Hank Paulson's Countdown to Armageddon

How the Chicken Little treasurer is nationalizing the U.S. economy

Tim Cavanaugh | September 25, 2008

"It pains me tremendously to have the American taxpayer be put in this position, but it's better than the alternative," Treasury Secretary Henry Paulson croaked Sunday, in the middle of a failed goodwill tour for his proposed $700 billion bailout package.

While Paulson's rhetoric of disaster has become more strident lately, he's been warning about the grim alternative to various government bailouts for nearly a year now. Lately, the pace has become tiresomely frenetic. Every Sunday, Dr. Paulson performs a few more unnecessary surgeries, warning that more procedures are needed. Every Monday the patient fails to die, and the doctor orders a new round of treatments, with a grim admonition that this round of incisions and laughing gas is preferable to the alternative.

But when Plan A is the de facto nationalization of the U.S. economy, it's fair to ask, just how bad would these alternatives be? Where are the soaring crime rates that are supposed to accompany an economic shock of the sort Paulson believes he is cushioning? Why are real estate values gradually coasting from exospheric back to merely stratospheric levels, when Paulson's nightmare vision should have them plummeting to earth? How are mortgage rates still hovering around 6 percent and business being conducted as usual, while unemployment spikes have been contained, as we would expect, to those areas of the country where the preceding boom was the strongest? Where are all these hypothetical retirees with depleted 401(k)s (and what could they have been doing so wrong all this time, given that even factoring in recent market turmoil, the Dow has nearly quadrupled since the beginning of the 1990s)?

Bluntly, why should any of us out here on what my friends in the mainstream media call "Main Street" give a rat's ass about the declines of Bear Stearns, Lehman Brothers, Morgan Stanley, Merrill Lynch, and Paulson's old kingdom, Goldman Sachs?

Just what is the catastrophe my great grandchildren will be paying $700 billion to avert?

It seems like a simple enough question. In a moment of unintended wit, Wall Street Journal spokesman Robert H. Christie recently told The New York Times, "‘Crash,' ‘panic,' ‘pandemonium,' ‘apocalypse,' those are the words we're staying away from."

So what words should we be using?

I've been trying to get this answer since late last year, when Paulson first began to panic. The closest I came was during a group question and answer session with the Treasurer in December. Some excerpts:

Jon Healey: Many of the people we speak with don't like this because they see the results of the government's work being sustaining housing values that should have been allowed to come down.

Henry Paulson: Again, I've given my answer to that. I think what we're doing is avoiding a market failure that would have forced housing values down in a way that was not in the investors' interest, and in a way that the market wasn't intended to work.

Tim Cavanaugh: How can you force values down? Why aren't values finding their natural level?

Henry Paulson: The way values would go down is, as I've said, you'd have market failure...

Henry Paulson: ...What this will do will make a difference in that we won't have housing prices driven down in ways that distort the market because the industry wasn't able to come up with procedures to deal with an unprecedented situation.

Tim Cavanaugh: Is it distortion in the market when the market was already distorted up to a degree that maybe wasn't unprecedented, but was certainly unusual in American history?

Henry Paulson: So you'd like to see it distorted down too...

Peter Hong: Could you be a little clearer on what you mean by "market failure"?

Henry Paulson: As I've said, chaos...when I say market failure I say that we have an unprecedented situation, and the private sector has to find a way to deal with that. Otherwise you're going to see them drowning in people who can't make resets, whom they would ordinarily want to keep in a home.

Peter Hong: You used the phrase "distort down." Is it distortion or is it a correction?

Henry Paulson: What I want is markets to work. And I would define a market failure as the system not being able to cope with the wave, so that foreclosures took place that would not have taken place if there were smaller volume...

Peter Hong: But are house prices too high?

Henry Paulson: I'm not going to—foreclosures are bad for neighborhoods. You have needless foreclosures that are driving down prices, created by a situation that is unprecedented and that would under normal circumstances not have taken place.

Even through the combative tone, the finely calibrated inanity of Paulson's comments remains a thing of beauty. It's a healthy market when prices go up, regardless of the potential value of the asset. It's a market failure when prices go down, even though they're going down specifically because we now know the asset was overvalued. (For the record, there's no mystery about the "normal circumstances" under which a foreclosure doesn't take place: If you pay your mortgage you don't get foreclosed; lenders who don't make an effort to ensure that you're a good credit risk run into problems. It's exactly that complicated.)

The secretary of the treasury isn't the only one trafficking in gnostic references to the pandemeltdownonalypse. In early 2007, as substantial numbers of subprime mortgage borrowers began failing to pay their obligations, a fanciful new language of contagion and epidemic sprouted up in the media. The crisis, so the narrative went, would spread to all levels of the economy unless it were quarantined through various governmental exertions.

This is a neat trick. Rather than the downturn's being the result of a series of bad decisions made by people who are now being punished, it's a force that threatens to engulf us all. We the American people may say the hell with mortgage deadbeats and the chumps who bought their loans, but that just shows why we need technocrats to show us the approaching storm. Hell, even Goldman Sachs is going down over this!

