Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.

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):

AssetsLiabilities
Good Assets450Debt475
Shitpile™50Equity25

(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:
AssetsLiabilities
Good Assets450Debt475
Shitpile™25Equity0

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
AssetsLiabilities
Good Assets450Debt475
Cash50Equity25

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:

AssetsLiabilities
Good Assets450Debt475
Cash50Equity25

Now, if and when the Treasury disposes of the $50bn of Shitpile™ it bought, two things can happen:
  1. 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!
  2. 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.
AssetsLiabilities
Good Assets450Debt475
Cash50Existing Equity250
Treasury Equity25

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

  1. 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)
  2. 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.

Display:
...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
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.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Sep 23rd, 2008 at 09:14:46 PM EST
[ Parent ]
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."

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Sep 23rd, 2008 at 11:19:36 PM EST
[ Parent ]
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 ]
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.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Sep 24th, 2008 at 08:12:24 AM EST
[ Parent ]
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 ]
Perhaps the collateral damage he means is not in the financial world but among homeowners?

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Wed Sep 24th, 2008 at 05:18:20 AM EST
[ Parent ]
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 ]
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".

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Wed Sep 24th, 2008 at 08:10:42 AM EST
[ Parent ]
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.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Sep 24th, 2008 at 08:18:26 AM EST
[ Parent ]
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 ]
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?

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Sep 24th, 2008 at 08:29:54 AM EST
[ Parent ]
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.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Sep 24th, 2008 at 08:25:35 AM EST
[ Parent ]
... 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)."

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

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


Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

by Martin (weiser.mensch(at)googlemail.com) on Tue Sep 23rd, 2008 at 09:16:38 PM EST
[ Parent ]
For reminding about the size of the problem:

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

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

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

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

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

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

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

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers
by Martin (weiser.mensch(at)googlemail.com) on Wed Sep 24th, 2008 at 06:00:01 PM EST
[ Parent ]
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 ]
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.

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

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

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Sep 24th, 2008 at 10:44:48 AM EST
[ Parent ]
This would essentially institutionalize an inherent "rent to buy" option for all of these properties.  US citizens are familiar with that term.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Sep 24th, 2008 at 01:02:39 PM EST
[ Parent ]
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"

"The future is already here -- it's just not very evenly distributed" William Gibson

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

"It is not necessary to have hope in order to persevere."

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

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Sep 24th, 2008 at 03:50:39 PM EST
[ Parent ]
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.

"The future is already here -- it's just not very evenly distributed" William Gibson

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


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Thu Sep 25th, 2008 at 02:13:51 AM EST
[ Parent ]
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 ]
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 ]
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 ]
To extend the simile, the TARP covers the whole process so we won't disturb the children.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Sep 24th, 2008 at 09:05:09 AM EST
[ Parent ]
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 (stevec@boreal.gmail@com) on Wed Sep 24th, 2008 at 09:00:09 AM EST
[ Parent ]
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 ]
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 ]
Perhaps the Abraham and Issac story gone further wrong?

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Sep 24th, 2008 at 09:07:43 AM EST
[ Parent ]
Goes without saying?

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

by PIGL (stevec@boreal.gmail@com) on Thu Sep 25th, 2008 at 07:57:12 AM EST
[ Parent ]
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 ]
... 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.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Sep 24th, 2008 at 09:31:38 AM EST
[ Parent ]
Hey, this would be worth a diary! We like history here.

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

*Lunatic*, n.
One whose delusions are out of fashion.

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

Any idiot can face a crisis - it's day to day living that wears you out.

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

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Tue Sep 23rd, 2008 at 07:53:56 PM EST
[ Parent ]
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.....

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Sep 23rd, 2008 at 09:27:57 PM EST
[ Parent ]
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 ]
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 ]
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 Cat on Wed Sep 24th, 2008 at 01:46:28 PM EST
[ Parent ]
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 ]
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 ]
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?

"Life shrinks or expands in proportion to one's courage." - Ana´s Nin

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

"Life shrinks or expands in proportion to one's courage." - Ana´s Nin

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

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Sep 24th, 2008 at 08:55:36 PM EST
[ Parent ]
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 (etg@eurotrib.com) on Wed Sep 24th, 2008 at 09:30:34 AM EST
[ Parent ]
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.

"Life shrinks or expands in proportion to one's courage." - Ana´s Nin

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

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Sep 24th, 2008 at 09:01:06 PM EST
[ Parent ]
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 ]
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.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Sep 25th, 2008 at 09:51:51 AM EST
[ Parent ]
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 ]
And the really big problem with that is that the Bad Guys have many more pundits than we do.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Sep 25th, 2008 at 02:15:50 PM EST
[ Parent ]
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 ]
by rdf (robert.feinman@gmail.com) on Tue Sep 23rd, 2008 at 07:04:29 PM EST
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
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 ShitpileTM at a loss by boosting their balance sheets with the new stuff:

2009 (illusory successful end of Dodd Plan):
AssetsLiabilities
Good Assets450Debt475
Cash50Contingent claim25
ShitpileTM 2.025Equity25

2010 (height of next bubble):

AssetsLiabilities
Good Assets500Debt525
ShitpileTM 2.050Equity25

2011 (next crash starts):

AssetsLiabilities
Good Assets475Debt500
ShitpileTM 2.025Equity0

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

*Lunatic*, n.
One whose delusions are out of fashion.

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

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Wed Sep 24th, 2008 at 03:35:43 AM EST
[ Parent ]
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 (etg@eurotrib.com) on Wed Sep 24th, 2008 at 09:33:25 AM EST
[ Parent ]
So, equity remains.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Wed Sep 24th, 2008 at 01:18:08 PM EST
[ Parent ]
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.

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi

by Cyrille (cyrillev domain yahoo.fr) on Wed Sep 24th, 2008 at 04:54:19 PM EST
[ Parent ]
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 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 05:02:25 AM EST
[ Parent ]
I'm not sure I follow.

You are going with the assumption that Treasury would take over those banks, eventually. But I assume banks don't really want to be taken over, and that based on past performance and lack of changed rules, they can avert it: they can become profitable again on paper with another bubble to the extent of weathering even if Treasure re-sells ShitpileTM 1.0 without a profit. And then an even bigger cycle starts.

So, is "liquidity" the key to an indefinite extension of this pyramid game, or do you mean something else?

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Wed Sep 24th, 2008 at 05:17:01 AM EST
[ Parent ]
Because nobody wants to buy Shitpile™, Shitpile™ asset prices have gone through the floor. Since the assets are required to be marked-to-market on the balance sheet, the fact that the market for them has frozen and the price has collapsed collapses the assets side of the banks' balance sheets. In the good old days, losses were not recognised unless they were realised, that is, an asset would be on the balance sheet at its original purchase price and the loss would be realised at the time of selling it. Liquidity had no impact on the balance sheet. Most of the Shitpile™ is still cash-flowing, it's just that the rights to that cash flow cannot be sold. The implied default risk given the prices is so astronomical as to be preposterous, but would you buy some Shitpile™ at what is currently likely a huge discount?

