European Tribune - Community, Politics & Progress.

How the Dodd bailout plan works

by Migeru
Wed Sep 24th, 2008 at 05:09:47 AM EST

Like many people I have been following what has been called Paulson's Authorisation for the Use of Financial Force. One of the most interesting developments around it has been a counter-proposal by Chris Dodd, Chairman of the US Senate's banking committee.

I have found Paul Krugman's blog very useful and I encourage you to read his analysis. Here I'll just quote his reaction to Paulson't and Dodd's plans.

I hate to say this, but looking at the plan as leaked, I have to say no deal. Not unless Treasury explains, very clearly, why this is supposed to work, other than through having taxpayers pay premium prices for lousy assets.
...
And there's no quid pro quo here -- nothing that gives taxpayers a stake in the upside, nothing that ensures that the money is used to stabilize the system rather than reward the undeserving.
I hope I'm wrong about this. But let me say it again: Treasury needs to explain why this is supposed to work -- not try to panic Congress into giving it a blank check. Otherwise, no deal.

I've had more time to read the Dodd proposal -- and it is a big improvement over the Paulson plan. The key feature, I believe, is the equity participation: if Treasury buys assets, it gets warrants that can be converted into equity if the price of the purchased assets falls. This both guarantees against a pure bailout of the financial firms, and opens the door to a real infusion of capital, if that becomes necessary -- and I think it will.

Jerome has written against the Paulson plan today, as have many others which you can see linked in that thread. Here I want to focus on how the Dodd plan plugs the holes in the Paulson plan, how it's supposed to work, and how it might yet fail.

The Paulson plan, in a nutshell, is this: give the Treasury Secretary (that is, Paulson) unaccountable authority to spend up to $700bn buying Big Shitpile™ from the few financial institutions left standing (including his former employer Goldman Sachs, in which apparently he retains a large equity share). One of the sticking points is the unaccountability - despite a provision to report to congress 3 months into the program and every 6 months thereafter, there is the following hair-raising provision

Sec. 8. Review.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

The Dodd plan, in contrast, establishes an "Emergency Oversight Board" and monthly reporting to Congress, as well as the judicial review implicit in the following:

SEC. 8. LIMITS ON REVIEW.
(a) IN GENERAL.--Any determination of the Secretary with regard to any particular troubled asset pursuant to this Act shall be final, and shall not be set aside unless such determination is found to be arbitrary, capricious, an abuse of discretion, or not in accordance with the law.

Funny how Paulson's section is called "review" when the content is total lack thereof.

Now, aside from lack of accountability, I have quoted Krugman saying he doesn't see how that plan is supposed to work other than by overpaying for the assets which is clearly unacceptable. Let's see why this is so.

The problem of financial institutions such as the failed Lehman Brothers is that they have bad assets on their books in an amount which, were they to be marked down sufficiently low, would leave them bankrupt. Suppose that a balance sheet looks like this (in billion USD):

Assets		Liabilities
Good Assets	450	Debt	475
Shitpile™	50	Equity	25

(Krugman's post Doubts about the rescue, written before he had seen Paulson's proposal, contains a substantially similar example)
Now, suddenly, nobody wants to touch the Shitpile™ with a 10-foot pole. In this particular example, if the Shitpile™ loses 50% of its market value, the company is borderline insolvent:

Assets		Liabilities
Good Assets	450	Debt	475
Shitpile™	25	Equity	0

The company needs to increase its equity - presumably by raising capital from unsuspecting yellow or brown people (also known as Sovereign Wealth Funds).
What Paulson proposes to do is to buy these assets, replacing them with cash

Assets		Liabilities
Good Assets	450	Debt	475
Cash	50	Equity	25

This makes the company solvent and gives it liquid assets (cash!) to face short-term liabilities, potentially solving the liquidity crunch. The problem is that if the company needs to be recapitalised, Paulson will have to pay more than the assets are worth, or else the need for new capital will not have been addressed.

Now, the Dodd plan addresses this problem by giving the Treasury equity (or debt, in the case of private companies which don't have listed shares) in the amount paid for the bad assets. Now, naively this seems even worse than the Paulson plan from the point of view of restoring solvency: if the treasury buys $50bn of Shitpile™ for $50bn, and in addition it gets $50bn of equity, the net effect is to add $50bn to the total liabilities which makes the company even more insolvent. Granted, the $50bn of shitpile have become liquid cash, but you're more bankrupt than before. The magic of the Dodd plan is that the Equity the Treasury would get is in the form of a contingent claim for 125% of the losses realised by the Treasury. This is how it works: as long as the Treasury doesn't resell the Shitpile™ it has bought, the contingent claims are off the balance sheet of the company:

Assets		Liabilities
Good Assets	450	Debt	475
Cash	50	Equity	25

Now, if and when the Treasury disposes of the $50bn of Shitpile™ it bought, two things can happen:

the Treasury sells the Shitpile™ at a profit; then the contingent claim expires as the contingency (realised losses) didn't take place. In this case, the company's balance sheet stays as above and the Treasury has made no loss!
the Treasury sells the Shitpile™ at a loss; then the contingent claim becomes realised as equity in the amount of 125% of the losses.

For instance, if the Shitpile™ is sold at $30bn the realised losses are $20bn and the Treasury immediately gets $25bn of equity in the company.

Assets		Liabilities
Good Assets	450	Debt	475
Cash	50	Existing Equity	250
		Treasury Equity	25

In that case, the shareholders get wiped out (The Dodd plan makes the Tresury equity "senior" and has non-dilution provisions) and the company is again borderline insolvent. If the losses exceed this threshold, then the company becomes actually insolvent.

Now, the treasury has a choice as to when to sell the Shitpile™. This means it can hold them until

the price is high enough to sell at a profit (this will take a few years for the economy to get out of recession, or inflation to catch up)
the company, now solvent, has healed its balance sheet to the point where exercising the contingent claim from selling at a loss doesn't bankrupt it - the Treasury now owns a stake in a profitable company, in an amount exceeding its losses by 25%.

These are win-win situations. You can also get to 2) by simply waiting for inflation to catch up with the 125%.

There is a catch: if the Treasury sells the Shitpile™ before these conditions hold, then the company goes bankrupt (and presumably the Treasury nationalises it). That is, the Tresury has the management of the company by the balls. For this reason, I don't expect the management of financial corporations to be keen on being "helped" this way. Because the management is protected, unless they own shares in the company they might prefer to just let it go bankrupt. Lehman's CEO didn't have a problem with that last week...

Another problem with the plan is that the contingent claim held by the Treasury doesn't make ordinary shares in the company very attractive to hold as there is substantial risk involved. So even if the solvency of the company is assured, a collapse of its share price is a real possibility, especially after the Treasury has published its holdings and the company it financial reports.

