[Rhodes22-list] Economics - Significant Post to List with wrong subject line!!!
Brad Haslett
The subject line should probably be edited to include 'Politics' since
that is always an aspect of economics, but let's stick primarily to
economics for now.
First, a quick personal note. My union called me this week - the wife
of one of our members is dying from cancer and he has burned through
his sick leave to be by her side. They asked me to cover one of his
trips last night, which I did. I contacted my superior in the
training department and asked that he get the word out to fellow
instructors to consider flying "back-side-of-the-clock" trips for
landing currency instead of the usual afternoon "gentlemen" trips, and
they have stepped-up to the plate. This is a great country, and I am
fortunate to work for a wonderful company and with a very professional
union.
Now about this little "financial problem" we face, it is bad. Just as
in every major airline crash that leaves a smoking hole in the ground,
the press immediately jumps to conclusions, focuses on the horror, and
is usually wrong in their analysis. What we are witnessing here is not
a crash (despite the MSM comparisons to 1929) but more like a GPWS
(ground proximity warning system) encounter - if immediate action
isn't taken, disaster will be the result. Like every aircraft
accident, the usual suspects start their spin, "It was the pilots
fault", "It was Boeings fault", "It was the company's fault", "It was
the weather". The reality takes years to discover and the root causes
are often something completely different than the original pundits
analysis. And most importantly, there is usually plenty of blame and
responsibility to go around.
Here's the quick and dirty on what we know. The financial markets
were about to shut down because the trust and faith in the underlying
assets that props-up the entire system were suspect.
I'll go into a more thorough analysis tomorrow after a good nights
sleep. Here's something you don't hear much about - I've read exactly
two articles that discussed "mark to market" including one from Steve
Forbes. He didn't name it but he's referring to FASB 157 (Financial
Accounting Standards Board) which went into effect November 15, 2008
that requires all assets including level 3 assets which include
collateralized debt obligations (what Warren Buffet described as
"weapons of mass financial destruction" in 2002) to be shown on the
books at market value. There lies the problem, no one knows what
these obligations are "worth" and when faith in these instruments
failed, the system started grinding to a halt.
I'm not very happy about the federal government nationalizing roughly
7% of the economy but let's hope this only a temporary jolt of
medicine and the government will divest themselves of their new
"ownership" position as quickly as they acquired it.
We'll discuss the culprits tomorrow.
Brad
On Fri, Sep 19, 2008 at 6:26 PM, Tootle <ekro...@charter.net> wrote:
>
> Brad just posted a significant post to the list, but its significance gets
> lost in subject line. All shoud read his last post:
>
> http://www.rhodes22.org/pipermail/rhodes22-list/2008-September/054616.html
>
> I am referring to the briefing to Congress.
>
> Ed K
> Greenville, SC, USA
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Tootle
Brad,
You are the accountant on this forum. If there are others, they do not have
courage so speak up.
This is also an ethical question, a legal ethical question. And lawyers
should be speaking up. But alas, they claim Marxism is good. Or they say
their practice is limited to real estate transactions or business matters.
What the hell caused this mess?
In South Carolina when the state legislature is not in session, lawyer
represenatives represent clients before judges they elect. Right and Wrong,
good and evil, when working in a gray areas, it is important that actions
withstand the scrutiny of sunlight.
Brad said, "Here's something you don't hear much about - I've read exactly
two articles that discussed "mark to market" including one from Steve
Forbes. He didn't name it but he's referring to FASB 157 (Financial
Accounting Standards Board) which went into effect November 15, 2008 that
requires all assets including level 3 assets which include collateralized
debt obligations (what Warren Buffet described as "weapons of mass financial
destruction" in 2002) to be shown on the books at market value. There lies
the problem, no one knows what these obligations are "worth" and when faith
in these instruments failed, the system started grinding to a halt.
If the people had been honest and ethical from the get go they would have
held the actions and the paper they were written on to sunlight and a simple
test of right and wrong. These events remind me of the lady who spilled the
beans in the Enron situation. And the media said Enron was big?
As you find time tell us where to find Steve's article and Warrens
admonition. And post any relevant sources.
Yes, Marxism is at issue because of the Federal requirement of banks to loan
in questionable situations instead of holding federally backed loans to a
high standard. The government compelled bankers to disregard risks.
Dictatorship, Marxism, Socialism, Progressivism, call it what you want, it
is wrong and leads to garbage.
