September 12, 2009

Once Again, Lizards Proven Smarter Than Democrats!

Aeons and millennia ago -- almost a year ago, actually -- we published a piece purporting to explain just what had happened to bring the financial heads to their knees. We discussed sub-prime mortages, how they were repackaged into Mortgage Backed Securities (MBSs) and Collateralized Debt Obligations (CDOs) (turning mortgages into bond-like securities), toxic assets, and so forth. This post spawned numerous others, until we had published literally thousands of words on the original "stimulus package" put together by then-Secretary of the Treasury Henry Paulson and (still current) Chairman of the Federal Reserve Ben Bernanke (all right, technically, he's "Chairman of the Board of Governors of the United States Federal Reserve." Is it really that important?)

Why the financial collapse?

First, what was the original problem? Here is our first cut at describing it, from Democrats Try to Hijack the So-Called "Bailout":

So what started as mortgages -- ranging from very secure prime mortgages, which are doing fine, to lousy subprime mortgages for too much money to borrowers who really didn't have either the credit history or income to justify such loans, many of which are currently in default 60 days or more -- were, by the magic of "securitization," turned into bond-like securities; and in the process, many of the bad and even defaulted loans were transmaugrified into AAA-rated investments....

But defaults, of course, are where the whole pyramid scheme broke down. While housing prices continued to rise, everybody was happy and there were few defaults. But starting a couple of years ago, when the housing bubble burst and the mortgage default rate shot up, a bunch of banks found themselves holding very insecure securities, losing money hand over teakettle. The crash began among the lenders and spread to secondary markets (the MBSs and CDOs) and even tertiary markets (insurance underwriters like AIG). In short order, institutions all over the world found themselves holding pieces of paper whose value was impossible to determine -- which are referred to as toxic assets.

Toxic assets are illiquid, meaning they cannot be bought or sold because nobody knows how much to offer for them; they are frozen. If you hang onto them, they might regain some value later... or they could disappear completely. Worse, illiquid securities see their ratings drop; and current law forbids some types of funds from holding anything but AAAs... which means they may be forced by law to sell -- but unable to sell because of illiquidity!

Not only that, but current law also requires that such securities be "marked to market," meaning they must be valued at the last price offered by some institution that was desperate to sell -- because of the law in the previous paragraph. Thus, even institutions that didn't have to sell their toxic assets had to reprice them; this meant that a number of financial institutions suddenly did not have sufficient reserves for the amount of loans or leveraging they had out. That meant they needed to get hard cash and fast... which meant they would have to panic-sell a bunch of securities, precipitating a new round of re-rating and re-valuating.

Eventually, nobody had a clue what anything was worth anymore; and nearly every financial institution in the world, it seems, was involved up to the fourth cervical vertebra in this mess.

It was that uncertainty that caused the mortgage market to collapse.

We further refined the problem in a later post, Is It Adios to Capitalism - or Only Au Revoir?:

We've all been looking at this problem from the wrong perspective: We keep thinking of the rescue plan as injecting liquidity into the banking system and other credit markets; but the real need is to inject, not liquidity, but information; liquidity is just a seredipitous side effect.

The more I read about the current world fiscal crisis, the more I believe that it's not a market failure, not a credit failure, not a mortgage failure, and not a liquidity failure: Those are all symptoms of the real, underlying failure.

What has actually failed is the world information supply. Simply put, everything related to finance, to trade, to buying and selling -- in short, everything connected with any kind of a market -- depends upon access to timely, honest, accurate, and believable information (hereafter "THABI"). For an example I have used before, you cannot buy a car based solely on a grainy picture in a newspaper, because you cannot put a value on it; does it even have an engine?

You need THABI before you can make an offer. And the same is true for mortgages, mortgage-backed securities (MBS), credit default swaps (CDS), construction loans, business letters of credit (LOC), and so forth. Without sufficient THABI, no seller has any idea what price to ask the buyer, and no buyer has any idea what price to offer the seller. Buyers and sellers cannot come to a "meeting of minds," which means nobody can agree on any contract. And that means no market can exist.

