Global Financial Crisis (Was: Subprime Meltdown)

[ewmayer]

Originally Posted by masser

Greenspan Defensive in WSJ Interview

Yeah, I saw that too this a.m. in the print version we get here at work - Thanks for the link.

He *should* feel defensive, the douchebag. Love when he says words to the effect of "people are criticizing me for things I didn't do..." - well, if those things include your job [esp. w.r.to the Fed's mandate to oversee consumer lending practices, an area in which Greenie and his stooges were completely and willfully negligent], they have every right to criticize you.

So, to sum up, Greenie says: "I am not the complete and utter douchebag people say I am ... I'm a different kind of complete and utter douchebag."

Ha, it must bug the crap out of him that economic history is busily recording and revising him the status of "complete and utter douchebagitude" and there's not a goddamn thing he can do about except to protest loudly and point to sales of his self-serving autobiography.

It worries me, however, that both John McCain and Hillary Clinton have laudingly invoked Greenspan in lines like "If Alan Greenspan says we're in a recssion - we should listen".

By way of "Apparently knowledgeable people who beg to differ with Mr. Greenspan's self-assessment and have data to back up their claims", here's a recent article by Jeffrey Sachs, Professor of Economics and Director of the Earth Institute at Columbia University, posted to the Project Syndicate website:

http://www.project-syndicate.org/commentary/sachs139

CAMBRIDGE - The US Federal Reserve’s desperate attempts to keep America’s economy from sinking are remarkable for at least two reasons. First, until just a few months ago, the conventional wisdom was that the US would avoid recession. Now recession looks certain. Second, the Fed’s actions do not seem to be effective. Although interest rates have been slashed and the Fed has lavished liquidity on cash-strapped banks, the crisis is deepening.

To a large extent, the US crisis was actually made by the Fed, helped by the wishful thinking of the Bush administration. One main culprit was none other than Alan Greenspan, who left the current Fed Chairman, Ben Bernanke, with a terrible situation. But Bernanke was a Fed governor in the Greenspan years, and he, too, failed to diagnose correctly the growing problems with its policies.

Today’s financial crisis has its immediate roots in 2001, amid the end of the Internet boom and the shock of the September 11 terrorist attacks. It was at that point that the Fed turned on the monetary spigots to try to combat an economic slowdown. The Fed pumped money into the US economy and slashed its main interest rate - the Federal Funds rate - from 3.5% in August 2001 to a mere 1% by mid-2003. The Fed held this rate too low for too long.

Monetary expansion generally makes it easier to borrow, and lowers the costs of doing so, throughout the economy. It also tends to weaken the currency and increase inflation. All of this began to happen in the US.

What was distinctive this time was that the new borrowing was concentrated in housing. It is generally true that lower interest rates spur home buying, but this time, as is now well known, commercial and investment banks created new financial mechanisms to expand housing credit to borrowers with little creditworthiness. The Fed declined to regulate these dubious practices. Virtually anyone could borrow to buy a house, with little or even no down payment, and with interest charges pushed years into the future.

As the home-lending boom took hold, it became self-reinforcing. Greater home buying pushed up housing prices, which made banks feel that it was safe to lend money to non-creditworthy borrowers. After all, if they defaulted on their loans, the banks would repossess the house at a higher value. Or so the theory went. Of course, it works only as long as housing prices rise. Once they peak and begin to decline, lending conditions tighten, and banks find themselves repossessing houses whose value does not cover the value of the debt.

What was stunning was how the Fed, under Greenspan’s leadership, stood by as the credit boom gathered steam, barreling toward a subsequent crash. There were a few naysayers, but not many in the financial sector itself. Banks were too busy collecting fees on new loans, and paying their managers outlandish bonuses.

At a crucial moment in 2005, while he was a governor but not yet Fed Chairman, Bernanke described the housing boom as reflecting a prudent and well-regulated financial system, not a dangerous bubble. He argued that vast amounts of foreign capital flowed through US banks to the housing sector because international investors appreciated "the depth and sophistication of the country’s financial markets (which among other things have allowed households easy access to housing wealth)."

In the course of 2006 and 2007, the financial bubble that is now bringing down once-mighty financial institutions peaked. Banks’ balance sheets were by then filled with vast amounts of risky mortgages, packaged in complicated forms that made the risks hard to evaluate. Banks began to slow their new lending, and defaults on mortgages began to rise. Housing prices peaked as lending slowed, and prices then started to decline. The housing bubble was bursting by last fall, and banks with large mortgage holdings started reporting huge losses, sometimes big enough to destroy the bank itself, as in the case of Bear Stearns.

