Perhaps it was a bit understated last week when we simply wrote “We’ll Go With [The] Worst” (with respect to Paulson’s proposed $700 billion bailout and approach). But hey, that’s how we roll. A few (hundred) others, however, not so much.

In a letter yesterday to congressional leaders, 166 academic economists said they oppose Treasury Secretary Henry Paulson’s plan because it’s a “subsidy” for business, it’s ambiguous and it may have adverse market consequences in the long term. They also expressed alarm at the haste of lawmakers and the Bush administration to pass legislation.

No kidding.

“The structure [of Paulson’s plan] is designed for the Treasury to be the first line of defense,” said [University of California-Berkeley economics professor David I. Levine], who studies organizations and incentives. “A whole lot of people made money supposedly by putting their capital at risk, and those are supposed to be the first line of defense, that’s how capitalism works.”

Bay Area represent (in more ways than one). And for some reason, this all sounds strangely familar. At least if you’re plugged-in.
UPDATE: The full text of the economists’ letter courtesy of a plugged-in reader and the bogleheads forum:

To the Speaker of the House of Representatives and the President pro tempore of the Senate:

As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function. We see three fatal pitfalls in the currently proposed plan:

1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.

2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.

3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America’s dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.

For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come.

And the 166 who signed.
QuickLinks: A Bloomberg Bailout Trio (And We’ll Go With Worst) [SocketSite]
Hundreds of Economists Urge Congress Not to Rush on Rescue Plan [Bloomberg]
Economists Letter To Congress [chicagogsb.edu]

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Comments from “Plugged-In” Readers

  1. Posted by EBGuy

    Someone please tell me that JBR sold his WaMu puts…

  2. Posted by JohnK

    Apparently some of these “acedemicians” have forgotten the concept of “public goods” or where public policy justifies the intrusion of government into the private sector. Does anyone really think that only the “fat cats” in financial institutions who “put their money at risk” are the only ones who will lose? The far-reaching effects justify goverment action in this case. As far as the future goes — we will then see a flurry of laws and regulations designed to re-vamp the system and prevent this exact situation from happening again. That is until someone figures out the loopholes and the same thing happens again, only differently. That’s our current economic cycle….

  3. Posted by John

    Only 166 academic economists are against it?
    We have more airchair economists on SS than that

  4. Posted by Dave

    We’re just rewarding bad behavior and punishing good. The responsible folks, who don’t borrow beyond their means and make all their payments, have to bail out the irresponsible borrowers who took loans they couldn’t pay back, and the unscrupulous banks that lent money to irresponsible borrowers.
    People and institutions that make bad financial decisions should pay for those decisions. Where’s my interest rate reduction, or my loan principal write-down? Oh, that’s right, I don’t get any breaks, because I pay my bills, so I get punished for my financial responsibility. I just have to pay for your bail out.
    Call me mad as hell.

  5. Posted by Dude

    Academics aren’t the only ones protesting:
    http://money.cnn.com/2008/09/25/news/economy/bailout_protests/index.htm
    Seems conservatives are also averse to giving Paulson’s needle exchange program the green light:
    http://money.cnn.com/2008/09/25/news/economy/deal_reached/index.htm?postversion=2008092513
    Don’t these people realize that without an endless supply of cheap debt, we’ll all be forced to save money and live within our means?

  6. Posted by Satchel

    I sure hope this bailout fails to pass! Senator Shelby is my hero, although I know deep down he’s fighting an impossible fight against the banksters.
    No surprise that our fearless leaders – Pelosi and Feinstein and Boxer – are all for this giveaway (they just want even a little more so they can steal a bit for their pet projects).
    BTW, WAMU finally gave up the ghost and was seized by the FDIC this afternoon. It looks like JP Morgan will get the deposits and good branches for a song, and the foolish taxpayer will eat the bad debt, but the details are still sketchy.

  7. Posted by John

    Actually, I wouldn’t say it is rewarding the bad behavior.
    The owners (stock holders) of those banks already lost almost all their money.
    And if there is no bailout, everyone will be punished, in term of economy and jobs. With bailout, at least we won’t get into Great Depression 2.
    Without bailout, the chance of anyone getting any mortgage is close to nil for the next year or so. It won’t matter whether the price tanks…because it will because nobody can buy it. The renters will be locked out of the market, not by price, but by financing (or lack of).
    With bailout, the price will still tank. However, buyers will hopefully get reasonable financing options, so we can actually take advantage of the situation.
    I hope some people like to see others suffering…. to me, I don’t care whether others suffer. I only care if I can take advantage of the situation.

  8. Posted by enonymous

    ah Satchel – i wrote the exact same words about Sen Shelby to my best friend who is a very, very senior staffer to Sen Shelby (for many years now) – glad we agree on this – he will die a martyr on this issue, at least in my mind
    maybe sometimes it helps to have a few friends in rather high places (i only wish I could impact policy like the banksters, but at least i’m in the loop a little)!
    and to post on another front – I read your reply elsewhere on the other thread – I wrote a long post, then this site crashed utterly and completely and I lost it all – so I gave up
    short version – don’t worry i’m still a monetarist – we both know what inflation really is (nd right now that M3 is looking mightly small)
    i reread all of your old posts you linked – brilliant analysis. makes me wonder if you are actually Paulson you were so scarily dead on.
    the other part of my post was my belief that if we went down this bailout rabbit hole, we would basically begin an enormous process of multiple bailouts, which would force the fed to inflate against its will. that is why i began to wonder about my previously deflationary bias.
    and i also was surprised that you sold long treasuries to go long equities the day before the huge short covering rally began last week. that was a masterstroke of market timing like I have never seen (and you posted before your actions – muy impressive). it was so uncannily accurate that i have to wonder where you get your information. intuition and analysis can only go so far (ask Bill Miller).
    and my final question to you. if i put a gun to your head, and told you that you had to structure a 1 trillion dollar bailout, how would you do it? and no, you can’t accept a bullet to the head (because i know that would be your response).

  9. Posted by Satchel

    “With bailout, at least we won’t get into Great Depression 2.”
    If any good is to ultimately come out of what is going to happen, it will be that people (perhaps) will stop believing in the tooth fairy of intervention and the idea that government can get fix things. It’s still amazing to me that after all these years, people still think the Great Depression happened because of a lack of government intervention. Just the opposite.
    I am still holding out a little hope that after this fiasco, people will throw out their Keynesian textbooks and open up the Hayek and von Mises works.
    @ enonymous – Thanks for the kind words. I’ve had a good run of luck this year in the markets. Please don’t confuse me with Paulson. I understand markets better than he does and have more experience in them than he does. He was an INVESTMENT banker – s corp fin guy. They do not understand risk at all because they are salesmen. Sort of like real estate brokers versus real estate investors. Any proprietary trader who survived long enough to get even a moderate amount of experience at a good shop could out-think that guy on markets (and Bernanke too), but perhaps not outfox him! About your question of a bailout, I’ll put up a post tomorrow morning about how to structure a $1 trillion bailout. It’s conceptually the easiest thing in the world, it would work, and that’s why it would never get done.

  10. Posted by enonymous

    i wasn’t kidding when i siad you were the wolf and i am the sheeple, Satchel. blunt words for blunt times.
    why wait until tomorrow for your proposal? it may be too late by then to get the credence your post would get if you put it up now…

  11. Posted by diemos

    “if i put a gun to your head, and told you that you had to structure a 1 trillion dollar bailout, how would you do it?”
    I’ll look forward to Satchel’s answer but in the meantime I’ll throw in my best shot.
    The arguement is that the real economy needs credit to function (which I think is true) so I would make the $1T available to be loaned out to businesses and consumers under the following structure:
    Funds would be provided as an interest earning deposit to a private financial entity who would then loan them out as they saw fit under the following conditions:
    The private entities would put 20% of their own money in a first loss position, no more than 4x leverage.
    All loans to be held on the entities books until maturity.
    Funds go to the entity offering the highest rate of interest.
    All other financial entities allowed to go kablooey.

  12. Posted by heheheh

    “why wait until tomorrow for your proposal? it may be too late by then to get the credence your post would get if you put it up now…”
    .
    because the guy is insane :-) he will probably stay up all night researching and planning defense of all statements.

  13. Posted by NoeValleyJim

    If the bailout works, it will work because it re-instills confidence in the current economic system. Economists, even today, only really can explain about half of all economic activity.
    The neoclassical model is particularly bad at modeling actual human behavior because humans don’t tend to act like the “rational man” of their theories.
    The overwhelming majority of economists agree that the New Deal lessened the effect of the Great Depression, the main problem is that the stimulus was not sufficient enough. This was proven when we entered WWII and government spending rose to 50% of the economy and full employment followed. Even during the period before the war, the economy grew at an average of 9-11%, the fastest economic growth period we have ever seen outside of wartime.

  14. Posted by Satchel

    I don’t have to stay up all night researching, but I definitely am a little insane :)
    “The overwhelming majority of economists agree that the New Deal lessened the effect of the Great Depression”
    The overwhelming majority of economists didn’t think there was a housing bubble either. In truth, the overwhelming majority of economists are fools.
    Slightly different, but related, topic. It looks like the WAMU deal might not be so bad for the FDIC/taxpayers. Apparently, the preferred, common and any subordinated debt are simply going to be wiped out, and JPM will acquire the deposits (so the FDIC is still on the hook, but these deposits are now part of a larger, presumably better bank). That’s the way it should be IMO.
    The reason I bring it up is that as part of the presentation materials, JPM made its assumptions public about house price declines it is expecting in California. They expect California to go down 44% peak to trough (that’s another 10% from where it is now), in the “no recession” forecast. In the event of a “severe recession” they expect California prices to fall another 24% (making it a 58% fall peak to trough). I guess the economists are singing a different tune now. Good luck, SF house owners!
    About the bailout, I think diemos’ idea makes tremendous sense. I’d add that the USG should put Fannie and Freddie into runoff mode, and should start a new agency to provide mortgage funding for as long as necessary on 2 conditions (NO EXCEPTIONS): 1) 25% down in cash, interest costs are fixed by the USG at treasuries + 1% (and the USG can duration match the liability – maybe hire 10-20 former MBS structurers at 1/2 their previous pay to model the prepayment issues as related to duration matching), with no more than 36% DTI ratio; 2) stated income is ok with 50% down, treasuries + 2% (at that spread, no need to model the prepayment risk IMO). No exceptions, and let the prices go where they will. USG funding costs will fall as foreigners realize that we are on the right path, the dollar strengthens, and as the US enters a deep (but short) recession that allows the current account to swing back into balance (I assume that dollar strength + economic weakness + increased propensity to save will lead to a rapid shift in the balance).
    On a macro level, the US economy needs to delever, so incentives for savings must be provided. Cut taxes on all forms of capital formation, including interest on savings deposits and capital gains. Reduce government spending because all government spending is CONSUMPTION (the government is not a productive economic actor), which requires throwing out all the Keynesians. Let interest rates rise to whatever level they will to equilibrate savings supply and capital demand. (They will fall soon enough as price deflation takes hold.) Allow real wages to fall.
    In short, do everything that Hoover and Roosevelt refused to do, and then you might have a chance at avoiding a Depression-style (or maybe a little friendlier Japan-style) deleveraging process. No chance of any of this happening, though, so I am battening down the hatches and trying to prepare for whatever is coming!

  15. Posted by diemos

    “I’d add that the USG should put Fannie and Freddie into runoff mode,…”
    Agree.
    The government providing private mortage originators with a taxpayer funded “Heads you win, tails I lose” insurance does nothing but distort the market and encourage wild bets.
    If we’re going to have a socialized mortgage market then let’s at least make sure to socialize the profits as well as the losses.

  16. Posted by NoeValleyJim

    The overwhelming majority of economists didn’t think there was a housing bubble either.
    No, that is not correct. The Economist has been saying that housing is severely overvalued and warning of a bubble for four or five years.
    Some have argued otherwise, but The Economist is pretty close to mainstream opinion, in most cases.

  17. Posted by FSBO

    Your plan gets my vote Satchel. Boehner, Shelby and Bunning and the few in Congress who are showing some backbone might go for it too. Maybe Gingrich would pitch it too (if you could pay him enough). You should send your plan to that Houston energy trader who took out the NY Times ad bashing the bailout. But I’m afraid you are right that there is no chance of any rational plan passing now. When we start with an insane plan conceived by probably the worst Republican Administration in history and then adust it to satisfy some of the most clueless, spendthrift Democrats ever (Pelosi, Boxer, Frank), we can be assured that it will be a disaster.

  18. Posted by diemos

    “In the event of a “severe recession” they expect California prices to fall another 24% (making it a 58% fall peak to trough).”
    At the peak of the bubble 8% of consumer spending was being funded by cash-out refis and HELOCS. There’s no way to avoid a “severe recession” once that spending goes away. The end of our debt fueled lifestyle will put us in a stronger position but not painlessly. I fully expect that within 5 years the US will be running a trade surplus.

  19. Posted by NoeValleyJim

    So SF prices have another 10-24% to fall? And they have fallen about 10% now, quite a bit less in most good neighborhoods.
    Not bad at all, especially considering what has happened all around us.

  20. Posted by NoeValleyJim

    Googling has not given me the answer, so I am asking here:
    Does anyone have a link to the letter by the 166 economists? I am curious who they are and what they have to say.