Ed K
Greenville, SC, USA
attachment:
http://www.nabble.com/file/p19593492/401k.jpg 401k.jpg
Brad
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Brad Haslett
It will take years to unravel this whole puzzle and no doubt a lot of
money will be made writing books about it, but here's what we know for
now. The economy was about to grind to a stop like an engine running
without oil, ie, financial institutions were about to stop lending
money because no one trusted anyone. The root cause was a lot of
really nasty mortgages made with horrendous lending practices. Add in
some new debt instruments that no one really understood (Mr. Buffet
excepted) and the problems accelerated. The "fix", if you want to call
it that, is for the federal government to allow financial institutions
to dump their toxic assets, clean up their books, and go back to "mark
to market" accounting with assets of determinable value. What this
will cost the government is unknown because the value of the assets to
be dumped is unknown. Just like the RFC during the Great Depression
and the Resolution Trust in the late 80's, some of these assets do
have value and the taxpayer will get some of their money back. One of
ideas being floated now is a reverse auction where institution bids
down to a price that they are willing to sell the government the bad
assets. This is truly new territory. Lehman Brothers had a chance to
be acquired by Bank of Korea and CITIC bank of China months ago but
thought they could get a better price. Now they'll settle for pennies
on the dollar.
Ever heard of a NINJA loan? Neither had I until a couple of years ago
and it didn't make sense then and it sure as hell doesn't now. NINJA
- no income, no job or assets. Who in their right mind would make
such a loan? No one, unless they thought they could palm the risk off
on someone else. Fanny and Freddie are the biggest culprits in this
mess. Now here's where it gets interesting. They and most banks
operated using sound lending practices until the late 70's when the
Community Reinvestment Act was passed by Carter. (I'm going to use a
"cheap and easy" citation here instead of financial news articles to
save time)
http://en.wikipedia.org/wiki/Community_Reinvestment_Act
Clinton strengthened the act in 1995 and shoved more bad lending
practices down bankers throats. One of the "leaders" in subprime
mortgages was Superior Bank in Chicago.
Superior went belly-up in 2001. Who ran Superior? Penny Pritzker, B
Hussein Obama's finance 2008 finance chairman, financial sponsor, and
also chairman of the successor to the Chicago Annenberg Challenge. The
point is, the demo model for subprimes was Superior and it failed.
Pritzker was to the sub prime mortgage what Michal Malkin was to junk
bonds.
In 2003 the Bush administration tried to reform Freddie and Fannie and
was shot down, led by Barny Frank.
http://query.nytimes.com/gst/fullpage.html?res=9E06E3D6123BF932A2575AC0A9659C8B63
Some Senators saw the handwriting on the wall in 2005 and again tried
to reform Fan & Fred.
By 2007, the problems were too big too ignore because so many
homeowners were defaulting. The financial markets stayed intact
because these "toxic mortgages" were hidden behind some really clever
debt instruments. Then everyone got scared.
I'll post more as information trickles in. Both political parties
have their fingerprints all over this mess and Wall Street threw some
good old fashioned GREED into mix for the final meltdown. Follow the
money-
http://www.opensecrets.org/industries/mems.php
What interesting times we live in!
Brad
Brad Haslett
Here's some interesting reading on Superior Bank from the GAO if you
have the time. This paragraph from page 3, outlining the main cause
of failure, can be applied to our entire nations banking system. As
Yogi Berra said, "deja vu all over again".
"The key events leading to the failure of Superior Bank were largely
associated with the business strategy adopted by Superior Bank's
management of originating and securitizing subprime loans on a large
scale. This strategy resulted in rapid growth and a high concentration
of extremely risky assets. Compounding this concentration in risky
assets was the failure of Superior Bank's management to properly value
and account for the interests that it had retained in pooled home
mortgages."
http://www.gao.gov/new.items/d02419t.pdf
Brad
Tootle
Brad,
1. Thank you for your posts on this subject. There are those who quibble
that this series of posts is not sailing related. Well it is. Because it
concerns our freedom to sail, buy a boat, keep a small sail boat maker in
business. It is important to understand the basics of business, economics
and ethics.
2. Warren Buffet was not the only one who understood the problems with the
mortagages, loans and financial instuments involved. The important thing to
comprehend is 'The holy media' did not understand. Why? Two important
reasons: 1. It flies in the face of liberalism and their advocacy, and 2.
the people who were reporters, editors or commentators did not have
appropirate education to understand what they reported or chose not report
the issues. [This goes back to my comments to Captain Rummy]
I am sure the lady accountant who broke the Enron scandal understands what
the financial and accounting issues are.
I am sure that those who support 'Progressivism' do not care to understand
the real results of their advocacy. Thank you for pointing out Obama's
financial advisors use of the problem causing techniques.
Again, thank you for the information.
Ed K
Greenville, SC, USA
Addenda:
1. "Character isn't something you were born with and can't change, like
your fingerprints. It's something you weren't born with and must take
responsibility for forming." Jim Rohn
2. "Leaders are made, they are not born. They are made by hard effort,
which is the price which all of us must pay to achieve any goal that is
worthwhile." Vince Lombardi
3. "Most of the poverty and misery in the world is due to bad government,
lack of democracy, weak states, internal strife, and so on." George Soros
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Rik Sandberg
First, thanks Brad for taking the time to post all this stuff.