The only way to buy Shitpile™ is on cash, a leveraged purchase is too risky on the downside and leveraged purchases are more vulnerable the longer you intend to hold the assets. So if you're Warren Buffet and you're swimming in cash, or you're Bernanke/Paulson and can manufacture cash, you can buy Shitpile™ and hold it to maturity.

Now, the policy question is, can you unlock the liquidity and then set a monetary and fiscal policy that doesn't allow a repeat of the bubble?

The alternative view is that the "preposterously" high default and low recovery rates implied by the Shitpile™ prices are actually "accurate", and then you have a solvency problem.

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 05:31:19 AM EST
[ Parent ]
See also these discussions.

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 05:34:23 AM EST
[ Parent ]
You're supposing that the shitpile is still generating cash-flows. This is increasingly untrue and will get worse.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Sep 24th, 2008 at 09:34:55 AM EST
[ Parent ]
Primary market mortgages originated, then securitized as if asset, are no longer generating sufficient income to pay huge classes of (CMO) investors --PLUS-- corporate bonds which may or may not be dependent on the same unearned income to pay interest and retire debt (averting default) and capital gain from securities available for sale (MTM assets) on the balance sheet.

Diversity is the key to economic and political evolution.
by Cat on Wed Sep 24th, 2008 at 02:01:22 PM EST
[ Parent ]
can you unlock the liquidity and then set a monetary and fiscal policy that doesn't allow a repeat of the bubble?

My argument was that the two go hand in hand: to prevent the repeat of the bubble, or a new bubble based on other exotic financial instruments that weren't subject to the loss of confidence (hence ShitpileTM 2.0), these markets have to be closed, from which it follows that the ShitpileTM bought by Treasury should not be up for re-sale even in theory. I'm not sure even holding to maturity is compatible with that.

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Wed Sep 24th, 2008 at 01:28:09 PM EST
[ Parent ]
What if everyone goes bankrupt by domino effect?

The domino is a linear cascade. The sandpile model is much better because sites toppling can cause their neighbours in every direction (usually 4) to topple as well.

When I adapt the sandpile model to finance I'm going to call it the Shitpile model.

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 05:54:10 AM EST
[ Parent ]
sigh, so scatological...first we are blessed  with golden showers of trickle down theory for decades, then we find our candy mountain reduced to human ordure.

freud must be giggling in his grave.

time to pull our collective finger out and evolve to a jungian era...

 

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Wed Sep 24th, 2008 at 06:10:41 AM EST
[ Parent ]
There's also the methapor of a house of cards.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Wed Sep 24th, 2008 at 08:05:32 AM EST
[ Parent ]
That's a good one for a pyramid scheme. But the shitpile model can be run on a spherical graph.

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 08:07:13 AM EST
[ Parent ]
Via FT Alphaville, $5 Trillion Cash Pool Needed to Stop Rout, Ohmae Says
Treasury Secretary Henry Paulson's $700 billion plan to buy devalued assets from financial companies is ``a joke'' because it doesn't go far enough to calm markets, said Kenichi Ohmae, president of Business Breakthrough Inc.

Ohmae, nicknamed ``Mr. Strategy'' during his 23 years as a McKinsey & Co. partner, called for a $5 trillion ``international facility'' to be made available to financial institutions. The system could be modeled on one used by Sweden during its banking crisis in the early 1990s, he said.

``This is a liquidity crisis,'' Ohmae said at an investor forum hosted by CLSA Asia-Pacific Markets, the regional broking arm of Credit Agricole SA, in Hong Kong yesterday. ``The liquidity has to be so big that people won't get panicky.''



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 04:28:05 AM EST
Via Naked Capitalism, via FT Alphaville, comes Institutional Risk Analytics: What is to be Done?: Interview with Bert Ely (September 23, 2008)
Ely: I am highly skeptical of the workability of the Paulson plan, largely because I worry that the hooks and conditions Congress will plug into it, such as limits on executive compensation and equity participations in the institutions which participate in the program, will discourage many institutions from participating in it. It will be too expensive to play, particularly if Treasury tries to low-ball its pricing for the assets it is willing to buy. Merely offering low prices also will have serious mark-to-market impacts on all balance sheets, which could be a major negative of this program.

...

Ely: That is of course the trillion dollar question. I have run the numbers looking at the capacity of the industry to pay the tab. Assuming that bank insolvency losses don't get way out of line, which I don't think they will, then the industry can handle it. It's not going to be cheap, but the banks can handle it and clean up their own mess. The losses will feed back through the industry to depositors and borrowers in the form of lower rates on deposits and higher cost of loans.

...

Ely: Yes, it is not necessary, even now. There is absolutely no need for the Treasury to have the authority, as you suggested, to "inject capital into solvent banks that are temporarily unable to raise new capital." If a bank truly is solvent, it can raise additional capital or sell itself, if its present owners are realistic about what their bank is worth. The reason solvent banks have a problem raising capital, or selling themselves to a stronger bank, is that they set their price too high, as did AIG. As an aside, I am glad to see AIG's shareholders getting whacked by the warrants associated with the Fed's taxpayer's loan to AIG. There is absolutely no need for the taxpayer to subsidize banks so they can stay independent, provided no barriers are erected to prevent new entrants into bank or specific banking markets.



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 04:36:36 AM EST
[ Parent ]
limits on executive compensation

Wow naked greed in all its glory. it's almost like they think we owe them money.

Any idiot can face a crisis - it's day to day living that wears you out.

by ceebs (ceebs (at) eurotrib (dot) com) on Wed Sep 24th, 2008 at 05:54:56 AM EST
[ Parent ]
To be honest, if the large private corporations are in symbiosis with the State (as, according to Galbraith's New Industrial State they are), there's no justification for astronomical executive compensation.

The symbiosis of Wall Street and the US Treasury has been hidden in plain sight, and now the veil is being pierced.

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 05:59:05 AM EST
[ Parent ]
The justification for high CEO pay is to make sure that corporations are in symbiosis with the state, putting them above oversight and outside of the law.

The symbiosis of Wall Street and the US Treasury has been hidden in plain sight, and now the veil is being pierced.

It's been a wake-up call for a lot of people whose life styles were crumbling - and they weren't sure why, because they were following the officially approved work ethic rules.

I think there's a lot more anger to come as people realise how badly they've allowed themselves to be screwed over.

The bailout debate is the overture, not the main performance.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Sep 24th, 2008 at 06:19:26 AM EST
[ Parent ]
I think high CEO pay has come from the realisation that CEOs had more power than shareholders. The pwn3r class therefore left ownership and entered management. A narrative of "competition for talent" was built to justify ever-incresing "executive compensation".

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 06:22:37 AM EST
[ Parent ]
the competition for talent argument is one I've never quite understood.  especially the fact that it seems only to apply at the top end of companies.

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Wed Sep 24th, 2008 at 06:25:26 AM EST
[ Parent ]
It's not surprising that you couldn't understand it, since it was specious.

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 06:35:56 AM EST
[ Parent ]
As I responded to Kos yesterday:


CEO pay matters for several reasons:

  • such high pay generates incentives for others to earn as much, and skews motivations towards management-income maximization rather than company income maximization;

  • more deviously, by making such figures, and their incomes, into representatives of success, it pushes forward the narrative of success = money and poverty = failure, which is the single most important driver of conservative policies (you're on your own, etc...);

  • by letting a small, but influential class earn huge amounts, it bring about massive lobbying power against taxes and in favor of deregulation, the exact consequences of which we see today;

Ultra high incomes, and growing inequality are bad things for society, and they need to be tempered by high taxes oe strong regulation - but regulation is fatally weakened when rich people can buy access to politicians and pundits and co-opt them.

