I am always happy to be instructed in these dark arts. As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."
Imagine the following scenario: the Dodd plan is adopted, Paulson and Bernanke overpay for the assets and early in Obama's administration they sell the assets at a loss and take over the banks (all the existing equity gets wiped out and Tresury owns 100% of the assets). A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith
The US Government has already taken charge of Freddie and Fanny. The portion of performing loans in their portfolios is not yet public knowledge. The location of the bottom for real estate prices is not known yet. It is possible that prices in some of the largest markets have another 20% drop ahead. It is not inconceivable that they could be $1 to $2 Trillion underwater by the time the bottom is reached. Who knows the extent of liability due to leverage on CDOs and MBSs which they own or which they have already guaranteed? May they be small to non-existent!
AIG could be in the same range of damage potential due to a larger portion of their obligations being leveraged. Even $40 Billion leveraged at 30 to 1 gives $1.2 Trillion. Then there are all of the banks lined up at the FDIC's door. Even if they end up only 10% under water on the typical 60% of their assets which are mortgages, could that total another $1 Trillion?
It seems to me to be far more responsible to insure that any more expenditures go towards efforts where the size and extent of the damage is well defined. That should start with a cold eye on the books of the Fed. If indeed, as Jerome's correspondent suggests, most of the demanded $700 Billion goes just to re-capitalizing the Fed, then that is just pissing into a hurricane unless the Fed is ordered to cease and desist in its policies of buying toxic trash for good money, as Market trustee suggested? How can we know the adequacy of the proposed solution if we don't know the size of the problem?
I can see that it is possible that the mortgage problem can be worked out over time. I do not see how leveraged financial instruments can be saved unless they miraculously save them selves by all netting out to zero. I fear they might be several Trillion dollars off. And that is in today's dollars. As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."
"Mitigate collateral damage from defaults" = "recapitalization"
A distinction without a difference? A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith
That is, because stuff was given investment grade ratings that should never in a million years have been given investment grade rating, all sorts of institutions that are only allowed to hold investment grade securities are on the hook if the house of cards is just allowed to collapse and then pick up the pieces later.
That includes pension funds, car insurance, fire insurance, annuities ... the Main Street finance sector, still operating, obscured by all the financial fireworks.
Example, five pools of mortgages each are supporting a family of five assets each. In each family, the senior member has first claim on the income, until it meets its face value income stream, then the next eldest, then the middle, then the second youngest, and the youngest is last in line.
Because the youngest is first in line for any shortfall, it sells at the steepest discount, and yields a high return up front. But it is not rated as investment grade.
Now collect the youngest members of all five families and send them off to school, with their allowances in tow. They pool the allowances, and set up a pretend family in their classroom, with the senior desk having first claim on a share of the pool, then the next senior desk, then the middle desk, then the fourth desk, then the last desk.
For random events ... "a tree fell on our house, we have to fix the roof, I can't bring in any allowance this week", the senior desk is well shielded by its position at the top of the ladder, "upgrading" it in terms of sheltering it from random risks. But if something hits all five families equally, then there may be no allowance at all.
No matter how you follow rules set down to create "security class" assets as the senior claim on a pool of income, if its a senior claim out of a pile of assets overexposed to systemic risks, you are concentrating exposure to systemic risk. And concentrated exposure to systemic risk is not supposed to be what institutions are supposed to be holding if they are limited to holding investment grade assets.
So a lot of those AAA ratings were big fat lies in terms of the regulatory intent of the restriction. But quite often very stylish lies told following all proper forms and so quite possible legally permissable lies ... "this is the kind of things we are allowed to rate as AAA, under established practice (even though you would be silly to treat this AAA as being really truly equivalent to that AAA)." I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