Finally, it is possible that $700bn won't be enough to capitalise the US financial sector sufficiently. And, as Jerome points out in his diary and Krugman does in The Humbling of the Fed this means you cannot fund the bailout without creating inflation.

But in March, and again this week, interest rates on T-bills fell close to zero -- liquidity trap territory. What does that do to the Fed's role?
...
You still see people saying, in effect, "never mind the zero interest rate, why not just print more money?" Actually, the Bank of Japan tried that, under the name "quantitative easing;" basically, the money just piled up in bank vaults. To see why, think of it this way: once T-bills have a near-zero interest rate, cash becomes a competitive store of value, even if it doesn't have any other advantages. As a result, monetary base and T-bills -- the two sides of the Fed's balance sheet -- become perfect substitutes. In that case, if the Fed expands its balance sheet, it's basically taking away with one hand what it's giving with the other: more monetary base is out there, but less short-term debt, and since these things are perfect substitutes, there's no market impact. That's why the liquidity trap makes conventional monetary policy impotent.

So, I think the Dodd plan is as close as it gets to a workable solution, but it might not be sufficient. And even if a systemic meltdown is averted, the stocks of financial corporations may still drop and the economy may remain in a recession for a while.

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How the Dodd bailout plan works | 177 comments (177 topical, 0 editorial, 0 hidden)

How the Dodd bailout plan works... (4.00 / 14)

...but only sort-of.

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

by Migeru (migeru at eurotrib dot com) on Tue Sep 23rd, 2008 at 06:04:00 PM EST

Re: The Phoenix Plan--fire and rebirth (4.00 / 3)

I think it all boils down to whose ox gets gored. I fail to understand why the existing institutions cannot be allowed to fail if What is not needed for capitalization of new institutions could be used to mitigate collateral damage from the defaults of existing institutions. If derivitives blow up, let them take out those who were involved. Perhaps this only makes sense to me because I an not trained in economics. But then it is the economics that has been used that has created this situation.

I am always happy to be instructed in these dark arts.

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Tue Sep 23rd, 2008 at 09:14:46 PM EST
[ Parent ]

Re: The Phoenix Plan--fire and rebirth (none / 1)

Apparently the end of a sentence was deleted. Should have read: "if a substantial portion of the proposed $700 Billion MOAB is instead used to provide equity capital to a series of new banks that are required to be run along 1970s lines."

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Tue Sep 23rd, 2008 at 11:19:36 PM EST
[ Parent ]

Re: The Phoenix Plan--fire and rebirth (none / 1)

The reason existing institutions cannot be allowed to fail is that default has knock-on effects on potentially every single other institution in the system. Nationalisation is the answer. Once you own the existing banks you can simply replace the management and run them "along 1970s lines" if that would fix the problem.

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 01:49:04 AM EST
[ Parent ]

Re: The Phoenix Plan--fire and rebirth (4.00 / 4)

I do not deny the problem of the knock on effect. However, given the size of the markets, $10 Trillion for residential real estate loans, and the degree of leverage to which many of these financial instruments have been subjected, 30 to 1 has often been cited, how can we even start to get an idea of the extent of the cost of an effective intervention without letting the markets clear?

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.

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Wed Sep 24th, 2008 at 08:12:24 AM EST
[ Parent ]

Re: The Phoenix Plan--fire and rebirth (none / 1)

What is not needed for capitalization of new institutions could be used to mitigate collateral damage from the defaults of existing institutions.

"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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 04:58:35 AM EST
[ Parent ]

Re: The Phoenix Plan--fire and rebirth (none / 1)

Perhaps the collateral damage he means is not in the financial world but among homeowners?

*Traitor*, n.
A benighted individual who perceives an illusory distinction between serving his nation and abetting the criminals who govern it.

by DoDo on Wed Sep 24th, 2008 at 05:18:20 AM EST
[ Parent ]

Re: The Phoenix Plan--fire and rebirth (4.00 / 2)

Um, a default of an institution doesn't directly affect the homeowners who are debtors, not creditors, of the defaulting institutions.

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 05:32:21 AM EST
[ Parent ]

Re: The Phoenix Plan--fire and rebirth (none / 0)

I was thinking that banks default because the price of derivatives is crashing after debtors default because of the crazy price structuring of their mortgages. The connection to bank defaults is indirect not direct, unlike for the banks' creditors, but I read this into "collateral damage".

*Traitor*, n.
A benighted individual who perceives an illusory distinction between serving his nation and abetting the criminals who govern it.

by DoDo on Wed Sep 24th, 2008 at 08:10:42 AM EST
[ Parent ]

Re: The Phoenix Plan--fire and rebirth (none / 1)

I was referring to what ever would emerge as an important but salvageable part of the financial system as the dust clears. It seems that the time for financial triage has arrived.

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Wed Sep 24th, 2008 at 08:18:26 AM EST
[ Parent ]

Re: The Phoenix Plan--fire and rebirth (4.00 / 4)

Triage requires full disclosure.

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 08:20:20 AM EST
[ Parent ]

Re: The Phoenix Plan--fire and rebirth (4.00 / 6)

My point exactly. We are assuming massive obligations without knowing whether they are salvageable. How do we help by giving ourselves a dynamite enema and lighting the fuse?

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Wed Sep 24th, 2008 at 08:29:54 AM EST
[ Parent ]

Re: The Phoenix Plan--fire and rebirth (4.00 / 4)

Martin makes similar points below. The chief virtue of my recommendation is to create new credit for ongoing business and for credit worthy borrowers. I don't know how much available credit is needed for the economy to work adequately. But credit freeze has been cited by Bernanke as the reason we must come up with the $700 Billion. I can see that it is a real problem. I would rather see that amount of money spent on something real and obviously helpful than on unwinding 30 to 1 bets.

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Wed Sep 24th, 2008 at 08:25:35 AM EST
[ Parent ]

The big problem is the inflation of .... (4.00 / 2)

... credit ratings that has allowed senior tranches of a pile of chickenshit to be treated like a basket of eggs.

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)."

Utsukushikereba sore de ii

by BruceMcF (agila61 at netscape dot net) on Thu Sep 25th, 2008 at 03:05:12 AM EST
[ Parent ]

Re: How the Dodd bailout plan works... (4.00 / 6)

I don't think this will remove the freeze up completely.

From a current stock holder, the plan is not very convincing. As your example makes clear, even with a positive balance sheet, you may end up wiped out, if you participate (the 25 bn equity is wiped out by the 20 bn loss). Only the lower borrowing costs help the company, so current stock holders might encourage the management to muddle through as long as they can.

This undermines the purpose, why the banks are rescued at all. There need to be banks making new loans or extending existing loans beyond the ones already made.

