Blogging on the Bailout
I would blog on the most recent bank bailout, but I don't really understand what the proposal is. The administration apparently wants to take $700 billion and ... do something with it. Frankly, I would prefer them to just let the banks totter over and spend the money, if they really feel it necessary, to clean debris up afterward, as they did with the RTC in the 1980s. At least that way we would avoid the moral hazard and know the money was going to cleaning up the worst messes. My guess is that $700 billion pseudo-randomly injected into whatever companies can cry the loudest at the treasury's door is not only creating bad incentives, but is probably going to waste at least half of the money.
Miklos Hollender:
Offtopic: I found an interesting article, on your favourite subject: transportation from tax money, by someone from the inside: http://mises.org/story/3106
September 22, 2008, 6:22 amErikTheRed:
Shhhhhh... It's a secret!
The whole situation beats my pair of jacks. On one hand, the mess seems to have either gotten started or gotten kicked into seriously high gear by the Gub'mint telling the banks to make housing affordable to people who... ummm... can't afford housing. Nobody dared make too much of a stink because they were afraid of being accused of being racists who hate poor people. On the other hand, the banks and Wall Street said "holy f#@!% s@%^.... ummm... as long as we're making crap loans and sweeping the evidence under the rug, we're going to make a f@#%-load of money and party like it's 1999." Now the party's over and they're bankrupt and the rest of us have a [pick a random number] $Bazillion bill to pay.
Personally, I think the whole thing is secret because even the government doesn't have a clue. As you've astutely mentioned, the bailout leaves the same frigtard bankers in charge that got us into this mess. And the brain-dead voters of Connecticut, North Carolina, and Massachusetts are leaving us with the same frigtarded politicians who got us into this mess. Maybe we should make the citizens of those three states pay the bill...
September 22, 2008, 6:38 amMark:
I think that the numbers in this situation are seriously overstated, just as the cost of the Savings and Loan fiasco was also inflated.
In 2007 the value of US sup-prime mortgages was $1.3 trillion. Even if all of these mortgages are in default, 100% of them, there would not be a $1 trillion loss because even severely discounted these loans have real collateral behind them (unlike much of the Savings and Loan debacle). That is, even if I never made a payment on my $200,000 sub-prime loan that loan still has a value of, lets say $100,000 because the property still has some value.
Currently around 20-25% or so of these loans are in delinquency. Particularly important, is that INCREMENTAL delinquency and foreclosure are almost all being pushed from this area. In other words the finance industry, including home mortgages always has delinquency and default. The "Credit Crisis" is being caused not by foreclosures that happen routinely but by a large influx of these foreclosures from the sub-prime market.
The fractional reserve nature of the banking idustry means that small losses of a portfolio are mulitplied into extreme losses of bank capital. This means that the curent holders and sometimes makers of these loans are no longer able to stay in business because they no longer have capital. To bad, and so sad.
Now, with some sort of "bailout", there are a lot more tools available to fix the problems. WHy is that? Well, if the government is holding the paper they are no longer subject to restrictions like fractional capital or profitability requirements. They can create programs to help get the mortgage current, discount rates, and frankly, wipe out large amounts of principle. My guess is that in some ways they may even be able to offset much of the cost by "rehabilitating" some of this volume and hten selling the mortgages on the "evil" secondary markets.
And, if that fails the government can simply liquidate what is left over, selling the paper for massive discounts. Then, investors can essentially buy the underlying property of the mortgage at steep discounts and be in a position to liquidate this inventory. SInce they acquired the property at deep discount they will be able to sell off the property cheap. This will move the foreclosures off the market and finally put a floor on the bottom of the real estate market.
It may hit homeowners hard, but from the bottom real estate prices can then at least stabilize. The impact on the "balance sheet" of households is significant, but that only really changes lifestyle. In other words, you would only realize a loss right now if you actually were forced to sell your home. The 1990-2004 trend of constant moving up in home values is over.
Otherwise, it is a paper loss. You also may be making a payment on a house value that is significantly higher than what the house is worth, but in many cases the interest rates of current mortgages are very low. What you are really doing is paying a higher "interest" rate on your home, I call it psuedo-interest.
All of this will cost money, but it will not cost even close to the $1 trillion mark people are jabbering about. My guess is that NET it will cost a lot of money, around $300-400 billion. On paper this is a lot of money, but it is just 1% of federal spending over the next 10 years.
September 22, 2008, 11:13 amBill Brown:
I analyzed the proposal over at my blog. It really seems like a pretext for a massive power grab that will be rammed through Congress.
September 22, 2008, 8:31 pmMethinks:
On the other hand, the banks and Wall Street said "holy f#@!% s@%^.... ummm... as long as we're making crap loans and sweeping the evidence under the rug, we're going to make a f@#%-load of money and party like it's 1999."
