Archive for the ‘Paulson’ Category

One noteworthy aspect of the current bailouts and its discontents is that investors seem to like it.  Even pseudo-tough Wall Street types who make a fetish of greed and the necessary hard knocks of the economy have whined like a bunch of college kids stranded in Cancun after their credit cards got stolen.  $700B is not enough.  We need lower interest rates . . . again!!!!

There is a notable dichotomy between the reaction of investors–for whom a downturn on Wall Street is a calamity far worse than the intense shocks endured by the working class for the last 30 years–and the more level-headed treatment of Paulson’s proposal by academic economists who remind us that loss, liquidation, and readjustments are facts of life inevitable after years of artificial inflation. 

Economists, after all, tend to consider the economy as a whole.  It is economists, and not big business types, who have long taught that everything from rent controls and farm subsidies to the public-private gobbeldygook partnerships in local government are inefficient at best, graft-breeding albatrosses at worst. 

Wall Street is simply not to be trusted; the individual and institutional interests of these whiners is on the line, and their institutional culture and compensation structures breed a highly irresponsible penchant for extreme risk.  They lack objectivity and credibility, as too does the former Goldman guy at the head of treasury and the former Goldman guy he just put at the helm of the toxic debt buyback.  Don’t listen to them; it’s the guys in the tweed suits who actually have some stake in reality and objectivity.

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Steve Sailer has a very funny piece on WaMu’s advertising, which bragged about the company’s contempt for stodgy old bankers. Pretty obvious generational and ethnic subtext in this ad: WaMu positioned itself as a new kind of bank for the the age of diversity and free spirits.

Interesting piece from the Von Mises Institute on the Federal Reserve’s direct involvement in Mortgage-Backed Securities (MBS). I was under the impression almost all of the Fed’s assets were in Treasury Bills, a near equivalent of cash. Since its liquidity, stability, and the like are supremely important, I’m a bit disturbed to learn this was going on through the System Open Market Account (which is also the institution that holds the Bear Stearns bailout entity, Maiden Lane, LLC.) I have no idea how much direct MBS exposure the Fed has, and I’m surprised this has not been discussed by more commenters.  Does anyone know the scoop out there? I think from this chart it’s either the “other loans” or “other assets” portion of the Federal Reserve’s asset pool. In any case, this year’s expansion of the Fed’s asset pool should be worrisome; it usually portends an equally significant expansion of their liabilities, i.e., printing of money either directly or otherwise.

Apparently the bailout is a done deal. There is no significant change in concept from original Paulson proposal other than a bit more oversight. Still no word on pricing goal, i.e., lowest possible, above market (to create upward bidding), or something in between. I will make a rare series of predictions: a rally of stocks for 1-2 months with big days this week, i.e., the last of our inflationary bubbles. A few months from now, probably after Christmas, Paulson with lame duck President Bush will solemnly announce massive and continuing losses from first wave of MBS purchases and continued deleveraging by nonparticipating or ineligible entities. The losses will stem from overpricing of the Mortgage and Asset Backed Securities (ABS) Paulson bought for the US, the stagnation of third party securities, the impact of declining credit on our consumption-oriented economy (and trade partners), and the failure of the market to push prices upwards for debt-based assets because of continuing, excessive housing inventory. In other words, this debt is toxic for a reason, and its revival depends upon an upward-moving near-term housing market, which will not materialize.

On news of the failure of the first stage of the bailout, the market tanks. Bonds fail and numerous big, credit-dependent companies seek bankruptcy. Runs on banks become more common. Credit markets manifest serious breakdowns in everything from commercial paper to auto loans. Deleveraging by institutions continues having an additional negative effect on the immediate money supply. Foreign bond rating agencies downgrade Treasury Bills, but the US rating agencies stand firm for fear of retaliation.  This creates a crisis of confidence in all US-rated paper.  There is a swift shift away from dollars as a reserve currency overseas.  A severe and also inflationary recession starts January-February 2008.

