Forecasting the Bailout

| Wed Sep. 24, 2008 1:59 AM EDT

FORECASTING THE BAILOUT....I'm looking forward to seeing responses to this op-ed from Bill Gross of PIMCO fame:

I estimate the average price of distressed mortgages that pass from "troubled financial institutions" to the Treasury at auction will be 65 cents on the dollar, representing a loss of one-third of the original purchase price to the seller, and a prospective yield of 10 to 15 percent to the Treasury. Financed at 3 to 4 percent via the sale of Treasury bonds, the Treasury will therefore be in a position to earn a positive carry or yield spread of at least 7 to 8 percent.

....Democratic Party earmarks mandating forbearance on home mortgage foreclosures will be critical as well. If this program is successful, however, it is obvious that the free market and Wild West capitalism of recent decades will be forever changed. Future economic textbooks are likely to teach that while capitalism is the most dynamic and productive system ever conceived, it is most efficient over the long term when there is another delicate balance — between private incentive and government oversight.

Gross provides no clue about why he thinks the Treasury auction is likely to buy assets at 65 cents on the dollar, or why he thinks these assets will eventually sell for 75 or 80 cents on the dollar. And since the bailout plan would obviously help PIMCO, he has a pretty obvious personal interest in painting an optimistic picture of how well it will work.

Still, it's a number, and you can't fight something with nothing. We may now be entering a phase in which the price of entrance into the bailout punditry arena is a dueling estimate of just how well or how badly you think the bailout will turn out. Gentlemen, start your engines.

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Four Down, One to Go

| Wed Sep. 24, 2008 1:38 AM EDT

FOUR DOWN, ONE TO GO....Here's some interesting news:

Goldman Sachs Group Inc. said it will get a $5 billion investment from billionaire Warren Buffett's company, marking one of the biggest expressions of confidence in the financial system since the credit crisis intensified early this month.

....The Berkshire investment will be a big boost to Goldman. Even though the firm hasn't posted a quarterly loss since the credit crisis began, its profits have waned and its stock got hit last week. It has examined a number of options aimed at bolstering its capital position.

So let's count: Fannie and Freddie have been bailed out. Bear Stearns and Merrill Lynch have been acquired. Lehman is gone. Goldman Sachs is apparently in good shape (I'm willing to take Warren Buffett's word for it, anyway). The big conglomerates (Citi, Chase, Bank of America, etc.) don't seem to be under any serious pressure.

So who does that leave? Morgan Stanley, of course. But who else? For better or worse, bailouts are usually limited to firms so big that their failure would cause systemic meltdown. So who are we planning to bail out? Little firms? Big firms that would survive regardless? Insurance companies? Hedge funds?

I'm not questioning the basic need for a rescue plan. I'm just wondering who needs rescuing right now. For more, see this post from Yves Smith, which quite plausibly argues that although a bailout may be necessary, it's not urgent after last week's intervention in the money fund market. If this argument is correct, it means we don't need to be stampeded into action. We can afford to spend some time to figure out who really needs help and what the best mechanism for helping them is.

Executive Compensation

| Wed Sep. 24, 2008 12:26 AM EDT

EXECUTIVE COMPENSATION....Should the Wall Street bailout include provisions to punish executives who were responsible for bad behavior during the housing bubble? Megan McArdle asks if this is even legal:

Here's a question: a lot of Democrats seem to want the Wall Street executives to disgorge things like their retirement packages and bonuses before cutting any deal. Can Congress do this, legally? I mean, yes, they make the law. But my understanding is that while you can grandfather in benefits, you can't retroactively punish people for behavior that was legal when committed. Can Congress reach in and retroactively void a private contract? I'm not asking for commentary on the wisdom or morality of such a move, just whether it would withstand a court challenge.

Not a chance. The Fifth Amendment prohibits the direct impairment of contracts, and Article 1 prohibits both bills of attainder and ex post facto laws. Felix Salmon adds some practical questions:

Which folks did you have in mind? The ones who ran subprime mortgage originators which have now gone bust? It'll be pretty much impossible to get money back from them. The MBS and CDO desks in investment banks? Most of them have been fired at this point, there's not much work for them any more. The senior executives at the banks? They've seen their net worth plunge along with their share prices. There might be a couple of fat-cats still around whom the government could ask to repay their bonuses. But it would be gesture politics.