Change one thing...tons of Wall Street retards didn't know they were making crap loans (justifying it by yammering about "paradigm shifts" in the credit markets). If that were not true, then banks wouldn't have so much of that crap on their books and John Paulson wouldn't have made $3.7 BILLION betting against mortgages last year. He wouldn't have found the liquidity. The other (long side) of all his trades were taken by well capitalized Wall Street professionals. Now, these same dumbasses...err...professionals are going to be hired by Hammering Stammering Hank to help him decide just how much you and I will be overpaying for these mortgages.
September 23, 2008, 5:28 amI_am_a_lead_pencil:
Mark, you said:
It isn't simply the "value of US sub-prime mortgages" that will be bought. This is a recapitalization of the banking industry.
From this mornings AP story:
"In an expansion of its original proposal, the Bush administration is asking for broad power to buy up virtually any kind of bad asset — including credit card debt or car loans — from any financial institution in the U.S. or abroad in order to stabilize markets."
This is not merely a purchase of sub-prime morts. This is an attempt to re capitalize institutions that are bumping up against debt/equity ratios limited under current banking regulations. I think Arnold Kling has it right.
September 23, 2008, 8:47 amMark:
"It isn't simply the "value of US sub-prime mortgages" that will be bought. This is a recapitalization of the banking industry."
I have not necessarily seen such claims. THe real cost of the bailout is taking the losses on the bad loans. Banks would then be "recapiltilized" because the frational amounts of capital involved in these bad loans would not then be lost on the balance sheet.
In other words, lets say you are a bank and you have $1 million in capital. You make $10 million in loans against this capital and 10% of those loans goes bad. You are now insolvent. Now the government comes in and buys the bad loans from you. Your capital has been, essentially, restored. It cost the government $1 million to do this.
Then, the government will turn around and liquidate those bad loans at a steep discount. So, the net cost to the government is $1 million minus the net value of the underlying property of the loan.
So, the point is that there are $1.3 trillion in sub-prime mortgages out there. About 25% of these are in bad shape. So, if the government bought all of this bad debt from the banks it would cost around $400 billion. And, because these mortgages have collateral the actual net loss would be substantially lower than that. For arguments sake, lets say that the homes that support the mortgages are wotht 50% of their original value. This means, the net cost of buying all of the bad sup-prime debt would be $200 billion.
September 23, 2008, 9:34 amI_am_a_lead_pencil:
Mark,
These non-performing assets are 'marked to market' on balance sheets now. The only way the balance sheet improves is if the asset is purchased at a value which is higher than the current carrying value. i.e. the government overpays for it.
September 23, 2008, 10:37 amMark:
"These non-performing assets are 'marked to market' on balance sheets now. The only way the balance sheet improves is if the asset is purchased at a value which is higher than the current carrying value. i.e. the government overpays for it. "
And, that is exactly what the governemnt will do, otherwise why bother. My guess is that they will pay essentially the "face value" of the note. This is WAY higher than hte current market value of the asset.
Regardless, the main point I am trying to make is that the numbers for the bailout are way overstated. Some people are taling $1 trillion plus, others $700 billion. But there isn't even $700 billion in bad mortgages out there. And even if there were, the net cost of buying $700 billion worth of bad mortgages is way lower than $700 because the underlying real estate still has value, however discounted. In my estimation, to liquidate all of the incremental (that is, over and above "normal" ) real estate foreclosures would only cost on net $200-300 billion which is about what the S&L RTC ended up costing.
September 23, 2008, 11:47 ammorganovich:
watching the congressional hearings on the TARP plan has been disgusting me beyond belief. i would like to point out a couple of facts:
the 1990 RTC did actually make money. the disposal of its assets was a big part of the 2000-2001 budget surplus. both parties declined to talk about this as they wanted to take credit with their current policies, but the facts are the facts.
it functioned much less well than it could have due to endemic corruption, cronyism, and significant delays and disruption in funding.
it also had a great deal less backing the assets than exists in the current situation.
it is absolutely possible to make a large profit for the treasury here by acting as a shrewd buyer of distressed assets, and that ought to be the government motive. taking assets at fire sale prices is plenty punitive. it will vastly shrink many financial institutions. it will also unfreeze the market and let it get back to its now greatly reduced business. but that benefit has a cost, and it involves getting a low price for what you unload to the feds.
allowing this entire program to be characterized as a bailout has been a terrible mistake. it is not nor should be a "bail out" it's a fire sale asset purchase to unstick a market and paulson knows all about being a prop desk and making a trade like that.
but watching these "hearings" and all the demands for default protection, ceo pay restrictions and mortgage balance resets just shows how utterly foreign the for profit motive is to government. it has never even dawned on these people that this could make money (or worse, it has and they are making sure it is already earmarked).
truly depressing to watch.