The storm, if it were allowed to arrive, would almost certainly be less dire than what Paulson and Federal Reserve Chairman Ben Bernanke have promised. Interest rates would increase (or no, wait, they'd soar!); business would slow down (I mean, it would crash); house prices would decrease (or maybe they'd careen); it would become harder to get a loan; the dollar would strengthen (something Bernanke, steeped in Depression studies, would not want). Then some time would pass and the economy would start to grow again. And credit would be provided by a newer and presumably wiser roster of banks. The mortgage downturn, like so many downturns, brings us back to the Foundation question: Isn't it better to let the empire collapse as quickly as possible, then move on to the next empire? Would anybody really miss Wall Street?

Christopher Thornberg, a principle economist at Beacon Economics and an opponent of the bailout, tries to understand the motivation for the rescue. "There are two kinds of financial stress," he says. "One is simple bad investments. The other is a panic and a run on the banks. But I don't understand why they think that's going to happen. And I don't see why the taxpayer has to be on the hook for a completely out of control Wall Street... The picture Bernanke's going to paint is: bank run after bank run. But there's no reason for banks to fail as long as the Fed is there as a backstop. That's the point of the Fed: to prevent bank failure by being a lender of last resort."

It's never been more clear what an orphan the free market argument is. The Republicans are looking to establish a form of crony socialism and the best the Democrats can come up with is to demand that the government establish CEO salary caps. And since everybody else sees an epidemic spreading, I'll see one too: Why should we stop at financial services? After this bailout, what will be the argument against having the government rescue health care, water and electric, airlines, print media, and other troubled industries?

The bright spot in the bailout argument is that the public—as it does with so much of what the government provides these days—seems to be spurning the offer. But if one pattern has become well established in 2008 economics, it's that nobody who matters cares what the public wants. In an apparently ironic statement on the bailout package, Matt Yglesias predicted that "everyone's going to have to give serious consideration to becoming a pretty hard-core libertarian." It may be more accurate to say we should all end up becoming financial Muslims, because if this is where lending at interest gets us, we'd be better off with no economy at all.

Actually, forget that last statement: I don't want to give Hank Paulson any more ideas.

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|9.25.08 @ 12:14PM|#

http://online.wsj.com/article/SB122230704116773989.html

An interesting counter point to Cavenaugh. When this first came out I wondered why the Democrats in Congress were so keen on it. Why not let the whole thing go down the tubes and get a new "new deal"? That answer I think is that they are convinced that the government will make money on this deal. There is nothing any congressman R or D loves more than money to spend on pet projects.

Most mortgages, even the bad risk ones are being paid. People like George Soros and Warren Buffett have made billions buying bad paper at dead discounts and waiting out the market. Why can't the fed do the same?

|9.25.08 @ 12:26PM|#

@John

They might make money on this venture, but it will still be disastrous in the long run. The market distortions will increase, and Wall Street recklessness will be encouraged.

Plus, everyone knows that when the government gets an infusion of cash, they never use it to reduce debt. They will increase the size of the budget by the size of their profit, and then when the profits dry up, we will be stuck with a fantastically large budget deficit. Shocker.

|9.25.08 @ 12:27PM|#

My take also. The politicians seem to be primarily worried about a correction to the housing market. The free market is cool as long as everything goes up, up, and away, but heaven forbid it works in the the other direction. And someone needs to get elected soon. I thought Bush's distillation of the situation in his speech last night was quite good and accurate (I didn't hear the bailout plan), and he did place some blame on people who took loans they couldn't afford. Meanwhile Pelosi on NPR yesterday afternoon said some of the most inaccurate crap I've heard about it (not surprising). At least most of congress is intent on slowing the pace of this decision, but I'm not holding out for a good plan.

|9.25.08 @ 12:29PM|#

Excellent points across the board. What Paulson is claiming is that a market failure exists because the market value of houses is not high enough to support bogus mortgage securities. Uh, I think what he really is saying is that he does not LIKE what the market is telling us about housing values.

There is no question that the housing market was entirely out-of-kilter. To claim that a strong economy depends upon overpriced housing is to claim that higher prices are what bring prosperity.

|9.25.08 @ 12:30PM|#

We the American people may say the hell with mortgage deadbeats and the chumps who bought their loans, but that just shows why we need technocrats to show us the approaching storm. Hell, even Goldman Sachs is going down over this!

Boy, that sounds so familiar.

J sub D | September 6, 2007, 10:53am | #

Who am I supposed to bail out? People who took mortages out on houses they couldn't afford, or those who gave them the mortages? To both groups my response is "You made your bed, now lie in it."

As you can see, my anger know has more than a years worth of steam driving it. To my three congresscritters (one rep and two senators) -Vote for a bailout that is greater than $1.98 and I will never vote for you again.