That is exactly what has happened and is still happening today, all around the world: a global shortage of THABI, of timely, honest, accurate, and believable information.

So the problem was that nobody knew how to evaluate those Mortgage Backed Securities (MBSs), because we had a catastrophic and entirely artificial dearth of THABI -- "timely, honest, accurate, and believable information" -- about those MBSs and related securitized mortgages: They could not be valuated because we didn't have a clue what they were really worth.

Therefore, financial institutions didn't know what their own investments were worth, either. They had no idea how much reserves they had, so they had to panic-sell a bunch of their securities to remain within the law. And the feds' insistance on "mark to market" didn't help, since it forced institutions to immediately value their holdings on the basis of the lowest recent bid, even if that meant they valued them far below their actual worth.

Under such circumstances, a free market is impossible. It's as if there were no medium of exchange; how could you buy anything if there were no currency -- or at least, if nobody could agree on the value of a dollar?

Enter Paulson-Bernanke

That was the reason for the original "stimulus" package. It was originally intended to inject, not liquidity, but information into the market. From Democrats Try to Hijack:

So what is to be done? Obviously, since the problem is the inability to set a value for these instruments, which makes them impossible to buy or sell (illiquid), the solution is to find a way to value them. Enter the Paulson-Bernanke emergency rescue plan....

As I understand it, here is the basic plan. Note that I'm drawing this from many sources, it's not yet written in stone -- or even in ink -- and I can't give you sources. If you want more information, you're on your own! But here is what I've been able to glean:

1. The Treasury is given authority to spend up to $700 billion (outstanding at any particular moment) to buy MBSs, CDOs, and related instruments that have become "illiquid." These "toxic assets" will be purchased from their current owners at a huge discount... meaning the banks and other investors who purchased these pigs in pokes will, in fact, take a significant financial hit... they're not being "bailed out."

So the Treasury can buy up these toxic assets; what do they do with them?

2. I believe the plan (which has not yet been formalized in legislation) is to create a Treasury owned and managed resolution corporation that will take ownership of these toxic assets. Analysts will then pore through each MBS, determining the status of all the underlying mortgages and making a report publicly available. This will make the opaque assets completely transparent. All the financial fundamentals will be visible, so analysts at private companies can examine all of the securities and decide how much they would pay for each.
3. The resolution corporation will then auction off each of the the now-transparent MBSs, selling it to the highest bidder; that very action allows the market to reset the value of the security.

That is why I characterize this rescue operation as "pressing the reset button."

HouseGOPs stick in their two cents worth (and that's overvaluing it!)

Then the House Republicans got into the act. They didn't like the idea of Treasury buying toxic assets, so they added one step in between: That the federal government would first try "insuring" the toxics, to see whether that would give them a sufficient base value that they could be valuated by the free market. From the Done Deal - at Least, Very Likely Done:

As we predicted, it is basically the original deal with some of the HRs' proposals rolled in... notably the insurance option, which would be one of the choices that Secretary Henry Paulson has at his disposal and is required to set up and at least attempt before buying the toxic assets on behalf of the government:

At the insistence of House Republicans, who threatened to sidetrack negotiations at midweek, the insurance provision was added as an alternative to having the government buy distressed securities. House Republicans say it will require less taxpayer spending for the bailout.

But the Treasury Department has said the insurance provision would not pump enough money into the financial sector to make credit sufficiently available. The department would decide how to structure the insurance provisions, said Sen. Kent Conrad, D-N.D., one of the negotiators.

The final cut: equity stakes in banks

However, the collapse accelerated much more rapidly than expected before the Paulson-Bernanke emergency rescue plan could be implemented, and they decided they needed to inject liquidity directly into the financial institutions. From Is It Adios:

As the market is unable to function without THABI, it cannot function to restore THABI. All that information must come from somewhere else; and the only "somewhere else" that can act quickly enough to stave off a global depression is the State. Because the State functions both within and without the market, it can force changes even when the market is stymied... just as it takes a State to enforce the decisions of a civil-court, because only the State can step outside the market to seize by force the bank accounts of those who flout the court's decision.

