Tuesday, September 30, 2008

Why Main Street should support this rescue

You know its bad when my wife, who under normal circumstances immediately dozes off when I start talking economics, is checking finance blogs looking for news on the credit markets. She is getting into heated arguments with friends over the bail out legislation. And to top it off, she's made a request that I explain to non-finance people why they should support a massive bailout of Wall Street. So here is my case. Hopefully regular readers as well as people far removed from finance will find this stimulating if not convincing.

First let's think about how modern lending works. Pick any type of loan: student loan, car loan, credit card, home mortgage, small business loan, etc. Any time a loan is made, whether its to pay for meal with your credit card or to pay for tuition, someone actually has to come up with the cash to lend to you.

Where do lenders come up with this cash? Primarily three places.

  1. Deposits.
  2. Borrowing from investors or from other banks.
  3. Securitization. This means that the loan isn't held by the lender, but sold to investors.

Lenders don't want to use deposits to make loans right now, because there is serious risk of depositors suddenly demanding their cash. Remember that banks don't ever actually have enough cash to give all their depositors their money on any given day. So when depositors are nervous, banks are nervous.

Normally if too many depositors happened to take money out (not in a panic, but just by happenstance) the bank would simply borrow cash from another bank. That's nearly impossible right now. Banks are generally unwilling to lend to each other. Banks can still borrow from the Federal Reserve, but they are so desperate for cash right now that they are accepting any interest rate, and the Fed is finding it nearly impossible to control short-term interest rates. Today banks took overnight loans from the Fed at 7%, 3 1/2 times the target rate set by the Fed. This is historically unprecedented.

Banks also cannot sell loans to investors. Even loans that are backed by governmental guarantees, like certain student loans, are not sellable in the current environment. Forget about automobile loans or business loans.

So if banks and other lenders cannot get cash, they cannot lend it. So what? Isn't our society doing too much borrowing as it is? Maybe, but let's consider the consequences of a world with no lending.

First of all, there would be no housing market. Very few people can buy a house with cash. Housing prices would continue to fall for many years. The result would be that people would almost universally live in rented housing. Wealthy land lords would own all the housing in America, and would reap all the profits from rentals.

Second, there would be no secondary education. Like housing, the vast majority of people need loans to get a college education. Granted, colleges would probably pare back on the quality of the education offered in an attempt to lower their costs. Even so, it would likely be that only wealthy people could afford college. The income gap in our society would increase as a result.

It would also be extremely difficult for average people to start a new business. Most businesses require start-up capital, most of which is normally borrowed. In addition, many small businesses need working capital, which allows the business to make payroll while waiting for accounts receivable to come in. So here again, only the wealthy would be able to start new businesses.

How will this bailout help? Mostly by creating a outlet for banks to sell "troubled" loans. What constitutes "troubled" isn't yet known. But suffice to say the Treasury will mostly be buying mortgage loans that probably shouldn't have been made in the first place. The price paid to the bank will be less than face value, thus the bank will suffer losses. Hopefully enough of these loans will recover their full value that tax payers do not suffer large losses.

But its a mistake to assume that, as tax payers, we aren't already on the hook for this mess. Currently there is about $8.6 trillion in assets that the FDIC insures. The truth is that the FDIC is ultimately funded by tax payers. So as tax payers, we are already on the hook for bank's behavior. And for way more than $700 billion.

In addition, municipal governments are suffering greatly in this crisis. Not only are their facing the prospect of decreased property tax assessments, but the cost of funding municipal projects has skyrocketed recently. Today, 7-day floating rate municipal bonds are carrying interest rates above 8%, breaking all records. Who will ultimately pay for these extremely high interest rates? Tax payers.

I completely understand the visceral anger that many Americans feel about the situation we're in. I'm sick over the fact that its come to this. But this is what it's come to. We would be foolish, as Americans, to destroy our long-term economic prosperity just to satisfy our righteous anger with Wall Street.

If we don't do this bailout, Main Street will pay anyway, and pay much more dearly. So I would encourage you to write your Representative and tell him or her exactly that. You are angry at Wall Street, but you also want to see some justice for Main Street.

Fell free to e-mail this or send links as you'd like. I don't really care about getting credit.


alan.seager said...

banks didn't borrow at 7% from the fed that was overnight libor. they are NOT borrowing from each other because the fed has made so much money available to them through it's facilities like TAF, PDCF, blah blah. why would they borrow from each other when they can borrow from the fed? this Paulson bailout is not worse than the alternative, which is either nothing, or a bailout that actually makes sense. i work in the finance industry and this bailout would help me but on an ideological level it is atrocious and disgusting and i can't believe it wasn't laughed off the face of the earth. Paulson should be fired.

alan.seager said...

one of (if not THE) the main reasons we are in this crisis at all is that everyone is waiting for the damn bailout. if they'd just kill the thing investors and banks could get around to fixing issues themselves. as it is nobody will do anything because they don't want to get run over by the govt. the bailout has become the problem.

spock said...

Banks won't lend because they know the other banks have mispriced assets and solvency problems.
"Illiquidity" = borrower wants to pretend its credit is better than it really is.