Yet another problem, how to account for gov't changes on mortgages. If the gov't says, it reliefs people by cutting down the mortgage they hold, they are producing losses for the banks, which might argue, without the gov't these losses wouldn't have been so big.

Another question is, when the toxic waste is sold, isn't there a large incentive for the banks to buy there toxic waste back at too high prices? As they have just purchased the stuff, there is no reason to book it lower than the fantasy price.
If the bank doesn't know if it will go bust in the long run, they might even buy themselves once again into insolvency terrain, which means, the long term borrowing costs of the banks won't go down really much, once a company has started to participate into the plan.
If the gov't forbids banks to buy its own debt back to overvalued prices to prevent that the bank just unmakes the plan, once it has profitted from the lower interest, then you prohibit as well that such a bank finds another source of refreshing its equity.
Or the banks make one to the left accounting, every bank takes the assets of its neighbouring bank for a fantasy price and everybody is happy. So the fed would have to hold the portfolio to maturity, which might be long times.

One possibility is as well, that a CEO, who knows he is running a fundamental insolven bank (but not illiquid as the toxic stuff is at the fed), might pillage his bank by selling fundamental sound stuff to another bank. If we have really an undervaluation problem right now, this selling would be below the recovery value. That means, the CEO would ride his bank deeper into the shit, but as the bank is anyhow a gov't owned bank the moment the fed sells the bad stuff, that doesn't matter for him. The bank taking the good stuff might be grateful to him, still (or his private hedge fund).

I think the best plan would be to buy bank of America (e.g. 95%) and just provide real economy credit via that bank by introducing a huge amount of equity, while leaving other banks to themselves. The Dodd plan might be better than the Paulson plan, but might not help to bring the financial market to function again.

Lich King/Caribou Barbie 08
Pain brings Katharsis

by Martin (weiser.mensch(at)googlemail.com) on Tue Sep 23rd, 2008 at 09:16:38 PM EST
[ Parent ]

Re: How the Dodd bailout plan works... (none / 0)

For reminding about the size of the problem:

OK, admittedly there the zero is supressed, but still scary.

Lich King/Caribou Barbie 08
Pain brings Katharsis

by Martin (weiser.mensch(at)googlemail.com) on Tue Sep 23rd, 2008 at 10:05:12 PM EST
[ Parent ]

Re: How the Dodd bailout plan works... (4.00 / 3)

From a current stock holder, the plan is not very convincing. As your example makes clear, even with a positive balance sheet, you may end up wiped out

Isn't this why the Tarp retains the right to sell the assets when it see fit? If the bank is insolvent, then it sells to get senior equity and obtain the proceeds from the liquidation. If the bank is not insolvent, it sells assets to get the profits until the difference between the price paid for the toxic asset and the sell price.

The equity holders therefore only loose money if the bank is insolvent, which is reasonable. OR maybe I just get this wrong.

Rien n'est gratuit en ce bas monde. Tout s'expie, le bien comme le mal, se paie tot ou tard. Le bien c'est beaucoup plus cher, forcement. Celine

by UnEstranAvecVueSurMer (holopherne ahem gmail) on Wed Sep 24th, 2008 at 12:46:17 AM EST
[ Parent ]

Re: How the Dodd bailout plan works... (none / 1)

I think you're substantially right but I don't know enough about corporate finance to go into the details.

So the fed would have to hold the portfolio to maturity, which might be long times.

Yes, that's what's going to happen. Bernanke has been explaining the difference between "firesale prices" and "hold-to-maturity prices" and people are still scratching their heads as to how this is going to work, but that's the idea. Either you sell after we got out of the recession, or you sell when inflation has caught up with 125%, or you don't sell and you only get equity in the banks in 125% proportion to the value of mortgages people default on.

Apparently when a US financial institution holds a debt instrument it can claim it "holds it for investment" in which case it doesn't get market to market but instead retains its original purchase price (the "hold-to-maturity price"). Maybe this is just a way to allow banks to change the classification of the assets. Because that is cheating, the Treasury gets equity in exchange.

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 01:56:33 AM EST
[ Parent ]

Re: Inflation (none / 1)

Won't help a lot. The bad mortgages will go bust rather soon. A rapid house price increase in the longer term would help only, when the banks would go for a Chris Cook style solution, where they essentially foreclose the homes, but don't sell them, but instead rent them out. Private banks are most likely not going to do that. If the gov't takes over the mortgages, it might do something like that.

But I doubt there will be a lot of house price inflation. The recent high (CPI) inflation numbers were mostly due to increases in the price of tradable goods. A dollar decline creates inflation in the tradable goods sector, but unless Asians and Europeans start to buy houses in the USA, this won't help the house prices to increase.
Only a wage price spiral could do that. Not in sight. The last quarters US GDP deflator was ~0.8%
Japan has not had a cumulative GDP deflator of 25% in the last 20 years. In a medium bad case scenario, the US would develop Japan-like. Probably still better than a great depression.

Lich King/Caribou Barbie 08
Pain brings Katharsis

by Martin (weiser.mensch(at)googlemail.com) on Wed Sep 24th, 2008 at 10:31:48 AM EST
[ Parent ]

Re: Inflation (none / 1)

A rapid house price increase in the longer term would help only, when the banks would go for a Chris Cook style solution, where they essentially foreclose the homes, but don't sell them, but instead rent them out. Private banks are most likely not going to do that. If the gov't takes over the mortgages, it might do something like that.

Buying the mortgages is effectively what the bailout plans want to authorise, and the Dodd version contains some specific provisions about preventing foreclosure on mortgages that the tresury buys, as well as giving the Tresury the contingent equity.

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 10:37:51 AM EST
[ Parent ]

Re: Inflation (none / 1)

If a reinflating of the house prices in the not-short term (in which I doubt, as I wrote) shall make banks whole, they need an equity stake in the houses.

While the Dodd plan may help to prevent forclosures, which may be helpful for the banks, especially those which don't know who their debtors really are and therefore can't make a deal with them, I'm pretty sure, it don't foresee an equity stake in the houses.

Lich King/Caribou Barbie 08
Pain brings Katharsis

by Martin (weiser.mensch(at)googlemail.com) on Wed Sep 24th, 2008 at 11:47:54 AM EST
[ Parent ]

Re: Inflation (none / 0)

If a reinflating of the house prices in the not-short term (in which I doubt, as I wrote) shall make banks whole, they need an equity stake in the houses.

No, the treasury buys the mortgages at par and then the banks hope that the house prices reinflate so that the Treasury doesn't have to exercise its option.