Obviously this is a bummer. We can, of course, demand that executives voluntarily agree to new compensation packages going forward if they want to participate in the bailout, but even there we need to be careful. For example, John McCain, in his new role as the Scourge of Wall Street, says we should just limit all executive compensation to $400,000 or less. But who knows what that means? Does it include only direct income? Perks? Stock options? Retirement pay? Bonuses? Or is it all of the above? If it is, all that will happen is that the brightest people at these firms — which, remember, we would like to succeed since we'll all have equity stakes in them — will scurry away for more lucrative futures at small hedge funds and boutique banks. Granted, given the performance of the brightest people over the past few years, maybe we'd be better off with a few dullards instead, but be careful what you wish for.

Much better, I think, would be structural changes that reduced income for everyone in the finance industry, not just the bankrupt firms. If Democrats had a spine, that might be feasible. Under present circumstances, however, I realize it's pie in the sky. A few ritual disembowelments is probably the best we can hope for.

Rick and Freddie

| Tue Sep. 23, 2008 11:47 PM EDT

RICK AND FREDDIE....John McCain says his campaign manager, Rick Davis, hasn't worked for Freddie Mac for several years. However, according to "two people with direct knowledge of the arrangement," that's not true. In fact, his lobbying firm been receiving $15,000 from Freddie every month since 2005:

Mr. Davis's firm received the payments from the company, Freddie Mac, until it was taken over by the government this month along with Fannie Mae, the other big mortgage lender whose deteriorating finances helped precipitate the cascading problems on Wall Street, the people said.

They said they did not recall Mr. Davis's doing much substantive work for the company in return for the money, other than speak to a political action committee of high-ranking employees in October 2006 on the approaching midterm Congressional elections. They said Mr. Davis's firm, Davis & Manafort, had been kept on the payroll because of Mr. Davis's close ties to Mr. McCain, the Republican presidential nominee, who by 2006 was widely expected to run again for the White House....No one at Davis & Manafort other than Mr. Davis was involved in efforts on Freddie Mac's behalf, the people familiar with the arrangement said.

You know, I'm basically willing to concede that Fannie and Freddie were bipartisan clusterfucks and just call it even as far as the campaigns are concerned. But only if they fess up to their sins and stop regaling us with ridiculous lies about their relationships. Rick Davis either needs to tell us what his firm was doing for its $15,000 a month or else he needs to provide a plausible explanation for why his firm continued to receive that sum for doing nothing. Come on, folks.

"Palin Syrah" Wine Sales Drop Because of Sarah Palin

| Tue Sep. 23, 2008 9:01 PM EDT

To a Miller Lite-drinking, displaced Ohioan like me, wine is wine. I enjoy it—the redder and drier the better—but I don't care if it's Cabernet, Merlot, or Pinot Noir.

But my fellow San Franciscans take their wine seriously enough that the vintners' label actually means something: The owner of a wine bar in the city says sales of "Palin," a Syrah, have plummeted since John McCain tapped Sarah Palin to be his running mate:

"It was our best selling wine before (the V.P. announcement)," said Chris Tavelli, owner of Yield Wine Bar, which has offered Palin Syrah, a certified organic wine from Chile, by the glass since July. But after Sen. John McCain tagged Sarah Palin as his running mate, sales of the wine with the conservative's inverted name plummeted.

Sure, the wine's name is ironic, but it's just wine; it's not as if naming it "Palin" turns it to moose blood.

Debt and Equity

| Tue Sep. 23, 2008 8:53 PM EDT

DEBT AND EQUITY....If Uncle Sam is going to bail out America's banks, should taxpayers receive equity in these banks in return for handing over vast piles of cash? Sure. But here's the specific language from the Dodd "discussion draft" of the enabling legislation:


(i) IN GENERAL.—The contingent shares to be received by the Secretary under paragraph (1) may, at the determination of the Secretary, include shares of the financial institution, its parent company, its holding company, any of its subsidiaries, or any other entity which is owned, controlled, or managed by such institution. [Details are laid out later in paragraph 2.C.3.]

(ii) DEBT INSTRUMENTS.—In the event that the equity of the financial institution from which such troubled assets were purchased is not publicly traded on a national securities exchange, the Secretary shall acquire a senior contingent debt instrument in lieu of contingent shares, which shall automatically vest to the Secretary on behalf of the United States Treasury in an amount equal to 125 percent of the dollar amount of the difference between the amount the Secretary paid for the troubled assets and the disposition price of such assets. The Secretary may demand payment of such contingent debt instrument under such terms and conditions as determined appropriate by the Secretary.