The bailout is the government trying to prop up the mispriced assets. This only worsens the problem while spending massive taxpayer funds. Illiquidity increases as market participants turn to lobbying instead.

I think the government can act to promote responsible lending. However this bailout is a desperate attempt to bring back the 100% interest only stated income piggyback teaser rates. Truly the opposite of responsible leadership.

Edward said...

This bail out is primarily a big earmark for Goldman Sachs and Morgan Stanley under the guise of an emergency that has yet to be explained in a coherent manner. (So says the BofA.)

For Congress to hyperventilate and say "we have an emergency, let's throw money at it" is inappropriate when the dollar value involved is randomly selected, and the bill does not even say what the money will be spent for (it could be spent on anything), where the underlying economics theory sounds like Milo Minderbinder (Catch-22) economics, where he could buy eggs in Malta for 7 cents each, sell them to the mess halls at 2 cents each and "everyone would make a profit".

Whether or not we need a bail out has not been well articulated, and it is nonsense that taxpayers should be happy for bankers to transfer their bad debts to the taxpayers - debts that are then merely moved around, not actually eliminated and will remain a drag on the overall economy. If the assets were any good, private parties would be buying them right now.

The problem is not the bail out per se but that this bail out measure makes no sense on any level except as the largest earmark in history for a few bankers. We are way past "bridges to nowhere" pork with this bail out.

There are many proposals for better alternatives. Let us hope Congress will now give them a serious look.

asphaltjesus said...

Spock's got it right.

The bailout deserves to die and die quickly. The Banks are the one's responsible for making their sh!t sandwich as small as possible before the end of their fiscal years.

You normally have great insight, but you are way off the mark on this call. I read the bill they voted on and it is a great improvement over the original, still leaves all of the details up to the Fed to act as they want and dramatically expands Fed powers. The $700 billion is poised to evaporate.

May I suggest a matching system? The bank sells a package for whatever price they can get in debt markets and the fed buys an identical package at the same rate to get some liquidity going again. Minimal expanse of treasury power with a mark-to-market component in the scenario.

DAB said...

Aha. We have hit what I (again) see as the nub of the problem. The market for vanilla loans is not illiquid. If a bank can make a loan, and borrow from anyone (on Libor, the fed, SWFs are swimming in cash still) at a high rate, the market is not illiquid. It is expensive. That expense should lead banks to offer up their interest rates on deposit accounts to be able to back more loans with deposits and engage in profitable traditional banking.

Credit for many traditional purposes should be expensive right now. The economy is in a rough patch. Businesses shouldn't necessarially be easily able to borrow to expand at this time. I have yet to hear of any, much less widespread, medium to large businesses unable to borrow to finance operations to the risk of bankrupcy. The counterargument is that it has not come to that yet, and that the plan will forstall that eventuality. I disagree. Balance sheets as of Q2 were still in fairly good shape accross the board.

The market for securitization and more exotic credit may well be illiquid, and perhaps some of that should never have been liquid to begin with.

All that said, I am personally on the fence regarding the 700 billion plan, though, since I think it likely that if it were passed eventually someone would figure out that the only sensable way to attack the root problem of the mortgages is for the government to restructure them. After spending 700 billion, at least they would have the securities to be able to deal with, and maybe the credit markets would have become less expensive in the mean time or as a result.

I would rather congress pass legislation to restructure the mortgages with all of the horribly messy details that involves (including, for example, the US government owning equity in basically creditworthy but overpriced housing).

Brad S said...

Unfortunately, there is no fix for the problem. Buying the assets won't fix the problem, it will just destroy the value of the dollar and tax us all into oblivion. Nope, we'll have to suffer for 6 months. That's okay, I can take it -- my pay checks will come in regardless. Bankers will get annihilated of course. Car dealerships will suffer, and realtors will go out of business. Nothing unfortunate about any of those outcomes that I can see. The price of NY and Conn real estate will probably drop markedly.

Who's making a killing is my brother in law. He works in a distressed asset hedge fund, those guys are eating your lunch right now. Too bad for the bankers that his hedge isn't hiring.

I wonder if when the washing machine was invented, all the wash women tried to get a government bailout. Nah, they probably just got harder, lower paid jobs somewhere else.

DAB said...

The other point goes back to a previous question I had posted in a reply on this blog. At that time, the question was premised that AIG and WaMu would fail (maybe AIG basically had? don't remember) who was next? I think I had asked "Wachovia" and the regionals as well. I have yet to hear or read that the regionals are in trouble as a group (PNC, Frost, etc...). Was Wachovia the last? In which case, since they are out of here is the last failure failed? In which case, why bail out now?

Unknown said...

If you were referring to fed funds when you said banks borrowed from the Fed at 7% overnight, you are off. The fed funds market opened at 7% this morning and is trading around 1% as I write. But these are not borrowings from the fed. They are overnight loans between banks which are established in the OTC market. It's a typical quarter end situation to have rates spike that was exagerated by banks unwillingness to lend to each other. The effective rate will still come out around 1.20% when the day is done.
If you were referring to the overnight LIBOR fix of 6.875% that still does not reflect borrowings directly from the Fed.

PNL4LYFE said...