Next, Ed, while I agree with most of what you have said I gotta' take
this with a grain of salt
> and 2.
> the people who were reporters, editors or commentators did not have
> appropirate education to understand what they reported or chose not report
> the issues. [This goes back to my comments to Captain Rummy]
Appropriate education is way over-rated. I have none to speak of and I
have been watching incredulously as this whole thing unfolded. I think
all this proves is that some of the most prestigious colleges in the
country graduate some of the least sensible people. It doesn't take a
rocket scientist to figure out that you can't loan money to people who
aren't going to pay it back and remain in business for long. You can't
continually make risky loans and expect to be able to pass the risk on
to some greater fool forever. Eventually even the dimmest bulb is going
to figure out he's being taken for a ride.
So, lets not try to claim that more education would have helped these
fools. What was and is obvious to a high school graduate should have
been child's play for someone with "higher education" yet, they show us
a complete lack of common sense. It seems you can't get good sense
through education.
Rik
Ayn Rand was a prophet - - it isn't my fault
Tootle
Brad,
Have you seen this site?
http://www.occ.treas.gov/ftp/deriv/dq403.pdf
Ed K
Greenville, SC, USA
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Ed, Brad,
Rik
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Brad Haslett
Thanks, I still don't have a good grip on all these debt swap and
derivative contracts but then neither did Warren Buffet. Anyway you
slice it, Fannie and Freddie were what brought this house of cards
down (see attached).
Brad
-----------------------------
Commentary by Kevin Hassett
More Photos/Details
Sept. 22 (Bloomberg) -- The financial crisis of the past year has
provided a number of surprising twists and turns, and from Bear
Stearns Cos. to American International Group Inc., ambiguity has been
a big part of the story.
Why did Bear Stearns fail, and how does that relate to AIG? It all
seems so complex.
But really, it isn't. Enough cards on this table have been turned over
that the story is now clear. The economic history books will describe
this episode in simple and understandable terms: Fannie Mae and
Freddie Mac exploded, and many bystanders were injured in the blast,
some fatally.
Fannie and Freddie did this by becoming a key enabler of the mortgage
crisis. They fueled Wall Street's efforts to securitize subprime loans
by becoming the primary customer of all AAA-rated subprime-mortgage
pools. In addition, they held an enormous portfolio of mortgages
themselves.
In the times that Fannie and Freddie couldn't make the market, they
became the market. Over the years, it added up to an enormous
obligation. As of last June, Fannie alone owned or guaranteed more
than $388 billion in high-risk mortgage investments. Their large
presence created an environment within which even mortgage-backed
securities assembled by others could find a ready home.
The problem was that the trillions of dollars in play were only
low-risk investments if real estate prices continued to rise. Once
they began to fall, the entire house of cards came down with them.
Turning Point
Take away Fannie and Freddie, or regulate them more wisely, and it's
hard to imagine how these highly liquid markets would ever have
emerged. This whole mess would never have happened.
It is easy to identify the historical turning point that marked the
beginning of the end.
Back in 2005, Fannie and Freddie were, after years of dominating
Washington, on the ropes. They were enmeshed in accounting scandals
that led to turnover at the top. At one telling moment in late 2004,
captured in an article by my American Enterprise Institute colleague
Peter Wallison, the Securities and Exchange Comiission's chief
accountant told disgraced Fannie Mae chief Franklin Raines that
Fannie's position on the relevant accounting issue was not even ``on
the page'' of allowable interpretations.
Then legislative momentum emerged for an attempt to create a
``world-class regulator'' that would oversee the pair more like banks,
imposing strict requirements on their ability to take excessive risks.
Politicians who previously had associated themselves proudly with the
two accounting miscreants were less eager to be associated with them.
The time was ripe.
Greenspan's Warning
The clear gravity of the situation pushed the legislation forward.
Some might say the current mess couldn't be foreseen, yet in 2005 Alan
Greenspan told Congress how urgent it was for it to act in the
clearest possible terms: If Fannie and Freddie ``continue to grow,
continue to have the low capital that they have, continue to engage in
the dynamic hedging of their portfolios, which they need to do for
interest rate risk aversion, they potentially create ever-growing
potential systemic risk down the road,'' he said. ``We are placing the
total financial system of the future at a substantial risk.''
What happened next was extraordinary. For the first time in history, a
serious Fannie and Freddie reform bill was passed by the Senate
Banking Committee. The bill gave a regulator power to crack down, and
would have required the companies to eliminate their investments in
risky assets.
Different World
If that bill had become law, then the world today would be different.