With the housing collapse lowering spending, the Fed, in an effort to ward off recession and help banks with fragile balance sheets, has been cutting interest rates since the fall of 2007. But this time, credit expansion is not flowing into housing construction, but rather into commodity speculation and foreign currency.

The Fed’s easy money policy is now stoking US inflation rather than a recovery. Oil, food, and gold prices have jumped to historic highs, and the dollar has depreciated to historic lows. A Euro now costs around $1.60, up from $0.90 in January 2002. Yet the Fed, in its desperation to avoid a US recession, keeps pouring more money into the system, intensifying the inflationary pressures.

Having stoked a boom, now the Fed can’t prevent at least a short-term decline in the US economy, and maybe worse. If it pushes too hard on continued monetary expansion, it won’t prevent a bust but instead could create stagflation - inflation and economic contraction. The Fed should take care to prevent any breakdown of liquidity while keeping inflation under control and avoiding an unjustified taxpayer-financed bailout of risky bank loans.

Throughout the world, there may be some similar effects, to the extent that foreign banks also hold bad US mortgages on their balance sheets, or in the worst case, if a general financial crisis takes hold. There is still a good chance, however, that the US downturn will be limited mainly to America, where the housing boom and bust is concentrated. The damage to the rest of the world economy, I believe, can remain limited.

[ewmayer]

Bloomberg.com | Volcker Says Fed's Bear Stearns Loan at `the Very Edge' of Legal Authority

Volcker, the Fed chairman from 1979 to 1987, had implicit criticism for U.S. regulators and market participants who allowed ``excesses of subprime mortgages'' to spread into ``the mother of all crises.'' The Fed's Bear Stearns loan was unusual, he said.

``What appears to be in substance a direct transfer of mortgage and mortgage-backed securities of questionable pedigree from an investment bank to the Federal Reserve seems to test the time-honored central bank mantra in time of crisis: lend freely at high rates against good collateral; test it to the point of no return,'' he said.

...

Volcker said the Fed's loan may send investors the wrong message.

``The extension of lending directly to non-banking financial institutions -- while under the authority of nominally `temporary' emergency powers -- will surely be interpreted as an implied promise of similar action in times of future turmoil,'' he said.

Volcker said the modern financial system has ``failed the test'' of the marketplace. When asked whether he predicts a ``dollar crisis,'' he said, ``you don't have to predict it, you're in it.''

Telegraph.co.uk | IMF Does About-Face on Economic Outlook as Crisis Deepens

"We all have to be a little humble about this."

You can say that again. Jaime Caruana's conclusion when presenting the International Monetary Fund's Global Financial Stability Report (GFSR) in Washington yesterday summed up how dramatically the economic mood music has changed during the past year.

This time last year, the IMF predicted confidently that the sub-prime mortgage slump would not affect America's economy.

Chief economist Simon Johnson memorably said he did not expect "the financial tail to wag the economic dog".

How wrong both he and the broader financial community were.

Yesterday's GFSR was among the gloomiest reports that has ever been published by the IMF - an institution that is hardly renowned for hyperbole.

The weighty 190-page document will be pored over for many months but the overall tone and conclusions are already clear: that this is the worst financial crisis in many, many decades, and banks, ratings agencies and regulators will have to overhaul themselves dramatically if they are to prevent a similar disaster in the future.
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It is a sobering thought. Much of the economic growth enjoyed by western economies - particularly the United States and the UK - has been directly or indirectly fuelled by the advances of the financial sector. Such impetus has gone, much of it never to return.

Most galling of all is the fact that the crisis is a direct result of the hubris which dominated for so long.

The report's chief conclusions are worth quoting at length:

• There was a collective failure to appreciate the extent of leverage taken on by a wide range of institutions - banks, monoline insurers, government-sponsored entities, hedge funds - and the associated risks of a disorderly unwinding.

• Private sector risk management, disclosure, financial sector supervision, and regulation all lagged behind the rapid innovation and shifts in business models, leaving scope for excessive risk-taking, weak underwriting, maturity mismatches, and asset price inflation.

• The transfer of risks off bank balance sheets was overestimated. As risks have materialised, this has placed enormous pressures back on the balance sheets of banks.

