March 24, 2008
JustQuotes: Resolution Trust Corporation Redux?
"Even after cutting rates by 3 percentage points since September, expanding the range of securities it accepts as collateral for loans and giving dealers access to its discount window, the Fed has been unable to promote confidence. The difference between what the government and banks pay for three- month loans doubled in the past month to 1.92 percentage points.
The only tool left may be for the Fed to help facilitate a Resolution Trust Corp.-type agency that would buy bonds backed by home loans, said Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co. While purchasing the some of the $6 trillion mortgage securities outstanding would take problem debt off the balance sheets of banks and alleviate the cause of the credit crunch, it would put taxpayers at risk."
∙ Fed May Buy Mortgages Next, Treasury Investors Bet [Bloomberg]
First Published: March 24, 2008 2:50 AM
Comments from "Plugged In" Readers
Bill Gross' PIMCO total return fund is overweight MBS -- here are the top 10 holdings, as a percentage of portfolio, as of Feb 2008:
Agency | Yield | Maturity | % of holdings
Freddie Mac, 5.5%, 02/12/2037 6.9
Fannie Mae, 5.0%, 02/13/2036 3.5
Fannie Mae, 5.0%, 03/01/2036 2.7
Freddie Mac, 6.0%, 01/15/2036 2.4
Fannie Mae, 6.0%, 01/11/2037 2.0
Fannie Mae, 5.5%, 02/01/2035 1.9
Fannie Mae, 6.5%, 01/15/2035 1.7
Fannie Mae, 5.0%, 08/01/2020 1.6
Fannie Mae, 6.0%, 12/01/2036 1.4
Fannie Mae, 5.5%, 01/12/2036 1.2
Note that there is no GNM debt here (which *is* guaranteed by the USG, but has a correspondingly lower yield).
This should explain why he has been calling for a taxpayer bailout (effectively of his funds) for some time now:
Will he get it? The FED has denied discussing this as of Saturday:
Given that its balance sheet is already stretched thin, the FED is not the right vehicle.
I think the main struggle of bondholders such as Gross is to transfer the risk to taxpayers before the full extent of the price declines/dollar amount is understood by the public. Moreover, they want to move the risk from agencies which need congressional action to be bailed out (such as PIMCO, FNM, or FRE) onto agencies which are guaranteed to be bailed out (such as GNM, the FHA, or the FED). Finally, they need to do this outside of congress, by regulatory fiat, as this is an election year with a democratic congress, and the Bush administration is reluctant to do anything other than kick the can down the road.
As I see it, this at least gives a chance to the taxpayers to let house prices decline a few more months before stepping in to backstop any further declines -- the Barney Frank proposal, and most proposals call for bondholders to take the loss on the difference between the mortgage value and the currently appraised value.
Hence the growing chorus that action must be taken *right now* before any further declines in prices. In fact, as the argument goes, taking action now will *prevent* further price declines. This is the only bone that bondholders are throwing to homeowners.
You may want to take this into consideration (and do your own due diligence) if you are investing in the PIMCO "total return" fund, which is often the only bond investment option in many 401K accounts.
Posted by: robert at March 24, 2008 2:20 AM
I've harped on this for some time now.
we will pay huge sums of money through taxation and inflation to bail out the financial system.
Bill Gross is talking his book. As the biggest bond investor in the world he would love to see an RTC type institution.
That doesn't mean it's not gonna happen, just know that Bill Gross is talking his book.
I'm not personally sure how the bailout will take place. there are too many bailout proposals right now, and I'm not sure which one will be taken.
but then again, that's the point with the "socialize the risk while privatizing profits" game... make it opaque so that people don't know what's going on.
make them think we're helping "the homeowners" and that we're preserving "home values". Decades later when we're still paying then some people will think about what was done... but even then maybe not. (how many people know how much the S&L cost us as example?)
My guess is that we've already started the process. we have FHA, Fannie, Freddie and Ginnie taking expanded risk. we have the Federal Home Loan Banks assuming tons of risk (over $50Billion loan to countrywide as example). and we have the Fed itself possibly at risk ($30b to Bear/JP Morgan).