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 04:50:51 PM EST
[ Parent ]

Re: Inflation (none / 0)

The question is what happens in the next few months. People will miss payments or make partial payments. This constitutes usually an event of default.
So what is the gov't going to do? Just ignore the missing payments? This payments after all are part of the value of the asset.
Wasn't it that the democrats wanted in such cases, that the principal is renegotiated at a court? In that case the loan would be simply cut. If later the house increases in value, why would the principal increase again?
An alternative would be, to just pack the missed payments as additional debt on the mortgage, which in the short term makes the homeowner even more under water, which is probably not, what the democrats have in mind, when they speak about relief for the overdebted.

Lich King/Caribou Barbie 08
Pain brings Katharsis

by Martin (weiser.mensch(at)googlemail.com) on Wed Sep 24th, 2008 at 06:00:01 PM EST
[ Parent ]

Re: Inflation (none / 0)

Right, mortgage defaults lead to losses for the Treasury and therefore some of the contingent equity is realised. Krugman has quoted an estimate that maybe $800bn will be lost on subprime because of the housing slump and that under $500bn of losses has been recognised so far. So nationalisation seems like the eventual, inevitable outcome.

But under the Dodd plans the equity is realised over months or years, and Obama can be blamed for nationalising the banks :-)

Under the Paulson plan, the Tresury simply loses money.

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 06:06:08 PM EST
[ Parent ]

Re: Inflation (4.00 / 2)

But under the Dodd plans the equity is realised over months or years, and Obama can be blamed for nationalising the banks :-)

So if the economy doesn't run well the next 4 years, because of the mess that is, it will be blamed on Obama's socialism.
Maybe the Dodd plan isn't that bad, as there is a scapegoat to prevent anti-capitalistic spin. I only hope Obama is really elected and the mess doesn't fall McCain on the feet ;-)
Maybe I should change my signiture, but I think by now it are anyhow only the masochists left favouring McCain.

Lich King/Caribou Barbie 08
Pain brings Katharsis

by Martin (weiser.mensch(at)googlemail.com) on Wed Sep 24th, 2008 at 06:14:09 PM EST
[ Parent ]

Re: Inflation (none / 0)

Won't help a lot. The bad mortgages will go bust rather soon. A rapid house price increase in the longer term would help only, when the banks would go for a Chris Cook style solution, where they essentially foreclose the homes, but don't sell them, but instead rent them out.

Not quite.

My solution is in fact a transfer of title by the Banks to a quasi REIT and then for the banks to sell off their Units in the affordable rental streams flowing through these REIT's.

The outcome of this "asset-based" solution is far more advantageous to the banks than any conventional "deficit-based"solution involving new credit.

In this model,the properties themselves will never be sold again, remaining in "custody".

However, the "Co-owner" Occupiers may change, and the "Co-owner" Investors may change, particularly as Occupiers may gradually become Investors as well, simply by buying Units.......

by ChrisCook (cojockathotmaildotcom) on Wed Sep 24th, 2008 at 10:44:48 AM EST
[ Parent ]

Re: Inflation (4.00 / 2)

This would essentially institutionalize an inherent "rent to buy" option for all of these properties. US citizens are familiar with that term.

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Wed Sep 24th, 2008 at 01:02:39 PM EST
[ Parent ]

Re: Inflation (none / 1)

Excellent point.

The key is always to use language which is understood, and not only do I tend to write "financespeak" but it's UK "financespeak".

The proposal also has elements of what I have heard called an "evergreen lease" (not a UK expression).

Sort of an "evergreen lease to buy"

by ChrisCook (cojockathotmaildotcom) on Wed Sep 24th, 2008 at 01:48:51 PM EST
[ Parent ]

Re: Inflation (4.00 / 2)

Glad I finally understood some of what you have been saying. Why don't you ask Mig to include a UK to US financespeak translation feature in his pending glossary? :-)

However, I think that a few "worked examples" set forth in common language would help, also. My biggest problem has been understanding how your system would work in practice. We have been taught to believe in "marketplace competition." Why should that competition not extend to the very nature of ownership in society?

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Wed Sep 24th, 2008 at 03:18:25 PM EST
[ Parent ]

Re: Inflation (none / 1)

We have been taught to believe in "marketplace competition." Why should that competition not extend to the very nature of ownership in society?

Why shouldn't we unlearn what we've been taught?

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 03:24:49 PM EST
[ Parent ]

Re: Inflation (none / 0)

Why shouldn't we unlearn what we've been taught?

A lot of effort has gone into writing this stuff into everyone's brain over the last 30 years. I agree that it would be best to write a better message, especially for the younger generations. For anyone over 30 it may be far more effective to modify the meaning and redirect the results of the existing hard wired brain structures. IMHO.

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Wed Sep 24th, 2008 at 03:50:39 PM EST
[ Parent ]

Re: Inflation (none / 1)

I'm all in favour of "competition" because I believe that the model I am outlining will actually "outcompete" the conventional one.

The reason is that there are no returns going to unnecessary "rentiers". This is what the Cooperative movement calls the "Cooperative Advantage".

The competition that I foresee is not for pieces of paper representing IOU's/claims over wealth made by intermediaries, but competition for "Quality" instead.

There is no Profit and no Loss within a partnership framework, merely creation and exchange of "Value" in all its forms (and "Money as Debt" is not one of them).

Such a "cooperative of cooperatives" partnership model would IMHO be what Yunus calls "Not for loss".

Here's an example.

A portfolio of 5,000 25 year mortgage loans @ 6% pa average $200,000 to a total value of $1 billion. Each borrower must currently repay $1303.77 per month or $15,645.24 pa for the life of the loan.
A rental is set at an "affordable" level - (say) an average "affordable" rental of $500 per month or $6,000 pa and this rental is then Index - linked. This gives a total Rental Pool of $30m in the first year, rising with inflation.
This Pool is "Unitised" into (say) a million "Units" or "millionths". Each Unit consists of one millionth of the economic interest / "ownership" of the pool of properties and carries an income of $30.00 in the first year, rising with inflation thereafter.
It is now simply a question of the market price of these Units: at $1,000 per Unit the initial return is 3%. The proceeds of a sale at this price would be $1bn, and this would pay off the debt at 100 cents on the dollar.
At $750 per Unit the initial return would be 4% and the proceeds $750m or 75% of the nominal value of the debt.
And so on.

The key point is that the higher the level at which the initial "Capital Rental" return is set, the less likely it is that it will be paid in its entirety, and therefore the less "certain" it is, and the more risky it is.

Risk does not lead to Reward: Reward leads to Risk.

by ChrisCook (cojockathotmaildotcom) on Wed Sep 24th, 2008 at 05:24:10 PM EST
[ Parent ]

Re: How the Dodd bailout plan works... (none / 1)

As I say below is nationalization of the Dodd's plan.

the Doods' plan will carry beside it an informal FBI watchdog to detect those practices.
they can be detected now that there are on investment baks.