• Notwithstanding unprecedented intervention by major central banks, financial markets remain under considerable strain, which is now compounded by a more worrisome macro-economic environment, weakly capitalised institutions, and broad-based de-leveraging.

The report also issues a highly unusual veiled criticism of the Federal Reserve for keeping its interest rates too low even as the US housing market started to power ahead.
[Full Story]

On the "Corporate Accounting Tricks and Legerdemain", we have Goldman Sachs, front and center:

Bloomberg.com | Goldman Sachs Reports Hard-To-Value Level 3 Assets Jump, Exceeding Rivals

April 9 (Bloomberg) -- Goldman Sachs Group Inc., the most profitable securities firm, reported an increase in harder-to- value assets during the first quarter, exceeding those at Morgan Stanley and Lehman Brothers Holdings Inc.

Goldman's share of Level 3 assets surged 39 percent to $96.4 billion at the end of February from $69.2 billion in November, according to a filing with the U.S. Securities and Exchange Commission today. The ratio of Level 3 to total assets rose to 8.1 percent from 6.2 percent.

So let me try to get this straight ... you had to mark a bunch of formerly-slightly-less-toxic Level 2 assets down to Level 3, a.k.a. "We have no clue what if anything this garbage might be worth if we actually tried to sell it to someone other than the U.S. Government." How do you make lemonade out of this asparagus-smelling winklepiss? Well, because Level-3 crud is by definition hard to value, you mark its fictitious value up generously, then spin it against your rivals as "Nyah, nyah, our fictitious assets are worth more than yoo-hoors...". You just gotta admire the sheer creative evil genius behind this kind of stuff.


And speaking of "Peddling turds as chocolate bars" spin, we have the news that Citigroup is going to sell $12 billion in leveraged loans. The spin in this case is that Citi is allegedly offloading a colossal wad of "troubled loans" at a healthy-sounding in-this-climate 90 cents on the dollar:

BOSTON (MarketWatch) -- Citigroup Inc. is reportedly in talks to sell $12 billion of leveraged loans and bonds at a discount as it tries to shore up its balance sheet in a move that may signal improving conditions in roiled credit markets.

The bank is close to sealing a deal which would allow it to sell troubled debt to private equity firms for an average price of around 90 cents on the dollar, according to reports on multiple media outlets Wednesday.

One report said the deal would be the largest single sale of leveraged loans in recent memory, while it comes amid hope that the credit market has bottomed and is poised for a recovery. Citigroup shares traded higher early Wednesday.

Note the relentlessly positive spin here: "may signal improving conditions...", "allow it to sell troubled debt ... for ... 90 cents on the dollar", "hope that the credit market has bottomed and is poised for a recovery...".

The dirty little secret here? Just because the loan portfolio in question is "leveraged" does not mean these are troubled loans! In fact these are leveraged buyout loans -- the kinds of bread-and-butter high-yield loans that companies like Citi normally use to make something mysterious called "profits". "Leveraged" in this context means an entirely different thing than e.g. when we talk about speculative hedge-fund-style investment leverage. The fact is, Citi is selling the only part of their huge loan portfolio which is still worth something at a loss because they are desperately scrambling for cash.

[garo]

Actually the Citi loans are much worse than they sound as Citi has agreed to indemnify buyers against the first 20% of losses. That's another way of pushing the 20% loss into the future.

http://globaleconomicanalysis.blogsp...citigroup.html

[ewmayer]

Lehman Brothers Bails Out Five Debt Funds, Assumes $1.8 Billion of Assets: Lehman Brothers Holdings Inc. bailed out five of its short-term debt funds, joining a growing list of securities firms and asset managers that have propped up investment vehicles crippled by frozen credit markets.

A.k.a. "Your tax dollars at work ... for a Wall Street Brokerage to try to bail itself out of the mess its own greed created for it." You didn't honestly think they were using their *own* money for these kinds of bailouts, did you? Nope - this is one example of how the Fed`s "liquidity injections", i.e. trading U.S. Treasuries at artificially low yields for the toxic debt of the banks - are being put to use.


Bloomberg.com | Hedge Funds Come Unstuck on Truth-Twisting, Lies

Commentary by Matthew Lynn

April 9 (Bloomberg) -- Has the hedge-fund industry been built on a series of lies?

For the past decade, its explosive growth has been based on a simple claim: that skilled money managers, motivated by high performance fees, could outperform the market when it was going up -- and sidestep the trouble when it was going down.

