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Some ballpark math on the US financial sector (i.e. just how big is $700b?)

by Brad Setser
September 23, 2008

The Federal Reserve’s flow of funds data indicates that US households have $11.2 trillion in outstanding mortgage debt on non-farm homes, another $2.4 trillion in outstanding “other mortgage debt” (a category that includes corporate farms, who knew … ) and $2.5 trillion outstanding consumer credit.

Figuring out how much households owe is the easy bit. Figuring out who owns the debt of US households is a bit harder.

For now, I am going to focus on the $13.6 trillion in mortgage debt. The Agencies have $7.9 trillion in debt and guaranteed bonds outstanding, but the GSEs hold around $800b of the debt that they guarantee, so their total holdings of mortgages and mortgage backed securities is more like $7.1 trillion. Like the Agencies or not, no financial institution is going to go bust holding Agency debt. That leaves around $6.5 trillion of outstanding mortgage exposure in the hands of the financial system, give or take. It might be higher because it is possible to create “synthetic exposure” to various kinds of securities — basically, financial institutions can make a side bet among themselves about the future value of a mortgage backed security. That exposure nets out, but the netting only works if the losing party to the bet can pay up (Note: this paragraph has been edited in light of the comments, which highlighted that my initial post failed to reflect the Agency backed mortgage pools held by the GSEs)

This math is not inconsistent with the Fed’s data on the outstanding stock of asset backed securities. There are $4.365 trillion in asset backed securities outstanding. Not all those contain mortgages, but many do. Table L 126 suggests that ABS issuers hold about $2.1 trillion in residential mortgages, another $640b in commercial real estate and a non-trivial $400b in Agency debt.

This math also seems consistent with data indicating that the commercial banks hold $3.7 trillion in mortgages and another $1 trillion in corporate bonds (a category that should include ABS) — i.e. up to $4.7 trillion in exposure. The thrifts report about $1.2 trillion in mortgage exposure — mostly from mortgages, “private” MBS and collateralized mortgage obligations (CMOs) sum up to under $100b — see table LII4). The broker dealers have $270b in corporate bonds (think ABS) — not a huge exposure. But they over half ($1.6 trillion of a $2.8 trillion total) of their assets is just labeled other.*

Willem Buiter thinks that the US Treasury will be buying up assets at roughly 33 cents on the dollar, which would broadly speaking move $2 to $2.1 trillion in face value of debt off the balance sheets of major US financial institutions. Buiter:

I assume that $700 bn will allow the purchase by the US Treasury (or its agents) of at least $2 trillion worth of mortgage-related securities at face value, as it would not make sense for the US tax payer to pay much more than 33 cents on the dollar for the mortgage-related rubbish that banks have loaded onto their balance sheets.

That would leave, on first approximation, $3.7 or $3.8 trillion of mortgage exposure in the hands of the financial institutions.

I am not though convinced that the banks can afford to sell at 33 cents on the dollar. If these assets were valued at par before the crisis, I think that implies taking an aggregate loss of $1.4 trillion — which seems much higher than the losses that the banks have recognized to date. The hit to the banks balance sheet might be too big.

My guess is that the Treasury’s average purchase price will be a bit higher — which implies that fewer bad assets will be moved off the aggregate balance sheet of large financial institutions.

What is the point of all this?

Well, to me it helps to highlight the challenge the Treasury faces. If it pays a high price for various dud assets, it won’t move nearly as much off the banks’ balance sheet — which may leave residual questions about the health of key institutions. On the other hand, if the Treasury pays a low price, it may leave a lot of banks in trouble and in desperate need of new equity.

It also helped me try to think through whether $700b is a lot a money or a little bit of money, relative to the enormous challenges the US now faces supporting a financial sector that is gravely ill. I was reminded just how big the balance sheet of the US financial sector is — and just how much of that balance sheet is tied up in the real estate market.

Finally, I wanted to see if others found this kind of analysis – call it the beginning of a balance sheet analysis of the US — at all helpful to a broader range of people before I try to go further.

*Since q2 2007, the broker dealers have reduced their holdings of corporate bonds from around $420 to around $270b — a meaningful fall. From q2 2007 on, their agency holdings soared from $120b to $310b. Total assets though from $3.2 trillion in q2 2007 to $2.9 trillion in q2 2008, so there was a bit of deleveraging, not just a shift toward Agencies. That though likely corresponds with the collapse of Bear. The bigger trend is probably less a brutal deleveraging and more the end of the rapid growth of broker-dealer balance sheets.

From the end of 2003 to q2 2007, the broker-dealers total financial assets (and liabilities) basically doubled. That seems to correspond with a rapid increase in their aggregate leverage. The expansion of their balance sheet was especially rapid in 2006 (up over $600b) and the first half of 2007 (up $400b). That expansion led to a roughly $100b increase in the broker dealers holdings of corporate bonds, but most of the growth came from “other” assets. See table L. 129. By comparison, figuring out what China holds is easy …

127 Comments

  • Posted by Simon

    I think this is a very interesting analysis. Please do take it further. What I would like to know is how solvent the US is now.

    A solvency stress test would make an interesting analysis. This is what all the currency dealers are pondering now no doubt. Their first vote is somewhat negative it would seem.

    There is a meme floating around about exactly how long it takes to pay back one trillion dollars at $1 a second. I guess a realistic look at the ability of the US to “give it back”…think Midnight Oil…lol…would be facinating. Some simplifying basic assumption would need to be made.

  • Posted by Dwight

    You have nailed the problem with the Paulson approach by questioning Buitner’s assumption that the assets to be acquired under it will be purchased at a significant discount to their historical cost. And no amount of Congressional wrangling can resolve that.

    I’m beginning to wonder if the ‘plan’ is best understood as a blank check, a war chest, as it were, to deal with issues as they arise. Sometimes the funding would be on savage terms (AIG) and sometimes almost quasi-charitable (the assist to the Bear Stearns acquisition), and sometimes not forthcoming at all (Lehman).

    Of course, that would be ‘pragmatic’ rather than ‘systemic’ but perhaps we are finally reaching a point calling for pragmatism rather than posturing?

  • Posted by moldbug

    Quite useful, but in the third paragraph “b” should be “t,” I think.

    One good thought-experiment is to think about how all these trillions in obligations can exist, and be priced at as if they actually have some chance of being repaid, in a world with only 825 billion actual dollars (M0).

    We can ask this question by imagining that starting Tuesday morning, it becomes physically impossible to issue new dollars. There will be no more bailouts, now or ever. What happens to asset prices, yield curves, etc, etc? How, for instance, does USG pay off a $10T national debt in a world with 850 billion dollars?

    What this thought-experiment tells you, or at least what it tells me, is that the Fed’s power – and willingness – to issue new FRNs, which is effectively used to insure both Treasury and many private obligations, is by far the largest component of all our asset prices. Adjusting this knob can yield all outcomes from hyperdeflation to hyperinflation. There is no “fair price,” unless that means the price when the knob is set to 0 – and we don’t want to see what happens when the knob is set to 0.

    I’m disappointed by the MOAB and even more so by most peoples’ reactions. I think far more aggressive action is necessary. By promulgating the “too big to fail” story and acting as a lender of last resort, USG issued a very, very large number of informal contingent dollars, which have become attached to the liabilities of insured institutions. This number is far above $700b, and buying $700b worth of bank assets is a strange and inelegant way to confirm the existence of these instruments. It is the creditors of the banks, not the banks, to whom they were granted.

  • Posted by HZ

    Is the 33c face value for defaulted loans only? I can see paying no more than that for an already defaulted loan. Why would anyone sell performing loan for such a discount. So if you take only defaulted mortgages the total amount should be significantly less.
    It will be good for Treasury to concentrate on buying defaulted mortgages and modify the loans into leases so that borrowers can stay as renters. That would achieve a public good and also helps stabilizing the property market. Once housing market is stabilized the aversion to mortgages will go away.

  • Posted by Matt Dubuque

    Matthew Dubuque

    Brad-

    It’s a helpful analysis. Please continue!

    You ask whether 700 billion is a big number or a small number for what is needed.

    In my view, it may well be a small number.

    Whether you think the Treasury will buy the highly radioactive contaminated waste at 33 cents on the dollar or at 45 cents on the dollar, both still imply huge hits to the capital stock of the banks.

    Due to Federal Reserve relaxation of restrictions over the last few weeks, Asian funds may now flow more freely into the banking sector, but there remains some uncertainty with respect to that.

    The Feds may (MAY) have to help recapitalize that shortfuall.

    Hence my view that 700 billion may not be enough. 700 billion may well be the first installment.

    Matthew Dubuque

  • Posted by manch

    Bravo Brad!

    Your analysis quantifies my thinking over the weekend. 700B is not to enough to move a lot of assets off banks’ balance sheet, at a premium price that Paulson has to pay to keep the banks alive.

    An even more cynical coworker of mine said Paulson could do some money laundering. He can buy at premium and sell at low price in secret transactions. They have to be secret to avoid banks marking to the real price. This way he can stretch that 700B a bit further.

    I don’t want to be that cynical. Can anyone convince me this scenario can’t happen? Or I should move to Zimbabwe instead?

  • Posted by Graham Cox

    HZ
    You are right that there needs to be a focus on getting the pre-foreclosure properties rented to existing owners or otherwise to reduce the foreclosure pipeline that all these big schemes and head line writers ignore. Very odd given that this is root cause .
    The huge REO inventory also needs urgent attention .

  • Posted by Sundblad

    Very interesting analysis. I agree with manch’s thought above – if every TARP asset purchase is followed by a sale to some other entity (friendly SWF:s, perhaps?) the $700B can buy far more assets than the initial value.

  • Posted by Erich

    The resque plan was only ment to get the banks’ stockprices up (up almost 15% last thursday and friday combined) so the rich bankers and their political cronises could load off as much as possible before the enetual crash hits the market.

    The PLAN will remain just htat, a plan, a “good intention” to give suckers hope of a better tomorrow, and thus keep stock prices at an artificially high level(for a while) .

  • Posted by Cedric Regula

    Uncle Bruno waza kinda worried ’bout howda feds turns inta a commercial bank. He tink dats a enough work ta figure out ana do’en da whole country coulda be too complicated.

    He sez so far da feds don’ta own hardly nutt’in, and just lose money lika bunch of drunken goombahs.

    Now they also gonna be like a S&L wida a bunch of mortgage assets backed wid houses. So’s dats like hav’en da biggest S&L in da world dats also owns a print’n press, treasureal press, an is all run by congress, regulators, agency people an’ da white house. Uncle Bruno calls dat a elephant wid four left feet.

    So’s he tinks it could go de uder way. First dey buy da loans at a price below face but somhow figure out howda keep da banks solvent, witch is da idea dey say anyway.Den da fed has da assets on da books and decides to show how good da plan is working over time and marks UP to market. Dat makes da national debt get smaller and dey can borrow against a smaller national debt. (dat made sense to Uncle Bruno when he said it, I tink). So’s Uncle Bruno tinks dat someday soon Brooklyn alone coulda be worth more dan Tokyo on da feds books.

    He tinks we need to watch dat.