Mike Laursen|9.25.08 @ 12:39PM|#

I haven't seen any explanation of how Paulson came up with the $700 billion figure. If we're on the verge of widespread bank failures, how do we know $700 billion is enough to stop it from happening.

I can being to see that if you were from Paulson's world, and had never been outside that isolated bubble, that you would perceive this as being the end of the world.

|9.25.08 @ 12:40PM|#

Nine tenths of cries of "market failure" are really "the market failed to do what I want." While it might be nice for Sec. Paulson if the market were his personal wish-granting machine, that is not really a failure, or at least not one that I care about.

|9.25.08 @ 12:44PM|#

|9.25.08 @ 12:45PM|#

I haven't seen any explanation of how Paulson came up with the $700 billion figure.

Yesterday I heard someone from the CBO on the radio say, "Well, based on our analysis, we're fairly certain they won't lose a hundred cents on the dollar." Clearly they have been doing some serious calculations on Capitol Hill.

|9.25.08 @ 12:46PM|#

Of course, I don't think that the government should be giving hand-outs anyway, but they certainly seem keen on it.

Mike Laursen|9.25.08 @ 12:47PM|#

Who am I supposed to bail out? People who took mortages out on houses they couldn't afford, or those who gave them the mortages?

The problem is there's no motivation for many of them to keep trying to pay off their mortgages. They're better off walking away.

For those who are still trying to make their mortgage payments, lenders work out compromise payment plans all the time. There's no need for any bailout or nationalization to make that happen.

And it's still not clear why the failing financial companies can't undergo normal bankruptcy proceedings, selling their assets off on the market at whatever rate they can get.

Mike Laursen|9.25.08 @ 12:48PM|#

"Well, based on our analysis, we're fairly certain they won't lose a hundred cents on the dollar."

Wow, that makes me feel better.

|9.25.08 @ 12:50PM|#

From the GOP fellating guys at Redstate.com

Posted by: Erick Erickson

Thursday, September 25, 2008 at 09:02AM

It is becoming abundantly clear that if the Paulson Plan does not pass by market close on Friday, the world will be a very different and more unstable place come sunrise Monday morning.

Why?

The credit market is crashing. There is not enough credit in the market right now. Come Monday, if Wall Street does not have the assurance of a workable plan, the nightmare scenario that there may not be enough credit to get paychecks cashed next week may very well come true.

As I angrily demanded on a different thread earlier today, Erick Erickson, put up or shut the fuck up!

Oh yeah, the Redstate.com website desription -

RedState: Conservative News and Community

Kiss my ass.

JMR|9.25.08 @ 12:52PM|#

"I haven't seen any explanation of how Paulson came up with the $700 billion figure."

Only Paulson's proctologist knows for sure where he came up with the $700 Billion figure.

|9.25.08 @ 1:01PM|#

I haven't seen any explanation of how Paulson came up with the $700 billion figure

He arrived at it after calculating all the bonuses that the managers at the banks are going to receive...for failing.

|9.25.08 @ 1:03PM|#

What are banks going to do with all of this extra money, anyway? They bought a house, the house foreclosed and dropped in value, they couldn't sell the house anyway so all they have is a crappy asset. So now that they haven't made any money, they get paid money by the government and get to keep their assets?

As I understand it, the money is to buy the bad assets from the banks, freeing up and stabilizing their balance sheets. The government will then resell the assets once their value is discovered/stabilized, and could make money on them. The big arguments right now are (a) how to set the government's price for the assets (b) how to cover the government's losses (if any) (this is where the equity stake in the banks comes in).

And, of course, like any big pile of money, this is seen as a Christmas tree for legislators to hang their pet projects off of.

Flyover Country|9.25.08 @ 1:05PM|#

It looks like we're all going to own a bunch of homes soon:

http://www.marketwatch.com/news/story/massive-rescue-plan-moving-closer/story.aspx?guid={9995E1C7-392C-4CE9-B41F-401C6FFCAA15}&dist=hplatest

|9.25.08 @ 1:06PM|#

J Sub D:
The credit market is crashing. There is not enough credit in the market right now. Come Monday, if Wall Street does not have the assurance of a workable plan, the nightmare scenario that there may not be enough credit to get paychecks cashed next week may very well come true.

"As I angrily demanded on a different thread earlier today, Erick Erickson, put up or shut the fuck up!"

Word. I also call bullshit: "Although certain financial institutions are undeniably in deep trouble-difficulties of their own making, we might add-the problems in particular financial circles should be kept in perspective. Note especially that credit markets in general have NOT ceased to operate. Moreover, lenders are extending credit in historically great amounts."

toshiro_mifune|9.25.08 @ 1:09PM|#

the money is to buy the bad assets from the banks, freeing up and stabilizing their balance sheets. The government will then resell the assets once their value is discovered/stabilized, and could make money on them.

But they'd be reselling the assets to the same people they bought them from, who'll never pay more than what they sold at. Unless we're expecting some third party to come in and pay for everything.