And yet the credit crunch has shown that to be a myth. Although a few hedge-fund managers have done brilliantly, far more have come unstuck.

Now it looks as if the industry might be based on a more systematic falsehood. Two recent academic studies suggest that hedge funds have been routinely dishonest, or at least economical with the truth.

...

Peloton Partners LLP liquidated its largest fund after making bets on mortgage securities that turned sour, while JWM Partners LLC, run by former Long-Term Capital Management LP chief John Meriwether, was hurt by swings in Japanese government bonds. Overall, hedge funds turned in their worse quarterly performance in six years, according to Chicago-based Hedge Fund Research.

...

[Wharton School of Business] Statistics Professor Dean Foster and Brookings Institution Senior Fellow H. Peyton Young said it is easy for hedge funds to start up and make money without having any real investment skills.

``It is very hard to set up an incentive structure that rewards skilled hedge-fund managers without at the same time rewarding unskilled managers and outright con artists,'' they said in a paper called ``The Hedge Fund Game.''

So how is it done? They say you can just replicate an investment strategy devised elsewhere, take big positions, and collect enormous performance fees until the whole thing blows up. By then, you will already have pocketed plenty of money, and you won't have to pay any of it back if the fund goes bust.

``It is extremely difficult to detect, from a fund's track record, whether a manager is actually able to deliver excess returns, is merely lucky, or is an outright con artist,'' they said.

Raw Deal

There is nothing about those conclusions that will surprise anyone who has followed the hedge-fund industry. The deal was that in return for high fees, which in effect gave the managers a stake in the fund, investors would get above-average returns.

Yet, it appears many funds have just been relying on a rising market and sitting back and collecting 20 percent -- the typical performance fee on a hedge fund -- of the profits.

The conclusion? The promise on which the industry was built looks to be largely a false one.

Investment guru Jim Rogers [cofounder with George Soros of the now-legendary Quantum Hedge Fund, one of the very few that actually *did* consistently outperform the broad market indices] weighs in on all the Greenscam and Bernanke Panky that's been going on - not being a Washington insider, he is a bit less diplomatic about his assessment of the Fed's machinations than ex=Fed=chairman Paul Volcker [see above] is:

Jim Rogers: More Pain for the Greenback, and the Failure of the Federal Reserve: By bailing out Wall Street and applying "band-aids" to the economy, the U.S. Federal Reserve may well be causing its own downfall - even as it hastens the demise of the greenback as a viable global currency, investment guru Jim Rogers told Money Morning during an exclusive interview.

Because of such strategic missteps, U.S. consumers could be facing a long and painful economic malaise, similar to the "lost decade" of 1990s Japan, or the stagflation-riddled 1970s in the United States, Rogers said.

Make no mistake: If that happens, there are two clear culprits - current Fed Chairman Ben S. Bernanke, and his predecessor, Alan Greenspan.

Bernanke "and Greenspan together will probably bring [about] the end of the Federal Reserve," Rogers said during the interview in Singapore. "We’ve had two central banks in America that failed [and] this third central bank will probably fail, too, because of Bernanke and Greenspan. The Federal Reserve [just] put $200 billion more onto its balance sheet of mortgages. Now I don’t know how big they can expand their balance sheet, but if they keep doing it, there’s only so much - and they just bought Bear Stearns (BSC)."

Small correction: The Fed paid full-dollar [OK, 29/30 of full dollar] but only bought Bear's overflowing cesspool of toxic debt - they gave the house, land and mineral rights to JP Morgan for 3 cents on the dollar. But, 'tis a quibble - let's continue:

During that interview here in Singapore, Rogers also said that:

* Although the United States faces perhaps its most daunting economic challenges in at least a generation, "in America, most people do not understand that there is a problem."
* Because of these weak-dollar efforts - as well as the billion-dollar bailouts - "America is now the largest debtor the world has ever seen."
* Although the central bank seems intent on engineering a U.S. economic rebound by creating an ultra-weak dollar, no country in history has ever emerged from a serious financial crisis by "debasing its currency."

The bottom line: The strategies that the central bank is currently employing are nothing short of "outrageous," Rogers said.

"You know, I’ve read the Federal Reserve Act," he said. "Nowhere does it say [the central bank is] supposed to bail out investment banks! Nowhere does it say you should bail out Wall Street. Their mandate was to have a sound currency, and then it was later expanded to have employment - to help employment. But nowhere does it say: ‘Bail out investment banks.’"