  • Posted by Geoff

    Sundblad said: if every TARP asset purchase is followed by a sale to some other entity (friendly SWF:s, perhaps?) the $700B can buy far more assets than the initial value.

    Isn’t this the only way this makes sense: as a means of maintaining the “vendor-financed” money-go-round. Your data on SWF purchases of Agencies suggested the Fanny Mae/ Freddy Mac bailout was forced by the US’s creditors.

  • Posted by Dave C.

    Marc Faber blames the Federal Reserve for the US Economic fiasco…

    Fed Acted Like a Liquidity Drug Dealer: Economist
    http://www.cnbc.com/id/26848829

    The Federal Reserve, which has encouraged excessive borrowing, is to blame for the credit crunch that has gripped world markets for more than a year, Marc Faber, the author of the Gloom Boom & Doom Report, told CNBC on Tuesday.

    “About 15 percent of U.S. households have negative equity. Who supplied the leverage into the system? It’s called the Federal Reserve Board,” Faber said.

    “If I’m the drug dealer I’m not responsible that everybody takes drugs, but I facilitate it, especially if I give it out free of charge, I can enlarge the market share, and that’s what the Fed has done.”

    Liquidity will dry up even more, volatility will stay high and financial assets are going to suffer as the crisis continues to unfold. The bailout plan is unlikely to work and the global economy will take the hit, he predicted.

    “People rely on the people in Congress, at the Fed, at the Treasury, people that brought us into this trouble, to take us out of trouble. I don’t think they will succeed,” Faber said.

  • Posted by bsetser

    moldbug — before i started working on the US and China, I worked mostly on emerging markets. And back then i thought $10b was a lot of money … thanks for the catch.

  • Posted by JKH

    —-
    Very interesting analysis – I’ve always thought you could connect your international flow monitoring to an overview of the US domestic balance sheet. It puts a lot of numbers into perspective, particularly when addressing a problem where rounding to the nearest trillion has become reasonable. The flow of funds report is helpful to this end.

    As others noted, the $ 700 billion is a proposed balance sheet constraint but not necessarily a flow of funds one. If Treasury acts as an effective dealer of this paper, $700 billion becomes the proposed inventory limit, but the final throughput of purchased paper can exceed $ 700 billion, depending on Treasury’s dealing activity.

    On the limit to losses: I see very few commentators distinguishing between pre-tax and after-tax losses. Announced losses are pre-tax. The hit to capital is after-tax.

    US institutions are absorbing the losses at the rate of about 50 per cent of the global total (the roughly $ 500 billion published as of about a week ago is a global number).

    These kinds of numbers are useful for high level, bank of the envelope stress testing for US financial institution capital adequacy. I find total financial institution capital difficult to derive from the FF accounts, but suspect it’s roughly in the range of $ 1 trillion to $1.5 trillion. (This is from other ad hoc reports also; it’s not obvious to me how the number is evident in the FF tables.)

    It’s also interesting to keep track of the total household net worth number as per the flow of funds report. It’s most recently about$ 56 trillion, down from a peak of $ 58 trillion. The number provides context for otherwise large quantities like mortgage losses, US bank capital raises, and NIIP exposure. A value at risk measure, as much as it’s been proven to be abused technology in the case of the recent financial institution blow-up, would be an interesting analytical idea for US household wealth. Much of the origin of the housing and mortgage problem can be related to the outsized run-up in this number. I also think this number should be part (i.e. the marked to market part) of solvency analysis relating to the current account deficit problem. Table B100 shows a leverage ratio (debt/net worth) for the US household sector of roughly 1:4. This compares to the same ratio for an investment bank of roughly 30:1. The household sector in aggregate has 120 times the comparative capital strength. If leveraged as much as an investment bank, it would have net worth of $ 500 billion instead of the current $ 56 trillion.

  • Posted by JKH

    —–
    Moldbug,

    With all due respect, I believe your defined M0 scope and application is somewhat narrow and static as the basis for the suggested analytical task.

    It’s too narrow, because the idea should include privatized dollars that have the same liquidity properties as the currency component of the monetary base – i.e. demand deposits in the financial system.

    It’s too static because it ignores the intraday velocity for the stock of M that acts to repay aggregate obligations over time. Intraday velocity of the money stock facilitates a netting process for daily settlement of monies due and owed and daily balancing of balance sheets (household and other) in the economic and financial clearing system. The result is a stock requirement that is a fraction of the aggregate macro sum of future financial obligation flows. Given the ease with which participants can convert time obligations of the banking system to demand obligations, this fraction, which is highly dependent on velocity, is whatever they want it to be, and whatever the monetary authorities are prepared to accommodate at prevailing policy interest rates.

    That all assumes normal liquidity and credit conditions, of course. To the extent there is a liquidity run on the privatized dollar sector, the central bank must replace privatized dollars with M0 dollars, buying assets previously funded with privatized dollars in exchange. The extreme limit would be nationalization of the full capital structure (including demand deposits) of the commercial banking sector.

    I’d better stop. That sounds dangerously like your point. But I think it’s the only way to get there.

  • Posted by Cedric Regula

    JHK:

    Da $58B in US private savings was from da 2006 fed survey, if’n I recalls correctly. Since it is mostly housing and stocks, the number would be significantly lower today, an’ arguably going lower yet.

    A side effect is always da “wealth effect”. And this can also slow “velocity”, but not to zero of course.

  • Posted by Twofish

    manch: An even more cynical coworker of mine said Paulson could do some money laundering. He can buy at premium and sell at low price in secret transactions. They have to be secret to avoid banks marking to the real price. This way he can stretch that 700B a bit further.

    If you are buying assets from a bank that is going to go bust once the assets get marked to market then you are going to have to put some money in, the question is how you put money in. The big question is *how* you put the money in, and my concern is to make things so that if the government pumps money into a bank, everyone knows and sees it.

    One proposal that I’ve heard which is a good counterproposal to the Paulson plan is that for every dollar that the government puts into a bank, that the government gets abck something that is supposed to be worth a dollar. So you put in a dollar and get back stock that is worth the difference between the one dollar and the mortages that you got. The logic behind this is that if it turns out that the mortgages are worth 10 cents, then government has this stock that is worth 90 cents.

    My concern in all of this is that no matter what you do, some Wall Street type is going to make some money off the situation. This is what Wall Street-types do. Right now, I’d like to see the deals structured so that if some Wall Street type makes money, that a good fraction of that money also ends up on Main Street, and that there is transparency about who is going to make money and how.

  • Posted by charlie

    There’s no way the treasury is going to only pay 33 cents on the dollar. It would defeat the purpose of this action.

    Contrary to what Paulson says, the problem isn’t liquidity, the problem is solvency. He knows this and purposely lies about it. It’s easier to sell the issue as liquidity due to lack of confidence, short sellers, etc… .

    The banks don’t have nearly enough asset values to cover deposits, so the plan is to way overpay for the assets so banks can cover their deposit base. I believe the price will be much closer to $1 than 33 cents.

  • Posted by Cedric Regula

    JKH:

    I’m mixing up my b&t’s too. Net personal wealth in da US s/b $58T, not B as I typed above.

  • Posted by Twofish

    Dwight: I’m beginning to wonder if the ‘plan’ is best understood as a blank check, a war chest, as it were, to deal with issues as they arise. Sometimes the funding would be on savage terms (AIG) and sometimes almost quasi-charitable (the assist to the Bear Stearns acquisition), and sometimes not forthcoming at all (Lehman).

    It’s also a first proposal. If you ask someone what to do in a situation, their first reaction may be “give me a blank check and make me king of the world” knowing full well that you won’t do that, and that you’ll negotiate the powers down. The balance is that you need to have enough flexibility to deal with new situations, but not so much that you give too much power and discretion to one person. Paulson would probably lean to giving too much flexibility while Barney Frank would probably lean toward giving too little. So you put the two in a room and having them fight over this, and what comes out is hopefully very balanced.

  • Posted by Twofish

    The other question is what fraction of mortgages will ultimately go bad. Right now you are looking at default rates of 25% in subprimes and 2-5% in prime mortgages. One thing that is interesting is that if you put in some numbers into the system, it turns out that the mortgages could be worth a lot more than what people are willing to pay for them if you hold them to maturity and if the economy doesn’t collapse.

    However, the trouble is that no one is willing to hold the mortgages to matury because no one knows whether or not the economy will collapse. However, if you assume that there isn’t a total economic collapse, then whoever ends up holding these mortgages will make quite large sums of money.

  • Posted by JKH


    Cedric Regula,

    $ 56 trillion is the June 30, 2008 number, down from a peak of $ 58.7 trillion at September 30, 2007.

  • Posted by Binggan

    Do all these numbers and the loss estimates add up?

    You mention that ex Agencies this leave a 5.8tn morgage pool. Can this pool really generate 500bn losses?

    If the 700bn are spent buying assets at 33cts on the dollar does this mean 1.4tn losses will need to be booked, out of a 5.8tn pool? Is that plausible?

    Thanks for your insights. Very interesting post.

  • Posted by Dave C..

    I am still breathless that Paulson would have the audacity to simply ask for an unconditional “blank check” from the US taxpayers to bailout his Wall Street buddies. The same people that brought us into this fiasco are trusted to administer trillions of dollars without any independent oversight. The taxpayer bailout is merely an expensive boondoggle rewarding bad behavior for politically connected Goldman Sachs which retains the biggest balance sheets of level-3 garbage debt.

    If the financial strategy is really to provide liquidity for lending to main street, then why don’t they contact a handful of healthy banks around the region and tell them to start accepting loans to the creditworthy? The poorly managed banks deserve to be liquidated. It’s the economy we want to save; not the Goldman Sachs banksters on Wall Street.

  • Posted by Cedric Regula

    twofishes:

    “However, the trouble is that no one is willing to hold the mortgages to matury because no one knows whether or not the economy will collapse. However, if you assume that there isn’t a total economic collapse, then whoever ends up holding these mortgages will make quite large sums of money.”

    There is still interest rate risk for domestic investors, and currency risk for external investors on top of the default risk.

    And that’s just on the paper. If you think mortgage rates may go back to the historical 8%, and people need to qualify for real and come up with a down payment, then house prices continue to decline, and so does the collaterall on existing mortgages. And that’s more risk factor on existing paper.

    I’ve been looking at closed end bonds funds of better paper and they are selling at 25% off NAV right now, but I’m not buying.

  • Posted by Twofish

    DC: If the financial strategy is really to provide liquidity for lending to main street, then why don’t they contact a handful of healthy banks around the region and tell them to start accepting loans to the creditworthy?

    Because everyone is scared, and healthy banks are likely to just say no and keep their cash. Part of the problem is that no one really knows which banks are healthy and which ones aren’t, including the banks themselves. The banks that end up in trouble may not be ones that did stupid things but rather banks that did things that they thought were reasonable which got them in trouble (like buy credit insurance from AIG for example).

    You might even get an perverse incentive problem in which healthy banks keep their cash, and its the bad banks that loan more money because they have nothing to lose.

    DC: The poorly managed banks deserve to be liquidated. It’s the economy we want to save; not the Goldman Sachs banksters on Wall Street.

    If the system goes under, it kills everyone, both the good and the bad.

