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?
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:
- 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?
- 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.
- 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:
- The assets can be valued;
- They will all have some nonzero value, because no mortgage is worth nothing (if nothing else, the land itself has value);
- All will be saleable, though often not at as high a price as the financial institution purchased them;
- 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
TrackBack URL for this hissing: http://biglizards.net/mt3.36/earendiltrack.cgi/3882
The following hissed in response by: congressive
On December 19, 2008, President Bush used his executive authority to declare that TARP funds may be spent on any program he personally deems necessary to avert the financial crisis, and declared Section 102 to be nonbinding. This has allowed President Bush to extend the use of TARP funds to support the auto industry, a move supported by the United Auto Workers.
I'm not ashamed to admit I'm confused here.
The following hissed in response by: Dafydd ab Hugh
So am I; what exactly are you quoting from?
The above hissed in response by: Dafydd ab Hugh at September 13, 2009 6:23 AM
The following hissed in response by: Dafydd ab Hugh
Ah, tracked it down; Google is my friend. It's a Federalist Society paper asking various legal and constitutional questions about the TARP program. It includes the following passage:
On December 11th the Senate voted to reject the auto industry bailout. The Treasury was not allowed to extend the funds to the auto industry because Section 102 of the Troubled Asset Relief Program (TARP) is limited to financial institutions, so it looked like the auto industry was doomed to fail. But on December 19th President Bush used purported executive authority to declare that TARP funds may be spent on any program he deemed necessary to avert the financial crisis, and with what amounts to a line-item veto, declared Section 102 to be nonbinding on the executive branch. This allowed President Bush to extend the use of TARP funds to support the auto industry. Does this move undermine Article I of the Constitution: “All legislative powers herein granted shall be vested in a Congress of the United States, which shall consist of a Senate and House of Representatives”? The definition of troubled assets in TARP grants a great deal of discretion to the Treasury Secretary. Given Article I, would the Founders have allowed Congress to delegate this authority to the Treasury Secretary?
Some points to make:
The authors do not say whether President George W. Bush issued this finding specifically to help the auto industry, nor whether he subsequently tried to buy shares in GM or Chrysler. The purpose of the finding could have been, for example, to enable the feds to extend TARP funds to securities insurer AIG (the ostensible subject of the Federalist Society's paper), which was still teetering on the brink of complete collapse in December.
Bush might have worried that AIG, troubled by the same illiquidity and toxicity that had threatened the financial institutions, might recollapse the credit market if it fell.
But it wasn't specifically covered by the TARP legislation; so Bush, relying on preexisting judicial precedent that the Executive has wide authority to spend federal appropriations as it sees fit, so long as it's not violating specific laws, found that section 102 ("limiting" TARP money to "financial institutions") infringed on Executive authority.
On the other hand, maybe Bush did have the auto industry in mind. If so, then that would be just as violative of the Paulson-Bernanke proposal as what Obama did. Remember that Bush in his second term, especially after the 2006 elections, drifted significantly to the left on economic issues.
(The Federalist Society paper doesn't answer the questions it raises; it just raises them.)
The above hissed in response by: Dafydd ab Hugh at September 13, 2009 6:41 AM
The following hissed in response by: Bart Johnson
The analysis of corrective/God-Help-Us activities will be useful when the whole thing happens again.
Which it will, if we don't go back to the original cause and fix that.
I refer, of course, to the Anti-Redlining laws passed and signed in 1977 by President Carter.
That, and the follow-ons passed and ruled by the Clinton Administration, which caused the creation
of Freddie Mac and Fannie May, led directly to the whole collapse.
The following hissed in response by: cdor
Excellent synopsis of the financial meltdown of 2008. GW Bush went beyond Presidential authority in stealing tarp funds to lend to GM and Chrysler. If the President can do such a thing, what is to stop him from funding wars using money allowcated for education or eliminating the EPA by spending its budgetary allotment on procurring a weapons system? Once Bush cracked open that door on his way out, the Obama guys bull rushed right through it on their way in. We now have begun the road to unlawful government. The next thing you know, Obama will sweep away the rights of legitimate secured creditors, giving their interests away to his most favorite goons.
Oh wait, he did that.
Well maybe he will just not prosecute illegal activity by his supporters at the voting booths on his way to stealing elections, Iran style.
Woops, he's done that too.
Perhaps this could lead to criminalizing previous administrations in order to eliminate political opposition...
oh no, that kinda sounds familiar as well.
The following hissed in response by: Geoman
Uncertainty caused the mortgage market to collapse. However, the government always makes this worse, not better. Government is a virtual fountain of uncertainty. How? It can do things that make no logical economic sense, break contracts, and change rules at a whim.
Bailouts create uncertainty. Lehman Brothers falls, but Morgan Stanley is saved? Both actions are problematic, but taken together they are worse than either would be alone. Let both fail or save both.
Remember the Keynes thing of burying rolls of money in the ground and allowing private individuals to dig them up? In theory this would stimulate the economy and prevent a depression.
Bernake is on the record as saying he would drop money from helicopters if necessary to prevent a depression. Fair enough, both are rhetorical flourishes, but illustrate an essential point, as an investor, do I buy shovels, or butterfly nets? Who do I believe? The economy starts to reorder itself in response to what it thinks the government will do, not what economic conditions demand. It starts to price in uncertainty.
This is why the Great Depression lasted as long as it did - Roosevelt's busy-body attempts to help actually created more uncertainty in the markets, delaying recovery.