My thought is that we'll keep unloading the garbage to the above entities. Then when they fail we'll be forced to bail them out.
just my guess. no better or worse than anybody else's. because like I said, there are countless bailout plans (like allowing the fed to purchase mortgages directly, having the govt buy all mortgages itself, giving tax breaks to homeowners, removing taxation on forgiven debt, etc)
Posted by: ex SF-er at March 24, 2008 5:30 AM
Well, I have been predicting this as well for a while. Although the "rumors" of course are that the Fed will "buy" mortgages, I wouldn't count on that. It's not what the Fed does.
What I think will happen (a slight embellishment of what I have been saying for a while) is that the Fed will point to the Federal Reserve Act, and say it is not able to "purchase" securities from private parties, and that it wouldn't be prudent to put the Fed in a position to do that because it would require the Fed to monetize debt (by "printing" the purchase prices) an "we wouldn't want that, etc....." Then, Congress creates the agency that will purchase the bad debt that is now sitting on the Fed's books as collateral for the loans it has been advancing to banks and non-bank institutions. These securities are largely worthless, but the taxpayer will buy them at an "appropriate" discount from par, say, 70-80% (who knows - just a guess), and the surviving investment and commercial banks will just laugh about the whole thing. The securities will be purchased from the banks and nonbank institutions, not the Fed.
And, of course, once the "crisis" has passed (it's just a crisis for the banks - the real crisis for homeowners happened a few years ago when they agreed to trade their labor income for artificially price-inflated houses), the Fed and the USG will not care where the price of housing goes. Normal lending standards can return, and interest rates will be allowed to normalize, and house prices can continue their fall towards fair value unimpeded by concerns about bank solvency.
About what the Fed can and can't do, John Hussman had an interesting discussion in his weekly market commentary (his stuff is WELL worth reading - I read it every week):
Here is a link to all his archived commentaries, and is where you can check for updates (usually every Sunday evening):
Posted by: Satchel at March 24, 2008 7:01 AM
It is quite humorous to read through these comments. Everyone predicted this.
Enlighten us, what are the headlines going to be tomrrow?
Posted by: Sack at March 24, 2008 8:05 AM
"Everyone predicted this."
LOL! You're right, Sack! It's sort of like the housing bust. Now everyone says that it was all predictable (hehehehehe).
But if I can stick up for ex SF-er, he HAS been harping on this for a while. As have I. In fact, here is a quote from me from February 7:
"Ex SF-er is right here: the legislation for RTC II is FOR SURE being drafted right now, and you can also be sure that there will be intense pressure to relax lending requirements."
Posted by: Satchel at February 7, 2008 4:25
Sack, you can find the thread here, and I would suggest you read through the entire thread (particularly my and ex SF-er's comments) for other "predictions":
In that thread I suggested that at some point soon the USG will start "bulldozing" houses in order to protect the value of housing, an incredibly stupid thing that is akin to what was done in the early 1930s with respect to agriculture (the Agricultural Adjustment Act). Well, whaddaya know, just last week (March 19 edition) just that was proposed in the editorial pages of the Wall Street Journal!
"Putting to the bulldozer a few housing tracts in California, Nevada and several other overbuilt states would be the precision way to prop up prices in vulnerable markets...."
Some of us have REALLY been thinking deeply about what has been going on, and for some time now.....
Sack, if YOU have a good read on what is going to happen, I'd love to hear it. I'm always looking for ideas, and I am sure there are a lot of SS readers who are too!!
Posted by: Satchel at March 24, 2008 8:29 AM
While we've seen some improvement in the delta of the delta, I think the only thing that could save housing from more huge drops is a forest fire. That said, I don't think the Fed should buy mortgages or declare some emergency and move more aggressively. Frankly, I think it's done almost all it can do aside from getting some decent regulation in place so this doesn't happen again. They might be able to loosen the collateral restrictions and play with the time of the loan etc...but I think, unfortunately, some kind of plan along the lines of the Frank plan is the next step. Hey - I never bought something I couldn't afford and I'm not inclined to pay taxes to help others be bailed out but I'm not sure this is avoidable.
Posted by: cooper at March 24, 2008 8:34 AM
"It is quite humorous to read through these comments. Everyone predicted this."
can't speak for "everyone" but I started speaking about housing bailouts and all that when Bear Stearns hedge funds blew up in summer of last year.
I was derided for it at the time.
