Friday, September 26, 2008

Meditations on The Bailout

The big topic of conversation around the coffeepot at work is The Bailout. Seems like everyone wants to know what I think about the Fed Gummint's proposal to spend $700 billion dollars to rescue a bunch of financial-type folks.

Before I start opining, allow me to be perfectly clear:

As far as I'm concerned "Economics" is as much a science as phrenology -- for the same reason. Where one claimed to be able to decypher the mysteries of personality by reading bumps on the head, the other claims to be able to decypher the mysteries of the economy by reading bumps in the market.

Frankly, once you get past the basic, "I have this. You want this. What will you give me in trade?" into more complicated stuff, I strongly suspect most economists are making it up as they go along.

However, since economics bores me to tears, I could be greatly mistaken.

Anyhoo, two things come to mind as I read about the Great American Bail-Out.

In my line of work (law enforcement) I have become very suspicious about deals involving money in which one party insists upon rushing the other party(ies) through the process. Folks, if there's a great deal of money on the table (and there is ... about $700 billion) and the other guy says that there either isn't enough time to read the fine print; or don't bother reading the contract because you won't understand it -- well, the odds are jolly good that somebody is probably about to get scammed.

The second thing that comes to mind is the plain and simple fact that this financial crisis -- for lack of a better word -- is the result of a whole bunch of conscious decisions made by a whole bunch of alleged adults.

Somebody had to make the conscious decision to apply for a loan that they couldn't possibly afford. Somebody had to make the conscious decision that approving that loan was a Good Idea. Somebody had to make the conscious decision that buying up a whole bunch of these bad loans Made Perfect Sense.

They were wrong. Those conscious decisions they made were bad decisions, and Bad Decision Have Consequences.

Unless, of course, the Federal Government gets involved.

So, my personal feeling about The Great Bailout is that Congress is about to go through my wallet at gunpoint (again) and give (more) of my hard-earned money to a whole bunch of alleged adults (not me) who monumentally -- and with their eyes wide open -- cocked things over.

And -- quite frankly -- I'm getting bloody tired of my tax dollars paying for screw-ups that I didn't make.

It grows ... irksome.

LawDog

21 comments:

jimbob86 said...

I just ran across this:

http://www.youtube.com/watch?v=H5tZc8oH--o

.....that sums it up pretty well.

If you have 10 minutes, give it a look.

This whole mortgage debacle has reaffirmed my belief that every time the gubmint tries to do a little social engineering, all you have to do is wait a bit, and there will be a trainwreck to see.....

phlegmfatale said...

Hear. Hear.

All's I know is when I was in real estate school about 18 months ago, they iterated the nine-ways-to-Sunday the buyer was to endorse/initial/give thumb&butt-print stamps in triplicate on all docs to verify they knowed what they was getting into so all the professionals couldn't be held accountable for duping same. All licensed real estate professionals have to buy "errors and omissions" insurance to cover them when someone decides retroactively they've been ood-scray. Now we hear that the professionals and industry insiders and experts need a bailout? Well, I think we the public should be as sympathetic with them as they have been with the lowly individual. As you have done unto the least of these, and all that crap...

Sorry. I can get a bit silly and wordy, plus it's late on a Friday and I've sniffed way too much laundry powder tonight. In two words: no bailout.

tooldieguy said...

What he said, In addition, the way I understand it, oversight of this huge pile of our dollars will be given to the very congresscritters who got the most "contributions" from the affected companies. Lets see, Company A gives congresscritter $10000, said congresscritter gives Company A $10000000 of my (and your) money. All the while trying to tell me that a member of the US congress would NEVER do anything untoward...
Riiiiight.

Tim Covington said...

I heard one of our congress-critters from Texas (can't remember his name) say that he will do his best to hold this up until all options are explored. Apparently, the Secretary of the Treasury told congress that he knew this was coming for almost a year. If this is true, why didn't he start demanding action back then.
An interesting fact, this bailout will cost every man woman and child in the USA will owe over $3000 to pay for it. That's not taking into account the devaluation the dollar will undergo because of all the additional money being printed to cover the 700 billion and interest.

Joseph said...

It was kind of obvious to me this was gonna happen...people who make 35,000 a year can't afford $300,000 house loans. Anyone who can balance a checkbook saw this coming.

