September 29, 2008

$700 Billion Bailout Breaking News: Round One Rejected By The House

"The fate of a controversial $700 billion financial bailout plan was in doubt Monday as a House vote turned against it. The next steps were not immediately clear but supporters were scrambling to put it up for another vote."

"The measure needs 218 votes for passage. Democrats voted 141 to 94 in favor of the plan, while Republicans voted 65 to 133 against. That left the measure with 206 votes for and 227 against."

Bailout plan rejected [CNN]
Once Again, We’ll Simply Go With The Worst (In Terms Of The Bailout) [SocketSite]

First Published: September 29, 2008 11:20 AM

Comments from "Plugged In" Readers

Wow. This is big. It appears Free Market afficionados of the Reaganomics kind are uniting with the lefty Robin Hood wannabes to kick the air out this bailout. We're in trouble.

Posted by: San FronziScheme at September 29, 2008 11:39 AM

Ouch

Posted by: bossmillion at September 29, 2008 11:40 AM

At the end of the day, this bill will get passed. The language will be revised yet again, but I think they’ll pass it by the end of the week. The market is getting killed in the meantime though.

Posted by: Lance at September 29, 2008 11:47 AM

I want my $5Bil back!

Posted by: Warren Buffet at September 29, 2008 11:47 AM

Depends on who they bring on board. Do they create a bill to get the conservatives on board or the progressives on board?

Posted by: BRCGranny at September 29, 2008 11:54 AM

This is the first positive step that our Congress has taken in a long time. They might actually be listening to the American people. I think that Jim Cramer needs start ranting about how the Fed (and Wall Street ) have no idea, NO IDEA, how much they are despised by most Americans.

Posted by: FSBO at September 29, 2008 11:56 AM

The progressives are already on board. They always are when it involves a big government program that as an added benefit invests almost dictatorial power in the Executive, which they hope to capture this November.

The conservatives need to hold the line here. Obviously, something is going to need to be done by the USG in order to make the coming transformation of the credit/lending system as orderly as possible.

But it seems to me that any system that has succeeded into getting average people to believe, say, that a perfectly ordinary 3/2 in a place like Bernal Heights (or 2/1 in Noe Valley) could actually be "worth" 10-15 times the median income of the city, is a system that needs to be destroyed, not propped up. I say let's control the collapse as best as possible and build a better mousetrap going forward.

These clowns in Congress have to go on recess soon to go back and campaign to keep their jobs, so I hope the grassroots can keep up the pressure for another week or two.

Posted by: Satchel at September 29, 2008 12:10 PM

Satchel,

This is the first time that I can say that you are dead wrong. Either this bill or something like it gets passed, or we are in for the next depression.

You are smarter than this. You know we need credit markets to function in order for the economy to work. I know you don't want interest rates on credit cards to dramatically increase, or for investment in new products/new factories/nearly anything productive to cease because their isn't credit available on reasonable terms.

I'm all for real estate prices reverting to the mean, but strangling the economy in order to so is nothing short of stupid.

Posted by: Jordan at September 29, 2008 12:17 PM

Excuse my typos there...

Posted by: Jordan at September 29, 2008 12:19 PM

Jordon - 227 Congressmen, 9 out of 10 economists, many of us here at Socketsite, and probably most Americans disagree with you.

Posted by: FSBO at September 29, 2008 12:21 PM

We already earned this depression/recession by fluffing up the crazy housing bubble. The quicker we can get it over with, the quicker we can recover.

Posted by: Mike B at September 29, 2008 12:23 PM

this House vote has made me proud of our system of governance for the first time in a long time

disclosure:
I am a homeowner, i am heavily long the equity markets and will continue to be so for decades to come.

but nothing, and i mean nothing, is worth our principles

in the long run, this bailout plan was and is an absolute disaster, i'm sure it will be resurrected with appropriate political cover, but until then, my faith in government has been restored

it is still of the people and by the people, and for the people.

Posted by: enonymous at September 29, 2008 12:26 PM

Does anyone else feel the sell-off is a little overblown? I'm betting (some of my recent winnings) on a rally tomorrow morning.

Things are never usually *that* bad.

Posted by: Jimmy (Bitter Renter) at September 29, 2008 12:35 PM

I really really hope I'm wrong and that everything turns out OK without a bill getting passed, but here's what I'm seeing:

*banks, including the safest banks that didn't make risky loans, are watching their deposits get sucked out into T-Bills, gold, etc..

*accountants, afraid of getting sued or looking less stern than the next guy, are making banks mark down almost all asset backed credit to levels that assume apocalypse scenarios.

*...which leaves banks dangerously undercapitalized and swiftly insolvent.

Panic has hit a high note. The longer it takes to get this thing passed, the more banks that will fail. I'm all for the necessary blood-letting after a boom, but know this: the collateral damage is going to be massive. It's not going to just hurt Wall Street. The pain is just weeks away from seriously affecting everyone.

Posted by: Jordan at September 29, 2008 12:38 PM

Agree wholeheartedly with enonymous. If President Lincoln would forgive the incomplete quote:

"It is for us the living, rather, to be dedicated here to the unfinished work which they who fought here have thus far so nobly advanced. It is rather for us to be here dedicated to the great task remaining before us -- that from these honored dead we take increased devotion to that cause for which they gave the last full measure of devotion -- that we here highly resolve that these dead shall not have died in vain -- that this nation, under God, shall have a new birth of freedom -- and that government of the people, by the people, for the people, shall not perish from the earth."

(All that being said, I am selling puts on the S&P here - full disclosure - because this decline might just scare them into doing something stupid like pass a slightly watered down bill, which will be worth a pretty big bounce. And don't forget the possibility now of "emergency" rate cut...)

Posted by: Satchel at September 29, 2008 12:40 PM

Satchel -- which broker do you use?

My crummy broker (Scottrade) wouldn't allow naked put selling as I was going to do a synthetic "long" on NCC (buy $2.50 call/sell $2.50 put), but couldn't.

Posted by: Jimmy (Bitter Renter) at September 29, 2008 12:44 PM

If some revised deal doesn't get passed, I'd also look for some other effort to "suspend" the mark to market accounting rules to avoid Jordan's second point and permit targeted entities to continue to pretend that certain instruments are worth more than they are.

Posted by: Trip at September 29, 2008 12:48 PM

Jimmy,

WAY OT (so please use scrollwheel instead of flaming if you don't care about trading).

I use Fidelity and e-trade, but my accounts are large, so I get all the goodies... You have to get prequalified to do naked options trading from the short side generally.

I like how you are getting into trading, Jimmy, but be careful (of course). The SEC with its shorting restrictions gave us those of us who knew it was coming a wonderful opportunity to set up shorts "against the box". Not all the commercial REITs have shorting restrictions yet (the SEC staff are not particularly savvy, and even let us get short GE and Capital None after the first go-around), although the most crappy of them do (like GGP, which was been an absolute joy to watch unravel...)

Posted by: Satchel at September 29, 2008 12:54 PM

I bought a lot of stock today with my cash reserves. Hope to see a nice bounce by the end of the week and watch my Q2 2010 home downpayment grow

Posted by: spencer at September 29, 2008 12:55 PM

1. I agree with those that say the bailout won't solve the problem
2. I do think it would prevent a lot of deadweight economic destruction.

The person who did the warren buffet post was pretty fun.

3. Abraham lincoln was a horrible presdident Satchel. good writer, but he was horrible otherwise.

Posted by: cooper at September 29, 2008 1:03 PM

Quote by Jimmy "If some revised deal doesn't get passed, I'd also look for some other effort to "suspend" the mark to market accounting rules to avoid Jordan's second point and permit targeted entities to continue to pretend that certain instruments are worth more than they are."

I am not completely sure but I was under the impression mark to market only applied to investment banks not regular banks. i.e. they had a little more leeway. I agree 100% that the rule was a bad one for securities that don't trade with liquidity. And last time I checked we had no more investment banks. Even if that's not true, the damage has been done on mark to market accounting for illiquid assets--not sure if eliminating the rule would really help confidence wise.

Posted by: cooper at September 29, 2008 1:10 PM

Warren Buffet is the man!

OK, maybe not for the 5Bil. I bet he'll call it a charity deduction on his tax return...

But more for his foresight:

http://www.reuters.com/article/newsOne/idUSN1837154020080918

Posted by: San FronziScheme at September 29, 2008 1:17 PM

Holy crap, the Fed is expanding TAF expanding TAF by $300 Billion to $450 Billion total. We don't need no stinkin' Paulson Plan. As I have previously pointed out the Fed has a little less than $300 Billion in Treasuries available (almost $200B are unavailable as they have been swapped out through TAF). Looks like the Treasury will continue to hold a bake sale for the Fed. Again I ask, do they need Congressional approval, or is this now the Ben and Hank show?

Posted by: EBGuy at September 29, 2008 1:18 PM

Panic has hit a high note. The longer it takes to get this thing passed, the more banks that will fail. I'm all for the necessary blood-letting after a boom, but know this: the collateral damage is going to be massive. It's not going to just hurt Wall Street. The pain is just weeks away from seriously affecting everyone.

This is my thought exactly. Let's face it, many of the people that caused all this are either going to get away with it (wall street wizards) or are already being punished (foreclosures).

There is no good solution, but congress is going to do something (free market extremists notwithstanding).

Posted by: anon at September 29, 2008 1:18 PM

Call your Representatives and Senators at 800-473-6711 or 202-224-3121 and say No Bailout!

Posted by: SAYnoTOpaulsonsPLUNDER at September 29, 2008 1:19 PM

We'll see if these new events affect the "Real SF" more than they do today. The "cash" market and the "rich foreigners" are probably taking a beating.

And last but not least: Google is under 400.

We'll see if Dub Dub's Google Lazy Indicator is proven right.

Posted by: San FronziScheme at September 29, 2008 1:23 PM

you do realize that both the dems and repubs that voted against this had done the calculation already:

i vote against, i stand on principles (or against this awfully constructed watered down crappy legislation - depending on which side of the aisle). the result will be a massive collapse in equity markets.
result - the number of constituents who wanted me to vote against will decline because people are weak and will yield in the face of pressure. a new bill will come up, i will then use that as cover to claim that we can pass it now because it is better legislation.

so really, this was a way to test the mettle of the average citizen. and now that the equity markets have tanked, people have turtled under.
shameful but expected.

Posted by: enonymous at September 29, 2008 1:24 PM

Sometimes people don't get it...

The credit bubble didn't just benefit few. It benefited everyone, in term of higher economic growth (comparing to if there was no bubble), which in term, created jobs.

Now, it is time to pay back - we will have to pay it back one way or the other, with each tax dollars, or very bad recession/depression.

The bailout is the best chance to have a smooth recession/recovery.

People saying bailout (nationalization) will be a disaster certainly never looked at world economy. Many countries have done it one way or the other, and there has never been a disaster that I know of.

Again, one example is China - 10 years ago, many economists said the Chinese banks have bad loans as high as 40% or higher, and urged Chinese government to let them shed blood. Instead, the Chinese government stood firm and put in more capital instead. Today, essentially the banks grow out of the mess, and arguably stronger than any banks in US.

An orderly free marketing is fine, but a panicking free market is a sure way to disaster.

Posted by: John at September 29, 2008 1:27 PM

enonymous, interesting contrarian view.

But whatever the outcome of the bailout, this won't change the fundamentals: RE prices and the underlying financing of them are overvalued and need to go down. No matter how it happens, this is necessary. Just let it go fast and it will rebound strongly otherwise this is Japan 1990s redux.

Posted by: San FronziScheme at September 29, 2008 1:28 PM

FASB 157 (requiring everyone to mark to market) is hurting everyone, including normal banks.

We've already had writedowns related to mortgages. The next shoe to drop is credit card/commercial real estate/student loan debt on the banks' balance sheet. Right now, they can't securitize anything. That means interest rates go up, and big. Panicked bankers are not going to be the ones to stop this rapid downward spiral.

Suspending mark to market accounting may not be enough to staunch the bleeding at this late stage.

This coming from someone who abhors socialism: the government needs to step in now and big. If not, we will quickly move towards an economy that requires purchasers to use cash because they won't be able to get access to credit.

When that happens, it will be too late for us to turn this ship around - we will already have hit the economic iceberg. Bush, Paulson and Bernanke need to start slamming Americans in the head with how bad it is right now, otherwise, this bill may not get passed.

I hate to sound so glum, but I'm getting the impression that many of you don't understand what bankers are seeing right now.

Posted by: Jordan at September 29, 2008 1:29 PM

If not, we will quickly move towards an economy that requires purchasers to use cash because they won't be able to get access to credit.

I think some of the extreme gold bugs want exactly this.

Posted by: anon at September 29, 2008 1:36 PM

"we will quickly move towards an economy that requires purchasers to use cash"

It's called "act your wage". If you're using debt for your day-to-day expenses, there's nothing we can do about that now, can we?

Of course you could be using debt to buy food because you overpaid for property. That's another story unraveling as we speak.

Posted by: San FronziScheme at September 29, 2008 1:38 PM

so I guess we can forget about rearranging the deck chairs and just cross dress and jump in the lifeboats

Posted by: irreverent at September 29, 2008 1:43 PM

It's called "act your wage". If you're using debt for your day-to-day expenses, there's nothing we can do about that now, can we?

Makes.No.Sense.At.All.

So we'll all buy houses for cash? and cars? Let's all just move back to farms and grow our own food while we're at it.

Posted by: anon at September 29, 2008 1:43 PM

So we'll all buy houses for cash?

Interesting you mention this. Because ultimately you're supposed to buy a house with cash. Deferred cash, but cash nonetheless.