So CEO pay is actually at the vey heart of the problem.



In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Sep 24th, 2008 at 09:40:06 AM EST
[ Parent ]
Mig
The symbiosis of Wall Street and the US Treasury has been hidden in plain sight, and now the veil is being pierced.
This makes now the perfect time to rip the veil of limited liability and force disgorgement by execs for compensation taken in the last  seven years on vehicles that are now blowing up. Sen. Dodd yesterday used the term "clawback" referring to such a recovery process.

This is like watching the French Revolution unfold.  What was unthinkable two days ago is policy today and will be hopelessly outdated and superseded in another two days.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Sep 24th, 2008 at 11:02:57 AM EST
[ Parent ]

This is a liquidity crisis

No it's NOT!

It's a solvency (or credit) crisis. Liquidity is being provided massively by the central banks - so much so that they are even taking credit risk on their balance sheets in increasing volumes, and it's still not enough.

Nope, banks don't need liquidity, they want to get rid of bad risk.

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

by Jerome a Paris (etg@eurotrib.com) on Wed Sep 24th, 2008 at 09:37:37 AM EST
[ Parent ]
In dodd's plan it does not really matter at the end of the day...

just like nationalization.. it really does not matter regarding the final finanatial consequences.. of course the bill is bigger if there is a solvency problem.. but both will help from t e top, the Dodd's plan is more flexible in some sense but moe complex , so easier to get nasty surprises.

But if you put the cost at two or three trillion dollars, you have that taxpayers will get roughly even if it is a iliquidity problem. If it is a solvency problem, taxpayers will nationalize most banks.

The Dodd program has the effect of creating uneven competition between rescued banks, non-rescued banks and partially rescued which is unfair. Nationalization of some banks will do the same but wthout the weird partiallyr escued. Natioanlization of the whole system will erased competition and fix one size fits all.

Precisely yesterday I made a long long comment trying to explain why it seems to be that there is no way to know with certainty which one will work better,or if they would work at all. There is no epistimelogichal way...

you just try one.. and in this case the palatable one (given the US media)

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 10:26:24 AM EST
[ Parent ]
It's not clear to me what's in "shitpile." Is that defaulted mortgages or does it include derivative paper?

Hey, Grandma Moses started late!
by LEP on Wed Sep 24th, 2008 at 05:40:39 AM EST
I assume it's everything that has dropped apreciatively in value. and that the banks think would be much better turned into cash.

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Wed Sep 24th, 2008 at 05:48:49 AM EST
[ Parent ]
I believe it's mostly CDOs, but as ceebs hints, the troubles with CDOs have extended to other asset classes because the markets for all kinds of instruments have dried up.

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 05:50:33 AM EST
[ Parent ]
It's my uneducated opinion that the government should not buy paper derivatives which are not "real" assets; mortgages are OK but not ether. The worldwide banks should get together and write off all their mutual bullshit derivative paper and then we can see where everyone stands.

Hey, Grandma Moses started late!
by LEP on Wed Sep 24th, 2008 at 06:39:10 AM EST
[ Parent ]
CDOs are not derivatives, they are mortgages cut into pieces and repackaged. Sort of like sausages made out of minced meat of various origins...

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 06:47:29 AM EST
[ Parent ]
You mean like the Fanny Mae bonds I used to buy which represent thousands of mortgages?

Hey, Grandma Moses started late!
by LEP on Wed Sep 24th, 2008 at 06:58:47 AM EST
[ Parent ]
I don´t think so?

Here is a nice explanation.


Let's jump back 18 months. Huge Investment Banks (HIB, for short) encouraged mortgage banks to make home loans, often providing the capital, and then would purchase these loans and package them into large securities called Residential Mortgage-Backed Securities (RMBS). They would take loans from different mortgage banks and different regions and generally grouped them together according to their initial quality, such as prime, ALT-A and the now-infamous subprime mortgages. They also grouped together second lien loans, which were generally made to get 100% or cash-out financing as home owners borrowed against the equity in their homes.

Typically, a RMBS would be sliced into anywhere from 5 to 15 different pieces called tranches. Ratings agencies would then give them a series of ratings on the various tranches, and who actually had a hand in saying what the size of each tranche could be.

The top or senior-level tranche had the rights to get paid back first in the event of a problem with some of the underlying loans. That tranche was typically rated AAA. Then the next tranche would be rated AA and so on down to junk level. The lowest level was called the equity level and would take the first losses. For that risk, they also got residual funds if everyone paid. The lower levels paid very high yields for the risk they took.

Since it was hard to sell some of the lower levels of these securities, HIBs would take a lot of the lower level tranches and put them into another security called a Collateralized Debt Obligation (CDO). And yes, they sliced them up into tranches and went to the rating agencies and got them rated. The highest tranche was typically again AAA. Through the alchemy of finance, HIBs took subprime mortgages and turned 96% of them into AAA bonds.

He probably gets to 96% because the HIBs didn´t stop with the simple CDO. They also created "CDO squared" (CDO^2). Buying the lower tranches of different CDOs and slicing them again into new tranches. I´ve even read about "CDO cubed" (CDO^3).
And all of them rely on the performance of the underlying mortgages.

The problem for ratings though was:


The ratings agencies used data supplied by the investment banks on what the likely default rates would be. It was like taking an open book test where you get to write the questions. And since home values had only gone up, default rates were low. Of course, the data was from an era when bankers lent money expecting to get paid back.

The situation of course has changed.

Mike Shedlock describes one mortgage pool originated in 2007:


This cesspool from May of 2007, was 92.6% originally rated AAA, even though loans had full doc only 11% of the time. In one year, the pool was 29.07% 60-day delinquent or worse. Of that, 13.87% is in foreclosure and 6.21% is bank owned real estate.

Mind you, if you only own the highest tranche you´re probably still pretty well protected. There are just two problems here as well:

  1. As I understand it, some funds (pension funds?) are only allowed to own "AAA" rated securities. If a CDO - even only the lower tranches - performs a lot worse than the models, the rating agency can downgrade every tranche of the CDO. Which means that the fund now has to get rid of its tranche, typically at a loss.
  2. If you want to really value a CDO, you have to take a close look at the underlying loans/mortgages. That´s probably time consuming, expensive and you´ll need experts for it.

Both of it means that almost everyone is now shying away from buying such securities. Unless they´re sold at steep discounts. Like Merrill Lynch in May 2008 (?) selling $30 billion of such securities at 22 cents on the dollar.
by Detlef (Detlef1961_at_yahoo_dot_de) on Wed Sep 24th, 2008 at 12:24:55 PM EST
[ Parent ]
mmm, differential calculus spewing.

Never my strong suit.

Diversity is the key to economic and political evolution.

by Cat on Wed Sep 24th, 2008 at 06:59:39 PM EST
[ Parent ]
... there is not a heavy systemic risk, because the rating was based datasets when fewer mortgages were as heavily exposed to systemic risks and the systemic risks were not as severe.