In 2005, 2006 and 2007, a blizzard of terrible mortgage paper
fluttered out of the Fannie and Freddie clouds, burying many of our
oldest and most venerable institutions. Without their checkbooks
keeping the market liquid and buying up excess supply, the market
would likely have not existed.
But the bill didn't become law, for a simple reason: Democrats opposed
it on a party-line vote in the committee, signaling that this would be
a partisan issue. Republicans, tied in knots by the tight Democratic
opposition, couldn't even get the Senate to vote on the matter.
That such a reckless political stand could have been taken by the
Democrats was obscene even then. Wallison wrote at the time: ``It is a
classic case of socializing the risk while privatizing the profit. The
Democrats and the few Republicans who oppose portfolio limitations
could not possibly do so if their constituents understood what they
were doing.''
Mounds of Materials
Now that the collapse has occurred, the roadblock built by Senate
Democrats in 2005 is unforgivable. Many who opposed the bill
doubtlessly did so for honorable reasons. Fannie and Freddie provided
mounds of materials defending their practices. Perhaps some found
their propaganda convincing.
But we now know that many of the senators who protected Fannie and
Freddie, including Barack Obama, Hillary Clinton and Christopher Dodd,
have received mind-boggling levels of financial support from them over
the years.
Throughout his political career, Obama has gotten more than $125,000
in campaign contributions from employees and political action
committees of Fannie Mae and Freddie Mac, second only to Dodd, the
Senate Banking Committee chairman, who received more than $165,000.
Clinton, the 12th-ranked recipient of Fannie and Freddie PAC and
employee contributions, has received more than $75,000 from the two
enterprises and their employees. The private profit found its way back
to the senators who killed the fix.
There has been a lot of talk about who is to blame for this crisis. A
look back at the story of 2005 makes the answer pretty clear.
Oh, and there is one little footnote to the story that's worth keeping
in mind while Democrats point fingers between now and Nov. 4: Senator
John McCain was one of the three cosponsors of S.190, the bill that
would have averted this mess.
(Kevin Hassett, director of economic-policy studies at the American
Enterprise Institute, is a Bloomberg News columnist.
Last Updated: September 22, 2008 00:04 EDT
Michael D. Weisner
Thanks for the story. It was well written and very interesting. Haslett on
Hassett.
If you are interested in viewing the original S.190 bill, you may find it
at:
http://www.govtrack.us/congress/bill.xpd?bill=s109-190
Sponsor:
Sen. Charles Hagel [R-NE]
Cosponsors [as of 2007-01-08]
Sen. Elizabeth Dole [R-NC]
Sen. John McCain [R-AZ]
Sen. John Sununu [R-NH]
If you're a purist and do not want the commentary and analysis, you may find
the text at the LoC:
http://thomas.loc.gov/cgi-bin/query/C?c109:./temp/~c109wHZu09
Mike
s/v Shanghaid'd Summer ('81)
Nissequogue River, NY
Brad Haslett
Here's a New York Time's article from 1999 that may shed some light on
how this mess got started.
Brad
--------------------------
http://query.nytimes.com/gst/fullpage.html?res=9C0DE7DB153EF933A0575AC0A96F958260&scp=1&sq=september%201999%20fannie%20mae&st=cse
September 30, 1999
Fannie Mae Eases Credit To Aid Mortgage Lending
By STEVEN A. HOLMES
In a move that could help increase home ownership rates among
minorities and low-income consumers, the Fannie Mae Corporation is
easing the credit requirements on loans that it will purchase from
banks and other lenders.
The action, which will begin as a pilot program involving 24 banks in
15 markets -- including the New York metropolitan region -- will
encourage those banks to extend home mortgages to individuals whose
credit is generally not good enough to qualify for conventional loans.
Fannie Mae officials say they hope to make it a nationwide program by
next spring.
Fannie Mae, the nation's biggest underwriter of home mortgages, has
been under increasing pressure from the Clinton Administration to
expand mortgage loans among low and moderate income people and felt
pressure from stock holders to maintain its phenomenal growth in
profits.
In addition, banks, thrift institutions and mortgage companies have
been pressing Fannie Mae to help them make more loans to so-called
subprime borrowers. These borrowers whose incomes, credit ratings and
savings are not good enough to qualify for conventional loans, can
only get loans from finance companies that charge much higher interest
rates -- anywhere from three to four percentage points higher than
conventional loans.
''Fannie Mae has expanded home ownership for millions of families in
the 1990's by reducing down payment requirements,'' said Franklin D.
Raines, Fannie Mae's chairman and chief executive officer. ''Yet there
remain too many borrowers whose credit is just a notch below what our
underwriting has required who have been relegated to paying
significantly higher mortgage rates in the so-called subprime
market.''
Demographic information on these borrowers is sketchy. But at least
one study indicates that 18 percent of the loans in the subprime
market went to black borrowers, compared to 5 per cent of loans in the
conventional loan market.