Of course in these years of 30/40 years mortgages and Interest Only loans, NOBODY expects to pay his house in full. Everyone expects inflation of appreciation to "bail them out" of an insane amount of debt.

Posted by: San FronziScheme at September 29, 2008 1:49 PM

This is like when your dad comes after you with the belt and he slips and falls on his way after you. You want to laugh, but you know deep down inside that you're gonna get it even worse, now.

What a wonderful time this was. Less productive members of society could live better than more productive ones. I'm shocked, shocked, that the economy is now suffering, with the near complete misallocation of resources in that fashion. We borrowed our way to get there and have no way to pay now that the bill is coming due. So the solution is to borrow even more (from ourselves!) and to give it all to bankers? Not. Going. To. Solve. The. Problem. It will fend it off until after the election, but other than that it's worthless.

BTW, I fess up: I was the poster behind the Warren Buffet post at 11:47. It was either going to be me or diemos: I just beat him to it.

Posted by: tipster at September 29, 2008 1:50 PM

I hate to sound so glum, but I'm getting the impression that many of you don't understand what bankers are seeing right now.

First of all, I have been arguing your position for a while (that people are neglecting how painful a crash in the credit markets will be). You can see my previous posts on the previous threads about it.

That said, I couldn't care less what the bankers see now. In the recent past they were either blind or stupid or greedy, and that led us to our situation today. So part of the problem is that people don't want to see what the bankers see-since that's clearly the path of foolishness, greed, or blindness.

Unfortunately, the proposed bill will only enrich Wall St (those that are culpable) without solving the problem.

doubly unfortunate: there probably isn't a solution. the solution was to never allow ourselves to get where we are.

regardless: I'm sure Congress will eventually throw tons of money into this problem. It'll start with $700B, but that's nowhere near enough. we'd probably need about $2-7 Trillion to "solve" the problem, depending on whose math you use.

Posted by: ex SF-er at September 29, 2008 1:54 PM

I agree with Jordan that the government needs to play an active roll in getting us out of this mess, BUT I don't think what's being proposed is the right plan.

Buying up the bad debt of lenders who made bad risk/reward bets is not the only means by which we can prop up the credit markets. Create a program to insure lenders who extend credit based on strict lending standards and watch the capital flow.

Posted by: Michael at September 29, 2008 1:54 PM

So if nothing passes, what happens? I'm not an expert but suppose:

the stock market drops another 2000 points

credit freezes up completely (no mortgages, no car loans, no business loans)

the LIBOR soars

etc...

Is that worse than the bailout? I'd say yes. And just to keep it in perspective, we've spent 700 billion on the war already, the defense budget is close to 500 billion a year.

Posted by: anon at September 29, 2008 1:58 PM

No home loans, no student loans, no new jobs, layoffs, record foreclosures, failure of small businesses,retirement accounts wiped out, a guaranteed recession and possibly the next Great Depression.

Yea, vote no Wall Street bailout.

Unbelievable.

Posted by: Flabbergasted at September 29, 2008 2:04 PM

Trying to prop up the markets is short-sighted and will just delay the inevitable.

A lot of the RE wealth built for the past 7 years did not exist. It was mostly funny money. Only the cash of the people who cashed out last actually exists, and even that is not 100% safe (100K FDIC insurance for less and less banks = not many places to hide)

Posted by: San FronziScheme at September 29, 2008 2:05 PM

"And just to keep it in perspective, we've spent 700 billion on the war already, the defense budget is close to 500 billion a year."

Thanks for the perspective. I hadn't realized just how much 700 billion is until reading this.

Gee whiz, how did we get ourselves into this financial mess? Beats me, but I'm heading down to the bank to see how much I can borrow before it is too late!

Posted by: location at September 29, 2008 2:05 PM

Credit should remain available unless the Chinese change their mind about investing their huge surpluses in the US.

And where else would they invest them? China itself is not safe because it still is mostly government run with endemic corruption, Argentina has given South America a bad rep, Putin has shown that any successful venture may be seized in Russia, and Europe faces the very same problems the US faces.

Posted by: flaneur at September 29, 2008 2:06 PM

How is this downturn of our economy going to affect san francisco housing prices? Can anyone make a prediction as to what is going to happen with prices at new condo developments in san francisco? I know they have been reduced, but what are we looking at? 10 percent 15 percent 30 percent? I was thinking about buying a condo at one ecker but the prices are still high. Anyone want to share some advice. thank you

Posted by: newinthemarket at September 29, 2008 2:12 PM

Michael:

Insuring lenders won't help if they don't have the capital to make loans!

Keep in mind, the assets that are currently hurting us so badly have been mostly written down to levels that are blind to any fundamentals. I'm seeing AAA-rated mortgage backed bonds (Alt A) trading at 40-50 cents on the dollar. For one particular issue I looked at today, 5% of the underlying loans are delinquent and there are no option-ARMs in the portfolio.

You can buy this today and not lose a penny of your investment, even if over 80% of the loans eventually default and you only collect 50% on the defaulted loans. On top of that, you get a 15%+ yield. (the numbers are all approximate because there is no real market for these assets, regardless of their intrinsic value)

These are the kinds of assets that the government would be purchasing. Unless you see the end of the world coming, the taxpayer would make money on credits like these, especially if the government is not permitted to buy these at a premium to their current marks (which I believe the bill would have required)

This just highlights the extreme levels of fear in the market. No one is buying. If the government doesn't intervene, this only gets worse.

Panic isn't stopped by panicked investors. Panic is stopped by an entity with a long time horizon and a big balance sheet. Right now, the government is the only player who fits that profile.

Posted by: Jordan at September 29, 2008 2:12 PM

I have been in the camp that believed that the government had not sufficiently made the case for such a massive bailout. The events of the last several days have changed my mind. I read today that banks across Europe are collapsing.

That said, the original bailout plan was conceived too quickly, was too favorable to the finance companies and gave too much power to one person. The revised plan was an improvement but was still insufficient.

There is no doubt that a bailout/rescue bill of some type will be passed before Congress leaves town. However, the odds have improved that we will see a plan that gives taxpayers a better shake.

As much as I hate the idea of a bailout, the alternative would likely be very painful for most of us who read this blog. Very few of us will enjoy Schadenfreude if the economy takes an excessively hard landing.

This isn't about propping-up the housing market...that's probably toast for the next 2 to 3 years at least. Home prices are going to have to reach an equilibrium level and this bailout plan is not designed to keep that from happening.

Posted by: SausalitoRes at September 29, 2008 2:16 PM

Jordan,

These numbers are very interesting.

But you're not accounting for the fact that this whole mess is still unraveling. RE prices could still go down and the feedback loop from the consumer/homeowner is not yet 100% at play.

When more people have lost their jobs, been squeezed by higher payments (Alt A resets are not flushed yet, CC rates are shooting up), then you could see more defaults. This is a slo-mo train wreck.

Posted by: San FronziScheme at September 29, 2008 2:19 PM

No home loans, no student loans, no new jobs, layoffs, record foreclosures, failure of small businesses,retirement accounts wiped out, a guaranteed recession and possibly the next Great Depression.

Unfortunately, the bailout as proposed would not have stopped any of this. we would have spent $700B and still had all the above.

Posted by: ex SF-er at September 29, 2008 2:21 PM

flaneur,

"Credit should remain available unless the Chinese change their mind about investing their huge surpluses in the US."

It's not as easy as that, unfortunately. As the world economy downshifts dramatically, much of the "surpluses" that China has been running will disappear. I think we will discover in short order that it really wasn't Chinese "savings". They are a growing economy, with a limited system of financial intermediation and tremendous poverty still, and they have been going flat out investing in their own country.

Much of the "savings" has been an illusion. They are the flip side of our trade balance. We borrow dollars against our houses and assets. We then ue those dollars to buy Vhinese goods. Chinese exporters give those dollars to their central bank. Their central bank "prints" yuan to give to the exporters, who then spend those yuan in domestic investment and consumption. This leads to price inflation in China (because the central bank is printing) and credit inflation in the US. The price inflation in China ultimately destabilizes their economy because of the pressure on profits and on the population. The credit inflation in the US leads to asset bubbles that are unsustainable in that the credit used to elevate the price cannot be repaid out of income. And around it goes.

When the lenders fear they will not be repaid (whether in the US or in China), and the producers cannot profitably run their businesses and/or the population cannot afford to eat (this is starting to be the case in China), the system collapses. All ponzi schemes end, and the fact that this one is collapsing at record low real interest rate levels should tell us volumes about what a mess the Fed has created by consistently trying to force real interest rates below their equilibrium level for so long. Those who on this blog used to argue that the Fed is so much smarter now than in the 1930s should really think about where we have arrived after all this "smart tinkering".

Any attempt to seriously "inflate" away the problem spooks the lenders and they stop lending. Deflation assures that the creditors are at least partially repaid with valuable currency, but it is extraordinarily painful to those leveraged buyers who were counting on "inflation" to bail them out, and iof course certain creditors will be out of luck anyway.

And so, we are at a macroeconomic impasse. I firmly believe that the guys who got us into this mess are not going to be able to get us out. But they sure will try!

Posted by: Satchel at September 29, 2008 2:22 PM

Agree with Jordan 2:12.

An article in today's Barron's On-line (Making a Mine by Jonathan R. Laing) makes the argument that the Treasury could achieve positive carry of around 7%-8% (their borrowing cost is 3% to 4%). He says that most of the paper held by banks consists of the highest-grade tranches of subprime and Alt-A...therefore likely to suffer limited losses and repay more than $0.65.

I can't evaluate whether these claims are true, but they seem to fit with what Jordan is saying.

Posted by: SausalitoRes at September 29, 2008 2:26 PM

SFS said "When more people have lost their jobs..."

That's exactly the point.

It is not about the RE market anymore. it is about the economy.

You think it is all about the stock market? Well, people are losing jobs with or without the bailout...except, with the bailout, the unemployment rate will probably go to 7% to 8%. Without the bailout, we will get 10% to 25% unemployment rate, and the economy probably stay down for 20 years, and we may get a WW3.

That was how the free market worked during the Great Depression.

Forget about RE market...without job market, nobody is going to come out ahead.

Posted by: John at September 29, 2008 2:26 PM

Satchel,

I really hope you are just talking your book here and are hoping to make money off of this. No, I don't care that you 'said' you are selling puts. Either way, I have no respect for you any longer.

I hope everyone on this board reads your posts at the start of this thread again, where you hope that this bill doesn't get done, (I agree wholeheartedly with enonymous...) and then read what you foresee happening as the 'ponzi scheme collapses'. It is clear that you are hoping against a potential solution to the problem.

Nonetheless, you are entitled to your opinion. I just hope everyone is clear about how you feel.

I'm done discussing this. I'm disgusted by what I've read here today.

Posted by: Jordan at September 29, 2008 2:35 PM

I'm sure there are some very good loans out there. But you can be sure there are some very bad ones.

Now, faced with the prospect of selling one or the other, which ones do you think the banks will keep.

And if they want to sell off loans like that, there are *plenty* of people who will buy them today. And if they have been writing those loans way down, when the sell them they can realize big gains. The problem is that the banks don't want to sell THOSE loans, they want to sell the crap. And there is no one who will buy the crap loans today. So the government is supposed to step in?

Posted by: tipster at September 29, 2008 2:35 PM

Without the bailout, we will get 10% to 25% unemployment rate, and the economy probably stay down for 20 years, and we may get a WW3.

No. The Great Depression was all about not letting the whole thing collapse from its own weight. Let RE go full circle back where it belongs. Let banks realize their losses.

Posted by: San FronziScheme at September 29, 2008 3:02 PM

Wow, everyone is testy today!

"No, I don't care that you 'said' you are selling puts."

Yes, Jordan, I did sell puts today. 50 contracts on the October 110 put on the SPY (basically corresponding with 1100 on the S&P), at a price of $4.60, filled at reported 3:31pm (NYC time), for a total premium of $22,922.50 (after commission), or 4.17% of the notional amount of $550,000. This is a medium sized trade for me, and I will risk a loss of approximately $25,000 before being stopped out of the trade. I like my odds on this. I'm not talking my book (and I am NOT recommending anyone do anything based on what a random blogger writes - please consult a licensed options broker before engaging in any options transaction, etc.). Just full disclosure.

Now, I still can't get over how everyone keeps looking to government to SOLVE the problem. The government (and the Fed) got us into this mess!!

I checked to be sure, but these are the major recessions and depressions since the beginning of the Republic to the immediate postwar period:

Panic of 1797
Panic of 1807
Panic of 1819
Panic of 1837
Panic of 1857
Depression of 1873-1896 (including Panics of 1873 and 1896)
Panic of 1907
Depression of 1920-21
Great Depression of 1929-1940 (including the Great Collapse of 1929-1933 and Recession of 1937-38)
Recession of 1953

In that time, the US went from being an empire wilderness to being the most powerful country on the face of the earth on any number of measures. We created more wealth and a better standard of living for more people more quickly than any country in recorded history. And, at least until Hoover's tinkering in 1929 (followed by FDR's basic seizure of the economy), the USG largely just let these panics and recessions/depressions happen.

No big deal. We'll get through this, we always do. Far from being the end of the world type I am always portrayed as, I am still moderately bullish on the US. We just need to take our medicine and stop bellyaching about it. Most of the jobs that will be lost are unproductive ones that should be lost. If we really care about individuals, we should allow real wages to fall, and cut taxes on capital formation. It's better to have 3 people working at $12 per hour in a deflating world, than to have 1 person working at $36 per hour and being taxed to death to support the 2 who have to sit home.