September 23, 2008, 11:50 amMark:
THe problem for the government not doing the "bail out" is that a substantial piece of this mess was caused by GSE. That makes them on the hook for some of the cost.
I liken this to the original Treasury bailout, where Alexander Hamilton bought the Revolutionary War debt at par. Since all of this debt was trading at but a small fraction of the par value of the bonds, the Jeffersonian's screamed and wanted the ORIGINAL owners of the debt to be the ones who received the incrementcal value. But, the Hamiltonian view, correctly, prevailed rewarding those "speculators" that held the bonds in the end.
September 23, 2008, 12:15 pmMethinks:
Morganovich,
the 1990 RTC did actually make money. the disposal of its assets was a big part of the 2000-2001 budget surplus.
Weren't the assets the 1990 RTC buying easier to price? Also, it was a liquidator, not a holder of assets. The risk of adverse selection should not be overlooked in this plan - particularly given the power the Treasury is asking for. Am I wrong?
it is absolutely possible to make a large profit for the treasury here by acting as a shrewd buyer of distressed assets, and that ought to be the government motive.
It is. The only problem is that taxpayers bear the whole risk, for which they will never be compensated. All profits will be quickly used up by government, any losses will be passed onto taxpayers. Further, it's not clear to me that Hank is actually planning to buy those assets cheaply. Word on the street is that there are bids for the loans but that the banks won't sell there because they're hoping to sell to a government patsy their worst loans at much higher prices than the market is willing to pay. From Hank's testimony (to which I listened with half an ear today), he doesn't want to be limited to buying at fire sale prices.
and paulson knows all about being a prop desk and making a trade like that.
Yes, he does. Unfortunately, it won't be Paulson making the decisions and it won't be Paulson overseeing the operation at all. He'll be out in a few weeks. While distressed debt funds make these types of trades all the time, they never do it on this scale and without incentives to make good trades. Traders at private funds are motivated by large bonuses for making the right bets. Government can't offer the incentive necessary (large bonuses) to attract good distressed bond traders who care if they've overpaid or not.
Doesn't it seem easier and more prudent to just temporarily reduce capital requirements for lenders?
September 23, 2008, 3:10 pmmorganovich:
that depends on what you mean by easier to price. if you mean, "mathematically simple", then yes. the 1990 crisis involved much simpler assets. the current version may need to hold more assets to maturity. but these assets do have cash flow streams associated with them and tangible, liquidatable collateral. clearly, they are worth nothing like par, but they are surely worth something greater than zero particularly the 1st and 2nd tranches. all the slop left over at the absolute bottom of the prepay/default hierarchy (which was mostly retained by the IB's after securitizing the rest, often as a free or even negative cost investment) has very low (if any) value. but this just argues for heightened ability on the party of the TARP to discriminate and make bids based on what is offered.
clearly, under a system of "we'll pay x% of face for whatever mortgage assets you want to unload" the TARP will get stuffed with all of the worst of the worst. this scenario ought to be avoided at all costs.
your point about the risk to taxpayers is true, but whoever heard of a riskless trade that offered any kind of significant reward? they may also make out quite well. it will all depend on the prices paid and how well the trade is administered. alas, it's not looking good in terms of the TARP having any kind of autonomy is it? nor is it looking good that any money made won't need to go to paying off the other hideously expensive populist programs that seem to be certain to get tacked on (default protection, principal restructuring etc). the same folks who made this mess (dodd, frank, etc.) are the ones piling on conditions to make sure the rescue fails. this is perfect for them as they get to help the homeowner, look stern on helping "wall st", get everyone to forget that it was freddie and fannie that made all this happen, and at worst, not have to pay for it, and at best have it be really expensive and make the administration look bad. these incentives are so perverse (and our politicians so lacking in ethics) that it terrifies me. and how doe sour media sit by and let the guys who made this mess look like robin hood and cast the blame on the guys who are trying to dig us out? once upon a time, we had a financial press. shame about losing it. the analysis in this week's economist is laughable.
with regard to reducing capital requirements, i don't think it's going to help. (though please understand this is not my area of expertise) what we don't need right now is more leverage. we need clean, unencumbered money that can go back to being the blood of the system. if they just lever up balance sheets still stuffed with loans for which there is no market, they are all still vulnerable to the mark to market downspiral that got them here. some one new goes out, there's another fire sale, assets get market down, and someone new is insolvent. repeat until you reach hooverville. only lessened leverage and getting some off this stuff away from the weakest players will create a firebreak for that cascade.