    One reason people speak highly of Goldman-Sachs is that its actually a very well run investment bank. It had far less exposure to mortgages and complex derivatives than its other competitors, and that’s why it ended up being the last investment bank to be around.

  • Posted by T. Aldrich

    Keep going with this. Re brokers and dealers, I combined brokers and dealers with funding corps. (there is a lot of cross linking that can be sorted out using the L. tables). If you go to the end to the “miscellaneous” tables, most of the unidentified broker dealer assets turn out to be securities loaned to the funding corps. As of 2008/Q2, the assets of the combination are:

    Checkable deposits $110 bil.
    Commercial paper 168
    Treasuries -84
    GSE paper 311
    Corporate bonds 653
    Munis 52
    Other loans 73
    Money market funds 727
    Equities 185
    Security credit (to households) 290
    Foreign direct investment, etc. 280
    Unidentified 258

    Total 3024

  • Posted by Twofish

    Regula: I’ve been looking at closed end bonds funds of better paper and they are selling at 25% off NAV right now, but I’m not buying.

    Right, and given a choice I think you probably wouldn’t be buying if it was 50% or 75% off NAV. If someone showed up at your door begging to give away that fund for free if you will just sign a piece of paper, you probably wouldn’t take it since you don’t trust that piece of paper.

    However, if the world doesn’t end, and someone puts up cash to buy those assets now, they are likely to make huge amounts of money in the end.

  • Posted by T. Aldrich

    Following my post above, you can do the same with the liability side for the broker dealer/funding corp. combination, which I won’t bore anyone with.

    Here’s my question: Concerning their own-balance-sheet operations (which these numbers represent) and not their old role as financing arrangers, brokers, etc. why do we need these guys at all as a conduit of credit to the non-financial sector?

  • Posted by bsetser

    T. Aldrich — thanks for the tip re: funding cos. The asset side seems to hold a ton of money market paper as assets — which seems strange to me, but this isn’t something I know a lot about.

    also, what is the best source for outstanding broker-dealer (and former broker-dealer) commercial paper — I saw that LEH had $8b outstanding somewhere (bloomberg i think) which seemed low to me.

    JKH — I probably should have focused on the domestic/ external interlinkages a bit more. one note tho — i am not sure how say UBS or RBS or HSBA or any other European bank with a major US presence would show up in the flow of funds data. My suspicion is that some foreign banks own us banks that still show up in the US data.

    binggan — the losses would come out of the mortgage portfolio NOT held by the agencies. the agencies will take losses, but for a host of reasons (limits on their activities during the peak of the boom, generally gauranteeing conforming mortgages rather than the riskier stuff) there losses should be more contained.

  • Posted by Cedric Regula

    Twofishes:

    “Right, and given a choice I think you probably wouldn’t be buying if it was 50% or 75% off NAV. If someone showed up at your door begging to give away that fund for free if you will just sign a piece of paper, you probably wouldn’t take it since you don’t trust that piece of paper.”

    Damn toot’n !!!

    Ana here’s I can yous why.

    Here’s a lovley bunch of assets, er, I mean collateral. Even been thru the area, an wish da people making da $400K had done da same.

    LA/Watts 90002 10 $172 -52.5%

    More upscale losses too. Have a look around. Don’t be shy.Deys ours now.

    http://www.dqnews.com/Charts/Monthly-Charts/LA-Times-Charts/ZIPLAT.aspx

  • Posted by Dave C..

    Twofish,

    Paulson’s scare tactics that the world will be ending if the taxpayer bailout for Goldman Sachs isn’t approved is truly repugnant. Paulson demonstrates that he completely lacks any scruples. There are various alternatives to a direct taxpayer bailout that were never even considered such as direct US government financing of main street businesses through the Small Business Loan Agency that currently already exists.

    From Bloomberg, Bank of America’s top credit strategy analyst says Paulson Debt Plan May Benefit Mostly Goldman Sachs.

    http://www.bloomberg.com/apps/news?pid=20601087&sid=aUj_9.k13q7s&refer=home

    Goldman Sachs Group Inc may be among the biggest beneficiaries of the $700 billion U.S. plan to buy assets from financial companies while many banks see limited aid, according to Bank of America Corp.

    “Its benefits, in its current form, will be largely limited to investment banks”, Jeffrey Rosenberg, Bank of America’s head of credit strategy research, wrote in a report dated yesterday, without identifying particular banks.

  • Posted by 3.1415

    Brad, could you please give a short conclusion for any of your complicated blog pieces? Whether 700 billion is sufficient might not matter as much as whether the chain reaction will happen quicker than the Congress can make laws. The hedge funds are going down. More rich people will scream for their Dog to wag its tail. Let’s see whether Comrades Paulson and Bernanke can get the check by this Friday. The market will call checkmate next Monday morning.

  • Posted by E Flanagan

    A question -

    What is your source for the assertion that “of the $13.6 billion of mortgage debt…. $7.8 trillion is held by the Agencies (Freddie, Fannie and the like)”

    Table L.125 in the Flow of Funds analysis shows that GSE-backed pools (which I interpret as securitization trusts or suchlike, which have been guaranteed in credit performance terms by the GSEs) hold $4.6 billion of (single-family) mortgages and Table L.124 shows the GSEs themselves hold directly $670 billion of mortages. This adds up to $5.27 billion, of course. Where’s the remainder?

  • Posted by Anantha Nageswaran

    Good stuff, Brad. Pl. complete your analysis.

  • Posted by tyaresun

    Brad,

    The $700B number is a balance sheet number, not the total amount of toxic waste that will be processed by TARP. They will be using this authority to process the $4-5T toxic waste, hence it is wrong to divide the first number by the second to come up with 33c. At least that is my 2c.

    We explicitly need to ask Paulson and Co. what methodology they will be using to price the toxic waste. I do not see any discussion around this in all that I have read. I am much more interested in this question than say things like limits on executive compensation.

  • Posted by bsetser

    E Flanagan — I used the liability side of the agencies balance sheet to estimate assets — i.e. i.e. i summed up line s14 and 15 in late L3. I was tired and it seems my rounding was off — it should be $7.9 trillion.

    looking at the assets of the GSEs does suggest that this overstates their holdings, as the GSEs hold $850b in Agency bonds. That reduces their net holdings to around $7 trillion. to get from $5.3 trillion up to their you would need to add the GSE’s $420b of corporate bonds (think private MBS) and perhaps the $920 in FHLB loans outstanding.

    I haven’t thought about the double counting issues there tho.

    good catch. thanks.

  • Posted by RebelEconomist

    Yes, interesting and useful, but there seems to be something wrong with the link to the flow of funds.

    jkh has addressed two questions that would interest me. How much capital do the banks have – I would want to see this fully depleted before public money is spent. And what fraction do the losses represent of the aggregate wealth of the US. My vindictive side would also like to know how much of that aggregate wealth was accumulated from bonuses in recent years so that it can be windfall-taxed.

  • Posted by indignant_prole

    The bailout focuses on MBS and consumer credit. What about the agency debt? Why are foreign central banks (aside from GCC) not buying agencies anymore if they’re “insured”? They yield much more than the 10 yr…

  • Posted by Freude Bud

    Yes, please continue analysis. Very helpful.

    … &, btw, $10 billion IS a lot of money …

  • Posted by RebelEconomist

    I also agree with jkh regarding Moldbug’s argument. Government debt does not represent banknotes-to-be-printed, because the government can appropriate existing banknotes in taxation to pay their debt. It is a bit like confusing stocks and flows.

  • Posted by Twofish

    DC: Paulson’s scare tactics that the world will be ending if the taxpayer bailout for Goldman Sachs isn’t approved is truly repugnant.

    If there isn’t some sort of rescue package in the next two to three weeks, then yes there is a chance that the world will end. Scare tactics are more effective if there is something really to be scared of.

    DC: There are various alternatives to a direct taxpayer bailout that were never even considered such as direct US government financing of main street businesses through the Small Business Loan Agency that currently already exists.

    Small business loans mostly use capital given by the banks. The government just acts as a guarantor. Expand SBA to issue money directly is probably something that can’t be done in a month. In any case, small business are doomed if they don’t have access to checking accounts and working capital loans.

    My goal in all of this is that in about two years when Wall Street and Goldman-Sachs makes a ton of money from this, no one will be able to complain about a backroom deal because all the deals were made in the front room with everyone looking on.

  • Posted by Twofish

    One thing about this bill is that $700 billion is the amount the Treasury can hold at one time. They can sell off assets and then buy new ones.

  • Posted by pseudorandom

    bsetser: It might be higher because it is possible to create “synthetic exposure” to various kinds of securities — basically, financial institutions can make a side bet among themselves about the future value of a mortgage backed security. That exposure nets out, but the netting only works if the losing party to the bet can pay up

    Brad,
    I think this is much more important than the space you have given to it suggests. Afterall these “side-bets” include CDS contracts which were at the center of the systemic risk fears involving AIG, LEH and BSC.

    I have seen reported cases of “CDS-chains” where one institution hedges its exposure to a CDS not by settling the contract, but by creating another CDS to “cancel out” its original exposure. Of course the exposures only cancel out if counter-party risk is neglected as you pointed out above. For e.g. see this:
    http://www.nakedcapitalism.com/2008/06/ubs-cds-lawsuit-harbinger-of-things-to.html

  • Posted by pseudorandom

    The discussion over whether $700B is sufficient or not is rather moot.

    From http://www.nakedcapitalism.com/2008/09/why-you-should-hate-treasury-bailout.html
    “$700 billion is not the maximum that the Treasury may spend, it’s the ceiling on the outstandings at any one time. It’s a balance sheet number, not an expenditure limit.”

    There is *no expenditure limit* under Paulson’s plan. It really is a blank check. I am surprised more people have not caught onto this.

  • Posted by pseudorandom

    Twofish: My concern in all of this is that no matter what you do, some Wall Street type is going to make some money off the situation. This is what Wall Street-types do.

    I don’t know why you keep repeating this BS. What is this based on exactly? Anything other than your faith in the dazzling brilliance of Wall St bankers to make money no matter what?

    It is not true that Wall St-types always make money. It is merely true that they are always trying.

    It is truly despicable that their greed should extend so far as to profit off of the tax-payers agony. But there is nothing inevitable about it. With firm oversight there is no need for any Wall St type to make windfall profits out of this bailout. Common decency demands that every effort be made to ensure that bailout money does not get skimmed off by these guys this time around. It has been done before and it can be done again.

    If you have any reason other than your touching faith in the banker’s superior intelligence to believe this is not possible, please share it with us.

  • Posted by Dave C..

    Twofish: If there isn’t some sort of rescue package in the next two to three weeks, then yes there is a chance that the world will end.

    DC: From the same Bush Administration characters that brought us the Saddam “weapons on mass destruction” lie and the Iraqi “biological weapons deployed on UAVs ready to attack the US” fable, somehow the “scary story about the coming collapse of the world” doesn’t have any credibility. If Paulson had any personal integrity, he would have at least reclused himself from any taxpayer bailout legislation for Goldman Sachs that he personally profits from.

    For all of Paulson’s condescending talk about the lack of Chinese transparency, the taxpayer bailout bill as proposed specifically prohibits any Congressional or Court oversight on how the $700 billion is spent or wasted. I don’t think any one individual on the planet should be trusted with $700 billion “black check” of taxpayer dollars.

