Global Financial Crisis (Was: Subprime Meltdown)

[cheesehead]

Originally Posted by ewmayer

Cheesehead, how do you compare the Forbes take on the senate version of the bailout with the alternative proposal of the Bloomberg analyst I link to in post #583?

Look at the very first sentence of the Bloomberg piece in your own quote:

"The fatal flaw in Treasury Secretary Hank Paulson's $700 billion bailout plan was that it wouldn't fix the problem: Too many important financial institutions don't have enough capital."

Looks like the same mistake you make: referring to the current rescue bill as though it were intended to be the solution to the entire problem, rather than acknowledging that it's only a first step to address the most time-critical part.

"And for a $700 billion investment, U.S. taxpayers should get a lot more in return than a gargantuan pile of toxic waste."

But the writer, like you, writes as though unaware that the "pile" will be acquired only at the fair market value of that "waste". And it's not really toxic waste, so don't press the analogy by arguing that the securities will actually share the properties of real-world toxic waste that are irrelevant to the securities.

"Instead of asking Congress to let Treasury recapitalize needy banks, he proposed buying some of their troubled assets at above-market prices."

As I already explained, there is no reason for the purchases to be made at above-market prices.

[ewmayer]

The Telegraph | AIG and the French Connection: Ambrose Evans-Pritchard says it is ironic that European banks have turned out to be deeper in debt than their US counterparts.

It took a weekend to shatter the complacency of German finance minister Peer Steinbrück. Last Thursday he told us that the financial crisis was an "American problem", the fruit of Anglo-Saxon greed and inept regulation that would cost the United States its "superpower status". Pleas from US Treasury Secretary Hank Paulson for a joint US-European rescue plan to halt the downward spiral were rebuffed as unnecessary.

By Monday, Mr Steinbrück was having to orchestrate Germany's biggest bank bail-out, putting together a €35 billion loan package to save Hypo Real Estate. By then Europe was "staring into the abyss," he admitted. Belgium faced worse. It had to nationalise Fortis (with Dutch help), a 300-year-old bastion of Flemish finance, followed a day later by a bail-out for Dexia (with French help).

Within hours they were all trumped by Dublin. The Irish government issued a blanket guarantee of the deposits and debts of its six largest lenders in the most radical bank bail-out since the Scandinavian rescues in the early 1990s. Then France upped the ante with a €300 billion pan-European lifeboat for the banks. The drama has exposed Europe's dark secret for all to see. EU banks took on even more debt leverage than their US counterparts, despite the tirades against ''le capitalisme sauvage'' of the Anglo-Saxons.

We now know that it was French finance minister Christine Lagarde who begged Mr Paulson to save the US insurer AIG last week. AIG had written $300 billion in credit protection for European banks, admitting that it was for "regulatory capital relief rather than risk mitigation". In other words, it was underpinning a disguised extension of credit leverage. Its collapse would have set off a lending crunch across Europe as banking capital sank below water level.

It turns out that European regulators have allowed even greater use of "off-books" chicanery than the Americans. Mr Paulson may have saved Europe.

[only_human]

Originally Posted by cheesehead

But the writer, like you, writes as though unaware that the "pile" will be acquired only at the fair market value of that "waste". And it's not really toxic waste, so don't press the analogy by arguing that the securities will actually share the properties of real-world toxic waste that are irrelevant to the securities.

"Instead of asking Congress to let Treasury recapitalize needy banks, he proposed buying some of their troubled assets at above-market prices."

As I already explained, there is no reason for the purchases to be made at above-market prices.

Treasury Secretary Paulson stated before the Senate that he intends to buy securities at above fire-sale rates. He intends to use the purchases to assist conflated liquidity and solvency problems.

The Congressional Budget Office Director Orszag states that that will be an inefficient means of helping insolvency.

Secretary Paulson expects the price he pays will set a market price that will be above the fire sale price. He states that the amount over the fire sale price to pay is one of the determinations that will be made. I'm not sure how much recent changes to the bill have affected Paulson's intent to proceed in this manner.

