A question for American friends - Politics

>>> May be you remember the S&L debacle of the 80’s. The result was federal government intervention and regulation i.e. “fair value” or “mark to market” evaluation of assets requirement.

The RTC was a pretty big success .... contrary to early estimates of a $500 billion - $1 trillion price tag, it "only" ended up costing taxpayers $124 billion.

>>> Until then, why cast aspersions on the "Krugman plan"

I'm not ... but I would say that I support the existing plan and do not favor nationalizing the banking system.

I am trying to shed light on the different ideas being put forth. I personally favor an asset purchase plan and wouldn't favor a nationalization - at this point. There may come a time when that is necessary in my opinion, but we aren't there yet - again, as I see it.

I happen to work for S&P - not in ratings - and used to be an investment banker ... so I have a bit of a front row seat.

>>> suggests that loans that aren't supposed to fail are failing and contributing to the snowball

To some extent, that's exactly what is happening. Housing prices have never fallen in concert across the country as they have been and projections about default rates in subprime pools far exceed even the most pessimistic estimates.

There are some criminals in all this and unwitting co-conspirators. I'm not saying there aren't bad guys.

The banks that will participate in this program are not the bad guys (for the most part) and this plan will likely force them to realize huge losses, but will allow them to clean house and prepare for private recaps.

Now there's an interesting thought! I wonder what the effect of the bailout will be on the oil and gas markets.

Cheers

James

>>> I've never heard defaulted mortgages referred to as AAA+ assets before. You must be a banker with something to sell.

I was a banker.

I'm sure the cartoon is clever and funny ... but this is how securitization works ...

http://www.occ.treas.gov/handbook/assetsec.pdf

In my opinion, subprime lending and securitization are important innovations that are here to stay.

"Junk" bonds - in part - caused the S&L crisis in the '80's ... they were abused at that time and issued recklessly, but that doesn't mean they don't have a place in the market. Today we call them "high yield" bonds ...

We'll find a new name for "subprime", too ... and the standards will tighten at the margin.

>>> Until you explain what caused the crisis to "hit" and what created the massive amount of bad mortgage debt you aren't going to get to the root cause or an effective solution.

I couldn't disagree more. When the house is on fire you put out the fire first and then worry about the cause and the changes to the fire code later. I'm happy to talk till the cows come home about how we got here, but we have an emergency that could cost 5 million Americans their jobs and permanently damage the life savings of many millions more. I'm ok ... and I'm gonna be fine, but I'm worried about the rank and file Americans that don't deserve this.

>>> I'm all for nationalizing certain banks, namely the one that creates and controls our money.

I'm not. I think that government has a regulatory role that it has abandoned - consciously - and that needs to change. I do not want the federal government at the center of the market for money and capital, but it should set and enforce rules and act as a lender/buyer of last resort.

I like the Federal Reserve System ... if the Fed had been able to more directly regulate Fannie, Freddie, Goldman, Lehman, AIG, etc .... things may never have gotten to this point.

Now there's an interesting thought! I wonder what the effect of the bailout will be on the oil and gas markets.

I see very little linkage. Oil prices - in my opinion - are pretty strictly determined by supply and demand.

Demand is a dispersed market force and is dropping as the world slips into a global slump, but the supply is pretty much controlled by the Saudis.

They can control the price and the pace at which they draw down their massive reserves ... they totally run the show.

Going totally off-topic. Jeremy I agree w/ you about Saudis in part. However the supply/demand based price for oil is about $100. When it went up to $150 a few months ago, that extra fifty bux was due to the futures traders IMO.

Cheers

James

Jeremy,

Thanks for your insight.

In the context of the original line of this thread; where did all this start? My understanding is that much of the deregulation, Fannie Mae oversight issues etc started in the 90's.

Or is this really all George Bush's fault, as is everything else bad in the world?

What I'm saying is that bad loans are not the entire story. I have a good idea what the other half of the story is, but we as ordinary citizens aren't going to be allowed to know for sure. Banks don't all collapse at once because people default on their mortgages; something is happening that is pushing these bad loans to the surface. Banks are required to maintain a fractional reserve and it's important to know what is going on there.