But I am damn tired of the gov't selling out my future and expecting me to pay for it. It benefits a couple of thousand people (the super rich getting richer) and screws over the rest of us.

wolfwalker said...

JimBob's video tells about 2/3rds of the story. Here's the other 1/3rd:

* Those damned "mortgage backed securities" so beloved by Fannie Mae and Freddie Mac depend on the value of the mortgages backing them.

* As of right now, nobody knows the value of those mortgages! Some of them will be paid off as every mortgage should, and those are worth quite a lot. But no one knows which ones or how many. Some of them will go to default and foreclosure, in which case whoever owns them will probably take a bath because of the crash in housing values. But no one knows which ones or how many.

* Because no one knows what those mortgages are worth, no one wants to buy or sell them. In other words, there is no market for mortgage-backed securities.

* There's a provision in the Sarbanes-Oxley Act that says investors must "mark their assets to market." In other words, every year the firm has to examine its holdings and recalculate their worth based on the current market values. Since mortgage-backed securities have NO market value, they must be marked as being worth $0. So many of these investment banks are seeing large fractions of their assets disappear like snow in July. This brings them much closer to insolvency.

* Being close to insolvency makes banks more cautious about lending money. They pick their risks more carefully and demand higher rates of return -- ie, higher interest rates. At the same time, the stock market distress makes a lot of other people more cautious about investing money -- like the kinds of people who buy corporate bonds. They demand higher rates of return too. All of this can be summarized as "borrowing money just got a lot harder and more expensive," AKA a "credit crunch."

* Companies need to be able to borrow money. Even highly profitable, stable, solvent companies with clean books and clean credit records. They get that money with short-term loans, long-term loans, and corporate bond sales. If they can't borrow that money when they need it, they can't keep operating. If the credit crunch continues at its present level for very long, a large percentage of American businesses will have to scale back operations or shut down completely. And hello, New Depression.

To sum it all up: one good idea (the original Community Reinvestment Act), plus two bad ideas (the expanded CRA and Sarbanes-Oxley), plus a bunch of greedy politicians and greedy businessmen, equals a situation where some sort of large-scale rescue plan is critically necessary.

The original Paulson 'bailout' proposal was intended to assign a market value to those damned mortgage-backed securities. Once they have market value again, even if it's only a dime to a dollar, the system can start working again. The problem is that the damned Democrats who caused the whole thing with Sarbanes-Oxley and the expansion of the CRA now want to lard up the bailout plan with socialist bullshit. And that's where things stand now.

Anonymous said...

Wolfwalker, I respectfully disagree with your statement that the Community Reinvestment Act was a good idea, because as I understand it, it was that Act which pushed the banks to accept marginal mortgages in the first place. Not that greed and herd mentality didn't help, mind.
Otherwise, thanks for adding to the video. And no bailout, thanks. If absolutely necessary, let's make haste slowly.
LittleRed1

Anonymous said...

Let them go belly-up. If I have a business and it fails, no one bails ME out. What's so special about Fannie and Freddie?-never mind, we all know the answer to that.
I propose that each head of family tax payer in the US of A be given an equal share of that $700 billion. Even taxable at something like 75%, it would still get a whole bunch of people out of a bind; in fact, far more people than those involved in the current disaster.
Whatever happened to the notion that you buy it, you pay for it-period?
LawMom

John said...

LawDog, you just demonstrated the difference between economics and finance. But a short course in "The Dismal SCience" is worthwhile, because, even if the economists aren't right all the time, hey have interesting and valuable insights.

Some books you might find enlightenin:
Centuries of Economic Endevour; and The Moral Economy. both by Jack Powelson. Powelson is a libertarian quaker with endless experience in actually seeing what works and what doesn't in the area of social programs. His son-in-law Loren Cobb publishes the Quaker Economist newsletter. Powelson is Emeritus professor of Economics at CU Boulder
Economics in One Lesson, Henry Hazlitt. Short and to the point. A semester course in 200 pages.
A Short History of Financial Euphoria, John Kenneth Galbraith. You want to understand bubbles? Here's the skinny from the last true economics genius.

Love the blog and thought I could contribute a little.

wolfwalker said...