Wachovia will almost certainly not be the last. There will probably be at least one more forced merger of large bacnks. Even after the bailout, there will be countless small banks failures handled by the normal FDIC process.

Given how open ended the bill is likely to be, it will be hard to know the outcome until the actually start buying junk. If they pay at or near mkt prices, it doesn't help the banks much at all. If they pay artificially high prices, they are effectively recaptilizing the banks. As long as they get sufficient equity participation, hopefully the actual cost to the taxpayer won't be too high.

Aaron and Kelly C said...

Giving the Feds a blank $700 billion dollar check to bail out a bunch of scandalous CEO's/Realtors/Appraisers/Mortgage Brokers/Insurance Companies/[insert guilty party here], is about as smart as just dividing up the money amongst all taxpaying 18+ year-olds with the idea that it would somehow boost the economy.

This would set a nasty precedence that is not warranted. Stop socializing losses and hang the culprits.

WAAS said...

I read the first five lines and actually when I saw the post I knew what it would be about.

It has been painfully obvious that the people actually working on Wall Street can't be objective about this issue. They personally see too many people getting blown up and they see their way of life challenged. They then justify the bill by we have to do something quickly so it doesn't matter what it is because not doing something quickly is way worse than not doing anything.

Most of main street, as everyone is calling it, has already seen the pain, they are feeling the pain. Remember they are the ones getting thrown out of houses. It costs you your bonus, it causes them to sleep in a car. Sure I am exaggerating a bit, but I am not that far off on things I have heard.

We need to do something that actually tries to protect the taxpayer. Buying crap from banks around the world and hoping is not going to work, and 700 billion isn't enough.

I will now go back and read the rest of the article, I will add if my original viewpoint changes.

bordoe said...

Read your comments often, and what you're doing on this site is appreciated.

It is extremely unlikely that this bail out will do anything to unfreeze the credit markets however: if this plan passed, and the toxic junk loans were taken off the banks balance sheets at favorable prices by Treasury, what would happen with that money?

You seem to assume that somehow they will find themselves going to auto loans, consumer debt, small business loans (ie, non-government backed debt).

Now, being an options trader, and never having been in a bank, not sure how banks actually behave.

But, it seems rather unlikely to me that banks will say "Hey, glad that's over, let's go 125% LTV on an 5-1 ARM!"

More likely they'll buy up US Treasuries, or maybe agencies, which are not the areas that have credit market access problems.

You may know more about it than I since you deal with the debt markets more directly.

Let me know if I'm wrong here.

Bonesetter Brown said...

If once you start down the dark path, forever will it dominate your destiny.

No $700B to overpay for assets.

No more government funded conduits like the AIG deal to bail-out Goldman and Morgan.

The only thing worse than what got us into this mess are the remedies Palpatine -- I mean Paulson -- proposes to fix it.

PNL4LYFE said...

I think a few CNBC commentators today framed this issue correctly; no one thinks this bill will solve all of our problems! Nobody thinks that it will make house prices stop falling or create jobs. What the supporters hope is that it will unfreeze lending markets (including interbank) long enough so that things can be sorted out in a relatively orderly manner.

Individual firms will continue to fail. Bear, Lehman, Wamu, Wachovia are gone and there will be others. The taxpayer has not lost 1 cent. Yes, there is potential liablity in the BSC and WB transactions, but realizing losses seems unlikely. But right now, banks won't deal with anyone because they don't know who will be next. Having a system in place to price bad assets and have a place to unload them will at least provide clarity so the "good" banks and borrowers can do business.

SG said...

Lab experiments with primates show that even they have have a wired in sense of fairness, and will reject a swapping deal which they precieve as unfair to them.

Nobody who opposes the bailout is in denial about the fact that the taxpayer is on the hook either way. What the proponents misunderstand is that the public will not accept a solution that does not punish the guilty. The bad banks must be closed, the bad managements dumped without their bonuses. The shareholders wiped out, etc.

If that is being avoided because it is feared that it will precipitates the fall of the CDS avalanche, well screw that. Bring it on. It's the only way that sort of unsound regulatory arbitrage will be brought under control. I mean, what the f%&k are we doing allowing insurance to be sold without statutory reserves for? It's a loaded gun now being held to our collective heads. Protection buyers who should have known better are as guilty as under-collateralized sellers, and should have to take their lumps for betting on an inherently faulty hedge.

For that matter why allow full payoff bond insurance to he written except for actual bond holders? The credit strength discovery mechanism of a broader market should work like stock options, with a strike price and a settlement value that doesn't present systemic risk.

The public will not and should not accept a solution which fails to address the systemic risk factors.

Instead of being an apologist for the totally over the top corrupt status quo, knowledgeable people like you should be advocating solutions which meet the minimum standards of fairness wired into our social natures. Otherwise, all you will get is a big NO, and whatever fallout results from the options non-experts arrive at without such assistance.

You are right about the risk. But the proposed non-solution is DOA with the public, and if it does manage to be forced through Congress there's going to be hell to pay.

If you really want to do something constructive, use your insiders knowledge to offer an alternative.