...

Q: Are we looking at a Japanese-style lost economic decade?

Rogers: The Federal Reserve is making the same mistakes that the Japanese made. They’re trying to say: "We won’t let anybody fail. We’ll print a lot of money. We’ll drive interest rates to zero. And we don’t want anybody to fail. We’ll put on as many Band-Aids as we have to."

Well, putting Band-Aids on a cancer patient is not a good solution.

So whether it’s like the ’90s in Japan, or the ’70s in America, remains to be seen.

[One-time U.S. Federal Reserve Chairman] Arthur Burns, who headed the central bank in the ’70s, did exactly what Bernanke’s doing. He raced in and printed money and said: "Oh, everything’s gonna be OK."

But the economy never recovered, inflation went through the roof, and the dollar was under duress. Eventually they had to bring in Paul Volcker and interest rates went over 20%. And eventually they killed inflation and they solved the problem.

They’re making exactly the same mistakes that Burns made. For whatever reason, though, this problem is going to last longer than previous difficulties in America. And it’s probably going to be worse.

Because, now, America is a debtor nation. Now we’re the largest debtor nation in the world. At least in the ’70s, we were still a creditor nation. Japan could survive because they were the largest creditor in the world at the time. So they didn’t fall off the face of the earth.

America’s now the largest debtor the world has ever seen. What’s happening in the U.S. is not going to be fun.

...

Recessions are usually good for the system. They clean out the excesses. And my God there’ve been excesses on Wall Street in the past 10 years. You don’t see a bunch of 29-year-old cotton farmers driving around in Maseratis and flying in private planes to exotic locations. Well, you see a lot of guys on Wall Street doing that.

And the idea that we’re now supposed to bail them out is ludicrous! I don’t see any of those guys sending their bonus checks back.

Huge amounts were made in the debt markets. We now know [that money was made] at least incorrectly, if not fraudulently, and yet, now we’re supposed to bail them out. It’s bad enough they get to keep their money. But the outrageous part is that it will cost more to try to prevent a recession than to have the recession.

[cheesehead]

Ernst, did you notice my question in post #143?

In general, what's your opinion of Volcker? (You seem to refer favorably to his opinions in press.) And what if Reagan had reappointed him in 1987 instead of Greenspan then? (I recall that Reagan didn't want to reappoint Volcker in 1983 -- after all, Reagan was taking all the credit for stopping inflation that really belonged to Volcker, so it was inconvenient to let him hang around -- but Wall Street convinced him otherwise.)

[ewmayer]

Originally Posted by cheesehead

Ernst, did you notice my question in post #143?

In general, what's your opinion of Volcker? (You seem to refer favorably to his opinions in press.) And what if Reagan had reappointed him in 1987 instead of Greenspan then? (I recall that Reagan didn't want to reappoint Volcker in 1983 -- after all, Reagan was taking all the credit for stopping inflation that really belonged to Volcker, so it was inconvenient to let him hang around -- but Wall Street convinced him otherwise.)

Sorry I forgot to reply to your earlier query - to sum it up in a few words: I distrust all central bankers and the institutions they serve, but of the lot I've experienced in my lifetime, Volcker was the only one who showed some real fiscal discipline, in the face of a severe crisis, and did not put the fortunes of Wall Street ahead of those of the metaphorical Main Street.

One lingering thing that puzzles me about Greenspan: appointed at the end of Reagan's term, i.e. under a classic - in fact perhaps the prototypical - neoconservative "We say small government, but we mean deficit-financed huge government" politician. Now during the Clinton administration, Greenspan showed a side of himself that has been utterly absent these past 7 years, namely that of deficit fighter. Sure, he was already busily blowing the first of the 2 massive speculative asset bubbles which [I hope] shall forevermore bear his name - the HighTech/DotCom one - during the Clinton years, but he in effect constrained Clinton to keeping the Federal budget house in order. Bush comes in, cuts taxes and blows spending into outer space, and Greenspan just seems to love it, expressing Reaganesque sentiments to the effect that the U.S. can "grow it way out of" the inevitable gargantuan budget shortfalls that result. That to me is the heart of the Greenspan conundrum.