The federal government will have blown the foreign creditors’ wads on the first stage bailout. But the more important FDIC bailout for commercial banks will become strained as nervous customers yank money from their longer-term accounts, just as unemployed depositers quit paying on their various loans. Instead of a sharp chastening lesson for Wall Street sorted out reasonably quickly in bankruptcy, the government will find that this bailout has strained its own ability to meet ex ante obligations to ordinary commercial banks. The banks who shifted their mortgage debt off the books to Fannie Mae, Freddie Mac, and other investors will now find the government’s bailouts of third-party holders of ABS and MBS left less money and weaker government credit available to fund the FDIC during the second-stage of the crisis (i.e., more WaMu-type failures and fire-sales).  Since money in checking accounts and saving accounts being wiped out is totally unacceptable politically,  the government begins monetizing the debt in short order.

I hope I’m wrong.  Bonus question below.

Which recessions since the Great Depression have been inflationary?

Answer: Every single one of them.

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Whether this $700B blank check for the treasury is bad, really bad, or a disaster depends a great deal on the price paid for the excess securities.  If nominal price is paid, it’s a complete disaster, essentially giving money to the outer-reaches of the economy engaged in multiple levels of speculation with other peoples’ savings at the expense of its core, the working-consuming-taxpayer.

If a deep discount is paid, it’s more fair, but then the banks will come back for more relief as their insolvent balance sheets invite lower levels of saving, “bank runs,” and the like.

If the price varies from bank to bank or asset-backed-security-pool to pool, then claims of favoritism, unfairness, or lack of zeal will be levied.  If after taking on all of these bad assets, syndicates rebuy them from the Treasury at an additional discount citing the lack of liquidity in the market, the taxpayer will have gotten fleeced both coming and going.

But the price is everything, and the price Paulson (or his successor) will pay is completely unknown.  The Economist had a useful piece on this:

One of the big myths currently circulating is that banks simply cannot unload these bad assets. In reality, however, there is still plenty of interest if banks are willing to reduce the price low enough. At the end of July, Merrill Lynch liquidated US$30.6bn of asset-backed collateralised debt obligations for US$6.7bn — a discount of 78%.

Most other banks have been reluctant to accept such a steep discount. This unwillingness puts Treasury in a difficult position. Mr Paulson could demand a big discount, which would help protect taxpayers from overpaying on assets that already have a limited market. However, if banks were forced to sell at fire-sale prices, they would suffer a sharp increase in their writedowns, causing them to seek even more capital, which would defeat the plan’s initial purpose.

Instead, Mr Paulson seems intent on paying fair-market values for these troubled assets, noting that any punitive discounts would limit the participation of financial institutions. But it’s not clear what the fair value of these illiquid assets really is. There is a very real danger that Mr Paulson will overpay for these troubled assets just to help recapitalise the beleaguered banks. This could force taxpayers to hold billions of dollars of assets to maturity or try and resell them — either of which has the potential to generate huge losses, especially as long as the housing crisis continues.

The fear of contraction is creating additional inflationary pressure, which will, in turn, create more bad investments, excessive expansion, cheap money, declining US credit, and an eventual meltdown of the currency, whether in hyperinflation, deflation, or some kind of supply shock combination of both remains to be seen.

That McCain and Obama both see this as a tail of heros and villains where hidden piggy banks of money in the form of executive compensation can sort this all out is the most worrisome feature of all. The money is not there, and our collective national lifestyle of “leverage,” low savings, high consumption, high levels of debt, generous government programs, “wars of choice,” mass immigration, cheap labor, multi-trillion dollar debts, trade imbalances, resource profligacy, a mania for toys, and an overall absence of any national economic policy is the cause.  Everyone who bought a house thinking he could flip it for 150-300% of its purchase price before the ARM kicked in bears some of the blame, as too do the race hustlers, liar loan liars, vacation-taking second mortgagors, and everyone in between.  Worst of all, our President who said “spend as an act of patriotism” during a time of war, while ignoring the impending solvency impact of entitlement spending, showed a complete absence of foresight of leadership.

No one giving this kind of speech, however, will get very far in a democratic regime. It’s so much easier to blame a few fat cats, or a few greedy Wall Streeters–and greedy they were!–but their greed is an epiphenomenon of an unbalanced economy fueled by a culture of rank speculation, leverage, and get-rich-quick scheming.

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