September 23, 2008, 4:28 pmMethinks:
While it's true that in a normal market risk and reward are inexorably linked, the problem with this plan is that government has no incentive to make sure that it is not taking too much risk for a given level of expected reward. In other words, there is no disincentive for entering into negative expectancy trades. In fact, there's every incentive to do so. While I agree with you that this "should" be avoided, we both know that normative statements are pretty useless. The government will not avoid negative expectancy trades and even if they do (accidentally) win on some of them, you can be sure that the risk adjusted return will be terrible. The only reason we know this is that no guidelines prevent them from doing so and it's unlikely that Wall Street's best and brightest will be lured to manage this portfolio when there is so much more incentive to figure out how to skirt regulation.
I agree with you about leverage. However, the leverage issue is as much accounting as anything else. If the assets are, as Treasury and the Fed claim, worth more than the banks are forced to mark them, then why not let the banks mark them up? That'll reduce leverage. If they're not, then by what logic (government logic doesn't count as logic, IMO) is the Fed willing to pay $0.60 for an asset marked to $0.25? Lowering reserve requirements is another way to write up assets. In a way, buying their loans for above market value, is also a write up of assets - although, it will have the added effect of making the assets liquid. Further, they can cut taxes for a period of time on bank profits which will attract more investors.
BTW, if we look at Coyote's latest post, we'll notice that the government has no intention of reducing leverage where leverage needs to be reduced the most. If LTCM's leverage at 70x was shocking, and bank leverage at 30x needs to be reduced, then why are we levering less savvy average Joes 100x or even to infinity in the purchase of his single largest and least liquid asset? As you can tell, I have no disagreements about the body that carries the bulk of the blame for this mess and the body that will be to blame for the next meltdown that it is busy creating right now. Outside of the editors of the WSJ editorial page, we no longer have a financial press.
As for salary caps, look on the bright side. At least a capped salary will not attract very smart people, leveling the intellectual difference between the moribund government patsies buying loans and the "private" bankers selling the loans to them. Thus, we increase the probability of some dumbass at a bank on occasion accidentally selling a loan to government which isn't completely toxic waste. Frankly, as a taxpayer, I fear that this might be our only hope of doing at least some positive expectancy trades.
September 24, 2008, 11:18 ammorganovich:
as i think i said somewhere else on this site, paulson lost the game as soon as he let the TARP being to be referred to as a bailout. as soon as that happened, he needed to stand up and say "it's not a bailout. we are not giving away money. we are acting like a sovereign wealth fund in our own interest and in that of the sellers of assets. we fully expect to make money on these trades. we will only buy at prices we believe to be attractive. this will add liquidity and put a floor on the market, but this is not a giveaway. banks may choose to trade with us or not as they wish, but we are here to provide liquidity and make money for the american taxpayer."
just creating a market floor would go a long way towards stopping the mark to market insolvency spiral. best, it might not even require that they buy that much debt. knowing the market has a floor, banks would be in a better position to work themselves out. a lot of what the RTC did in the 90's was let thrifts swap assets and create a market again.
granted, this is all dependent on purchases being made at the correct price (which ought to be possible) particularly as many of the current mark to markets already price many assets well below their likely future cash flows and recoverable collateral. the problem is that no one can buy because they are all overstretched. someone has to start and price must be determined by transactions. i have serious doubts that investors and counterparties are going to believe arbitrary pricing on CDO's just now...
but, in the department of telling it like it is, this is going to be an absolute money pit. it is now so thoroughly politicized that i think we are pretty much cooked. perhaps we would have had a better result were we not 5 weeks to a presidential election. then again, perhaps not...
September 24, 2008, 12:45 pmMethinks:
I can't disagree with any of that, Morganovich.
September 24, 2008, 3:36 pmLee:
You know what smacks of deception? People who say to me, like my financial advisor, that people are not smart enough to choreograph this. I would have been proud to be a member of the Manhattan project, I would never have imagined the results, but if you can take a group of people and create a reality out of an Idea 70 years ago, what makes people think that that cannot occur again. It’s the idea that good ideas are believable but deceptions are so much more difficult to believe. The fundamental diff. between dems and reps. I love the fact that people can believe we’ve been to the moon, but there’s no way people can come up with this collapse. To quote Bill Maher †Are you fucking kidding me?†Call me a conspiracy theorist, but I have given up on getting a straight answer from anyone. If our economists are so smart why can’t they follow the river backwards. I do every day. Follow the leads to the cause. Doesn’t everyone? I have been writing and calling my congressmen/women and senators and still haven’t received anything concrete. I have rarely felt as helpless and uninformed as I do right now.
Where is the truth? Why can't we have a politician that runs on truth? Now that would be change.
October 2, 2008, 10:32 pm