So: the idea is that the Treasury buys toxic waste from the banks and eventually sells it off. If it sells at a loss, it receives shares equal to 125% of the loss. This is based on the share price at the time it bought the assets, which means that if the bank prospers in the meantime and its share price rises, the taxpayers share in this good fortune.

Fine. But note the second paragraph: if we bail out a private firm, we get senior debt instead of equity. Fair enough: equity in a private firm is hard to value, so why add in the additional complexity of trying to negotiate a fair value?

But here's the thing: Does accepting senior debt do the banks any good or doesn't it? Taking debt instead of equity essentially amounts to restructuring the bank's debt and giving it some breathing space, possibly enough to allow it raise capital privately. It doesn't directly change the bank's capitalization ratio, but if restructuring debt without changing capitalization ratios is useful for private banks, why not for publicly held banks too? After all, they're both faced with borrowing money from the same people with the same concerns over possible insolvency.

Maybe I'm an idiot. It wouldn't be the first time. But I continue to be a little perplexed by the mania for equity. The removal of toxic waste combined with a restructuring of debt either does some good or it doesn't, and if it does, then let's use it for publicly held banks too. If the borrowing firm eventually goes bankrupt, senior debt is better than equity anyway. If it prospers instead, equity will turn out to be the better deal, but I don't really care about that. I don't especially want Uncle Sam playing the market, and I don't especially want Uncle Sam to own potentially large stakes in half the banks on Wall Street. I just want the best chance of getting our money back.

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Chart of the Day

| Tue Sep. 23, 2008 6:50 PM EDT

CHART OF THE DAY....Via Propublica, here's a history of government bailouts starting with the Penn Central bailout of 1970. All adjusted for inflation, of course. Click the link for all the gory details.

Yes, Joe Biden's Helicopter Really Was "Forced Down" in Afghanistan

| Tue Sep. 23, 2008 5:31 PM EDT

One of the narratives the blogs are talking about this week is that Joe Biden is—gasp!—"gaffe-prone." Nevermind the fact that this has been the story about Biden for 30 years: now journalists are even finding gaffes where none exist. In a post on The Stump exploring Biden's unfortunate attack on his own campaign's ad, Michael Crowley claims that this Joe Biden anecdote is a "gaffe":

"If you want to know where Al Qaeda lives, you want to know where Bin Laden is, come back to Afghanistan with me. Come back to the area where my helicopter was forced down, with a three-star general and three senators at 10,500 feet in the middle of those mountains. I can tell you where they are.

In an unsigned follow-up post on The Plank (accompanied by an awful Slate-style "gaffe meter"), someone claims that this quote "could teeter into Hillary-in-Bosnia territory." But what exactly is wrong or misleading or inaccurate about Biden's story? The Jake Tapper post Crowley links to is an admirably straightforward fact-check of the story—it turns out Biden's helicopter was forced down by a snowstorm. But did Biden say the helicopter was "forced down under fire" or even "shot at"? No. And Tapper points out that Biden went on, saying this:

[John McCain] says he'll follow [Al Qaeda] to the gates of hell. You don't have to go to hell. Just go to Pakistan. Just go to that area. That superhighway of terror that exists between Afghanistan and Pakistan.

Biden's right on in the rest of the quote, too: As far as we know Al Qaeda and bin Laden are in what Biden calls, "That superhighway of terror that exists between Afghanistan and Pakistan."

So Sarah Palin is Meeting With World Leaders...

| Tue Sep. 23, 2008 5:25 PM EDT

You'd think this is something the McCain campaign would be excited to broadcast to the world, right? You tell me. They let the press observe a meeting between Palin and Afghan President Hamid Karzai for 29 seconds. The press then got 15-20 seconds of a meeting between Palin and Colombian President Alvaro Uribe. Hmm.

Oh, hey, just FYI? This person might be elected vice president of the United States in less than six weeks.

Asheville, NC is Out of Gas

| Tue Sep. 23, 2008 4:45 PM EDT

gas.jpg The city of Asheville, North Carolina and surrounding towns are so short on gas that residents must wait over an hour to fill their tanks, reports the Asheville Citizen-Times.

Many gas stations have closed altogether. Those which remain open have police stationed at the pumps to prevent fights from breaking out—one driver threatened another with a baseball bat. Asheville officials have canceled all nighttime events, and the county is asking that nonessential employees work from home or switch to a four-day week.

The gas crunch began after Hurricanes Gustav and Ike swept through the Gulf Coast, shutting down the oil refineries that supply western North Carolina. Because of its relatively remote location high in the Blue Ridge mountains, county officials estimate that shortages in the Asheville area will continue at least through the end of the month.