  • Posted by moldbug

    jkh,

    That’s kind of the point of the M0 exercise: it helps remind us of the difference between the “privatized” or “virtual” dollars (deposit liabilities) in M1 and the “real” dollars in M0.

    These are certainly not the same thing. But the exchange rate between the two is 1:1. Why? Because there is complete confidence in USG’s informal guarantee to FDIC, which is backed by the power to print. Remove the power to print and M1 vaporizes, like everything else.

    So, effectively if circuitously, the Fed has declared that a bank liability is a dollar, just as it declares that a piece of green paper is a dollar. In theory if not in law, it can repudiate dollars, too – USG could declare that all FRNs with serial numbers divisible by 3 are henceforth invalid. But it shouldn’t.

    The case of M1 is relatively clear-cut. So is the case of Treasury obligations, which are risk-free for exactly the same reason. Confidence here is ironclad. But these options have metastasized to a wide variety of other instruments, generally liabilities of financial institutions and other large corporations. At its edges, informality bordered on illusion.

    By letting Lehman fail, TPTB announced the demise of the “too big to fail” theory, and cancelled a very large if utterly unquantifiable quantity of these instruments. A profoundly deflationary move, and perhaps a healthy one, but it does not seem as systematic as I’d like.

    There is a sort of latent libertarianism in even the most left-wing responses to this crisis, which I find very inappropriate. A lot of people seem to feel that the government is best which governs least, institutions should fail, and prices should return to their “natural” level.

    Well, I am all for natural – but we are dealing with a very artificial system here. Being a libertarian about the dollar system is like being an environmentalist in New York City. If you build a new skyscraper in Manhattan, what “environment” are you “impacting?” Rats and pigeons?

    Libertarians should realize that if they want a libertarian financial system, the only way to get there from here is through determined and effective government action. The mother of all bailouts doesn’t even approach the level of intervention that would constitute a cleanup.

  • Posted by Dave C..

    From the same Bush Administration characters that brought us the Saddam “weapons of mass destruction” lie and the Iraqi “biological weapons deployed on UAVs ready to attack the US” fable, somehow the “scary story about the coming collapse of the world” doesn’t have any credibility. If Paulson had any personal integrity, he would have at least reclused himself from any taxpayer bailout legislation for Goldman Sachs that he personally profits from.

    For all of Paulson’s condescending talk about the lack of Chinese transparency, the taxpayer bailout bill as proposed specifically prohibits any Congressional or Court oversight on how the $700 billion is spent or wasted. I don’t think any one individual on the planet should be trusted with $700 billion “blank check” of taxpayer dollars.

  • Posted by London Banker

    Orchestrated Looting: White House Dispatches Team to Push Economic Bill

    Fratto insisted that the plan was not slapped together and had been drawn up as a contingency over previous months and weeks by administration officials. He acknowledged lawmakers were getting only days to peruse it, but he said this should be enough.

  • Posted by Richard Cownie

    Very interesting numbers.

    I’ve been thinking about the question of the total value of the mortgage-backed securities. Is there a figure for total mortgage payments ? Or for total default rates ? Given the pain of foreclosure and/or bankruptcy, I find it hard to imagine that more than 30% of homeowners will default, even if they have crappy predatory loans. And indeed, from the figures I’ve seen, even the subprime loans have only about a 17% default rate so far (though perhaps that 17% is skewed towards the larger loans, giving a bigger impact on aggregate payments).

    So my hypothesis is that aggregate mortgage payments are going to stay at least 70% of what was predicted when the bonds were first sold. And thus that a patient investor can afford to pay up to 70% of the original price – as long as he/she is getting a random sample across the whole market.

    The danger, of course, is information asymmetry – if you offer 70% for everything, you’ll get stuck with the worst of the toxic sludge, and the banks will hold on to the relatively good stuff.

    Does any of this sound plausible ? Or am I being too optimistic about this ?

  • Posted by JKH


    Moldbug,

    “There is a sort of latent libertarianism in even the most left-wing responses to this crisis, which I find very inappropriate… Libertarians should realize that if they want a libertarian financial system, the only way to get there from here is through determined and effective government action.”

    I’ve noticed this – very interesting point, I think. Paradox? Irony?

  • Posted by Dave C..

    For the good of the United States of America, Fax the Senate to stand up to justice and protect the taxpayer. Tell them, “No blank taxpayer check” for Wall Street bailout.

    Fax List

    Sen. Richard Shelby (R) 202-224-3416 or 202-224-5137 (try both not sure which is correct)
    Sen. Harry Reid (D) 202-224-7327
    Sen. John Ensign (R) 202-228-2193
    Sen. Jim Bunning (R) 202-228-1373
    Sen. Chuck Grassley (R) 202-224-6020

  • Posted by Twofish

    Cownie: Precisely. That’s why I think that someone is going to make a ton of money from this. Right now all of the valuations for the securities include the possibility that the world will end, and assume worst case scenarios. Part of the reason people are doing that is that “worst case scenarios” in the past have been proven wrong, and there is a non-zero chance that the world will end.

    If the world doesn’t end, then there is going to be a ton of money to be made even out of the worst of the toxic junk.

  • Posted by Chris

    These are very interesting numbers and thoughts.

    The quality of the underlying security for the loans comes to mind as an issue, more than the foreclosure rate.

    If housing prices return to the long term growth trend what might that indicate about the quality of these household liabilities known as bank assets. May be a comparison of the rates of growth of both might be interesting.

    Then of course there’s the question of income and its growth and what level of housing aggregate value that could support without respect to the fictional equity provided by the strange financing of the years 2002-2007. That would be the percentage of homeowners still paying mortgages less a number estimated for the super rich.

    Can’t help but thinking that the lenders supported the overall price rise through the appraisals they accepted for new and used homes, among the other things that seem to have been done.

  • Posted by pseudorandom

    Richard Cownie: I’ve been thinking about the question of the total value of the mortgage-backed securities. Is there a figure for total mortgage payments ? Or for total default rates ?

    These number change a lot month to month. See for e.g.:
    http://www.marketwatch.com/news/story/transunioncom-mortgage-loan-delinquency-rates/story.aspx?guid=%7B03A11852-E04E-48D3-963E-7C02145BB778%7D

    RC: Given the pain of foreclosure and/or bankruptcy, I find it hard to imagine that more than 30% of homeowners will default, even if they have crappy predatory loans.

    Subprime delinquencies are just beginning to flatten out. 30% for thos class is not inconceivable. If a borrower is broke, they will default whether they like it or not. Still overall delinquency rates are much lower than this see link I offered above.

    RC: So my hypothesis is that aggregate mortgage payments are going to stay at least 70% of what was predicted when the bonds were first sold. And thus that a patient investor can afford to pay up to 70% of the original price – as long as he/she is getting a random sample across the whole market.

    Or a patient investor can examine each class of mortgage separately and estimate its value. The problem of course, is there are no patient investors around these days – or the assets are still priced well above the 70% would justify.

    RC: The danger, of course, is information asymmetry – if you offer 70% for everything, you’ll get stuck with the worst of the toxic sludge, and the banks will hold on to the relatively good stuff.

    Yes which is why this would be an exceptionally poor way to structure the bailout. Because of the widely different quality of assets out there, if you make a blanket offer for everything you are just asking to get robbed.

  • Posted by Twofish

    moldbug: Being a libertarian about the dollar system is like being an environmentalist in New York City. If you build a new skyscraper in Manhattan, what “environment” are you “impacting?” Rats and pigeons?

    Or for that matter being a Marxist on Wall Street, as I am. Personally I think that Marx was right that the economic system is a means by which the ruling classes perpetuate their power and authority. The part that he got wrong was the idea that he had a better system in mind. You can and should modify the system to prevent the worst abuses, but ultimately the people that ended up bashing evil capitalists and bankers were pretty unable to come up with a better system.

    You kind of see it in this case. People are screaming against a taxpayer bailout, but no one has come up with a major alternative. Yes there can and should be some changes to what Paulson has proposed, but in the end I think you’ll see the thing pass with some relatively minor changes.

    Part of the problem is that anyone that knows enough to make something like this work is part of the system. Do Wall Street bankers have conflicts of interest in talking about bills that affect Wall Street banks? Hell yes. But do you really expect to get a sensible workable bill on banking written by pastry chefs? The notion that you can shoot the lawyers, the bankers, and the social parasites is a popular fantasy, but when people have tried it, the people that have ended up in power have often been worse.

    Paulson’s proposal has the one advantage of being clean and easy to understand “give the Secretary of Treasury a $700b blank check and appoint him king of the world.” Everyone is going to look at how much money Goldman-Sachs gets out of this, and there will be a lot of screaming about how much money that will be.

    One problem is that if you start including restrictions and paragraphs is that you’ll end up with a hundred page bill that ends up giving things to various people in non-obvious ways, and you don’t know where to look to see if your pocket is being picked.

  • Posted by Dave C..

    http://www.counterpunch.com/whitney09152008.html

    Securitization has failed. The cuts to the Fed’s Funds rate have failed. The auction facilities — TAF, PDCF, and TSLF — have all failed. The off-balance sheets operations, the debt-pyramiding asset-inflation, the Enron-style accounting, the SIVs, the CP, MBS, CDOs, have failed. The subprimes, the piggybacks, the option-ARMs, the Alt-As have all failed. Structured finance has failed. The system doesn’t work; won’t work; can’t work. It’s built on the misguided assumption that capitalism can thrive without capital; that one dollar can be infinitely magnified by complex debt-instruments and mega-leveraging to generate real wealth and keep the wheels of finance and industry humming along. It can’t be done.

  • Posted by Richard Cownie

    “The quality of the underlying security for the loans comes to mind as an issue, more than the foreclosure rate.”

    If you look at the collateral you’re going to be pessimistic. House prices have fallen a lot, and they’re still falling. A wave of foreclosures makes them fall further. And the costs of foreclosure proceedings and the discount needed to sell a foreclosed property give a further penalty.

    So yeah, the collateral is junk. But the payment stream is real, and with overall delinquency at 3.5%, on average (or in aggregate) that’s still 96.5% of the maximum possible. And when the bonds were originally sold, they probably predicted at least 1.5% delinquency. So that should still be around 98% (= 96.5/98.5) of original value.

    Obviously things can get worse; and subprime loans – especially from fraudulent lenders – are going to be a lot worse. But it’s hard to imagine circumstances where the delinquency rate rises from 3.5% up to 30%.
    So a lot of those securities are going to generate a pretty healthy income stream.

    If I understand it correctly, the source of the “crisis” is twofold: a) the banks got so heavily leveraged that even a modest drop in these assets was too much, and that happened because they suckered themselves into believing the AAA credit ratings, and b) the complexity of the securities, and the slicing and dicing, means that no-one’s quite sure how to predict the income stream on any particular security (as opposed to predicting the aggregate income of all mortgages).

    With the undercapitalization and the lack of transparency, the whole market froze up leading to the current firesale prices. But the fundamentals, in the aggregate, just can’t be that bad.

  • Posted by Chris B.