That is a gloss of my interpretation of watching Paulson, Bernanke, and Orszag (on C-Span) speak before the Senate and also my reading of the director's blog at the Congretional Budget Office. I will, if need be, hunt down the relevant information.
http://cboblog.cbo.gov/

Cost of Division A

Under the TARP, the Secretary would have the authority—if deemed necessary to promote stability in the financial markets—to purchase any financial asset at any price and to sell that asset for any price at any future date. That lack of specificity regarding how the authority would be implemented and even what types of assets would be purchased makes it impossible at this point to provide a meaningful estimate of the ultimate impact on the federal budget from enacting this legislation. Although it is not currently possible to quantify the net budget impact given the lack of details about how the program would be implemented, CBO has concluded that enacting Division A would likely entail some net budget cost—which would, however, be substantially smaller than $700 billion. The net budget cost would reflect several factors:

Net gains or losses on the TARP transactions. As noted in CBO’s recent testimony before the House Budget Committee, the net gain or loss on the TARP transactions would reflect the degree to which the federal government sought to obtain, and succeeded in receiving, a fair market price for the assets it purchased, and the degree to which, because of severe market turmoil, market prices would be lower than the underlying value of the assets.

Although some classes of assets and purchase mechanisms are conducive to determining a fair market price, it is unlikely that the program would be limited exclusively to those classes of assets and purchase mechanisms. The program would probably include assets that have the worst credit risks and hence are difficult to price, making it likely that the government would, in some cases, pay prices that fail to cover those risks. Although it is possible that future increases in asset values would generate gains even on assets for which the government initially overpays, an overall net loss is more likely if the government initially overpays.

The bill includes a provision intended to protect against such future net losses by requiring that firms selling troubled assets to the government also provide warrants or senior debt instruments. CBO anticipates that this provision would not have a substantial effect on the net cost of the TARP, however. On the one hand, warrants or senior debt instruments might reduce the incentive for sellers to overcharge for low-quality assets. On the other hand, since the warrants or debt instruments would have value, Treasury would generally face higher prices because sellers would seek compensation for both the value of the troubled asset and the value of the warrant or debt instrument. In addition, the warrants or senior debt instruments may be difficult for the government to value, complicating even those auctions in which the government is otherwise most likely to obtain a fair market price.

In any case, the ultimate cost to the government on the transactions would not be the total amount spent to purchase assets—limited to $700 billion outstanding at any one time—but rather the difference between the amount spent by the government and the amount received in earnings and sales proceeds when all of the assets are finally sold, presumably some years from now. That net cost is likely to be substantially less than $700 billion but is more likely than not to be greater than zero.

Recoupment mechanism. The recoupment mechanism is designed to offset any net losses the government experiences on the TARP transactions. The mechanism, however, requires only that the President submit a proposal to offset such costs after five years. Even if it would be fully effective in offsetting any net losses, the President’s proposal would require a future act of Congress to be implemented. Any savings from such legislation would be estimated when the proposal is considered and would be credited to that legislation for Congressional scorekeeping purposes.

[cheesehead]

Originally Posted by only_human

Treasury Secretary Paulson stated before the Senate that he intends to buy securities at above fire-sale rates.

. . .

I'm not sure how much recent changes to the bill have affected Paulson's intent to proceed in this manner.

My understanding is that that is partly addressed in the auction mechanism.

Of course, firms have colluded throughout history. I don't know how easy it would be to hide or prevent that in the proposed auction.

From the Forbes article:

What About Oversight?

The Treasury secretary would periodically submit to Congress a detailed report of the bailout's progress, including all financial transactions and the "types of parties involved." In addition, every quarter, a special inspector general would provide Congress with a report including all purchases made and income received from the bailout.

So every transaction will be reported, and thus subject to investigative scrutiny.