In fact, I've made a lot of predictions on this board. I feel that many of them are quite accurate. and I stand by what I've said. A few were off. When in error, I've tried to acknowledge it. If you would have followed my advice you would be up HUGE in your net worth. I have even at times discussed openly my personal investing so people could see that I had skin in the game, but also to be wary of what I said because I, too, was talking my book, just like Bill Gross.
You can do the work of googling my predictions for yourself.
As example: from September 18th, 2007.
Socket site link from 9/18/07
But while this happens we MAY (my crystal ball is very opaque on this) see huge increases in gold, oil, commodities, and other hard assets. (due to the currencies becoming more and more worthless)
but for San Franciscans:
don't EXPECT a return to cheap mortgages. it could happen, but is unlikely. (this is very hard to foresee)
The previous buyers of American mortgage securities were Foreigners and foreign banks and foreign central banks etc... they were burned by bad performance and bad Fed policy so won't come back for a while. (years/decades)
however, with the Fed dropping rates, they announce a war on savers. We will have higher inflation, yet lower interest rates on our savings (so our life savings lose value). thus, many savers may decide to invest in riskier assets like mortgages again, to try to hold out against inflation. I doubt this will happen, but it is possible.
Posted by: ex SF-er at March 24, 2008 9:22 AM
and here's what I said from JULY of 2007-so 7-8 months ago.
That said, I agree... there will be a bailout. But not of homeowners. The bailout will go to the banks (disgusting, I know). The Federal Reserve is a PRIVATE bank and they will look out for someone... the banks. Thus, when a "too big to fail" bank starts to fail, it will be kept aloft by the Federal Reserve and govt, at huge TAXPAYER expense.
This is why it truly is disgusting. These banks abrogated all their responsibility to rake in HUGE profits the last 5 years. now the doodoo is hitting the fan... they will take losses and go crying to govt for a bailout.
PRIVATIZE the profits, and then SOCIALIZE the downside risk.
read this: (about the largest bank failure to date, Continental Illinois)
Posted by: ex SF-er at March 24, 2008 9:26 AM
Satchel, sorry if that was a little abrasive I was just trying to poke fun at you guys. I wish I had the time to get to understand all of this better but in the meantime I just read your posts and recite the ideas at the water cooler (as im sure everyone on here does) :-)
Posted by: Sack at March 24, 2008 9:29 AM
Is this a bail out or just some clean up? There appear to be vast differences in point of view. Some see the Fed as attempting to restore the past and failing, others see the Fed as attempting to soften at least slightly the severity of the crunch that is unfolding. What exactly is going to happen to abandoned and unowned properties if no RTC 2 ever showed up? Many developments are festering partially built and no longer selling, so why exactly should these development not be bulldozed? They should not be bulldozed because someone might believe that bulldozing them might raise or at least maintain prices? Calling two bucks a share for Bear Stearns a bailout is not realistic. That was a wipe out, not a bail out.
What this shows more than anything else is that politics, as usual, is way out in front of reality. Disperse the remains of a wrecked bank for two bucks a share? That is a generous bail out and give away. Bulldoze some homes that never should have been built and might never sell? That is an attempt to prop up the market. Form a corporation to collect and redistribute assets from busted organizations? That's a bail out and a conspiracy, thus RTC 2 and RICO join as serpents to eternally consume each other along with the excess inventory. All this is very poetic, but is any of this truth or is it all just perception?
Posted by: Mole Man at March 24, 2008 10:17 AM
You bring up a lot of interesting questions, but the *truth* is that most everything that is going on is both a bailout AND a conspriacy!
Things are often not what they seem. But just to take one example that you brought up, Bear Stearns. The $2 sale price was MOST DEFINITELY a bailout (since raised to $10 - that's immaterial), but the Fed and the USG cleverly distracted everyone. Common stock? That's what people commonly think of when they think of companies. But the bailout was the DEBT. Take a look at BSC's most recent 10-k and you will see $68 BILLION of long-tem debt on the balance sheet. This has subsequently risen to about $75 BILLION. Now, JP Morgan is the obligor, and JP Morgan is being "backstopped" by the Fed. Just how much do you think the bondholders would have recovered had Bear gone into bankruptcy (as it should have of course)?
The stock "bailout" was worth $250M (at the $2 price), now approximately $1.25B at the $10 price. Not too many people talking about the $75 BILLION the smiling bondholders just put in their pockets......
Most definitely a bailout, but you have to know what to look for!