In moving, even tentatively, into this new area of lending, Fannie Mae
is taking on significantly more risk, which may not pose any
difficulties during flush economic times. But the
government-subsidized corporation may run into trouble in an economic
downturn, prompting a government rescue similar to that of the savings
and loan industry in the 1980's.
''From the perspective of many people, including me, this is another
thrift industry growing up around us,'' said Peter Wallison a resident
fellow at the American Enterprise Institute. ''If they fail, the
government will have to step up and bail them out the way it stepped
up and bailed out the thrift industry.''
Under Fannie Mae's pilot program, consumers who qualify can secure a
mortgage with an interest rate one percentage point above that of a
conventional, 30-year fixed rate mortgage of less than $240,000 -- a
rate that currently averages about 7.76 per cent. If the borrower
makes his or her monthly payments on time for two years, the one
percentage point premium is dropped.
Fannie Mae, the nation's biggest underwriter of home mortgages, does
not lend money directly to consumers. Instead, it purchases loans that
banks make on what is called the secondary market. By expanding the
type of loans that it will buy, Fannie Mae is hoping to spur banks to
make more loans to people with less-than-stellar credit ratings.
Fannie Mae officials stress that the new mortgages will be extended to
all potential borrowers who can qualify for a mortgage. But they add
that the move is intended in part to increase the number of minority
and low income home owners who tend to have worse credit ratings than
non-Hispanic whites.
Home ownership has, in fact, exploded among minorities during the
economic boom of the 1990's. The number of mortgages extended to
Hispanic applicants jumped by 87.2 per cent from 1993 to 1998,
according to Harvard University's Joint Center for Housing Studies.
During that same period the number of African Americans who got
mortgages to buy a home increased by 71.9 per cent and the number of
Asian Americans by 46.3 per cent.
In contrast, the number of non-Hispanic whites who received loans for
homes increased by 31.2 per cent.
Despite these gains, home ownership rates for minorities continue to
lag behind non-Hispanic whites, in part because blacks and Hispanics
in particular tend to have on average worse credit ratings.
In July, the Department of Housing and Urban Development proposed that
by the year 2001, 50 percent of Fannie Mae's and Freddie Mac's
portfolio be made up of loans to low and moderate-income borrowers.
Last year, 44 percent of the loans Fannie Mae purchased were from
these groups.
The change in policy also comes at the same time that HUD is
investigating allegations of racial discrimination in the automated
underwriting systems used by Fannie Mae and Freddie Mac to determine
the credit-worthiness of credit applicants.
Herb Parsons
Clinton Administration?
Did that article say "under increasing pressure from the Clinton
Administration to expand mortgage loans among low and moderate income
people"
That's got to be bogus. This mess was caused by the Republicans dammit,
all those kool-aid drinkers couldn't possibly be wrong...
Since we're blowing away a little smoke from the "let's blame the
Republicans" kool-aid fans, fast-forward from 1999 to 2005, and take a
look at the Federal Housing Enterprise Regulatory Reform Act of 2005.
In part, here's what Charles Hagel had to say about it: "Our legislation
would create a new independent world class regulator for Fannie Mae,
Freddie Mac and the Federal Home Loan Banks. Our bill provides the new
regulator with enhanced regulatory flexibility and enforcement tools
like those afforded to the Federal Deposit Insurance Corporation, the
Federal Reserve System, the Office of the Comptroller of the Currency
and the Office of Thrift Supervision. "
Here's what McCain (a co-sponsor) had to say about it: "For years I have
been concerned about the regulatory structure that governs Fannie Mae
and Freddie Mac--known as Government-sponsored entities or GSEs--and the
sheer magnitude of these companies and the role they play in the housing
market. OFHEO's report this week does nothing to ease these concerns. In
fact, the report does quite the contrary. OFHEO's report solidifies my
view that the GSEs need to be reformed without delay."
Would have been nice, huh?
Unfortunately, the bill never made it out of committee. Chris Dodd was
on the committee at the time, and is now chairs it. He's the all time
highest receiver of money from the Fannie-Freddie lobbies. It's worth
noting that Obama is #2 in receiving those lobby monies.
But, ignore all that. Pelosi says it's all the Republican's fault. Would
that be cherry, or grape kool-aid?
Hey politics fans, see if you folks can guess who said this back in 2005
- "If Congress does not act, American taxpayers will continue to be
exposed to the enormous risk that Fannie Mae and Freddie mac pose to the
housing market, the overall financial market, and the economy as a whole."
Brad Haslett
It goes back further than that. Between Fannie & Freddie, FHA, and VA
housing loans, and the home mortgage interest deduction, the federal
'gubment' has been waaaay too involved in the housing market. My home
loan is with the credit union where I bank and they hold the paper.