And we shoudl remember that nobody cares abut hedge funds as long as no private bank holds stakes on them... and soon they will not have it.

Another point, even if a hedge fund with no oversight wanted to follow the path you indicate because he has at the other side a bank too big to fall, the FEd and the FBi can crack him down if the problem is not systemic (if the banks depend signficatively on hundred of ehdge funds revenues for part of their assets , then I think nationalization is the only option).

but if hedge funds effects are low (as I think theya re),a dn the FEDs go with the FBI, the Dodd bill seems workable if we put the tag at a couple trillion dollars at the end of the day.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Wed Sep 24th, 2008 at 09:42:50 AM EST
[ Parent ]

For muddling through, ... (none / 1)

... senior preferred shares that have steep penalty contingencies if the full dividend is not paid have an appeal, since a return to profitability can lead to a return to positive equity for common shareholders. A firm will not be insolvent if they are unable to pay a full preferred dividend ... they simply operate under the contingent penalties.

And for common shareholders, the size of the public authority preferred holding is known up front, rather than being a subject of speculation regarding how the sale of the shitpile will work.

Utsukushikereba sore de ii

by BruceMcF (agila61 at netscape dot net) on Thu Sep 25th, 2008 at 02:13:51 AM EST
[ Parent ]

TARP (4.00 / 6)

TARP-Taxpaper Anal Rape Program

This is a scam by having a Dodd plan vs. Paulson Plan. Look at the players-Dodd is the Senator from Connecticut who has been bought by the finance and insurance industry. Paulson when he was CEO of GS was shorting the same financial instruments they were selling the previous year.

You cant trust people who are saying they want to save a banking system which has allowed the greatest inequality of income since the 1930's and contribute only 7% to the GDP but take home 40% off all corporate profits.

Why even compare. The government should nationalize all the deposits and good loans of these financial institutions and let the banks go under with the bad loans. When the banks try and come out of bankruptcy;they have a choice either they have stringent regulations on who and how they will loan and will get back the previously government nationalized deposits and good loans if the depositors and good loans wish to go back to the bank or the bankrupt banks start from scratch or dont come out of bankruptcy.

The government then creates its own national credit unions or whatever and has the good deposits and loans secure there.

What these criminals-not one indictment in this whole mess so far nor any reregulation in exchange for previous bailouts-want is to be able to keep a sick system alive.

And we havent even factored in the coming defaults of the Alt A mortgages which are due for resets over the next 16 months.

What are we doing listening to these guys trying to extend their criminal practices with our continued operation because they are threatening to blow up the world finance system which doesnt work anyway and regardless of a bailout; the finance system will have to be completely overhauled if finally the people are to be protected instead of a proverbial few bankers compared to the hundreds of millions of people they have harmed.

by An American in London on Wed Sep 24th, 2008 at 08:35:55 AM EST
[ Parent ]

Re: TARP (4.00 / 6)

Why the ongoing American obsession with anal rape? It seems to me that any economic problems the US might have could be solved by immediately instituting an Apollo like programme to produce suitable anti-anal-rape shields. There would clearly be a ready market.

by Colman (colman at eurotrib.com) on Wed Sep 24th, 2008 at 08:39:34 AM EST
[ Parent ]

Re: TARP (4.00 / 2)

Perhaps because it equally applies to both men and women plus it fit the initials TARP. I didnt make it up;its been going around the finance sector since Paulson called in the Congressman and said their world (campaign contributions, jobs after government etc.)would end if they didnt pass the plan in a week based on a three page summary,5 days before they were to go home to their districts to campaign for an election 6 weeks away.

The whole thing smells like the way Bush rammed (sorry about the verb) home the Iraq Invasion.

Call them on their bluff and see ifthey dont come back for a much smaller handout to use for their cronies with total oversight.

by An American in London on Wed Sep 24th, 2008 at 08:48:43 AM EST
[ Parent ]

Re: TARP (4.00 / 2)

To extend the simile, the TARP covers the whole process so we won't disturb the children.

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Wed Sep 24th, 2008 at 09:05:09 AM EST
[ Parent ]

Re: TARP (4.00 / 4)

It's the unofficial punishment for criminals, sanctified in pop culture. It has become the most feared or at least archetypal injustice for the innocent. The reasons are murky, probably has something to do with puritanism and watching to many movies.

by PIGL on Wed Sep 24th, 2008 at 09:00:09 AM EST
[ Parent ]

Re: TARP (none / 1)

You forgot some sort of warped homophobia ...

by Colman (colman at eurotrib.com) on Wed Sep 24th, 2008 at 09:01:18 AM EST
[ Parent ]

Re: TARP (none / 1)

Paging MarketTrustee for a Jungian analysis...

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 09:02:14 AM EST
[ Parent ]

Re: TARP (none / 0)

Perhaps the Abraham and Issac story gone further wrong?

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Wed Sep 24th, 2008 at 09:07:43 AM EST
[ Parent ]

Re: TARP (none / 0)

Goes without saying?

Or more like, I just wasn't inventive enough to fit it into my rant!

by PIGL on Thu Sep 25th, 2008 at 07:57:12 AM EST
[ Parent ]

Re: TARP (none / 0)

It has become the most feared or at least archetypal injustice for the innocent.

See The Shawshank Redemption.

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 09:03:19 AM EST
[ Parent ]

Note above that the BoJ action WORKED ... (4.00 / 5)

... whereas the description is as if the BoJ action failed.

The point of the BoJ action was to drive the cash rate down as low as it could go ... effectively 0.1%. That led to the swing in the Yen exchange rate from an Importers rate to an Exporters rate, which supports the monetary policy.

No monetary policy ever works one-handed, and the other half of the policy to allow Japan to weather the storm caused by the massive restructure of production by Japanese corporations from roughly 90% domestic value added to roughly 60% was an extended period of very high deficit spending.

That massive restructure knocked the legs out of domestic investment in plant and equipment in Japan for a decade. But without the move to the for-most-intents-and-purposes 0% cash rate and big government stimulus, the "lost decade" would have been a Depression rather than a decade of relative stagnation punctuated by three recessions.

Utsukushikereba sore de ii

by BruceMcF (agila61 at netscape dot net) on Wed Sep 24th, 2008 at 09:31:38 AM EST
[ Parent ]

Re: Note above that the BoJ action WORKED ... (none / 1)

Hey, this would be worth a diary! We like history here.

(One question: what exactly is the "cash rate"?)

*Traitor*, n.
A benighted individual who perceives an illusory distinction between serving his nation and abetting the criminals who govern it.

by DoDo on Wed Sep 24th, 2008 at 01:16:33 PM EST
[ Parent ]

Still (4.00 / 6)

What happens if nothing is done?

It seems like bailout or no, the dollar is screwed and the recession doesn't go away. Why should the American tax payer be asked to borrow even more money to throw after bad paper?