This plan also does nothing to alleviate the credit engines (securitization) which are now gone or address the earnings various companies booked which are largely illusory.

|9.25.08 @ 1:14PM|#

R C Dean | September 25, 2008, 1:03pm | #

What are banks going to do with all of this extra money, anyway? They bought a house, the house foreclosed and dropped in value, they couldn't sell the house anyway so all they have is a crappy asset. So now that they haven't made any money, they get paid money by the government and get to keep their assets?

As I understand it, the money is to buy the bad assets from the banks, freeing up and stabilizing their balance sheets. The government will then resell the assets once their value is discovered/stabilized, and could make money on them. The big arguments right now are (a) how to set the government's price for the assets (b) how to cover the government's losses (if any) (this is where the equity stake in the banks comes in).

And, of course, like any big pile of money, this is seen as a Christmas tree for legislators to hang their pet projects off of.

For me, all of this is as simple as this: We've pretty much proven that we can't produce our way out of debt, so the only way to get this country out is to start cutting our costs however we can. It may hurt, but with all of our current liabilities, I don't understand how they think they can just keep giving money away. And I still don't think that prices are going to go up for those assets until the market is good and ready. I hope that market forces remain strong and concentrated against the governments attempts to dilute them. And this is coming from somebody who bought their house early this year and can only lose from prices going down.

toshiro_mifune|9.25.08 @ 1:19PM|#

atabrat & J sub D;
The credit market is crashing as measured in Treasury EuroDollar spreads. This morning they briefly touched %3.27.
The TED spread is the difference beween 3mth US treasuries and 3mth Euro. It is used as an indicator of willingness to lend, the high the spread the less lending is being done. It is also used as a benchmark rate for a lot of commercial paper.
Usually the spread is at %.5.

|9.25.08 @ 1:20PM|#

Register your opinion! It is easy to do, but it is important to to it today:

You can contact Congress to register your oppositions to these bailouts -- bailouts of the rich at the expense of the poor -- by visiting your congressional delegations' home pages on the Internet, or by dialing the U.S. Capitol switchboard.

To locate and e-mail your Representative, simply enter your ZIP code in the "Find Your Representative" form at the top of the House of Representative's website at http://www.house.gov or dial them at (202) 224-3121.

To contact your Senators, simply select your state from the "Find Your Senators" menu at the top of the Senate's website at http://www.senate.gov or dial them at (202) 224-3121.

Letters do not need to be long, or even well written. A simple statement of objection is sufficient.*

Please make your opposition well known ...and then forward these instructions to your friends!

* Example: "Sir (or Madam): As a member of your constituency, I wish for you to know that I object to the bailout."

rhywun|9.25.08 @ 1:21PM|#

It looks like we're all going to own a bunch of homes soon:

Looks like you're right. The Dow's up almost 300 so far--the bankers are happy about something.

|9.25.08 @ 1:21PM|#

Sometimes dominoes are arranged to fall one after another. Because of fractional reserve banking (which I'm not opposed to in principle), a panic to retrieve one's deposits can cause a bank to fail if it can't easily liquidate its assets. So, if people start fearing a collapse and pull money out of money markets or their banks, then the mm or banks have to raise cash quickly. So bank X calls up your employer and says, "We need to call in that $1mm you borrowed against the line of credit you have with us. It is callable whenever we wish." And employer says, "Hey I got to pay for materials for a big contract we just got, and payroll is due Friday, plus the school district real estate tax is due. How the heck am I going to pay you right now?"
"Cancel the order, lay off some employees and delay paying the school district. But we need you to pay off your line of credit immediately." So unless your employer is essentially debt-free, don't go walking around acting like a potential financial collapse is something to be pursued. Remember too, the likely outcome isn't going to be an installation of Ron Paul solutions, but will be more like what happened when post WWI Germany inflated through the roof: the public is going to demand totalitarian controls. Is that what we really want?

Invisible Finger|9.25.08 @ 1:27PM|#

Good article, Tim.

So what words should we be using?

ASSET FREEZE.

That is really the problem. Washington Mutual is insolvent. Probably others. Washington Mutual has more in "insured" deposits than the FDIC has to back them up. If WaMu is taken over by the FDIC, they'd have a massive run on the bank, and the FDIC would have to freeze assets until they can get the money from the Treasury and Fed to pay the insured deposits. The FDIC is having difficulty getting anyone to take part of IndyMac's business, a WaMu failure would flood the market with additional bad bank assets and the FDIC would get even fewer takers for the sum total of IndyMac + WaMu "assets" thus pushing the price down even more.

The Fed and Treasury are trying to be proactive to avoid asset freezes. Even prudent borrowers or people who own their homes free and clear are using an insolvent bank for their demand deposits (as well as time deposits) AND an asset freeze occurs on those funds while the FDIC sorts through the insurance claims, even the prudent consumer is going to be stuck with claims from creditors like utility companies and landlords for unpaid bills. (If the checks won't clear the bank, you haven't paid yet.) When IndyMac was taken over by the FDIC, IndyMac customers taking their FDIC checks to deposit at WaMu branches were told that the funds would be frozen for EIGHT WEEKS.