  21. Posted by FSBO

    NVJ – Here is the gang of 166:
    Acemoglu Daron (Massachussets Institute of Technology)
    Adler Michael (Columbia University)
    Admati Anat R. (Stanford University)
    Alexis Marcus (Northwestern University)
    Alvarez Fernando (University of Chicago)
    Andersen Torben (Northwestern University)
    Baliga Sandeep (Northwestern University)
    Banerjee Abhijit V. (Massachussets Institute of Technology)
    Barankay Iwan (University of Pennsylvania)
    Barry Brian (University of Chicago)
    Bartkus James R. (Xavier University of Louisiana)
    Becker Charles M. (Duke University)
    Becker Robert A. (Indiana University)
    Beim David (Columbia University)
    Berk Jonathan (Stanford University)
    Bisin Alberto (New York University)
    Bittlingmayer George (University of Kansas)
    Boldrin Michele (Washington University)
    Brooks Taggert J. (University of Wisconsin)
    Brynjolfsson Erik (Massachusetts Institute of Technology)
    Buera Francisco J. (UCLA)
    Camp Mary Elizabeth (Indiana University)
    Carmel Jonathan (University of Michigan)
    Carroll Christopher (Johns Hopkins University)
    Cassar Gavin (University of Pennsylvania)
    Chaney Thomas (University of Chicago)
    Chari Varadarajan V. (University of Minnesota)
    Chauvin Keith W. (University of Kansas)
    Chintagunta Pradeep K. (University of Chicago)
    Christiano Lawrence J. (Northwestern University)
    Cochrane John (University of Chicago)
    Coleman John (Duke University)
    Constantinides George M. (University of Chicago)
    Crain Robert (UC Berkeley)
    Culp Christopher (University of Chicago)
    Da Zhi (University of Notre Dame)
    Davis Morris (University of Wisconsin)
    De Marzo Peter (Stanford University)
    Dubé Jean-Pierre H. (University of Chicago)
    Edlin Aaron (UC Berkeley)
    Eichenbaum Martin (Northwestern University)
    Ely Jeffrey (Northwestern University)
    Eraslan Hülya K. K.(Johns Hopkins University)
    Faulhaber Gerald (University of Pennsylvania)
    Feldmann Sven (University of Melbourne)
    Fernandez-Villaverde Jesus (University of Pennsylvania)
    Fohlin Caroline (Johns Hopkins University)
    Fox Jeremy T. (University of Chicago)
    Frank Murray Z.(University of Minnesota)
    Frenzen Jonathan (University of Chicago)
    Fuchs William (University of Chicago)
    Fudenberg Drew (Harvard University)
    Gabaix Xavier (New York University)
    Gao Paul (Notre Dame University)
    Garicano Luis (University of Chicago)
    Gerakos Joseph J. (University of Chicago)
    Gibbs Michael (University of Chicago)
    Glomm Gerhard (Indiana University)
    Goettler Ron (University of Chicago)
    Goldin Claudia (Harvard University)
    Gordon Robert J. (Northwestern University)
    Greenstone Michael (Massachusetts Institute of Technology)
    Guadalupe Maria (Columbia University)
    Guerrieri Veronica (University of Chicago)
    Hagerty Kathleen (Northwestern University)
    Hamada Robert S. (University of Chicago)
    Hansen Lars (University of Chicago)
    Harris Milton (University of Chicago)
    Hart Oliver (Harvard University)
    Hazlett Thomas W. (George Mason University)
    Heaton John (University of Chicago)
    Heckman James (University of Chicago – Nobel Laureate)
    Henderson David R. (Hoover Institution)
    Henisz, Witold (University of Pennsylvania)
    Hertzberg Andrew (Columbia University)
    Hite Gailen (Columbia University)
    Hitsch Günter J. (University of Chicago)
    Hodrick Robert J. (Columbia University)
    Hopenhayn Hugo (UCLA)
    Hurst Erik (University of Chicago)
    Imrohoroglu Ayse (University of Southern California)
    Isakson Hans (University of Northern Iowa)
    Israel Ronen (London Business School)
    Jaffee Dwight M. (UC Berkeley)
    Jagannathan Ravi (Northwestern University)
    Jenter Dirk (Stanford University)
    Jones Charles M. (Columbia Business School)
    Kaboski Joseph P. (Ohio State University)
    Kahn Matthew (UCLA)
    Kaplan Ethan (Stockholm University)
    Karolyi, Andrew (Ohio State University)
    Kashyap Anil (University of Chicago)
    Keim Donald B (University of Pennsylvania)
    Ketkar Suhas L (Vanderbilt University)
    Kiesling Lynne (Northwestern University)
    Klenow Pete (Stanford University)
    Koch Paul (University of Kansas)
    Kocherlakota Narayana (University of Minnesota)
    Koijen Ralph S.J. (University of Chicago)
    Kondo Jiro (Northwestern University)
    Korteweg Arthur (Stanford University)
    Kortum Samuel (University of Chicago)
    Krueger Dirk (University of Pennsylvania)
    Ledesma Patricia (Northwestern University)
    Lee Lung-fei (Ohio State University)
    Leeper Eric M. (Indiana University)
    Leuz Christian (University of Chicago)
    Levine David I.(UC Berkeley)
    Levine David K.(Washington University)
    Levy David M. (George Mason University)
    Linnainmaa Juhani (University of Chicago)
    Lott John R. Jr. (University of Maryland)
    Lucas Robert (University of Chicago – Nobel Laureate)
    Luttmer Erzo G.J. (University of Minnesota)
    Manski Charles F. (Northwestern University)
    Martin Ian (Stanford University)
    Mayer Christopher (Columbia University)
    Mazzeo Michael (Northwestern University)
    McDonald Robert (Northwestern University)
    Meadow Scott F. (University of Chicago)
    Mehra Rajnish (UC Santa Barbara)
    Mian Atif (University of Chicago)
    Middlebrook Art (University of Chicago)
    Miguel Edward (UC Berkeley)
    Miravete Eugenio J. (University of Texas at Austin)
    Miron Jeffrey (Harvard University)
    Moretti Enrico (UC Berkeley)
    Moriguchi Chiaki (Northwestern University)
    Moro Andrea (Vanderbilt University)
    Morse Adair (University of Chicago)
    Mortensen Dale T. (Northwestern University)
    Mortimer Julie Holland (Harvard University)
    Muralidharan Karthik (UC San Diego)
    Nanda Dhananjay (University of Miami)
    Nevo Aviv (Northwestern University)
    Ohanian Lee (UCLA)
    Pagliari Joseph (University of Chicago)
    Papanikolaou Dimitris (Northwestern University)
    Parker Jonathan (Northwestern University)
    Paul Evans (Ohio State University)
    Pejovich Svetozar (Steve) (Texas A&M University)
    Peltzman Sam (University of Chicago)
    Perri Fabrizio (University of Minnesota)
    Phelan Christopher (University of Minnesota)
    Piazzesi Monika (Stanford University)
    Piskorski Tomasz (Columbia University)
    Rampini Adriano (Duke University)
    Reagan Patricia (Ohio State University)
    Reich Michael (UC Berkeley)
    Reuben Ernesto (Northwestern University)
    Roberts Michael (University of Pennsylvania)
    Robinson David (Duke University)
    Rogers Michele (Northwestern University)
    Rotella Elyce (Indiana University)
    Ruud Paul (Vassar College)
    Safford Sean (University of Chicago)
    Sandbu Martin E. (University of Pennsylvania)
    Sapienza Paola (Northwestern University)
    Savor Pavel (University of Pennsylvania)
    Scharfstein David (Harvard University)
    Seim Katja (University of Pennsylvania)
    Seru Amit (University of Chicago)
    Shang-Jin Wei (Columbia University)
    Shimer Robert (University of Chicago)
    Shore Stephen H. (Johns Hopkins University)
    Siegel Ron (Northwestern University)
    Smith David C. (University of Virginia)
    Smith Vernon L.(Chapman University- Nobel Laureate)
    Sorensen Morten (Columbia University)
    Spiegel Matthew (Yale University)
    Stevenson Betsey (University of Pennsylvania)
    Stokey Nancy (University of Chicago)
    Strahan Philip (Boston College)
    Strebulaev Ilya (Stanford University)
    Sufi Amir (University of Chicago)
    Tabarrok Alex (George Mason University)
    Taylor Alan M. (UC Davis)
    Thompson Tim (Northwestern University)
    Tschoegl Adrian E. (University of Pennsylvania)
    Uhlig Harald (University of Chicago)
    Ulrich, Maxim (Columbia University)
    Van Buskirk Andrew (University of Chicago)
    Veronesi Pietro (University of Chicago)
    Vissing-Jorgensen Annette (Northwestern University)
    Wacziarg Romain (UCLA)
    Weill Pierre-Olivier (UCLA)
    Williamson Samuel H. (Miami University)
    Witte Mark (Northwestern University)
    Wolfers Justin (University of Pennsylvania)
    Woutersen Tiemen (Johns Hopkins University)
    Zingales Luigi (University of Chicago)
    Zitzewitz Eric (Dartmouth College)

  22. Posted by enonymous

    hi NVJ:
    (courtesy of the bogleheads forum) here is the open letter
    http://faculty.chicagogsb.edu/john.cochrane/research/Papers/mortgage_protest.htm
    enjoy!

  23. Posted by FSBO

    I’m in agreement with the 166 on this issue – but here is a great article on the “science” of economics:
    http://www.fooledbyrandomness.com/FT-Nobel.pdf

  24. Posted by NoeValleyJim

    Thanks!

  25. Posted by ToonArmy

    Long time listener, first time poster, so excuse the long post.
    @NVJ:
    Here is the petition and the list of signatories:
    http://faculty.chicagogsb.edu/john.cochrane/research/Papers/mortgage_protest.htm
    And seconded that there were plenty of economists (Nouriel Roubini at the head) who were screaming “housing bubble” for many years.
    @satchel:
    How do you see the trade deficit closing? Slowdown in the US definitely reduce imports, and increased propensity to save would certainly improve the capital account ledger (the flip side of the trade balance). But a rising dollar would tend to increase manufacturing imports and decrease exports (but would decrease the cost of oil and other commodities). My impression was that would be a net negative on the trade balance. Not so?
    Regarding the JPM forecast of 44% peak-to-trough price declines (and noting that 34% of this is already in the bag), how does that square with the state of the SF market? We certainly haven’t seen 34% drops across any breadth – is the number here going to be significantly smaller, or is there a lag? Any bets on the peak-to-trough here?

  26. Posted by The Red Pill

    When John Thain sold a bucket of CDO’s for $0.22 on the dollar, every trader with a book full of this stuff pulled out a calculator (an HP 12c), punched up some digits and promptly said under his breath, “f*ck”. There was a bid for these things after all, and it was so far away as to be an abstraction. The second thought these guys had was this. If John Thain was hitting the bid, they would have to as well. Eventually.
    Credit John Thain for doing more than any other Chief to remain in charge of his own destiny. That it failed indicates just how gnarly things have become. The rest have done what people in pain do. They get together and beg, plead and scream for help.
    I’m ambivalent about the bail out. These guys should suffer. But everyone else will suffer even more if the bailout doesn’t happen. The reason it will happen is that there is legitimate panic at all levels. Congress has to make a show of it because the numbers involved are breath taking. But passage of the bailout is academic.
    Call options are too expensive. Own equities, sell dollars (for euros, ringgits, anything). Time to buy metal as well. The hedge funds have one last gasp this year to scare up some ducats. Volatility is going to be exceptional. Few things are more aggressive than a hedge fund trader who knows his seat is expiring in a matter of weeks.
    If this market makes a run for 12,000, get flat quickly. Before the ‘bad’ news shows up again.

  27. Posted by Trip

    It’s 90% politics and 10% economics on the bailout plan right now. The Republicans don’t see any profit in letting the Democratic Congress pass something that may save us all. If it passes and does end up helping, nobody will remember their opposition anyway so they lose nothing. If it does little or no good (the likely scenario), they can say “I told you so — big government doesn’t work,” which is the prevailing mindset among the majority anyway. And the Democrats are not going to go out on a limb and pass this thing on their own and thereby put the Republicans in that pretty good strategic position. So who knows what will pass, if anything.
    This is from the AP on an 11th hour Republican alternative they are demanding to be considered: their “proposal would have the government provide insurance to companies that agree to hold frozen assets, rather than have the U.S. purchase the assets.”
    Awfully short on detail. But I’ve got to say, for what is probably the first time in my adult life, I like what I see from the Republicans on a major issue. If I were the Dems, I’d take this, assuming the rest of the plan makes even a little sense. Puts them in the no-lose situation of taking credit for a “solid compromise” if it works and blaming the Repubs if it doesn’t.

  28. Posted by diemos

    While we’re at it here’s how I would completely restructure the banking business to eliminate bank runs and create a stable system without any need for government intervention.
    Banks would have two kinds of accounts:
    Demand deposits (like checking accounts) where the deposit would be kept on hand and not lent out.
    Investment accounts where money would be lent out and interest paid.
    The source of systemic risk in the current system is the lie that a depositor can have his money back at any time even though it’s been lent out for 30 years. To create stability you have to eliminate that lie.
    Money deposited to the investment account would be invested and receive interest. In order to remove money from the account the depositor would submit a bid stating the discount on his funds that he would accept. Available money from new investors or loans running off would be distributed to the low bidders. With this system there would never be bank runs or forced asset sales and there would be no need for government insurance.
    Again I would require the bank to put it’s own equity into a first loss position with no more than 4x leverage from the depositors. Any non-performing loan would have it’s value marked to zero until it was restructured. At 10% non-performing loans (half the bank’s equity gone) new loans would not be allowed. The bank would have to wait for it’s current loans to run off and restore it capital ratios.

  29. Posted by Satchel

    @ FSBO – The book “Fooled by Randomness” by Taleb is well worth reading. Definitely his best book.
    @ The Red Pill – I agree with a lot of what you wrote, except I think you are early. The dollar has a last gasp still IMO. Calls are too expensive agreed, selling puts makes a lot more sense on panic moves down. There is actually a chance that this bailout fails now (some dissention at the Fed apparently) and in any case, the market is likely to be disappointed with whatever comes out because NOTHING is enough to solve the problem. I’m sensing that we are going to get an “emergency rate cut” imminently (Fed funds are behaving very strangely and the Fed has drained a LOT of liquidity in the last few days in that market to INCREASE the rate towards the target).
    @ToonArmy – I agree with your framing of the current account issue, but I think on balance that the falloff in import demand from a slowing economy and falling real wages + better terms of trade on the oil imports issue (due to rising dollar and/or falling oil) would outweigh the potential attractiveness of imports because of a stable-rising dollar. We don’t have to flip the whole balance immediately (like Indonesia did in 1998, for instance) to ensure dollar strength. And we don’t need the dollar to strengthen dramatically on a trade-weighted basis – just enough to provide enough stability that the USG can continue to fund in the sovereign markets at these wonderful “reserve currency” rates. No one wants the system to blow up, so I think we’d have a few years to totally get the c/a into balance. We don’t run huge fiscal deficits (most of Europe perennially has had higher deficits and Japan currentlyhas a higher fiscal deficit and higher total government debt) and a little restraint on the fiscal side would work wonders IMO with our creditors.

  30. Posted by ToonArmy

    @Satchel:

    I agree with your framing of the current account issue, but I think on balance that the falloff in import demand from a slowing economy and falling real wages + better terms of trade on the oil imports issue (due to rising dollar and/or falling oil) would outweigh the potential attractiveness of imports because of a stable-rising dollar.

    Fair enough, that seems reasonable, although I’m curious whether the dollar rise/fall is a cause or effect here. My take is that the slowdown, and shutting off of the HELOC faucet, reduces domestic standard of living (no longer living beyond our means), which drops imports, as the dominant factor. That also means less dollars that the Bank of China etc have to recycle into treasuries, which would raise interest rates, which would encourage domestic capital formation as well. Higher interest rates would also support the dollar short term, at least.
    As you say, it then becomes a question of whether creditors trust the dollar enough to stay invested (v. taking advantage of the situation to draw out their capital), and you’re right that largely depends on whether the fiscal policy looks sound. There I’m not so sanguine – the key drivers long-term are medicare/medicaid, which have both demographics and medical inflation working against them. Absent serious reform of the health-care system, I don’t see a way out of that. Granted the overall deficit levels are lower compared to Europe and Japan, but we’re also earlier on the demographic curve (due in part to more immigration) than they are, and, I fear, have a less functional (more polarized) budget process.

  31. Posted by NoeValleyJim

    The EU overall has less total debt as a percentage of GDP than the United States. Germany and France are about the same, Italy is quite a bit higher and the rest of the EU is quite a bit lower.
    http://en.wikipedia.org/wiki/List_of_countries_by_public_debt
    No one has been deficit spending the way Bush has.
    http://z.about.com/d/uspolitics/1/0/n/G/095.png
    You can see when Reagan took office deficit was about 35% of GDP, he increased it to about 65%, Clinton and Gingrich got it down to 58%, then Bush and the GOP got it back up to around 70% or so.

  32. Posted by asiagoSF

    about how to fix things with $1T, I’ve heard this on one of the many threads I’ve tuning in lately (my head is spinning for the number of forums I’m reading, so I can’t remember which one, might even be SS): let the banks that deserve to fail fail, and loan some cash to the healthy banks that survive, so that they can provide enough credit as needed. That would be a very low-risk loan and the market would have the same access to credit it would have if we make the crooks whole with taxpayers’ money, as is being proposed now.

  33. Posted by ex SF-er

    I agree with much said here, but 2 small points
    @Satchel: Reduce government spending because all government spending is CONSUMPTION
    This is incorrect and you know it. There are many governmental expenditures that are investments. For example: many sensible infrastructure products (like national highways) can only feasibly be done by government, and yet they substantially improve the productivity of the private sector (hence they are investment, not consumption).
    You could argue that some infrastructure products (air traffic control) can be done privately. But there is no company on earth that could privately build and maintain an extensive highway system.
    Clearly I am not arguing that there isn’t waste in govt, nor that all infrastructure projects are investment (e.g. the highway to nowhere).
    Also, although I am not a Keynsian, I will put one thing forward: in general they recommend governmental expenditures during recessions, and then PULLBACK in govt spending during boom times. Their advice to my knowledge has never been taken. it’s only been used “half”. During recessions political folk over spend (keynsian) to stimulate the economy… then during bad times they continue the spending (anti-keynsian). so I’m not sure the Keynsian school is “wrong” rather the application of their principles is impossible politically.
    ===
    @John
    With bailout, at least we won’t get into Great Depression 2.
    Many of us aren’t sure this bailout will help versus GD2. it is true that there is a plan, and that it involves lots of money, but many of us worry that this will not achieve its objective.
    It’s similar to this:
    pretend you have a friend who is on fire and they’re screaming HELP ME!
    the answer would be of course to put out the fire.
    but what if you drafted a plan to hire a fireman?
    sure it looks good on paper. but you need to throw water on the poor friend!
    same thing here. we have a BIG problem that could conceivably lead to a depression. we also have a bailout plan. but the bailout plan does nothing to prevent the depression.
    the problem is that there is significant disagreement about WHAT can be done. there is a large possibility that nothing can be done. I’ve used this analogy before: Stage 4 small cell carcinoma of the lung is fatal. there is no treatment. once you get it, you die. The “treatment” is to never smoke. In the same way we have a massive problem with a bunch of 3 letter words (MBS, CDO, CDS, ABS, etc). The treatment was to never allow it to happen. oh well.
    now we’re in emergency mode. we’ll have to see if we can do anything about it.