You mark to model with an optimistic model that assumes that the risks you can't track account for are a risk of 0, and you are in serious trouble is there is a systemic downturn.

And of course, that is the nature of systemic risk. Mixing together junior derivative tranches of different pools in different parts of the country will do fine to diversify the stochastic risks, and the senior-most tranches will be relieved of almost all stochastic risk.

But if there is a systemic risk that they are all exposed to that they are all ignoring, then the entire pool of junior tranches are at risk of being completely wiped out, and being the senior-most tranche from a pool of junior tranches from pools of mortgages means that almost all the risk exposure is systemic risk. So the higher the grade in the second-level pool, the worst the overvaluing if exposure to systemic risk is systematically underestimated.

And then the junior tranches of those pools of junior tranches are garbage and are pooled together to provide more senior tranches were very little stochastic risk, but the understated systemic risk exposure rising exponentially.

And regulated institutions have that crap in their balance sheets as if they were bona fide AAA grade securities ... that is, institutions that the law still decides after fifty years of financial deregulation cannot be permitted to play high risk games with their funds.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Sep 24th, 2008 at 08:01:34 PM EST
[ Parent ]
And if the rot is real, and this isn't a liquidity problem, but rather, that the shitpile really is an overleveraged shitpile, then the 125% of loss equity stake will be worthless.

Equity participation is nice, but it probably does not protect taxpayers, and it doesn't offer real control of these financial institutions.

But it has the nice effect of kicking the problem down the road so that the current cast of cronies who've profited over the past decade (or, really, three) can avoid real accountability.

In fact, the likelihood of this actually being a liquidity crisis is probably less than the nasty alternatives, in which case the best solution is to simply cut to the chase and nationalize, expropriating assets of those who've profited, and start putting some of them in jail.

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Wed Sep 24th, 2008 at 05:52:03 AM EST
Equity participation is nice, but it probably does not protect taxpayers, and it doesn't offer real control of these financial institutions.

I don't follow: in a scenario where the Treasury sells at a loss and ends up owning 100% of the equity, you have real control and nationalisation, right?

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 05:56:13 AM EST
[ Parent ]
Nationalisation is a political position - the means of production are state owned and run by and for the population.

Buying up a ShitPile™ isn't the same, because it's a disorganised mess of claims and counterclaims, and not a strategy for the entire indutry.

True nationalisation would mean ownership and strategic management, with the explicit goal of running the finance industry for the benefit of Main St, not Wall St.

The Dodd plan has some elements of that, but it falls short of going all the way.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Sep 24th, 2008 at 06:22:53 AM EST
[ Parent ]
Nationalisation is a political position - the means of production are state owned and run by and for the population.

Except that that's not how they were run, even in the Soviet Union in the 1960's, if Galbraith is to be believed.

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 06:25:05 AM EST
[ Parent ]
Ah, but we are meant to avoid the errors of our predecessors, no?

The Hun is always either at your throat or at your feet. Winston Churchill
by r------ on Wed Sep 24th, 2008 at 06:28:32 AM EST
[ Parent ]
Um, he doesn't seem to believe it is an error but an organic need of complex planning systems.

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 06:33:21 AM EST
[ Parent ]
You always have a trade off between a rentier class and an apparatchik class - although lately in the US they've become the same.

I don't think there's an organic need in complex planning systems. The problem is setting aims - jobs, quality of service, profits, pick any two - and getting a balance between dynamism and stability.

Monolithic state enterprises vs predatory freebooting capitalists aren't the only two possible options.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Sep 24th, 2008 at 07:01:34 AM EST
[ Parent ]
My point is that in a "Peer to Peer" world, rentiers are redundant.

To paraphrase Gilmore

"The Internet interprets rentiers as damage and routes around them"

Apparatchiks probably are Damage, too.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Sep 24th, 2008 at 07:06:43 AM EST
[ Parent ]
Monolithic state enterprises vs predatory freebooting capitalists aren't the only two possible options.

And neither of them appear to have been the dominant forms in the 1960's, again if Galbraith is to be believed. I wasn't alive to see it, were you?

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 07:07:35 AM EST
[ Parent ]
British Telecom (formerly the GPO - responsible for mail and phones), British Leyland, British Steel, and Brtish Rail weren't exactly fleet footed when they were around.
by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Sep 24th, 2008 at 07:12:48 AM EST
[ Parent ]
No large corporation is fleet-footed. It's a planning organization, that's the point.

The "dynamism of markets" narrative simply doesn't apply.

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 07:31:38 AM EST
[ Parent ]
Erm - Google? HP used to be pretty good before it was turned into an ink manufacturer. You could argue that the investment banks used to move fast, even though it was usually in a toxic direction.

I agree that there's no such thing as inherent market dynamism. But I don't see that as the issue.

It's really about management culture. The problem with nationalised industries is that they're managed by ignorant civil servants and equally ignorant time-serving pols, who are parachuted into departments where they're supposed to offer expert direction even though they have no fucking clue.

The problem with piratical freebooting industries is that they're run by vampires and psychopaths.

Somewhere between those extremes are lean cultures which move fast and actually work well.

There's nothing inherently economic about this - it's almost entirely a management problem.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Sep 24th, 2008 at 07:43:59 AM EST
[ Parent ]
Right, and in The New Industrial State Galbraith claims that by and large in the 1960's both US and Soviet large enterprises were in the middle.

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 07:48:22 AM EST
[ Parent ]
Hmm. IBM? The 60s were politically different because there was still a culture of Innovation as a Good Thing. So in IT especially, and less so in other kinds of engineering, there was a lot happening - but mostly it had been seeded by investment in education during the 50s, and the 60s were a harvest period for that.

By the mid 70s that effort had largely run of steam - certainly in the UK, and probably also in the US. I don't know enough about Soviet Rrrrussia to say anything plausible about what was happening there, but the Soviets didn't seem to have a similar innovation culture, and never really got over their pseudo-Lysenkoist ambivalence about science.

By the 80s a lot of these middle ground enterprises were dead, dying, or on life support, which suggests they can't really have been all that responsive.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Sep 24th, 2008 at 08:34:11 AM EST
[ Parent ]
Okay, Google. That's one exception though it might be argued it's more scatter-brained than fleet-footed. Any more? Apple? In any case, when product development takes a couple of years "fleet" is a very relative term.

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 07:50:40 AM EST
[ Parent ]
Oh come on, not apple, they're one of the worst smoke and mirrors, style over substance units out there, no quicker than their competitors, but with a 'Look at the shiny thing' front

HP used to be very good but nowadays its more their tech support than anything else thats of great quality. Tech companies in general are no better than their nuts and bolts counterparts in having new ideas. google just has so much money nowadays it can afford a scattershot development approach, either that or buy up anything that looks like its a got a good chance of being successful.

Any idiot can face a crisis - it's day to day living that wears you out.

by ceebs (ceebs (at) eurotrib (dot) com) on Wed Sep 24th, 2008 at 08:01:50 AM EST
[ Parent ]
Yep - buy Apple, and you'll be special.

But not.

I'm really starting to dislike Apple. If you take away the maDz Dezignz Skillz there's a fascist jackboot behind that funky Gap-wearing facade.

