid and don't need to buy on margin at all. And people with that kind of money, well, they aren't going to but until it bottoms, either... they didn't get that rich by being stuck on stupid.

OBloodyHell said...

Ace weighs in with another rational proposal

OBloodyHell said...

Also:

From the NY Times on September 30, 1999: "Fannie Mae Eases Credit To Aid Mortgage Lending"

(hat tip, Carpe Diem)

bobn said...

As a matter of fact, unless I am recollecting wrongly, didn't you comment somewhere that YOU made a bad investment? That YOUR own house is overpriced?

Why aren't you dumping it, bob?

You don't voluntarily enter into a bad investment.


I bought a house in November 2005, the very top of the market. I had never seen the graphs showing the incredible increase of price-to-income ratios. If I had, I'd probably still be renting. I am fully prepared for it to lose 30 - 40 % of the price I paid. I doubt I'll live long enough for it to come back up, even in nominal terms, to what I paid.

I actually started trying to clean it up and talking to a realtor to sell it - but August 2007 happened first.

Unlike Paulson and his Pigmen, I'm taking it responsibly. Unlike Paulson and his Pigmen, I'm not looking for taxpayers, most of whom make less than me, to bail me out.

I did it innocently. I did it honestly - full doc loans, the whole ball of wax.

I did "benefit" from the easier lending standards - in the any other environment I could probably not get the loans for the CLTV I got. In retrospect I'd have been better off, financially.

Unlike Paulson and his Pigmen, I'm not petioning for a bailout. I made a mistake and unlike Paulson and his Pigmen, I'll live with. But I'm damned if I'm going pay for the swindlers's criminal activities.

If the swindlers want to sit on their shit and wait for it to improve, more power to them. But that is no reason for us to do it for them.

The smart person isn't going to buy NOW even if all rational sense says it's already a good buy

Anybody who tells you the typical house is a good buy is out of their minds or just plain lying. In certain cases, REO sales may be approaching the correct price. In some parts of CA, REO sales outnumber all other sales for that reason.

I'm not going to respond to CRA issues anymore. They are totally off-topic. You're dogma makes you so clueless it is pathetic.

Carl said...

OBH:

You can't equate CRA with low documentation loans. One is a stupid law, the other a bad business practice that encourages fraud and high default rates. But Ace--and McCain--are spot-on.

bobn:

I have no idea how you conclude illiquidity is a myth. When a few failures implicate literally dozens of counter-parties, who suddenly themselves can't pay, the system breaks down rapidly, especially in view of mark-to-market. You've said a great deal about what you wouldn't do. Is this merely a populist nostrum, aided by the illusion that only rich fatcats would suffer in a depression?

bobn said...

Carl,

I believe that in a fair market where everybody has the information they need to evaluate what's being sold, things will find their correct value.

I think that a large percentage of the MBS being held by the IBs is in fact complete garbage. They have not done anything to dispel this notion - in fact everything they have done (abetted by Bernanke and especially Paulson) for the last year has been to delay price discovery. They are indicted by their own actions. (Google "level 3 Assets".)

This is not a panic inspired by false rumors. This is a market finally acting sensibly after years of complete foolishness. The few failures are a natural consequence.

You have linked to my post railing against the proposed bailout in its original form. Nothing in that piece'o'crap prevented the taxpayers from being skinned alive on this garbage. That POS also made the Sec'y of Treasury a law unto himself. There is nobody I would trust with that much unchecked power, another reason any conservative should oppose it. It is that form that I meant when I said that nobody could claim to be a conservative and fail to oppose that bill.

What would I do if I were in Congress? I would seek advice from people who saw this coming, like Nouriel Roubini and Robert Schiller. They knew what was happening while Bernanke and Paulson were still lying and/or stupid. I would use proven techniques like the HOLC that Roubini references.

I would try to bail this from the bottom up - refinancing those homeowners who are capable of paying a conventional fixed rate loan, but were pushed into a crappier loan instead (there are a lot of these, though it is not the whole problem by any means).