At the very bare minimum, passing a n income tax surcharge on all income above $1m for the next X years would show at least a sense of shame and responsibility about what has been dumped on our collective laps.

Smart guys like you need to think about protecting your own credibility. Being smart about economics and dumb about human nature isn't going to wash here.

capitalhill said...

I guess I'll be the lone voice here supporting AI's view.

Those of us who were watching the money markets trade on September 18 know that the financial system--not just the financial markets--is in a very precarious position. The ship was listing that day. It was a very troubling feeling. In my view, the only way to address that is to provide a means for some banks to clean up their balance sheets.

I don't like the plan that got rejected yesterday, but doing nothing isn't an option, and I don't see anybody offering anything better. And the fact is, Treasury is very likely to make a good return on this venture.

If I could borrow $700 b without covenants to buy bargain assets and hold them until the market came back, I would do it in a minute. I could make a lot of money. Since I can't, somebody else might as well.

Unknown said...

No bail-out.
No way.
No how.
I don't care if there's a depression coming. Poor people, like me, can survive with fewer food, clothing or shelter. Rich people, like you, can you?

Unknown said...

You can't get credit?

That's strange, I just happened to have closed on a $50k HEL yesterday. Now my TLV is still below 80%, but I'm in NorCal.

Ok, now if you don't have good credit (like some banks) then you can't borrow.

This all seems more like a scare tactic on the public to get a bailout passed than a real problem. No one is willing to explain what the problem really is and why it came up 'all the sudden'. Even drafting the original bailout plan started 45 days ago according to the SIFMA call.

No like others have said, the bailout plan precipitated the event it was supposed to prevent. That then requires the bailout... Right?

Happened with the Patriot Act. Happened with the War.
Why not trust the idiots again?

Daniel Newby said...

"Lab experiments with primates show that even they have have a wired in sense of fairness, and will reject a swapping deal which they precieve as unfair to them."

Computer simulations (of the iterated prisoner's dilemma) have also found that retribution is the most profitable long-term strategy.

I agree that we need to rescue the financial system, but we can still afford to give them a taste of Armageddon first. A lot of the financial wizards will only learn the significance of fire by being burned.

mOOm said...

In the meantime "the bailout" is proceeding anyway. For example in the Wachovia-Citibank deal, the FDIC agreed to absorb all losses above $42 billion. The ongoing bailout is reactive and piecemeal while the proposed one is proactive and systematic. I'd guess the proposed one has lower economic costs.

Also most lay commenters assume that somehow $700 billion in cash will be handed over to these banks. The reality is that new treasury bonds of that value will be swapped for the mortgage debts. The cost to taxpayers is the interest on those bonds. But in the meantime Treasury receives some mortgage interest unless everything they buy is already defaulted.

cap vandal said...

This is Warren Buffets take on it:

Last week will look like Nirvana (laughs) if they don't do something. I think they will. I understand where they're very mad about what's happened in the past, but this isn't the time to vent your spleen about that. This is the time to do something that gets this country back on the right track. What you have, Joe, you have all the major institutions in the world trying to deleverage. And we want them to deleverage, but they're trying to deleverage at the same time. Well, if huge institutions are trying to deleverage, you need someone in the world that's willing to leverage up. And there's no one that can leverage up except the United States government. And what they're talking about is leveraging up to the tune of 700 billion, to in effect, offset the deleveraging that's going on through all the financial institutions. And I might add, if they do it right, and I think they will do it reasonably right, they won't do it perfectly right, I think they'll make a lot of money. Because if they don't -- they shouldn't buy these debt instruments at what the institutions paid. They shouldn't buy them at what they're carrying, what the carrying value is, necessarily. They should buy them at the kind of prices that are available in the market. People who are buying these instruments in the market are expecting to make 15 to 20 percent on those instruments. If the government makes anything over its cost of borrowing, this deal will come out with a profit. And I would bet it will come out with a profit, actually.

I think it is much better to use this approach on the crappy asset backed securities then to watch this stuff cascade through the system with unpredictable results.

The money market failure made a believer out of me.

Further, watching GE's Jeff Immelt explain how GE has no problems with its commercial paper program because "we have backup lines with banks" was surreal.

Even if GE "has it covered" what about the next guy down the food chain?

The mere idea of GE having to explain that it is financially sound, based on systemic liquidity, is a big deal.

It has my attention.

There is all sorts of stuff out there ready to crumble. A lot of regional banks were heavily nicked when Paulson tanked the agency preferred stock which they were encouraged to buy.

All the above applies to asset backed securities. We have already nationalized the home loan markets, via F&F. I don't know if there is anything that can be done about the traditional banking system and their loan portfolios.

I am a firm believer in Roubini and think that there is enormous stress in the financial system.

However, I am not interested in watching a meltdown.

cap vandal said...

I also don't think the regulated banks are the biggest issue. The credit markets involve all sorts of non bank banks. Maybe they shouldn't exist, but it is a mistake to have them unwind in a disorderly manner.

I think one "problem" is that a lot of things really aren't frozen up right now. That doesn't mean that they aren't close to it, and it can happen fast.

In a bear market, the only thing that goes up is correlations.

Unsympathetic said...

AI, we're going to have to agree to disagree on this.