Paul|9.25.08 @ 1:29PM|#

I'm working on designing two political signs/posters. Here are the slogans:

NO Intervnetion in Economy!

US Out of Economy NOW!

|9.25.08 @ 1:33PM|#

Wow, credit will get tight. Maybe money won't be lent to fucktards who can't pay it back. Maybe buying a house will get even cheaper. That would be baaad. As I have already demanded, where are your writings from before 2004 about all of this?

So why should I listen to your (or others) "solutions"?

I've never said that this is going to be painless. I've posited that an irresponsible intervention will do more harm than good. I want your (and others) demonstrated prescience about medium term economic trends.

I'm waiting.

Paul|9.25.08 @ 1:36PM|#

Henry Paulson: Again, I've given my answer to that. I think what we're doing is avoiding a market failure that would have forced housing values down in a way that was not in the investors' interest, and in a way that the market wasn't intended to work.

must.....resist....smashing.....computer.....monitor.....

toshiro_mifune|9.25.08 @ 1:36PM|#

J sub D;

I wasn't proposing a bailout. Let them fail. The current bailout will do nothing more than buy some time. They won't be able to re-inflate.
Just because they want your cash though doesn't mean they a wrong.

|9.25.08 @ 1:41PM|#

"I haven't seen any explanation of how Paulson came up with the $700 billion figure. If we're on the verge of widespread bank failures, how do we know $700 billion is enough to stop it from happening."

The 700 billion figure is meaningless. No one knows what these assets are worth. That is the problem. Moreover, people are not willing to buy them because they know some of them, which ones no one is sure, are worthless. Some of them, however are worth quite a lot. Not everyone has defaulted on their mortgage, even the really risky ones.

In a normal market, someone would buy these assets as so many cents on the dollar and make a killing. This is not a normal market however. The instruments themselves have gotten so complex it will take months to figure out which ones are good and which ones are bad. Moreover, the problem is so big that there are enough speculators to buy up the bad paper.

Here is the situation you have. You have banks that have the MBSs that are in reality worth some figure X. But since no one knows or can figure out or even guess what X is and there is so many MBS out there, their market value becomes zero. Since the market value is zero, the banks go under. There is an old saying "the market can irrational longer than you can stay solvent." That is the case here. By the time people figure out what the actual value of these things are, the banks will be bankrupt and the damage will be done.

I don't have a problem with buying the paper at a deep discount and letting the fed roll the dice on it. There is a good chance it will make money or at least not lose too much and I think an overwhelming chance that whatever it loses it will be less than the cost of letting the credit markets go south. Cavanaugh asking what main street cares about Wall Street is the equivalent of saying "why should I care if the electric company goes bust, my electricity comes from the plug in the wall."

If you do the bailout, you have to also take measures to ensure that this doesn't happen again.

1. Credit is no longer a civil right. No more community organizers and activists forcing banks to make bad loans.

2. No more investment banks. Bring back Glass Steagal so that collapse in one area of the economy doesn't kill the whole thing.

3. The price for the feds buying bad paper ought to be taken in blood from the CEOs of the companies involved. No golden parachutes and any bonuses given out over the last few years should be surrendered back just like they would be in a chapter 11 procedure. If you make it painful for the people up top, they won't want to go through this again.

|9.25.08 @ 1:48PM|#

Every Sunday, Dr. Paulson performs a few more unnecessary surgeries, warning that more procedures are needed. Every Monday the patient fails to die, and the doctor orders a new round of treatments, with a grim admonition that this round of incisions and laughing gas is preferable to the alternative.

"There's nothing wrong with you that an expensive operation can't prolong."

kinnath|9.25.08 @ 1:48PM|#

In general, I'm a "you broke it; you fix it" kind of guy. But that only works when the dude that broke it did it by accident, and he has the capability of fixing it. When the dude broke it by incompetence, he's more likely to fuck things up worse than just leaving it broken.

In this case, it is clear the federal government (through its agencoes and sponsored entities) broke the financial markets (or at least exposed the markets to the unthinking, greedy bastards running the major banks).

So now we get to choose between a severely repressed economy when the major banks go boom or a severely inflated dollar if the feds intervene.

As a guy with a nice house, but a tiny 401k, I supposed I should be cheering the feds on.

I think I'll be sick to my stomache now.

toshiro_mifune|9.25.08 @ 1:49PM|#

John - I don't have a problem with buying the paper at a deep discount and letting the fed roll the dice on it.

That would at least be somewhat palatable, but therein is the crux of the problem. Should these assets be sold to the Treasury/Fed at a discount the banks currently holding them will have to realize the loss, which they can't afford to do. So the Fed has proposed to buy the assets at Mark-to-Maturity pricing. Basically overpaying now on the hope it will be worth more later.

|9.25.08 @ 1:50PM|#

One final point before I commence getting snot slinging drunk -

When disaster doesn't happen this year the market interventionists will be crowing about how they were proven right. Doesn't that ~~blow~~ medicine feel soooo good as in enters the bloodstream? See, no problem anymore. I got my fix. I'll quit tommorrow.