  34. Posted by ex SF-er

    Lastly:
    I really like Diemos and Satchel’s hybrid plan.
    that said, I disagree with Satchel on this point:
    About your question of a bailout, I’ll put up a post tomorrow morning about how to structure a $1 trillion bailout. It’s conceptually the easiest thing in the world, it would work, and that’s why it would never get done.
    i guess it depends on what the “purpose” of the bailout is.
    if the purpose is to simply unfreeze the credit markets initially, then I totally agree that the above plan works.
    however, Satch/Diem’s plan has a weakness: it doesn’t address the cascading CDS cross-default issue. this IMO is one of the big sticking points that needs to be addressed… (in fact I think it is THE elephant in the closet that nobody has the balls to talk about) and one that unfortunately I’m not sure has an answer. Nobody can say that they know what the result of a cascading default issue would be (in a gloom/doom way or a rosy way), because it’s completely opaque. so sure, we can unstick lending for a while, but we may end up with 1000’s of bank failures anyway and complete pension funds bankrupt and municipalities bankrupt- in other words GD2.
    the only (very messy) way that I can think of to fix (or at least stall) the cds problem would be perhaps to buy the underlying assets at par. So as example, use the bailout money to buy all the underlying mortgages just before they default. that would in theory hold up the CDS market. during that time, we would have to ban future CDS completely or only have new cds issues on an open market.
    it would be M-E-S-S-Y though, and you’d surely be punishing those who work hard paying off their mortgage and rewarding those who go into foreclosure. (some of) Main street would like it though.
    Moral hazard indeed.
    another way would be to halt FASB accounting rules. That’s what some house republicans are
    suggesting… and in theory it could work by buying time for the banks to hide bad assets until they could recapitalize. It would create a Japan-style “zombie bank” phenomenon. On the upside, it MIGHT buy banks time. on the DOWN side, it creates opacity again and banks become even LESS willing to lend to one another. Regardless, we don’t have the national savings that Japan did so we may not be able to survive that, and this process as we know takes DECADES to play out.
    anyway, I agree with Diemos and Satchel’s plan (my own plan is quite similar) but we must recognize that there is nothing “easy” about our lives going forward. there is no “easy” way out. And there might be no escape from depression. many of us have been saying this for years, but it’s new information to a lot of people.

  35. Posted by Satchel

    NVJ,
    I think you are confusing the terms “deficit” and “debt”, at least the way they are commonly used. Deficit is usually the annual governmental fiscal shortfall, while debt is the accumulated shortfalls from prior periods.
    I can’t find a handy comparative table on the web (if you can, I’d love a link), but our fiscal deficit as a percent of gdp has been fairly small (almost always less than 4% of gdp, except for WW2, a few years in the 1980s (1983-86 I think), a year or two in the early Clinton years, and (maybe) 2004 and 2009. A country like Japan, for instance, was running fiscal deficits about TWICE these numbers as recently as 2002, and Europe perennially in the 1990s (for instance) had a tremendously difficult time getting to under 3% of GDP deficits in the run up to the euro (under the Maastricht treaty, which required it, but they all cheated and many missed the numbers anyway).
    US government debt is not too bad (yet). While it’s gone up from 35% to 70%, interest rates have fallen dramatically and so the burden is less than HALF what it was in the 1970s, for instance (as a percent of Federal expenditure). I think Japan (just going from memory) has over 150% government debt/gdp ratios, and much of Europe is well over this 70% figure as well.
    The problem was not the extra 35% debt/gdp that was added by government IMO. People tend to focus on this because they want to make ideological points (Clinton ran small surpluses for 3 years at the end of the stock bubble – of course, Bush ran a surplus too his first year!).
    The problem is TOTAL debt in the US system, especially household debt in the 2000s. This cycle was started under Greenspan – it was a conscious credit inflation encouraged by the Fed – and BOTH political parties encouraged it and did nothing to stop it. The chart doesn’t lie:
    http://comstockfunds.com/files/NLPP00000%5C292.pdf
    IMO, the attempt to “smooth” the business cycle and “tame” recessions since the 1980-82 double dip recession was a very foolish policy. Now, we are going to get the “mother of all recessions” because the excesses of the past were not allowed to clear in smaller, more frequent downturns.

  36. Posted by diemos

    “it doesn’t address the cascading CDS cross-default issue.”
    Derivatives were an unmitigated disaster. They allowed investors to think that all risk could be transfered to someone else leaving a risk free investment. In reality all it did was convert default risk and interest rate risk and all the other risks into counterparty risk. And now it is revealed that the counterparties don’t have any resources with which to make good on their promises.
    That’s one problem where I would go with the gordian knot solution. Cancel all of them and then restart the system by imposing the same regulation as on any other insurance contract.
    We’re not as rich as we thought we were and I don’t see any way of avoiding facing that unpleasant reality. In the future you won’t be able to trade your assets for as many loaves of bread or gallons of gas as you currently think you can.

  37. Posted by Satchel

    ex SF-er,
    CDS is a mess. I say let it all blow up, and we’ll pick up the pieces later. There will be winners and losers, for sure. Let the bankruptcy courts sort it all out. We have plenty of safety nets, but as diemos says, life is going to get much tougher. It’s time to take our medicine, and nothing can stop that.
    About government spending being “consumption”, well of course the ultimate purpose of CERTAIN government spending (such as infrastructure) can be viewed as an “investment” ultimately.
    (And there can be lots of reasoned back and forth over what truly needs to be done by government versus the private sector – clearly, we need to accept the inefficiency of government control in certain areas because the economically efficient alternative would be societally worse. For instance, imagine if corporations had fleets of F-15’s and standing armies! OK, bad analogy, I guess they do :) )
    But the first step to ALL government spending is consumption. It CONSUMES the savings of the population. That’s where it gets the money! And, of course, every dollar consumed is one less available to be saved. This is the central theoretical problem with Keynes IMO (you’ve definitely nailed one of the practical problems). Keynes makes a large mistake in assuming that savings and debt are interchangeable as regards productive allocation of resources. It’s definitely too OT for a blog (even this one) but you should read de Soto’s critique in “Money, Bank Credit and Economic Cycles” (available on the web for free in pdf).
    One way of (relatively) painlessly reducing government expenditure would be to pull all of our troops and bases out of Europe and Korea. Europe can pay for its own defense, and it’s time for Japan to re-arm anyway. Alternatively, we could charge them – say – $500M per day for the prtotection of Pax Americana. I think they’d opt to pay :)

  38. Posted by diemos

    “Alternatively, we could charge them – say – $500M per day for the prtotection of Pax Americana. I think they’d opt to pay :)”
    I’ve been wondering if we would see the “loans” (wink,wink) that are never going to be paid back morph into open tribute to the empire from our vassals.
    Currently we don’t entirely earn our way in the world through productive enterprise. The only way we could maintain our standard of living if the “loans” were to stop coming is if we point our nukes their way and say, “Hand it over.”
    Like any organization whose core competency is the projection of force we may come to rely on banditry and extortion to earn our daily bread.
    (Genteel banditry of course, like having our legions squat on top of the largest oil fields in the world in the name of bringing the blessings of democracy to our little brown brothers.)

  39. Posted by FSBO

    Gridlock in Washington is our best hope. I hope the House Republicans can hold on and stall the vote on this plan indefinitely. The marketplace is moving ahead – look at the actions of JPM and Morgan Stanley. Let the CDS market blow up – it will sort itself out. We don’t this plan or any other plan. Paulson has been working all these weekends – he should take the next four months off and then come in and clean out his desk.

  40. Posted by NoeValleyJim

    Yes, I used the word “deficit” when I should have said “debt” in my last sentence. I thought about correcting myself but decided that it was obvious, sorry if it created any confusion.
    In any case, Europe in general does not have a greater national debt as a percentage of GDP than the United States. So I hope it is clear that European deficit spending cannot have been much higher over the long run. The 3% Maastricht treaty goal was much lower than the deficits that Bush has been running, which are in the 5-6% range. The United States would have never been allowed to join the EU, at least not this decade.
    There is quite a bit of variation here, of course, with the Dutch and Swedes running smaller deficits and the Italians and Greeks running the highest.
    Japan has much more debt, as a result of a bunch of failed economic policies in the 90’s, and in fact is a cautionary tail for us now. One thing that is very different in the United States is that stimulative spending here actually gets spent, where in Japan it just got put in low yielding savings accounts.
    Clinton did the “right” thing economically, stimulating the economy during a recessionary period and cutting government spending as a percentage of GDP during boom times. I doubt this was due to any economic genius of his, mostly due to the fact that Congress was taken over by the GOP during his second term, and they were hostile to any Democratic spending initiatives, while Clinton and Gore stuck to shrinking the size of government, mostly through shrinking the Armed Forces.
    The Swedes actually had a similar banking crises in the early 90’s and I think any bailout plan here should follow a similar model. I don’t have time to summarize, but here is a link to a pretty good NYT article about how they did it:
    http://www.nytimes.com/2008/09/23/business/worldbusiness/23krona.html
    They ended up nationalizing a bunch of banks, some of which were later closed and some of which were re-privatized.

  41. Posted by Satchel

    NVJ,
    “the deficits that Bush has been running, which are in the 5-6% range.”
    Once again, partisan ideology trumps any regard for factual analysis. I’ve become used to that in the Bay Area but it;s all in good fun…..
    Here are the official numbers for the Bush years (I tracked them down). You could make some arguments that the USG is fudging accurate analysis (and in many cases I would be inclined to agree), but you are always the one who argues that USG numbers (like the deflator, GDP growth, inflation figures, etc.) are accurate, and you are always accusing me of being the conspiratorialist!
    2001 1.3% (SURPLUS!!)
    2002 -1.5%
    2003 -3.5%
    2004 -3.6%
    2005 -2.6%
    2006 -1.9%
    2007 -1.2%
    2008 -2.9% (estimated)
    http://www.whitehouse.gov/omb/budget/fy2009/pdf/hist.pdf
    (See Table 1.2 on page 25)
    Keep in mind of course that the US was fighting two wars during much of this period, and was also recovering from the 2001-02 recession and stock mrket collapse. Don’t you advocate deficit spending in downturns? :)
    The US would have of course qualified under Maastricht, but Italy and France would not have (but they fudged the numbers and criteria at the last minute). (I made a small fortune betting on convergence of Italian BTPs against a gigantic position (in excess of $500M) in the DM/FF forward markets when I was at a hedge fund in the mid-90s, so I know this stuff pretty well.)
    “One thing that is very different in the United States is that stimulative spending here actually gets spent, where in Japan it just got put in low yielding savings accounts.”
    The Japanese government spent a fortune on infrastructure projects, highways all over the place, etc. This is foolish Keynesianism of course, because all the money spent by the government was misallocated. The response of the people of Japan to all this nonsense was of course to stuff the money in mattresses, low yield savings account and to send a lot of it to seek higher returns in markets OTHER than Japan, which was being so foolishly managed. This process was the genesis of the ASEAN bubbles, which ultimately blew up in 1996-1998. (I made a much smaller fortune betting then that Japanese government bonds would rise as people lost confidence in their system.) That IMO is the cautionary tale for us.

  42. Posted by NoeValleyJim

    These numbers do not include “off budget” items, including most of the Iraq War. I will post the accurate numbers later.
    What a surprise, that the White House would lie to us about something like this.

  43. Posted by FSBO

    Plan? Plan? We don’t need no stinking Plan!

  44. Posted by Brutus

    Satchel,
    I’m disappointed in you with those numbers posted above. I’m sure that you know that those don’t include “supplementary” allocations, which somehow MOST of the war spending of the last decade has fallen under.

  45. Posted by ex SF-er

    Let the CDS market blow up – it will sort itself out
    It’s hard to respond to this and do it justice. Let me just say this: nobody- not you,not me, not anybody, knows what will happen if we allow $63T (and counting) of CDS to blow up
    it is possible (who knows?) that it could take down EVERY major national and regional bank as well as every investment bank and many of the insurance carriers. We could take that maybe one by one… but all at once?
    sure it WILL sort itself out, but it could take MONTHS to sort out and during that time ALL involved parties would NOT KNOW if they were solvent or not.
    The problem with a cascading cross default situation is that it is possible in theory for everybody to be bankrupt immediately together, or at least for everybody to NOT KNOW if they are solvent or bankrupt together. It is similar to how Lehman imploding caused a money market fund to break the buck, but on a grander scale.
    how would we have commerce if EVERY bank went down together? And it could take months to figure out who was really insolvent and who survives.
    Imagine if we let it all fail, and then suddenly tomorrow ALL of your credit cards are rejected, ALL of your cash cards stop working, ALL of your banks are closed as they sort out if they are solvent or not. and this could go on for months as forensic accountants sift through the toxic pile of the CDS market to see who lost money, who got money and collects, and who got money but fails to collect since their counterparty failed.
    this is the very scary thing that nobody wants to confront. we really do have a serious, possibly unsolveable, monster out there. And it’s not mortgages or WaMu or AIG either. It’s the CDS market.
    This is why (I think) Paulson wants a blank check to use at his discretion. Because with that blank check he can punish the hell out of anybody on the short side of the CDS market. If he does it again and again then in theory it can stop the losses in the CDS market and then the CDS market can be slowly and carefully unwound. but he can’t say this for political reasons. (imagine him saying “I will preferentially slaughter the shorts of certain firms only” he can’t say that).
    That’s what they’re talking about in back rooms.
    all of course, IMO.
    on a side note: this is why AIG was bailed out (they wrote significant amounts of CDS) and Lehman was not.
    on a side side note: the Fed/Treasury “learned” how difficult it was to create a “clearing house” when they tried it with Lehman… it was a complete and utter debacle.

  46. Posted by ex SF-er

    Keep in mind of course that the US was fighting two wars during much of this period
    but it’s all in supplemental “emergency” bills, that isn’t included.
    and this has not traditionally been done before except for the very first request. (as example, it was not done for Persian Gulf War 1 or even for Clinton’s attack of Yugoslavia)

  47. Posted by FSBO

    ex SF-er – Good points, but I’m not sure that I buy them. I certainly place very little faith in anything coming out of the mouths of Paulson and Bernacke. Even in a worst case scenario, I can’t image that it would take months (or even weeks) to get most things functioning again. If the markets are so polluted by these undecipherable instruments, then the private parties should start the cleansing process now – without delay and with absolutely minimal govt intervention. Govt oversight OK – but no taxpayer infusions.
    Just my opinion.

  48. Posted by John

    ex SF-er,
    That’s exactly how great depression would happen – when all the financial institutes close.
    And there are dozens of government interventions over the last decades. Why would people only focus on Japanese?
    How about let’s look at China….supposely, the Chinese banks had over 40% bad debt (worse than the Japanese), and some US academic economists has warned that without dealing with it, Chinese economy will collapse. What did the Chinese do? The government backed the banks and add new capital. Now, who is facing a banking system collapse?
    If the Chinese banks did as US economists suggested – write down the bad debt, trigger a national panic – that would be the real way to kill the economy.
    Even if you look at the Japanese economy, it is not as bad as you think. Yes, their growth is low (1% to 2% per year over the last decade). However, a major factor is that they have a very small population growth and the aging of the population. Their working-age population is essentially flat from 1980 to 2000 (and decreasing since then). When you factor in that, I don’t think their economy is bad at all.

  49. Posted by ToonArmy

    @Satchel,
    Piling on a little here, but you are using the “unified” deficit numbers. That’s fair for comparing overall government financial position (taking account of the supplemental appropriations, as others have noted – saying we’re paying for wars but not including them in calculating the deficit is, well, “conservative” :-).
    However, much of Europe (and Japan’s) fiscal deficits are due to demographics (aging population, with less immigration than the US has had).
    As the baby boom generation ages, the long-term liabilities change the social security trust fund contribution to the unified budget from the recent (actuarially necessary) surplus to a deficit. So a fairer picture of fiscal rectitude is the on-budget (excluding SS) deficit (in the same table).
    Forward projections of the budget situation are trickier due to the subterfuge of time-limited tax cuts designed to dress up the budget projections while being politically impossible to expire quietly.

  50. Posted by ToonArmy

    @John:

    Yes, their growth is low (1% to 2% per year over the last decade). However, a major factor is that they have a very small population growth and the aging of the population. Their working-age population is essentially flat from 1980 to 2000 (and decreasing since then).

    A very good point, and one I wish we’d see more of in all the “growth rate” discussions. GDP growth per se isn’t as good an indicator of economic efficiency without accounting for population and demographic shifts. Without getting into the whole can of worms about whether GDP captures the right things, but surely there can be no dispute that it is per capita GDP that is the more telling figure than overall GDP.

  51. Posted by Satchel

    Brutus & NVJ,
    I of course know that supplemental “war” funds have been allocated to fight the Iraq and Afghanistan wars. I thought these were included in the unified on budget figures in that budget document I linked to, but perhaps I’m worng?
    The large distinction that makes comparisons tricky across countries is what ToonArmy references, namely that our “unified” budget includes transfers from social security excesses (I do think ToonArmy makes the case a little too stringly, though. Our demographics are bad, but nowhere near as bad as Japan or most of Europe, which is of course committing siucide slowly. We do retain the ability to attract and assimilate immigrants – at least we used to be able to assimilate them! – so this helps our organic demographic issues.)
    You can see the transfer mechanism in the table I referenced as well, and it has been consistently reported throughout the years (at least since 1974, and earlier periods were restated to reflect the new convention). For instance, if you look at the “on budget” figures from the Clinton years, you will see that he ran deficits EVERY SINGLE YEAR, except for 2000 when there was balance (no surplus, once you exclude the transfer payments).
    About whether the Iraq and Afghanistan war supplementals are included, please provide me with a cite that explains it because I thought they WERE included in the “total” budget when presented historically. You guys seem pretty sure of yourselves here, so it should be easy to point to it.
    Also, let’s not get carried away. NVJ said that Bush ran 5-6% budget deficits, which is of course wrong. The war costs in 2003, 2004, 2005, 2006, etc. were always less than 1% of GDP. Even today, they are less than 1% of GDP. So far, I’ve seen estimates that we have spent $580B on Iraq so far over 4 or 5 years. That’s less than 4% of GDP TOTAL, or way less than 1% per year.
    So, NVJ (brutus did not make the claim) how do you get to “5-6%” deficit figures under Bush? Could you provide a link or cite?