Trust me, they made damn sure I was able to pay the money back before
they made the loan. Like a lot of Depression era programs, Fannie may
have sounded good in the beginning but should have been eliminated
decades ago. President Johnson spun off Fannie to a quasi
private/public company to make his budget numbers look better and
created Freddie for competition. The seeds of destruction were planted
a long time ago. Ed posted a list of proposals and warnings from the
Bush Whitehouse earlier - 43 was aware of the problem as well as the
Congress, it was just cross-purpose with the liberal agenda. However,
as amusing as it is to study the history of this issue, it does
nothing to solve the problem. I don't think most folks realize how
close to the brink we came. Here's a newspaper article on the
experience and a really good analysis from an astute blogger.
http://www.nypost.com/seven/09212008/business/almost_armageddon_130110.htm
http://meganmcardle.theatlantic.com/archives/2008/09/how_close_was_the_financial_sy.php
There's only two solutions to this problem that I can see, either
flush the "turd" loans out of the system or give banks a reprieve on
FASB 157 and temporarily suspend "mark to market" accounting. Nancy
and Harry are clueless demagogues. There's plenty of smart people on
both sides of the isle. Now would be a good time for some real
leaders of both parties to take control and tell some of the bigger
mouths (Barney Franks for example) to STFU.
Whatever the solution, I think we've got some tough sledding ahead of us.
Brad
Brad Haslett
More good analysis from a blogger is attached. His thoughts on Franks
parallels mine. Remember, our current Congress has an approval rating
lower than Bush 43's. Now would be a good time to act like adults and
actually represent the nations best interests.
Brad
---------------------
A Tale of Two Financial Crises
Posted by: Blackhedd
Monday, September 22, 2008 at 05:44AM
40 Comments
We're now into our second day of market reactions to the Treasury and
Fed's Troubled Assets Relief Program ("TARP"), or if you prefer,
Mother of All Bailouts ("MOAB"). Market reaction in general is quite
positive, which I'll get to shortly. But the action is moving to
Capitol Hill, where Paulson and Bernanke need to convince Congress to
pass enabling legislation for the plan before they leave on Friday to
face the voters. I'll tell you how that's going so far. And I'll also
tell you what questions Congress needs to ask, so that we all can get
a better understanding of how the TARP will actually work.
Two Crises
We face not one but two financial crises: a liquidity crisis and a
credit crisis.
Both ultimately stem from declines in the value of securities and
derivatives that are based on mortgages. But the liquidity crisis
primarily affects the financial system in the near term, while the
credit crisis affects the larger economy and is a longer-term problem.
And markets have responded favorably to news of the TARP, because it's
widely expected to relieve the near-term disruptions that have rolled
through the financial world like one Category-5 hurricane after
another.
The reason markets are in acute crisis is because the failure or
near-failure of so many important institutions (including Fannie Mae,
Freddie Mac, Lehman Brothers, Merrill Lynch, AIG Insurance, and many
others) makes normal trading impossible.
You can't trade with someone you're not sure won't be bankrupt
tonight. And when "someone" is just about every big name out there,
that means you practically can't trade with anyone.
The Darkest Night
That drives a flight into the safest and most liquid assets, even at
the cost of losing money. In the darkest hours of the crisis last
week, which came as you were asleep on Wednesday night and Thursday
morning, interest rates on short-term Treasury debt became literally
negative for brief periods of time.
And money-markets showed nearly half a trillion dollars in sell orders
that night, by some accounts. If this hadn't been stemmed by an
extraordinary intervention by the Federal Reserve at 3am EDT that
morning, it's possible that there might not have been enough money in
the bank for the company where you work to open its doors that
morning.
To say that we came to the edge of Armageddon last week may be
understating the case.
Pulling Out The Biggest Weapon
After 24 hours of extreme tension, the Treasury leaked word of the
TARP, an extraordinary program that will borrow money from world
markets, guaranteed by the taxpayers, to buy up to 700 billion
dollars' worth of a range of distressed assets from financial firms.
That news broke on Thursday afternoon around 3pm EDT. It was the
source of the roughly 800-point rally in US stock markets that you
heard about, and of the nearly orgasmic sigh of relief that went up
from trading desks all over lower Manhattan and elsewhere.
By Friday morning, the interest rate on short-dated discount Treasury
debt had gone from around 5 basis points (a level last seen in the
days following World War II) to a still low but workable 95 BPs or so,
where it stands this morning.
For now, markets have stabilized and the fever has broken.
And an acrimonious debate has broken out over the details of the plan.
The action shifts down the Atlantic corridor from New York to
Washington.
The Debate in Congress
Many well-respected conservatives are dead-set against the plan, which
of course is blatant socialism just as the RTC was. These voices are
screaming at the top of their lungs that the TARP should not go
forward.