The direct injection of liquidity by Treasury buying equity is also outside the market, because that money is extracted from people by force, in the form of taxes. But at the core, even this direct investment is an attempt to buy time to complete the "transparentizing" (horrible neologism, I know) of the toxic assets -- the recreation of the information that was lost by multiple unregulated securitizations of massive collections of mortgages.

Once the THABI has been restored to the mortgage-backed securities and other instruments, the market can reboot itself:

1. The assets can be valued;
2. They will all have some nonzero value, because no mortgage is worth nothing (if nothing else, the land itself has value);
3. All will be saleable, though often not at as high a price as the financial institution purchased them;
4. Each institution will thus be able to figure out how big a write-down it must take... and whether it can even stay in business or needs to sell itself to another institution.

There... that's a market! With the restoration of the missing THABI information, the market can reboot, and the catastrophe will be averted. So long as partial-nationalization of the banking industry lasts only long enough to retransparentize the toxic assets, thus allowing the market to begin functioning again, it will be an acceptable, even necessary intervention.

Alas, I then made an implied prediction that did not come true:

Bush and Paulson have really worked hard to make it difficult for a future president to use this plan as the camel's nose poking its way under the big top; the plan is designed to sunset automatically, allowing the banks to buy back their equity in no longer than three years, but earlier if both they and the incoming administration agree.

Enter the Obamacle

And that is exactly where the entire scheme broke down, because incoming President Barack H. Obama actually had no intention of allowing this "crisis" to go to waste. From Democrats Channel Hugo Chavez in Rescue Demands:

When people read "fascism," they immediately tend to envision concentration camps, jackboots, and Nazis goosestepping at mass rallies; but the real danger of fascism, especially liberal fascism (fascism with a smiley face, as depicted -- against author Jonah Goldberg's wishes -- on the cover of his book Liberal Fascism), is government control of corporations. The more control is handed over to politicians and bureaucrats who have no hand in actually producing the product (loans and securities, in this case), the more critical decisions will be made on irrelevant political considerations, often leading to financial disaster... and another bailout, leading to even more government control. Eventually, the State completely hijacks the corporation for political purposes... and we're well on our way to Hugo Chavez-land.

Why am I recapping this stream of previous Lizardry? Well, take a look at Thursday's story from Cybercast News Service:

A report issued by the Congressional Oversight Panel (COP) tasked with overseeing the implementation of the 2008 Troubled Asset Relief Program (TARP) questions whether the Bush and Obama administrations had the legal authority to use TARP funds to bail out General Motors and Chrysler.

The report, issued Wednesday, confirmed what CNSNews.com had previously reported: that the law which created TARP -- the Emergency Economic Stabilization Act (EESA) -- did not grant the government specific authority to use taxpayers’ funds to rescue the auto industry.

In other words, we're blowing our own forked tongues here: The original stimulus plan, the original Paulson-Bernanke plan, would have restricted that $700 billion to buying toxic assets; the later House Republican version would have also allowed funds to be used to insure toxic assets. And the final Paulson-Bernanke plan would also include using the money to buy equity stakes in the financial institutions themselves, in order to inject liquidity directly.

But under Barack Obama, the government appears to have criminally abused the stimulus bill to buy General Motors and Chrysler stock -- which has absolutely nothing to do with injecting liquidity into the financial markets to stave off collapse... and everything to do with bailing out the auto manufacturers to benefit the United Auto Workers.

So once again, it turns out that Big Lizards was either smarter than the Democrats (in figuring out what we needed to so) -- or at the very least, more honest than the Democrats.

And that's a revelation that must have stunned all of our readers!

Hatched by Dafydd on this day, September 12, 2009, at the time of 10:48 PM

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