It is not the absolute amount of actual bad loans that creates the crisis. It is the increase in the rate of default. The bubble burst. The secondary market disappeared.

I lived through the Savings & Loan debacle. I knew somehow who went to jail because of it. Today's situation isn't quite the same, but watching the bubble burst was eerily similar. As the banks went to hell in Texas after the market crash credit dried up quickly. When Nations Bank (since purchased by Bank of America) bought the merged Texas Republic and Interfirst banks, I received a call from our loan officer. He was calling the line of credit. We had 5 days to pay back $300,000. Credit criteria had changed. Nothing else mattered. They didn't want our loan on their books, regardless of 5 years of solid loan performance. Now for the same reason, no bank wants interbank loans in their portfolio. That is why interbank lending rates have more than doubled. The crisis is not bad loans. The crisis is a restriction in credit.

The CEO of JP Morgan Chase saw the writing on the wall and chose to exit the market while others were still profiting. It's an interesting story.

Who's been profiting recently through oil futures? High crude oil prices are the result of cornering the market on futures.

No one is cornering the market. It's supply and demand and the expected future change in supply and demand. There are hedgers and speculators. There are those willing to pay someone to assume risk. There are those willing to assume risk for a fee and a high return. In all works out in the long run. Who's losing on oil futures lately?

Back to real estate....

The first question my Real Estate Finance Professor asked in class was, "Is real estate a good investment?"

The correct answer is, "It provides no greater return relative to risk than any other investment" (Note, the question uses "is" and not "was".

Substitute anything else for the term real estate. When returns start exceeding historical trends, beware!

Jeremy,

Thanks for your insight.

In the context of the original line of this thread; where did all this start? My understanding is that much of the deregulation, Fannie Mae oversight issues etc started in the 90's.

Or is this really all George Bush's fault, as is everything else bad in the world?

You might find this article interesting. Note the date.

http://www.wsws.org/articles/1999/nov1999/bank-n01.shtml

A lot of this has to do with the political process. If a President doesn't like a bill, there is only so much he can do to keep it from getting passed. One thing Bush and his people have done is add a new wrinkle -- if you don't like a bill, sign it and add a statement that says you don't agree with it and won't enforce it. But that is neither here nor there. Bottom line, a lot of momentum and a lot of money has gotten behind the deregulation push in many areas. Whether the proponents in Congress act out of their well-informed beliefs in the free market or something else is something each voter has to decide for him or herself. The whole system of lawmaking is now based on cobbling together a patchwork of rules, regulations and loopholes -- creativity is rewarded, at least in the sort term . . .

where did all this start?

This problem has lots of "parents" and lots of "starts" ...

In many ways, this started in 1977 when Fannie Mae and Freddie Mac were privatized under the Community Reinvestment Act.

My issue with how Fannie Mae and Freddie Mac have been run to date is the following ... compared to a regular private mortgage REIT and other banks, Fannie Mae and Fredie Mac were:

*** allowed to use more leverage

*** had less regulation

*** operated with the perception that their debts were "guaranteed" by the Federal Government giving them a borrowing advantage in debt markets

Then, a little less than 10 years ago they started buying "subprime" loans. That was a big change ... http://www.huduser.org/Publications/pdf/subprime.pdf This was a new market and new borrowers and the history was just not there to make good predictions about the future. Things worked great as prices and incomes rose ... but the first whiff of trouble in the housing market sent things tumbling. The financial system withstood the heat for much of 2006, but by the end of 2007 the whole financial system was teetering. It was fragile all winter and spring, but the summer got strangely calm. Financial markets were quiet and the real economy ground to a quiet halt. Then, when the Treasury and the Fed let Lehman fail (possible a HUGE mistake in hindsight), people across the world lost faith and confidence in the banks and started pulling cash out of banks and mone markets and started buying 3 month treasuries. That is HUGELY deflationary in a monetary sense. When money essentially flees the system and hits the mattresses (treasuries), the whole system starts to gunk up. Credit markets have essentially been frozen since 9/16-9/17.