Apart from the shiny, they're good at building closed consumer markets which they can dominate ruthlessly, in the same way that Microsoft tries to build and dominate business markets.

Jobs was smart enough to realise that hardware and software are drug pusher techno-teasers now, and you make your money from building a content bazaar and renting out space in it.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Sep 24th, 2008 at 08:48:11 AM EST
[ Parent ]
No, no, it's hating Apple that makes you special. Don't you know anything?
by Colman (colman at eurotrib.com) on Wed Sep 24th, 2008 at 08:52:51 AM EST
[ Parent ]
Don't mind me - I just try to review the stuff dispassionately for a living.

All I know is that while the addicts are still enslaved by the shiny, it's getting harder and harder to find Apple journos, many of whom used to be fans, who actually like Apple any more.

Wouldn't it be a huge surprise if there were good reasons for that?

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Sep 24th, 2008 at 09:59:44 AM EST
[ Parent ]
They're a company. You expect to like them?
by Colman (colman at eurotrib.com) on Wed Sep 24th, 2008 at 10:15:26 AM EST
[ Parent ]
They used to be liked.

But it's always good when a company doesn't kill viable products just because it can.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Sep 24th, 2008 at 10:21:19 AM EST
[ Parent ]
Referring to their customers as "addicts" is dispassionate?
by Colman (colman at eurotrib.com) on Wed Sep 24th, 2008 at 10:20:03 AM EST
[ Parent ]
Okay, look - people queue for hours overnight in the cold to buy a phone which it turns out they can't register, and which has some issues when they try to use it as a phone.

In some cases the phone bricks itself on the spot.

Then the police have to be called in to some locations because there's serious danger of rioting.

Purely dispassionately - really, does anything about this seem sane to you?

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Sep 24th, 2008 at 01:08:33 PM EST
[ Parent ]
Yep - buy Apple, and you'll be special.

But not.

Reminds me of a mate and I seeing the Levellers in Wolverhampton, and literally crying with laughter at the crowd all chanting in unison "Theres only one way of life and thats your own"

Any idiot can face a crisis - it's day to day living that wears you out.

by ceebs (ceebs (at) eurotrib (dot) com) on Wed Sep 24th, 2008 at 08:56:56 AM EST
[ Parent ]
ThatBritGuy:
Apart from the shiny, they're good at building closed consumer markets which they can dominate ruthlessly, in the same way that Microsoft tries to build and dominate business markets.

is it so ruthless, when people are contributing apps from all over that work on apple's OS?

apple just makes IT easier for luddites and non-nerds to enjoy worry free computing, the whole 'think different' was good pr, but only could take on a rebel, 'creative' aspect because MS was ruthlessly locking people into bloatware that didn't work very reliably.

as apple got bigger, quality went down in some areas, but unless you're into linux, apple still represents a middle way, happy medium between gateswarez and the future, which undoubtedly will go to open source, peer to peer, drm free eventually. power to the people!

it's an interim thing...

(and yes the mac superiority complex is as ugly as any other!)

once you work with a mac, it's hard to go back, but one day i want to go beyond, to the starry firmament where the really free spirits live and code...

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Wed Sep 24th, 2008 at 12:30:04 PM EST
[ Parent ]
once you work with a mac, it's hard to go back, but one day i want to go beyond, to the starry firmament where the really free spirits live and code...

Just to contribute a bit more to the total OT-ness of this subthread:

Have you looked at Ubuntu?  The Momcat has been trying off and on for years to kick the M$ habit.  She has had a spin or two with several different Linux distributions, but even with live-in tech support (me) she never really got completely comfortable.  Like a smoker breaking down, she would always eventually go back to the borg.  About two years ago she tried Ubuntu and immediately fell in love.  She shows every sign of being quite happy with it.  She has gone through at least one complete upgrade with essentially no help from me.  She still keeps an old W98 installation for the odd anime DVD that won't play nice, but she rarely uses it anymore.

We all bleed the same color.

by budr on Wed Sep 24th, 2008 at 02:01:22 PM EST
[ Parent ]
No largemature corporation is fleet-footed. It's a planning organization


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 10:26:00 AM EST
[ Parent ]
I wasn't alive to see it, were you?

I turned 21 in '63.  The economy was dominated by a large number of large corporations, in every industry.  Banking and finance was a rather small area. The sort of industrial policy to which Gailbraith refers required consensus amongst a wide number of participants.  That is much less so today.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Sep 24th, 2008 at 11:15:03 AM EST
[ Parent ]
What ThatBritGuy said.

The Hun is always either at your throat or at your feet. Winston Churchill
by r------ on Wed Sep 24th, 2008 at 06:27:26 AM EST
[ Parent ]
What really pisses me off is that it's okay for foreign "Sovereign Wealth Funds" to recapitalise the banks, but for the Government to use its "domestic Sovereign Wealth" to buy them after they blow themselves up is "Socialism"...

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 06:59:46 AM EST
[ Parent ]
You may get some of that...

AFP via google: FBI probes finance giants for fraud: report

The US Federal Bureau of Investigation is probing allegations of fraud by 26 Wall Street firms including several investment giants whose collapse sent world markets into turmoil, US media said Tuesday.

The FBI has set its sights on investment titan Lehman Brothers, mortgage giants Fannie Mae and Freddie Mac and insurer AIG, in a wide-reaching inquiry that comes as lawmakers rush to agree a 700-billion-dollar government bailout of the troubled US financial sector.

...

FBI Director Robert Mueller said last week that the bureau was probing 24 financial institutions, but gave no details other than to describe them as "large corporations" that may face allegations of misstated 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 07:13:35 AM EST
[ Parent ]
And if the rot is real, and this isn't a liquidity problem, but rather, that the shitpile really is an overleveraged shitpile, then the 125% of loss equity stake will be worthless.

If the toxic waste is taken off the balance sheet, on terms that recapitalize the firm, which is a senior equity stake in that firm worthless? Exercise of the senior equity stake only destroys the value of existing, which would be junior, equity ... by no company ever goes bankrupt because a class of common shares loses value, even if it is completely wiped out.

And in extreme cases that is what a non-dilutable senior class of common shares will do ... if there is net equity overall, then the preferred shares will claim that equity up to their face value. If there is nothing left, common shareholders get nothing, if there is something left, common shareholders get something.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Sep 24th, 2008 at 09:40:04 AM EST
[ Parent ]
Mechanically speaking, you are correct, cetera paribus.

But, not all other things are equal, and if the scenario I describe comes to pass, it will be much more than the "assets" envisioned in the current bailout which will be at risk, it will be far wider swathes of the American economy which will be deemed overvalued, with corresponding debt obligations essentially irrecoverable.

Credit card debt, corporate debt, especially in highly leveraged sectors of the economy (starting with those implicated in the private equity boom of the past few years), prime mortgage debt, municipal debt.  

If this were simply a liquidity crisis limited to the "assets" currently under "assault" because of lack of proper market pricing signals, that would be one thing, and then, you would be right.

But if the rot is systemic, and therefore not simply limited to the 700 billion we are currently talking about (but rather, three times that, as some believe, starting but not ending with Roubini) then all that equity won't buy you 100 meters of ocean front in McCain's home state.

