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After the Bailout
AFTER THE BAILOUT....Following on to my post this morning about the Wall Street bailout, you might be wondering what happens after Hank Paulson buys up all the toxic waste that U.S. banks are currently holding on their balance sheets. If the feds pay some kind of halfway reasonable price for this stuff (whatever that might be), and after everything is cleaned up it turns out that — surprise! — everyone is insolvent after all — what then? 
Hell if I know. I guess we're just hoping that this turns out not to be the case. If Hank & Co. are wrong about this, it means yet more taxpayer dough down the rathole, I suppose. We have to have a functioning banking system, after all, so we're sort of over a barrel here.
If I can be allowed to state the obvious for a moment, one of the things that makes this so frustrating for us little people is that most of the tycoons who made fortunes off this Ponzi scheme are going to get off scot free (or close enough not to make a difference). Sure, we can punish the banks if we want to, but who really cares about that? They're just legal fictions. What you'd really like to do is punish the people who were running the banks while all this was happening. But they've already got their money, and there's no legal way to take it back. The poor saps who are losing their homes, however, are easily and personally identifiable, so it's easy to punish them. And we will. In the end, the titans of Wall Street will funnel their newly titanic fortunes into numbered Swiss bank accounts and lie low for a couple of years, while all the rest of us pay the price. Makes you feel all tingly inside, doesn't it?
The only upside from this steaming mess is the possibility that Congress might pass laws to rein in bad behavior in the future and make the Wall Street casino a wee bit less insanely profitable than it is today. Maybe by taxing extremely high incomes at higher rates. (Hell, taxing extremely high incomes at normal rates would be a start.) Or regulating leverage ratios for everyone, not just commercial banks. Or putting an end to no-down-no-doc-no-asset mortgage idiocy. That's closing the barn door a few years too late, of course, but at least it would force tomorrow's rocket scientists to go to the trouble of figuring out new ways to fleece us.
Atrios says: forget it. Sensible new regulations aren't gonna happen. And he may be right. Republicans will certainly fight any serious reforms that might hurt rich people, and Democrats haven't exactly covered themselves with glory on this score either. But look: that's what we're all here for. We should be raising hell with our congressional representatives to get serious about this stuff, and if they won't do it we should be working to elect new ones. If the current crew won't commit to changing things, then stop giving them money. After all, this is at least as important as net neutrality or immigration reform or raising the minimum wage, isn't it? So pick up the phone and start complaining.
And while we're on the subject, it's easy sometimes to lose sight of the outright fraud (and might-as-well-be-fraud) that was the foundation stone for so much of our current crisis. After all, most of the day-to-day coverage over the past few weeks has been about arcane financial maneuverings and numbers with lots of zeroes after them. To refresh your memory, then, you might want to check out Dean Starkman's "Boiler Room" in the current issue of CJR. If you're not mad enough to call your congressman yet, this ought to help get you there.
If the feds pay some kind of halfway reasonable price for this stuff (whatever that might be), and after everything is cleaned up it turns out that ? surprise! ? everyone is insolvent after all ? what then? Hell if I know. I guess we're just hoping that turns out not to be the case.
Then you live in fantasy land. Every economist who has been correct about this debacle (as opposed to the ones -- including Paulson -- who have been consistently wrong) recognize that these banks are insolvent.
If the feds pay some kind of halfway reasonable price for this stuff (whatever that might be), and after everything is cleaned up it turns out that ? surprise! ? everyone is insolvent after all ? what then? Hell if I know. I guess we're just hoping that turns out not to be the case.
Then you live in fantasy land. Every economist who has been correct about this debacle (as opposed to the ones -- including Paulson -- who have been consistently wrong) recognize that these banks are insolvent.
I vote for a 5 year retro tax on profits made from the housing industry.
The whole thing makes any arguments against the experience of Obama or Palin null and void. It was experts and genius's that got us into this mess.
We need less expertise, and more common sense.
George Bush on the bailout plan: "I decided to act and act boldly"
Where have we heard that before?
actually, people swore by the hair on their chinny chin chins that they were valuing assets appropriately when they filed all kinds of forms.
i think that an investigation of fraudulent accounting practices at banks might have the salutary effect of sending some of these clowns to jail.
After the bailouts fail, foreign countries will own much of American real estate and whatever else is worth owning. I wonder who's going to buy all the nukes and missiles?
I guess the third world's better than no world at all.
And yes, Mr. Starkman's essay made by blood boil again. You see, that the whole system is very shaky is obvious to anyone who turns off the noise machine for a few months and opens their eyes (and reads the internet).
We've just been playing a mega game of 'borrowing from Peter to pay Paul'. Sooner or later, Guido, at the insistence of Peter and Paul, comes to settle the score. Ouch, this is gonna hurt!