Of course, that wouldn't necessarily deter Paulson during all of the four months he has left, but Bush probably doesn't want his administration to end with too big a scandal.

That is a gloss of my interpretation of watching Paulson, Bernanke, and Orszag (on C-Span) speak before the Senate and also my reading of the director's blog at the Congretional Budget Office.

How long ago were those? Did they precede the current bill the Senate passed?

[only_human]

Originally Posted by cheesehead

My understanding is that that is partly addressed in the auction mechanism.

So every transaction will be reported, and thus subject to investigative scrutiny.

Of course, that wouldn't necessarily deter Paulson during all of the four months he has left, but Bush probably doesn't want his administration to end with too big a scandal.

How long ago were those? Did they precede the current bill the Senate passed?

Yes, they preceded the current bill. Both this and a subsequent House session that I also watched (although not as closely) preceded the original House vote. I believe I was watching this:

U.S. Credit Markets and Federal Rescue Plan

Product ID: 281281-1
Format: Senate Committee
Banking, Housing and Urban Affairs
Last Airing: 09/24/2008
Event Date: 09/23/2008
Length: 4 hours, 52 minutes
Location: Washington, District of Columbia
C-Span Video Library (This link points to a purchase, not viewing page) U.S. Credit Markets and Federal Rescue Plan

Additional impressions are that Paulson came across a bit squirmy and evasive, Bernake was terse and only slightly evasive, and Orszag was clear, helpful, non-evasive and deliberately non judgmental.

Basically Paulson explained reverse auctions, how the functioned, etc., but stated that as lower and lower prices were offered, he wouldn't necessary wait for lowest prices to be offered but would buy at a higher price. He intended to use market experts to evaluate tranches of MBS and other paper for purchases organized by CUSIP numbers and attempt to establish a prices that he felt were
--- (my interpretation and paraphrase here) --
a compromise between the best price he could get and the full possible value to full term etc. Not all securities were amenable to reverse auction purchases but in all his purpose was to use experts to decide on pricing and use the purchases to establish market prices above fire sale pricing. This way he would be attempting to get a fair (but not best) price and also driving money into the market to help solvency.

CBO Director Orszag drew a clear distinction between illiquidity and insolvency. He stated that buying toxic paper might help with illiquidity but paying extra for it would be an inefficient method of helping insolvency.

If you look back in my previous messages in this thread you will see some carping about overpaying for securities about the time that this played. I wish I had expanded in more detail then because it is harder for me to reconstruct now. I have also looked at the Senate site and Library of Congress but have not mastered them. Here is a page on that day (I am unfamiliar with this and can't seem to find what I need) from the Congressional Record: http://frwebgate.access.gpo.gov/cgi-...6&position=all

This link points to partial clips from recent C-Span programs (Page 15 of currently for what I watched). http://www.c-span.org/Recent/Default.aspx

These following video clips are from the program I watched and are available for free viewing but I don't see any that help me at this time:

Senate Banking Cmte. on Federal Intervention of Financial Markets. Tuesday, September 23, 2008 : Washington, DC
Senate Banking Committee Chairman Dodd (D-CT) meets committee members in Washington.

Sen. Chris Dodd (D-CT) blamed the turmoil in the financial markets on "private greed and public regulatory neglect," the AP reported. Members of the Senate Banking Cmte. asked about the details of the Bush admin.'s $700 billion intervention in the financial markets. Witnesses include Sec. of Treasury Henry Paulson; Ben Bernanke, Chair of the Federal Reserve System; and others.
| Treasury Sec. Paulson
rtsp://video1.c-span.org/project/eco...308_paulson.rm

| Fed Chair Bernanke
rtsp://video1.c-span.org/project/eco...08_bernanke.rm

| SEC Chair Cox
rtsp://video1.c-span.org/project/eco...n092308_cox.rm

| OFHEO Dir. Lockhart
rtsp://video1.c-span.org/project/eco...08_lockhart.rm

rtsp://video1.c-span.org/project/eco...308_banking.rm

| Sens. Dodd & Shelby News Conference
rtsp://video1.c-span.org/project/eco...092308_dodd.rm

[xilman]

Following the problems with Lehmann Bros and in the sub-prime lending market in America and the run on Northern Rock, HBOS and Bradford & Bingley in the UK, uncertainty has now hit Japan.