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Wed Sep 24th, 2008 at 03:35:16 PM EST
[ Parent ]
Clearly the Dodd proposal is aimed at a solvency crisis, not at a liquidity crisis.

"Solving a liquidity crisis" is what we have been doing, and how the Fed ended up with such a shitpile of its own on its balance sheet, in pseudo-collatoralized repo loans to borrowers liable to go bankrupt, where the value of the repo asset by no means adequate as collateral for the loan.

And we certainly are not going to have any serious problem doing without half of our current finance sector, as long as the remaining half covers all the bases and has sound balance sheets.

The question I have about Dodd's plan is that it requires the Resolution Trust authority to wait until an appropriate time to try to sell the acquired financial assets, with the disposal proceeds determining how much the firms on are on the hook for. SO they swap shit for cash that they can use to buy Treasuries, and kick the can on realizing their capital loss down the road.

What keeps up the pressure to actually ever resolve those assets? That's what I'm not 100% sure on. Preference shares with restrictions that kick in when the dividend rate is not met ensure that they try to avoid going for any more asset disposal than they have to, and then rather than resolution hanging over their heads, coming back to a profit position and meeting the preferred dividends allows the operating condition of each firm to dictate how quickly they get out from under the restrictive conditions.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Sep 24th, 2008 at 06:35:56 PM EST
[ Parent ]
What keeps up the pressure to actually ever resolve those assets?

Short answer is bankruptcy. The "resolution" in Resolution Trust Corporation means liquidating assets to pay bank(s) creditors and (re)insure the bank(s) depositors. Proceeds from sale of assets are rarely, usually never, distributed to common shareholders. Owners of equity hold claims to a firms net earnings. A bankrupt firm by definition reports zero net income. And retain earnings, if not exhausted, are accounted as asset for liquidation. The RTC seized the assets of over 700 bankrupt S&Ls. It didn't buy equity or assets. It did not profit from its roles as conservator or receivor. The fact that the RTC issued a substantial number of its own bonds to finance its fiduciary duties, so incurring interest expenses and not fully recovering FDIC and administratives costs from proceeds, contributed to bottom-line loss to the enterprise.

RTC 1995 Financial Statement, GAO audit of operations 1991-1995 (pdf)

It seems to me that perhaps you are confusing RTC and RFC, the Reconstruction Finance Corporation. Congress established that GSE to purchase preferred shares and corporate bonds and lend cash to companies --industrials and banks-- unable to raise capital in the private sector. Preferred shares normally subordinate all other classes of equity and, depending on provisions, specify immediate dividend payments, calls (or not) and warrants. The RFC didn't "profit" either from income (plowed it back investment) but did provide much needed liquidity for, gee, 20 years.

20 years is indeed a reasonable benchmark term for today's market "resolution," in the colloquial sense of the word.

See "Economic Consequences of the Operations of the Reconstruction Finance Corporation," Sprinkel, Beryl W., The Journal of Business of the University of Chicago, vol. 25, no. 4 (1952), pp. 211-224; It's not flattering, but it does deliver quantitative support.

Perhaps your proposal combines both into a necessarily new type of Treasury or Commerce GSE --an investment bank? That is the function of the new FHFA established in H.R.3221 this July. James Lockhart (formerly OFHEO) is now its director and named conservator of the Fannies.

Preferred Agreements FAQ - 7 Sep 2008 (pdf)
GSECF fact sheet - 7 Sep 2008 (pdf)
GSE MSB purchase FAQ - 7 Sep 2008 (pdf)

There really is a lot of experience to back a plan that doesn't buy junk assets from firms that are not bankrupt and not depositor insured.

Diversity is the key to economic and political evolution.

by Cat on Wed Sep 24th, 2008 at 08:10:59 PM EST
[ Parent ]
... is proposing be set up. As I understand it, these assets will be purchased from the institutions currently holding them on a contingent basis, and the seller will be on the hook for 125% of the difference between the acquisition price and the disposal price.

So unlike the SLC bail-out that you referred to, the institution is not acquired in toto, but rather the low quality assets, with the proportion of equity in public hands determined by how much over the eventual disposal value the public institution pays for the asset.

Obviously $700b that would suffice to allow institutions with 3-month loans from the Fed using repo's of assets of dubious quality to meet their obligations to the Fed and avoid collapse before Christmas, or else acquire Treasuries to use to roll-over the lending, so that if the institution then goes bankrupt the Fed's books do not look so bad. So it would get Paulson off the hook for collaborating in collecting a pile of toxic waste on the asset side of the balance sheet of the Fed. As its speculated that there may be around $600b in toxic waste in the hands of the Fed as the collateral for short term lending, that would explain the $700b figure ... $600b to clean up the Fed balance sheet plus some additional funds to clean up the balance sheets of financial instutitions considered to be strategic in avoiding an immediate collapse.

Sorry about triggering a definition dump.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Thu Sep 25th, 2008 at 01:58:39 AM EST
[ Parent ]
So the Paulson plan is simply about dumping Big Shitpile™ wholesale on Obama's first 100 days and Dodd's plan doesn't fix that? Not to speak of letting the current insiders run to the Bahamas.

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 02:56:15 AM EST
[ Parent ]
... the system along with 3-month loans since late last years, in every growing amounts, as happens when you treat a solvency crisis as if it was a liquidity crisis.

The figure $600b was raised by a correspondent of Jerome a Paris that he quoted (but whom probably did not want to be quoted by name), so I don't know how firm it is ... but it sure as heck would make sense of the $700b figure.

Dodd's plan is, go ahead and hide up the mess you have made of the Fed's balance sheet in a series of band-aids to cover an expanding infection, but shareholders in the short term and executives who do not get out in time in the long term shoulder some of the cost of the bail out of Paulson's and Bernanke's incompetence.

I'm not a legislative lawyer, but reading it just now, I got the impression that Dodd's plan allows executives to get out while the getting's good, in that Treasury does not own any shares until the corresponding asset is diposed of or matures, therefore revealing the "true" value, and that the exercise of restraint on executive salaries happens once the Treasury owns shares ... perhaps if Treasury owns a controlling interest.

All of this is why the US needs a growth industry in the productive sector of the economy, since otherwise there's no way for the finance sector to muddle through as it downsizes. As you know, I propose a New Energy Economy crash program to jump start that growth industry.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Thu Sep 25th, 2008 at 03:22:35 AM EST
[ Parent ]
I made two historical references to two similar market failures both determined by income, specifically assets that did not generate income to the owner.

In neither instance were firms "acquired" in either form of assets or corporate securities. In fact purchasing an assets does not convey any firm shareholder privileges; it conveys only ownership of the asset.

The definition of an asset is simply a person, process, or thing that produces income. The definition of equity is in itself reciprocal: a firm liability (future expense), a shareholder asset (future income).

In the S&L case, assets not corporate equities were confiscated to repay, to resolve, creditors FDIC, FSLIC, FICO.

In the case of the Banking Act of '34, credit was awarded by purchasing restricted shares with cash not treasuries. Credit did not convey ownership of the firm; it secured a claim to repayment. Then borrowers repurchased the restricted shares.