The problem in my mind was that they (Fannie and Freddie and their most aggessive private comps) were destined to fail for a few reasons:

*** Having the implicit guarantee on their debt encouraged them to take extra risk which combined with lax regulation made them destined to fail. In my circles, for 10 years, we have talked of WHEN fannie mae and freddie mac would fail and not IF

*** The private competitors who competed with them took extra risks just to try and keep up

Another couple side narratives:

*** Democrats are to blame for pushing too hard for expanded home ownership to folks who should just still be renters

*** Republicans are to blame for pushing too hard to circumvent all the checks and balances put into play from 1933-1940

*** George Bush is to blame for cutting taxes during a war when the economy was relatively healthy. I don't totally disagree with the 2001 tax cuts as we needed a kick to get out of the recession, but they should have been turned back in 2003/4 when the economy picked up and we went to war in Iraq.

There's so much more ... I'll give more thoughts later ... gotta jump into a meeting ...

It is not the absolute amount of actual bad loans that creates the crisis. It is the increase in the rate of default. The bubble burst. The secondary market disappeared.

How, exactly, do you and Jeremy know this to be true? I know the "bubble burst" but I don't know exactly what burst, how it burst, and what precipitated the bursting. I believe decisions were made that exposed these crappy loans. I don't believe it's simply an upturn in the rate of loan defaults that has caused multiple gigantic banks to fail throughout the world. I believe that's a naive view. These banks are short on capital. Is it the failure of the loans that has caused the shortage of capital or is it a shortage of capital that has exposed the loans? I believe that those who are truly in a position to answer that aren't going to say.

No one is cornering the market. It's supply and demand and the expected future change in supply and demand. There are hedgers and speculators. There are those willing to pay someone to assume risk. There are those willing to assume risk for a fee and a high return. In all works out in the long run. Who's losing on oil futures lately?

I disagree and others do as well. As for who loses, for every winner there's a loser since nothing is produced in futures trading. If you think no one is making a profit from oil futures, I'd say really? Funny how Goldman Sachs advises on $150-200 a barrel oil prices after they apparently invest heavily in oil futures. Yes, Goldman Sachs.

Substitute anything else for the term real estate. When returns start exceeding historical trends, beware!

If only that advice were helpful in anything other than hindsight.

Investments of all kinds are subject to the arbitrariness of mass crowd ignorance and emotion. Logic works on markets over the long haul but it doesn't tell you what to do from day to day.

Finally, I'm not saying you, George, or Jeremy or anyone else here is any more or less smarter or more well informed than I am or anyone else, I'm saying that this is an extremely high stakes game being played by the wealthiest, most power-hungry, most ruthless, most dishonest and amoral people on the planet and whatever it is that any of us are being told, we should be suspicious. Odds are nearly 100% that we are being lied to.

I know this to be true because this is what I live and breathe all day long*** and have for many years. I have a masters in finance and used to work for JP Morgan and I now work for Standard & Poor's ... and I personally know scores of market participants and we talk about this stuff a lot.

I'll respond to the substance of your posts more thoughtfully when I get home later this evening.

*** (that is when I'm not either underwater or thinking about how to get underwater)

Jeremy: I for one appreciate your posts in what was (to begin with) such an outrageously-opened thread, I thought it was deliberate troll-bait.

I think the/some banks have capital but they don´t trust each other to lend it and they won´t until they know where the money went/is through the subprimes, securitization etc...

One question is what would you do if you were Bernanke? lower the money interest rate or higher it?

Here (in Spain) the economy minister just said that "the spaniards savings are perfectly save"...hold on to your chairs!!...

As 50% off topic I received this email about Palin:

http://www.mediacurves.com/Politics/J7011-...WildlifeRecord/

Just so you know - not saying you are wrong - but ...

 

That's what people said in 1929 in this country and in 1989 in Japan.

 

The treasury plan does not "bail out fat cats" ... it is an attempt to create a market. It does not recapitalize the system - it relies on the market to do that once the "spark" from the program lights the market pilot light.

 

More liberal plans - like those proposed by Paul Krugman - would have the US taxpayer actually recapitalize the system and under some proposals redistribute taxpayer wealth to home owners who are likely to default.