In the last 7 days Origami Bank has folded, Sumo Bank has gone belly up and Bonsai Bank announced plans to cut some of its branches.

Yesterday, it was announced that Karaoke Bank is up for sale and will likely go for a song, while today shares in Kamikaze Bank were suspended after they nose-dived.

While Samurai Bank is soldiering on following sharp cutbacks, Ninja Bank is reported to have taken a hit, but they remain in the black. Furthermore, 500 staff at Karate Bank got the chop and analysts report that there is something fishy going on at Sushi Bank where it is feared that staff may get a raw deal.

(Not my own work, I'm sorry to say, but something seen on the cam.misc newsgroup)

Paul

[ewmayer]

LOL, thanks Paul, I think we all needed that.

Now for the less-funny news...

-----------------------------

Bank Rescue Nearing Passage After Lawmakers Switch Position on Legislation; The U.S. House of Representatives cleared the way to complete action on a Senate-passed $700 billion financial-market rescue package that was refashioned to entice enough votes for passage.


U.S. Payrolls Plunge in Sign Economy May Enter Worst Recession Since 1982: U.S. payrolls plunged in September, signaling the economy may be heading for its worst recession in at least a quarter century as the 13-month-old credit crisis on Wall Street finally hits home on Main Street.


California asks Fed for $7B loan: In a letter to the Treasury secretary, Gov. Schwarzenegger said the state may need an emergency loan for day-to-day operations.


Credit Crisis Spreads a Pall Over Silicon Valley: High-tech entrepreneurs, investors and executives now believe the question is when, not if, the financial chaos will hurt the country’s cradle of innovation.


Nouriel Roubini's Take on the Bailout Proposal

Nouriel Roubini's Take on the Bailout Proposal

The claim by the Fed and Treasury that spending $700 billion of public money is the best way to recapitalize banks has absolutely no factual basis or justification. This way of recapitalizing financial institutions is a total rip-off that will mostly benefit – at the huge expense of the U.S. taxpayer - the common and preferred shareholders and even unsecured creditors of the banks.

The US and global financial crisis is becoming much more severe in spite of the Treasury rescue plan. The risk of a total systemic meltdown is now as high as ever,

Roubini, who has pretty much been spot-on on the whole sequence of unfolding housing and credit-market events to date, has a very worrying prediction for what`s next:

Roubini Sees 'Silent' Run on Banks, Urges `Triage': Bloomberg Radio Interview

The next step of this panic could become the mother of all bank runs: a run on the 1 trillion dollar plus of the cross border short-term interbank liabilities of the U.S. banking and financial system as foreign banks start to worry about the safety of their liquid exposures to U.S. financial institutions. Such a silent cross border bank run has already started as foreign banks are worried about the solvency of U.S. banks and are starting to reduce their exposure

And Roubini`s Global EconoMonitor site also has an interesting article contrasting two different kinds of "Resolution Corporations":

The RTC or the RFC? Taxpayers as Involuntary Equity Investors

Alex Pollock and John H. Makin argue that the Reconstruction Finance Corporation set up in response to the Great Depression would have been a better model for the bailout than the RTC. In the RFC model, the public would make equity investments rather than just provide subsidies to banks.