  52. Posted by EBGuy

    I am curious as to what others think about the “rotating moral hazards” that have been employed by the Fed, Treasury, and FDIC during this crisis. The shear variety and means of addressing problems within the financial industry (see: de facto nationalization, assisted mergers, usurious loans, stripping banks of indebtedness) seems to have kept investors on their toes as it is difficult to pick the winners and losers. It also means the “fallout” from each rescue is different (as well as the unintended consequences). As a rank amateur, I’ve been impressed with the arsenal of weapons at their disposal, but fear if they have to resort to reusing some tools (say, a repeat of the FDIC handing WaMu to JPM on a platter) we will see the system break down.

  53. Posted by cooper

    @Diemos I like you idea to get the credit markets functioning.
    @Satchel The WM takeover has JPMorgan taking over all the WM loans as well. It wasn’t just the deposits. As for you being smarter than Paulson- I really don’t know. Goldman is a lot more than a sales shop, their prop trading is huge. I agree that Paulson is not as smart as everyone makes him out to be. I have not seen a lot of evidence of deep thought.
    As for you guys and your love fest over Shelby. Gime a break. you know he is going to probably end up voting for the bill anyway right? The guy talks out of two sides of his mouth on every bill.
    He’s partisan trash just like Reid is. Both sides are crap including Shelby.
    As for that list of “economists” who are against the plan. Man David Beim was my finance professor at CBS. He is not an economist, he’s a former investment banker (dillon Read(sp) I believe. Really good professor tho.
    I like the idea about some sort of government insurance that the GOP guys have put forward. I really dont like 700 b to the banks. I think it’s too much cash for us to dish out and it won’t be enough to work.
    What if the Fed guaranteed loans based on discounted cash flow, then paid for it by insurance fees that would be put in place on all origination starting in say 18 months. So the government would be essentially loaning money to this insurance fund to be paid out of the fund in the future. I really don’t like the idea of the taxpayer bailout and having the US taxpayer pay for it.

  54. Posted by Satchel

    “Goldman is a lot more than a sales shop, their prop trading is huge.”
    No question. Most of the guys I worked with when I was based in London came off the Goldman prop desk.
    But PAULSON is an I-banker. He came up through the ranks on the cororate finance side. This separates him a bit from most of the Wall Street CEOs in recent years (e.g. Blankfein, Corzine, Rubin, Gutfreund, etc.), who came up on the trading side. Prior to the mid-1980s, the upper echelons were exclusivelt the province of the corp finance guys. That’s all I meant about Paulson – he never traded markets, and so does not seem to have a feel for them.
    There is a huge chasm – even in investment banks – between the corp finance guys (mostly I-bankers, but also the advisory M&A crowd) and the sales and trading side. Perhaps that’s broken down a bit over the last decade – I’ve been out of it all for while!

  55. Posted by NoeValleyJim

    Here is a graph I found that contains accurate information about the total increase in the United State’s debt over the last seven years:
    http://en.wikipedia.org/wiki/Image:Reported_Deficits_vs._Debt_Increases_-_2007.png
    As you can see, the increase in debt was $600B in 2004, when the GDP was $11.75T, which is well over 5%. It looks like it was closer to 4% in 2007, though it is sure to be higher this year, especially when the cost of all the bailouts is included.
    An apple to apples comparison of EU vs. United States debt and deficit spending requires you to pull out Social Security surpluses, because that is how they calculate deficit.

  56. Posted by sparky-the-bear

    That list of economists looks like it was just sent around to a few universities.

  57. Posted by NoeValleyJIm

    I am frankly a little surprised to find you so vigorously defending Bush’s disastrous economic policies. I thought you were more of a “small government” kind of guy and as I am sure you know, Bush engaged in the largest government growth since Johnson.

  58. Posted by ToonArmy

    @Satchel:
    For instance, if you look at the “on budget” figures from the Clinton years, you will see that he ran deficits EVERY SINGLE YEAR
    Be fair, you can’t change the budget balance (3-5% of GDP, ballpark) overnight, when you’re working on a tax/spending base of ~20% of GDP. Which is why it is the trend (and especially the trend over an economic cycle, so you can compare peak-to-peak or trough-to-trough) that is important, and indicative of the actual fiscal propriety and budget sanity.
    Regarding the demographics issue, I was saying that our current demographics are much better than the majority of OECD/devloped countries, in large part due to immigration (I think we’re in agreement there).
    My concern is that counting on continuing to do so, while at the same time advocating policies that deter immigration (the “no furriners” advocates, and the post-9/11 clampdowns and delays on student/professional visas), is dangerous. I don’t have hard figures, but anecdotally, it seems that the tightened visa regime here, combined with improving opportunities elsewhere (including moves towards openness in Europe, and explosive growth in China/India) have shifted a significant portion of the top-talent immigration away from being exclusively US-bound.
    Regarding the inclusion (or not) of supplementals in the budget, the first result I found (admittedly not definitive, but I have to head out in a moment) is in Wikipedia:
    http://en.wikipedia.org/wiki/Federal_budget_(United_States)
    which says:

    Using 2007 as an example, the “On-Budget” deficit of $344 billion is reduced by the “Off-budget” surplus of $182 billion to arrive at the “Total” deficit of $162 billion. It is this latter amount that is often reported in the media. The national debt increased approximately $500 billion in 2007, which is the $344 billion on-budget deficit plus an additional $156 billion of supplemental appropriations or otherwise non-budgeted expenditures, primarily the wars in Afghanistan and Iraq and earmarks

    and that references the growth of total federal debt outstanding, here:
    http://www.treasurydirect.gov/govt/reports/pd/histdebt/histdebt_histo5.htm
    As for Bush’s 6% deficit, will you take Reagan instead? 1983 – both unified and on-budget deficits were 6%. I think that was the costs for the Grenada war, though :-) And Bush Sr. was 5.4-5.5% in 1991 and 1992.

  59. Posted by NoeValleyJim

    I am not sure if non-subscribers can access this page, but this is where I am getting overall budget deficit numbers from outside the US:
    http://www.economist.com/markets/indicators/displaystory.cfm?story_id=12304922
    As you can see, the EU region is running a 0.9% overall deficit this year, with many countries, including Germany, the biggest economy, in surplus.

  60. Posted by cooper

    ooh Citibank and Wachovia in business combo discussion. Talk about putting two one legged men together.
    Anyway..
    I am a little surprised Satchel defended bush’s budget record too. The increase in spending is horrible, the numbers you put up there don’t include like the trillion or so we are spending on Iraq. I agree that peopel in ncal love to bushbash tho and don’t look at reality!

  61. Posted by cooper

    @NVJ-
    Deficit to GDP, is not the same thing as debt to GDP. Deficit fluctuates quite a bit.

  62. Posted by cooper

    Does anyone know the answer to this, or have a link to a fed paper or something that explains this.
    I’m talking about this chart of total debt to GDP for the Us. we’ve talked about it on this site before. Basically it’s gone from 150% of GDP in the 70s etc to 350% now.
    http://www.ft.com/cms/s/0/a09b317e-898d-11dd-8371-0000779fd18c.html
    To get it down to 150% we’d need to take tens of trillions out of our economy. My question is, how much of this increased debt is “transmuted” i.e. debt that has arisen for transaction demand. i know a lot of this debt is based on property values and as those values come down, debt will be written off and come down. But say 15 trillion? Something else has to be going on. i.e. the commerical paper markets. soemthing. I’m trying to understand where this number needs to get down to for us to have some sort of equilibrium.

  63. Posted by Satchel

    Cooper,
    I don’t have time right now to delve into it, but I think the Fed’s Z1 flow of funds report breaks it down (going by memory here).
    Something like 30-40% of that 350% debt/gdp figure is the increase in mortgage debt alone after 2000. In other words, if you think that 150-200% is sustainable and trend-normal (I’d agree with that), fully 1/4 to 1/3rd of the increase debt load was taken on for wholly unproductive assets. I suspect credit card, auto, and other consumer debt is a big slug too.
    Check out the Z1 and let us know what you find!

  64. Posted by NoeValleyJim

    Yeah, that link is another way of presenting the overall increase in debt graph that Satchel keeps posting. I find that FT one much more interesting, because it puts it into perspective as a percentage of GDP.
    I had not realized before that the overwhelming increase in debt was in the financial and household sectors, not in government borrowing. Perhaps arguing about Bush deficits is just focusing on the sideshow, not the main event.

  65. Posted by cooper

    Satchel, you just answered that question like an investment banker.
    I know what two sectors have driven the increase…i know how to read charts. I am looking for a paper that explains what all that debt is being used for. for example is there X % of an increase to finance short term payroll #s?
    Perhaps if we knew the duration of the debt. i.e. short term vs long term then compared % in 1980 vs the current situation. There has to be some fed paper somewhere that looks at this huge increase and explaisn what changes in the modern economy has forced this. thats what i am looking for. It’s a chart Iv’e watche for years and im tired of not understanding it.

  66. Posted by Satchel

    “I had not realized before that the overwhelming increase in debt was in the financial and household sectors, not in government borrowing. Perhaps arguing about Bush deficits is just focusing on the sideshow, not the main event.”
    This is the beginning of wisdom IMO :)
    In the 1970s, the USG spent something like 20% of Federal receipts on debt service (interest rates were high). Today, it spends less than 10% on debt service. Having the reserve currency and the ability to fund at these wonderfully low rates is a great thing. I have always bet that no way the Fed will “inflate” or crush the dollar just to save the indebted household sector.
    I posted some intuitions a number of times (at least 3) on SS about why this debt load is unsustainable and why the Fed has wanted to collapse it (yes, I still believe tha the Fed has intentionally caused this credit collapse, signalled by the installation of Bernanke in 2006).
    The most concise of my posts is this one from back last March for those who care:
    http://www.socketsite.com/archives/2008/03/sunday_night_special_the_bear_stearns_blowup_and_balanc.html
    (See “Posted by: Satchel at March 17, 2008 11:51 AM”)

  67. Posted by cooper

    Satchel–
    I was like –in those threads man. i already know hat you’ve said in the past. You just point out the graphs and debt% levels. I am looking for an economic paper on the topic. There must be one the fed has done. I’ll search around myself.
    As for your point not to worry about the government debt. That’s way too polyanna. Yeah debt service is low because interest rates are low now but it’s not like the treasury is issuing 30 years now instead of t-bills up the butt. the rates could go up in a month.
    we are a hop skip and a jump from having to issue debt in yen or Euros. or What happens if interest rates go back up, say to 8%, or worse 15%? All very possibe. And in those instances, debt service would go through the roof.

  68. Posted by Lurker

    http://www.socketsite.com/archives/2008/03/fannie_maes_new_confirming_loan_limit_guidelines_in_sum.html
    To Satchel’s credit, he predicted this entire scenario or at least the pre-cursor – months ago.

  69. Posted by ex SF-er

    Even if you look at the Japanese economy, it is not as bad as you think.
    @John: you misunderstand me. I believe that the Japanese situation might be the BEST possible outcome for us. In other words, we do what Japan did, which will allow the zombie banks to recapitalize over decades. I worry that we will not be able to pull off the Japanese feat however because they were a creditor nation and a net exporter whereas we are a debtor nation and a net importer. if it works: we have time to recapitalize our banks. If it doesn’t: the banks continue to refuse to lend to one another and we get frozen markets.
    ===
    I certainly place very little faith in anything coming out of the mouths of Paulson and Bernacke
    @FSBO: agreed. I listen to NOTHING that’s coming out of their mouth. In fact, if you look at my posts, you’ll see I’m most concerned about what they’re NOT talking about: the CDS market. I think that Bern. and Paulson are terrified of the CDS market but are unable/unwilling to talk about it.
    But I DO believe the words that come out of some of my economic mentors… and they all agree that NOBODY understands what is going on in the CDS market. NOBODY. (that includes Bernanke and Paulson and me and Satchel). it could be really bad folks. Or it could be like Y2K, no big deal. but the problem: nobody knows.
    Even in a worst case scenario, I can’t image that it would take months (or even weeks) to get most things functioning again
    it took YEARS to iron out Fannie’s books. They STILL don’t have totally updated financials for this decade.
    the CDS nightmare will be 1000x worse as you will have hundreds if not thousands of different firms with different positions. worse, there will be countless litigation based on decisions made.
    as example: you as a firm have a CDS contract with company X, who is now bankrupt. The clearing house abriter decides to give bankrupt Company X’s assets to company Z… but X also owes you… and you need X’s money so that you can pay the money you owe Company R. so you sue to get some of company X’s assets from company Z to pay company R… see the problem?
    ======
    @Lurker: I’m sure Satchel predicted this YEARS (not months ago), as did many people including me. however, I still disagree with a few of the finer points of his current argument. for instance, I think that the the real problem is not “easy” to fix… but I see the “real” problem as the CDS market as I elucidated above, not the simple issue of the freeze in credit markets which can be obviated by Satchel/Diemos’ hybrid plan.

  70. Posted by sojurn

    Satchel is predicting the end of the world using recycled economic charts. He doesn’t actually understand them. This is a bad crisis but it is something we are going to escape out of.

  71. Posted by notgreat

    USG credit default swaps show a higher probability of default that those of McDonald’s.
    China has called for a “deal” to stop panic selling of US debt.
    With recessions looming world-wide, it’s not clear (to me at least) why foreigners will choose to continue spending their savings on financing USG debt, vs. spending in their own economies, *especially* if the USG insists on infecting its own balance sheet with the virus that has already brought down every major investment bank, adnd is threatens to reduce the # of commercial banks to 3 (BAC, WFC, JPM).

  72. Posted by FSBO

    ex SF-er – More good points. General questions – how did the CDS market get as large as it did, how did debt markets function before the invention of the CDS, and does it serve a necessary function (at least in theory)?