Posted by: Satchel at September 29, 2008 3:12 PM

Obviously a lot of people are spooked by an 800 point drop in the Dow. But as I've said before, this bill is all about politics. Look for some immaterially re-vamped bill (perhaps some added bit of oversight), then enough "nay" reps can claim NOW it is good enough -- thank god you had me protecting the public interest. And it will also pass the Senate, where you don't have everybody running for re-election.

We're in for a world of hurt regardless of this bill. But we need it -- the debate is whether it is better to rip off the bandage all at once or slowly over several years.

Posted by: Trip at September 29, 2008 3:15 PM


"Most of the jobs that will be lost are unproductive ones that should be lost."

What, like sitting at a computer making trades for profit and not actually producing anything tangible for the benefit of the society as a whole?

Isn't that the type of self-serving behavior that has allowed the US to become a banana republic today?

What happened to Americans actually making sh*t? Instead of trading puts, buys, sells, cdos, cdss, and everything else of a financial hocus pocus that has brought the US to the brink of a catastrophe.

Country First indeed. My ass it is.

ME first, screw everyone and everything else.

Posted by: Army Geddon at September 29, 2008 3:26 PM

I was in your camp, Trip. But I check the comments from both extremes: SFgate readers and WSJ readers. Almost everyone is still hopping mad and very much opposed to any bailout. I think the congress is seriously worried about their jobs.

I think they have every right to be worried.

Posted by: tipster at September 29, 2008 3:27 PM

Satchel said: "Now, I still can't get over how everyone keeps looking to government to SOLVE the problem. The government (and the Fed) got us into this mess!!"

Uh, what about the deadbeat borrowers who borrowed money on fake incomes and assets? Or bought option arms with no prospect of being able to pay them back? All the while raising asset prices in real estate and the rest of the economy hmm Mr Secretary?

The point of this whole thing is to make the decline in asset prices orderly. Otherwise you have a lot of economic destruction that is "deadweight". i.e. actaully destruction of healthy business activity. It takes a LONG time to build that back up. That's why I am in favor of SOME kind of bailout to make markets orderly.

The Fed put in what --700 billion almost of cash into the system? Almost no impact. We need some way to loosen the market just a bit so it starts to flow again. The prices are still going to keep going down. As well they should but some sort of bill is needed to prevent good businesses from vaporizing.

p.s. I sold about 500 puts today too. But it was against long puts I had. I am kinda regretting it as I think this thing has a few more days possibly of -700 point days. Maybe I will get lucky and the market will open with a rebound. Not likely tho.

Posted by: cooper at September 29, 2008 3:35 PM

By the way, when I said "we need it" up above, I didn't mean the bailout bill but the inevitable and painful correction. The pain cannot be eliminated or even reduced by any government action, just (at most) delayed or prolonged.

Army Geddon, we've been a service-based economy for at least 50 years. "Making stuff" is not the only productive use of talents or capital.

Posted by: Trip at September 29, 2008 3:35 PM

"What, like sitting at a computer making trades for profit and not actually producing anything tangible for the benefit of the society as a whole?"

I totally agree! But that's what I am good at. I'm responding to the incentives the Fed and the USG set up for me. I went "where the money was". I often wonder what I would have done if the markets hadn't been there....maybe something really productive? Well, all I can say is that when I was trading professionally I met and worked with some extraordinarily smart people. We all could have done something more productive for society. Allow this foolishness to collapse and the next generation of "us" will!

Posted by: Satchel at September 29, 2008 3:36 PM

I am saddened (but not surprised) by how many people are upset now that the equity markets have tanked. Until they did, everyone seemed to be against the bailout. Now, all of a sudden, they are crying about the pain.

Again, full disclosure:
I am long equity markets. I am a buy and hold investor. I am not smart enough, nor do I have the time to use options, engage in security selection or market timing. I am a homeowner.

I am not interested in [schadenfreude]. I am interested in maintaining some semblance of a capitalist market that can and will allocate our resources efficiently. I will hurt deeply if the equity markets continue tanking, but the pain is in the short run. Years from now, this too shall pass. Stay the course.

But in the meantime, how can anyone honestly claim that this intervetion is a good one. It should be noted that those on the idealogical far left and far right came together to scuttle this monstrosity of legislation. When the far left and far right agree it is usally because both liberty and justice are under attack. Remember this fact.

If you are willing to trade your financial sense of well being for liberty and justice, then please, identify yourself as for this bailout package.

In the end we all want a fair and healthy economy. Throwing 700 billion into a terrible and hastily concocted piece of legislation does not accomplish any of our goals. How many of you have actually read the legislation?

Posted by: enonymous at September 29, 2008 3:37 PM

If the Fed/Treasury couldn't solve anything with 300 billion (Bear + Fannie + Freddie + AIG ), and recent WAMU and Wachovia transactions, then why do they need 700 billion $. This is completely political and I would say corrupt. This administration understand that fear-mongering can get american people do anything for them. Didn't we fall in the same trap 5 years ago for an Iraq War?????

Now there it goes again, different words but same result..WWIII, Great-depression.

How can I even trust the same people who got us into this mess? If needed, I would give money to someone else to clean this mess. I am not dumb to make same mistake and I hope my congressmen is not either. Oh well, Nancy Pelosi already voted for it.

Posted by: SFwatcher at September 29, 2008 3:38 PM

Enonymous-

You should never ever be a "buy and hold investor". That's just some free financial advice. If you can't watch your money then buy t-bills and hold on to em like a squirrel holds on to nuts.

Now- the reason to do this bill is not to stop the decline in asset prices. but to make sure the credit markets can continue to function so healthy parts of the economy don't get destroyed. Should we stop farming just because of this banking crap?

What happens if a farmer cant get money for fertilizer? That means less food and higher food prices and it takes longer to ramp up production when the economy does return. Thats an economic deadweight loss as a result of an expected decline in the over leveraged areas.

Anyway-you wanted an argument for this bill- that's one. We need credit market to work for the non impaired areas of the economy that need to grow and should grow.


Posted by: cooper at September 29, 2008 3:42 PM

actually, Satchel, an efficient market hypothesis believer (like me) needs traders to determine valuations and thereby set resource allocations as appropriate. unless the lot of you are always wrong, in which case it isn't useful and productive. but then the comeuppance will find you.

Posted by: enonymous at September 29, 2008 3:43 PM

cooper-

i am an intelligent asset allocating investor. i rebalance. i have studied asset class theory. i understand risk premia in detail. quite frankly, security selection and market timing do not work for the overwhelming number of individual investors (too many academic studies to name to support this finding!). Satchel may be different, but none of us know that for sure. People (maybe even Satchel) are incredibly good about compartmentalizing and ignoring their losses. Trust me, I have no need for your financial advice, but thanks anyway.

sorry i typo'd schadenfreude - such a wonderful word - to be butchered by me is pure horror.

Posted by: enonymous at September 29, 2008 3:48 PM

I thought this article and the supporting IMF study were informative. I'm not sure what the best option is, but it's pretty clear that the proposed plan was not the right move.

http://www.guardian.co.uk/commentisfree/2008/sep/29/wallstreet.useconomy

Posted by: Publius at September 29, 2008 3:50 PM

Enon-- the ideas of Asset allocation and "intelligent investor" can't really coexisit. Long term buy and hold is really one of the worst frauds ever to be sold to poor suckers. Doesn't matter if you have 5 million or 200 million it's always bad --if you are talking equity. you gots to watch your stuff minute by minute in markets like this or pay someone else to.

Anyway...you didn't respond to my reasoning as to why the bailout is a good idea. Sounds like you are just ignoring the good reasons for a bill to try and make the recession a bit more orderly.

Posted by: cooper at September 29, 2008 3:56 PM

By Publius:
I thought this article and the supporting IMF study were informative. I'm not sure what the best option is, but it's pretty clear that the proposed plan was not the right move.

http://www.guardian.co.uk/commentisfree/2008/sep/29/wallstreet.useconomy

----------------------------------
First of all nice article. I had not seen this. Nouriel is often difficult to listen to but he os iften right so its worth reading the article. However, his main point seems to be that the best bailout model is the Scandnivaian one which was buying preferred eequity in the banks immediately. But if you actually read the legistlation today preferred equity is in this bill as long as you are above 100 billion. And I think under that the SOT can issue a waiver.

I don't get why people who are opposed to the bill think that preferred equity is somehow gonna make the damn thing so much better. Look its a crappy bill either way but beter then nothing -- I don't want to see people making food/commodtiies or other things we are going to need have a credit problem.

p.s. for those startup minded people reading. What a great time to start a bank eh?

Posted by: cooper at September 29, 2008 4:15 PM

enonymous,

The efficient market hypothesis is not inconsistent with some people making outsized returns. All it really implies is that in an efficient market, those people who CAN consistently make money will be rewarded, and those who cannot will do worse than the "market" (whichever one we are talking about).

It's similar to the reasoning (I forget which finance guy put it forth) that any market can be bifurcated into "active" and "passive" segments. By definition of course, returns to the pool of "active" investors must equal the returns for "passive" investors (ignoring trading costs). Of course this by definition implies that certain active investors do "better" than other active investors. Now, how much data is required before one can say outsized returns to a particular investor result from an innate "edge" (could be anything - in my case, it's discipline I think, at least to the extent that any edge I have proves to be real) is difficult to pin down, and may ecompass more observations than a trading career, as you know!

BTW, I am pretty rational. We all have biases of course as human beings, but being aware of the major ones (compartmentalizing, loss aversion, decreasing marginal utility of gains versus increasing pain of loss (non linear loss function), availability and representativeness heuristics, etc.) helps me overcome them (or at least try to). It sound like you are an academic finance guy, so I'm sure you understand these better than I do!

Posted by: Satchel at September 29, 2008 4:35 PM

And, enonynous, thanks for putting in a kind word for speculators. If SF houses could have been sold short, I can guarantee you that a lot of people would have been saved a lot of pain that is coming (they would have been knocked down to lower prices, and therefore many fewer people would have "top ticked" the market!).

Posted by: Satchel at September 29, 2008 4:39 PM

cooper -

Roubini is very critical of the idea of recapitilization by the purchase of toxic assets (at least any more than $175B). Roubini goes on to state that where the purchase toxic assets has occured the fiscal cost was much higher (than it could/should have been?). Maybe I have an older verion of the proposed bill, but all I see is the purchase and insurance of "troubled assets." Please let me know if I have missed it.

Do you really think this proposed bill is the best way to deal with the situation?

Posted by: Publius at September 29, 2008 4:44 PM

Satchel - "Now, I still can't get over how everyone keeps looking to government to SOLVE the problem. The government (and the Fed) got us into this mess!!"

Even if you count Freddie and Fannie as the USG, they weren't the ones that "got us into this mess." Most of the bad lending was done by private institutions. The way in which the government/Fed "got us into this mess" was by sitting on the sidelines and doing nothing while the bubble built up. So now that we got into this mess from the government not intervening, your solution is...for the government to not intervene.

Look, no one rational claiming that any government intervention will make things better - clearly doing it in a stupid way could make things worse (possibly much worse). But your argument above doesn't make any sense...it's just a vacuous sound bite that has no inherent logic once you think about what it means.


Posted by: gmh at September 29, 2008 4:51 PM

publius:

The version I have says he favors the Scandinavian version of the bailot which is buying equity straight up. He basically says if you look at like 80 bailouts this is the model that works the best. I agree that's true and its a lot more efficient. If you buy debt it only allows the bank to buy more debt or sit on its ass while it waits to recapitlize itself.

I don't think the proposed bill is the best way to be honest but often in politics you gotta go with what you can get. Is the GOP gonna go along with a preferred equity plan? I dunno. When I listend to paulson it sounded like he was going to propose something brand new--maybe--if he does I'd like to see an equity based plan.

If I had to do a plan I'd do two things:

1) Raise the FDIC cap to 1 million bucks. This keeps runs on banks from happening which means we need fewer bailouts.
2) I'd do 250 billion in preferred equity instead of debt.

From a pure economic point of view. It's the best way to go.

Now --for those who actaully are against any bailout. I'd like to know why you think every other country has gone and bailed out its banks and somehow the US should be exempt from having to do this.

Posted by: cooper at September 29, 2008 4:53 PM

cooper -

The problem is the way this has been sold. Even use of the word "bailout" is a problem. Why do taxpayers need to "bailout" the banks? And I believe the purchase of toxic assets is exactly that -- a bailout.

If government intervention is required here, it needs to be sold to the public as "freeing up the credit markets." People understand that credit is necessary to run businesses, buy homes, etc. The worst thing that can happen from the politicians perspective is to support a "bailout" that fails. Too many angry voters would result.

Posted by: Publius at September 29, 2008 5:09 PM

gmh,

This entire mess comes down to one core problem. Everything else flowed from this (and I agree, there were numerous actors, including greedy homeowners, but as a mass all these actors were just responding to the signals created by this core "problem").

In my view this core problem was (just as in the 1920s) the repeated and successful attempts by the Fed and the USG to encourage credit creation by driving down the cost of credit to below that rate that would otherwise prevail in a more sound monetary system.

Now, I don't really feel like debating this idea on the blog, but I would encourage people who are intrigued by this idea (and can see logically how it has led (1) to the encouragement of asset inflation and a desire to ensure ever higher asset prices against which to lend and (2) a systematic distortion of the real economy in the direction of those nonoptimal activities that surround those rising assets - such as housing and Wall Street and rampant consumerism to name just a few distortions), to read the works of von Mises and Hayek. There are others of course (Minsky, de Soto, etc) and I can't say I've read everything of course, but clearly more than most have. I've found their framework very helpful to my trading and thinking on how to position investment-wise over the years.