The "CRA Caused the Subprime Mess" Lie

The pro-deregulation crowd [mainly the Republicans and their shills like former House Speaker "She Turned Me Into a Newt" Gingrich] have been peddling this claim that the *real* blame for the subprime debacle lies with - not George Bush and Alan Greenspan and the reckless borrowing habits of American consumers! - but rather with Bill Clinton, by way of the Community Reinvestment Act (CRA) which Clinton promoted and signed into law. This is pure, unadulterated fiction, and The Big Picture's Barry Ritholz does a great job demolishing it in one of his recent posts:

Misunderstanding Credit and Housing Crises: Blaming the CRA, GSEs

"It's telling that, amid all the recent recriminations, even lenders have not fingered CRA. That's because CRA didn't bring about the reckless lending at the heart of the crisis. Just as sub-prime lending was exploding, CRA was losing force and relevance. And the worst offenders, the independent mortgage companies, were never subject to CRA -- or any federal regulator. Law didn't make them lend. The profit motive did."

My Comment: This is not to say that Clinton and the Democrats are blameless in this mess- far from it. But let`s put the blame where it really lies, for instance the Greenspanian rock-bottom-interest-rates-forever policies which were already in full swing on Clinton`s watch [and which helped fuel the Dotcom bubble], and the 1999 Gramm-Leach-Bliley Financial Services Modernization Act.

And whatever evils may have occurred under Clinton, keep in mind that that administration did not leave the country with a Trillion-dollar [and growing as we speak] annual account deficit, nor with a "hollow economy" in which very few people are engaged in the actual production and providing of value-add goods and services. Bush and Greenspan turned us into a nation of speculators and house-flippers, in which the vast majority of the populace now subscribes to the destructive notion that they are entitled to "the good life" without actually earning it, and that credit [i.e. borrowed money] rather than actual *capital* [= earned money] is "the lifeblood of the economy".

[Fusion_power]

I'm laughing at citi vs wells fargo arguing over who gets to marry wachovia. What do you care to bet that citi now tries to beat the wells fargo bid?

The squabbling is worse than buzzards fighting over a dead rhino.

DarJones

[cheesehead]

The current NPR "This American Life" episode is ...

Originally Posted by http://www.npr.org/templates/story/story.php?storyId=95395712

"Another Frightening Show About the Economy," a one-hour special report for This American Life. In the show, Alex Blumberg and NPR's Adam Davidson — the two reporters behind the popular "Giant Pool Of Money" explanation of the mortgage meltdown — explain what happened in the last week, including what regulators could've done to prevent this financial crisis from happening in the first place.

"Giant Pool of Money" was the first explanation of the origins of the mortgage meltdown that I understood.

Their new show is explaining why the commercial paper market froze, what credit default swaps have to do with that, how troubles in the mortgage market spread to companies to other companies that have nothing to do with mortgages, and what proper government regulation could have done to avoid the problem. Now (as I'm listening to the broadcast) they're starting to talk to people who urged such regulation years ago, and what happened ...

(Summary so far: Credit default swaps (CDS) were a type of "insurance" that was _highly_ leveraged. Lehman Brothers, which owned CDSes, went bankrupt because their CDSes went bad. That meant that the Reserve Fund money market fund that had invested in commercial paper from Lehman Brothers wasn't going to be paid back, so its mutual fund shares "broke the buck". That scared all other money market funds who routinely invested in commercial paper, so that froze the commercial paper market. ...)

Now they're talking to economists about the Paulson plan and proposed alternative stock injection plan ...

[ewmayer]

Europe Tested by Financial Crisis: European nations scrambled further Monday to prevent a growing credit crisis from bringing down major banks and alarming savers as Sweden followed Germany, Austria and Denmark in offering new protections for bank deposits.


Financial Crisis overwhelms German Government: For weeks the chancellor and her finance minister understated the magnitude of the crisis. At least until the weekend, when the rescue of mortgage lender Hypo Real Estate once again stood on the brink. Now the government is hectically trying to become master of the situation, but Chancellor Merkel is making promises she will find difficult to keep.