Oh, one more thing I should probably add. If I understood the original Paulson proposal correctly (just the original, not the larded-up version being pushed by the damn socialist Dems), then the ultimate cost to the taxpayer might very well be nil.

See (as I understand it), here's what Paulson proposed to do:

A "mortgage-backed security" is basically a bundle of mortgages. Suppose, just for example, you own such an item which contains five mortgages on five $200,000 houses. So your mortgage-backed security has a face value of $1,000,000. But you can't sell it for that, because nobody knows which (if any) of those five borrowers will pay off and which ones will default. In fact, right now you can't sell it for any price. Hence its market value is 0. Now, you need to borrow some cash short-term, but that (worthless) security is the only asset you've got. So Jack's Bank up the road won't lend you anything.

I come to you and say "I will buy that $1M mortgage bundle from you for ten cents on the dollar, or $100,000." You agree. Now you have assets again and you can go talk to Jack's Bank and get your loan. But what have I got?

Answer: I've got a bundle of five mortgages that's worth a total of a million dollars if all five borrowers pay in full and on time. If even one borrower pays his $200K mortgage in full and on time, I just doubled my money. The only way I can lose is if all five borrowers default, and the five properties put together don't bring at least $100K on the resale market.

The reality is much more complicated, but in essence that's what Paulson proposed the US Treasury do: buy up the toxic mortgage securities, for a market price far below the face value, and then collect on those mortgages exactly as a bank would. There are many variables and many possible outcomes numbers-wise, but in the end the Treasury stands a good chance of turning a profit on the deal. Maybe a big profit. Maybe a REALLY REALLY big profit. Meanwhile, the borrowers have to pay off or default, as borrowers should, while the banks take a big financial hit (they just sold assets for ten percent of what they paid), and so do their CEOs (whose compensation is usually tied to corporate performance). Seems like a pretty good outcome to me.

This is, however, before the damn Democrats started larding it up with all their pet projects and other damnfool socialist crap.

BCFD36 said...

I have seen at least two comments about "larded up with pet projects". Specifically, to what are you referring?

John said...

Actually, the original Paulson plan would have saddled each and every American with over $200,000 in additional national debt, AND had no oversight AT ALL. Given that lack of oversight os part of what got us into this mess, it does not strike me as a good way to go.

But feel free to blame it all on the Dems. I think there's enough to go around.

But Wolfwalker makes a VERY good point: the idea that all the BBB mortgage-backed securities are worth ZERO is simply NOT TRUE. (The problem is we don't know WHICH ONES ARE! So we can't mark them to market accurately. BUT WE NEVER COULD! The treasury Dept (Paulson) and the SEC (Cox) never set guidelines for valuation, but allowed the companies to set their own.) In general, we can assume that the AAAs will pay at 95%+ and the BBBs will pay at 50%, plus recoup an additional 50% of the value of the defaults at sale. So we can make some guesses as to the value of the mortgages and THAT's the money that Treasury should pay, if in fact they should pay anything.

Sidenote: the original CRA was not a bad idea: it allowed the bansk to make non-conforming mortagages when there was sufficient underlying income, even if there wasn't a 20% downpayment. Things didn't go funny until CRA2 and let's not even get into Sarbanes-Oxley, which most people (even on Wall St) don't understand: they just know they're against it.

John said...

Oops, sorry to take over your blog, but a couple more things:
Paulson's plan would have allowed the companies to value the mortgages themselves, AND be responsible for overseeing compliance. Hmmmm.

Change of topic: When I bought my last house, I wasrned the bank that I wanted to look over all the documents before signing. They didn't believe me when I told them I wouldn't sign until I had read and verified everything, so we spent over 4 hours in escrow, while I read and proofed the documents, went online to check interest rates and spreads, and a lot more. THe bank rep, escrow agent and 2 RE agents had to sit there while I did this. Every time the RE agents wanted me to sign and go, I reminded them that I had asked for the documents prior to closing and that this was their problem, not mine.

Yes, I can be a pain the the ass. But since I'm the one left holding the bag, thanks to those signatures, I don't mind.

Thanks again, LD

armedandsafe said...

Just think about dividing that $700,000,000,000 among the 200,000,000 adults in the United States and sending that amount to each of them. Then charge them 33.3% tax, and get one third of it back into the treasury.