  73. Posted by NoeValleyJim

    Imagine if we let it all fail, and then suddenly tomorrow ALL of your credit cards are rejected, ALL of your cash cards stop working, ALL of your banks are closed as they sort out if they are solvent or not. and this could go on for months as forensic accountants sift through the toxic pile of the CDS market to see who lost money, who got money and collects, and who got money but fails to collect since their counterparty failed.
    I think this is actually Satchel’s dream scenario. Correct me if I am wrong here. :)

  74. Posted by ex SF-er

    how did the CDS market get as large as it did, how did debt markets function before the invention of the CDS, and does it serve a necessary function (at least in theory)?
    before I begin, my answers are far from gospel and I have taken liberties, although the gist is all correct.
    First:
    a simplified (although somewhat erroneous) way to think about a CDS is like it’s insurance.
    prior to the cds market a pension fund might buy a bond. So let’s say: Calpers bought Ford’s bonds. The bonds may be pretty safe and give a return… but Calpers is at a little risk becuase Ford could default on its bonds. So in the past Calpers would do a lot of due diligence, and then if they felt Ford was worthy they would buy Ford’s bonds. If Ford did ok, Calpers gets paid back plus interest. If Ford goes BK, Calpers loses it’s investment (some or all).
    Then someone had a great idea. Create an insurance product (but don’t call it insurance because insurance is regulated)! So now, if Calpers is worried about Ford, but doesn’t want to sell the bonds that it owns, then Exsfer comes to the rescue! Exsfer will sell a CDS to Calpers. Calpers has $10billion in Ford bonds. Exsfer will charge 2%/year for this. So now, Calpers will pay Exsfer $200k/year (2% of 10 billion). If Ford goes under, then Exsfer will give Calpers all the money it loses on it’s Ford bonds. Let’s say Ford defaults and Calpers loses 60% on its bonds. Then Exsfer must pay Calpers $6B. If Ford doesn’t go under, Exsfer keeps the money and Calpers will get it’s $10B back from ford when the bond matures.
    So if Ford doesn’t go under then Calpers makes less, but now they have no risk! they have “offloaded” the risk to Exsfer, who can theoretically handle the risk. Everybody benefits. Ford benefits because people are more willing to buy its bonds. Calpers benefits because it is risk-adverse and it knows it won’t lose its money although it will need to pay a little to do it. Exsfer benefits because he can make a little money and can presumably handle the extra risk.
    So to answer your question: yes the CDS market USED to serve a great purpose in the market.
    For a while, this market functioned quite well, so more and more pension funds (and other entities like municipalities, companies like berkshire hathaway etc) started using CDS to reduce their risk. (so called “hedging” their risk). It is great as it is shifting risk towards those who want it and can handle it, and shifting risk away from those who either can’t hankle or don’t want risk.
    ====
    so now the problem:
    1) people thought they got rid of risk. They didn’t. the risk is still there, but spread around. but in the frenzy with everybody buying and selling CDS to everybody else, it became difficult to tell if the person selling you CDS could actually handle the risk or not. But a lot of parties didn’t care, so long as they could show ON THEIR BOOKS that the risk is “somewhere else”.
    2) These morphed too much. Originally these were basically insurance products between 2 parties who did due dilly on each other and who could handle the risk asseessment.
    However: a CDS can be between any 2 parties, about anything. In the past, the CDS usually was backed by something… like a bond or a note. And one of the parties was usually involved.
    as always, these things morphed…
    speculators/investors started selling more and more CDS regardless if they were involved in the transaction or not! One doesn’t need to actually own the underlying bond to have a CDS as example. So I might decide one day “hmmm I think that Ford is going down!” So I could buy a CDS from someone, pay them the quarterly payments, and then if Ford goes down I still collect money based on the terms of the CDS!
    This was great for some firms, because there may be no stock to short, but you can “bet” on Ford with using CDS!
    even moreso: some of the CDS can be traded. so you may have a CDS that is sold by one of the parties to another party at a discount or a premium. this of course changes the equation.
    You can also play with buying or selling bonds and combining that with buying or selling CDS contracts. it is esoteric and boring and I don’t really understand it well enough to explain it except to say that it happens.
    remember: these are UNREGULATED. So this was especially nice for hedge funds and investment banks (cough! Goldman Sachs) and insurance companies (cough! AIG) because they could make huge bets OFF the books where nobody knew their position!
    so you started having more and more people involved, many of whom wanted to keep their trades quiet, many of whom had no real fundamental interest in the underlying asset, except to the extent that it would or wouldn’t make them money. Some of them were well capitalized, and some were not. This of course all goosed by leverage.
    So now you might have Firm A that has $1B in bonds, but $10B in outstanding CDS. if Firm A defaults and only recovers 50%, then the bond holders lose $500M, but the CDS losses are $5B (which is more than the value of Firm A’s bonds in the first place!)
    There was a “silent” mania in the CDS market! the data is hard to come by, but in 2005 there was something like $13T notional of CDS, last year there was $43T, and by this year we’re to $65T and counting.
    so going back to my original point: this is the problem with the CDS market. It is SO big, and there are SO many participants (across our entire economy) and SO opaque. nobody knows what would happen if we get defaults! contrary to others’ beliefs-it would be very difficult figuring out who is solvent and who is not because there are so many contracts between so many people!
    It’s like financial STDs.
    not sure if that helps or not.
    This is why I THINK that Paulson/Bernanke are REALLY trying to get $700B to use in the CDS market. It’s also why they want it hush hush, without oversight or anything. Because they want to be able to watch the CDS market like a hawk. And then when “an event” is about to happen, they can swoop in and buy the underlying security to stop the default.
    So if you have $100M of MortgageX Bonds outstanding, and there are $2T of notional CDS related to it waitng for a trigger, then Paulson can “save” a $2T notional event by buying up just some of those $100M bonds.
    if he does this again and again, people will stop speculating in the CDS market (on the short side)
    or likewise: let’s say you have a big player like AIG. AIG wrote a bunch of CDS. If they went down, ALL their counterparties then have to readjust their books accordingly (since their CDS is now worthless). So Hank/Bernanke could swoop in and “Save” AIG, which is really saving everybody else.
    the more I think about it, the more I think that’s what’s really going on.
    but it’s late and now I’m just rambling. hope that helped.

  75. Posted by FSBO

    Thanks ex SF-er – that was very informative and helpful. I now understand how the $65T could arise from a much smaller amount of “actual” bonds. I don’t know how this insurance was priced – but it seems like you’d have to consider the riskiness of the primary bond (Ford in your example) plus the riskiness that the CDS seller would actually be capable of paying off in the event that Ford couldn’t. So AIG and other big sellers of CDS now can’t pay off – and most parties can’t even compute where they stand on a net basis since most where buying and selling. And guys like Taleb say their pricing models weren’t worth a damn anyway. Wow, I can see where this entire house of cards could come down and the collateral damage that this could cause – but really shouldn’t we just let it happen? If it is a house of cards, it needs to fall. The profiteers and architects could pay up or declare bankruptcy and maybe end up in court. Yeah it’s a mess and it impacts us all – but, if I had the choice, I wouldn’t spend one dime of my money to preserve this system. Imagine if every taxpayer had a line item veto on their tax return – the Iraq war would probably get more voluntary funding than this plan. I wonder if $700B will be enough? Thanks for the tutorial.

  76. Posted by NoeValleyJim

    That is why I call it a Giant Casino. No one was really doing anything economically useful, they were just making a bunch of side bets, like gamblers do when watching two people playing dice. Now a bunch of Billionaires who were making 20%/yr taking insane risks want the rest of us to bail them out, since they are losing money this year.
    The worst part of it all is, we probably have to bail them out, because we need their money in the long run. And they will get it, because all that money buys a lot of Senators.

  77. Posted by ex SF-er

    FSBO:
    There are 2 “systems” here. I don’t THINK it’s about saving the CDS system. in fact, the current CDS system will not survive. The reason: too many people now understand that risk was never eliminated as previously thought (duh), but was instead spread in such a way that it causes massive systemic risk.
    The system “they” are trying to save is the financial system (there is argument if the US financial system is worth saving or not)
    So the CDS system will likely go back to its original intent (a small practical system of insurance), but there is a difference between allowing something to collapse, and unwinding something. An example might be a wire under high tension connected to a winch. You could just cut it, and it would whip around and do some serious damage maybe killing you. Or you could unwind the winch a little, removing tension, and then cut the wire safely.
    A lot of the CDS have durations on them (specifically, they expire when the underlying securities mature). so if you can hold things together long enough and NOT allow more CDS writing, much of the current CDS will expire over time. (using my example above: Ford’s $10B in bonds will eventually mature. at that time the CDS contracts go away!). The longer dated CDS can slowly be matched up and cancelled out in an orderly fashion.
    A side note: I’ve been saying for about 1.5 years on Socketsite now that the RE bubble wasn’t really a RE bubble, it was a credit bubble. And if you recall, I’ve often told people that we aren’t going back to “normal” (2002-2007) anytime soon because it takes years for a credit bubble to unwind. Hopefully everybody understands why that is now. And now you see why (without govt intervention) we will not be seeing easy lending any time soon again. It can take years and even decades to repair credit bubbles.
    .

  78. Posted by ex SF-er

    and a secondary side note. I forgot to give the answer why the CDS market got so big so fast. One must just put our sytem in context.
    anything can be securitized. Car loans, auto loans, student loans, credit cards, you name it. You take them, bundle them together (a mortgage/auto/student/credit backed security). In the past, investors would buy this security (we’ll use an MBS for our purposes). But the MBS had good mortgages and “Bad” mortgages in there, and the investors didn’t want “bad” stuff.
    so then you chop the MBS up (a Collateralized Debt Obligation). You put the “great” mortgages in the top “tranche” and it’s AAA. you put the ok mortgages in the middle tranche and it might be BBB. you put the garbage in the lowest tranche and it might be CCC. You sell the AAA tranche to a pension fund. But nobody wants the lower 2 tranches.
    so you take the middle BBB tranche, you mix it up a little into another CDO, and you take the top tranche of that and INSURE it (using a CDS) with an entity who has a AAA rating, and now the BBB tranche becomes AAA!!!
    And then you take the remaining garbage, mix it up again into another CDO, and then insure that with an entity who has an AAA rating again, and now that becomes AAA too!
    So basically, the CDS market allowed garbage to be sold as gold (AAA), since the garbage was “insured”
    every year that home prices went up it reinforced the (incorrect) idea that house prices never go down, and thus the CDS will never “trigger”. Thus, more and more people were willing to sell CDS (thinking they’d never have to pay up) and more and more people trusted the insured-garbage so bought the insured garbage as though it was AAA (when it was really CCC)
    Thus, the non-speculation reason why we saw an explosion in the number of CDS written. and why loans got so easy to get starting in 2000. because you could make some really bad loans, mix them up, cut them into pieces, and then insure the pieces and sell it as though it was AAA.
    But now house prices are going down. CDS are thus triggering. CDS sellers are finding out they can’t afford to pay up (like AIG). CDS buyers have garbage MBS on their books that is only AAA because it’s “insured” but who knows if the insurance is good or not? So they are valuing those AAA MBS as though they are AAA (because they are technically). But nobody else wants to buy the MBS at AAA rates because they don’t trust the “insurance”. So nobody will buy or sell.
    needless to say, nobody wants NEW CDS insured MBS! (which is why Wells is charging 9% for a Jumbo)
    So long as the bank doesn’t sell the MBS then there “is no market” and they can mark them on their books as worth 100cents on the dollar (mark to model or Level 3) But if they sell the MBS then they might get 40cents on the dollar-then they have to write down 60cents on the dollar on their earnings, which might make them technically insolvent. (mark to market, Level 1).
    ====
    so when people say “just let it crash!” they don’t understand that we don’t know where the CDS is. any bank with any exposure to a CDS wouldn’t know if it is solvent or not, because they’d have to figure out if their counterparty had money or not to pay up.
    and this could take months if not years to figure out.
    or maybe it would be easy. Again, nobody knows (it’s never been done before, and we don’t know where the stuff is).
    An example (simplified) after a massive cds “crash”
    A sold CDS to B for 100
    A sold CDS to C for 200
    A bought CDS from D for 100
    A bought CDS from E for 200
    this can be unwound easily. If A goes down, then you can match up!
    now D technically sold to B for 100
    and E technically sold to C for 200
    and A is bankrupt.
    but what if:
    A sold to B for 100
    A sold to C for 200
    A sold to D for 400
    D sold to C for 400
    This is nice because D is actually a net zero (it bought from A and sold to C for the same amount). Right?
    wrong.
    what if A fails.
    Now B is out 100
    D is out 400, and now bankrupt too
    C should be out 200 to A, but get 400 from D for a net +200. But D is bankrupt, so C is out 600.
    worse yet:
    B is a municipality that is now bankrupt. (like Orange County).
    C is a bank. due to losing 600 it now has to be taken over by FDIC.
    D is an insurance agency, so now people are worried that their premiums are gone.
    F (which wasn’t even involved) held a lot of stock in companies D and C, and so they take a big hit (even though they weren’t involved)
    G is a regular business but can’t get move it’s commercial paper because C went down. thus they can’t fund daily operations so they go down.
    I is a private investor who was told that ABS were “liquid and safe” but now the ABS market is frozen and his retirement savings are illiquid and perhaps gone.
    remember: these might not all be banks. it could be banks, hedge funds, insurance agencies, municipalities, pension funds.
    but again: we don’t know. all these trades might match up easily and cancel each other out like my first example. we just don’t know.
    I too say “let the CDS market fail!” but then I step back and realize that this could in theory cause something worse than the great depression. or maybe it’ll be a nothing burger like Y2K. who knows? I don’t. Satchel doesn’t. Paulson/Bernanke don’t either. Nobody does.
    is it worth the risk? (honest question).

  79. Posted by Satchel

    “is it worth the risk? (honest question).”
    I say yes, even though of course I do not know the exact windup of what will happen.
    (BTW, nice description of the CDS market-casino, ex SF-er. The only thing you left out is the impossibility of hedging. The CDS market is so large that it dwarfs the subject securities. A seller of CDS insurance would traditionally short the underlying security in a delta neutral way when things got dicey. However, because the CDS are so large – say $50B of swaps (payout value in the event of default) on a company with a debt capitalization of $5B – there is no way to sell enough secutities short to hedge the CDS writer’s risk.)
    IF the problem is so large that it’s a systemic issue, than $700B will not solve it. The USG can only fool the market for so long, and the game is ending.
    How will things like “suspension of the mark to market rules” help engender trust? How will a game like injecting a bit of cash into the CDS market (which “cash” BTW has to be taken from somewhere else!) to keep the wobbling top from falling over fool particpants into thinking this is all going to work out? Any games like this (as Japan found out) lead to increased distrust among market participants, and lending would plummet anyway. Even healthy participants will be tainted by the suspicion that they are being propped up, and will not want to enter into deals with other particpants whom the healthy ones fear might be being proppped up.
    As firms go belly up, and insolvency proceedings are instituted, AT THAT POINT the USG can come in if necessary and either (1) provide standard “debtor-in-possession” financing to the bankrupt entity in exchange for all the equity (assuming that the CDS liabilitie would chew through the entire capital structure) or (2) in extraordinary circumstances (perhaps like an AIG) the USG could exercise emergency controls under the Commerce Clause and suspend the bankruptcy proceedings and take direct control of the subject company and deal with the creditors on a case by case basis (this would require an Act of Congress I’d assume, but if we’re really facing Armageddon, that shouldn’t be too hard to do). This sort of dealing with the “problems” would cause the potentially solvent CDS players to find religion FAST, and unwind this mess privately if possible. Perhaps we need a “stimulus” package to hire bankruptcy attorneys and judges!
    There are no good “solutions” to the mess we are in, which is of course the natural result of repeated and successful attempts to avoid recession by stuffing the system with debt by artificially forcing the cost of credit below its equilibrium rate for at least 15 years. Periodic recessions and even depressions are NECESSARY, as we are finding out. The first step to fixing this mess is accepting that premise. All these financial firms were heavily REGULATED entities. As would be expected, they simply bought off the regulators (just why was the CDS market “unregulated”? why were firms “allowed” to play off-balance sheet games?).
    Karl over at Market Ticker had a worthwhile piece with some specific suggestions about the CDS market that proposed forcing all derivatives contracts onto a transparent exchange over a specificied short period. Something like that – combined with a case-by-case bankruptcy/USG intervention like I suggested above – might work.
    http://market-ticker.denninger.net/archives/593-CONGRESS-STOP-AND-THINK!.html
    The key again in my view is to accept the obvious conclusion that we are going into a deep downturn, and that lending is not going to – and SHOULD NOT – return to anything like what we’ve seen in the last 10 years. Quickly airing this dirty laundry, and allowing asset prices and incomes to collapse (as they must) would ensure that this downturn is cathartic and quick, and would allow us to get back on a sustainable economic path as fast as possible.

  80. Posted by Satchel

    Since I always post about the Fed’s policy on printing money, I though I should give everyone a heads up on something potentially very worrying.
    http://research.stlouisfed.org/publications/usfd/page3.pdf
    This huge increase in the monetary base I assume is a result of the AIG bailout in which the Fed purchased Treasuries and printed the currency to do it (so that it could lend to AIG). I’m not too worried yet because I’ve always expected the Fed to engage in some limited “printing” to offset the collapse in the “shadow” money supply of easy credit. But if Bernanke expands base money aggressively for a sustained period of time, I’ll change my view and prepare for an inflationary collapse. There’s plenty of time IMO to get positioned right if the Fed has actually changed course.
    (I sort of think this is what is forcing Bernanke’s and Paulson’s hands now – they do not want to “print” money because the consequences would be catastrophic, think mortgages at 12%+ – but AIG showed them that Congress needs to get the taxpayers to east the losses and pronto!)

  81. Posted by diemos

    “I’m not too worried yet because I’ve always expected the Fed to engage in some limited “printing” to offset the collapse in the “shadow” money supply of easy credit.”
    Me too. You should be able to support some money printing to offset the shrinking credit base without igniting general inflation. If I was Heliben I’d be watching the price of oil to gauge how much stimulous I could get away with.
    I’m still not expecting any significant wage inflation though.

  82. Posted by enonymous

    ex SF-er
    single best post i have read anywhere, in a long time. should be required reading for anyone who has any interest in the mess we are in.
    satchel,
    i actually tried to post that exact link previously during the socketsite failure (kind of the like the russian market). it was in response to the deflaton vs inflation question. i knew you would stumble upon it somewhere (i first saw it posted at CR).
    i agree it is a short term move, almost certainly due to the AIG mess. the fed has been draining liquidity at a furious pace also, presumably trying to find its way back to the target overnight rate of 2%.
    my suspicion is the fed’s balance sheet is not so pretty at all right now. i suspect in fact, that they have some liquidity issues themselves, which has really forced their hand into either ‘printing’ or getting the taxpayer to pony up fast. of course, they will never let anyone know the true status of this situation (hi american taxpayers, we the fed are having trouble with liquidity, so we are going to print some money while we wait to grab your wallets and take your money).
    the fed has so many garbage assets on its books right now that are not liquid. I know the CDS issue is enormous (and a friend of mine who was party to the Lehman CDS ‘clearing session’ told me it was ‘mayhem’ and a ‘a total disaster’). I actually think the other unspoken enormous issue is that the fed is up against the wall on this one now. either the taxpayer ponies up, the fed inflates, or we default.
    not pretty stuff.