The choice with mortgages was between liquidity and information. There is nothing that says you have to value the securities today - you can simply hold them to maturity, and then the value will be known to all parties.
The crises ended when the government eased the mark to market accounting rules. There has been no buy up of toxic assets because none there are no sellers. Everyone is just holding the toxic assets to maturity. Why take the potential loss now? In the mean time banks and financial institutions are socking away money for a rainy day, just in case the the securities are not worth as much as hoped. It should take about 3 to 5 years for the toxic mortgage backed securities to fully clear, which will be the probably length of this recession.
Interesting - the mark to market rules were created by the government to increase transparency. How'd that work out?
The following hissed in response by: Dafydd ab Hugh
Beware the lure of lightswitch reasoning! "If a little government intervention is good, then a whole lot of intervention must be super-good!" is an obvious liberal-socialist fallacy we all recognize; but libertarians, Randroids, and hard-core capitalists (such as myself) are just as tempted by the converse statement as liberals are by the first: "If reducing the size and scope of government is good, then completely eliminating all government action must be heaven!"
Consider this wild thought experiment: Suppose some terrorists (about twenty, or maybe a little fewer) hijack some jumbo jets and fly them into one of the premier financial centers of the world, destroying many terabytes of financial data, some of which is not backed up anywhere else. (They also kill a bunch of people, but that's not germane to this thought experiment).
Securities transactions worth hundreds of billions, perhaps trillions of dollars hang in limbo, because nobody is exactly sure who sold what to whom and for how much (not even the participants). The markets begin tanking, because everybody realizes funds will be tied up for years sorting out all the various legal questions of contracts, tort, ownership, and liability.
Individual small investors begin to panic-sell, thinking that more waves of terrorist attacks may be on the way. We start seeing hoarding, which causes shortages of basic necessities, and other unfriendly responses.
Perhaps the Holy Agora can eventually sort this all out; but "eventually" could mean ten years or more -- and our economy would not likely survive ten years of total chaos.
It makes sense to me, as a capitalist, that in a dire emergency such as this, the federal government should step forward: temporarily (for a few days) stop trading at the various securities markets; temporarily (for at least six months) suspend a bunch of normally necessary regulations; allow delayed tax filings; help coordinate data recovery; make quick and relatively accurate estimates of the financial transactions and holdings that are in limbo; give those estimates the force of law (subject to later revision as the real numbers come in) so that companies can get back to business (lines of credit, corporate checking accounts, bank reserves, and so forth); spend some money to financially aid those companies hardest hit (subject to being paid back later, when they're back on their corporate feet); and so forth.
Sometimes, the best thing that government can do is -- do nothing except get out of the way; but not always.
In this case, I think the original Paulson-Bernanke plan was a very good one, given what we knew then. What was actually done under Bush turned out to be pretty good too, although we certainly haven't recovered, and those toxics are not getting any better; they're just being swept under the rug. (I think it was significantly riskier, however; and that argues against repeating it.)
But one can -- and must -- distinguish between the reasonable government interventions of the Bush era (excluding the GM and Chrysler loans, if indeed they actually made any -- for which I'm still awaiting evidence)... and the Oogo Chavez-style nationalization of banks and manufacturers; schemes to allow the President of the United States to set all corporate salaries; the corrupt and out of control political ideologues trashing the economy to help their cronies; and the mounting socialism of the Obama administration: "Never let a good crisis go to waste!"
If we cannot distinguish between those two poles, not just in degree but in kind, then we have reached the point of self-parody.
The above hissed in response by: Dafydd ab Hugh at September 14, 2009 2:12 PM
The following hissed in response by: Roy Lofquist
"Once Again, Lizards Proven Smarter Than Democrats!"
Hell, my dog is smarter than Democrats.
The following hissed in response by: Geoman
I didn't think there was anything wrong with the Paulson- Bernake Plan per se, it just didn't work as intended because easing of the mark to market accounting rules made it irrelevant.
I believe that government regulation is necessary, but we should always default to the least amount of government intervention to solve the problem. Better still, write the regulations before a problem is apparent, not after it has cratered the market. Post crises intervention often makes the problem more intractable, not less.
The government must never say "we will do whatever it takes to solve this crises" it should say "our intervention will be temporary, and limited to the following items."
By the by - I don't think the problem is now solved - the resolution has just been smeared out over the next 3 to 5 years. Paulson-Bernake would have solved the problem faster (within a year). But at higher government cost, and greater private loss. The accounting rules solution is the Japan solution - zombie banks, zombie economy.
The take away is - the government really doesn't know what it is doing, otherwise it would have eased mark to market at the beginning of the crises, preventing the crises in the first place. Another sign they don't know what they are doing - Obama is lecturing Wall Street on greed, yet I have yet to hear anyone discuss the true source of the problem - ratings agencies that gave AAA scores to worthless sub prime junk and the GSEs that love them.
Banks bundled up the mortgages sure, and made a lot of money. But the ratings agencies convinced everyone they were good investments. And the prime buyer was Fannie and Freddie, government sponsored corporations.
IF Fanny and Freddie had not provided a market, the problem would be much smaller. IF the ratings agencies had done a better job (perhaps with firm government guidelines) we wouldn't have this problem. Certainly if the derivative market had been better regulated, the problem would not have been so severe. So I'm not regulation adverse, I'm intervention adverse.
The government may not always build the bomb, but it always intensifies the blast.
Or a better analogy - I support more building inspectors to identify problems in advance, not adding more fire crews after the fact to contain the flames.
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