Posted by: Satchel at September 29, 2008 5:09 PM

this sucks. the economy stinks, and the housing market is crazy, but you know I am pretty young, I am sure I'll see it go back up and maybe even down again.

My great grandmother who just turned 98 gave me some eye opening information the otherday over lunch. She said when her and my great grandfather bought there last house in 1959 for $88k they didnt see it go up in value for at least 5 years. And even after that it maybe went up 1k or so a year. It wasent until the 80's thru 2006 where it took HUGE jumps, up to the several million dollars that it was worth in 2006. Now maybe a million less than the peak but still huge. Long story short I think we all knew the bubble was going to pop, and we shouldn't be all that surprised. All this equity gain wasn't going to last forever.

Back to the topic at hand: I think throwing 700B at the problem is like putting a band aid on a broken bone (said before) and I hope that the people representing us in Washington can come up with a much better long term solution... I hope.

Posted by: Ryan at September 29, 2008 5:10 PM

Ryan,

Your great grandmother's house must be a really nice place (btw, sensible perspective, and kudos for timing the beginning of the great credit inflation perfectly - early- to mid-1980s). Could you share some details about the purchase in 1959 (where, how big, etc.)? I'm fascinated by this stuff.

As I've posted before, I'll share my living arrangement and purchase price. I rent an expanded 3/2 1950s ranch in a nice part of Tiburon. It's one of the less expensive houses on the street, but would sell for about $1.2M now. It sold new to the father of my landlord for $14,000 in 1954 or thereabouts, so very much less than your great grandmother's I guess. I'm renting it for $2800/mo. (just signed a two year lease this past July).

Posted by: Satchel at September 29, 2008 5:18 PM

Publius- I agree with your comment but it's a republic and people should vote for what is best for the country not necessarily what people want at a given second.

I think it was satchel who just said a cause of the great depression was expansion of monetary supply to drive up asset prices. Actually we were on a partial gold standard. And the monetary based decreased by 1/3rd from 1929 which is what many believe caused it to turn into a depression. You can't inflate the money supply if you are on a gold standard. Just hate seeing all this misinformation out there.

Posted by: cooper at September 29, 2008 5:21 PM

"You can't inflate the money supply if you are on a gold standard. Just hate seeing all this misinformation out there."

cooper, stop this now. I don't mind the flame wars and fights, but please stop being so sloppy and confusing everybody. The money supply as you know can be defined many ways including BANK CREDIT. Are you saying that under a gold standard, you cannot have expansion of bank credit, for instance? What do you think led to all the bank panics of the 19th century - wasn't it usually bank depositors demanding their deposits back (convertable into specie because we were on a gold standard), and wasn't the problem that the bank had lent out (ie, increased the money supply) some multiple of the notes/specie in the vault??

Please, just stop it. You really do not understand this stuff - I don't know how else to break it to you and you are confusing the issues.

(BTW, why are you worried about a failure of the bailout bill. Can't the Fed just give everybody a credit card, buy up all the bad debts itslef, and ensure that everything will keep functioning? I mean, it would be messy, but no worse than where we are now!)

Posted by: Satchel at September 29, 2008 5:34 PM

Jordan, I think I might be the only one on this thread who agrees with you-- something has to be passed and will be this week. Yes, the Dow down 777 is newsworthy and is causing pain out there, but the bigger problem is what has been going on every day in the fixed income markets. Nothing is trading-- you can't trade tbills right now. This really is one of those cases where failure is not an option-- and I'm not talking about just the stock market or real estate market, but for the broader economy as a whole.

Posted by: anon111 at September 29, 2008 6:12 PM

Satchel-

Their home is a rather modest 1940's SFH close to the end of Jackson street (almost) backing up to the Presido. Just under 4,000sf and on about a 9,000sf lot. It's had about $325k in renovation over the last 50 years. I am sure today listed would command somewhere in 5-6MM range, and in 06 maybe even 6MM+

But it's one of those properties that I am sure will never be sold, sentimental properties have no price tag. Its something I would love to see stay in our family for many more years to come.

Posted by: Ryan at September 29, 2008 6:21 PM

Another way of looking at the mess is that we end up paying if there is a liquidity injection or not, so that part doesn't matter so much. What does matter are the systemic details that came undone.

Appraisals became useless numbers bought and sold along with the properties they pretended to represent. Rigorous oversight of appraisals was attempted after the 1980s blow out, but failed because of lack of staff and any useful way of forcing discipline on bad players.

German banks thought they ended up owning large sections of Cleveland, and they did get some, but in many cases posession of titles to these homes has become ambiguous.

Simply insisting on some mechanism for public disclosure of appraisals and more thorough and robust checking of title transfers could entirely change the market. To bail out or not isn't really relevant relative to how we choose to structure property transactions and set values of assets.

Posted by: Mole Man at September 29, 2008 6:50 PM

Satchel
1. the money supply as measured went down by 1/3rd from 1929.
2. It's possible to have credit but you can't print money like you can in the traditional sense with a flexible exchange rate. It's really quite limited.

That's why people often argue going to a gold standard--to stop the government from printing money. Comparing printing money now--to then is really not even possible given the markets are completely different.

As for why I am concerned about the bailout bill, if I already said why. Good busiensses can't get credit.

You are too fixated on the Fed without actually understanding it. That's why you missed what I wrote and got confused about buying Tbills from the Fed as opposed to the open market or the government and why you thought an act of congress was required for AIG. I think you even made a commment once the FEd was a private institution owned by the shareholders (in fairness that might have been someone else but I wouldn't be surprsied if that was you too).

I think daytraders or whatever are cool and have lots of good ideas but I think doing some research before posting here and spreading bad info is not helpful to people understanding stuff.

Here is a link on the gold standard for those interested. The government can't inflate the money supply on a gold stanard and as you can see from teh bullet from berkley-- the lack of the ability of the government to grow money supply is what most people say caused the great depression. i.e. the opposite of what satchel said.

--http://econ161.berkeley.edu/Politics/whynotthegoldstandard.html

and an excerpt from the berkley link below:

* Commitment to the gold standard prevented Federal Reserve action to expand the money supply in 1930 and 1931--and forced President Hoover into destructive attempts at budget-balancing in order to avoid a gold standard-generated run on the dollar.
* Commitment to the gold standard left countries vulnerable to "runs" on their currencies--Mexico in January of 1995 writ very, very large. Such a run, and even the fear that there might be a future run, boosted unemployment and amplified business cycles during the gold standard era.
* The standard interpretation of the Depression, dating back to Milton Friedman and Anna Schwartz's Monetary History of the United States, is that the Federal Reserve could have but for some mysterious reason did not boost the money supply to cure the Depression; but Friedman and Schwartz do not stress the role played by the gold standard in tieing the Federal Reserve's hands--the "golden fetters" of Eichengreen.
* Friedman was and is aware of the role played by the gold standard--hence his long time advocacy of floating exchange rates, the antithesis of the gold standard.

Posted by: [cooper] at September 29, 2008 6:55 PM

cooper,

I assume you wrote the above post, because it was not me :)

If the "money supply" (note - not defined) went "down" from 1929-1933 (which on many measures, such as the monetary base, it did), couldn't it go up? Was gold physically destroyed? No, of course not. Demand for money went down, and that's what caused the money supply (as measured by the base) to go down in those years.

Note, in my original post above that you, cooper, again misrepresented, I said:

"In my view this core problem was (just as in the 1920s) the repeated and successful attempts by the Fed and the USG to encourage credit creation by driving down the cost of credit to below that rate that would otherwise prevail in a more sound monetary system."

I specifically noted the attempt in the 1920s to encourage CREDIT creation, and said nothing about money supply. Again, cooper chimed in with a misrepresentation (that I said the "money supply" went up - that did too btw in the 1920s, even under a gold standard of course), a misunderstanding (namely, that credit creation is not a component of broad "money supply"), and basically a confusion about how credit is created and encouraged.

About the cite to the Berkeley professor's piece about the Great Depression and the role of the fall of base money in the collapse of 1929-1933, I would recommend as an alternative explanation Murray Rothbard's excellent treatment of the whole period, "America's Great Depression" (available on the web in pdf). I know many of the professors at Berkeley and IMO it is not a strong department (and in finance it is quite poor, although there are a few shining stars, and Terry Odean in particular has done some great work there).

And with that, cooper, I would like to thank you. I have been looking for an appropriate time to exit this blog, and this sort of nonsense is exhausting. I do have a number of other things to do, I have posted WAY too much on this blog, and obviously I have become too much of a distraction, and for that I'm sorry to all.

Don't worry. When I get bullish on SF real estate, I will reappear! Until then, I would like to thank everyone for a very stimulating exchange of ideas these last 10 months or so, and wish everyone best of luck!

Posted by: Satchel at September 29, 2008 7:21 PM

Ciao Satchel,

Drop in and say hi from time to time.

Posted by: diemos at September 29, 2008 7:30 PM

Satchel, your thoughts are one of the reasons I visit this site everyday. Thanks for sharing your time.

Posted by: Justin at September 29, 2008 7:33 PM

Satchel,
Ditto to what Justin said. As a frequent reader and seldom poster, I have very much enjoyed your insights. You, Ex-SFer, Diemos, Trip, tipster, SanFronz, Epon, FSBO, and a few others make this blog. Will look forward to your return when you are bullish on SF (Spring 2010?)...

Posted by: WestPortal at September 29, 2008 8:17 PM

Any analysis on who won Cooper Vs. Satchel?

Also,

"security selection and market timing do not work for the overwhelming number of individual investors (too many academic studies to name to support this finding!). Satchel may be different, but none of us know that for sure."

There is a great site called covestor where you can make your trades public and follow others:

http://www.covestor.com/

Maybe Satchel, Ex-Sfer, etc. will humor us sometime.

Posted by: So at September 29, 2008 8:27 PM

Thanks satchel, and good luck!

I don't know Brad DeLong, but a quick search gives some info:

"J. Bradford DeLong is a professor of economics at the University of California at Berkeley, chair of its political economy major, a research associate of the National Bureau of Economic Research, a visiting scholar at the Federal Reserve Bank of San Francisco, and was in the Clinton administration a deputy assistant secretary of the U.S. Treasury."

Posted by: dub dub's scrollwheel finger at September 29, 2008 8:29 PM

Satchel,
Full disclosure: I only understand 1/10th of everything you post :-) but it's become a habit of mine, in these troubling times, to comb through these threads so that I might better predict how to position myself when the inevitable bailout happens - and it has helped. I'm sure I'm not the only one. Thanks.

Posted by: Richie Cunningham at September 29, 2008 8:45 PM

Maybe Satchel, Ex-Sfer, etc. will humor us sometime

ROFL. it is slightly intriguing, but no way. I purposefully post generalities so that others don't trade on my "advice". That's too much pressure! in the past I've posted a few specific trades from time to time to either give full disclosure, or to silence the critics. but I don't want to be the next Cramer.

also, unlike Satchel, I am not a trader, although I have traded with SOME of my funds the last 1 year.

I personally feel that trading is way too dangerous right now given massive governmental manipulation. it really is more gambling than anything else, although I do have a few positions here and there.

although I disagree with Satchel once in a while, I'll miss his analysis as well. good luck to you.

===
In many ways, this weekend is the end of a journey for me as well (although I'm not going anywhere). The journey began 1.5 years ago (geez, so long ago) when I posted about the Bear Stearns Hedge funds and how it was going to end badly. at the time most thought I was a crackpot gloom and doomer. Now it's ended badly, and it's common knowledge to everybody. it's sorta weird. I don't really take much joy in my "victory". Intellectually it's sorta nice to know that I analyzed things correctly, but in the end the future is scary and thus my victory is hollow.

now things are moving so fast I'm not sure any human can really comprehend what's going on and what the future will hold. and at the end of the day isn't that the essence of the problem?

eventually the history books will write about how things turned out, and they'll pin the "blame" or the "credit" on one person or one decision. but in the end the outcome is really being written by all of us every second of the day.

so we must all look at the various plans and try to quell our anger. anger is not a helpful emotion at this time. Instead we must evaluate our options, ALL of our options, and choose for our society what we think will lead to the best outcome.

The question shouldn't be "choose this bailout or we'll have GD2"
it should be "what options do we have, and what is most likely to reduce our future pain."

I personally think this bailout plan will not reduce our future pain, which is why I'm against it.

once we've gotten through this, then we can have anger and pitchforks... but sadly the true culpable will never be punished. And in the end most all of us contributed to the madness.

Posted by: ex SF-er at September 29, 2008 9:23 PM

wow, the loss of Satchel (again)

too bad really, I didn't always agree with him (or you if you are listening) but I will miss his thinking quite a bit. he was precise and often posted ex ante. something that many others here never do.

we'll miss you (him/her/ or whoever).

see you (him/her/ or whoever) on CR or elsewhere.

i'm also out. (thanks cooper for the push out of here, and please keep trading and watching over your money closely, it allows us passive asset allocators to reach our goals so much more efficiently!)
since i didn't get a chance to give you my last retort - here is the landmark fama french paper that describes the three factor model. A good place to start if you want to learn about risk premia. IMHO, this is the path to investing enlightenment. I hope you reach nirvana, cooper.


http://faculty.fuqua.duke.edu/~charvey/Teaching/BA453_2004/FF_Common_risk.pdf

good night, and good luck (and enjoy the bailout when it comes)

Posted by: enonymous at September 29, 2008 9:25 PM

I ditto everyone above. Satchel is one of the few that makes SS tolerable and puts a questioning spin on everything (good and bad) he makes us think a little! Don't go, not now.