I would attend that national block party. The economy would come around in a neck-snapping whip-crack and all the poiticians could take credit for it.

Just think: No more mortgages in the United States. No more credit card debt. All student loans paid off. Health care for all our parents dependant on their kids.

Best of all? a buch of leeches and bureaucrats (redundant, I know) out of work.

Not my original thought, but I like the irony of the thought.

Pops

Tbeck said...

Congress needs to STFU and get out of Secretary Paulson's way. Wolfwalker summed up the situation nicely.

These securities would be purchased at a reverse auction. The banks willing to take the biggest haircut would get to sell theirs first. I'm betting that Treasury would be able to buy these things for $0.20 on the dollar. That's $3.5 TRILLION worth of assets for that $700 billion.

Now sure, not all of these mortgages are going to pay. Right now 93% of mortgages in this country are paying on time. Even if 50% of these mortgages default, Treasury still has $1.75 trillion in assets that they paid $700 billion for.

Treasury doesn't have to abide by the mark-to-market rules that the Feds saddled the rest of us with. They can and will hold these things until the market receovers and they can sell them at a profit. My biggest concern is what those 535 fiscal crackheads are going to do with over a trillion dollars in windfall profits.

Here's an anecdote that I think sums it up. Secretary Paulson approached Congress with a 3-page prospectus outlining his plan. Congress came back with an 80-page response.

This is not a bailout. These banks will be receiving less than one-fifth of what they paid for these assets. But they get them off of their balance sheets and get some much needed liquidity. Treasury laughs all the way to the Fed. Just keep Congress out of the way!

wolfwalker said...

bcfd36 asked: I have seen at least two comments about "larded up with pet projects". Specifically, to what are you referring?

This article at the Politico does a good job of covering the items I've heard about. I have no doubt there are other, even worse provisions that I haven't heard about yet.

John and LittleRed1: IMHO the original CRA was a good idea that proved troublesome in practice. A good idea because something did need to be done to fight redlining; troublesome in practice because the specific language of the law forced banks to make some excessively risky loans in order to comply.

armedandsafe: I think you might want to do that math. $700B divided by 200M adult Americans works out to only $3,500 apiece. You won't be paying off many mortgages with that.

Peter said...

Can I copy all your comments and send them to all the asshat people I work with? I have been trying to explain this situation to them and you all put it in words even my idiot coworkers can understand

wolfwalker said...

One more thought, directed to those who still believe we can get through this without some kind of government action: some very senior people in the government seem to disagree. Of course, unsourced and anonymous comments are often exaggerations, but it's hard to see what the individuals quoted could gain by lying or exaggerating. Even if you assume things are only half as bad as the article suggests, that's still pretty damn bad.

Jean Poole said...

The problem with the doom-sayers, in my mind, is that they are mistaking an economic shift for a collapse

US producing and manufacturing is Up. Export are hopping crazy! Just 3 years ago if a shipper called up on a Monday asking for a container to load on Wendnesday and sail in Friday of the same week - 95% of the time I could make that happen - because exports were in the tank and ship lines were selling container slots pretty much "at cost" - just to repo the containers to China so they cound turn around back to the US with more wal-crap. Because the linees actually were loading empty container on transpac routes to get cans to Shenzhen or whereever.

Today a shipper calls up and wants to export that same container - he is going to have to wait 2-4 weeks to get vessel space - because ships are actually overbookedwith exports from the US on all trade lanes.

We are seeing exports higher than they have been since most of us started in the business. Export Freight rates are up and going higher ~ the Econ 101 concept of Supply&Demand.

Trouble is that must of the high-rollers were from the import & service-sector side of the coin and those guys are taking a hit; rather like that hit that the export side manufacturers and producers have been taking for the last 20+years.

It all cycles around, and folks just have to learn to roll with it, not get 100% invested in one sector or the other and just buck up and deal.

Sean said...

Can I hear an "Amen" from the congregation?

I said, CAN I HEAR AN "AMEN" FROM THE CONGREGATION??

Amen, brother! AMEN!

BlogDog said...

There is one way I'll get behind this abortion of a legislative action: If the Community Reinvestment Act is repealed. Killed. Stake driven through its heart. Then we can talk.