Dodd can put any price (transaction value) he wants on the assets of these beggars --corporate and derivative securities outstanding and available for sale-- but that "investment" will not be recovered any time soon. Because (1) the assets do not generate income and (2) the assets are not marketable because they do not generate income. They will not generate income because these CMOs, CDOs, and RMBS are dependent on continuous, reliable mortgage payments made by insolvent borrowers, US and UK citizens.

Confront the reality --the US federal government is not an entrepreneurial organization-- or concede your fealty to "Bush doctrine."

As you explain Dodd's "plan" it is the worst business decision ever, barring uncontested abrogation of Article I of th US Constitution to the FRB, agent of the Executive branch. He's advising his colleagues to buy worthless assets now --on margin!-- hoping some day they will produce income for US Treasury, "for the people."

Does anyone have a link to this draft bill?

Diversity is the key to economic and political evolution.

by Cat on Thu Sep 25th, 2008 at 07:28:28 AM EST
[ Parent ]
There are links in the body of the diary, but I got them from Politico via Krugman's blog.

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 07:50:07 AM EST
[ Parent ]
I downloaded PPM41_ayo08b28.pdf on Monday when you published. It transmitted to a blank pp44 doc.

I search thomas.gov. Has not introduced any "legislation", a bill. Therefore, I cannot read pp44 of provisions. I cannot comment on any text other than what politico.com --Bush PR organ-- has its writers editorialize.

I locate Dodd's senate URL. The only document is an HTML summary. And I note that Dodd is still pushing HOPE for Homeowners (enrolled), and the "summary" places no, zero, quantitative constraints on Paulson's bailout valuation, $700B.

Perhaps the full draft --which I can't read-- expressly limits expenditures or expressly establishes audit "controls"? (see GAO audit of RTC above. "Automated controls" failures figure prominently in underestimation of expenses and unaudited payments.)

#5 Warrants? "the government took warrants in the companies in exchange for our assistance." No. The government did not take warrants in AIG. But Treasury FHFA seized the Fannies as conservator (Ch.11 measure).

The warrents attached to AIG bonds ("credit facility") permit the FRB to confiscate 79.9% of common shares "to obtain" uncontested voting rights in AIG operations in the event AIG defaults on "convenants." In effect the FRB board and its shareholding member banks would than operate an insurance agent --paid by inflationary US treasuries-- to compete with FDIC --at an extra-legal advantage-- to guarantee and supervise forementioned FRB banks.

19 Sep Item 1.01. Entry into a Material Definitive Agreement.

On September 18, 2008, American International Group, Inc. ("AIG") made a filing on Form 8-K with respect to a revolving credit facility with the Federal Reserve Bank of New York ("NY Fed").

This Form 8-K/A filing corrects certain errors in, and supersedes, yesterday's filing.

The summary of terms of the revolving credit facility provides that AIG may borrow up to $85 billion from the NY Fed. AIG's borrowings under the revolving credit facility will bear interest, for each day, at a rate per annum equal to three-month Libor plus 8.50%. The revolving credit facility will have a 24-month term and will be secured by a pledge of assets of AIG and various subsidiaries. The revolving credit facility will contain affirmative and negative covenants, including a covenant to pay down the facility with the proceeds of asset sales.

The summary of terms also provides for a 79.9% equity interest in AIG. The corporate approvals and formalities necessary to create this equity interest will depend upon its form.

A copy of the press release is attached as Exhibit 99.1 to this Current Report on Form 8-K/A and is incorporated by reference herein.

Never, ever underestimate Harvard-educated attys.

18 Sep  Item 1.01. Entry into a Material Definitive Agreement.

On September 16, 2008, American International Group, Inc. ("AIG") issued a press release announcing it has entered into a revolving credit facility with the Federal Reserve Bank of New York ("NY Reserve Bank").

Under the terms of the revolving credit facility, AIG may borrow up to $85 billion from the NY Reserve Bank. AIG's borrowings under the revolving credit facility bear interest, for each day, at a rate per annum equal to three-month Libor plus 8.50%. The revolving credit facility has a 24-month term and is secured by a pledge of all of the assets of AIG and its Material Subsidiaries. The revolving credit facility contains affirmative and negative covenants, including a covenant to pay down the facility with the proceeds of asset sales by AIG.

In connection with the revolving credit facility, AIG issued a warrant to the Board of Governors of the Federal Reserve ("Federal Reserve") that permits the Federal Reserve, subject to shareholder approval, to obtain up to 79.9% of the outstanding common stock of AIG (after taking into account the exercise of the warrant). AIG anticipates calling a special meeting for such purpose as promptly as practicable.

A copy of the press release is attached as Exhibit 99.1 to this Current Report on Form 8-K and is incorporated by reference herein.

Dodd is extending US DEBT --in exchange for limits on borrowers'CEO's compensation-- to finance the "modernization" of FRB regulatory structure, according to this model.

NOTE: (1) AIG must default, fail, bankrupt in order for FRB to exercise its option, or "warrant," for common shares; and (2) terms of the bond --extortionary LIBOR plus 8pts, greater than TED by any measure-- imply huge risk for AIG debt service if LIBOR panelists cannot reset among themselves.

Say, buh bye to legitimate, "reformed" competition among depository and investment institutions for US consumer "savings."

Diversity is the key to economic and political evolution.

by Cat on Thu Sep 25th, 2008 at 09:50:39 AM EST
[ Parent ]
I downloaded PPM41_ayo08b28.pdf on Monday when you published. It transmitted to a blank pp44 doc.
http://www.politico.com/static/PPM41_ayo08b28.html still seems to point to a readable PDF of Dodd's proposal...

Sorry I can't help you any further.

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 10:08:12 AM EST
[ Parent ]
Is there a bill (S or H.R.) or amendment (Amdt) number on the document you have?

If not, I can wait for it to be introduced on the floor and text submitted to the clerk. Neither Frank nor Dodd have introduced anything this week. Perhaps someone else will.

Diversity is the key to economic and political evolution.

by Cat on Thu Sep 25th, 2008 at 11:03:12 AM EST
[ Parent ]
Nope, sorry, no S.** number

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 12:16:03 PM EST
[ Parent ]
... that's why the number and bill name sections are left blank.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Thu Sep 25th, 2008 at 06:16:38 PM EST
[ Parent ]
Clearly, but it makes it hard to search for the text.

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 06:20:38 PM EST
[ Parent ]
I don't understand the problem viewing the text ... I was able to view it just fine when I looked yesterday.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Thu Sep 25th, 2008 at 06:23:28 PM EST
[ Parent ]
And I today.

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 06:23:51 PM EST
[ Parent ]
The problem viewing the text: here is my suggestion on scope of your inquiry.

Millions of people on the internet have machines with different capabilities -- packaged software such as MSFT Office of different vintage/versions or operating systems which do not execute. They may use browser that are not "supported" by certain internet publishers, e.g. politico.com, for one or more released. Similarly, corporate IT standards require conformation of all machine capabilities to communications permissions, according to internal and external license.

Further, certain www publishers manufacture interactive, web-based applications and static products using custom software or customized versions of packaged software. In that case, the "portability" of documents and run-time of applications is not reliable across all operating systems. Transmittal failure could be determined by XML checks of OS.v*, browser.v*, or pdfReader.v* from server-side.

open source file formats are solutions to facilitate cross-platform transmitals of data. A *.pdf is puportedly an open source file format as is ASCII. Let us assume either (1) politico.com published the draft bill using custom *.pdf print format or (2) my browser was unable to reconcile the politico.com digital coding of the pdf.