Posted by: Ryan at September 29, 2008 9:26 PM

Satchel, it is ok to post on this blog without responding to things one disagrees with (see this)

FWIW, you've added value to the blog. And socketsite hasn't grown so large that it should be abandoned, yet.

Posted by: Delancey at September 29, 2008 9:30 PM

Ok guys, it was fun! But without the dueling duo (Satchel vs. "the realtor who shall not be named") this place just isn't gonna be too interesting...

Which is fine since I should spend more time making money and less time on the 'net.

Later!

Posted by: Jimmy (Bitter Renter) at September 29, 2008 9:31 PM

People who quote Fama French as if it is the Bible are always those that have just 'got religion' on passive investing. And then they think that they are super cool when they invest in DFA funds. Whoo Hoo!

Im sure Cooper has heard of Fama/French.. like many of us, and possibly has chosen to ignore them.

Warren Buffet agrees with Cooper. Basically paraphrasing: if u have the time and skill you can beat passive. If you dont, then passive 3,4,5,6,7 or whatever factor models are much better.

Satchel, get ur petulant ass back here after u buy those puts back :)

Posted by: mac at September 29, 2008 9:51 PM

Posted by: San FronziScheme at September 29, 2008 10:21 PM

Satchel -

Your comments will be greatly missed and were a welcome alternative viewpoint to the MSM message. I hope this isn't the last time we have heard from you on SS.

Posted by: R at September 29, 2008 10:28 PM

Come on Satchel! Part of the reason you come to this site is for the dissidence. You'll miss it when you're gone. Thanks for the book suggestions by the way. I've actually picked up a few of your suggestions and am now wading through them.

If nothing else SS has piqued my interest in economics. It's making me regret I did not get my MBA with my JD.

Is it too early to start another bring back Satchel campaign? I'd also like to see a return of the realtor who shall not be named.

Posted by: Publius at September 29, 2008 10:31 PM

A few random thoughts:

1 - I think Satchel needs a decent enough nemesis. Anybody wants to play the market cheerleader?

2 - Can I take this as the ominous sign of a bottom?

3 - I checked a competing web site (yeah, the one with the f!uj) and it was eeringly quiet.

4 - Maybe bulls are all sitting all day staring at a blank wall thinking of whether they should head for high ground or fight it off with bravado.

Posted by: San FronziScheme at September 29, 2008 10:57 PM

wow, you guys can really whip each other into a frenzy. maybe you could all just try taking a bit more time to you know, simmer down, do some work and come back and invest in more sustainable posting?

i don't think I'll ever be convinced by satchel that we need to return to the gold standard, or whatever his austrian books tell him, but I'll miss (trying) to read his posts...

in a way this ss drama is a rather amusing anecdote in an otherwise depressing news week.

my $0.02... i think most of you are crazy; i think a gov't created mess requires a gov't sponsored solution.

Posted by: kaya at September 29, 2008 11:43 PM

Very sorry to hear Satchel is going. I had just been thinking today of how clear, data-driven, and well thought out his posts were, and how he (almost) never let the emotion-driven, ad hominem, and frequently ungrammatical attacks of his opponents keep him from being gracious, factual, and often even humble in his responses. I will miss his informative posts.

Posted by: Po Hill Jeff at September 30, 2008 1:11 AM

i think a gov't created mess requires a gov't sponsored solution.

this is where you and Satchel are wrong. Despite what a lot of people really really really want to believe, this was not a government created mess.

as always, it was a creation of government and the market. Much of this can only very peripherally be tagged to the government if at all.

the biggest issue is the completely unregulated CDS market. there is not, nor was there any, government regulation or involvement there at all. In fact it got so big because the private firms flocked to the shadow banking system to avoid govt's hands.

Satchel et al like to try to portray the CDS problem as governmental through the longstanding policies of the Federal Reserve and/or monetary/fiscal policy. However, this is naive at best and misleading at worse. Because the CDS market could have happened on a gold standard and also without a Fed and also without a government. So it's a strawman argument.
even the moral hazard argument, although a good one, does not make this a problem "created by government". at best it exacerbated the problem

The government's blame on this is
1) not enforcing the regulations it did have. however may I point out to you that this is the Solution that Satchel et al propose: even less regulation... how will LESS regulation improve things? will 80x and 120x leverage work better than 40-60x leverage did? are more off balance entities helpful?
2) bailing out after the fact which causes moral hazard.

in sum: the cause of this was unfettered laissez faire ideals in the CDS AND the shadow banking system (which are unregulated and thus have nothing to do with government) which was exacerbated by (not created by) governmental policies: namely lack of oversight and regulation when they were able and then creation of moral hazard

the govt was PART of the problem, and so were all the related businesses and investors and consumers. In sum: EVERYBODY was the cause of this. SO using your arguments, since everybody was the cause, nobody can help. see again? strawman argument.

the correct way to say this is the following: govt was part of the problem, and thus they must be part of the solution. But just as they didn't fully cause the problems, they also cannot fully cure them. we will need coordination between govt, the private sector, and the citizenry.

roles:
govt: implement a functional framework of rules and laws and then enforce those rules and laws consistently (it failed miserably at this).

private: engage in activites that promote long term economic value. (they failed miserably, they now only look for short term profit regardless of any long term outlooks, worsened by antiquated compensation models that allow executives to hijack and destroy shareholder value)

citizen: be responsible allocating personal capital. the citizens get an F- for this, being ignorant of even the most basic of personal finance, flunking such subjects as "can I buy a house with mortgage payments higher than my salary"


(notice: my above govt plan doesn't include bailout)
---
Lastly:
Satchel often would tell me to simply read an Austrian book and I'd understand his point of view. what he doesn't know is that I own and have read Huerta De Soto's "Money, Bank Credit, and Economic Cycles" (it's on my desk) and I too have studied Austrian Economics. I understand his point of view from an Austrian standpoint, especially where he is incorrect.

Posted by: ex SF-er at September 30, 2008 5:32 AM

Bailouts. How to structure a bailout in a way that clears the market, reliquifies the banks and doesn't reward the malefactors?

How about this?

The government auctions off $1T in housing vouchers. Individuals can buy the vouchers to purchase a house or pay off their loan. The value of the property is marked to the amount paid for the voucher.

For instance, someone could buy $1M in vouchers for $500K. Use it to purchase a "$1M" home and the new comp would be $500K. The banks would get more of their loan paid back than would otherwise happen. People who bought houses they couldn't afford would be replaced by people who could bring cash to the table.

Posted by: diemos at September 30, 2008 7:27 AM

I think that it is obvious why Satchel is leaving: He bought a house. He can't face the music and the ire here when it comes out, so he is shoving off.

Good job Satchel enjoy your new digs, I'm sure you got a reasonable buy vs. rent evaluation.

Posted by: sparky-the-bear at September 30, 2008 7:43 AM

Satchel - thank you for all of your insights and the considerable amount of time you've put into your posts here. I live in Seattle and read Socketsite mostly for the commentary from you, ex SF-er, and a few others. (I was born in SF and my sister lives on Telegraph Hill, so that's what inspired me to check out SF real estate blogs.)

Cooper's flame war is an unfortunate waste of everyone's time, and doesn't add any value to the discussion -- especially now that it's convinced you to take a hiatus from Socketsite.

As someone who will probably never buy real estate in SF, I'm much more interested in your insights about the financial markets than SF real estate. I'm sure there are many others who would appreciate your insights about the markets even before SF real estate reaches affordable levels.

BTW, has anyone here read "Anatomy of the Bear", which covers the 4 largest DJIA crashes in the 20th century? It's easier to put the volatility of the current market into perspective by looking at the volatility from past secular bear markets. It's amazing how big the rallies were on the way to the 1932 and 1982 bottoms...

Posted by: Eric K at September 30, 2008 7:45 AM

Thanks to ex-sfer for all your commentary. You've mixed financial acumen with an understanding of the human and social cost of our economic predicament. The word I'm searching for is balance, and I will miss yours. All the best to you and your other half.

Posted by: michiko at September 30, 2008 8:12 AM

And with that, cooper, I would like to thank you. I have been looking for an appropriate time to exit this blog, and this sort of nonsense is exhausting. I do have a number of other things to do, I have posted WAY too much on this blog, and obviously I have become too much of a distraction, and for that I'm sorry to all.

Don't let the door hit you on the way out. I, for one, found Satchel's rants tedious and rooted in this bizarre 19th century mindset.

Posted by: anon at September 30, 2008 8:32 AM

"I think that it is obvious why Satchel is leaving: He bought a house. He can't face the music and the ire here when it comes out, so he is shoving off."

LOL...unemployed home based day traders don't buy houses...

Posted by: paco at September 30, 2008 8:34 AM

So said "Any analysis on who won Cooper Vs. Satchel?"

Well given Satchel is leaving town (again), doesn't this sorta mean Cooper won. Satchel likes to post all this vitriol but doesn't like it when people challenge his ideas.

he can't win the argument so instead he tries to get people to feel sorry for him.

Posted by: SFREBUYER at September 30, 2008 8:36 AM

Thanks for all the kind words, but as far as I know I'm not leaving! I just feel that going forward I'll have less to add, since most people now understand the gravity of the situation.

in the past I had a firm concept of what was coming. Going forward I honestly have to say that I'm not sure. It all hinges on what a very few people do (political and economic leaders). if my crystal ball clears I'll likely hypothesize further, or add my own "analysis" to future situations.

but have no fear: I'll still post about growing trees in San Francisco and the fragility of bamboo flooring and my dislike of lofts!

Posted by: ex SF-er at September 30, 2008 8:42 AM

@ Satchel and others,

I am not in the financial industry, but am obviously troubled and affected by all the recent market events. I've been following as much of the commentary here and elsewhere as I can take, of which I get the jist, but honestly most of the details and financial terms fly way over my head.

So, I have a question for you. We delayed our 2007 SARSEP IRA contribution payment until now and the deadline is looming (Oct 15?). The funds in our IRA are currently distributed in mutual funds evenly in the Morningstar 9 style sectors (value/core/growth-large/medium/small). They performed better than the market for what its worth. We're about 40 years old. How should we invest our impending contribution? Stick with our current investing or is there a change we should make?

Sorry if this is very basic stuff, but I guess I'm one of the Joe six-packs stuck in all this mess and more than capable of making naive/stupid decisions.

Posted by: spooked at September 30, 2008 9:04 AM

Talk about a tempest in a teapot! While I pretty much never agreed with Satchel about anything, I found his contributions stimulating and he exposed me to some ideas that I had not been very familiar with before. If you are going to post controversial ideas on a public forum, you can't be too surprised when people disagree with you and for the most part, people here are pretty civil. I actually expect him to be back sooner than Spring 2010.

I can see how posting 10 times a day can be a big time sink: I pretty much only have time to post on the weekends.

We *will* get a bailout, make no doubt about that, this current failure to do so is just political posturing. Too bad we won't get the one we need, which is the Swedish model I have been talking about for some time. At least the government will get some equity now, so the total final cost to the taxpayer will be less.

Posted by: NoeValleyJim at September 30, 2008 9:10 AM

"Don't let the door hit you on the way out. I, for one, found Satchel's rants tedious and rooted in this bizarre 19th century mindset."

Admittedly, Satchel can come off as pedantic and maybe even a little condescending at times. But let's call a spade a spade here. Most of people that did not like Satchel the first time he left were realtors that did not understand economic markets. Satchel pointed out how ridiculous the mantra "It's always a great time to buy real estate" is. Or how ridiculous the notion that SF is immune to the wider markets is ("Every Market is different!"). I notice there is less and less of that here now.

By the way, thanks for the link Fronzi. I had not seen that -- it made my morning.

anon - I'm not sure if you are the same anon who posted a reply on the tax-implications-of-buying-versus-renting thread a month or so ago. If that was not you forgive me. But if it was, you were completely wrong there.

As far as the cooper business goes, it is clear they were talking past each other. I like most of cooper's posts. And some of the economics discussion goes over my head, but it is clear that cooper's contention that the Fed can do what ever they want (providing some colorful examples) is not accurate. The Fed only has the legal authority to provide loans (thanks for the link Trip). Now, whether they can get away with something that they have no legal authority to do under the pretense that it is in the best interests of the economy is another matter (apparently they can -- at least in the short term). I think we can expect legislation that tightens control of the Fed and the banking industry in general as result of this mess.

I, for one, have enjoyed Satchel's well-articulated posts. I can also verify that his legal analysis on this site has been dead on. Which is impressive given he never actually practiced law.

If you think Satchel was wrong, post an articulate response and let the readers decide. There is too much "you're wrong, but it's not worth my time to fully explain why you're wrong" on this site. That doesn't do anything for the majority that follow the comments to gain a little insight.

Posted by: Publius at September 30, 2008 10:27 AM

ex SF-er,
Thanks for the response and in general for your insight. To be honest, I don't believe this is a gov't created mess, but 1) I'm an engineer, not an economist 2) I don't really have the time it takes to invest in most of the back and forth that goes on here. That was my super condensed reasoning behind my opinion that I think it'd be crazy to let the ship sink. I guess we can wait and see if things are as bad as they're trying to tell us, but I've been successfully spooked.
I believe the private sector was able to manipulate gov't policies to exacerbate the problem and have great doubts that the same people were "taken advantage of" will suddenly find the ability to create reasonable regulation.
Maybe when the banks are done eating each other they'll be able to figure out who owns what and what it's worth, but I'm afraid a lot hurt will go around before then.