These people need to look at the consequences of the instantaneous
return to extreme market instability that would take place if they got
their wish. This bailout plan is an absolute requirement.
Many liberals, on the other hand, are seeing an opportunity to embed
once again the perception that free markets just don't work. They're
trying to load the TARP special legislation with a raft of Democratic
goodies, including more handouts for people facing foreclosure,
additional funding for the hard-left ACORN and other "community
organizing" groups, and more support for cities that face revenue
shortfalls as foreclosures rise.
Secretary Paulson and Chairman Bernanke spent a good part of the
weekend on Capitol Hill with key lawmakers from both parties,
answering their questions about the TARP bailout plan. (Or not
answering them, depending on who you ask.)
The basic idea, according to draft legislation that I saw on Saturday,
is that Treasury will set up a two-year program to purchase a broad
range of assets from financial firms. The purchases will be funded by
sales of Treasury debt, which of course are guaranteed by the
taxpayers.
It's reminiscent of the RTC of the late Eighties and early Nineties,
which purchased the assets of failed savings-and-loan associations for
pennies on the dollar, and then sold them off over time. The end
result of the RTC was that taxpayers made a profit, and it's more than
likely that the TARP will end doing the same thing.
But there are some critical questions about how the TARP will work.
Questions for Mr. Paulson and Mr. Bernanke
The biggest and most important questions regard the valuation at which
the mortgage-backed securities will be purchased from the
participating banks and Wall St. firms.
How many pennies on the dollar? And who will make that determination?
Banks and Wall Street firms are suffering because they own large
amounts of mortgage-backed securities and related derivatives that are
now worth less than they paid for them. The losses mean that they
can't go forward from here and fund new investments in productive
business activity.
Ideally, you'd want to sell off your bad assets and either continue
life with a smaller balance sheet, or else raise additional equity
capital to start growing again. Neither option is available as things
stand.
The point of the TARP is to provide a bid for the bad mortgage-based
assets that, in Paulson's words, are "clogging the balance sheets" of
many financial institutions. He wants to provide a market so that
financial firms can sell these assets and get on with life.
The price at which they will be sold is all-important. Get it too low,
and you'll put a lot of firms out of business, because they will be
forced to realize capital losses they can't recover from.
Get it too high, and you'll be doing two extremely bad things: you'll
be rewarding banks and Wall Street for making bad decisions; and
you'll expose the taxpayers to losses and inflation.
So the key question for Paulson and Bernanke is: who will be
determining the valuation? You want above all to make sure that this
job is done right, which means getting the best available people from
the private sector to do it. How will they be compensated, and what
are their incentives?
Already Barney Frank is saying that the people who do the valuation
must not be allowed to make a lot of money. How do you get really top
people on that basis? Given the dire implications of getting this
wrong, it's charitable to say that Mr. Frank is being shortsighted and
probably a little vindictive.
The really deep problem I have, however, is this: what if the true,
correct valuation of distressed mortgage-backed assets is actually
very, very low? Like, say, five or ten cents on the dollar?
This outcome, if it happens, would be reflective of the fact that the
housing industry significantly overbuilt, in response to the price
bubble that burst in 2006. And that's a misallocation of resources
that simply can't be willed away by bailouts, taxpayer handouts to
Democratic constituencies, or fairy dust.
If that indeed is where we are, then the TARP will solve the near-term
liquidity crisis, but not the longer-term credit crisis. And the US
may be facing a long, possibly multiyear period of very slow economic
growth.
A lot like what Japan has gone through after their real-estate bubble
popped. In Japan, they call it "The Lost Decade."
All eyes on Ben Bernanke at this point. A close student of the Great
Depression, he understands deflation as few others do. He'll be
mouthing the same words as Paulson, to get us through this immediate
crisis.
But does he really believe we're addressing the longer-term problem?
That's a question I'd dearly like to know the true answer to.
-Francis Cianfrocca
Herb Parsons
right now. Folks that lose their homes will still need a place to live,
and houses are going to be cheap to buy.
Brad Haslett
That's a point that a lot of people miss, there's no shortage of
housing stock, people will still have a roof over their head. Owning
your own home is usually a good deal but not always. A home is
primarily a place to live and a hedge against inflation, not an ATM.
My rental house is sold and I'm hoping it closes by the end of the
month. Owning ten or more would be fine because you could hire
someone to manage the properties. Having just one is a major PITA!
I'm using the money to retire the balance of my business debt and
hunker down for a good long while. For a couple looking for their
first home, now is a wonderful opportunity to buy a nicer house in a
better neighborhood than they would ordinarily be able to afford.
Cash is always king in any market. Just ask Mr. Buffet.
