Sunday, September 21, 2008

It's Worse Than That

As bad as the publically stated objectives for Paulson's plan may be, they are a misrepresentation to cover up the even more egregious truth of what Paulson actually intends. And the Democratic leadership is 100% in the know about what Paulson intends. Read this excerpt from naked capitalism's post Why You Should Hate the Treasury Bailout Proposal:

It would be best if this provision were expunged, but failing that, the Treasury should articulate what scenario it is worried about and any shield against legal intervention should be made as narrow as possible.

Now to the substance. The Treasury has been using the formula that it will buy assets at "fair market prices". As we have noted, there is simply huge amounts of cash ready to bottom fish in housing-related assets (we saw an estimate of $400 billion a couple of months ago). The issue is not lack of willing buyers; it's that the prospective sellers are not willing to accept prices that reflect the weak and deteriorating prospects for housing. Meredith Whitney, the Oppenheimer bank analyst who has made the most accurate earnings and writedown calls of her peer group, has noted how the housing market price decline assumptions used by major banks fall short of where the market is likely to bottom, given traditional price to income ratios and expectations reflected in housing futures prices.

In addition to the factors that Whitney (and others) have cited, the duration of the 1988-1992 US housing bear market and major financial crises suggests that that a peak-to-trough decline of 35-40% is realistic (obviously, this average masks substantial variation across markets and housing types). We are thus only a bit more than halfway through, as measured by the fall in prices.

Yet as we discussed, the plan makes no sense unless the Orwellian "fair market prices" means "above market prices." The point is not to free up illiquid assets. Illiquid assets (private equity, even the now derided CDOs were never intended to be traded, but pose no problem if they do not need to be marked at a large loss and/or the institution is not at risk of a run). Confirmation of our view came from a reader by e-mail:

I worked at [Wall Street firm you've heard of], but now I handle financial services for [a Congressman], and I was on the conference call that Paulson, Bernanke and the House Democratic Leadership held for all the members yesterday afternoon. It's supposed to be members only, but there's no way to enforce that if it's a conference call, and you may have already heard from other staff who were listening in.

Anyway, I wanted to let you know that, behind closed doors, Paulson describes the plan differently. He explicitly says that it will buy assets at above market prices (although he still claims that they are undervalued) because the holders won't sell at market prices. Anna Eshoo pressed him on how the government can compel the holders to sell, and he basically dodged the question. I think that's because he didn't want to admit that the government would just keep offering more and more.

I don't think that our leadership has been very good during this negotiation (or really, during any showdowns with this administration) at forcing the administration to own their position. If Paulson wants this plan, then he needs to sell it to the public, and if he sells a different plan to the public (the nonsense buying-at-market-price plan) then we should pass that. I'd rather see the government act as a market maker for the assets to get them transferred over to private equity firms and sovereign wealth funds and other willing holders. And if we need to recapitalize these companies, it seems like the cheapest way for the taxpayer is to go in and buy up the distressed debt and then convert that to equity.

So unlike the Resolution Trust Corporation, which took on dodgy assets which had fallen into the FDIC's lap due to the failure of thrifts, and the Home Owners' Loan Corporation, which was established in 1934 after the housing market had bottomed, this program is going to swing into action with the clear but not honestly disclosed intent of buying assets at above market prices when future markets and the analysts with the best track records on forecasting this decline (you can add Robert Shiller, CR at Calculated Risk, and Nouriel Roubini to the list) believe it has considerably further to fall.

As we said earlier, this is a covert, not particularly well designed, inefficient, and unduly costly recapitalization of the banking system. Why?

Losses on the paper acquired are guaranteed. This is not a bug but a feature. The whole point of this exercise is an equity infusion to banks. The failure to be honest about it upfront will lead to a taxpayer backlash (or will lead to the production of phony financial statements for the rescue entity, which will lead to revolt by our friendly foreign funding sources).

Taxpayers have no upside participation.

There is no regulatory reform as part of the package. This would seem to be a minimum requirement for a donation of this magnitude.

There is no admission that deleveraging is inevitable. This plan seems to be a desperate effort to keep bad debt from being written down. Yet the sorry fact is that a lot of these assets simply will not be repaid. There appears to be no intention to do triage. The financial services industry, on the back of an explosive growth in debt, has reached an unsustainable size. The industry will have to shrink. Yet the Administration does not address this issue; indeed, it appears it intends to forestall the inevitable. Regulators need to decide who will make it, who won't, and figure out what to do with damaged institutions. Instead, the reaction is ad hoc. The stunner was the contemplation of a possible merger between Morgan Stanley and Wachovia. As far as I can tell, the only thing the two firms had in common was coming into crisis on roughly the same timetable. For all I know, their IT systems are not compatible (many an otherwise promising bank merger has been scuttled over IT integration issues).

This really is little more than a scam to make the taxpayers provide the money to cover the losses for all the bad debt issued by the financial industry. What the Democrats have to do is refuse to get on board and put forward their own legislation that actually addresses the problem, send that to Bush and dare the bastard to veto it. Hang this around Bush's neck and stop letting the High Broderists shame the Dems into backing down. Barney Frank and Hillary are showing them how it's done.

Yes, Harry & Nancy, it IS class warfare, there is no "bipartisan" option, and you have a world historic moment in which to redefine both your party and your nation for the better.