Posted by: Satchel at March 24, 2008 1:20 PM
The holders of the default swaps for Bear are certainly not smiling; at least thats what I can gleam from this article:
Posted by: swap space at March 24, 2008 4:08 PM
Well sure, swap space. the CDS market is basically a zero sum game. Those who bet on Bear Stearns' demise are out of the money. But remember the "unseen" winners in the CDS game. Those who sold the insurance are laughing their a$$es off! Not only do they not have to pay, but in truth they probably NEVER could have!
The Fed and the USG are picking the winners and the losers now, and the danger is the game becomes so rigged - and is recognized as such - that "real" money takes their ball away and goes home. The history of government planning of economic fortunes is not a rosy one. Over the last 25 years especially, the USG and the Fed have tried to avoid "bad outcomes" to the exclusion of allowing markets to rationally allocate resources. That's part of the reason why we have had twin bubbles of equities (in the 1990s) and housing (in the early 2000s, mostly), all against the backdrop of a maniacal credit inflation. All done to "tame" the business cycle and reward bankers and financiers IMO.
I think the old Soviet Union used to boast that a recession was not possible in a communist system such as theirs - their successive 5-year plans (begun in the 1920s) ensured that there would not be a business cycle. Of course, as the distortions grew and the cumulative misallocation of capital became unbearable (you had an economy that could hit the moon with a rocket before the US did, but couldn't ensure a supply of toilet paper!), the system did what economics said it had to: it died, circa 1985-90. There is a lesson in there for us IMO!
Posted by: Satchel at March 24, 2008 4:44 PM
Regarding Bear Stearns, points taken. It will be interesting to see how the game turns out since that ball appears to still be in play
The comparison to Soviet Communism is way, way off. Rampant Bolshevism, far more corrosive than mere Communism, had put the whole Soviet system in a completely different state well before World War Two, even. Everything about life there was different in ways that do not even begin to remotely compare to American economic activity. Goods came with little or no choice and involved standing in long lines even before 1930. Houses and consumer products were not so much available as occasionally assigned. Russian audiences that were able to watch The Grapes of Wrath were astounded that the American poor had car--something that seemed about as improbable to Russians as calling upon a fleet of dirigibles for transport. Furthermore, the organizational, technological, economic, and cultural backbone of the Soviet system was Russia. Russia had been roughly 200 years behind the rest of Europe since the Mongolian invasion and the culture remained so hostile to modern industrialized culture that German immigrants who prospered almost everywhere else, especially America, eventually gave up and left en masse. It is important to understand that Communism collapsed from internal rot rather than being pushed down, but the idea that we could potentially evoke any significant fraction of the problems of Russian Communism here in the US is way off the mark.
Closer to home people like yourself expected Cuba to succumb when farming collapsed after diesel stopped being imported. Instead the Cubans have perfected an extremely efficient system of organic production that has incredible potential value for future Capitalist owners and operators. Communism provides easy rhetorical targets, but the reality is really quite a bit more complicated than all that.
Posted by: Mole Man at March 24, 2008 5:04 PM
Well, points taken as well from my end, Mole Man!
I am VERY familiar with Russia. I speak Russian (a bit) and spent a good deal of time there in 1995 and 1996 (never lived there - only on "investment" trips when I was based out London). Of course, everything was different than the US. But do not lightly discount the fundamental issue: the allocation of resources by fiat (diktat) rather than market forces. If you are up on your Russian history (as you seem to be) you will be very familiar with how the Russians in the 1930s "invented" whole new methods of solving simultaneous equations (involving matrix algebra) - the only relevance for this discussion was the necessity to invent these methods in order to solve the "input-output" equations for factory production that a market-based system solves effortlessly through the actions of numerous financial actors. I'm not saying that our future is like Russia's, only that there is a lesson in there that we would do well to consider.
About Cuba, the reality today is not nearly so rosy as you seem to imply. It's a mess. I don't have any formal background in it. But my wife is Cuban - all her sisters were born there. My father in law was a classmate of Castro and he knew him at the University of Havana. They fled in the early 1960s, and maintain some contact with family back there. I've never looked at their economics or their statistics, though.
Posted by: Satchel at March 24, 2008 5:20 PM
Ask and you shall receive. Whether it's in the Fed's mandate or even legal seems to be an afterthought...but RTC 2 to the rescue:
Posted by: Dude at March 25, 2008 8:58 AM