Brad
Michael D. Weisner
Buying "cheap" real estate can result in some real problems. On the face of
it, it sounds like a great idea; buy up houses at low prices and rent them
to the folks who can't afford to own them. Unfortunately, many of the areas
that are affordable have significant foreclosure problems encouraging higher
crime due to the large number of abandoned homes. In some of the areas, the
homes are gutted for the copper pipe and wire content which is sold as
scrap, leaving a shell that needs to be razed. It may be to your benefit
that you are not so well off!
There are some real sailboat bargains out there, if you have any money left
after buying up all that bad paper in the bailout.
Mike
s/v Shanghaid'd Summer ('81)
Nissequogue River, NY
Brad Haslett
It's not just the "bad" neighborhoods. The neighborhood next to mine
is a McMansion neighborhood with houses in the 5-6000 square foot
range. Some acquaintances of ours made a "low ball" offer on one of
two houses in forclosure in that neighborhood, and much to their shock
the bank took it. Now they are having to replace light fixtures,
faucets, HVAC units, anything that could be removed, and, they're
making two house payments. Now if you want a house razed, my brother
has that down to a science. We've taken down houses with less than ten
feet separating it from the next one. He chews out the center with the
trackhoe and makes the house fall in on itself. I can't stand to
watch it and I'm a brave man.
Brad
On Mon, Sep 22, 2008 at 10:56 PM, Michael D. Weisner
Michael D. Weisner
So much for the bargains. Hopefully, your friends will be able to pull the
rabbit out of the hat and salvage the deal.
So, were they planning to move to the McMansion or was it just for
investment? What will become of the second home?
I think that your concept of hunkering down is the best at this time. We
are very happy not to have a mortgage obligation with the uncertainty of the
immediate future.
Mike
s/v Shanghaid'd Summer ('81)
Nissequogue River, NY
Brad Haslett
They're going to live in it but they have the same problem as everyone
else, they have to sell their house. My neighborhood has been a hot
one for the first eight years we were here and most homes sold FSBO in
less than a week. Now they're taking 90 to 180 days, which while
better than average, is much slower than what we're used to seeing.
One thing I learned almost 30 years ago from my old boss when I was
selling airplanes, "son, don't ever make an offer on an airplane we
don't want in our inventory no matter how cheap the price, you never
know what a man might actually take". The same goes with houses now.
It's only a "bargain" if you need the house. The last thing I want is
a bigger house - been there, done that.
Had I known the market for airplanes was going to tank I might have
waited and bought something in a later vintage. How's the market on
your Mooney doing? One would think it would be the least affected
because of the fuel efficiency.
Brad
On Mon, Sep 22, 2008 at 11:30 PM, Michael D. Weisner
Michael D. Weisner
Your old boss was a truly wise fellow, one never knows how desperate the
seller can be (or why he is selling.) Big house "bargains" - agreed - been
there ... bigger simply means higher taxes, heating bills and harder to sell
nowadays on LI.
As far as your Bo goes, if you had waited, you wouldn't have had all that
"quality time" in the hangar (maybe more stick time?) And the Mooney?
Wrong Mike - Mike Cheung has the Mooney 231.
Brad Haslett
Sorry about the mix-up, that's what happens when you stay-up too late.
Airplanes have lost 30% or more in value the last year with the fuel
costs going up. What department do I apply to for my "I made a bad
financial decision and I want some money back"?
The spec house I built in 2002 in an 80 year old neighborhood was
about 1400 square feet with another 500 ft designed in upstairs that
could be finished (the buyer purchased the home in the framing stage
and opted to finish the upstairs). The architect did marvelous job of
making it look from the outside like it had been in the neighborhood
forever, and he incorporated some ideas of mine that I imported from
Europe and Asia to make it "live" bigger than it was. I keep watching
the market on the MS Gulf Coast to build but real estate there is
still overpriced. The target market is around 1200-1400 ft sq around
$130,000. It can't be done right now with current lot prices but
maybe someday when reality settles in, who knows? When the dust
settles on this real estate meltdown, I anticipate the market moving
to smaller houses (but my crystal ball is cracked and often cloudy).
Run the world for me, will ya? I'm off for some of that "quality hangar time".
Brad
Michael D. Weisner
I tend to think that the "ideal house" is slightly larger than 1400 sq ft.
In this area, we are seeing more and more older couples, retired or still
working, in the 1800-2200 sq ft house. These typically have enough room for
the occasional child still at home or "visiting" and are able to support
immediate family (with spouse & kids) gatherings (overnights, 3-4 beds, 2
baths.) They are not unreasonable to heat or cool if they are multi-story
dwellings, fairly well insulated.
But what the heck do I know, I never thought that the US would have bought
into the Denali/Tahoe/Expedition product lines.
Quality time in the hangar: priceless - that's what Bud & Gojo were invented
for ... enjoy
Mike
s/v Shanghai'd Summer ('81)