 

A Krugman-like plan would likely cost $1-3 trillion and have a significant portion of the banking system nationalized.

 

Paulson's plan doesn't pick winners and losers - it just creates a new market for illiquid asset-backed securities ... and it may not work as it assumes private capital steps in to re-equitize the banking system.

 

Here's the difference in a nutshell ... think of a balance sheet - it can stand in for the whole financial system or one particular institution ...

 

Prior to the crisis (say January 2007), the total assets were 100. 95 "good" assets and 5 "questionable" assets bought for 5. The Liabilities are 95 - 80 in deposits and 15 in debt ... leaving equity of 5.

 

The crisis hits, and the market collapses for these "questionable assets" ... most of which are AAA+ and never supposed to default ... but the perfect storm hits and housing craters and they start losing value. Merrill sold $30 billion worth at 20 cents on the dollar.

 

So ... no we find ourselves with these questionable assets written down to 1 on the balance sheet. That directly hits equity ... which falls from 5 to 1. Now the bank/system is under severe stress and highly over-leveraged. It needs to sell those assets AND raise new equity.

 

Under the Paulson plan, we buy those assets from the company for 1-2 ... leaving it STILL undercapitalized and the hope is that private capital steps in and takes the bait.

 

Under a Krugman-like plan, we buy those assets from the company for 4-5 and get back warrants/equity/ownership in return ... and the bank is recapitalized, except the Federal Government now owns 80% of the company.

 

The Krugman plan would be WAY more expensive and would truly be socialism and represent the nationalization of the banking system. We have already effectively nationalized the biggest insurer (AIG) and 50-75% of the mortgage market (Fannie and Freddie). Do we really want to nationalize the banks, too?

 

That's the choice as I see it.

Wow..my text disappeared. Here are some observations/questions:

1. what will this do to the value of the dollar...if it goes South because of the bailout it might defeat its intended purpose.

2. Will a correction be that bad? You still have people with money who are investing capital as we speak. I sort of feel pissed off at the moment. My house has lived below its capability for years. I've watched people move into houses they couldn't afford and now I'm helping to bail them out. Nice. We used to call those Mominthem loans. Because 3 years after getting one you were back living with Mom and Them.

3. Bad loans are the problem. You can say it runs deeper but this started in the 1990s with lowering interest rates to a ridiculous levels. Pretty soon ordinary folks were removing "perceived" equity from their homes to purchase luxury items. This pumped up the economy to artificial levels. Pretty soon you had banks loaning people 65% of their gross income minus outlays. That is ridiculous. Now its all come to a head and instead of letting everyone involved fall down, people who made the right decision get to bail them out. I feel like a parent with a ton of irresponsible kids.

4. Whose to blame...and in order.

1. Clinton/Greenspan - Depending upon who you say called the shots. Brilliant move on Clinton's part to figure this out and infuse the economy.

2. Bush/Greenspan - for allowing this farce to continue. BTW, these open market operations were much more responsible for this than tax breaks. Tax breaks came in the for of money directly infused back into the economy...not credit.

3. Any and all who lobbied to have banks loan money to individuals who didn't qualify. You can put Obama's name at the top fo this list. He actually was the lawyer involved in suing Citibank for not loaning money to the underpriviledged. He also worked with groups like ACORN through his community organizing to get bad loans to his neighborhoods in Chicago. Barney Frank who chairs the Senate Banking Comittee. He squashed any debate about Freddy and Fannie's up and coming insolvency and is on record doing so.

4. John McCain - Who actually said something about all this in 2004 but did nothing.

5. Congress from 1992 to present day. We ought to fire them all and start over.

BTW...It is my understanding that the banks are only short on capital because of free market rules imposed on banks...ie the amount of cash per assets required to have on hand. So if I default on my land deal..the bank gets the land but then has to have X amount of liquid capital on hand because of that asset...someone correct me if I'm oversimplifying this.

What they should do?

1. Let it crash.

2. Deal with the fallout.

3. Rebuild with a lesson-learned approach.

Keeping this farce going will only put this burden on our posterity.