The current plan does not buy whole loans - only the crappy paper based on them - so mortgage workouts remain more difficult.

I would make sure that any company that received taxpayer money did so under circumstances that would prohibit windfalls and would inhibit the bad behavior (hence the cap on executive compensation). And I would search very hard for something that doesn't look like "throwing good money after bad" as this plan still does.

I do not labor under "the illusion that only rich fatcats would suffer in a depression". The lower classes suffer much more.

But I do labor under the idea that giving more money to the swindlers that caused this crisis cannot be the best solution.

And I also can see from graphs that for more than 30 years, home prices maintained fairly fixed ratios to both income and rental prices, and that these ratios are still high by that standard. That says that this crappy paper will only get crappier. Anything that assumes anything else, fantasies that Paulson and Bernanke both subscribe to (continuing to state that one of their goals is to stabilize house prices, an economic impossibility), is just wrong.

In short, "do something now!" just isn't good enough. It must be a right thing. Consider how far 700 Billion would go to cleaning up the mess afterward if we just wait and see? Using fractional reserve lending, that would be 7 Trillion of new credit. It would be a sin to waste this by giving it to swindlers.

bobn said...

They now owe the buyers of these Credit Default Swaps on junk mortgage debt trillions of dollars. It is this liability that is the bottomless pit of liability for the financial institutions of America.

If you want to quote Ben Stein (which is dangerous, actually) then look at what he's saying: there is no amount of money, by itself, that will fix this.

This started because people gave money to the swindlers for investment. The proposal is to give more to the swindlers.

First rule: When you are in a hole, stop digging.

Carl said...

bobn:

I see two separate issues. First is mortgage lending itself, which collapsed after a decade-old decision to expand home ownership beyond risk and collateral. Regardless of who blundered, home ownership is so central to our lifestyle and economy that some relief for homeowners seems warranted. Agree?

Second, the broader effects on other sectors. Were the collapse confined to the financial markets, I would be less inclined to intervene. But now the credit crisis threatens the ruin of un-related industries--one example is the dominance of AIG in insuring aircraft, and the potential consequences for air travel had AIG gone under. Forget AIG in particular--do I remember that you didn't object to that bail-out? The question is: if financial collapse would knock-out unrelated, huge sectors of the economy, would that justify some sort of bail-out?

bobn said...

Carl,

AIG happened so quick, I never had time to think about it. Also AIG is less 1/10 the size of what Paulson proposed, and is allegedly a loan to an outfit that has some non-bad assets. Time will tell.

The article you found on Fannie and Freddie is very interesting. However, it is my understanding that GSE share of the loan markets actually went down significantly during much of the hey-day of the really awful financing, increasing again only when they became the only game in town after the freeze-up Aug 2007. Still, what you found bears studying, far more that the "blame-the-CRA" lunacy others have raised. I agree with your "good riddance to Fannie and Freddie" BTW.

The question is: if financial collapse would knock-out unrelated, huge sectors of the economy, would that justify some sort of bail-out?

I am absolutely in favor of government taking considered, well though-out action to avoid a Depression.

The Paulson plan fails on several accounts. First, it's Paulson. He's been wrong and lying for more than a year about this thing. Ditto Bernanke - he was the idiot that suggested to Congress that they raise GSE conforming limits, which prolly helped the GSEs end up where they are.

On the other hand, Nouriel Roubini, has been right on target for 2 years. They used to call him Doctor Doom, before he was proven so absolutely correct. He has good credentials, beyond the fact that he saw this coming when very few others did. He has blasted the Paulson plan.


So far, there is no evidence of any plan derived from consultation with anybody outside the administration or Congress. New blood is called for.

Secondly, it is not well thought out. The original Paulson proposal had no thought behind it other than buying toxic sludge - which if bought at market value, accomplishes nothing. So it would have to be bought at a premium to market - and I happen to think the market is right about the value most of this stuff. I don't trust a stiff like Paulson to get it right.