  83. Posted by Trip

    Yeah, excellent stuff on the CDS mess. The fantastic irony is that the entire premise of a CDS is a concern that the company behind the underlying debt will go broke and be unable to pay the debt — thus expressly recognizing the risk of such an event. But in buying a CDS and thinking they have now eliminated all risk, they discounted by 100% the risk that the counterparty would go broke!

  84. Posted by Cat5

    Thanks Ex SFer for the clear description of the CDS problem.
    I have a question, maybe a stupid one:
    At this point, if we’re going to have a crisis anyway, wouldn’t inflation be better than deflation?
    Inflation would inflate Real Estate prices, closing up the source of the problem, mortgage defaults.

  85. Posted by cooper

    Satchel Said “Since I always post about the Fed’s policy on printing money, I though I should give everyone a heads up on something potentially very worrying.
    http://research.stlouisfed.org/publications/usfd/page3.pdf
    No. That’s everybody buying tbills instead of holding cash and or banks wanting to hold bills instead of lending cash to other banks.
    That’s why the Tbill rate is so low.

  86. Posted by cooper

    To Ex-sfer. Very good explanation of the Cd market.
    Don’t you think this market has a valid place and purpose but it just needs to be regulated? I wish there had been a proper market for it so I could have bought swaps on Lehman paper!

  87. Posted by Trip

    If the CDS market were regulated like insurance — which is what it is — it could be a viable tool but it would be several orders of magnitude smaller as an industry. State insurance regulators are quite good and quite conservative. If an insurer wants to write something where the risk cannot reasonably be valued using accepted actuarial standards, they won’t let you write it. In addition, regulators do not permit insurers nearly the leverage that we’ve seen in the financial mess. Capital requirements are very stringent. As a general rule (varies from state to state and line to line), you can write about 3X in policies as you have surplus on hand. The types of investments in which you can place that surplus is also tightly regulated (the result of the junk bond fiasco in the early ’90s that brought down some big insurers). Reinsurance can be obtained only from those who also meet strict requirements — so you can’t just buy a CDS-type financial instrument from some hedge fund and do an end-run around all the regulations.
    On top of all that, insurers are all on the hook for one another (to some extent) through legally-mandated guarantee funds. So if one carrier starts getting into some funny lines of business or investments, their competitors will be quick to notify the regulators about it and put a halt to it.
    This is all done at the state level and it works well — recall that not a single insurer went under after Hurricane Katrina. AIG’s insurance subs are all just fine. If the AIG parent would have stuck with regulated insurance and avoided the unregulated financial services that it bet big on and lost, the company would still be a trillion dollar independent company today. Because the states do such a good job, I wouldn’t be surprised if the end result of all this chaos is new law removing insurance from state oversight and placing it under a federal insurance regulator.

  88. Posted by diemos

    CDS insurance is pointless.
    If the interest rate of the bond minus the premiums for the insurance is larger than the T-bill yield then you are betting that a private company is financially stronger than the USG which is backed by an infinite printing press.

  89. Posted by tipster

    ex SF-er,
    Great explanation. It is true that this could unravel. But if we prop up the market, wouldn’t that just cause people to continue the process?
    If there is less perceived risk because the government will step in and backstop everyone, why wouldn’t I just start selling $5B in CDS tomorrow? Certainly my counterparties would have no problem buying from me (in spite of the fact that I don’t exactly have $5B lying around) because it is really the government from which they are purchasing insurance, not me, I just collect the payments. And if the government really is backstopping everything, my risk of loss is pretty low.
    So if you have a bail out, and everyone does what is in their best interests, doesn’t the problem get even worse?
    And as for Satchel’s alarming hockey stick graph, how does the disappearance of the extra $400B in Lehman assets announced on Friday, and the disappearance of the equity and bonds in WaMu play into that increase? Doesn’t it serve to cancel it out, at least partially, if not more, as an inflationary force?
    Man, if I were half as smart as you guys, I wouldn’t have to ask all these questions. I have almost everything in Treasuries and now I’m even starting to worry about that. But when you search around, all you find are articles on how you should learn how to grow your own food and buy cars in which the seats fold back so you can sleep in them.

  90. Posted by cooper

    Again. Satchel’s graph is not the govt printing money.
    That’s banks that stop lending to other banks and instead they buy t-bills from the Feds. The cash then sits in the federal reserve and boosts money supply. Adjusted money supply includes money on the Fed’s balance sheet. The t-bills that they buy replace things they would otherwise do with it like buy commercial paper or lend cash to other banks.
    It’s not the government printing money.

  91. Posted by Satchel

    cooper,
    I don’t think you are right on this.
    All “dollars” are a liability of the Federal Reserve, not an asset.
    The base is currency in circulation plus bank reserves (basically). Any dollars that are “taken out” of the system by the banks and placed “on deposit” with the Fed just reduces currency in circulation by the same amount the “deposited” amount would go up. It would be base neutral. Anyway, why in the world would private banks “buy” treasuries and then deposit them on SOMEONE ELSE’s balance sheet? (The USG “sells” treasuries, not the Fed, except of course when the Fed engages in its open market operations, which are never on this scale!)
    The “assets” of the Federal Reserve are usually treasuries. However, they’ve lent most of them out and now a lot of toxic crap is sitting there in their place. If it had any left, it could have sold them to the marketplace and absorbed the cash and then advanced that cash to AIG. But it doesn’t (or at least its inventory is low enough that it feels it doesn’t have the flexibility).
    Since all dollars are a Fed liability, the increase in base money has to reflect the Fed growing its balance sheet. How did it purchase those treasuries with which to expand its asset base? It “printed” them (actually it’s all just digits on a computer somewhere).
    At least that’s how I have always understood the process. Maybe someone on this board who understands it better than we do could explain it better?

  92. Posted by Satchel

    tipster,
    “And as for Satchel’s alarming hockey stick graph, how does the disappearance of the extra $400B in Lehman assets announced on Friday, and the disappearance of the equity and bonds in WaMu play into that increase? Doesn’t it serve to cancel it out, at least partially, if not more, as an inflationary force?”
    You obviously understand this better than most! As the “shadow” money supply (which consists of things that are not worth what people thought they were, such as LEH bonds, houses on Caselli Street, CDS-“insured” bonds, etc., which nevertheless served previously as a means to borrow more money/credit) contracts, my belief is that the deflationary impact of that contraction overwhelms limited money printing.
    Obviously, how much “printing” is enough to “offset” the deflationary pressures is anyone’s guess. I don’t have the stats handy, but I recall Japan increasing its money supply at triple digit rates in the early 2000s (“quantitative easing”) and that obviously was not enough to counter the deflationary forces acting on assets there (although it did stabilize CPI-type inflation).
    Rampant money printing in a country like the US that runs a large current account deficit would be extremely risky – almost unthinkably so IMO. It’s not wacko at all to contemplate what would happen in the event that the US currency melts down and USG interest rates on treasuries spike to over 10-15% in a world in which there are thousands of nuclear weapons around. I’m pretty sure TPTB want to avoid a dollar meltdown and USG funding crisis, but you never know these days….

  93. Posted by cooper

    Satchel-
    1. I told you the Fed could give money to any company or even an individual if it chooses. You told me I was wrong and they needed congressional approval. Now that you’ve seen the crisis unfold, do you doubt I was 100% right and you were wrong?
    2. I told you that your last graph on fed lending was misleading because it invluded the investmen bank bailout. After checking your facts, turns out you were wrong which you admitted.
    3. You are incorrect on monetary base not including the cash reserves held on the balance sheet of the Fed, Or any central bank. Adjusted money supply includes dollars (or whatever the home currency is at the central bank).
    For your reference see below:
    Investopedia Says:
    —————————–
    For example, suppose country Z has 600 million currency units circulating in the public and its central bank has 10 billion currency units in reserve as part of deposits from many commercial banks. In this case, the monetary base for country Z is 10.6 billion currency units.
    For many countries, the government can maintain a measure of control over the monetary base by buying and selling government bonds in the open market.
    —-
    for someone who does not like investment bankers- and thinks he is smarter than Paulson (which may or may not be true). I bet Paulson knows what adjusted monetary base is and doesn’t throw panic charts around without understanding whats in them eh? you’ve lost my vote for treasury secretary.

  94. Posted by Satchel

    cooper,
    You engaged in the same sort of disinformation the last time, and it’s getting silly.
    On your points:
    1. The fed has not “given” one dime to anyone, as far as I can tell. It has only lent. I have always said that the Fed can lend to anyone under its 13(3) powers. Can you point to 1 single entity that the Fed has “given” anything to in this crisis? If not, then a simple “You’re right, Satchel” will suffice. Be careful with your words – don’t be sloppy like most fools.
    2. The chart I posted on reserves was NOT misleading. I thought we had established that, because we discovered (together) that the “loans to i-banks” that you thought were so important were only like $3B total. I was wrong on a small technical detail, and of course I was big enough to admit that, as I always am. I’m not intimidated by reasoned argument and a mutual attempt to understand a tricky and fluid situation, as you seem to be.
    For anyone following this silliness, the thread that cooper is referencing is here:
    http://www.socketsite.com/archives/2008/08/justquotes_the_fed_holds_rates_the_markets_react_accord.html
    (It’s a little technical, sorry in advance!)
    3. “You are incorrect on monetary base not including the cash reserves held on the balance sheet of the Fed,” Can you read, cooper? You are writing this silliness in response to my post above in which I said the base is “currency in circulation plus bank reserves (basically).” What did you think I meant by “bank reserves”??
    Now, seriously, nonborrowed reserves at the Fed (this is advanced through things like the TAF) are now in excess of NEGATIVE $150B. Required reserves have recently gone down as banks fail (so aggregate required reserves go down) to $40B. There are “excess reserves” (these are funds in transit this week as all this craziness is getting sorted out) of about $65B. That’s the reserves picture at the Fed right now.
    Instead of just lobbing bombs my way, why don’t you explain exactly where the Fed “got” the $85B to advance to AIG. Here’s a hint:
    http://www.bloomberg.com/apps/news?pid=20601087&sid=aF1B.T6IoiW8&refer=home
    How did the Fed “pay” for those special auctions of treasuries? In addition, in general can you explain exactly “how” the fed “prints” money, and in which aggregate we would see it (assuming my description is wrong)?
    I don’t enjoy this sort of interchange, cooper. I recall an earlier thread when you thought our problems were similar to the ASEAN crisis, and when we delved into it it turned out you didn’t even know the sequence of events back then, let alone the underlying dynamics.
    Oh, and please tell me who the Fed “gave” money to, and while you are at it, please let me know which assets the Fed “purhased”.

  95. Posted by cooper

    By Satchel
    “The fed has not “given” one dime to anyone, as far as I can tell. It has only lent. I have always said that the Fed can lend to anyone under its 13(3) powers. Can you point to 1 single entity that the Fed has “given” anything to in this crisis? If not, then a simple “You’re right, Satchel” will suffice. Be careful with your words – don’t be sloppy like most fools.”
    Uh what about the purchase of 80% of AIG which is not even a bloody bank or regulated by the Federal Reserve. They can do a loan or equity and already have to people that have nothing to do with the Federal Reserve.They just decided to do it because they felt they needed to which they have the right to do under statute by Congress.
    So no I’m not blind, and I think the AIG example proves which one of us is. How you see that as “disinformation” is puzzling but it’s the same accusation I have of you. The difference is, the AIG equity infusion is an example I have, and you don’t have one to back up what you are saying.
    2. Your statement claiming that treasury purchases and sales are “base neutral” confirms you don’t understand that that’s the tool the Fed or any central bank uses to add or subtract to the money supply –its not base neutral. Check the rest of money supply–commercial paper and other “money like” instruments are crashing. Everyone is storing their money at the Fed.
    You claim to be so much smarter than Paulson and demean his investment banking experience as “sales” but you are just as imprecise as any investment banker I have seen. You post these graphs but don’t seem to understand or even want to understand them.
    Oh and I still think the Asia/Russia crisis has similarties here. And while I have been saying that asset prices in real estate need to come down for a while –I think excessive panic spread by people at this point is unproductive. The world is not coming to an end, and we are not all going back into the stone age.
    If you don’t enjoy the interchange that stop posting panic graphics that you don’t understand.
    An

  96. Posted by enonymou

    1.) tipster’s point is dead on
    the fed’s inflating (which I think is going to be temporary though I am unsure on this point), real as it is, has been, to this point at least, vastly overshadowed by the massive deflationary forces of the vaporization of credit (due to the implosion of their underlying assets – the asset backed securities, which are now nothing backed securities – or the implosion of housing values, resulting in worthless home equity lines, institutional and retail examples respectively).
    2.) the monetary base has increased. that hockey stick is real. it has been vastly outweighed by the massive deleveraging and loss of credit (money) elsewhere. when the deleveraging slows down (it will eventually), and the fed doesn’t need to pump its liquidity up, and the taxpayer has bought all of their useless toxic collateral, the fed will slowly drain out this jump in the money supply, lest it risk real inflation. the fed needs to protect its balance sheet. it is too important to its own survival (and that of the US reserve currency status).
    can the fed print its way out of this mess? probably not. more to the point, even if they try, can they get the timing of it right? that is probably a better and more important question. if they are off we either get deflation for a long time then inflation, or we get deflation for a short time then inflation.
    either one will hurt, just depends on which bets you have made…
    and check the TIPS = treasury implied inflation expectations – that falling off the cliff should tell you what expectations are…
    http://www.clevelandfed.org/research/data/tips/index.cfm

  97. Posted by SteveR

    “Uh what about the purchase of 80% of AIG which is not even a bloody bank or regulated by the Federal Reserve.”
    LOL Satchel got owned.

  98. Posted by Satchel

    cooper,
    I guess we’ve discovered you were (are?) an i-banker! For the record, where have I said that I was “smarter” than Paulson? I said I understand markets better, because that is my background. I may or may not be right.
    Correct me if I am wrong, but isn’t the AIG “infusion” a LOAN, in fact made at LIBOR+850? Yes, the Fed also got warrants, but don’t think that LIBOR+850 over is a loan? They have been lending to all sorts of toxic institutions at basically treasuries rates through the TAF. It sounds like the Fed “took” something, not “gave” something, namely 80% of the equity capitalization of the company.
    They structured it this way because they do not have the authority to “give” anyone anything un derthe Federal Reserve Act. (Now, do I think they will get paid back in full? That’s a different question, and I think is part of the reason why the Fed is now in the process of getting Congress to give the Fed the authority to do all sorts of things that were previously unthinkable…)
    I understand open market operations very well, almost certainly better than you do. I understand very well how the Fed can alter the base by buying or selling treasuries on the open market, either temporarily (TOMO) or permanently (POMO). I see you skirted the question, where did the Fed get the dollars to “buy” those treasuries it bought in the special auction referenced in that Bloomberg article? I’d really like to know your take, because I don’t understand all of this 100% (who does?).
    Last, cooper, you really are in over your head here. “Your statement claiming that treasury purchases and sales are “base neutral” confirms you don’t understand that that’s the tool the Fed or any central bank uses to add or subtract to the money supply –its not base neutral.” Please reread what I wrote. VOLUNTARY PLACING of reserves at the Fed are base neutral. I NEVER said that fed “purchases and sales” are base neutral. Are you saying that the “excess” reserves that you say are being parked at the Fed were actually PURCHASED? As I wrote above, I understand TOMO, POMO, sterilized versus unsterilized purchases, etc. pretty well. Do you?
    And last, about panic. Remember the first rule of trading: Don’t Panic. Second rule: If there is going to be a panic anyway, Panic First! Back in August, when you were saying I was alarming people for no reason in that thread I referenced above (the one in which you seem to still think you “proved” that the graph was misleading – it wasn’t, obviously), I hope no one took you seriously. I’d say the events of the last few weeks more than bore out any attempt to “panic” people into sensibility, wouldn’t you?
    @ SteveR – I know how desperately some people want to see me be wrong. Not on this one, although I of course make mistakes like anyone. Not as big as the mistakes that so many have made this year in real estate or markets, though (knock wood)!