I think the/some banks have capital but they don´t trust each other to lend it and they won´t until they know where the money went/is through the subprimes, securitization etc...

One question is what would you do if you were Bernanke? lower the money interest rate or higher it?

 

Here (in Spain) the economy minister just said that "the spaniards savings are perfectly save"...hold on to your chairs!!...

 

 

As 50% off topic I received this email about Palin:

 

http://www.mediacurves.com/Politics/J7011-...WildlifeRecord/

I've learned more about Sarah Palin in 1 month than I have Barak Obama in 18. That is troublesome.

>>> 1. what will this do to the value of the dollar...if it goes South because of the bailout it might defeat its intended purpose.

Save it from further decay. A strong economy + sound fiscal and monetary policy = strong dollar

Between the tax cuts, the unfunded prescription plan and two wars we have done far more damage to the value of the dollar in the Bush administration.

If Bush's fiscal policy had been more prudent - i.e. raise taxes back to Clinton levels when we came out of the recession recession and went to war in Iraq - we would have a lot more flexibility on the fiscal side to provide stimulus. The failure to "reload the fiscal canon" when times were good was a monumental mistake in my opinion.

No rescue plan of some sort = REALLY bad recession instead of bad recession. I think without massive government intervention SOON we are looking at 5 million jobs lost within the year, chaos in financial markets, huge equity market losses (20-30% more downside easy) with huge swings/volatility on the way down, declining federal tax revenues, increased federal debt and deficits, massive cuts to state programs and severe slowdowns in all economic activity. This is no joke.

>>> 2. Will a correction be that bad? You still have people with money who are investing capital as we speak. I sort of feel pissed off at the moment. My house has lived below its capability for years. I've watched people move into houses they couldn't afford and now I'm helping to bail them out. Nice. We used to call those Mominthem loans. Because 3 years after getting one you were back living with Mom and Them.

See above. There were "smart" rich folks who bought stocks in 1929 after the crash and then lost 40% more. Same in Japan ... the Japanese stock market is still 30%+ below where it was at its peak in 1989.

This starts feeding on itself. In most markets, when asset prices fall, that stimulates demand. In the markets for many kinds of financial assets, a declining price on a sustained basis decreases demand which makes them more illiquid and therefore less valuable and therefore more illiquid ... sometimes, this stays contained to specific markets. That was the case for about 18 months. Houses and mortgage-related securities were falling in value, but everything else seemed ok. Now we are entering new territory ... the values of many classes of financial and a much broader class of real estates assets is dropping and this is causing a massive crdit crunch as people and banks start to hoard cash expecting a recession. In this case, the cash hoarding is getting so bad that it is becoming not just a self-fulfilling prophecy, but a devastating liquidity crunch on an already hobbled system.

>>> 3. Bad loans are the problem. You can say it runs deeper but this started in the 1990s with lowering interest rates to a ridiculous levels. Pretty soon ordinary folks were removing "perceived" equity from their homes to purchase luxury items. This pumped up the economy to artificial levels. Pretty soon you had banks loaning people 65% of their gross income minus outlays. That is ridiculous. Now its all come to a head and instead of letting everyone involved fall down, people who made the right decision get to bail them out. I feel like a parent with a ton of irresponsible kids.

The bad loans are the problem ... and a BIG one. They have punched a HUGE hole in the overall balance sheet of the world's financial system. Even in normal times the system is pretty fragile. At the core of the system are highly leveraged intermediaries. This leveraged core was stressed due to $500 billion in realized losses and many more hundreds of billions in unrecognized and ancillary losses ... and we now have a liquidity crisis - essentially a run on the global banking system kicked off by Lehman and AIG's failures. This same kind of run and deflationary forces caused the Great Depression and the "Lost Decade" in Japan.

We don't want to go there. That would really suck.

>>> 4. Whose to blame

Lots of people ... Lenders. Borrowers. Investment Bankers. Ratings Agencies. Congress.

Well it looks like a country where allot of people lived way beyond their means.

You cannot blame the lenders.

If want to buy something but have to get a loan but cannot afford the repayments, don't get one or if you did you have to sell to give it back....Pretty simple really.