    Brad,

    Your analysis came before Bernanke told Congress that the intent of the bailout is to pay close to par value (far above market value) for these securities. It seems to me that they are trying to reverse price discovery and set an artificial value for these securities allowing a mark-up on the balance sheet of these other trillions of dollars worth of similar securities. If that is true, then the true cost to the taxpayer is going to be very close to the $700 billion cap, and it is all a ruse to get around FASB 157. Why not just repeal FASB 157 and save $700 billion??

  • Posted by gillies

    my memory – from figures concerning helicoptering in cash to the kurds (literally helicoptering ) is that $100 dollar bills weigh one tonne per $100m. so the answer to your question is : 7000 tonnes of $100 bills.

    how big is bernanke’s air force ?

  • Posted by pseudorandom

    Twofish: Everyone is going to look at how much money Goldman-Sachs gets out of this, and there will be a lot of screaming about how much money that will be.

    You still haven’t given one reason why it is desirable or inevitable for Goldman to get a penny out of this.

  • Posted by Michael Richman

    twofish says:

    “One problem is that if you start including restrictions and paragraphs is that you’ll end up with a hundred page bill that ends up giving things to various people in non-obvious ways, and you don’t know where to look to see if your pocket is being picked.”

    Maybe we should button that pocket before it gets picked, e.g. no bailout. Once my pocket is picked, I don’t think I care who picked it, all I know is, I’m out of money.

  • Posted by moldbug

    jkh,

    We’re wildly off-topic here, but IMHO the problem is that libertarians think of their bugaboo, the State, as a completely separate class of animal from the private corporations which they so admire. Despite the considerable resemblance between the two.

    You’d expect that even just for its own selfish reasons, a well-managed state would pursue basically liberal/libertarian policies. A state’s capital is its real estate, and bureaucratic government (or worse) is not a value enhancer. But this does not tell us anything about how to get from here to there. The result is a persistent failure in translating libertarian thought into effective and productive action.

  • Posted by Dave C..

    http://www.globalresearch.ca/index.php?context=va&aid=10313

    “This is the de facto nationalization of the entire banking, insurance and related financial system..That’s right – every bank and other financial institution in the United States has just become a de-facto organ of the United States Government, if Hank Paulson thinks they should be, and he may order them to do virtually anything that he claims is in furtherance of this act…..The bill gives Paulson the ability to nationalize unlimited amount of private debt and force you and your children to pay for it.”

    “The claim is that this is intended to ‘promote confidence and stability’ in the financial markets. It will do no such thing. It will instead strike terror into the hearts of investors worldwide who hold any sort of paper, whether it be preferred stock, common stock or debt, in any financial entity that happens to be domiciled in the United States, never mind the potential impact on Treasury yields and the United States sovereign credit rating.

    If this passes it will precipitate the mother and father of all financial panics.”

  • Posted by Cere Davis

    Brad, I know this isn’t your economic focus but I would be keen to get your feedback on this thought, idea.

    I don’t understand why we bailing out the big banks sub prime problem after leveraging? That would seem to cost way way more money than just bailing out homeowners directly. It always amazes me how our government can find money out of thin air for Wall Street but can’t seem to solve our own health care system at a fraction of the price.

    Why shouldn’t we just use the roughly 700billion dollars to pay for Americans mortgage directly (before all the ridiculous leveraging) as an effective method of backstopping the losses. If you assume that there are roughly 50million homeowners in the US with mortgage debt, divide 1 trillion by the 50 million, you get $20,000 for each homeowner to pay there mortgage and “save” a better part of the sub prime mess. Many homeowners would be able to pay off there loans while others would be in a functional position to maintain their mortgage and some may be able to reduce there monthly payments due to a positively shifted loan to equity value ratio (getting rid of private mortgage insurance payments, etc). There would have to be more to this plan and something would need to be offered to renters as well, to be fair. This strikes me as a more patriotic, fair and effective solution that may, in fact stimulate the economy and satisfy out creditors (which are largely foreign entities these days). Is there something I am missing here? Likely. But I think this kind of idea should at least be a more prominent part of the conversation.

  • Posted by RebelEconomist

    Twofish: “People are screaming against a taxpayer bailout, but no one has come up with a major alternative”

    What is wrong with the existing solution. If people default on their mortgage the bank gets possession. It’s up to the bank how they sell the house, but if a bank defaults as a result of its losses, bankrupt the bank. In short, liquidate, liquidate.

    Then, when the process has gone far enough and asset prices start to look cheap, ease like crazy. If more than a desirable number of banks have closed, nationalise the rest that go bankrupt. Spend public money on easing the transition by expanding the bankruptcy court system. Give grants to encourage renters to buy the foreclosed houses so that they don’t stay empty. Give grants to those who leave graciously to move and spend money on jailing those that don’t. Spend money on retraining surplus realtors, bankers and builders. Spend money on productive infrastructure such as railways, bridges, levees and windmills, on schools in deprived areas. In short, reflate.

    Where does the money come from? Windfall tax those who have benefitted from the boom. Increase inheritance taxes. Borrow money if bond yields are low. Print money if inflation turns negative.

    There. Easy!

  • Posted by Twofish

    pseudo: You still haven’t given one reason why it is desirable or inevitable for Goldman to get a penny out of this.

    It’s inevitable because you have some very smart people that have a history of a system and figuring out how to make money off of it, and there are a lot of ways of doing it.

    Whether it’s desirable or not, is another issue.

  • Posted by Twofish

    Richman: Maybe we should button that pocket before it gets picked, e.g. no bailout. Once my pocket is picked, I don’t think I care who picked it, all I know is, I’m out of money.

    Your pocket is still going to be picked if there is no bailout, and unless you want FDIC insurance to fail, there is going to be a federal bailout of some sort. Right now we are looking at $700 billion to recap the banks, and FDIC only has $50 billion in cash.

  • Posted by pseudorandom

    Cere Davis: Why shouldn’t we just use the roughly 700billion dollars to pay for Americans mortgage directly (before all the ridiculous leveraging) as an effective method of backstopping the losses. If you assume that there are roughly 50million homeowners in the US with mortgage debt, divide 1 trillion by the 50 million, you get $20,000 for each homeowner to pay there mortgage and “save” a better part of the sub prime mess.

    A very good idea! However you don’t want to leave out families without mortgage either, so how about just making it a $2T stimulus package which will give more than $13k for every American family and materially improve the mortgage delinquency?

    But it won’t happen because Paulson does not care so much for bailing out poor families.

  • Posted by Twofish

    RebelEconomist: If a bank defaults as a result of its losses, bankrupt the bank. In short, liquidate, liquidate.

    Because without putting in federal money, depositors lose their checking and savings accounts in the process. At this point economic activity just stops. People lose their jobs, factories close, and tinpot wannabe dictators with funny moustauches look attractive.

    Yes things will eventually recover, but last time this happened it took 15 years.

  • Posted by Auditor Jane

    Has anyone asked what the [investment] banks will do with this money once their balance sheets are “dressed up”?

    Here are some possibilities:

    1) Loan money to consumers? Probably not – many consumers are tapped out.

    2) Loan money to US businesses to invest? Probably not – Most US businesses are cautious and not looking to invest in the US. Business Spending is only 7 to 10% of the total economy in the US anyway. In 2004 GDP numbers, 7% would only be about $700 billion.

    3) Merge and buy out each other? Maybe

    4) Lend money to companies for mergers? Perhaps.

    5) Loan money to overseas customers?

    6) Compensate their executives with large bonuses?

    Are there too many resources in this sector of financial services? Does the 700 Billion injection prevent what should occur – some consolidation and release of resources to other industries?

    The key question is – What WILL the entities do that receive these funds? If you don’t know this, how can this even be considered?

  • Posted by Twofish

    pseudo: A very good idea! However you don’t want to leave out families without mortgage either, so how about just making it a $2T stimulus package which will give more than $13k for every American family and materially improve the mortgage delinquency?

    At that point you’ve made massive transfer of wealth from savers to borrowers. If you borrowed huge amounts of money on a house you couldn’t afford, you win big. If you saved lots of money in a CD, then assuming the bank doesn’t go broke, the value of that CD gets inflated away. This is also bad if you are a renter.

    If people want this, then sure it can be done.

    pseudo: But it won’t happen because Paulson does not care so much for bailing out poor families.

    Actually I think he does. The trouble is that if the economic system goes poof, then no one wins.

    Also, one thing that you have to be careful about is whether something really does help poor families. Fannie Mae and Freddie Mac were able to get into subprime business was that in 2004 and 2005, they talked about “making mortgages affordable for the poor.”

    Quite frankly, I don’t see the point in giving people money if the bank is just going to take it. It makes more sense to me to change the bankruptcy laws to make it easier for poor people to wipe out their debt.

  • Posted by pseudorandom

    pseudo: You still haven’t given one reason why it is desirable or inevitable for Goldman to get a penny out of this.

    Twofish: It’s inevitable because you have some very smart people that have a history of a system and figuring out how to make money off of it, and there are a lot of ways of doing it.

    Yeah and there are lots of ways of restraining them too. In the end you are simply it is inevitable based on nothing more than your own faith in the brilliance of the bankers.

    That’s hardly an objective basis to draw any conclusions. This is just your unsupported opinion, nothing more.

  • Posted by Twofish

    Auditor: Has anyone asked what the [investment] banks will do with this money once their balance sheets are “dressed up”?

    Well since you asked, it really depends on what the final package looks like. There are a few ways where Wall Street will make money:

    1) buy distressed mortgage securities, hold them until it looks like the world is not going to end and then resell them,

    2) if you have a bankrupt bank, then there is a lot of money to be made by restructuring the bank so that it becomes profitable again,

    3) if the government decides to hold on the mortgages then someone is going to have to do things like collect fees, send out bills, etc. Also the government could subcontract the management of the assets, or it could basically create its own investment bank,

    4) whoever buys the mortgages are probably going to need portfolio management services.

    Again whatever happens depends on what the plan looks like, but whatever the plan is, someone in Wall Street is going to make money.

  • Posted by pseudorandom

    Twofish: Quite frankly, I don’t see the point in giving people money if the bank is just going to take it. It makes more sense to me to change the bankruptcy laws to make it easier for poor people to wipe out their debt.

    Why is it either/or? Why can’t we have both a stimulus package and a change in bk laws?

    Twofish: At that point you’ve made massive transfer of wealth from savers to borrowers. If you borrowed huge amounts of money on a house you couldn’t afford, you win big. If you saved lots of money in a CD, then assuming the bank doesn’t go broke, the value of that CD gets inflated away. This is also bad if you are a renter.

    How does a renter lose if he/she also gets a stimulus check? Why does a CD inflate away if the stimulus is sterilized by selling bonds as the Treasury. Or rather why would it be any different from what would happen by giving a $1T to Wall St instead?

    Twofish: Fannie Mae and Freddie Mac were able to get into subprime business was that in 2004 and 2005, they talked about “making mortgages affordable for the poor.”

    Yeah that’s what they talked about in their PR. But what happened in reality? Most real-life subprime mortgages were not affordable but instead usurious and predatory. FAN/FRE were only a small part of the subprime market.

  • Posted by pseudorandom

    Twofish: Again whatever happens depends on what the plan looks like, but whatever the plan is, someone in Wall Street is going to make money.