The only answer that makes any sense to me - and I'm not saying it makes much, mind you - is that Greenspan reined Clinton's spending in in a perverse attempt to set Clinton up for an economic downturn, thus making him easy prey for a Republican neocon candidate. This backfired because Greenspan's debt-fueled economic model is fundamentally flawed - both the Clinton and Bush economic paradigms can produce short-term material prosperity, but unsustainably so in the latter case, as we are seeing all around us now.

Like I said, it sounds like way-out-of-left-field conspiracy-theory hokum - I am open to more-rational-sounding explanations of the Greenspan Riddle.

[ewmayer]

U.S. Treasury Expands Ponzi Financing Program: Meanwhile there is more evidence that the US Government’s finances are in disarray, with an exploding deficit that will require the Treasury to issue ever more debt simply to pay off maturing debt. Week in and week out Treasury borrowing is outstripping the Treasury Borrowing Advisory Committee’s previous estimates of borrowing needs by an ever increasing margin. This week the Treasury began a program this week to allow individuals to buy Treasuries in denominations as small as $1,000. If that’s not more evidence that it is conducting a Ponzi scheme, what is?


GE Blames Bear Stearns For Earnings Miss

"With that, GE admits what many of us knew already. GE, like GM is not a manufacturing company. Both are finance companies loaded to the gills in debt. The difference between the two is GM has subprime products and subprime debt while GE has arguably higher qualities of debt and products."

And what would our Fridays be like without a Moron of the Week [MOTW, pronounced "MotWee", like Elmer Fudd trying to say "motley"] Award? This week's MOTW goes to former Fed Vice Chair Alice Rivlin, who has a hugely disingenuous, self-congratulatory-in-the-way-only-a-central-banker-can-be Op-Ed in today's NY Times, in which she opines that the Fed's bailout of Bear Stearns was a good idea, and was not about "bailing out a Wall Street Financial Firm whose own greed was its undoing", but rather, "saving the whole world":

The Fed’s Money Well Spent

ONE benefit of the Federal Reserve’s rescue of Bear Stearns is that public outrage has aroused the political system to action in mitigating the foreclosure crisis.

Never mind that the supposed conflict between Wall Street and Main Street is a false one — Main Street runs on credit and cannot prosper if the financial system is in shambles and credit dries up. Never mind that the supposed Fat Cat “bailout” was a disaster for Bear Stearns stockholders, and that the idea of a “moral hazard” risk — that other investment banks will be tempted to emulate Bear Stearns — is preposterous. Never mind that if markets head back up and the collateral can be sold at a profit, taxpayers may lose nothing.

In the end, the Fed’s action was not aimed at rescuing those who made bad decisions out of greed or stupidity, but at protecting the rest of the country — and indeed the world — from the possibly devastating consequences of a financial meltdown.

Good grief, where to begin ... Let's take things point-by-specious-point:

- The allegedly "false conflict" between Wall Street and Main Street is not at all false if the chief beneficiaries of the Fed's largesse were Bear execs [who would have had to pay back their multimillion dollar bonuses if bankruptcy had not been averted] or one of Bear's chief rivals, JP Morgan.

- How many underwater homowners were helped by the Fed backstopping all of Bear's toxic debt and letting JPM skim the cream with the promise of no-risk USGov guarantee? How many overleveraged homowners have been helped by the Fed's slashing of lending rates? Hello - mortgage rates have gone *up* since then.

- Moral hazard - which Ms. Rivlin pooh-poohs without a shred of "this is *why* it's preposterous" logic to back up her claim - is at the very heart of the housing bubble and inevitable mortgage crisis. The banks and financial institutions who crafted these oh-so-clever financial instruments based on cleverly bundled and crooked-ratings-agency-blessed mortgage debt created a system where the folks peddling the mortgages had zero vested interest in seeing that they were likely to be repaid by the borrowers - instead, huge amounts of money were made by getting as many folks from main street [not immune to moral hazard themselves] to sign on the dotted line for as much house as conceivably possible, in many cases with explicit encouragement to lie about their income in order to maximize the amount of the loan. The loan issuer took their cut, then promptly resold the debt to the financial geniuses on Wall Street, who packaged it into toxic bundles of debt wrapped in the shiny gold foil of a AAA rating from S&P/Moody/Fitch, and these CDOs, SIVs, Alt-As, what-have-you's were sold all over the globe to folks looking for the mythical high-yield-with-no-risk investment vehicle. Classic moral hazard at every stage.