The Big 2.5 are getting their measly 25 megabuck low interest loan too.

One of the final must-pass measures of the year, the bill, technically known as a continuing resolution and approved on a vote of 370 to 58, totals more than $630 billion. It provides nearly $23 billion in hurricane and flood relief as well as $25 billion in loan guarantees for the nation's auto manufacturers.

Raise your hands if you believe that this is the last time the auto execs are in D.C. begging.
Or if you think hurricane and flood relief will not require emergency spending legislation in three of the next five years.

I would add number 4,

Make it easier to forclose on homes. Letting someone stay in a home they can't afford, just makes recovering some value on the debt harder and artificially raises the price of homes since that home can't be recirculated into the market.

Paul|9.25.08 @ 1:52PM|#

There is a good chance it will make money or at least not lose too much and I think an

You're exactly wrong on this, John. If there was, as you and many other people keep saying "A good chance it will make money" then the private sector would be ALL OVER THIS. It's exactly that simple. The problem is, the private sector (market) doesn't see a way to make money on this. More importantly-- nay, MOST importantly, the financial firms about to be bailed out of this mess they created don't want to sell their loans and instruments at pennies on the dollar. So they won't, because they know Uncle Sam will buy them for much more than that.

These companies are specifically avoiding a fire sale situation because a very wealthy, very dumb player with deep pockets is driving into the parking lot. I'll let you figure out who that player is.

|9.25.08 @ 1:56PM|#

If I was a Congressman (in addition to being a smartass) I would sponsor an alternative to the bailout bill that set up a charitable foundation enabling citizens to donate to failing banks. Maybe we could get a couple of ex-Presidents to film a commercial with a 1-800 number at the bottom...

|9.25.08 @ 1:58PM|#

"That would at least be somewhat palatable, but therein is the crux of the problem. Should these assets be sold to the Treasury/Fed at a discount the banks currently holding them will have to realize the loss, which they can't afford to do. So the Fed has proposed to buy the assets at Mark-to-Maturity pricing. Basically overpaying now on the hope it will be worth more later."

I don't think that is true. I thought that they planned to set up a reverse auction whereby firms competed on how little they were willing to take on their bad paper. That would not be full market value. But, the quality of reporting on this plan has been abysmal, so I may be wrong about that. You don't fully appreciate how stupid and shallow most journalists are until you read the reporting on something really complex like this.

kinnath|9.25.08 @ 2:01PM|#

I thought that they planned to set up a reverse auction whereby firms competed on how little they were willing to take on their bad paper.

That's my recollection as well. The Feds set up an auction with a fixed dollar amount, the banks bid as many assets as they want against that value.

Of course, nothing prevents the banks from being stingy or the feds from making bad deals.

|9.25.08 @ 2:03PM|#

"You're exactly wrong on this, John. If there was, as you and many other people keep saying "A good chance it will make money" then the private sector would be ALL OVER THIS."

In an ideal world, yes, but this is not an ideal world. Given time to sort out these things, the private sector will be all over them. Look no further than Warren Buffet going into Golman Sachs for an example. The problem is that there isn't time to sort it out and there are not enough big players to buy it all. Further, there is the lemon problem. Since no one knows which ones are worthless, people assume all of them are worthless and won't buy.

Eventually somoene will buy the MBSs and make money. The question is do we let the market do that and watch a whole bunch of our investment banks go down the tubes before that happens or do we intervene and buy the things from them and act as a holding company and slowly sell them off. I am not totally convinced which is the right thing to do. I frankly don't care if this or that bank goes down. But I do care if the credit market dries up and the country goes into a deep recession. The rub of course is will that really happen if we do nothing. I honestly don't know and a lot of very smart people are on both sides of that question.

Should these assets be sold to the Treasury/Fed at a discount the banks currently holding them will have to realize the loss, which they can't afford to do. So the Fed has proposed to buy the assets at Mark-to-Maturity pricing. Basically overpaying now on the hope it will be worth more later.

I see this as just a way to prop up the banks' balance sheets by paying (nearly) face value for badly damaged, if not worthless, assets.

toshiro_mifune|9.25.08 @ 2:04PM|#

I thought that they planned to set up a reverse auction whereby firms competed on how little they were willing to take on their bad paper.

That was part of the talking points I heard as well on Sun and early Mon. By late Tue and all of yesterday it seems to have been discarded. None of the players, it seems, can afford to take any loss. They are that weak.

You don't fully appreciate how stupid and shallow most journalists are until you read the reporting on something really complex like this.