Posted by: kaya at September 30, 2008 10:43 AM

it seems that some of the people debating endlessly the effects of a bail-out, are also making huge killings in the stock market in the mean-time. let's spend a fraction of this energy sharing your stock tips, and i can make some money too in the stock market and buy a home regardless if homes are going down 10% in SF proper.

Posted by: condoshopper at September 30, 2008 10:57 AM

"are also making huge killings in the stock market in the mean-time. let's spend a fraction of this energy sharing your stock tip"

go to 'day-trader.com' and start trading them up.

of course those "making huge killings" are too smart to buy a house. they have all this money and want the renting lifestyle.

Posted by: paco at September 30, 2008 11:03 AM

To Publius with love from Cooper:

From the NY TIMES Today:

the United States government will receive 100,000 shares of A.I.G. convertible participating serial preferred stock. The preferred shares will have an interest equivalent to 79.9 percent of the votes of A.I.G. and be entitled to receive 79.9 percent of any dividends paid by A.I.G. on A.I.G.’s common stock.

The preferred shares will be convertible into shares equaling 79.9 percent of the common stock of A.I.G.. Here, the first interesting quirk arises. The preferred shares are actually issued to a trust, of which the Treasury Department is a beneficiary.

to Satchel:
I think you get too emotional in these exchanges. I like it when people disagree with me as it helps me to make better decisions and refine my views. I know that if I get very upset it is a sign that my ideas might need to be reworked as its a sign I myself know there is a problem.

For example the last person who ever launched a personal attack on me was F__j, then you. And i think Paco told me once to go back to my home state (even though I was born in California).

In any event peace. Although I have a feelign we'll see ya again. Maybe not under the name Satchel--but if I see someone call for the elimination of the Federal Reserve and adoption of the gold standard I'll know its you. peace.

Posted by: cooper at September 30, 2008 11:14 AM

wasn't me coop!

Posted by: paco at September 30, 2008 11:33 AM

Satchel,

please tell us you're just having a bad day and you'll be back tomorrow with more insightful, enlightening and provocative posts.

I mean, when f!uj left there was not one sad commentary wishing he hadn't left. Here now, half of this board is begging you to come back already!

You can't be insensitive to that and over-sensitive to ONE flaming poster... c'mon man...

Finally, if you think your time is being wasted on this site, think of it as intellectual volunteering. Seriously.

Posted by: asiagoSF at September 30, 2008 12:06 PM

Good riddance Satchel. I agree with the MANY other posters here that won't miss the condescending attitude and 19th century ecomnomic theories.

Posted by: suckeredbyinfinity at September 30, 2008 12:12 PM

Sad to see Satchel go. There's an old Chinese proverb about playing violin for cattle. I'm guessing Satchel realized that his insightful (and usually accurate) predictions here weren't really the best use of his time, plus they fell on many imperceptive ears. I, for one, look forward to his return and the "I told ya so" comments.

Posted by: Dude at September 30, 2008 12:25 PM

Being an engineer with very little understanding of economics, I've found Satchel's posts incredibly educational. They have spurred me to inform myself on subjects that I had avoided in the past. After reading his/her posts, I found myself reading books and searching the web for more information just to keep up. While I did not agree with all of his/her conclusions, I'm very sad to see the posts end. They were of great value to me.

On a side note to ex-SF'er, thanks so much for your posts explaining the CDS market on the other thread. It was the clearest explanation I have ever read. If only my thermodynamics professor in college had been that comprehensible!

Posted by: pica1986 at September 30, 2008 12:38 PM

"The preferred shares are actually issued to a trust, of which the Treasury Department is a beneficiary."

Thanks cooper, I saw that. Nice bit of structuring that is better than an end run around the Federal Reserve act. Or is it?

"More on the (Absence of) Legal Authority for the AIG deal -- Whether or not the Fed has the authority to buy/lend to AIG, the story does not end there. In order to lend/buy, the Fed needs to come up with $85 billion, which is conveniently being supplied by the Treasury Department, which is in turn borrowing it from whoever will lend money to the U.S. government, to be paid back by us or our descendants, unless the AIG deal miraculously turns out to be profitable. On what statutory authority does Treasury Act? Unlike the Fed, the Treasury does not bother to explain where its authority comes from in its press release."

A great place to follow this issues is the following blog which concerns legal/economics issues:

http://volokh.com/

The Beckner-Posner blog is also very good. Posner is generally against any kind of goverment stake in private business (simplistic view of course, go to the blog for details).

http://www.becker-posner-blog.com/index.html

Again, thanks cooper. Unlike Satchel, I like our interaction.

Posted by: Publius at September 30, 2008 12:43 PM

nah it wasn't to get around the statute. Its huge power and no approval of congress is needed. All they need is a determination of exigent circumstances to do anything at all. Here is the exact statute they used and it was the one I said a year ago they could use if things went bad. Note you could theoretically even buy goods or services with the statute and no congressional approval needed:

http://www.federalreserve.gov/aboutthefed/section13.htm

Anyway-back to the bailout plan. The funniest defense of the bailout was reposted on Kedrosky's blog.

here is an excerpt that basically bashes "alleged conservatives" who are against bailing out the banks.

VIA PAUL KEDROSKY HERE on the bailout:

http://paul.kedrosky.com/archives/2008/09/30/the_shopkeeper.html
------------------------------
It's amazing how many people, including some on this blog, are totally misreading the situation.

The House Republicans fear socialism, even this "socialism for the rich", more than collapse of the economy. They are mostly well-trained rabble, pious schoolchildren, who sincerely believe the free-market ideology that led to this disaster in the first place. They have been more than happy with handouts to the rich for decades! But their deep fear of anything non-capitalist has brought them to total absurdity: they want bankrupt businesses to buy government insurance and to escape capital gains tax, even though these businesses obviously have no revenue!

Do any of them understand that the day-to-day operations of the US government and military are totally in the hands of foreign rival creditors? We can and should hate Paulson but at least that lying miser understands the stakes for US capitalism and world power. The "no" vote is a sign of deterioration not "victory for the people."

Do these small minded rightist fools understand BWII, the international flow of funds, the organization of world trade, etc.? Do they understand the link between the military, petrodollars, bonds, and export-led growth? OF COURSE NOT. They just want their small minded and frankly shopkeeper fascist fantasy that they too can one day get rich.

But US capitalism has happily cultivated these Panglossian delusions for decades, if not two centuries, because it has helped them repress various domestic untermenschen. So the US deserves such self-destructive stupidity. It is the economic equivalent of falling on your own sword.

Posted by: cooper at September 30, 2008 1:02 PM

cooper -

"All they need is a determination of exigent circumstances to do anything at all. Here is the exact statute they used and it was the one I said a year ago they could use if things went bad. Note you could theoretically even buy goods or services with the statute and no congressional approval needed."

Where do you see that the statute authorizes the purchase of goods and services? I've read it and I don't see that authority granted anywhere. I'm not alone, the legal experts agree:

"the Fed statute does not say that the Fed can purchase businesses, and it seems reasonable to interpret the statute to forbid the Fed to purchase businesses. So here’s the question, is the AIG deal a purchase or a loan? I suspect the deal is a loan in form but a purchase in substance. Unfortunately, the details are not available, but the press accounts suggest that the Fed is receiving AIG equity (more precisely, the option to obtain equity) as collateral for the loan but that it’s going to exercise the option more or less automatically. Here’s an analogy. Suppose that I lend you $100 and we agree that all of the equity in your business will be collateral for the loan. The contract provides, however, that you must pay me interest of a gazillion dollars, due one second after closing, and that if you fail, that counts as a default, whereupon the collateral is mine. The parties use the loan form but substantively a sale occurs. A court would almost certainly interpret the transaction as a sale, not a loan, if tax or other legal consequences turned on the distinction. If the AIG loan is like this, then it’s illegal."

http://volokh.com/posts/1221659975.shtml

Under exigent circumstances (defined by case law and the courts, not by the public or anyone else) the Fed has the legal authority to issue LOANS. The loan can be secured by goods a services. But this is a little different is it not?

Of course, whether they can get away with something that they have no legal authority to do is another matter. And this argument may be largely academic unless some rule-of-law types object. There also may be standing issues to challenge the actions taken by the Fed. But there are attorneys all over this country that like to make sure government agencies stay within their statutory authority (even if the Fed is not a true goverment agency).

What is clear is that the Fed has limited statutory authority and can't do whatever they want, even under exigent circumstances.

Citing to the statute is great, but still does not explain why the statute gives the authority you think it does. I coverd this in law school and have reviewed it again and don't reach the same conclusion you do. Perhaps you could point out in the statute, or case law interpreting the statute, or in the legislative history, where such authority is granted.

Posted by: Publius at September 30, 2008 1:59 PM

Publius,

Don't bother with cooper. He doesn't know what he is talking about. Here is his authority:

"There was a paper by the Kansas City Fed that basically listed all the things the Fed could do if things went to hell...but they took it down from the website after 15 minutes. I know during the concerns over deflation in 2001/2002 Greenspan had the idea to buy goods and services if needed in his tool belt.

Posted by: cooper at March 19, 2008 1:12 PM

http://www.socketsite.com/archives/2008/03/justquotes_the_fed_cuts_by_075_and_sees_weakened_outloo.html

If you want a sensible, reasoned discussion, read Satchel's post at March 19, 2008 11:10 AM in that same thread. Don't be thrown off by cooper's red herring of "open market authority". He doesn't know that the SOMA account and the discount window are the only way that the Fed interacts with the money markets (and you don't "lend" to nondepositories through the discount window).

The Fed itself has also addressed this very issue:

http://www.federalreserve.gov/Pubs/Feds/2004/200440/200440pap.pdf

(See the top of page 29 there, and note the restriction on "purchasing" equities. That's why - among other reasons - the AIG loan was structured as a loan, and the equity warrants were given to the USG, because of course the USG and the Fed are different entities because the Fed is not part of the USG.)

That paper will explain a lot of why this is going down as it is.

Posted by: anon at September 30, 2008 2:12 PM

Publius, you are right, of course. The statute is very clear. There can be some tough line drawing between a loan and a purchase on certain deals, but the Federal Reserve Act does not permit the Fed to buy anything. For crying out loud -- that is why Ben Bernanke sat before Congress for days last week begging for a new law to give him the authority to buy assets from companies -- because the Fed does NOT already have that authority.

We're advising about a dozen big financials clients on this issue as we speak. The Fed can't buy anything from them unless the bailout statute passes.

Posted by: Trip at September 30, 2008 2:19 PM

"Don't let the door hit you on the way out. I, for one, found Satchel's rants tedious and rooted in this bizarre 19th century mindset."

Anon,

I think you and others have missed the true reason for Satchel's departure - it's medical. How so, you ask? Well, I'm sure everyone remembers his self-aggrandizing, grandstanding habit of reposting his own quotes, to remind you how smart he is. The "I'm smarter than Paulson" quote is another indicator of his delusions of grandeur. Anyway, all of that patting himself on the back caused him to dislocate his shoulder quite severely. He'll be back in a few months - it's really tough to type fast with a bum shoulder.

Glad ex-SFer is staying. Now that's an intelligent, level-headed perspective everytime, whether I concur or not.

Posted by: huh? at September 30, 2008 2:35 PM

"Don't bother with cooper."

All this may or may not mean much to cooper, I am sure there's many a small fry like me on here that's glued to every word. If you guys enjoy writing as much as I enjoy reading this stuff, we all come out ahead. The only other thing to do is thank Socketsite for providing the platform.

Posted by: chuckie at September 30, 2008 2:35 PM

Thanks anon! It's really helpful when people post sources.

Posted by: Publius at September 30, 2008 3:01 PM

LOL that post by "anon" makes me think Satchel had a one day hiatus and is back already but too ashamed to post his on name. Just admit you can't help yourself man.

I mean who else goes back and finds quotes on socket site from 5 months ago to try and back themselves up? Anon?

Satchel-you may not like it that the Fed bought equity and consider it's illega but they did it anyway despite your rant. This may have made you lose your bet with cooper and skulk away in shame but nobody is taking Bernake to the Supreme Court. Unless you want to?

If that really is I think you might have gone over the edge with that "STOP LISTENING TO COOPER" comment.

Get a grip man.

Posted by: missionbayrez at September 30, 2008 4:32 PM

"you may not like it that the Fed bought equity and consider it's illega but they did it anyway despite your rant."

Did they really? Looks very much like a loan secured with equity. But that could be a distinction without a difference under the circumstances.

http://www.sec.gov/Archives/edgar/data/5272/000095012308011496/y71452exv99w1.htm

The point that was made by Satchel and some leading legal experts is that an equity purchase is illegal (See the links I posted earlier). In fact, I have not seen one argument that states that the Fed has the authority to purchase equity (except the conclusory claim by the Fed that they do). Most of the legal analysis that supports the AIG deal states that the deal is probably illegal but that we should ignore the statute as anachronistic or that Congress should make an express admendment to the Federal Reserve Act. On the other hand, I have just seen some analysis that shows case law that may support the Fed's claim.

The only thing clear is that the Fed has no clear authority to purchase equity. Perhaps the use of the trust instrument with the Treasury as beneficiary will mitigate claims that the Fed has acted outside their authority and that the deal should be recinded.

This deal has not gone unnoticed by the legal profession. We will hear more on this.

Posted by: Publius at September 30, 2008 5:32 PM

The actual reg just says it can provide "discounts" which leaves pretty vague and open language allowing them to do anything at all under exigent circumstances.

Where is the actual language in the exact statute that says they can't buy equity that you are referencing that says no equity purcahses? can you provide the link again? i coudln't find it?

As for what they did there is no question it's equity. Just ask Hank Greenberg. The equity they held is now the Fed's. There might be some kind of lawsuit but it looks like there won't be..nobody is challenging it.