My Comment: Above is my translation of a Welt Online headline. The automated translation I got from Freetranslation.com was worth roughly what I paid for it - here it is, for your bemusement:

The Federal Government overcharges the finance crisis
of Jan Dams and Jörg own village
6th of October 2008, 18:00 clock

For weeks the chancellor and its Treasury Minister had small spoken the crisis. To the weekend when the rescue of the Hypo hung actually Estate again in the balance. Now the country tries hectically to become gentleman of the situation. To be sure the chancellor delivers promises full-bodied, that she only heavily can hold.

Overnight Commercial Paper Rates Advance as Bank Bailouts Spread Globally: Corporate short-term borrowing rates soared as bank bailouts spread through Europe and the Federal Reserve committed to doubling its auctions of cash to banks to as much as $900 billion to unfreeze short-term lending.


Emerging Markets: Things getting really ugly on that front:

Brazil's Bovespa Plunges 15 Percent, Trading Halted; Vale, Petrobras Sink: Brazilian stocks headed for their biggest drop in a decade as commodity producers plunged on concern the economic slowdown and global credit crisis are worsening.
My Comment: The 1-year chart for EWZ pretty much tells the story.


Mexico's Peso Plummets to Record Low as Investors Fall Into `Fear Mode': Mexico's peso plunged to a record low as the global financial crisis deepened, prompting investors to pull money out of higher-yielding, emerging-market assets.


Emerging Market Stocks Head for Worst Decline Since 1997 as Russia Slumps: Emerging market stocks fell the most in at least two decades and exchanges in Brazil and Russia were forced to halt trading as the global banking crisis escalated in Europe and oil fell below $90 a barrel.


U.S. News:

Full of Doubts, U.S. Shoppers Cut Spending: Consumers are pulling back on their spending, all but guaranteeing that the economic situation will get worse.


FHA Takes on Subprime Mortgages, Alt-A Home Loans From Battered U.S. Bank: [i]The Federal Housing Administration has grown so large that by the end of the year it will guarantee mortgages for three in 10 U.S. borrowers, many of whom have bad credit or loans that required no verification of income.[/i[

Like J.P. Morgan, Warren E. Buffett Braves a Crisis: J. Pierpont Morgan’s role in the Panic of 1907 has its echo in Warren E. Buffett’s actions during the current financial troubles.


SEC’s ’04 Rule Let Banks Pile Up New Debt

On that bright spring afternoon [of 28 April 2004], the five members of the Securities and Exchange Commission met in a basement hearing room to consider an urgent plea by the big investment banks.

They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.

The five investment banks led the charge, including Goldman Sachs, which was headed by Henry M. Paulson Jr. Two years later, he left to become Treasury secretary.

Pressured to Take More Risk, Fannie Reached Tipping Point

When the mortgage giant Fannie Mae recruited Daniel H. Mudd, he told a friend he wanted to work for an altruistic business. Already a decorated marine and a successful executive, he wanted to be a role model to his four children — just as his father, the television journalist Roger Mudd, had been to him.

Fannie, a government-sponsored company, had long helped Americans get cheaper home loans by serving as a powerful middleman, buying mortgages from lenders and banks and then holding or reselling them to Wall Street investors. This allowed banks to make even more loans — expanding the pool of homeowners and permitting Fannie to ring up handsome profits along the way.

But by the time Mr. Mudd became Fannie’s chief executive in 2004, his company was under siege. Competitors were snatching lucrative parts of its business. Congress was demanding that Mr. Mudd help steer more loans to low-income borrowers. Lenders were threatening to sell directly to Wall Street unless Fannie bought a bigger chunk of their riskiest loans.

So Mr. Mudd made a fateful choice. Disregarding warnings from his managers that lenders were making too many loans that would never be repaid, he steered Fannie into more treacherous corners of the mortgage market, according to executives.

For a time, that decision proved profitable. In the end, it nearly destroyed the company and threatened to drag down the housing market and the economy.

[R.D. Silverman]

Originally Posted by ewmayer

[from bringing down major banks and alarming savers

Alarming savers......

Where is the bailout for those whose retirement savings/IRAs are being
ruined by the wall street incompetents???? Can we mount a class-action
lawsuit???