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Tuesday, September 23, 2008


'mark to maturity'

i happen to be at home today, and watching he testimony of ben bernanke, hank paulson and chris cox before the senate banking committee.

it is a sham. cox is an afterthought, but bernanke and paulson clearly have no idea how they want to use $700bn, much less how they should. financial catastrophe or not, if this is the best they can manage, congress should send them away to clarify the options and recommend an actual plan rather than a fantastic concept.

congress is being asked to risk the currency of the united states on an incredibly complex bailout mechamism. it should at least be given a technical manual to explain the mechanism and how it would hopefully work. bernanke and paulson are giving them side 2 of "metal machine music".

so void of meaning and clarity is much of the testimony that one cannot help but suggest diversion. exemplary is bernanke's testimony that there are "methods" by which he can determine the "hold-to-maturity" value of the mortgage-backed securities it purports to buy out of the banking system. this is a fraud -- it presupposes that he knows with accuracy in both price and time how far house prices will fall. no one knows this, and no one can.

bernanke himself, if he is not caught in a god complex, knows this. so why would he pretend to know?

there is a disingenuity in this line of testimony and others. i deeply suspect it turns out that the paulson plan is to throw money at the banks without direction or specific intention. it sets up as a colossal boondoggle. no one hereafter should reference the resolution trust corp, as usually that reference implies that taxpayers might "make money". they won't here.

but the bigger question is "will it work?" -- and no one knows. but here is context.

the economist cites an IMF working paper regarding past systemic bailouts.

Sooner or later most governments realise the need for a comprehensive solution to the crisis, involving public funds. This can take different forms, from bank recapitalisation to forgiveness of all the underlying debts. In three-quarters of the cases, governments shored up bank capital by, for instance, injecting preferred stock. About 60% of the time, governments set up institutions to manage distressed assets.

The evidence from these attempts is sobering for proponents of an RTC II. Some institutions worked well. In the early 1990s, for instance, Sweden successfully set up an asset-management company to take over and sell the bad loans from its biggest banks. But, in general, the paper argues, such government-owned asset-management firms are ineffective — often because politicians try to push them around.

On average, the study finds that government attempts to stanch systemic banking crises over the past three decades have cost 16% of GDP. That average hides enormous variation, much of which depends on how crises were handled. America’s mess, even if it has already led to the demise of famous Wall Street firms, is far from finished. That is why the international lessons are worth taking seriously. Resolving a financial mess is cheaper, quicker and less painful if governments take a rounded approach. For the moment, the bail-out tacticians are in overdrive. But the strategists’ moment is approaching.

american GDP runs about $14tn. a 16% fraction implies an average bailout cost of $2.3tn. but, as the economist notes, variation is wide -- and the united states today is the most financialized and debt-dependent major economy in world history. moreover, the current incarnation of the paulson plan will bail out banks of foreign origin holding impaired american securities. and as noted above treasury will looks to pay not clearing prices but exceptionally high prices -- perpetuating illiquidity by crowding out any potential private capital transaction. in light of such considerations, if anything, the american bailout should be more expensive than average. and if cost is to be kept to a minimum, it will have to be exceptionally well directed.

brad setser also attacked the problem of bailout size. his point:

Figuring out who owns the debt of US households.... That leaves around $6.5 trillion of outstanding mortgage exposure in the hands of the financial system, give or take. It might be higher because it is possible to create “synthetic exposure” to various kinds of securities....

Willem Buiter thinks that the US Treasury will be buying up assets at roughly 33 cents on the dollar, which would broadly speaking move $2 to $2.1 trillion in face value of debt off the balance sheets of major US financial institutions. ...

I am not though convinced that the banks can afford to sell at 33 cents on the dollar. If these assets were valued at par before the crisis, I think that implies taking an aggregate loss of $1.4 trillion — which seems much higher than the losses that the banks have recognized to date. The hit to the banks balance sheet might be too big. ...

What is the point of all this?

Well, to me it helps to highlight the challenge the Treasury faces. If it pays a high price for various dud assets, it won’t move nearly as much off the banks’ balance sheet — which may leave residual questions about the health of key institutions. On the other hand, if the Treasury pays a low price, it may leave a lot of banks in trouble and in desperate need of new equity.

It also helped me try to think through whether $700b is a lot a money or a little bit of money, relative to the enormous challenges the US now faces supporting a financial sector that is gravely ill. I was reminded just how big the balance sheet of the US financial sector is — and just how much of that balance sheet is tied up in the real estate market.

and of course there are trillions in non-mortgage failed securitizations and pier loans that the paulson plan would be designed to help sop up.

in short, on an examination of both scale and acuity, what congress is being presented cannot be a probable "successful" solution insofaras success means general economic health. it seems clear early on that it was not enough, and represented more of a 'down payment' on a realistic final cost. what it may do is prevent some banking receiverships that would otherwise have been inevitable. chances are, though, that the next treasury secretary will be back to ask for much more money later.

in the final analysis, i think kevin depew has this right.

There is only one thing necessary to understanding what is happening and it is this: no one at U.S. Banks, no one at the Federal Reserve and no one in politics can accept the reality that real estate assets in this country remain oversupplied, overpriced and overleveraged.

It is that simple.

TAF, TSLF, SuperSIV, TARP, none of that matters. No matter what acronym is created to disguise the fact that assets are overpriced, or what government intervention is created to prop up those asset prices, the market will inevitably overpower it. This time is not different. In fact, it is continuing to play out almost exactly as the Great Depression did. The bottom line is that despite the proposed bailout, whatever form it may take, risk in owning stocks has increased, not decreased.

UPDATE: see that high-side bailout estimates are growing into the $5tn range.

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"i deeply suspect it turns out that the paulson plan is to throw money at the banks without direction or specific intention. it sets up as a colossal boondoggle."

Isn't that the definition of government.

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gm, as a former CEO of Goldman Sachs, is it public how much stock Paulsen owns in Goldman Sachs?

Keep up the great work.

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ccd -- paulson was forced to sell his goldman holdings upon taking office. of course that doesn't matter much -- like any pol, it's all about accumulating favors that are cashed in upon leaving office. paulson is making an unimaginable amount of money out of this. he just won't receive it for a few more months.

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