Posted by: missionbayrez at September 30, 2008 6:19 PM

"Did they really? Looks very much like a loan secured with equity. But that could be a distinction without a difference under the circumstances."

Every time you make a loan against collateral you are buying the collateral but providing an option to the borrower to buy it back.

Which is way I firmly say that there is not one person in america who has lost their house over the past several years. The only people who were removed from their dwellings were people who had a mortgage. If you have a mortgage then it's not your house, it's the bank's house. They just let you pretend to own it as long as you pay the mortgage.

Posted by: diemos at September 30, 2008 6:31 PM

"The actual reg just says it can provide "discounts" which leaves pretty vague and open language allowing them to do anything at all under exigent circumstances."

Not according to most of the legal analysis I have seen. For instance...

"the Fed statute does not say that the Fed can purchase businesses, and it seems reasonable to interpret the statute to forbid the Fed to purchase businesses. So here’s the question, is the AIG deal a purchase or a loan? I suspect the deal is a loan in form but a purchase in substance. Unfortunately, the details are not available, but the press accounts suggest that the Fed is receiving AIG equity (more precisely, the option to obtain equity) as collateral for the loan but that it’s going to exercise the option more or less automatically. Here’s an analogy. Suppose that I lend you $100 and we agree that all of the equity in your business will be collateral for the loan. The contract provides, however, that you must pay me interest of a gazillion dollars, due one second after closing, and that if you fail, that counts as a default, whereupon the collateral is mine. The parties use the loan form but substantively a sale occurs. A court would almost certainly interpret the transaction as a sale, not a loan, if tax or other legal consequences turned on the distinction. If the AIG loan is like this, then it’s illegal."

http://volokh.com/posts/1221659975.shtml

If you have a source that supports your argument that the Fed can do "whatever it wants" under exigent circumstances, I would be very interested to see it. The plain language of the statute is not enough.


"Where is the actual language in the exact statute that says they can't buy equity that you are referencing that says no equity purcahses?"

This is backwards. Generally, authority to perform actions must be identified in the Act. The Fed, therefore, must find authorization to perform actions under the Federal Reserve Act. Any actions not expressly found within an act are not allowed. There are of course some exceptions to the general rule. Thus, the proper question is where in the act authority has been given to the Fed to purchase equities? The answer is nowhere.

Check out this Fed paper that expresses this very point(p. 29).

http://www.federalreserve.gov/Pubs/Feds/2004/200440/200440pap.pdf

Re: Hank Greenberg - he was not voted out but pressured to resign. There have been some SEC invesigations into some of AIG's practices that also put pressure on him. The New York AG's office was also looking at them at one point.

http://www.businessweek.com/magazine/content/05_15/b3928042_mz011.htm

The only thing I can see in the deal that I can see that strongly indicates that this is an equity deal is the voting rights for the shares that are held in trust (See Exhibit D). Did you get a chance to read the deal? Any other analysis of the deal is appreciated.

I have seen almost no support that this deal was legal under the act. I suspect this deal will come under scrutiny and I believe we'll see further tightening of the Fed's authority, but I could be wrong.

If you find anything to the contrary, please let me know.

Posted by: Publius at September 30, 2008 7:10 PM

diemos -

You're going to make me wish I paid more attention in my secured transcations class. I don't think the law looks at it that way (the law makes it a little more complicated).

Taking my two-year-old to grab something to eat. I'll come back to this later.

Posted by: Publius at September 30, 2008 7:18 PM

Publius--I read the stuff on volokh also a while ago. It's just commentary. i.e. much like here people giving opinions.

When all else fails my suggetion would be to read the actual statute--not commentary. In fact I remember in Congressional testimony Senator Shelby had the same question to Bernake--hey you can't buy businesses. Bernake replied oh yes we can--and we did thanks to an act of Congress.

Also, for what it's worth I found out about the statute from Alan Greenspan who basically alluded to the fact that it would have been available in the deflation scare of the early 2000s. his opinion is commentary too however the fact that the Fed actually bought AIG sort of flys in the face of those who say it can't dont ya think? hoppe that helps

anyway looks like this bailout bill is gonna go through. I really hope they target it more on financing healthy businesses rather than bailing out bad loans. while I think we need to do something I am just not sure this is gonna do the trick

Posted by: cooper at September 30, 2008 7:44 PM

"I don't think the law looks at it that way (the law makes it a little more complicated)."

Yes Publius, I know. ;)

But I still question what it means to "own" something that someone else has a right to take away from you. I'm baffled by people who "buy" a house for the "security" when they are, in fact, one mortgage payment away from having the deputies show up to toss them and their crap out onto the street. That doesn't sound very secure to me.

Posted by: diemos at September 30, 2008 7:50 PM

Hey cooper -

We're starting to retread old ground here. I still haven't seen what language in the statute you think allows the Fed to do whatever they want even in exigent circumstances. The plain language of the statute is not enough. Even if those who are self-intersted say it is -- Bernake and Greenspan don't get to define their own authority.

I linked Volokh for an example, there are many more. Also, I know the qualifications of those who blog there and they are experts not just some no name poster on SS (like Publius).

And just because action was taken doesn't make it legal. I have actual experience with this. I worked a case where we sued a state agency for exceeding it's statutory authority. They agreed to change their practices before we went to court.

I think what is left is to see what happens with the bailout plan and the AIG. If it ends badly for the taxpayers, we may really find out what is legal and what is not. Like I said earlier, it is largely academic at this point.

With regard to the bailout, I have seen your suggestions gaining traction in the press. More and more talk about something like the "Scandinavian model." And I see Obama and McCain both asking for an increase in the FDIC.

You must have placed some phone calls. :)

Posted by: Publius at September 30, 2008 8:09 PM

Okay, diemos, I understand your point.

With respect to the AIG deal, it is more appropriate to view ownership in a legal sense not the broader macro-version because that is how it will be scrutinized in the courts (should it get there).

But I certainly agree with your broader point.

Posted by: Publius at September 30, 2008 8:33 PM

"Did you get a chance to read the deal? Any other analysis of the deal is appreciated."

Check out section 8.18 of the loan documents (p. 61 of the main Credit Agreement).

Standard revolver loan. The Fed will never buy the company (it will never foreclose on the equity held in the trust for the benefit of the Treasury - not the fed). The plan all along was to to liquidate the bad paper in AIG by selling it to the taxpayer. The Fed gets paid back any advances made under the revolver, it maintains its senior position in the capital structure at all times (that's why this really isn't equity - although its a close call), and the potential "problem" under 13(3) of the Federal Reserve Act is avoided.

Posted by: LegalBeagle at September 30, 2008 8:38 PM

"With respect to the AIG deal, it is more appropriate to view ownership in a legal sense"

While I may impersonate an economist on the internet I'll leave law to the lawyers. I'm sure they have a crack team writing up the boilerplate and can argue that what they're doing is legal.

Posted by: diemos at September 30, 2008 8:59 PM

Let me try and address both publius and legalbegal.

Here is the exact statute. Someone show me exactly where they can structure it as they see fit? It's incredbily broad and designed to be so.

After all. The whole intent of the statute is not to limit the ability of the fed to own equity (which is really besides the point), it's to get money to people or corporations when needed. After all, that is exactly what was needed in the depression (and now) and that's what the Fed is doing and what Greenspan suggested that the Fed could and should do. And as you can see from the statute there is no act of congress required as some argued with me on months ago.

I did a venture deal once where it had a note and warrants for 50% of the company excercisebale to common. that looks the same as a preferred equity deal or a note w/ warrants.

Furthermore, even if they didn't buy warrants for 80% of the company it would still be equity. Unless I am misremembering my legal mumbo jumbo anything over 30% (or thereabouts) on debt --thats pretty much equity in terms of what you have to file and such and is classified as equity. and this note is what 80% interest or so?

Also people keep talking like the Fed is not the Federal government as if it somehow evades the statute? Where exactly would that evade the statute and where is the strucutre of the transaction limited in terms of type of return?

Last,
If the government does not hold all the equity of AIG who are you guys proposing does? Is it in "limbo", is it classified top secret? :)

----------------------------------------------
3. Discounts for Individuals, Partnerships, and Corporations
In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions. All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe.


Posted by: cooper at September 30, 2008 9:10 PM

"I did a venture deal once where it had a note and warrants for 50% of the company excercisebale to common. that looks the same as a preferred equity deal or a note w/ warrants.

Furthermore, even if they didn't buy warrants for 80% of the company it would still be equity. Unless I am misremembering my legal mumbo jumbo anything over 30% (or thereabouts) on debt --thats pretty much equity in terms of what you have to file and such and is classified as equity. and this note is what 80% interest or so?"

A little venture deal with warrants attached that are exercisable into common is effectively equity of course, especially in the very simple capital structures that VCs typically encounter. This AIG deal is structured as a loan from the Fed, which it is allowed to do under 13(3) in exigent circumstances. The Fed is a lender and is effectively senior to all equity classes in a bankruptcy (as well as to any existing subordinated debt that does not contain a covenant aginst the incurrence of additional debt).

In coordination with that loan made by the Fed, the USG is taking an equity preferred interest, held through a trust. The USG position here is junior to the Fed. The equity interest is contingent upon the shareholders of AIG agreeing to the change in its capital structure.

The Fed and the USG are not the same entity. One is part of the government, and the other is a creature of statute (not constitutionally part of the Executive). Congress has delineated the limits of Fed power in the Federal Reserve Act, which allows loans but not equity purchases. Congress can of course abolish the Fed. It cannot abolish the Treasury Department without an amendment to the Constution. The entities are separate.

To some extent this is all a distinction without a difference regarding "purchase" versus "loan", but it is important to understand why it is being structured this way. The Fed cannot "buy" assets like bad mortgages under 13(3), nor can it "give" anyone money for services.

It can make loans that look an awful lot like equity, though, to anybody, but understand where this puts the Fed in the capital structure: senior to any equity interest. So, if the Fed wanted to effectively "buy" these bad mortgages from all these bad banks, it couldn't. It would have to LEND to the entity holding the mortgages, effectively putting itself senior to all the equity, which is then wiped out unless the loans are repaid. The Fed doesn't want "its" bank shareholders (and subordinated debt holders - and perhaps even senior debt holders depending on the "optics" and how hard the Fed wants to push - or wants to be seen to push) to be wiped out. And so, it needs to go to Congress to get it done.

There wasn't enough time to do it this way with AIG (it started the dominoes), and so AIG equity got subordinated to the Fed loan. The Fed can keep LENDING against all these bad mortgages (and other bad paper) through the TAF to its preferred companies (commercial banks, now the two investment banks that have reregistered as eligible banks), but this just kicks the can down the road. Someone needs to put in capital. The Fed would like this to be the taxpayer, and so would those bank execs and sub debt/senior debt holders who don't want to suffer the AIG (or worse, LEH) fate.

The language of the statute (13(3)) is very clear that the Fed can only lend, not give. You posted the language, and if you cannot understand that then you need legal training. It looks like even taking a direct equity interest in AIG (in connecion with the loan) gave the Fed's lawyers the willies, and so AIG equity was effectively seized by the USG (not the Fed) and put into a trust. It doesn't exist in the "ether". it "lives" as the corpus of the trust (a separate entity efectively controlled by the Treasury/USG). At some point I am sure, the bad paper in AIG right now will be sold to the taxpayer under the TARP program, the Fed will be repaid its LIBOR+850 advances under the loan just made, and the USG will sell off its equity stake, returning AIG to the private world (assuming it can sell off enough bad paper to ensure that it can stumble back to the world of the living on a reasonable timetable).

Interesting that you now say that Alan Greenspan "whispered" the magic of the Fed's power in your ear sometime in 2001-2004. Last time, in March, when the relevant limits of Fed power were (accurately) explained to you, you said that there was some secret "paper" on the Kansas City Fed's website that "disappeared" after 15 minutes, but of course not before you were able to glean the secret wisdom therein that all these eminent lawyers that Publius referenced on that legal blog (to say nothing of the significant legal knowledge on this SS blog) say just isn't there.

Posted by: LegalBeagle at September 30, 2008 10:01 PM

Thanks Legal -

That is the clearest explanation of the deal I have seen anywhere. One quick question...

"The Preferred Stock will vote with the common stock on all matters submitted to AIG’s stockholders"

What is your take on the voting rights associated with the 100,000 shares held in trust?

Posted by: Publius at October 1, 2008 12:02 AM

Whew a lot there. You give Satchel a run for the money in terms of length of response.

1. Lots of your stuff is on one agency not being a constitutional entity. Does that mean it's part of the government. I'm sure you are not saying Treasury is not part of the government because it's a constitutional creation and the Fed isn't? This reminds me when Satchel used to tell me the Fed was a private entity. That always cracked me up.


2) On the actual language that you claim I can't read but fail to cite yourself-- if you actually read it the first part looks like they are only talking about loans. But the last sentence adds all the flexibility in the world

"All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe".

With 5 votes they can prescribe any terms they want including turning it into equity--and that's what they did. If you don't think they can--feel free to sue em:)

That pretty much means they can do anything they want..that's the clause they are using to justify their position that they can and nobody is legally challenging it.

3. Some little venture deal? almost all private equity deals --even hundred million dollar ones use preferred equity which has something called a liquidation preference. That LP is senior to all other equity, so is the preferred equity itself. Does that make it debt--of course not.

Just because it's senior has zero to do with whether its equity or debt. Also the size of an instrument doesn't have anything to do with wheter it's equity or debt. Like what are you talkign about?