    You can repeat this a 1000 times but that does not change it from your unsupported opinion into reality.

    There is no objective reason to support the thesis that it is inevitable for someone on Wall St to make money on the bailout. Taxpayers should not just lie over and accept this.

  • Posted by Dave C..

    Rehashed “Scare tactics” from the same Bush Administration wrecking crew:

    Iraq War:
    “mushroom clouds could accompany Congress’s failure to act on the war request”

    Bankster bailout:
    “financial Armageddon could accompany Congress’s failure to act on the bailout request”

  • Posted by RebelEconomist

    Twofish,

    I am not saying don’t put in Federal money, but I am saying follow established procedures, going down the creditor hierarchy to take as much as possible from those who accepted risk, first. No depositors have lost money from recent bank closures in the US have they?

  • Posted by Twofish

    pseudo: Yeah and there are lots of ways of restraining them too.

    Sure, and an IB will gladly accept consulting fees to tell people how to set up the rules so that investment banks get restrained. Takes a thief to catch a thief.

    pseudo: In the end you are simply it is inevitable based on nothing more than your own faith in the brilliance of the bankers.

    It’s partly because I know people that work on Wall Street, and I think that they will find an angle. Not all bankers are smart, but a lot of the dumb ones got wiped out recently. Goldman-Sachs has a higher than average chance of finding an angle, but if they don’t, someone else will.

    pseudo: That’s hardly an objective basis to draw any conclusions. This is just your unsupported opinion, nothing more.

    We’ll see in two years.

  • Posted by pseudorandom

    Twofish: Sure, and an IB will gladly accept consulting fees to tell people how to set up the rules so that investment banks get restrained.

    Anyone who depends on Wall St’s advice on the matter is either stupid or corrupt.

    pseudo: That’s hardly an objective basis to draw any conclusions. This is just your unsupported opinion, nothing more.

    Twofish: We’ll see in two years.

    Oh we’ll find out in 2 weeks. The only thing that matters is whether reasonable rules and checks/balances are put in place for the bailout.

    It has nothing to do with Goldman’s alleged geniuses. It has everything to do with having Henry Paulson in your pocket to make the process non-transparent and unaccountable and make the looting possible.

  • Posted by Twofish

    pseudo: Why is it either/or? Why can’t we have both a stimulus package and a change in bk laws?

    If you can get it to pass then sure. The trouble is that counting votes, I don’t see the votes to pass everything you want, so you have to compromise and keep the most important parts. Bankruptcy relief I think is more important than economic stimulus. Stimulus you can pass if Obama gets elected, but if you don’t change the bankruptcy laws now, it’s unlikely that there will be another chance to do so.

    More money is always politically popular, but loosening bankruptcy laws is not, since once this crisis is over, you are going to have the banks talk about “deadbeats” whenever someone loosens bankruptcy law.

    Right now, when the banks are desperate, you want to get your pound of flesh while you can.

    pseudo: How does a renter lose if he/she also gets a stimulus check? Why does a CD inflate away if the stimulus is sterilized by selling bonds as the Treasury.

    Because if you add $1 trillion to the money supply to issue stimulus *and* you issue another $1 trillion to recapitalize the banks once FDIC goes broke, you will get inflation. At this point you are just printing money.

    pseudo: Or rather why would it be any different from what would happen by giving a $1T to Wall St instead?

    Because unless you want to have people lose their FDIC-insured checking accounts, you have to pop $1T into the banks whatever you do. If you don’t put money into the banks, then people will get a stimulus check, but they lose their checking accounts and their jobs, so you’ll have people having a check from the government, but nowhere to deposit the money to because the banks are all dead.

    If you look at most households, they have only two/maybe one asset. A job and a house.

    pseudo: Yeah that’s what they talked about in their PR. But what happened in reality? Most real-life subprime mortgages were not affordable but instead usurious and predatory. FAN/FRE were only a small part of the subprime market.

    Sure. That’s why I distrust people that aren’t transparent about what they really are after. If someone goes up to me and says, I want your money. This is how much I will take, this is what I will leave you with, and this is why you should give it to me, that’s fine.

    But if someone starts talking about helping the poor, protecting taxpayers, or saving baby seals, and I can’t figure out what they want and how it will benefit them. I get very, very suspicious. Either they are a wolf, who will stab me in the back the second I turn around, or they are a sheep that will get eaten by wolves the second I leave.

  • Posted by david

    very interesting.

    but what about commercial mortgage debt (I don’t think you have included that, and the 700 billion can be applied to that as well can’t it).

  • Posted by LB

    pseudo: You still haven’t given one reason why it is desirable or inevitable for Goldman to get a penny out of this.

    if i may interject a 2 word answer re: inevitability:

    Litton Loans

    http://tinyurl.com/4ota33

    note the timing of the purchase…

  • Posted by Brad

    Please forgive my ignorance, so much of what is occurring boggles my mind and I’ve been having serious problems making sense out of the market behavior of the last few months.

    My assumption:

    It is true that unless Wall St gets comfortable enough with their neighbors again to start lending, Main St will go down the tubes with them. Removing the doubt (bad CDO’s, CMO’s, whatever, etc) will certainly increase faith in the future ability of banks to repay each other.

    My question:

    If Glass-Steagall had remained in effect, limiting commercial banks to say the 5% or 10% broker activity derived revenue, would this crisis have such far reaching implications that it threatens the (relatively simple) financial transactions required to run business from day to day?

    I have no real clue, forgive me again, but my suspicion is that the fall-out would likely have been much more contained.

  • Posted by pseudorandom

    Twofish: Because unless you want to have people lose their FDIC-insured checking accounts, you have to pop $1T into the banks whatever you do.

    I don’t see why. If you do a strong stimulus package, the influx of new deposits from the stimulus checks will automatically save most of the banks by giving them a massive increase in liquid reserves. It is the opposite of a bank run.

    Twofish: If you don’t put money into the banks, then people will get a stimulus check, but they lose their checking accounts and their jobs, so you’ll have people having a check from the government, but nowhere to deposit the money to because the banks are all dead.

    The very stimulus checks will save most of the banks. Why would a bank fail when there are so many new deposits coming in? That does not make any sense to me.

    Twofish: If you look at most households, they have only two/maybe one asset. A job and a house.

    Since when is a job an “asset”?

  • Posted by longtooth

    pseudorandom — you said:

    “Common decency demands that every effort be made to ensure that bailout money does not get skimmed off by these guys this time around. It has been done before and it can be done again.”

    Since what point in historical time has common decency had anything to do with the profit motive?

  • Posted by Michael

    3 Points:

    1. I own MBS (sold by Countrywide) rated AAA that pay 6% and I get my payments on time every time (thank you Ken Lewis). Current open market value is 55 cents on the dollar. There’s 27 years left to maturity, and I’d be surprised if they got paid off early (the original “risk” mentioned at the time of sale). I’m not buying the “End of the World” panic-mongering , and short of WWIII I’m going to hold it to maturity – and take no losses (other than possible interest rate risk as in any other long bond held to maturity); unlike the geniuses on Wall Street I can do this, because I paid for it with cash in hand, not leveraged debt.

    2. DC is absolutely right, and anyone who is missing the exact parallel between the “Supr-Hurried Rush to Save the Financial System” and the fear&lie-based selling of the blank check Iraq War Authorization deserves exactly what we’re going to get for being railroaded again.

    3. I notice none of the Congressional crowd managed to summon up the courage to ask Hank Paulson: “If we authorize your request, will you make a binding commitment that when you leave your current position you will not take employment or serve as a paid consultant for any business that directly or indirectly receives financial benefit from the funds you wish us to let you hand out?”

  • Posted by slumlord

    The 700 billion is a only a balance. Paulson’s poodle stated that he wants to pay close to par for the toxic assets.

    Lets do the math.
    Buy toxic assets at 95cents in the dollar.
    Sell into the open market at 60 cents in the dollar.

    Cost to treasury 35cents in the dollar. Total amount of trash laundered through this system.
    2.85x 700billion=Approximately 2 Trillion dollars.

    Banks get recapitalised.
    Buyers of toxic debt probably make at profit at low price.
    Average taxpayer with high debt level and falling home price remains in the same situation and economy remains moribund.

    Problem no 1.

    Whats to stop Goldman selling its crap to Treasury for 95cents in the dollar and then buying it back at 60?

    This is Junta economics people.

  • Posted by dennis

    Guys, I made this short video at the NYC financial district last night. It’s crude but I think it gets the point across. Please pass it on to politicians and friends if you agree.

    http://www.youtube.com/watch?v=eMD1yGJIrQg

  • Posted by Michael

    OK, I’ve got a 4th Point:

    4. The whole point of all these bailout frenzies (setting aside the “feed-your-cronies” theories) is to sustain the business affairs of overleveraged companies and households by direct subsidies and by propping up drastically bloated asset values. Every generation thinks it is much, much smarter than those who came before, and they always make the same mistake. This generation – which has substituted debt for earnings and savings as a means to growth and wealth – thinks it has superpowers to prevent the deleveraging that has begun from reaching any free market equilibrium. Subsidies, asset-buying, and nationalization have all been tried before, many times, and they have never prevented the fall of asset prices to equilibrium. Just as many could never picture housing prices falling precipitously and many could never picture credit markets seizing up in the modern world, many still can’t picture the coming refusal to fund the U.S. through continued purchase of Treasuries that are being printed like Monopoly money and pay negative real returns. When that music stops, don’t even bother looking for a chair.

  • Posted by pseudorandom

    slumlord: Whats to stop Goldman selling its crap to Treasury for 95cents in the dollar and then buying it back at 60?

    According to Bloomberg, Paulson wants to pay “hold to maturity” prices on the mortgage assets. He claims that these assets are currently undervalued because of illiquidity.
    http://www.bloomberg.com/apps/news?pid=20601087&sid=a5LnfjbIV3bU

    But how do you determine the “hold to maturity” price? This raises the possibility of abuse just like you pointed out above.

    Luckily there is a very easy way to avoid this kind of abuse: Paulson can buy the assets but then he has to hold it to maturity (or sell it at par). Congress needs to ban Paulson from doing fire-sales of assets he purchases using bailout money.

  • Posted by RebelEconomist

    A lot of people, including me, are criticising the TARP proposal because it does not seem to extract as much as it could from the banks’ equity, but I wonder whether the 500 pound gorilla here is the seemingly sacrasanct “homeowner” (debtor, really) who must be “kept in their home”. At worst, these people were greedy chancers, at best they were unwise. How much is protecting them costing? And who is speaking for those who are being kept out of the housing market because house prices are being propped up?

  • Posted by slumlord

    PsuedorandomLuckily there is a very easy way to avoid this kind of abuse: Paulson can buy the assets but then he has to hold it to maturity (or sell it at par). Congress needs to ban Paulson from doing fire-sales of assets he purchases using bailout money.

    Let’s see Congress try to impose that limitation on Paulson, it will be a no deal. Liquidity is stymied at the moment because no one knows who’s next to go under. Hidden insolvency is causing market illiquidity.

    Michael: You are correct. Assets are being repriced to a realistic level. There is no painless solution to this problem. The question is how to make the process least painful and not exacerbate it. Paulsons plan keeps the idiots who got society into this mess in power, while sticking the bill to taxpayers.