I've rarely retrieved a blank *.pdf document, believe it or not, in 20 years of internet access --despite the fact none of machines have ever been WINbox and none of my package software is "current" version.

Diversity is the key to economic and political evolution.

by Cat on Thu Sep 25th, 2008 at 07:14:40 PM EST
[ Parent ]
... active html page rather than a direct link to a real pdf file. I had not noticed that ... it worked on Firefox on Windows and Iceweasel on a Knoppix (Debian based) system.

I'll email the document and if the .pdf can be read, its some bug in the active .html page at politico.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Sep 26th, 2008 at 12:04:32 PM EST
[ Parent ]
... the amount of financial junk purchased ... $100m in junk is sold ... or disappears ... and the difference between the acquisition and disposal sets the size of the stock acquired through the warrants, common stock amounting to 125% of that difference, based on the average share price the two weeks before the warrant is exercised to translate from the dollar shortfall to the quantity of shares received.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Thu Sep 25th, 2008 at 06:22:33 PM EST
[ Parent ]
Thinking further about this whole bailout situation, the US government is in effect handing over $800 billion of its tax reciepts to the banks. now 2007's tax reciepts came to $2,568 billion (PDF warning)so thats 31% of reciepts going straight to the finance industry. So it could be said that the government has just reduced itself to becoming the taxation or extortion arm of the US finance system, finally overtly against its own population.

Bringing us almost beyond Smedley Butler

War Is a Racket - Wikipedia, the free encyclopedia

"War is a racket. It always has been. It is possibly the oldest, easily the most profitable, surely the most vicious. It is the only one international in scope. It is the only one in which the profits are reckoned in dollars and the losses in lives. A racket is best described, I believe, as something that is not what it seems to the majority of the people. Only a small 'inside' group knows what it is about. It is conducted for the benefit of the very few, at the expense of the very many. Out of war a few people make huge fortunes."


Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Wed Sep 24th, 2008 at 06:44:23 AM EST
ceebs:
So it could be said that the government has just reduced itself to becoming the taxation or extortion arm of the US finance system, finally overtly against its own population.

That's what you get for voting for robust freedom-and-enterprise loving Republicans instead of whingy and demanding tax-and-spend Liberals.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Sep 24th, 2008 at 07:14:59 AM EST
[ Parent ]
I, for one, welcome our new Giant Talking Penis overlord.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Wed Sep 24th, 2008 at 09:34:16 AM EST
[ Parent ]
Not as long as foreigners want to buy US bonds..

and if they eventually do not want.. well.. it means the system is decoupled and F*** the US would be the santard rant you will heard from other central banks.

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 10:46:50 AM EST
[ Parent ]
um, no. Tax receipts are obligated by statutory budget. Some portion pay monthly interest of public debt -- tens of billions of trillions of tax and "other" income. The rest is commited to mandatory expenses (e.g. US gov employee and dependent trust funds, annual SS and Medicare, Medicaid outlays, agency operating budgets) and discretionary programs (e.g. pork). Monthly interest payment costs are directly related to FRB fed funds (primary) rate, of which technically CPI-U is one determinant.

"Discount rates" offered by the FRB to certain T-bill dealers are, well, less than coupon yield issued (H.15)
http://www.federalreserve.gov/releases/h15/Current/

Public debt to the penny
http://www.treasurydirect.gov/NP/BPDLogin?application=np

Interest payments on the public debt
http://www.treasurydirect.gov/govt/reports/ir/ir_expense.htm

The Treasury and Congress, like any American household, "budgets" and "negotiates" with its creditor (FRB) to pay minimum interest due each month. MoM it's roughly 10% of total receipts -- OUTLAYS exceeding MoM balance roll-over into MoM total debt.

Treasury
http://www.fms.treas.gov/mts/mts0808.txt

Yeah, it's a scary way to run an organization.

Diversity is the key to economic and political evolution.

by Cat on Wed Sep 24th, 2008 at 02:51:45 PM EST
[ Parent ]


Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Wed Sep 24th, 2008 at 08:01:06 AM EST
Is that a Stearn Bear and the Merrill Lynch bull?

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 08:02:28 AM EST
[ Parent ]
Nope, just regular ol' Bear and Bull.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Wed Sep 24th, 2008 at 08:11:48 AM EST
[ Parent ]
I am actually going to have to get round to reading this

Amazon.co.uk: Two Hund Pharaohs, Five Billion Slaves: Adrian Peacock: Books

Two Hundred Pharaohs, Five Billion Slaves examines the rise of the international bourgeoisie and the creation of their world of intense leisure shopping. Starting from thesis that the whole of capitalist society can be viewed as nothing more sophisticated than a vast, unstable network of constantly rising and tumbling pyramid schemes, it highlights the fact that only a handful of socially isolated and insecure billionaires (the 'pharaohs' of its title) can hope to benefit from a system that squanders the immense potential of modern technology. The strength of this work is derived from its exposition of how this system alters our build environment and determines the very fabric of our daily lives.


Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Wed Sep 24th, 2008 at 08:53:33 AM EST
... in response to an economic downturn. As the Fed showed in 1981, a Fed policy to create an economic downturn quite certainly can work one-handed.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Wed Sep 24th, 2008 at 09:34:01 AM EST
Three questions:

  1. The "bail-out" is rapidly becoming THE defining issue of the election.  Obama's objective has to be to avoid contamination or blame for the fall-out - so he will probably not do much - except perhaps support the Dodd plan.  Has he done so?

  2. What is the problem with using the $700Billion to help distressed borrows who are at risk of default - i.e. go to the source of the problem and help the people effected directly.  This would mean that the assets lose their toxicity whilst at the same time more discretion can be applied as to who is helped with their repayments.  It also starts to reverse the impoverishment of the middle classes.  Paulson/Bernanke/Bush have effectively legitimised a massive increase in public spending - why not use the $700MB to help those citizens wo need it most - those who have been forced into debt beyond their means?

  3. What if the $700B isn't enough, and much more is eventually needed.  Could we then not see an inflationary spiral of Weimar/Zimbabwe proportions?  All the more reasons to bail out distressed borrowers rather than irresponsible bankers?


Vote McCain for war without gain
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Wed Sep 24th, 2008 at 09:53:43 AM EST
Both the two trillion Dodd plan and a one trillion foreclosure-infraestructure plan are needed.

If you only prevent foreclosures and put money on people's hand you do not solve the credit problem the US has to make the transition in the eocnomic system from construction-debt to doing-stuff and local copetitive services.

Of course, you can change the Dodd's plan for nationalziation of the banking system.

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 10:43:45 AM EST
[ Parent ]
BHO is triangulating. yesterday's news he back-pedalled promises to support (any) bailout and bite McCain's ankles. Sorry.

Maybe he'll have a better angle tomorrow.

Diversity is the key to economic and political evolution.

by Cat on Wed Sep 24th, 2008 at 02:58:39 PM EST
[ Parent ]


Display:
Go to: [ European Tribune Homepage : Top of page : Top of comments ]