Banks need to be capitalized? They're giving preferred shares or being outright nationalized in the Sweden model - that's it, those are your options.

Your (Wall Street, not you personally..) extraordinary arrogance in assuming that you have some "right" to free taxpayer money is rhetorical pablum at its most absurd. Your minions named Paulson and Bernanke have been saying for months how good this economy is.. and now all of a sudden this is "required?"

Nope. You levered up for returns at 40:1.. well, delever, take your marks at whatever some silly foreign investor will give you for your insolvent securities.. and deal with yourself. Or issue preferred shares, or be nationalized. That's your choice.

Main street will feel it either way? Then guess what - Wall Street is going to learn what it means to suffer. If it's going to be bad either way, you're going down with us.

Americans do not buy these lies. This is a gut-check moment for the country. Americans are fundamentally about saving money, investing carefully, and living within our means. It's been that way since the country was founded. Wall Street firms that do not fit that mold - you know, all of them - do not deserve to exist in America.

Look, you tapped a deep nerve with this imperialistic trash. No taxation without representation.

America has fought a war for this before, and we will do it again. You want to bet this isn't the pitchfork and torch moment? Take that chance, buddy. Please. Guess what? We've got nothing to lose.

Unsympathetic said...

And to the previous commenter on Warren Buffet.. that guy has written enough out-of-the-money puts on the S&P index such that if the market does crash, he is BANKRUPT. He supports the bailout because it keeps him financially solvent.

The problem is not the fact that buyers are lacking.. they exist, at 16 cents on the dollar, the price for Lehman's bonds the last time I checked. Wall Street, however, does not want to accept that valuation so they have gone whining to the taxpayers. Ironically, instead of being humble, Paulson chose the CEO tack and pissed people off.

I will repeat this because it bears repeating. FOREIGN INVESTORS ARE WILLING TO BUY. They simply are not willing to give the prices Wall Street wants to see.. and because they're arrogantly out of touch with the world, Wall Street CEO's think they can just make demands to get out of their bad gambles.

Also, this $700B is not the sum total.. it will end up being $5 trillion at minimum.

Unsympathetic said...

An additional point:

Paulson has made it clear he will recommend a veto of any bill that contained a clear provision that said if Americans did not own the asset on September 20th that it can't be sold to the Treasury.

This means that Bank of Shanghai can transfer all of its toxic assets from anywhere around the world to Bank of Shanghai of Los Angeles.. and sell them to the Treasury the next day.

What does this mean? Hundreds of billions of US tax dollars are going to bail out foreign investors. Paulson knows it, Paulson demanded it and the bill has been carefully written to make sure that can happen.

The above is the direct transcript of the interview of Rep. Brad Sherman of California on CNBC.

TimingLogic said...

I read your blog infrequently and I do appreciate your work. If this isn't the most hilarious post from a professional, it comes close. I have a hard time believing that you, yourself, really believe this or if you are posting for your wife. It seems quite a hollow argument. And, it is rife with nonfactual innuendo. The bailout will not solve this crisis. It most likely won't even impact this crisis for very long until we have another similar recursive experience.

If the government is to do anything, at least follow some of the other case studies of banking crisis highlighted at the IMF that have a chance of working. Or, use historical context of similar crises in the U.S. and what we learned from these solutions. The probabilities of this style of intervention succeeding are very low from a case standpoint. Additionally, I could give you ten sound and scientific reasons why it won't work.

You can do much better than this.

Anonymous said...

AI, I really appreciate your post, it's the first sensible explanation for why this bill should pass that I've seen.

The thing a lot of us really dislike about it is that the government wouldn't just be buying up troubled loans from troubled banks. As I understand it we will be buying "assets" from "financial institutions". To me this translates into buying toxic CDOs with a diffuse relationship to the underlying loans, and in some cases buying them from hedge funds whose managers have been absurdly overcompensated and whose investors have been chasing yields while the rest of us have been chumming along earning bupkiss on our munis, treasuries, and CDs. That's what stinks about this idea.

I can't believe we can't find a solution to the problem that doesn't involve bailing out these "playahs".

Erika said...

These are honest questions....

If there is a bail out, what lessons are learned by the guilty banks that made such poor decisions? What are their "real" consequences? What does that teach the next business who takes on too much risk?

Unknown said...
This comment has been removed by the author.
Anonymous said...

Well we forget that the banks didn't want to make these loans in the first place. Historically they had never made such loans. There was pressure from "main street" and congress via. The Community Reinvestment Act.....

Acting in a greedy way that apparently is only seen on Wall Street, many "Main Streeters" used this new legislation to their advantage as a means to speculate on real estate. This sort of speculation was NOT what this act had in mind, and never in the history of our country had "main streeters" made such speculative gamble on housing prices. It is also apparent that in retrospect the idea of getting people into homes without credit checks or down payments was pretty foolish and another governmental interference of capitalism.... however since this interference was in favor of "main street" noone opposed it.... interesting...

Furthermore voting against the bailout caused the market to lose about $1.4 trillion dollars in value as it dropped 777 points. Considering most people have 401k's, pension plans, etc. I'm fairly certain the inaction has cost the taxpayer about twice as much as it would.