Why should others have to bail you out?

Just like the reason why people get fat.... because of what they eat and drink and lack of exercise...not the junk food or beer companies that sold them the stuff.

Well it looks like a country where allot of people lived way beyond their means.

A small minority, but far too many.

You cannot blame the lenders.

Well, "lending" is complicated in today's market. There are originators, syndicators, packagers and ultimately securitized asset owners.

There were crooked originators and and crooked packagers and syndicators ... but those left holding the bag are banks small and large that did not have anything to do with the poor lending.

If want to buy something but have to get a loan but cannot afford the repayments, don't get one

Yup

or if you did you have to sell to give it back....Pretty simple really.

Well, the selling back part is rough when the loan is for more than you can sell the house for ... that causes some problems that cascade across the whole system

Why should others have to bail you out?

Ultimately, we are bailing ourselves out. The "lenders" aren't being "bailed out" - they are being offered a fair price for assets they need to sell but can't.

Here's the analogy. The banking system in the US is like a guy that commutes to work every day. He drives. A couple years ago, he spent a big sum of money on a BMW - 50,000. This BMW was supposed to be brand new, with great mileage, totally reliable and a guaranteed no-cost service plan for 5 years. Sounds good, right? Except the fine print said all that was subject to the credit risk of BMW - but heck, they'd been around for 100 years, so no biggie, right?

Two year in, the car breaks down. Turns out, lots of them broke down. Especially the ones bought in the last two years. So you take it to BMW, but they say they are going out of business, sorry. You can't find anyone to fix your car. You list it for sale for 10,000, but nobody calls. There is a new car you could buy for 15,000 and you really need to, but you need to sell the BMW first. Everyone agrees it is worth 10,000, but nobody bites.

The boss calls and says show up tomorrow or your pay will be docked.

The government steps in and offers 10,000 for the car. With the 10,000 and a new loan of 5,000 you buy the new car for 15,000 and get on with your life.

You used to drive a 50,000 BMW and now you drive a 15,000 used Kia ... but at least you didn't get fired.

No rescue plan of some sort = REALLY bad recession instead of bad recession. I think without massive government intervention SOON we are looking at 5 million jobs lost within the year, chaos in financial markets, huge equity market losses (20-30% more downside easy) with huge swings/volatility on the way down, declining federal tax revenues, increased federal debt and deficits, massive cuts to state programs and severe slowdowns in all economic activity. This is no joke.

Jeremy,

Tough times build tough people. If we keep handing the government a blank check everytime there's a self inflicted crisis, what lesson is ever learned. Maybe that's the anger speaking but I've been on this treadmill that keeps demanding more every year for 10 years in corporate America. Mentally, I'm more prepared for some really tough times than to ratchett up the pace again next year just to make ends meet.

On taxes we disagree, but not on the lack of action. Tax relief is a stimulus to the economy, not a burden. Lower taxes promote real economic growth...not just the pseudo growth fueled by perceived equity in a home. What should have happened under Bush is the interest rate should have been raised back into the 9-10 percent range once the economy stablized in 2004.

Two year in, the car breaks down. Turns out, lots of them broke down. Especially the ones bought in the last two years. So you take it to BMW, but they say they are going out of business, sorry. You can't find anyone to fix your car. You list it for sale for 10,000, but nobody calls. There is a new car you could buy for 15,000 and you really need to, but you need to sell the BMW first. Everyone agrees it is worth 10,000, but nobody bites.

 

The boss calls and says show up tomorrow or your pay will be docked.

 

The government steps in and offers 10,000 for the car. With the 10,000 and a new loan of 5,000 you buy the new car for 15,000 and get on with your life.

 

You used to drive a 50,000 BMW and now you drive a 15,000 used Kia ... but at least you didn't get fired.

Take the bus to work...saves money, gas and the environment. Bummer you gotta get up a little earlier.

Unfortunately the government isn't offering me anything. We have always been very responsible by making purchases which were reasonable given our income. So now I get to see someone who was irresponsible get to keep their mansion down the road because my tax dollars are helping to bail them out. Sorry, I'm still not on board with that idea.