Why not go from the bottom up and skip the bad paper? It is funny money — it has no value, obviously — so why should we prop it up. The U.S. could spend $700 billion to help ease the people's pain if the country slips into a depression, instead of bailing out Wall Street.

by Magnifico on Tue Sep 23rd, 2008 at 06:40:07 PM EST

Re: Still (4.00 / 3)

I believe the argument is that at that point the economy grinds to a complete halt. Banks stop lending, and call in loans whenever possible. Without credit lines existing businesses go bankrupt. Without the possibility of credit or capital, no new businesses get formed. That is the ensuing economic crunch is much worse. Sure, the majority of the crap that the financial industry has been playing with seems to be largely a way of shuffling money back and forth, leveraging up, and raking in the profits on a completely useless activity, but capital markets also play a necessary role in our economy. In that way they're no different than any other industry that seeks to make money off of gambling on exotic paper - an electricity company which relies on derivatives trading for its income can go bankrupt. The derivatives trading, or at least most of it, was completely useless from society's perspective. But that doesn't mean we can do without energy supplies.

by MarekNYC on Tue Sep 23rd, 2008 at 06:51:30 PM EST
[ Parent ]

I doubt that (4.00 / 7)

So why not have the U.S. government invest that $700 billion dollars directly to those businesses and not through private banks? Why should the government take on the bad paper so the banks can roll the dice again?

And most electric companies are guaranteed a profit because they are a state-sanctioned monopoly.

by Magnifico on Tue Sep 23rd, 2008 at 07:12:22 PM EST
[ Parent ]

Re: I doubt that (4.00 / 4)

Well if you look back, there were about 1 1/4 million houses in the US last year at some stage of the foreclosure process, an investment of somewhere south of 10 billion, maybe as low as 1 billion at an earlier stage of the process, could have helped the homeowners keep their heads above water and stopped the foreclosures, which would have prevented a lot of the paper turning toxic, and prevented much of the sorry mess.

but then that would never have worked, as it's a form of socialism.

Life should consist in at least fifty percent pure waste of time, and the rest doing what you please.

by ceebs (bunchofwankers (at) gmail (dot) com) on Tue Sep 23rd, 2008 at 07:24:35 PM EST
[ Parent ]

Re: I doubt that (4.00 / 4)

1 billion - that's less than $1000 per house in foreclosure at that stage, before administrative costs. Ten times that wouldn't have done much either. In any case the damn prices were completely unsustainable, they had to fall, and fall a lot.

Something close to that was Barney Frank's proposal to allow people to reduce their mortages to 85% of the current market value, The government pays the banks that 85%, the banks write off the rest, and the first x of any eventual gain on a later sale of the home goes to the government. Given foreclosure and resale costs, the banks effectively get more than what they'd get by foreclosing. The homeowners don't lose their home, and in the long term the government shouldn't lose that much money since it's holding mortgages at, on average about two thirds of the nominal peak price, with the right to capture much of the eventual upside. But the upfront costs would have been much more than ten billion. A very watered down version of this plan eventually passed, but it was done in a way that very few would qualify for paticipation.

by MarekNYC on Tue Sep 23rd, 2008 at 07:44:38 PM EST
[ Parent ]

Re: I doubt that (none / 1)

well it's between 1 month and 10 months hoam loan payments, enough to get peoples heads back above water for a few months, Time to do something for themselves. if it had been put in last year before everything went really wrong, you dont have to pay off the full ammount if you act quick enough, just give the individuals aspace to help themselves. OK a lot won't be in a position to, but it's better than the mess thats about now.

Life should consist in at least fifty percent pure waste of time, and the rest doing what you please.

by ceebs (bunchofwankers (at) gmail (dot) com) on Tue Sep 23rd, 2008 at 07:53:56 PM EST
[ Parent ]

Re: Swap for "Equity" Instead (4.00 / 4)

Say I have a house with a 30 year $200,000 mortgage which has just been reset from 5.0% to 7.5%.

My payments go from $1084.19 to $1411.18 per month.

Let's foreclose on the house, put it into the hands of a "Custodian" and charge a reasonable "Capital Rental" to the "Occupier-formerly-known-as-Owner", and then index-link the rental.

At an initial "Capital Rental" of 4% the finance cost is $667 per month: at 3% $500.00 and so on.

Anything the Occupier pays in excess of the "Capital rental" due buys him Units, and if he wishes, he can always pay the Rental with Units if he doesn't want to, or can't, pay in cash.

The outcome is Units of a "quasi REIT" asset class which the owner of the distressed debt can sell off to long term investors.

The lower the Capital Rental is, the more affordable it is, and the more likely it will be paid.

I reckon a 2 to 3% (index-linked) return could be quite achievable for Units in a "Pool" of over a million homes....

Safe as Houses.....

by ChrisCook (cojockathotmaildotcom) on Tue Sep 23rd, 2008 at 09:27:57 PM EST
[ Parent ]

Re: I doubt that (4.00 / 4)

The subprime folks generally couldn't afford the house, period, unless you permanently reduce their payments. To make matters worse, most of the loans in trouble, subprime, alt-A, or prime are adjustable. In the latter two often option ARM's. That means ballooning payments. Folks often stretched themselves thin just to make the initial teaser rates. Unless you foresee a sudden rise in incomes then all we're doing is paying money to the banks without doing anything about the underlying problem.

by MarekNYC on Tue Sep 23rd, 2008 at 11:23:31 PM EST
[ Parent ]

Re: I doubt that (4.00 / 5)

Well, the problem is bad loans were made which means money was created (by the magic of fractional reserve banking) which shouldn't have. Now that money is going out of existence, making a number of companies and people bankrupt. You can allow those bankruptcies to take place and the money to disappear, or you can make good on those commitments by creating cash to back them up.

The second possibility leads to inflation, but it saves the institutions and allows the system to continue to function.

The first possibility would have knock-on effects as one company's bankruptcy immediately impairs assets on everyone else's balance sheet. You could conceivably end up with everyone filing for bankruptcy protection. That would also be a solution: if A owes money to B who owes money to C who owes money to A it can all be netted out to zero but the required disclosures will only take place if A, B, and C are all in bankruptcy court. But it everyone is bankrupt there will be no credit creation and, again, the economy will grind to a halt.

Another way to get the required "circular claims" disclosures to be made is for the government to pull a Roosevelt:

On March 5, 1933, the day after Roosevelt's inauguration, he called a special session of Congress which instituted a mandatory four-day bank holiday. This act provided for the reopening of banks after federal inspectors had declared them to be financially secure.

Just tell people that unless they all sit at a table with the Treasury Secretary and net out their outstanding bad claims, nobody will be allowed to continue in business.