    Once again this is Junta economics.

  • Posted by slumlord

    Rebel economist.

    I understand that the Democrats want the provision of allowing Judical modification of mortgage contracts in order to keep people in their houses. Dumb idea. Who the hell would want to investing in housing when the return can be arbitrarily modified by a Judge. It will further drain credit from the market and further depress asset prices.
    The only workable solution to this problem is to increase the income of average Americans through structural changes in the distribution of profits and investment in manufacturing. This is going to take years. Once again. No painless solutions.

  • Posted by Judy Yeo

    wow, lotsa concerned people. anyway, thought to drop a note on the only blog post that doesn’t seem to have completely written off the dollar – do take a look at pritchard’s blog post on the telegraph- the emu smash up though may not sit well with many people, nor the crumbling chinese banking system – anyone saw the fitch report, do post links if at all possible.

  • Posted by Judy Yeo

    rebeleconomist

    well, those sacrosanct houseowners are also likely to be the gorillas with voting rights in a month’s time- who wants karma kicking in?

    betcha brown’s thinking the same thing, will we see “byebye labour” next year?

  • Posted by Cedric Regula

    Here’s da summary of da plan from RGE. Uncle Bruno don’ta know wad dis stuff is, but tinks its da $10T dat have nut’in to do wid mortgages dat wads really scaring Ben & Hank.

    Uncle Bruno tinks we shoulda just put our heads between our legs an’ let it blow. Den if any savings & checking accounts geta taken out, move dem to remaining banks and have da FDIC do wadda dey do.

    Den break up F&F inta baby butts and privatize dem as sum new S&Ls.

    Probably take some money to do all dat, so’s it woulda be good to have some left after ita happens anyway even wid da $700B plan.

    Der already is da F&F bailout to spend $200B ona new or restructured loans. Also last years subprime bailout of $300B.

    If’n dey think dey gonna buy all da loans at face value dats $11T. Enough is enough.

    ++++++++++++++++++++
    Details Of $700bn Troubled Asset Relief Program (TARP): Bernanke Proposes ‘Hold-to-Maturity’ Purchase Prices

    * In its original version, Treasury requests the right to buy anything from any institution (incl. hedge funds) at theoretically any price it deems right without oversight or legal recourse. Management of assets will be outsourced to the private sector. Authority expires Sep 2010. By order of magnitude, the entire shadow banking system incl. brokers and hedge funds is $10 trillion of which $5 trillion are buried in off-balance sheet vehicles. Ben Bernanke proposes ‘hold-to-maturity’ purchase price instead of current market value described as ‘fire-sale’ price.
    * Krugman: if taxpayers are to overpay for securities that other private market participants would not take at any price then an equity stake is a MUST; i.e. should be make-or-break issue in Congress.
    * Democrats’ alternative plan includes measures on: restrictions on executive compensation, Equity stakes in return for bailout to recapitalize institutions and retain upside for taxpayers; Bankruptcy reform to lower debt value of purchased mortgages; Independent oversight of how $700bn are spent; Second stimulus package for Main Street next to bailout for Wall Street.
    * Industry groups want to temporarily suspend mark-to-market accounting in order no to take a writedown on sold assets
    * Tett: valuation and pricing issues prevented the first Super-SIV from working, the same might happen again. If bad asset purchase price is too low, writedowns might be too large to bear; if price is too high, taxpayer overpays and has limited upside eventually–>
    * Geithner (via MarketWatch): The ‘shadow banking system’ that needs to be re-intermediated is a $10 trillion market without adequate capital provisions (=$2.2tr commercial paper conduits incl ABCP + $2.5tr repo/reverse repo market + $4tr combined brokerage assets + $1.8tr hedge funds = $10.5tr in 2007) that boomed outside traditional banking. In comparison: the traditional banking system is also $10trillion.
    * In July, FASB has decided to “eliminate the concept of the Qualified Special Purpose Entity (QSPE)” in the revised financial-accounting standard, FAS 140, starting November 2009. This requires banks to consolidate off-balance sheet vehicles used to package assets into securities –> Up to $5 trillion of dollars worth of illiquid assets/derivatives are buried on banks’ Variable Interest Entities (VIEs)
    * BIS Joint Forum: CDO of ABS (i.e. structured finance CDOs), CDO^2 are not likely to survive the turmoil .
    * SIFMA: Global issuance of CDOs from 2004 – 4Q2007 totaled $1.47 trillion. CDO issuance by underlying collateral in 2007:
    -$254.8bn structured finance CDOs (collateral pool consisting of RMBS, CMBS, CMOs, ABS, CDOs, CDS, and other securitized/structured products)
    -$148.3bn high-yield loans (rated below BBB-/Baaa3) CDOs
    -$78bn investment-grade bonds CDOs

    Sep 23, 2008

  • Posted by Twofish

    RebelEconomist: I am not saying don’t put in Federal money, but I am saying follow established procedures, going down the creditor hierarchy to take as much as possible from those who accepted risk, first.

    There are no established procedures for what is going on, and the procedures that people thought would work are failing utterly. What people thought would happen is that if a bank went under that there would be private credit insurance that would pay for it. This is not working.

    RebelEconomist: No depositors have lost money from recent bank closures in the US have they?

    No. But if you jump off a 100 floor building nothing bad happens for the first 90 floors.

    pseudo: I don’t see why. If you do a strong stimulus package, the influx of new deposits from the stimulus checks will automatically save most of the banks by giving them a massive increase in liquid reserves.

    That will help you if you have a liquidity problem, but not if you have a solvency problem. Once everything gets sorted out it is likely that a lot of banks will not have enough assets to cover deposits, and new deposits will not help. If you deposit $20 into a bank, the bank now owes you $20, and so the banks net position was the same as it was before.

    pseudo: Why would a bank fail when there are so many new deposits coming in? That does not make any sense to me.

    When you give a bank $20, you do expect it back don’t you?

    pseudo: Since when is a job an “asset”?

    A job is by far the most important asset people have. When you go to apply for a loan, how much money a bank is willing to loan you is largely based on how much money you make.

  • Posted by Andrew Foland

    As I noted over at CR’s last night, the total of the top 20 financial holdings of Level 3 Assets, excepting Fannie, Freddie, and AIG which have already been accounted for, is $755BB. Anything outside the top 20 is chump change.

    I suspect that all financials’ Level 3 Assets, paid for at their current marks, may not be a bad place to look for where they came up with the dollar figure.

  • Posted by Twofish

    slumlord: Whats to stop Goldman selling its crap to Treasury for 95cents in the dollar and then buying it back at 60?

    In the AIG and Freddie and Fannie bailouts, the government ended up with shares of AIG and Freddie/Fannie, so if Goldman did this, then Feds can exercise their warrants recover their money.

    The question then becomes what makes you think that Paulson won’t do a sweetheart deal, and the answer is that the Treasury Secretary is hired by the President who you elect. The fact that this answer is not good enough for a lot of people is why people are adding clauses to the bill as we speak. Paulson is not going to get a blank check.

    slumlord: Who the hell would want to investing in housing when the return can be arbitrarily modified by a Judge

    Fewer people investing in housing is not a bad thing, and the judge is merely the messenger of doom. The house has already lost its value, and probably *NEVER* was at the price that the bank put out the loan for.

    The judge just makes it official, and having a situation in which people are forced early on to deal with losses rather than hide them, seems like a good thing to me. If you want to argue that the pile of crap is really gold bricks, then you can do it in bankruptcy court.

    In any case, it’s not fair that big companies get bailed out if little people are stuck with the price tag which is what *will* happen if you don’t have bankruptcy provisions.

    The reason the clock is ticking now is that once the assets of Lehman get put before a bankruptcy court, everyone is going to have to remark their assets prices, and it’s not going to be pretty.

  • Posted by Twofish

    Brad: If Glass-Steagall had remained in effect, limiting commercial banks to say the 5% or 10% broker activity derived revenue, would this crisis have such far reaching implications that it threatens the (relatively simple) financial transactions required to run business from day to day.

    I really don’t think so. The big mega-banks aren’t the one’s falling from the skies. This is for several reasons.

    1) The first is that the big mega-banks have more capital and so their investment banking operations are less prone to volatility and they are less prone to take risks and use leverage.

    2) The second is that when you merge an investment bank with a commercial bank, the combination becomes much more tightly regulated since you have both the securities regulators, the banking regulators, and the federal reserve looking at the combination.

    3) Third, you end up with information sharing. In the mega banks you had the people running mortgages telling the investment bankers that people were starting to not pay their mortgages, and so they were less exposed than pure investment banks.

  • Posted by slumlord

    Twofish:

    “in any case, it’s not fair that big companies get bailed out if little people are stuck with the price tag which is what *will* happen if you don’t have bankruptcy provisions.”

    Totally agree. That’s why I’m opposed to the bailout as is. The problem is however lending money to people who want to use it for whatever reason is intrinsic to capitalism. Borrowing is what funds homes, factory’s and other productive endeavours. You want people to keep borrowing even during an economic downturn. Making lending risky from the point of the view of the lender is not such a smart idea, especially in an economy that will be shrinking. Irrational lending can be both permissive or restrictive, you don’t want the second option in a recession.

    Paulson wants carte blanche; the fact that he cant get it is a feature of the constitution, not the President. Bernake has gone on the record to say that he wants to pay above current market prices for the waste. Why doesn’t he just come out and say that he wants to give the banks a grant? Because it politically unacceptable, therefore the shenanigans.

    I reckon any government intervention in the markets may lessen the initial pain but will prolong its duration. Look, 700 billion would probably be better spent on trying to repopulate the middle class through productive means. House prices have to come down, incomes have to rise and dumb banks have to fail.

    Financial pain is intrinsic to capitalism. It does not insulate people from financial misjudgment. This current crisis is capitalism working normally.

  • Posted by pseudorandom

    Twofish: That will help you if you have a liquidity problem, but not if you have a solvency problem. Once everything gets sorted out it is likely that a lot of banks will not have enough assets to cover deposits, and new deposits will not help. If you deposit $20 into a bank, the bank now owes you $20, and so the banks net position was the same as it was before.

    With time, the banks will eventually get recapitalized. Time is on the side of banks because their assets invariably yield more than their liabilities.

    Twofish: When you give a bank $20, you do expect it back don’t you?

    Eventually. See above.

    Twofish: A job is by far the most important asset people have. When you go to apply for a loan, how much money a bank is willing to loan you is largely based on how much money you make.

    I don’t see the value of this line of thinking. A person can quit a job, get fired, take a sabbatical or retire etc. It confuses more than illuminates to speak of jobs as assets.

  • Posted by Alan von Altendorf

    I haven’t read through all the comments, but had to give a heads up on this one:

    “Small business loans mostly use capital given by the banks.”

    Wait a minute. Whoa. Business and industry are historically funded mainly by retained earnings, i.e., profits – not bank lending. Where the intermediaries are useful and add value is VC, underwriting new issues, mergers and consolidations of listed firms in a crowded sector. I agree with the post that asked what do we need these guys for?