Agreed. Most simply do not understand what is happening.

|9.25.08 @ 2:05PM|#

According to the WSJ, they have reached an agrement on this in Congress.

toshiro_mifune|9.25.08 @ 2:08PM|#

A link from Reuters with Bernanke discussing plans for mark-to-maturity.

I see this as just a way to prop up the banks' balance sheets by paying (nearly) face value for badly damaged, if not worthless, assets.

That is it. You're doing a better job than %90 of the press.

kinnath|9.25.08 @ 2:09PM|#

On the counter, there are many paper bags. Some are full of cash; some are full of horseshit.

If you knew the percentage of cash to shit, you could evaluate the risk and buy some or all of the paper bags and determine your chances of making a profit on your purchase. You could then determine the market value of the average paper bag.

But no one knows how many bags are full of shit; so no one will buy any bags at all. The market value of all paper bags becomes zero.

toshiro_mifune|9.25.08 @ 2:10PM|#

Me and my lousy cut n' paste ability screwed the link in the above;

http://www.reuters.com/article/marketsNews/idUSN2338396920080923

Anonymoose.|9.25.08 @ 2:14PM|#

phil | September 25, 2008, 1:56pm | #
If I was a Congressman (in addition to being a smartass) I would sponsor an alternative to the bailout bill that set up a charitable foundation enabling citizens to donate to failing banks. Maybe we could get a couple of ex-Presidents to film a commercial with a 1-800 number at the bottom...

Not quiet the same, but people can donate arbitrary amounts to help pay down the national debt.

kinnath|9.25.08 @ 2:15PM|#

. . . Bernanke discussing plans for mark-to-maturity.

The feds have now decided that horseshit is a valuable commodity and will pay premium prices for all paper bags regardless of their contents.

I love the smell of unbridled inflation in the mornings.

Anonymoose.|9.25.08 @ 2:17PM|#

kinnath | September 25, 2008, 2:01pm | #
I thought that they planned to set up a reverse auction whereby firms competed on how little they were willing to take on their bad paper.

That's my recollection as well. The Feds set up an auction with a fixed dollar amount, the banks bid as many assets as they want against that value.

Of course, nothing prevents the banks from being stingy or the feds from making bad deals.

That's not really going to determine market value, though, is it. The government is going to use X amount of money, regardless if the deal is truly a good deal. Seems like we're gonna get a no lube anal fucking.

toshiro_mifune|9.25.08 @ 2:20PM|#

kinnath - I love the smell of unbridled inflation in the mornings.

Maybe not. I don't think the Chinese are going to play along. We ran this scam on the Japanese too. I'm not sure if it'll work again.

|9.25.08 @ 2:21PM|#

The problem is that there isn't time to sort it out and there are not enough big players to buy it all. Further, there is the lemon problem. Since no one knows which ones are worthless, people assume all of them are worthless and won't buy.

No one took the time to sort out any of these mortgage-backed securities in the first place, and no one really ever knew which ones were worthless, YET they bought then anyway (and took out insurance on their bets too). The only thing different now is that the government is getting involved, so now these firms are betting that they will be able to make more money on assets they STILL know nothing about because the government is likely to pay them more than what they're worth.

|9.25.08 @ 2:26PM|#

Kinneth,

Your post at 2:09 describes exactly the situation we are in as best as I can figure. When you see these figures on mortgage foreclosures you see what I am talking about. Even if a mortgage forecloses, it is not valueless since you are entitled to the collateral. Unless of course it is a second or third mortgage and other liens beat you to the money. The value of a foreclosure depends on your priority and the resale value of the collateral. Wrap up a few thousand mortgages all on different properties with each with a different probability of being foreclosed, a different priority and a different value on the collateral and you get a sense of just how fucked up the whole thing is.

kinnath|9.25.08 @ 2:30PM|#

Your post at 2:09 describes exactly the situation we are in as best as I can figure.

I like to keep things simple.

toshiro_mifune|9.25.08 @ 2:36PM|#

John - When you see these figures on mortgage foreclosures you see what I am talking about. Even if a mortgage forecloses, it is not valueless since you are entitled to the collateral.

But that would be with a traditional mortgage. We are not talking about that in the majority of these cases. These are debt instruments, pools of mortgages, or more precisely pools of mortgage payments.
If you'll pardon the explanation; and IB will take a mortgage (let's say a 30yr fixed), look at the number of monthly payments (in this case 360) and then sell off each of these monthly payments for a profit. They assign a risk rating based on the likely hood that a payment will be made which affects price, buy some insurance in case of default, etc. etc.
That's a very simplified version of what the Treasury/Fed will largely be buying, not whole mortgage notes. So it is entirely possible that a given tranche (one of those sliced payments) is completely worthless; the tranche for payment # 200 is worthless is the borrower defaults at payment #30.

|9.25.08 @ 2:38PM|#

Snarkmeister | September 25, 2008, 1:20pm | #
Register your opinion! It is easy to do, but it is important to to it today:

make sure you tell your Congressperson what you think about the bailout.