The Democratic additions to the plan help. Maybe they help enough. I don't know. Until we get somebody who doesn't have a proven track record of being wrong all the time, we can't know.

Thirdly, even when Bush spoke in prime time last night (night before?), he said this was needed to avoid a recession. Until he says the D word, I'm not listening. He's still politicking. The Republicans seem think that the business cycle can be abolished. Wrong, it's here with a vengeance - because we pumped the up side up with funny money, the down side will hurt more.

Newt Gingrich was on one of the cable channels last night. He doesn't like the Paulson plan either. IIRC he favored loans to the Banks and a modification of the M2M rules to give them a chance to work this out.

With regard to market liquidity, I previously said:

This "illiquid market" is a myth. There are no illiquid markets. Markets clear when buyers are able and willing to buy at prices the seller is willing to accept. Just as in the housing market, the owners of these MBS are asking too much. The assets are not "troubled" because the market is "illiquid". The market is unwilling because the assets are crap relative to the price being asked.

and:

I bought a house in November 2005, the very top of the market. I had never seen the graphs showing the incredible increase of price-to-income ratios. If I had, I'd probably still be renting.

Obviously, my first statement on markets relies on everybody rationally using accurate information to evaluate decisions. I didn't on the upside, so I have to concede that some may not do so now on the down side. On the other hand, I don't buy houses for a living - if I ever buy another I expect I'll do a much better job.

This argues that "mark to market" could have problems, but what else is there?

Here is an interesting thought: The Level 3 assets of the swindlers are still on "mark to model" basis, generally considered to really mean "mark to fantasy". Shouldn't we find out what this stuff actually is before we go barreling around spending 1 Trillion of our children's and grandhildren's money?

OBloodyHell said...

> Anybody who tells you the typical house is a good buy is out of their minds or just plain lying.

bob, that statement makes no sense.

The context of the statement is utterly relevant to the whole matter.

I have a house that was selling at $350,000 two years ago. I'll sell it to you now for $500.

Is that a good deal, you think?

(It's hypothetical. I don't actually own).

Suppose that, ten years ago, it was selling for $150,000, and it's being offered for $125,000 right now. Good deal?

But right now, in the current market, one might have a problem selling it for $80,000, or even $60,000. Credit's tight, so many of the people who might jump on it can't. And those who can afford it would be looking to make more money than they can at that price, so they will hold off until the price drops sufficiently that they don't think it will drop further.


Some properties one can buy right now are probably worth 'x', or will be when prices stabilize. The price you can SELL them for, however, may be well below that reasonable price -- because not many people have the credit needed to buy.

If you're cash-rich, however, you're fine and dandy: I'll lay you huge odds there are some Rich Bastards out there buying things left and right at these firesale prices, or are waiting until the bottom has fully dropped out...

OBloodyHell said...

> Shouldn't we find out what this stuff actually is before we go barreling around spending 1 Trillion of our children's and grandhildren's money?

You mean less than a month's income for the USA? That money?

OBloodyHell said...

The only reason we haven't fixed the issue of the deficit is becausee we've got a bunch of idiots on both sides -- the Dems won't ack that FDR's blatantly failing Ponzi Scheme is in trouble, and the GOP doesn't have the balls required to stand up to them and ram it down their throats even when granted the power by the 2002 and 2004 elections.

The amount of money actually involved isn't as bad as that. It's still only a substantial fraction of a year's income for the USA. Easily fixable if someone actually set out to do it and took the responsibility to make sure the problem was fixed.

Anonymous said...

Hey, what about a McCain-Biden ticket running against an Obama-Palin ticket. I think that makes more sense.

OBloodyHell said...

> Hey, what about a McCain-Biden ticket running against an Obama-Palin ticket. I think that makes more sense.

No way. You would not want to be the one insuring Obama's life in that case.

The Right is the one with the guns, remember? And it has its own share of nutjobs, I will not deny. The result would be race riots, even though policy, not race, would be the killer cause.

Anonymous said...

Private parties would have bought most of AIG had they been given the opportunity.