  99. Posted by cooper

    Wow that was a sorry attempt at trying to avoid “being a gentlmen when I find out I am wrong”. So that’s two thing now we both know that are not true.
    If you are going to deny preferred stock at 80% of the company is not proving you 100% wrong then I don’t think I’ll even bother trying explain it. If you don’t understand what preferred equity or warrants are then one of us is wasting time explaining it. AIG was not a regulated institutuon. As I said 9 months ago or whenever it was –the Fed can give money (lend, equity or any terms it decides even 0% interest) to any corporation, individual or entity when it deems necessary. It used that very law that was created in the great depression to do so to AIG.
    Oh and we didn’t discover the bailout as included in your funds to ibanks together. I told you I thought you were wrong and then you said you weren’t then I said, look at the footnote in your own chart. After you bothered to actually read it only then when the footnote was on your own chart did you admit you were wrong.
    That I think is my larger point which is you come up with these points and they are backed up by very little–just hair on fire panic. Like that’s what we need is to panic people about real estate more. Note, I was right there with you saying there would be a big crash in real esate a year ago, but now this is pointless and I don’t like seeing people over react with even more panic which is what you appear to do.
    Now–to enyonymous
    I gave a pretty good explanation as to what I thought was causing that increase in currency. The short version is, people are lending so there is a ton more cash sitting on the sideline.
    1. Why do you think that is not occurring. I think it’s a pretty reasonable explanation for that surge. Do you think that money hording is not occuring?
    2. What the hell else do you think it is? If it is creating money then there would be money going to the US treasury not to the Fed. The Treasury would issue bills straight to the fed. If it was the Aig investment as you and I think others are speculating, it wouldn’t show up in money supply since the cash would be at AIG and the Fed gets preferred stock and a note in return.
    I gave an explanation as to what it possibly could be. But you “Mr. the world is going to end ” and you seem to be 100% convinced that its printing money. Exactly how and it what form?

  100. Posted by cooper

    Edit above-I meant to say “people are lending LESS (or not at all), and so that creates more cash on the sidelines which is what that graph shows.

  101. Posted by Satchel

    cooper,
    You know, I have to hand it to you. Stick to your guns even when you know you’re wrong.
    I’ll leave aside the question about the increase in nonborrowed reserves from the earlier thread (which you said was misleading and I showed you wasn’t because loans to investment banks were a VERY MINISCULE part of what was going on – no big deal).
    Your intuition about monetary base today is all wrong as well. Yes, people are lending less. They have been lending less and pulling in risk for MONTHS now. Why the sudden spike? My surmise is that is has something to do with AIG. Not too much ink has been spilled yet on this by the “professional economists”, so perhaps I’m wrong. But the idea that SUDDENLY banks started “buying” treasuries “from the Fed” is silly. (They buy them in the open market, and thre is no need to custody them at the Fed – they could keep them at any depository or even with the US Treasury itself, which is what I do with a substantial portion of my large treasuries position.)
    You’re still on this thing about how you “showed me” that the Fed could buy anything from anybody without an Act of Congress. I found our original exchange, and you sounded as silly back then as you do now:
    “@Satchel. The Fed does not require an act of congress to buy mortgages. If the Fed wanted to use the money to buy goods and services it could do so –it can use that money to buy aircraft, elliot spiters hookers, or whatever without an act of congress.
    Posted by: cooper at March 18, 2008 8:02 PM”
    Note my reasoned, humble and respectful responses to your dunb assertion, including actual cites to fed papers, etc. Also note that if I wasn’t sure, I frankly admitted it and offered to report back, which I did.
    For those responses, see “Posted by: Satchel at March 18, 2008 8:22 PM”, and “Posted by: Satchel at March 19, 2008 11:10 AM”.
    All these posts (including cooper’s quoted above) are from:
    http://www.socketsite.com/archives/2008/03/justquotes_the_fed_cuts_by_075_and_sees_weakened_outloo.html
    You’ll also see in that last post of mine, cooper, that I correctly predicted how this would go down, namely that the Fed would get Congress to set up an agency so that it wouldn’t have to purchase the assets that you thought they could. That’s about where we are now.
    What you keep thinking about is the Fed’s authority under 13(3) of the Federal Reserve Act to LEND to anyone provided that 5 of the governors declare “exigent circumstances”. Once again, even though you posited something foolish (the Fed buying elliot spitzer’s hookers) I was reasonable and respectful and made a sincere attempt to understand what was going on.

  102. Posted by notgreat

    @Satchel
    First of all, you must be very good with children…
    Second, my understanding of the Treasury’s auction is that it was intended to borrow money on the open market & “give” it to the Fed so it could continue funding its various alphabet soup activities. Thus, instead of the Fed “printing” to buy up treasuries, this is almost a reverse situation, where the Treasury took money out of circulation by selling bills & put it in its Fed account. Now the Fed can spend that money in whatever way it chooses, but it seems like this would be overall monetary inflation-neutral. I could well be wrong about this, though.

  103. Posted by Satchel

    notgreat,
    Thanks. I actually spent a lot of the day setting up a new large aquarium with my 4 year old…
    About whether the Fed printed up the money to buy the treasuries, or whether these were somehow given to the Fed after being auctioned off by treasury – you know, I’ve seen both reported now, and I think from trying to decipher the Treasury’s press release, that you are right. These look to have been purchased on the open market and somehow transferred to the Fed, and thus would be money supply neutral.
    On reflection, I guess the spike in the base money is likely a result of these crazy bank mergers that are being forced. Perhaps somehow a huge slug of reserves is “stuck” as old TAF loans to failing institutions are unwound and the acquirers are posting reserves to cover the requirements of the failed banks.
    It’s all so nontransparent, that frankly I am not sure what is up anymore. We’ll have to see where the base goes in the next month or two. That was the point of my post that got cooper’s panties all in a twist – I don’t think it was alarmist at all. I have been one of the most vocal proponents on this site that the Fed has NOT been inflating, and I have many times pointed to the adjusted monetary base figures. I felt that I owed everyone a heads up on such a sudden spike, but I guess I should have waited until I had it all figured out.
    In any event, cooper’s idea that banks are “parking” treasuries at the Fed (that they bought from the Fed) is nonsensical on any number of levels. The most important being that the Fed cannot pay interest on excess reserves as far as I know (besides the fact of course that the Fed does not “sell” treasuries in the amount of $68 BILLION as part of its OMO!).
    The other component of the base is currency in criculation. This is essentially CASH (and coins), ie, dead presidents. There’s no way that $60+ BILLION of cash suddenly entered into circulation (I’m pretty sure vault cash is part of currency in circulation, though not part of M1).
    Honestly, I don’t know what cooper’s problem is with what I posted today on a potential change in Fed policy. I’m getting more reassured that there hasn’t been any policy shift towards printing, which has always been my contention – the Fed wants to DEFLATE us, not INFLATE us. Really, if the Fed could “buy” mortgages and “elliot spitzer’s hooker” from any entity, why is everyone going through this agonizing process right now to get CONGRESS (ie, the taxpayer) to buy all this crap!

  104. Posted by Jimmy (Bitter Renter)

    Hi Guys,
    Thanks for the inquiry about my puts on WM and WB.
    Yes I sold my position in WM before it went BK and collected a hefty return! Didn’t quite hit the timing perfectly but its hard when you have a real job and the markets are moving as quick as they do now.
    I was in Washington on Thursday and made a point of stopping by my congresswoman’s office to express my dismay at the impending bailout. I was told by her staff that about 99% of the calls they receive are opposed. Then I stopped by a reception hosted by the Beer Institute … apparently every single staffer on the hill was in the mood for a LOT of free beer that day. Notwithstanding the bailout calamity, its business as usual in DC!
    Looking for a nice drop on Wachovia if they don’t pair up with Citi on Sunday. This time I’ve got my good-til-canceled Limit order in place already to sell it out for a solid 100% profit in 2 weeks.
    Cheers!

  105. Posted by notgreat

    @Satchel
    The reason I’m guessing it was “borrowed” is this line in the latest H.4.1:
    Deposits with F.R. Banks, other than reserve balances 142,043 + 127,677 + 130,300 187,138
    U.S. Treasury, general account 5,088 + 147 + 327 5,175
    U.S. Treasury, supplementary financing account 117,046 + 117,046 + 117,046 159,806
    Now I really have no idea what goes into the adjusted monetary base graph you posted, so even though the 100B+ jump above roughly matches the increase in the adjusted monetary base, I’m not sure what the relationship there is.
    My not-so-expert opinion for what’s going to happen here in the US is this: a deflationary economic collapse as credit contracts, along with a currency collapse, which will manifest itself in higher prices for anything that can be sold for hard(er) currencies (e.g., food & gas more expensive, manual labor & houses in stockton less). So basically, the Argentina scenario. Of course the powers that be will try to avoid this, but I don’t think it’s in our hands any more — our foreign creditors will determine the fate of the dollar.

  106. Posted by tipster

    notgreat,
    But wouldn’t it be ideal if, each time a firm collapsed, resulting in a deflationary force, the government handed out enough dollars using a bailout, or any other excuse, so that we at least partly counteract the deflationary force with an inflationary force.
    That way, you can moderate the economic collapse AND the deflation at the same time, look good to your constituents (you are DOING something) and last but not least, get a LOT of people indebted to you for getting a piece of that bailout pie (=campaign contributions).
    Now, if only we had helicopters from which to distribute the bailouts, then Ben could say he TOLD US all along he was going to engineer this. And we’d know exactly why Paulson was up on the hill asking for money. Each time the drain opens up, Paulson is going to open the spigot. The net effect will be a sinking deflation, but not as quickly as it otherwise would be.
    Of course, it will cost taxpayers a certain amount of money, and it probably will not be good in the end (we spend all this money to end up in the same place), but a slow deflation is probably more politically tolerable than a fast one.
    $400B in a deflationary force from Lehman (and that’s just the amount they lost in the last few weeks) is kind of a big piece to bite off all at once. A couple hundred billion in bailout cash would make a nice inflationary boost back up. Rinse and repeat.

  107. Posted by notgreat

    @tipster
    I personally don’t consider deflation as a force to be fought against, rather I view it as the market’s proper reaction to correct the misallocations of capital that have gone on. The economic losses suffered from building too many houses are real, so the government printing up some money won’t replace those losses, it’ll merely contribute to debasing our currency. The best thing we can do is allow the market to correct as swiftly as possible, and credit will eventually start to flow to productive channels again. What the government is doing can only delay this process, and that can’t be good for the economy.

  108. Posted by FSBO

    Looks like some kind of a deal was just reached on the Paulson Plan. What a travesty – I’m sure there are not nearly enough members of Congress with the courage to vote against it. I think part of Paulson’s legacy will be the tarnishing of investment bankers’ reputation (and deservedly so). Right now, I’d place them well below politicians and some plaintiff attorneys. (The American taxpayers could use a good class action lawyer now – they should certify a class consisting of every worker outside of Wall Street and the Beltway.) The NY Times is reporting that Lloyd Blankfein (Paulson’s successor at Goldman Sachs) was in the meeting at the Fed where Paulson decided to take over AIG and let Lehman die. Blankfein was the only Wall Street executive at this meeting. Turns out that Goldman had $20 billion at risk with AIG – and of course Lehman was just a competitor. What the hell was Blankfein doing there? When Paulson became Treasury Secretary, did he have to take an oath of office? Not that any oath to act in the best interest of the citizens of the US would supercede his blood oath to Goldman.
    Satchel had a great point earlier in this thread about how instead of the Paulson Plan we should have a stimulus plan for hiring more bankruptcy judges and lawyers. We should also build an expanded IB wing at one of the federal prisons,

  109. Posted by Satchel

    @ notgreat – You and I see eye to eye, and I did see those H.4 numbers as well. That base graph is really just cash in the economy + reserves on deposit with the Fed. I am a little more sanguine than you are on the dollar short term – I think the world has a huge stake in getting this right because of the geopolitical/military implications – but I fear that you are right in the medium/long term.
    @ FSBO – It’s even worse than you think regarding the criminality of what has been going on (e.g., Blankfein at the meeting that decided to extinguish Goldman’s competitor). Remember the Bear Stearns deal that was “brokered” by the NY Fed, in which Jamie Dimon’s JP Morgan acquired Bear Stearns for a song with an explicit backstop from the Fed? Take a close look at the Board of Directors of the NY Fed, see anything coincidental??
    http://www.newyorkfed.org/aboutthefed/org_nydirectors.html
    I’m ALWAYS amazed how the general population has this almost childlike faith that the Fed is “looking out for us”. They look out for themselves. It’s a cartel of private banking interests masquerading as part of the USG.

  110. Posted by cooper

    Satchel,
    The Aig equity line is exactly what I said it could do, and what you said it couldn’t. So much for you being “a gentlemen and admitting it when you are wrong”.
    Even in this post you first triedto somehow claim it isn’t because it was “debt” which is what you tried at first doesn’t even pass a minor smell test. It also doesn’t pass the smell test because it isn’t just debt– just ask the bloody shareholders of AIG.
    The fed can pretty much provide cash to anyone in, in any form, exigent circumstances which its done.
    You brought up my old post to you trying to give you extreme examples like hookers. It was an extreme example using humor to try and show you what the Fed could do.. The Fed has gone well outside of banks in buying AIG without the Congressional approval you said it needed for any further action. Turned out to be “not true”-ask Congress, ask AIG.
    Also, stop putting words in my mouth. I never said people are “parking treasuries at the fed”. You are actually confusing what is actually occuring–its the opposite. It’s really pretty simple:
    1. People are afraid to lend money so they stop lending to businesses and other banks.
    2. The amount of loans, leverage and other credit like instruments goes down
    3. As a consequence, the amount of cash goes up.
    4. The amount of credit goes down by much more than the amount of cash.
    5. Adjusted money supply goes up.
    While I don’t know that that explains 100% of what is going on in the graph, It’s at least more credible than your claim which was they were printing money.
    Panic lack of lending is occuring–it’s happening and it was accelerated by what happened at Lehman. Your original assertion was that the Fed was printing the money. I notice that once I said “how is it printing money”–i.e. show the mechanism and I questioned why AIG wouldn’t show up as an equity investment–not cash that would explain the rise on the graph, you seem to have given up “printing money” as an explanation in your last post “on further reflection”.
    hey–how about you do the further reflection post before you write somethign next time? Think before you write dude.
    As for “how right you were”. You seem to be craving some sort of recognition from me seeing the RE crash when so here ya go–Congrats for seeing that. But many other people even on this site have been saying that for some time. So all the people that were right about real estate deserve shared credit.
    Where you and I differ is you think the world is going off a cliff, and I think the country will survive and thrive. My view is more stagnation for a year combined with a strong upturn next summer. Not end of the world crap.
    Whether it’s claiming the Fed is printing huge money or showing panic graphs without context deliniated right in the footnotes.the stuff you are putting out there is pure panic. Panic was fine a year or two ago and it was warranted, but now I’m tired of seeing it and people need to keep their heads. Eventually, people need to start to get their shit together and stop this sky is falling weak sauce crud.

  111. Posted by suckeredbyinfinity

    Cooper–why are you even trying?
    This is some kind of ego battle and he won’t admit he is wrong. You are wasting your breath–he’s just gonna try and weasel. Just move the hell on.

  112. Posted by NoeValleyJim

    But wouldn’t it be ideal if, each time a firm collapsed, resulting in a deflationary force, the government handed out enough dollars using a bailout, or any other excuse, so that we at least partly counteract the deflationary force with an inflationary force.
    That way, you can moderate the economic collapse AND the deflation at the same time, look good to your constituents (you are DOING something) and last but not least, get a LOT of people indebted to you for getting a piece of that bailout pie (=campaign contributions).

    Yes, I think this is pretty much what The Fed and Treasury are trying to do. We need to re-allocate capital more effectively, but there doesn’t have to be an economy-wide recession for that to happen. Remember after the Dot Com bubble burst, there was a severe downturn in the tech economy, but the rest of the economy barely noticed. Housing and finance are a bigger slice of the pie than tech, but if we can keep other sectors roaring, the way manufacturing is roaring now, we can at least absorb some of the blow that way.
    I know this anathema to some observers, being a command economy way to pick winners and losers, but it is not like the private sector has done such a great job of allocating investment dollars these days. The best plan would just spread the pain out over time and keep the rest of the economy afloat while the banking sector shrinks down to the size it really needs to be. These huge economic shocks might look great on paper, but no so great to the huge numbers of people negatively effected. Is it better to take a 20% paycut as two years of unemployment in the next decade or as ten years of depressed earnings? I think most would pick the latter.