I'm not opposed to the plan, although it sucks that the government will now be running the largest hedge fund in the world.
The government seeks to make money on this... Watch all the leading Bond Experts salivate while wishing they could get their hands on these securities.

Great article (Although, I think the heart of the problem is the commercial paper market, if there is one,which will cause problems for every company (Such as companies who buy their holiday inventory on credit), too bad ignorance, anger and politics are delaying the progress.

Unknown said...
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Unknown said...
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Unknown said...

dab said.." I have yet to hear or read that the regionals are in trouble as a group (PNC, Frost, etc...). "

FWIW, common stock of PNC Bank has a GAIN on the time frames of YTD, 1 year and 2 year. I just bought some preferred. JP Morgan and Wells Fargo also have some great deals on preferreds. Some with 15% tax rate!

SalmonDaze said...

I believe you’ve captured the salient points regarding the financial arguments summarizing why the bailout is fundamentally a poor decision.

I can only add the following: the mechanisms proposed to implement the tactics supporting the strategy are as flawed as the strategy itself. The “local” institutions that will be funded to liquidate the assets include, but are certainly not limited to, ACORN and other highly contentious organizations.
The underlying reasons for the failures lie at the feet of legislation by fiat. When Fan & Fred set these wheels in motion, the outcomes were inevitable. Therefore, all the comments to date decrying adding fuel to the firestarters’ arsenal are logical and well advised.

Anonymous said...

Please READ your feedback, Mr. Accrued Interest! In short, I don't see much support for TARP in the comments here, among those of us that follow economics closely and/or perhaps among those working in the financial industry...

What's wrong with collateral?
What's wrong with security?
What's wrong with sanity?
What's wrong with a world where CASH (finally, again) is king?

Those supporting the bailout simply wish to return to business as usual -- albeit now requiring forced participation of the American taxpayer to the risk Wall Street high risk matrix -- i.e. as the ultimate backstop to irresponsible Wall Street shenanigans as have occurred for at least one decade or more thus far.

However, those opposing the bailout want to FIX the system, returning it to sanity. We want secured lending. We want less churn. We want greater stability in our financial markets. In short, we want America (world) financial systems to work as they had previously when CASH (not a credit line) mattered -- when America and the world economy were not prone to the instability inherent in the system - i.e. bubble after bubble after bubble and crisis after crisis after crisis and collapse after collapse after collapse.

Thus, this crisis and potential collapse represents a unique opportunity for us, who consider ourselves sane, relative to your/others' insanity regarding structured finance - i.e. your desire for a world where a human being's only options are: a.) spend all wages immediately to avoid loss of value relative to inflation OR "invest" (trade) in insanely risky markets (to be exploited by hedge funds and very, very large investors).

Thus, if, in the process of de-leveraging, as sanity requires, this world's economy goes "into the tank" for several decades, in order to simply restore financial sanity, then SO BE IT.

Because your "business as usual" has simply failed the vast majority of human beings alive today on this planet. Therefore business as usual cannot (or at least should, rationally, not) be allowed to continue.

CASH SHOULD BE KING and money should mean something -- otherwise what is the point of having a complex, highly structured economy.

Specifically, what is the point of an economy where the vast majority of human beings work for IT, but IT simply does NOT work for them?

Answer: there is no point. END WALL STREET (exploitation) INSANITY NOW!

leem said...

If you want to help via a bailout type of situation, help the 10,000 people per day going thru foreclosure. Many (not all) cannot afford the current payments due to thier payments being drastically increased either from balloon payments or ARM rate increases. Even if 1/2 of these were fixed and the payments could be made, millions would flow back to the mortgage holders and be available for loans. Also these houses would not be a drag on the market which would help "naturally" to support the housing market. The "bailout" needs to be down at the bottom and it would then with natural forces, help (not a quick fix) the overall situation.

This would not be a quick fix but it would change the direction in a more normal way.

Unknown said...

I dont think the bailout will help that much and the only banks that it seems like it would help are the "dead" ones. I think the market will crush the debt/eq of any "healthy" firm taping the fund,as a show of weekness....any thoughts?

ronmac said...

Totally wrong-headed article. I see some people saying we have to do "something", so lets do this. Why? It won't work. A depression -deflation is already in progress. Google "liquidity trap" and you will see what is and will be happening. Don't add hyper-inflation to the problem (well that may be too late). I hear the Senate, fools that they are, are adding tax cuts to the bill...figures. Get the government out of this.

Anonymous said...

The citizenry was told Iraq War 2 would cost $50B. Today the costs look more like $3T.

If we're told the bailout will cost $700B (an arbitrarily selected "big number"), how much will it have cost five years from now? $42T?

viking said...


I know that where we are is a surprise to you, AI. It is not to me. I've repeatedly told you that you were wildly underestimating this thing.

But now YOU want to tell US why the bailout is a good thing. You neglect to address the fact that 700B isn't NEAR ENOUGH, and will just dig a deeper hole and make the eventual and inevitable reset that much more painful.

In your own weird and wrongheaded way, you are consistent.

Christopher Wheeler said...