Go go to Congress.org to find your local officials and email them through their website.

kinnath|9.25.08 @ 2:41PM|#

|9.25.08 @ 2:42PM|#

I don't pretend to be an expert, but I thought another part of the valuation problem that the MBS's were sliced and diced so many different ways that it's difficult to tell what exactly they're based on.

The operative assumption is that Uncle Sam could just foreclose on the deadbeats and sell the distressed properties. But since those mortgages are split up between a zillion different securities, isn't it possible that private entities would still own little pieces of that mortgage? In fact, I believe that the fractured nature of MBS's has hampered foreclosure efforts in several states, with judges refusing to approve foreclosures in the absence of clear proof as to who exactly owns the mortgage.

What a mess. I oppose the bailout on principle, but I'm afraid of the consequences of a complete meltdown of the banking system.

I haven't seen much discussion about the possibility that the ChiComs and others aren't too eager to slurp up all the T-Bills necessary to finance this largess from Uncle Sugar.

|9.25.08 @ 2:44PM|#

There is a good chance it will make money or at least not lose too much

Can I add that to the list of these faves?

Amtrak will be self sufficient if this legislation is passed.
Oil revenues from Iraq will pay for the war.
This bipartisan legislation places social security on a firm foundation.
Projections indicate a balance budget in ________.

Paul|9.25.08 @ 2:44PM|#

Since no one knows which ones are worthless, people assume all of them are worthless and won't buy.

Exactly, so the U.S. Government comes and pays top dollar without figuring out which assets are worth any money. This is why this interference must not go on.

The only divide between us, John, is that you don't believe that the government should let any pain be felt, I believe there should be pain felt. And I believe that there should be pain felt because I sincerely believe that the very act of purchasing worthless assets, flailing around in a complex market, and nationalizing these industries (even if only temporarily) nationalizes risk, and privatizes profit. That's what's wrong with this picture, and that's why any involvement is a Bad Idea(tm).

toshiro_mifune|9.25.08 @ 2:46PM|#

I don't pretend to be an expert, but I thought another part of the valuation problem that the MBS's were sliced and diced so many different ways that it's difficult to tell what exactly they're based on.

It is. There is also the problem that some slices were sold more than once (this story hasn't gotten much play outside of some blogs). In other words the pieces add up to %110.

toshiro_mifune|9.25.08 @ 2:50PM|#

I haven't seen much discussion about the possibility that the ChiComs and others aren't too eager to slurp up all the T-Bills necessary to finance this largess from Uncle Sugar.

They aren't, but it doesn't get much play in the American press.

Did I also mention that banks were using these same securities for further leverage? In to even riskier assets/classes? No?

Invisible Finger|9.25.08 @ 2:52PM|#

Make it easier to forclose on homes.

I disagree because the foreclosure in a simple lender-still-has-the-mortgage scenario is not all that difficult. The difficulty is that the mortgage has been packaged and repackaged so many times finding the actual holder of the mortgage is harder to do. In a lot of cases the servicer knows the loan is defaultin, but the servicer can't find the paperwork. I don't see any justification in making foreclosure easier for these knuckleheads.

Invisible Finger|9.25.08 @ 3:05PM|#

If you'll pardon the explanation; and IB will take a mortgage (let's say a 30yr fixed), look at the number of monthly payments (in this case 360) and then sell off each of these monthly payments for a profit. They assign a risk rating based on the likely hood that a payment will be made which affects price, buy some insurance in case of default, etc. etc.

This brings up the point that the 30-year amortized loan was itself a bailout method of the 1930's that has since become the norm when the norm should have been phased back to 10-15 year terms by the end of the 50's. Instead we're bailing out the old bailout.

|9.25.08 @ 3:23PM|#

Did I also mention that banks were using these same securities for further leverage? In to even riskier assets/classes? No?

What sort of investment is riskier than the lower-rated MBS tranches? A trip to a Las Vegas sports book to bet in favor of the St. Louis Rams and Detroit Lions?

This whole thing makes me think of the movie "The Cooler", for some reason...

|9.25.08 @ 3:29PM|#

Thanks to toshiro_mifune's excellent explination of the nature of these securities I am starting to think maybe we should just follow the ChiComs lead and just shoot the bastards and be done with it.

|9.25.08 @ 4:02PM|#

The only economy that is threatened is the Bush adminsitrations fake borrow-and-shop bubblenomics economy.

Mike Laursen|9.25.08 @ 4:10PM|#

This brings up the point that the 30-year amortized loan was itself a bailout method of the 1930's...

Well, there you go. The answer is to turn all of the subprime mortgages into 60-year loans!

|9.25.08 @ 6:24PM|#

Well, there you go. The answer is to turn all of the subprime mortgages into 60-year loans!

Don't laugh. At the height of the bubble, the mortgage industry's big answer to stupidly inflated housing prices was to introduce the 40-year mortgage. And there were saps who took 'em up on it.

Invisible Finger|9.25.08 @ 6:39PM|#

100-year mortgages were done in Japan.

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