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 04:56:43 AM EST
[ Parent ]

more simple, more simple times (4.00 / 2)

Few "structured" securities and almost all the banks had capital (securities available for sale) tied up in railroad or utilities firms. Both of those operated under monopoly conditions, hiding ponzi earnings reporting schemes.

Diversity is the key to economic and political evolution.

by MarketTrustee (pbing@estudioinc.com) on Wed Sep 24th, 2008 at 01:46:28 PM EST
[ Parent ]

Re: I doubt that (4.00 / 2)

Let's forget about the market rhetoric as it is just that, rhetoric.

The credit institutions have a wealth of information about the financial system (and those mortgages). You want to at least save the institutional memory in those banks.

This can be achieved by letting them all go bankrupt and then buying up the pieces. But the government would have to have a "public holding company" or something like that to be able to own companies. This is not the case.

Except that the Dodd plan creates that authority, while keeping within the market narrative and thus being palatable.

One more point: this bailout plan has been designed for the Financials, but other corporations will want in on it. When the SEC decided to ban short selling of Financial stocks, some industrial companies successfully lobbied to be included in the short ban. Who is to say that General Motors won't ask the Treasury to buy some Shitpile™ from it?

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 02:07:30 AM EST
[ Parent ]

Re: I doubt that (none / 1)

The key word is palatable, Dodd is there to create a paltable program... ebcause somehow natioanlziation is not cosnidered palatable.

I ahve the feeling that nationalization would have a slightly higher chance to succeed... but a Dood program with a robert Reich approach investment during the transition has similar or higher.

IN any case, I am not still completely sure it woudl work..

So, Is Euroep , China and Japan ready for derivative meltdown? and for a huge contraction in US demand?

These are the two questions we should be worried here.
I know about Spain.. no big deal about the ocntraction demand, but given that we are in the same bubble process than the US, a credit default will eb really bad for Spain..

the US falls, Spain goes with it.. at least we make some kind of deal with the Chinese and convince them that we are in better shape than the US and can send ther saving around here :)

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Wed Sep 24th, 2008 at 10:01:05 AM EST
[ Parent ]

Re: Still (4.00 / 2)

Marek, don't banks have to still do business and make a profit? Perhaps the most entrepreneurial sectors get squeezed, but life goes on, does it not? The entire spigot doesn't get turned off.

i get at least two calls a day from banks and funds around the world asking about windpower. Some of them are probably reeling from the caps on short-selling, as well as investor bailing. But they still want to put whatever funds remain into something productive.

Am i missing something here?

Skennah Kowa

by Crazy Horse on Tue Sep 23rd, 2008 at 07:39:16 PM EST
[ Parent ]

Re: Still (none / 0)

The system hasn't collapsed, it's just in bad shape. If you allow a full collapse no more such calls until new banks get formed.

by MarekNYC on Tue Sep 23rd, 2008 at 07:46:48 PM EST
[ Parent ]

Re: Still (none / 0)

Are those banks exposed to the banks you want to see fail?

E.g., if Goldman Sachs defaults on its debt and the recovery rate is 5%, does your phone stop ringing?

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 01:58:58 AM EST
[ Parent ]

Re: Still (4.00 / 3)

One can't be sure, because i don't know how much good paper they or others have remaining. But for certain, as any good hobo knows, the freight trains didn't stop running during the Depression.

When Gore ratchets up the renewable energy = fix the economy argument, trying to emulate Germany, we should at least manage to keep working. Somebody will finance that growth.

Some bankers have told me that the flight from toxic capital to windpower is partly responsible for high valuations of the public companies.

Skennah Kowa

by Crazy Horse on Wed Sep 24th, 2008 at 04:05:07 AM EST
[ Parent ]

Re: Still (none / 1)

But for certain, as any good hobo knows, the freight trains didn't stop running during the Depression.

And neither will your wind turbines stop spinning, but how many new loans for the purchase of new freight trains were made during the Depression?

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 04:13:55 AM EST
[ Parent ]

Re: Still (4.00 / 2)

This is, of course, one of the great dangers: a depression could rob us of the capital and capacity required to refit the economy just when we most need it and drop the price of oil to a level that makes greening seem economically unnecessary.

Good luck selling wind turbines when the unemployment rate sky-rockets - unless someone persuades governments to indulge in a huge investment programme in the face of US$40 oil.

by Colman (colman at eurotrib.com) on Wed Sep 24th, 2008 at 04:28:38 AM EST
[ Parent ]

Re: Still (none / 1)

Good luck selling wind turbines when the unemployment rate sky-rockets - unless someone persuades governments to indulge in a huge investment programme in the face of US$40 oil.

Reconstructing the energy and transportation sectors and educating the next generation of scientists and engineers with incentive scholorships would be a 21st Century equivalent of the '30s WPA and similar projects along with the post WWII GI Bill.

As long as we do these things within our economy and don't require imported goods we should be readily able to finance it. It is primarily a question of vision and political will.

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Wed Sep 24th, 2008 at 08:55:36 PM EST
[ Parent ]

Well (4.00 / 3)

Speaking form experience, even profitable business lines (like financing wind power) get squeezed when there is no liquidity.

We are being asked to reduce our activity, right now. Many other banks have been absent from the market from months already.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (jeromeguillet@yahoo.fr) on Wed Sep 24th, 2008 at 09:30:34 AM EST
[ Parent ]

Re: Well (none / 1)

I don't dispute that many, perhaps almost all banks, are "reducing activity." But i find far more banks than 18 months ago are making serious inquiries and even investments in various windpower sectors. Each individual bank may be diminishing funding, but the sum total is greater, perhaps far greater. (There are no stats in this sector i am aware of.)

A bank still standing, thanks to its relationship with the current SecTreas, is exploring new markets for wind as we speak.

Skennah Kowa

by Crazy Horse on Wed Sep 24th, 2008 at 04:43:27 PM EST
[ Parent ]

Re: Still (none / 0)

the economy grinds to a complete halt. Banks stop lending, and call in loans whenever possible. Without credit lines existing businesses go bankrupt. Without the possibility of credit or capital, no new businesses get formed. That is the ensuing economic crunch is much worse.

At that point, you might as well have the Fed lend money to the Treasury to give people credit.

If a credit system is central to the material provisioning of society, then we shall have a credit system. It may not look like the one we've had so far...

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

by Migeru (migeru at eurotrib dot com) on Wed Sep 24th, 2008 at 04:47:38 AM EST
[ Parent ]

Re: Still (none / 1)

For a portion of the $700 Billion Paulson is requesting we could have available credit by using that money as equity for new banks. If the banks could pay back the equity, they could be independent. Either way they could provide Trillions of new credit. If existing credit is being destroyed, this would not necessarily be inflationary. Once the new banks started functioning, the existing banks that are viable would have to start making loans or they would massively lose market share.