Wow. I thought most of the people reading this blog were Wall Street types. Based on the feedback I'm reading, most of the commenters do not work in financial services and will not directly benefit from any bailout the Federal government puts in place.

From where I sit, it looks like the pool of liquidity has gotten shallower, but has not dried up. LIBOR and the TED spread have spiked higher, but loans are still being made. At the Main Street level, it is harder to get loans, but if the bubble has taught us anything, it is that credit should have been tighter all along.

I think one of the things that bothers Americans about this bailout is that we have seen no evidence of sacrifice from the Wall Street guys who work in the system the bailout is purported to save.

As I have commented elsewhere, when Lee Iacocca went to the Feds for loan guarantees for Chrysler in the 80's, he volunteered to go for a year without a salary or bonus. There was an article on MSN today about the soon to be former CEO of Wachovia. The guy was brought in to turn around the situation just two months ago, and he failed. Between his signing bonus and severence package, he is going to walk away with $19 million.

When they read about skewed incentives like that, people just see red. Okay, when I read things like that, I see red. Anyway, until some of the guys running things on Wall Street start volunteering to take a personal hit themselves, I don't think the "crisis" is that dire yet.

On a separate note, keep up the great work, AI. This blog has some of the best analysis and explanation of the credit markets out there.

DaveinHackensack said...

"Second, there would be no secondary education. Like housing, the vast majority of people need loans to get a college education. Granted, colleges would probably pare back on the quality of the education offered in an attempt to lower their costs. Even so, it would likely be that only wealthy people could afford college."

Where to begin in response to this? First, if this bailout doesn't pass, credit will be more difficult to come by, but it won't disappear entirely.

Second, even if it did, some elite universities have large enough endowments that they could afford to waive undergraduate tuition now if they wanted to. They could also skew their admissions to accept more applicants from lower income backgrounds if they so chose.

Third, before colleges pared back on the quality of the educations they offer, they could first pare back on the spa-like amenities many of them have been adding to woo spoiled kids to apply.

Fourth, I doubt that access to money for college significantly impacts inequality. There is plenty of scholarship money available for bright kids from poor backgrounds, and there are ways for smart, ambitious folks to succeed without overpaying for a four year degree.

Jim Schlemmer said...

shockandbrah said...

"Well we forget that the banks didn't want to make these loans in the first place. Historically they had never made such loans. There was pressure from "main street" and congress via. The Community Reinvestment Act....."

This is a thoroughly debunked conservative canard, no doubt kept in circulation by talk radio hosts. Did the Community Reinvestment Act also mandate the repackaging of mortgages into MBSs and CDOs?

The janitor making $35K who bought a $350K house in SoCal was enabled by greed up and down the financial ladder, not by the CRA, bud.

Author said...

Banks were PIGS - They overleveraged themselves so that they could inflated their income statements, rewarding management / shareholders with an artificial run up in the stock price. The blame here lies with the US government, that permitted this to happen. Clinton's administration repealed Glass Steagall Act, which was meant to separate "risk taking" investment banks from depository lending based institutions. Like everything in this society over the last 20 years, nobody has wanted to pay the piper for bad decisions. It's all coming home to roost now. The Bailout will only prolong the pain.

This is changing the world as we now know it. The printing of money to insure anything and everything against failure. That's not capitalism. We're giving up control of our society to the Wall St. elite and the politicians at the expense of our kids ! http://displacedema.blogspot.com

Unsympathetic said...

David - The bill repealing Glass-Steagall had more than enough votes in the House and Senate to pass over a presidential veto. Republicans controlled both the House and Senate at that time. Good try at blaming that one on Clinton, though! Wikipedia has the vote counts. You should know the bill by its other name.. the Gramm-Leach-Bliley act.

Not coincidentally, McCain's current proposal for Sec'y of the Treasury? None other than Phil Gramm. It's fun to note that the current bill adds an additional $100B of spending. Oink oink!

JoshK said...

AI, I always enjoy your blog, but disagree with this bailout. Some banks will fail, and the Wamu and Wachovia transactions seemed pretty healthy overall.

Maybe we have seen a massive over-extension of credit to people who shouldn't have ever had it. Trying to put 700b in to buying past loans doesn't seem to be likely to change bankers' newly more prudent analysis.

Maybe it's better for the Fed to put bids into the CP market and even into the market for new, good ABS's? That makes more sense to me.

DAB said...

One more point, I think Joe Nocera's piece in the Times today was supposed to convince res populi that the bailout is needed (or at least report the case from wall street's point of view, crediting the Times with reporter's objectivity). It is neither a bad nor a great read, but I do recommend it.

I am a skeptic by nature, but I am still not convinced, particularly by the facts and timeline as outlined in that article. Hedge funds worrying about their redemption and clearing brokerage has NOTHING to do with vanilla corporate finance. Ok, maybe bond issues are hard right now. Where is the evidence that non-financial (which should have been my qualifier on my earlier post above) medium and large corporations can’t borrow to finance operations (not expansion) if needed to stave off bankruptcy? Small businesses may be financially in trouble, but the problem there is a lot of small businesses do fail every year regardless of the financial climate. More will fail in a slow period. I contend that reflects economic slowness more than a liquidity crunch, as it is not rational necessarily to lend to a failing small business in a slow period…

venkat said...