Do you stand with Hoover or with FDR?



Anonymous said...

Barney Frank wants the GAO to dog-watch the knee jerked Bush's from handing money over to their friends without changing the fundamentals.

It's important to let money get to the market but not the whole $700 billion. Let the next president be in charge of the bulk of the money. If it happens to be Obama, we might have a chance that he'll do it right (not more than 50%). If it's McCain, then nothing really changes and we are as hopeless as we can get.

Unknown said...

I was talking to a friend, a retired professor from a community college, about the bailout. He said that Paulsen's solution will only make the problem worse because it's not a Wall Street problem as much as a consumer problem. He said that the consumers are broke, and saving the the financial institutions with taxpayer money is taking from the poor to give to the rich.

He was not familiar with Hillary's solution, but it seems to me, he was echoing Hillary, that unless the government helps those who are being foreclosed, the problem is not going away.

jangles said...

When you look at the people surrounding Obama, I have little hope that our 700 B would be appropriately spent. I think McCain did have some credibility in the set up for the Resolution Trust Corp in the S&L debacle. But truly the oversight and conditions of this kind of massive program has to have some serious thought to it. I would sure like to have HRC be designated by the Senate leadership to head up a special committee to design this bailout, set up the oversite parameters of it and hold regular hearings to evaluate its progress. Usually, congress just seems to make things worse. It would be a giant break through if this became the opportunity and the reality of real change. On the blogs one picks up a lot of noise from conservative Republicans who find this proposal just unreal---as a complete sell out to nationalizing our economy. I'm not sure Bush may have the Republican votes he needs. This whole thing is surreal. This must be what it was like in 1929 except now the government is trying to stop a cataclysmic event and then they were just watching it happen. I'm not sure I truly understand all of this---the economics and manipulations are dense---but it seems like what the Paulson wants to do is create and structure the bottom of this market, no matter what.

Anne said...

Yes, Harry & Nancy, it IS class warfare, there is no "bipartisan" option, and you have a world historic moment in which to redefine both your party and your nation for the better. Do you stand with Hoover or with FDR?

Looking at their actions of the last two years, I think they stand with both Hoovers. Herbert and J. Edgar.

Schools who fail, don't get money. Small business who fail , don't get money.
But banks who built epic failure into a bubble, THEY get money....and boat loads of it

This mess wasn't created by simply giving house loans to those who could not afford one. This melt down was also created by the banks bundling bunches of theses lousy loans together and then selling them as investments! Like they were stock in something that actually existed! If only it was simply sub prime loans to the public .

But it's a scam, pure and simple....and they aren't done yet. They will be back for another hand out ,using the endless war funding scams that have worked so well for Bush.

If congress does not demand over site and just hands over the money, put a fork in us, we are done.

alibe said...

One does get the feeling that Hank Paulson, formerly of Goldman Sachs, is merely looking out for his former company and probably his own investments. This bailout makes no sense. The term money down a rat hole comes to mind. It seems counterintuitive to throw $700 Billion at a problem without oversight, when the cause of the problem was no oversight.
It would be better to bail out the homeowners with subsidized loans, than bail out the banks who made them. We will end up with people with no homes, the price of homes collapsed and banks just putting that money in their black hole with golden parachutes galore and the ones in the know leaving with sacks full of taxpayers' money.

Chinaberry Turtle said...

After reading all your blog posts, and a lot of the links you suggest, I feel like I am really on top of this issue. And the more I understand the more I realize how kinda monumental this is, which has made me reflect even more on Hillary vs. Obama.

Anyone who's watched any of my comments in the past knows that I love Hillary, hate Obama, for two primary reasons: sexism and classism. Although people always harped on Obama for the experience issue, I didn't really care so much except as a bullet point under the larger sexism category (i.e. "if Hillary were inexperienced like him she'd be excoriated"). But I didn't care about the inexperience issue in and of itself.

But now, good god - I take it all back. This one crisis, this one crisis that could, in all reality, mean that I am without a job in a couple years, demands an experienced hard-nosed wonk at the helm. So, to all those commenters for whom experience was a prime motivation in your support for Hillary, my hat's off to you.

Chinaberry Turtle said...

You know, the more I think about this the more it seems like the right solution is to offer no support whatsoever to the market. I know that some liberals argue that some kind of market bail-out is in order because a market meltdown will also hurt lower income people who need credit.

I'm starting to think that's bunk. Poor people have lived through worse shit than this. True, a market meltdown will hit the poor hard, but they'll survive and it probably won't be the worst experience in their lives.

The people who WON'T survive, the people who will be utterly DESTROYED in the conflagration if the market is allowed to implode, are all the fat-cat jerks who got us into this mess in the first place.

So I say let this whole thing burn down to the ground. Let it burn baby burn. Because, at the end of the day, the constituency I most care about will come through the apocalypse. The people who will end up in the coffins are exactly the fat-cats desperately clamoring for a no-strings bail-out right now. Let those assholes rot in hell for all I care.

Funny thing about hurricanes. In the aftermath of a real doozy, when everything is blown away, you can't tell rich from poor. Everybody stinks from not showering and everybody's toilet is backed up. Maybe a financial hurricane could bring a little parity to this country.