- More moral hazard at work: Just this week we read about Lehman Brothers packaging $3B of toxic debt into their patriotically named Freedom Fund [as in "We are so glad to be free of this junk, and we got US Treasuries at par value with our fake valuations for it! How cool is that?"] and trading it to the Fed for real assets - i.e. of the kind where the taxpayer is on the hook, with no default allowed. The real preposterous thing here is Rivlin's hollow claim of preposterousness.

- Rivlin neglects to mention that the odds of any of this steaming financial sewage ever being worth more than pennies on the dollar in an open-market sale are virtually nil, because that would require all those overpriced homes to magically reappreciate to their height-of-the-bubble values, and all those folks who lied about their incomes in order to buy way more home than even their fictional income would have justified would suddenly have to be making that much money and more. That is a delusional fantasy. Of course she wraps herself and the rest of the big-finance cabal in the flag - "we did it not for ourselves, but to save the country, nay, to save the entire world." What a load of horseshit.

[ewmayer]

Originally Posted by ewmayer

The most interesting of the Big Bear Losers [to my mind] is Bill Miller, the until-recently-considered-legendary longtime manager of the Legg Mason Value Trust mutual fund - talk about a so-called expert who appears to have no clue as to the dynamics of a true Bear Market [pun fully intended]:

Check out Legg's current top-10 holdings, ~47% of their assets:

Company                Symbol  %Assets YTD Return %
-------------------    ------  -----   ------------
AMAZON.COM INC         AMZN    6.91    -23.04
AES CORPORATION        AES     6.20    -22.02
UNITEDHEALTH GROUP     UNH     5.93    -40.91
AETNA INC. NEW         AET     5.20    -27.09
JP MORGAN CHASE CO     JPM     4.73    - 0.72
QWEST COMM INTL INC    Q       4.10    -34.48
SPRINT NXTEL CP        S       3.91    -49.07
EBAY INC               EBAY    3.46    -10.09
YAHOO INC              YHOO    3.43    +24.38
GOOGLE                 GOOG    3.18    -36.30

Now take, for example, the top holding, AMZN. It`s clear we are already in a recession, which is likely to be quite bad and - CNBC paid-pumper blather notwithstanding - will *not* be over by the 2nd half of the year. Tapped-out consumers watching their home-as-ATMs plunge in value are cutting back on spending, hard. Growth/momentum stocks like AMZN rely on expectations of huge continued future earnings growth to justify their lofty P/E ratios - yet with no realistic expectation of major earnings growth based on increased consumer spending, AMZN still has an massive P/E of 66 - 5x a normal valuation! Like I said, the kind of stock [along with eBay, Google, Yahoo, Qwest, Sprint, etc] that has never seen a true Bear Market. What is Bill Miller thinking? The only one of Miller`s current Top 10 which is in the black for the year is Yahoo, and that's not because they're making money, it`s strictly the one-time pop due to Microsoft offering to buy them because it has nothing to throw at Google in terms of "things people want to pay money for which we can't ram down their throats strictly on the leverage our market monopoly gives us".

[jasonp]

Originally Posted by ewmayer

Growth/momentum stocks like AMZN rely on expectations of huge continued future earnings growth to justify their lofty P/E ratios - yet with no realistic expectation of major earnings growth based on increased consumer spending, AMZN still has an massive P/E of 66 - 5x a normal valuation! Like I said, the kind of stock [along with eBay, Google, Yahoo, Qwest, Sprint, etc] that has never seen a true Bear Market. What is Bill Miller thinking?

An interview with Miller was reprinted in an anthology of financial articles, where he was specifically asked why a value-oriented fund would invest in a company like AOL. Miller's reply was that AOL was a very different company in 1996 when he bought, and was grossly undervalued at the time. The Washington Post has an article that basically says Miller's fund loaded up on financials because after the last wave of mergers big financial companies were selling for their cheapest prices since 1990. The fund was big enough that it could not divest itself before the dot-coms crashed. It doesn't have that problem now :)

[ewmayer]

Ah, how fleeting the laurels of easy housing-bubble-momentum-stock-picking fame: After Wachovia Bank reported unsurprisingly horrid earnings this a.m., this was seen on the associated Yahoo! Finance message board:

http://messages.finance.yahoo.com/St...Miller Buying?

wachover:
I had most of my IRA money with him for those 15 years, started in 1992 and got out June 2007. His style has changed. Before, he was early in on up and comers (a lot of internet "bets"), now he is bottom fishing for value traps. He is losing hugely, and my guess is he will end up with a trailing 15 year track record of sub 500 returns. One cannot take many 50% losers for so long. I got out when I decided to short Beazer Homes last May, and noticed LM was the largest shareholder. That was the first stock I had ever shorted, and it sure has treated me right.