I am not opposed to govt intervention or the bailout as it is called now. I understand that properly working credit markets are integral foe economic growth. That said I do not support the proposal in it's current form. The intervention in case of AIG and agencies at least made sense in that the govt was assuming the role of a share holder and if it's efforts succeeded, the public will enjoy the benefits.
In case of Paulson's plan, the down side is the same as in the case of AIG bailout but the upside is very limited.

Though these two bailouts are different in their structure, they are aimed to achieve the same, improve balance sheets and increase confidence and liquidity . That being the case why should one accept such an unfair risk-return position by buying these toxic Assets? Let us use that 700 b instead to buy capital and dilute the existing shareholders who should rightfully suffer. This plan is nothing but socializing the losses.

joshfrompdx said...

Great post. Clear, articulate, and well-reasoned. We would all be in a better place this week if Bush had simply read your posting when he was trying to get taxpayer support for this plan.

Unknown said...

Its a short term fix...markets will go up for a couple days maybe a couple weeks but its not solving the large problems here. The government is looking to take some crazy action I read today. I dont think it will help only hurt. Take a look http://www.gotoguy.com/?p=367

cap vandal said...

"And to the previous commenter on Warren Buffet.. that guy has written enough out-of-the-money puts on the S&P index such that if the market does crash, he is BANKRUPT. He supports the bailout because it keeps him financially solvent."

I shouldn't bother, but Buffett wrote at the money puts on 4 global indices, but the are 15 and 20 year european puts and had hefty premiums, no collateral requirements for BRK, and -- having collected in advance, no counterparty risk. No need to worry about any cash impact unless the indices to to zero and stay there for 15 to 20 years. As far as the worst case, he goes from 0 leverage to a little leverage, with no cash impact.

If all the indices go to zero, we are all pretty much BK, no?

dlr said...

Hey wait a minute, Steve, "At the very bare minimum, passing a n income tax surcharge on all income above $1m for the next X years"? No way. That is guilt by association. LET THE GUYS PAY FOR IT WHO CAUSED THE PROBLEM. Not rich guys in general, but those EXACT rich guys that caused the problem. Fair is fair. Penalizing a group to pay for something that some members of a group did is wrong. For the same reason racism/sexism/ageism/ is wrong.

I read today that one of the proposals in Congress to recoup any losses on this $700B is to levy a tax on all banks across the board. That is just WRONG. There are PLENTY of responsible banks out there that didn't engage in irresponsible lending practices. They should not have to pay to bailout the banks that did. It would be unfair. In fact just exactly as unfair as making the taxpayer pay for the bailout.

SG said...


My point is that it would be less unfair, and it would fall to those who have benefited the most during the party. Wrongdoing aside, those who have been making out in all parts of the economy on the effects of the credit bubble while middle class income stagnated share a greater responsibility for the clean up costs. If it helps with your sense of fairness, this includes myself, as I am a high enough income individual to get scalped by the tax surcharge alternative you objected to. But I understand that my business thrived and my real estate investments were more profitable based on the prevailing conditions than they would have been in more long run average environment.

It's not my first choice, and I hope there will be plenty of civil judgments and criminal prosecutions of the actual guilty. And I wouldn't expect that the entire $800b would come from just us. But proper symbolism and a realistic bite are important.

Rich people are generally too quick to assume that their wealth is due entirely to their skill and hard work and not to the health of the society in which thei9r efforts take place. Adam Smith is misunderstood by anyone who hasn't read the companion volume to Wealth of Nations, which explains the duty and values which must be in place underlying a market economy and specialized production.

la plage said...

you make the fatal error of having the underlying assumption (you actually don't even discuss the idea that MAYBE this is not the solution to the problem) that this "$700b" is a step in the right direction in solving the lack of illiquid asset liquidity and credit advancement.

because of this huge leap of faith you are asking your readers to make, i believe you should dedicate a post to explaining WHY the '$700b' solution is the right one. otherwise, the rest of your post is a moot point.

Anonymous said...

Jim Schlemmer:

Just revisited this post after a long time. The CRA didn't "Mandate" the repackaging of mortgages. However the amount of risk associated with these mortgages basically made it a necessity to pass this risk through to investors with a higher risk tolerance than individual banks. With only a small nubmer (17?) failing this year, I believe that spreading the risk throughout the economy was a better scenario than having every single regional bank in the country fail due to a portfolio of risky loans.

Also what the hell is a Janitor who makes 35K a year doing thinking he can buy a 350K dollar house... As someone who prides himself on being self taught I figured you of all people would agree that homeowners should have made more educated choices...

inchirieri apartamente cluj said...

Robert Kiyosaki says "You know there's good debt and bad debt. Bad debt makes you poor," so we have to be very carefull which kind of dept are we using in our economy. It is very easy to say that this greedy Wall Street will make us suffer greatly in this crisis.

Harv Eker says in his beautiful book something like this "When you are complaining, you become a living,breathing “crap magnet.”" and I don't want anyone wants to be that kind of magnet, no ?