  113. Posted by enonymous

    NVJ – I am interested to read your next five year plan
    regards,
    the proletariat

  114. Posted by Satchel

    cooper,
    This is silly, and it should teach me to get into these sorts of arguments on a thread like this!
    With all respect, your understanding of how the monetary base works is not accurate, and it is leading you to false conclusions. (This is a technical point, so for those who don’t care, please disregard. The scroll wheel is there for a reason :))
    “Also, stop putting words in my mouth. I never said people are “parking treasuries at the fed”.”
    Please review what you wrote above at “Posted by: cooper at September 27, 2008 11:16 AM”. There is no other way to read what you wrote.
    Now look at what you wrote later:
    “It’s really pretty simple:
    1. People are afraid to lend money so they stop lending to businesses and other banks.
    2. The amount of loans, leverage and other credit like instruments goes down
    3. As a consequence, the amount of cash goes up.
    4. The amount of credit goes down by much more than the amount of cash.
    5. Adjusted money supply goes up.”
    You DO understand that the monetary base does not measure things like t-bills held by the general population, or by corporates, don’t you? It doesn’t measure “money” in money market funds, or in time deposits at banks, etc. The monetary base measures (in addition to reserves that have to be “parked” at the Fed) PHYSICAL CURRENCY IN CIRCULATION – ACTUAL FEDERAL RESERVE NOTES AND ACTUAL COINS! (Sorry for shouting.)
    When a company takes a pile of actual cash and trades that in to the Treasury for t-bills, the monetary base goes DOWN, not UP, because that physical currency is taken “out of circulation” (it sits with the Treasury).
    Of course, no one buys t-bills that way. When a company or individual purchases t-bills using the digital equivalent of money (say, book entries between two banks/depositories) those t-bills are NOT picked up in the monetary base. They may hit M2, or MZM, or some other aggregate, but NOT the base. Therefore, your idea that the monetary base rise relates to a flight to safety is not right, UNLESS you mean people are literally going down to the banks and demanding cash to stuff into their mattresses! If you don’t understand this basic aspect of how the system works, you can’t even begin to understand what the chart I posted is saying or try to interpret it, and you shouldn’t have jumped all over me and derailed this thread.
    You should really make an attempt to understand what the monetary aggregates actually represent, before criticizing me. Here’s a start:
    http://research.stlouisfed.org/publications/mt/notes.pdf
    Similarly, cooper, your misunderstanding of how the Fed “gives” money under its 13(3) powers led you to the false conclusion that it would purchase mortgages or “elliot spitzer’s hookers” back in March. Yes, of course there is a grey line between senior preferred equity and debt, and I would agree with you that there is tremendous overlap when you get into something like the AIG loan. I noted that grey line back when we first had that interchange about the Fed “buying” whatever it wanted to or “giving” money to anyone it wanted to.
    Since I correctly comprehended the legal subtlety here, it led me to the conclusion that in fact the Fed would not buy mortgages or hookers, but would rather get Congress to do it. There are some lines the Fed at this jncture feels it cannot cross, and buying mortgages (or hookers) is one of them. You might want to check out how the Fed itself has tried to pass off th AIG loan, and again I don;t disagree that the Fed has gotten into a very tricky legal area here, and that’s why they are going to Congress:
    http://www.federalreserve.gov/newsevents/press/other/20080916a.htm
    I’m not looking for recognition here, but let’s face it – anyone with a greater than double digit IQ could have predicted a housing crash, but I don’t think anyone on this blog ever put forward the specific ramifications of how the credit crisis would go down. If that sounds like I’m seeking approval or recognition, well so be it, but I like to look at it as some validation that my approach to thinking about how to position for the future has had some merit. I hope my analysis has been helpful for some, that’s all, but frankly I am starting to think that I have worn out my welcome on this blog.

  115. Posted by Trip

    What is this whole debate about the AIG bailout? Whether it was a “loan” or a “purchase”? Boy, this is a lot of fighting about semantics. It is true that section 13(3) only permits loans and not purchases or gifts. Actual language is that any Federal Reserve Bank is permitted “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.”
    Under this section, loans are permitted, but purchases are not. But the dividing line between the two can be fuzzy. I don’t think one can reasonably doubt that this authority to lend includes the right to demand collateral in exchange for the loan. The AIG deal is certainly an extreme example of that. It is structured as a revolving credit facility but includes the issuance of preferred shares for the benefit of the Treasury. “Loan” or “purchase”?
    There has been a lot of discussion on the law blogs about the legality of this deal. See, e.g., http://legalblogwatch.typepad.com/legal_blog_watch/2008/09/federal-bailout.html
    Bottom line is that the courts are not likely to review this deal, so it doesn’t matter. But there is also likely a point where a bailout is so far removed from a loan that it does not even come close to falling within the statute’s language that a challenge might succeed. (Paying for hookers, I think, would cross the line and get shot down in a TRO).

  116. Posted by anon

    I hope my analysis has been helpful for some, that’s all, but frankly I am starting to think that I have worn out my welcome on this blog.
    It has been, very much so. Don’t leave because of cooper’s little temper tantrum.

  117. Posted by FSBO

    I would second anon at 10:37AM’s comment.

  118. Posted by notgreat

    Third that. I like the macroeconomic discussions, and I’ve learned a lot from Satchel’s posts.
    @Satchel
    I have an outlandish theory that it’ll be Russia who tries to start a run on the dollar — they have the least to lose since the came into the dollar system relatively late (they’ll certainly experience some short-term pain — but hey, they were totally broke 10 years ago, so nothing new for them), and as a once-and-aspiring superpower they have a lot to gain from overturning the dollar’s hegemony.

  119. Posted by Satchel

    notgreat,
    Interesting idea about Russia. I was very involved in trading the Russia bubble and collapse in 1995 throgh 1998. I spent a good deal of time in Moscow in 1995/96 (just intemittent trips, though – I was trading out of London).
    I fear you may be right. When I was in Russia, I was struck by the shattered nature of the culture. Their old people literally slunked away and died after the ruble pensions stopped meaning anything after about 1992 or so. If you spent any time at western hangouts like the “Nite-Flite” (which had then just opened) and spoke some Russian (I do), you would have been shocked at the background of the “working girls” all over the place. Solid backgrounds, educated, etc. – the society had obviously come apart.
    And yet, it turns out, all the while Russia was developing its weaponry, and recently unveiled that they had developed a fourth generation nuclear sub. That sort of development takes YEARS. All along, as the society melted and life expectancy plunged, TPTB in Russia went on “business as usual”.
    Different topic – thanks for the comments on my contributions. I reread what I wrote and I want to apologize to the many other good posters who have posted sensible and accurate analysis and predictions about aspects of this credit collapse, in particular ex SF-er, tipster and enonymous (and always great info and analysis on SF real estate #’s from FSBO, unlike our “friend” who played fast and loose with data). I just meant that I have been the one who has been on this idea for the longest time that the Fed’s interests are not the same as the USG’s or the population’s (but after looking at this bailout, it’s looking like the private interests promoted by the Fed are also being promoted by the Congress! Too bad, population, you lose).

  120. Posted by notgreat

    @Satchel
    I think it was Milton Friedman who said “There’s a lot of ruin in a country”, and Russia has more than most… I’m from there, the people are used to hard times & expect the worst. Anyways, the dollar is trading up right now, so you’re right for tonight at least. ;)

  121. Posted by diemos

    I suspect the most impactful aspect of the current bailout bill is the suspension of mark-to-market rules. Now we’re setup to allow all the banks, pension funds and insurance companies to pretend that they’re solvent while the bonds slowly go bad and are written off. That will successfully kick the can quite a ways down the road. We seem to be headed down the Japanese road to zombification and a lost decade or two.

  122. Posted by John

    OK, it seems the bailout will pass, and according to Satchel, that means Great Depression 2.
    So, Satchel, where do you put your money in preparation for GD2?

  123. Posted by Trip

    I certainly did not expect a provision allowing for the suspension of FASB 157 mark to market rules — the bill does not eliminate it but permits the SEC to suspend it on an issuer by issuer basis. I suspect this was added to permit specific companies to “fix” their balance sheets with FASB 157 suspended and thereby avoid certain catastrophic CDS triggering provisions. But I really don’t know if there was something specific in mind with this provision or if it was just a sledgehammer they wanted to give the SEC to let any banking or financial entity remain “solvent.” If this is used too often, it will do more harm than good in the stock markets since there will be no disclosure of a company’s true position. But it could provide a clever end run around some of the protections in the CDS agreements.

  124. Posted by EBGuy

    One burning question I continue to have is: can the Treasury continue to hold bake sales for the Fed? Why do we need the Paulson Plan? Can’t they continue to bury the bodies at the Fed (or would the Treasury’s extracurricular activity eventually require Congressional approval)? I haven’t really heard anyone talk about this — except in the context of the Fed’s balance sheet looking like crap and The Plan obviously corrects that. I suppose the danger in keeping it on ice at the Fed is there is no real recapitalization, but instead zombification of banks who loan their bum collateral to the Fed.
    Oh, and we had some great interludes on this thread. For one glorious moment it looked like Satchel had put on the tinfoil hat and Ben had fired up the printing presses :-)
    Again, if anyone knows about limits to the Treasury injections of cash to the Fed, I, for one, would be very interested. For some reason this doesn’t seem to get covered by the MSM.

  125. Posted by Satchel

    That’s a GREAT question you pose, EBGuy. I can’t wrap my head around the idea that the US Treasury is holding auctions of bills and then simply “giving” the proceeeds to the Fed, which looks like is whatis going on. Does the Fed have to “pay back” these proceeds?
    Clearly, the rise in the base that we have been kicking around on this thread has something to do with this expansion of the Fed’s balance sheet. It looks like these dollar proceeds recived by the Fed found their way into “excess reserves” held by the banks at the Fed (from the latest H.4 release noted by notgreat).
    I guess it’s “money supply neutral” in the sense that what the Treasury did is akin to a sterilized intervention by the Fed (the cash was sopped up from the market by the special bill auction). Nevertheless, these funds were apparently somehow converted directly into the monetary base without any intermediation by a depository, and in that sense it sort of looks like money “rained down from a helicopter” on someone! I have to admit I’m confused here, and I hope some people with real expertise start to question this and spill some ink on it.

  126. Posted by cooper

    By Satchel:
    “I hope my analysis has been helpful for some, that’s all, but frankly I am starting to think that I have worn out my welcome on this blog.”
    I think the issue is not acknowledging when you are wrong and doing victory dances when you are right. Also, someone needs to defend investment bankers, why not me?
    On your huge long treasury thing you made one slight mistake. They were not buying the notes from the government, they were buying them from the Fed instead of putting them in the normal places. Look at the last two fundings. The negative tbill rate explains it also-banks are going into this and the cash is going up at the Fed. That combined with banks ceasing all lending means money supply goes up also. That’s why I said you got it backwards. Thanks for the all caps tho wow..LOL
    [ Removed by Editor – attack the arguments not the individual.]

  127. Posted by cooper

    SAID BY TRIP
    What is this whole debate about the AIG bailout? Whether it was a “loan” or a “purchase”? Boy, this is a lot of fighting about semantics. It is true that section 13(3) only permits loans and not purchases or gifts. Actual language is that any Federal Reserve Bank is permitted “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.”
    Under this section, loans are permitted, but purchases are not. But the dividing line between the two can be fuzzy. I don’t think one can reasonably doubt that this authority to lend includes the right to demand collateral in exchange for the loan. The AIG deal is certainly an extreme example of that. It is structured as a revolving credit facility but includes the issuance of preferred shares for the benefit of the Treasury. “Loan” or “purchase”?
    There has been a lot of discussion on the law blogs about the legality of this deal. See, e.g., http://legalblogwatch.typepad.com/legal_blog_watch/2008/09/federal-bailout.html
    Bottom line is that the courts are not likely to review this deal, so it doesn’t matter. But there is also likely a point where a bailout is so far removed from a loan that it does not even come close to falling within the statute’s language that a challenge might succeed. (Paying for hookers, I think, would cross the line and get shot down in a TRO).
    ———————————————–
    Exactly Trip. To bad Satchel was not the gentleman he said he was and refused to admit he was wrong. I can’t remember the original post back in the day his whole point was the Fed needed congressional approval and didn’t even think a pure loan would be legal. i.e. he didn’t even know that statute existed and asked me to find it to prove it to him.
    Given that, I don’t even understand why he brought up the loan distinction particularly when anyone who was fit to be treasury secretary would know the distinction between equity and debt is very very fuzzy.

  128. Posted by Satchel

    cooper,
    “To bad Satchel was not the gentleman he said he was and refused to admit he was wrong. I can’t remember the original post back in the day his whole point was the Fed needed congressional approval and didn’t even think a pure loan would be legal. i.e. he didn’t even know that statute existed and asked me to find it to prove it to him.”
    Here it is, cooper:
    http://www.socketsite.com/archives/2008/03/justquotes_the_fed_cuts_by_075_and_sees_weakened_outloo.html
    Read through the entire thread, and you’ll see your continuing mischaracterization of the exchange, what I said, etc.
    We’ve beat this to death. [Removed by Editor (once again, attack the arguments)]
    [Editor’s Note: And now back to the bailout…]

  129. Posted by Lurker

    Satchel, how can I get in touch with you ? I respect your insight and would like to discuss a scenario with you, if you’re okay with it.

  130. Posted by Satchel

    Lurker,
    If you send an email to the editor, I’ll try to contact you offline. Thanks for the kind words.

  131. Posted by cooper

    Thanks. It’s right here in a quote by you:
    “Well, cooper and I have gone back and forth a little on this issue of whether the Fed can buy assets from private parties, etc., without an Act of Congress. I asked if anyone had any learning on this but – who would have thought?”
    AIG is a private party and they used equity instruments to buy 80% of it. It also notes how you didn’t even know of the statue and though an act of Congress was required.
    Also I will note the personal attacks you have made and the apologies for your own behavior for reacting so poorly. Isn’t that a clue that you know you are wrong? The last personal attacks I recieved on this site were from someone whose name started with an F, and ended with the J and a L and U in the middle.
    Oh and I have never worked at an investment bank as per your personal attack (that I think was deleted by socketsite–it was funny tho). I had a similarly funny response but it was also deleted. FYI. I’m more a venture capital/private equity guy. Altho I did spend some time in the White House for a small government stint as an economist. Other than that–all on the investor side. Doh! Wrong guess again dude! Man you are bad!

  132. Posted by Satchel

    editor – leave cooper’s comment that he so childishly keeps reposting each time after you delete it. Let him have his say, and it’s detracting from what is going on right now.
    It looks like this bailout might actually FAIL in the House. Amazing that the republicans held firm! Way to go! (I hope the no bailout vote sticks!)

  133. Posted by Trip

    I am quite stunned the bailout is failing (barring some significant twist to get the Republicans on board). But see my post above — it’s all politics. Paulson et al knew this when they tried to rush it into law with no debate. Once those running for election started thinking it through, they realized there is little up-side to handing out $$$ to Wall Street. And re-election is all they care about.

  134. Posted by Satchel

    Well, officially (for now) the bailout has failed to pass the House. As Trip notes, there can still be significant arm twisting and we may well see a re-vote later.
    Let me also be the first to admit I was WRONG, WRONG, WRONG!! I though for sure that the banks would push this through an the first vote. I am actually incredibly surprised and impressed that the American people have had the sense to oppose this at the grassroots level. The Founders would be proud! I hope we can now get to some sensible solutions to this crisis.

  135. Posted by EBGuy

    That’s a GREAT question you pose, EBGuy. I can’t wrap my head around the idea that the US Treasury is holding auctions of bills and then simply “giving” the proceeeds to the Fed, which looks like is what is going on.
    Thanks for the validation — I am guessing we might get some answers (or at least see how long the Treasury->Fed injections last) given that the bailout is going down in flames and there is still more toxic waste to deal wtih. I can’t help but think we may be over analyzing the mechanics a bit too much. Treasuries are sold all the time by the Treasury to finance our deficit and the proceeds are used to pay the bills for the US govt. How is this any different? (other than being “non-productive”, and, therefore, perhaps inflationary?)

  136. Posted by cooper

    They are probably going to put the bill up again. They just need 10 GOP votes –altho its still pretty tricky.

  137. Posted by cooper

    To EBGUY-
    Moral hazard is not an issue, in fact I think it’s actually made the solution here worse. There are examples of this. For example-Paulson was so confident in his effort to prevent moral hazard he took all the preferred stock in the Fannie/Freddia nationalization and eliminated all dividends.
    Sounds good right–no moral hazard? Of course, it destroyed the Preferred market which wouldn’t normally be that big of a deal except that’s how banks typically raise equity. Look at Lehman–they went after that because of moral hazard. But instead of taking over Lehman, they let the thing fail which causes far more systemic problems.
    Look-any company that gets wiped out passes the “moral hazard” test. But those are just two of many examples where moving around moral hazard ends up causing a lot more problems than it solves.

  138. Posted by EBGuy

    Look-any company that gets wiped out passes the “moral hazard” test.
    Well, the FDIC is where the action is now. Its not really clear to me that the process of stripping a company of debt and “handing” it to another bank is open and transparent. That said, it looks like they were more proactive with Wachovia and, hopefully, got a better deal (for the FDIC, and, ultimately, the taxpayers) with multiple bidders.
    I appreciate what you are saying about the preferred market. I think it goes without saying that intervention by its nature introduces hazards and unintended consequences. I, for one, appreciate the all the different tools being used, as it seems to keep anyone trying to game the system a bit off balance. Obviously, there is a concern that the patient might not survive all the bloodletting…

  139. Posted by Brutus

    Why does everyone keep saying that they need “10 GOP” votes or that the “Repbulicans held strong” – look at the votes – 97 Democrats voted against it too. It’s a pretty bi-partisan group that voted for and against.
    It was not popular in the polls, so every member of the House who is in a battle for their post voted it down.

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