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Wed Sep 24th, 2008 at 09:01:06 PM EST
[ Parent ]

Re: Still (none / 0)

Well, at a 3% reserve ratio, $700bn allow over $20tn of credit. Just orders of magnitude here, but you get the picture.

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

by Migeru (migeru at eurotrib dot com) on Thu Sep 25th, 2008 at 02:59:31 AM EST
[ Parent ]

Re: Still (none / 1)

I was being more conservative at a 15/1 ratio, but yeah, we don't have to take the dynamite enema route to solve this crisis, although that may be our leader's choice.

If sanity be culturally normative, then by the norms of this culture I claim insanity.

by ARGeezer (argeezer a in a circle yahoo dot com) on Thu Sep 25th, 2008 at 09:51:51 AM EST
[ Parent ]

Re: Still (none / 0)

The problem is that if a "compromise" is achieved on the Paulson/Dodd proposals on the Hill, even if all the economists in the land blog that it's a bad compromise, it will be adopted (by definition of "compromise"). And then when things go pear-shaped every commentator will blame the Bush administration, the Republicans or the Democrats according to their prejudices.

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

by Migeru (migeru at eurotrib dot com) on Thu Sep 25th, 2008 at 10:12:28 AM EST
[ Parent ]

Re: Still (none / 0)

And the really big problem with that is that the Bad Guys have many more pundits than we do.

- Jake

Ceterum censeo Chicago esse delendam

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Sep 25th, 2008 at 02:15:50 PM EST
[ Parent ]

Re: Still (4.00 / 4)

The best answer I have read is Brad De Long's one.

The US is in the middle of a transtion in the economic model, from construction sector and services related plus debt, to one based on doing stuff to export, local services sector (where there is competition) with a low dollar and, hopefully, a more efficient Health-care system with exapanding jobs if Obama gets to enact his plan.

this change in job distribution structure needs time, and money to build the factories that never existed and the company structure for the services to slowly get market share from japanese and europeans int he local market thanks to the lower dollar.. so you need a bunch of money to start-up those companies.

Otherwise, it will not be a problem to let the banks go falling one after the other...with only the government as lender... but you precisely need the credit to make the transition.

So, it is clear that th other option is the full nationalziation of the US bank system... so either the Dodd bailout or nationalization. Otherwise I think the Us is in bigger than bigger trouble.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Wed Sep 24th, 2008 at 09:04:21 AM EST
[ Parent ]

Elsewhere (4.00 / 2)

There is an extended discussion of this on Mark Thoma's blog:

http://economistsview.typepad.com/economistsview/2008/09/hold-to-maturit.html

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Tue Sep 23rd, 2008 at 07:04:29 PM EST

I am a complete simpleton on this market problem (4.00 / 3)

But given, as I understand it, the key cause is the subprime mortgage loaning bad debt after bad debt -

if the USA Treasury is going to try and buy out the trouble, why wouldn't it instead of buying lousy institutions, pay off all the defaulting mortgages, which would give the banks etc. cash, remove the bad debt, and give Americans houses?

be kind in your responses :-)

"This can't possibly get more disturbing!" - Willow

by myriad (imogenk at wildmail dot com) on Wed Sep 24th, 2008 at 01:44:46 AM EST

Re: How the Dodd bailout plan works (4.00 / 2)

It appears to me that even the Dodd plan is a bad idea. Going beyond Martin's arguments, isn't the toxic stuff a basic problem? That is, on one hand, should all these derivatives the government buys from the banks be terminated, rather than re-sold? On the other han, shouldn't banks be kept from creating new toxic assets? I mean, the banks could induce Treasury to sell the first Shitpile^TM at a loss by boosting their balance sheets with the new stuff:

2009 (illusory successful end of Dodd Plan):

Assets Liabilities
Good Assets 450 Debt 475
Cash 50 Contingent claim 25
Shitpile^TM 2.0 25 Equity 25
2010 (height of next bubble):

Assets Liabilities
Good Assets 500 Debt 525
Shitpile^TM 2.0 50 Equity 25
2011 (next crash starts):

Assets Liabilities
Good Assets 475 Debt 500
Shitpile^TM 2.0 25 Equity 0

Also, in a crisis of confidence, would the price of Good Assets fall, too?

*Traitor*, n.
A benighted individual who perceives an illusory distinction between serving his nation and abetting the criminals who govern it.

by DoDo on Wed Sep 24th, 2008 at 03:30:59 AM EST

Re: How the Dodd bailout plan works (none / 1)

If you write the glossary, there is just one term I am really confused about (despite having read dictionary and Wiki entries several times in the past): equity. There seem to be multiple meanings, even in your diary.

Others may be "warrant" (I see it should be equivalent with "contingent claim" in this case, which you sufficiently explain; but don't know what to associate at in general, knowing only "arrest warrant") and "short-selling".

*Traitor*, n.
A benighted individual who perceives an illusory distinction between serving his nation and abetting the criminals who govern it.

by DoDo on Wed Sep 24th, 2008 at 03:35:43 AM EST
[ Parent ]

A warrant (4.00 / 3)

is a right to purchase equity at a pre-agreed price and a pre-agreed time (or subject to pre-agreed conditions).

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (jeromeguillet@yahoo.fr) on Wed Sep 24th, 2008 at 09:33:25 AM EST
[ Parent ]

Re: A warrant (none / 0)

So, equity remains.

*Traitor*, n.
A benighted individual who perceives an illusory distinction between serving his nation and abetting the criminals who govern it.

by DoDo on Wed Sep 24th, 2008 at 01:18:08 PM EST
[ Parent ]

Re: How the Dodd bailout plan works (none / 0)

I'm with DoDo there. I thought the company was (or at least could be) insolvent when debts got greater than assets. If the shitpile is sold for equity, and in that case I will actually suppose it's sold for shares in the company, I thought that precisely that made it more solvent.
Like, ending with 450 of good assets and 50 in cash, against 475 in debts, with shares diluted by a 200% increase in capital.

I fail to see how that would make the bank more insolvent.

"The womb that spawned that thing is fertile yet"

by Cyrille (cyrillev domain yahoo.fr) on Wed Sep 24th, 2008 at 04:54:19 PM EST
[ Parent ]

Re: How the Dodd bailout plan works (none / 1)

What if everyone goes bankrupt by domino effect? Then you'll have to create a public credit facility to keep the economy going.

What, then, is the downside to taking over the existing banks? (case when the contingent claims are exercised by reselling Shitpile™ at a loss)

And if the rescue of the banks allows them to be profitable again and the tresury can resell the Shitpile™ at a profit, then it will have been proven that the problem was one of liquidity (if you believe the problem is one of solvency then you will end up in the previous case).

A vivid image