If you think because it's senior to common it somehow becomes debt then I can assure you that has no bearing in actual reality. It's not just done that way some of the time in private equity it's doen that way ALL the time. It's really never happens any other way and to call it debt beacause of that doesn't pass the test of reasonableness.

And again, even it if was only debt--take the equity out. It's still equity because the rate is 80%. That certainly isn't at the discount rate?

4) You are admitting they used equity, then you say it really isn't, then you are saying it is but it went to another part of the government so it doesn't count. You seem confused. all I can tell you is Greenspan thinks they can do it, Bernake thinks they can do it. they did it :)

5) On the Kansas city fed paper that dissapeared. That was 5 months ago, I don't remember what was in it. That's something I talked about with Satchel a LONG time ago--where are you getting that from? And please remind me, what did I say was in the paper?

That's a good well thought out explanation.
However, you are saying size of a deal somehow makes it debt vs equ

Posted by: cooper at October 1, 2008 7:45 AM

Thanks Publius.

"What is your take on the voting rights associated with the 100,000 shares held in trust?"

I assume that you are thinking about who gets to vote on the fundamental change to the capital structure now being undertaken (once everything settles, the USG will effectively dominate most corporate decisionmaking, as it has/will have even more than the highest 75% supermajority required to effect fundamental changes under most corporation codes).

I honestly don't know, and I may not have time to look into it (I hope you understand). Perhaps this question has come up on the legal blog discussions?

However, that being said, most well drafted articles of incorporation will require class voting on fundamental changes affecting a particular class to its detriment (as here). AIG is a Delaware corp, and the Delaware Corporation Code of course also contains these sorts of protections, and the Chancery Courts there as you know have a very well-developed body of case law on the protection of shareholders. So my informed guess is that there will be a separate class vote. The proxy in advance of the vote will spell out all the niceties I'm sure (maybe it's out already - I haven't looked).

That's law, of course. There's also the reality. The USG is very powerful and will twist whatever arms are necessary. I can't see the existing common shareholders refusing this "offer that can't be refused".

Posted by: LegalBeagle at October 1, 2008 7:49 AM

"It's still equity because the rate is 80%. That certainly isn't at the discount rate?"

Goodness gracious. Poor Satchel would have been tearing his hair out by now.

The rate is LIBOR + 850. That's 850 basis points. That's about 11.5% when the deal was struck. Or, about 9% or so above the discount rate, not 78% or so.

"if you actually read it the first part looks like they are only talking about loans. But the last sentence adds all the flexibility in the world"

There is a world of legal subtlety in that one word "such" in the sentence you reference. Read it again.

"If you think because it's senior to common it somehow becomes debt"

It's senior to ALL equity (even preferred). Remember, sloppiness of thought results in sloppiness of conclusions.

"On the Kansas city fed paper that dissapeared. That was 5 months ago, I don't remember what was in it."

Take a look at anon 2:12's post above for a reminder.

"Whew a lot there. You give Satchel a run for the money in terms of length of response."

Yeah. That Satchel guy was always pretty careful and really made an attempt to explain things in a way that even people without a technical background in these concepts could understand. That made his posts long - too long, obviously.

Posted by: LegalBeagle at October 1, 2008 8:03 AM

"Yeah. That Satchel guy was always pretty careful and really made an attempt to explain things in a way that even people without a technical background in these concepts could understand"

LOL!!

1) you are right on the rate of debt. Someone told me it was 80%. My mistake.

2) private equity transaction transactions have the preffered come in senior to ALL equity whether its a venture deal or a 100mm deal. Making it senior dosn't like turn it into debt. The liquidiaiton preference or "the debt" comes in senior before any other preferred or any other equity gets paid. That is a highly unproductive line of reasoning and does not resemble the real world.
3) There is also the phrase "subject to" and "as the FRB may prescribe"

All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe

According to you interpretation that would have to use the discount rate and couldn't mess with it at all. Obviosuly not even possibly true.

You keep saying how I am not a legal mind and can't read. But this is the precise statute Bernake cited in Congress, Greenspan cites and they acutally used. It's not like I am not pulling it from nowhere.

They also used legal counsel that specializes in this stuff and have planned to use it in a worse case.

And guess what-their interpretation is even worse then you think. For example, say I am a Steel company about to go bankrupt. In a dire situation the Fed could give me cash in exchange for a loan with the steel as collateral. Whether they want to prescribe other terms to it just as equity is entirely up to the Fed.

In a year or two someone may try and ammend the statute to make it clearer but for now--

It is what it is. Unlimited power!!

Posted by: cooper at October 1, 2008 8:16 AM

Let's part friends! Best of luck to you in all of your endeavors.

(And, by the way, "discount" is a general term in that context relating to the ability of lenders to charge interest on principal; not a specific exhortation to the Fed that it can only use its "discount rate" for these special exigent circumstances loans.)

Posted by: LegalBeagle at October 1, 2008 8:22 AM

>>Let's part friends! Best of luck to you in all >>of your endeavors.

As always:)

Posted by: cooper at October 1, 2008 8:25 AM

Is it just me or does LegalBeagle sound a lot like Satchel did. He even complimented himself in his own comment.

Posted by: suckeredbyinfinity at October 1, 2008 8:52 AM

"Is it just me or does LegalBeagle sound a lot like Satchel did. He even complimented himself in his own comment."

Maybe it is the legal training. I can confirm that LegalBeagle's analysis is consistent with what I have read from the legal experts. I can also confirm that Satchel's comments regarding legal issues on this blog have been dead on.

The Fed derives its authority from the Federal Reserve Act. Its power is limited by the act. Now to determine what those powers are one must look to the statute. But it does not end there. Statutory interpretation is a legal matter. That doens't mean nonlawyers can't read. It just means that lawyers are trained in a number of principles that courts use to interpret statutes. Merely reading the statute is not sufficient.

(As an aside, I work a little landlord/tenant pro bono. It is interesting how many different interpretations you get when someone reads a statute. Usually, people read only a part of the statute, or don't review the case law, or legislative history. This usually results in either the landlord or the tentant interpreting the statute to mean what they want it to mean. Almost every time both interpretations are wrong.)

I have now seen four attorneys on this site that have explained the limits of the power of the Fed. I also follow the legal blogoshere closely and experts in the field have reached the same conclusion. Also, please see LegalBeagle's excellent explanation on how the deal was structured to comply with the requirements of statute.

The only source that I have heard from that states the Fed can do whatever they want is one lonely soul on this site. This source has not pointed to anything other than his own nonlegal interpretation of the statute and personal opinion.

So, I think it is time to leave it to the other readers to decide for themselves who has credibility here.

Posted by: Publius at October 1, 2008 10:07 AM

There is a universal "Socketsite ether" (SE) which is distributed amonst all commenters at any instant.

Our theoretical understanding of *how* the SE is distributed is poorly understood, however, and some folks seems to attract it more than others.

I'm writing a paper on the relationship between the SE and comment column inches. I've got some good ideas, and am constructing experiments right now.

Or I could theorize about macroeconomics and fed powers, your choice :)

Posted by: dub dub at October 1, 2008 10:32 AM

By Publius, "The only source that I have heard from that states the Fed can do whatever they want is one lonely soul on this site." This source has not pointed to anything other than his own nonlegal interpretation of the statute and personal opinion. So, I think it is time to leave it to the other readers to decide for themselves who has credibility here"

In the sense of being able to exchange money freely for collateral --that really is unlimited power of buying and selling assets or anything that can be deemed as collateral.

To use a fun example I did a year ago...do you not see that you could issue a security with 1 billion worth of beer as collateral from a liquor company on the verge of insolvency?

Given that they print the money--yeah that's totally unlimited power. What do you think the limit is? As long as they have collateral they can do it.

On the debt vs equity thing btw that is a 100% red herring Satchel used. The argument that it doesn't really count as equity even though it has complete equity characterisics is a truly bad one. Is it not clear from the AIG docs that you can structure a loan to be just like equity as AIG shareholder have seen? And that since it was senior to equity so its debt? Man that was not a legal and espeically not a business argument.

And last--Publius you make it sound like its me against you and satchel and legal begal. (two of which may be the same guy)

My sources are Bernake, Greenspan, Congressional testimony on this topic, and the statute that says they can exchange money for collateral and "prescribe" terms as they see fit.

What's your source? A link to a legal discussion where they are like--hey it looks illegal to me but I'm not sure?

But I also have something on my side that you Publius don't. It actually happened like I said it would a year ago to AIG a month ago.

To use a Supreme Court term, I have a presumption of correctness on my side of the argument given the Fed has done it and there is not one single legal challenge to date.

Posted by: cooper at October 1, 2008 11:08 AM

this just kicks the can down the road. Someone needs to put in capital. The Fed would like this to be the taxpayer, and so would those bank execs and sub debt/senior debt holders who don't want to suffer the AIG (or worse, LEH) fate.

Beagle,
Thanks for fighting the good fight.
Here’s an interesting article from yesterday’s NY Times.
The Treasury Department has already created a series of “supplemental” Treasury securities to finance the Fed’s activities, and there is no limit to how many more it can issue and sell.
…But because of all the new lending programs for banks and Wall Street firms, analysts estimate that the Fed’s balance sheet now has less than $300 billion in unfettered reserves.

So the 'no bailout' scenario looks like the Fed loaning against/swapping (no buying!) the toxic assets and rolling over TAF/TSLF 'til the cows come home. Hold to maturity (they're undervalued at current levels anyway :-) ) -- sound familiar? Seems like this could take zombification to a whole new level. While I've appreciated the discussion on the Fed's limits, what I'd really like to know about is if there are limits to the amount of debt that the Treasury can issue on behalf of the Fed (the NY Times article says no).

Posted by: EBGuy at October 1, 2008 11:10 AM

"what I'd really like to know about is if there are limits to the amount of debt that the Treasury can issue on behalf of the Fed (the NY Times article says no)."

Yes. It's up to the FCBs and the FOREX markets.

"What if they gave a debt auction and nobody came?"

Posted by: diemos at October 1, 2008 11:17 AM

Well theoretically there is no limit assuming the dollar remains a reserve currency.

Right now the dollar is holding up well since the world financial system is completely based on it. If it were ever to drop severely then foreign countries would stop buying our debt. Then rates would go higher and eventually the Treasury would be forced to issue debt in another currency such as Euros or Yen.

For the first time in years there is a threat of that happening and it would be a nightmare scenerio for the US and would put a hard stop to everything.

Posted by: cooper at October 1, 2008 11:21 AM

You guys jumped all over that ;-) By limits, I meant besides the "natural limit" of the marketplace. The idea the the Treasury can issue debt in my name (without Congressional approval) seems -- well, just wrong (if not undemocratic!).

Posted by: EBGuy at October 1, 2008 11:27 AM

They can't issue treasuries above the approved debt ceiling so that would limit I think the amount of money created. I am not 100% sure tho man.

the 300b # is low--i.e. they don't have a lot of cash left.

Posted by: cooper at October 1, 2008 11:34 AM

the 300b # is low--i.e. they don't have a lot of cash left.
FWIW, $300Billion is the number I've been flogging (or is that blogging). The the latest H.4.1 from the Fed shows $480B of Treasuries. Subtract the $197B of Treasuries that have been swapped out through the TSLF and you're left with ~$300Billion of fun money for OMO and fun extracurricular activities like TAF.
Good to know that the debt ceiling is a real constraint -- wouldn't want to give too much power to the triumvirate (Paulson, Bernanke, Cox).

Posted by: EBGuy at October 1, 2008 11:49 AM

cooper -

I hope you don't think it's rude if I do not respond to the substance of your post. We are clearly talking past each other at this point. And I would just be reiterating what has already been said here anyway.

We'll just have to leave at I disagree with your conclustion regarding the Fed's powers. I disagree with your characterization of the AIG deal. And I disagree with characterization of my sources and your sources.

I suppose we'll have to agree to disagree on this one.

Posted by: Publius at October 1, 2008 12:23 PM

yep, let's just agree to disagree.

If you ever get any statutes or some such to back up your point of view that the AIG deal was in fact illegal I'd be happy to revisit it though.

Posted by: cooper at October 1, 2008 1:33 PM

Sounds good cooper.

The "Scandinavian" model is gaining even more traction. And it looks like FDIC is going to get raised.

http://thehill.com/leading-the-news/soros-floats-alternative-bailout-plan-with-dems-2008-09-30.html

Posted by: Publius at October 1, 2008 2:14 PM

Well in the current bill you could do the scandinavian model but paulson will probably use the buy debt model rather than use equity because the GOP hates the idea of owning banks.

it's too bad because the fdic/scandinavian model is far far superior. i'd like to see that used with a 10 year limit of owernship so the govt has to sell at the end of 10 years or sooner

Posted by: cooper at October 2, 2008 11:14 AM

The Scandinavian model cannot apply to the US. The US is 20-30-50 times bigger than any Scandinavian country. When Scandinavian countries are in trouble, they're not in the void. They have the rest of the world as investors, importer, partners. If their assets are deflated, you just need a small number of world players to snatch up those assets and put things straight. A Scandinavian bailout/crash is a mere blip on the world's economy.

Posted by: San FronziScheme at October 2, 2008 11:43 AM

SFS -- there are plenty of actual economists and investors who disagree with you (google it). It's natural for banks to want to sell only their bad apples rather than part of their orchard, but as taxpayers we ought to drive a harder bargain.

Also, see this great article on the superbond idea (a variant of the equity stake):

http://www.hussmanfunds.com/wmc/wmc080929.htm

Whatever they do, they better do something fast. Our business is officially seeing new order flow practically halted (same thing happened in April tho).

Posted by: dub dub at October 2, 2008 11:51 AM

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