    Right now, there’s nothing for banks to do except take deposits, clear checks, ration commercial and household credit for short term transactional purposes and hedge some foreign exchange. Honest to God, the one best thing the govt can do is cut spending and taxes, federal state and local.

  • Posted by Alan von Altendorf

    <>

    Way off base. Best thing that happened so far is the Lehman bankruptcy. Bidders came forward to buy Euro and Asian branches. That’s what should happen universally and why some in Conngress refuse to change the bankruptcy laws. Unless TARP is shot down, there will be massive shorting of Treasurys and a foreign buyers strike.

  • Posted by Alan von Altendorf

    Twofish wrote: “Your pocket is still going to be picked if there is no bailout, and unless you want FDIC insurance to fail, there is going to be a federal bailout of some sort. Right now we are looking at $700 billion to recap the banks, and FDIC only has $50 billion in cash.”

    Then bailout FDIC. [EDITED FOR LANGUAGE]

  • Posted by Murph

    Richard Cownie: “Given the pain of foreclosure and/or bankruptcy, I find it hard to imagine that more than 30% of homeowners will default”…

    Because of the structure of many of the instruments, the value can be well below ( 100% – Default% ).

    The investment banks (“grandpa, what was an investment bank?”) were pros at cobbling together instruments of equity- and junior-tranches and still securing “A”, “AA”, and even “AAA” ratings.

    Even for prime loans, the equity- and junior- tranches take the first losses, so, instruments composed of those tranches are very much at risk…

    And, recombine a few of those into a CDO^2 (CDO-squared: a CDO of CDO’s) and you truly have something which can very easily, at the end of the day, be worth absolutely nothing.

    A good indication that a high percentage of these instruments are basically worthless is that the banks have had a YEAR to offload these things and delever. The Fed did a good job of buying them time. The banks could find no buyers at any price which would not have revealed their basic insolvency.

    This points to Brad’s 33-cents-on-the-dollar figure being a good ballpark estimate.

  • Posted by bsetser

    Murph

    I agree with your basic point — namely the banks (including the former broker-dealers) had a year, and still didn’t onload the majority of this stuff. And I agree that combining risky tranches created structures that can have amazing little value – despite initial ratings.

    The 33 cents estimate tho was from Buiter — not me. I used it, so i didn’t think it was totally outlandish, but it would seem a bit on the low side as the average valuation for a $2.1 trillion pie. The outstanding stock of ABS is $4.4 trillion, and I have no good estimate of the likely current market cap of all of that. but not all of it will be the really nuclear stuff. At least i hope not …

  • Posted by bsetser

    alan — if I had to bet, there will be a foreign buyers strike if the TARP is shot down. Foreign willingness to hold the credit of US banks would plummet fast …

  • Posted by dieselm

    Warren Buffett invested $5B into Goldman Sachs today.

    For his cash, he received perpetuity preferred shares w/10% dividend, plus $5B more in options priced at 8% below the close.

    Can anyone here explain why if a bank like Goldman is stable enough for the world’s pickiest investor to put money in today, why we need to give $700 billion of taxpayer money for free, no strings, no dividends, no equity, no options?

    If Warren would up his investment to $7B, 99 more private investors like him and we’d be at $700 billion. Or we can give half of 2007′s personal income tax from every taxpayer in america to the banks for free.

    Outrageous. This crisis is a sham.

  • Posted by Murph

    Alan von Altendorf: “Business and industry are historically funded mainly by retained earnings, i.e., profits – not bank lending.”

    Respectfully, the vast majority of businesses doing $1 million or more (and many doing less) operate with a bank line of credit of some sort. And, the larger companies fund their day-to-day operations with commercial paper (about $1.8 Trillion which rolls over continuously).

    Very few businesses of any size could operate on a cash basis.

    Should the bank lines be terminated, and the commercial paper market freeze up, economic life would literally come to a standstill.

    As in a “hide in your bunker and hoard ammunition and canned goods” kind of standstill.

    I am not happy about the Treasury’s plan. I am not happy to be paying for the sins of others. However, we have to know what we’re facing on the other side of this…

  • Posted by Richard Cownie

    “Because of the structure of many of the instruments, the value can be well below ( 100% – Default% ).”

    Sure. But if the aggregate payment stream is still at 70%, then the aggregate value is still at 70%. If you’ve concentrated the risky tranches, then a lot of other stuff is pretty good.

    There must be a lot of stuff that will perform well – it’s just hard to tell which it is.

  • Posted by Cedric Regula

    Murph:

    “Should the bank lines be terminated, and the commercial paper market freeze up, economic life would literally come to a standstill.”

    Calm thyself. It’s not that bad. These are called commercial money market funds and it’s our savings and liquid cash that is providing the financing in the most efficient, low overhead way. I can do it with my Ameritrade account. All it needs is a clearing house and honest ratings of the paper.

  • Posted by Dr.Bubb

    ABOUT THE MATHS:
    http://www.greenenergyinvestors.com/index.php?showtopic=4292&st=60

    A GOOD START but i can see huge flaws in this analysis.
    It looks like Brad is assuming ALL of the banks mortgage exposure is worth only 33cents, not just the impaired/ subprime part

    WHERE have see seen falls of over 67% in house prices???
    AND that assumes there was zero equity in these homes in the first place.

    About 1/3 of Americans own their homes outright, and another big part have small loans, lets say under 50% LTV. Why should those loans be impaired at all.

    A lot of the junk debt secured by duff mortgages is outside the banking system, and
    those holders dont get the bailout, as i understand it

    Why not put together a pro-forma balance sheet on the entire US banking system, and then see what impact this plan could have, assuming the bailout funds are used to buy only the (undervalued?) illiquid mortgage backed bonds.

    BTW, how will the new agency sort out defaults when they occur to bonds they are holding? This is going to be messy work, and is not ideal for government bureaucrats, who are desk-jockeys, not problems solvers prepared to deal with individual homeowners.

  • Posted by Alan von Altendorf

    Brad, sorry about the language.

    Murph, if you want to argue that everything has changed in the past decade, okay, but for three centuries, banks have refused to fund new products and new industries. That’s what VC does for start-ups and retained earnings at established firms. Basic rule of corporate finance is to calculate NPV using a very high hurdle rate (opportunity cost of capital that could be deployed elsewhere). Not bank loans. Capital.

  • Posted by a

    Those who support this 700 billion proposal can provide zero evidence that it will help anything. Zippo. Zippo evidence that the world with the proposal will be a better, safer, more stable (add in your adjective) world than without it. The supporters play on fear – it’s the end of the world without it! – without seeming to explain that it improves nothing, so if it is the end of the world without it, it still is with it.

    Americans consume too much. When the system changes so that they cannot get car loans, it’s the system *working*. Trying to prop up the financial system so that the consumer continues to spend as usual, will only cause the system to break *somewhere else*, be it a crash in the dollar or a buyer’s strike of Treasuries or something else again, until Americans are not able to afford their cars. Pissing away 700 billion or more at this stage is the height of stupidity, and is far more likely to bring about the advent of moustached dictators than voting this proposal down.

  • Posted by Twofish

    Alan: Wait a minute. Whoa. Business and industry are historically funded mainly by retained earnings, i.e., profits – not bank lending. Where the intermediaries are useful and add value is VC, underwriting new issues, mergers and consolidations of listed firms in a crowded sector. I agree with the post that asked what do we need these guys for?

    I was talking about working capital. That happens in the commercial paper market through money market funds, and the people that run that are the investment banks.

    But anyway, suppose a VC gives you $15 million in funding. In the United States they don’t show up with an armored truck, they show up with a check, which you take and deposit in your bank account. If the commercial banks to under then this system falls apart.

    Alan: Right now, there’s nothing for banks to do except take deposits, clear checks, ration commercial and household credit for short term transactional purposes and hedge some foreign exchange.

    More or less, but if that system breaks down, then economic activity stops.

  • Posted by Twofish

    diselm: Can anyone here explain why if a bank like Goldman is stable enough for the world’s pickiest investor to put money in today, why we need to give $700 billion of taxpayer money for free, no strings, no dividends, no equity, no options?

    Because Goldman-Sachs is a very well run bank and doesn’t need a taxpayer bailout, and they aren’t the target of the bailout, and I doubt that they will get much if any funding from the government.

    The big problems are likely to be in the regional banks and some of the national banks whose names have come up in the news.

    So why is Paulson fighting for this if it doesn’t benefit his ex-employers. Well as hard as it to believe sometimes a politician will actually do something that they think is in the public interest.

  • Posted by Twofish

    Alan: Murph, if you want to argue that everything has changed in the past decade, okay, but for three centuries, banks have refused to fund new products and new industries.

    That’s intentional and a good thing. New products and new industries mean risk, and commercial banks have functions that are too important to put at risk. It’s a bad thing if *no one* funds these things, but there are VC and angel investors that are willing to put their capital on the line and take the risks. The main role for commercial banks is to make sure that the checks clear.

  • Posted by Twofish

    Cedric: These are called commercial money market funds and it’s our savings and liquid cash that is providing the financing in the most efficient, low overhead way.

    And last week, those came within a hairs breath of collapsing before Treasury came in and gave a FDIC-like guarantee to them.

  • Posted by a

    “And last week, those came within a hairs breath of collapsing before Treasury came in and gave a FDIC-like guarantee to them.”

    I see you read the New York Post.

  • Posted by Alan von Altendorf

    I would like to be shown that I’m wrong. Maybe it’s my skewed view of the world from Houston. Companies have cash. Capitalists like Buffett and Pickens have cash. FT says the S&P 500 have $500+ billion on hand or in short-term notes. Wells Fargo, JPM, Bank of America, Wachovia are well capitalized and solvent. So who’s in trouble? The brokers and hedge funds who placed OTC side-bets and leveraged x 30. They deserve to go out of business. Period.

    The crisis “will create a real winner takes all environment,” said Jason Trennert, chief investment strategist at Strategas Research Partners. “Well-run companies not dependent upon credit markets will take market share from companies which aren’t well run and are [dependent on credit].”

    http://www.nakedcapitalism.com/2008/09/corporate-america-sits-on-its-cash.html

  • Posted by John D Crowder

    interesting analysis but;

    No one seems to know anything “for sure”.

    Apparently all the King’s horses and all the King’s men really don’t know how to construct anything – only destruct.

    So let’s let “the market” play out this lethal scenario and take our hits when/where they occur.

    We may still have to face the music regardless of bailing out the losers.

  • Posted by flow5

    $700 bill to finance EXISTING property??? This has to exert a depressing effect on the economy.

    Why not $700 bill to finance NEW/REAL investment (plant & equipment), etc.

    Screw the gamblers.

  • Posted by Ben C

    There’s an article on SeekingAlpha which throws out similar numbers (http://seekingalpha.com/article/96826-do-paulson-and-bernanke-really-understand-what-s-going-on). The thing is, that article says many of the losses will come from non-subprime mortgages and corporate debt, which he estimates at 20 trillion with perhaps a 5% default rate.

    Is he just making up this 20 trillion number? It doesn’t seem to jive with your numbers. What do you think of his analysis?

  • Posted by bsetser

    the upper limit on outstanding mortgages — from the flow of funds — is $15 trillion. that is the sum of commercial mortgages as well as residential mortgages.

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