[ewmayer]

NYTimes Op-Ed: Home Buyers Needed

By EDWARD E. LEAMER
Published: April 14, 2008

OUR politicians are devising economic stimulus measures to encourage consumers to spend more. These measures will cost taxpayers $200 billion or more. This is not money well spent. The problem is not too little consumer spending; the problem is too few home buyers.

Of course, way too *many* homebuyers paying far more than they could afford over the past 5 years was not a problem - only the "bust" part of the classic boom/bust cycle is a problem. The "huge speculative bubble" part, that was just fine.

Many argue that we don’t need government intervention to bring the buyers back; we just need the market to work its magic through lower prices.

Sounds good to me. You got a problem with that? of course you do, otherwise you wouldn't be writing an Op-Ed to the NYTimes.

Well, not entirely. When it comes to housing, lower prices don’t inevitably cause sales to rise. Why? Because lower housing prices create the expectation of still lower prices later, causing buyers to wait for a better deal. Left alone, a weak market therefore overshoots with prices too low and construction too little.

Leaving aside the bizarre grammar at the end of that last sentence - "overshoots with prices too low" sounds pretty good to me, since I've been waiting on the sidelines, watching in shock and awe as housing prices "overshot with prices too high" and "construction too much" for the past few years. What you describe sounds like a "healthy correction and reversion to the mean" to me.

But a hot market can also overshoot with prices too high and construction too great. The Federal Reserve should control a hot housing market by raising interest rates to limit excessive price appreciation and overbuilding. When the housing market heats up, as it did between 2002 and 2004, the last thing the Fed should offer is low interest rates. But that’s what it did — now it doesn’t matter what the rates are; not even low levels can entice buyers when house prices are declining.

Like I said, boom and bust, my friend - you're talking ancient history here - what you really mean is that the Fed "should have controlled" an overheated housing market. They didn't - quite the opposite, in fact - and the proverbial horses are long gone from the metaphorical stable. Since it's too late to prevent the speculative bubble, so why not just let it unwind itself?

The only solution is for the federal government to offer a temporary 5 percent tax rebate — up to $25,000 — for first-time home buyers.

The "only" solution? Just a bit pompous there, dontcha think, Eddie, my man? Heck, just add or subtract a few $ from your "only" solution and you get ... another alleged solution. Proof by contradiction, as the math geeks like to say. But seriously, besides wasting a whole more of the taxpayers` money, what would your oh-so-necessary scheme accomplish? In most inflated "hot" housing markets, simply waiting a few more months will bring the average house price down by at least the amount you propose as a subsidy.

This rebate is ideal because it would go to middle-class families who thought they were priced out of the market forever and young couples who will benefit from getting a home sooner rather than later. It doesn’t bail out speculators. But by creating demand for homes, this rebate cushions the fall for everyone and stimulates economic growth.

I agree that the timing of such a handout is important, but in the sense that the ideal timing is "never". There is zero harm from those folks you mention who were priced out of the market simply continuing to rent for another year or two while they wait for prices to drop back to more-affordable levels closer in line with long-term historical means. And anything which provides an artificial prop for inflated housing values - which you so kindly refer to as "cushioning the fall" - as the proposed remedy does, in addition to wasting more ten of billions of dollars in taxpayer money - is just stupid.

The really good news is that the cost for this program is minimal and would likely stimulate enough spending and growth to more than pay back the Treasury with higher revenues later.

It's *not* minimal - zero would be minimal. Multiple tens of billions? Not minimal. The part about boosting spending and growth is an assumption, and I think the degree of debt and lack of savings of the average American family speaks loudly against it. The last thing we need is more of the same thing that caused the mess - namely unsupportable spending and bogus economic "growth", both based on a gargantuan credit and asset bubble.

As this editorial by the NYT editorial board that appears on the very same page notes:

"It makes no sense to encourage buyers to jump in when further price declines are likely. Scarce resources should be put toward preventing foreclosures."

Edward E. Leamer is a professor of management, economics and statistics and the director of the Anderson Forecast at the University of California, Los Angeles.

Pssst ... Professor Leamer is probably underwater on his mortgage, as well. [Or perhaps he gets funding from the National Association of Reamtors.]