Once again let me explain it for you, Kevin:
By the end of the weekend (if not already), bloggers and independent economists will have figured out the whole big putrid scam , and laid out the gory details for the world to see.
As simple and short as I can make it:
1. Whether this plan is approved or not, banks and Wall Street firms will fail, companies will go bankrupt, people will lose their homes, and there will be a whole lotta hurting all around.
2. If the plan is approved, the Bush gang gets a $700 billion kitty they can use to save some of their buddies' asses. With no oversight whatsoever.
The dilemma is this:
If Obama was going to do the bold and and right and honorable thing, he would oppose this plan. In fact, he would lead the fight against it with every breath and drop of blood in his body. He would do this even if it meant that McCain could call him bad names because, if this plan passes, there will be nothing left of the country for Obama to be president of. The Republicans will own us.
Will he oppose it?
Does Obama have the guts to lead?
The mistake you keep making, Kevin, is to assume that anything the Republicans do or say can be taken at face value. Thus, you waste a whole lot of energy and time figuring out whether wit will work the way they say.
I'm not proud of the fact that I'd probably be willing to join a lynch mob going after those CEO's at this point.
There is a way to make the people who created the mess responsible. The garbage that we're going to pay for was being reported as an asset on the balance sheet at an unreasonable value. That's fraud. Referrals should be made to the Justice Department. Perhaps by the time the process is underway we'll have an Attorney General who'll prosecute these bums.
As I understand it, among all the owrthless paper we're going to be collectively acquiring will be a lot of worthless mortgages. Why doesn't Uncle hold title to the properties and lease them back to the people who were foreclosed on for something like a reasonable rent? The value of the properties will eventually go back up, after all, and then we'll have something.
We could work out rent-to-own arrangements with many of our tenants, I'm sure.
(I recognize that mortgages make up only part of the debacle, 'leverage' being what it is, but it might be better than nothing.)
Where does this stop? How many other failing large corporations are now going to demand equal treatment with cushy loan deals or getting government to "buy" their bad assets? The car companies have already gone to Uncle Sam with hat in hand, won't the airlines be next?
If the feds pay some kind of halfway reasonable price for this stuff (whatever that might be), and after everything is cleaned up it turns out that surprise! everyone is insolvent after all what then? Hell if I know. I guess we're just hoping that turns out not to be the case.
Then you live in fantasy land. Every economist who has been correct about this debacle (as opposed to the ones -- including Paulson -- who have been consistently wrong) recognize that these banks are insolvent.
If the banks are insolvent, this plan is a useless gesture.
If the banks are solvent, then this is the greatest shake-down scheme of all time.
Why must taxpayers spend $700 billion to get banks to stop lying to each other?
We are without a doubt the suckiest generation of Americans ever.
That Dean Starkman link was pure gold.
We cannot let these bastards get away with this.
What do you mean there is no legal way to get the money back?
We just pass a law saying (in effect), "Give the fucking money back or you get to spend some time in Federal 'Pound me in the a$$' prison."
Legal problem solved.
Just did a quick spin around the blogosphere... left and right seem to think the bailout screws the taxpayers.
The first candidate that fires their lobbyists CEO types and hires a bubble blogger gets my vote.
Three quick and simple points:
1. Remember the report that said 2/3rds of all US corporations paid NO taxes for the last several years? Time to pony up.
2. Now more than ever, Obama's plan to progressively tax the rich more than the middle class and poor makes sense. They can't claim that they haven't been receiving the largesse of the revenue received by the government.
3. Note that Bush/ McCain's claim of tax cuts for any situation looks utterly moronic now that the debt ceiling has been raised to $11.3 trillion - with a "T"! Remember, Greenspan stated that the ENTIRE debt would have been paid off by 2005 or 2006 without the tax cuts.
The mind boggles...
Art Eclectic, I second your statement on Starkman's article - pure gold. For the first time I get it!!! It's exactly what I thought might have gone on, except I couldn't figure out why major investment banks were buying up the bad mortgage bundles. I figured they had to be smarter than that. But it was for the purpose of selling them to global buyers!, which was a partially successful gambit, judging by the failure of Northern Rock and the current turmoil in global banking.
This is just mindblowing. It was out and out fraud on an industry-wide scale.
"Now more than ever, Obama's plan to progressively tax the rich more than the middle class and poor makes sense. They can't claim that they haven't been receiving the largesse of the revenue received by the government."
I have been a Palin/McCain supporter, but if Obama takes a stand against this bailout, then my vote is his.
p.s. I agree with the statement about tax cuts. Tax hikes are inevitable at this point.
Not a regular here but ...
First, Paulson & Bernanke are correct in that the immediate problem is a liquidity crisis. Short-term treasury rates are close to zero while many financial institutions have trouble borrowing at all, hence A.I.G.'s willingness to pay an effective 12% to the Fed for their ability to borrow.
Second, the problem - at least at the moment - is not with banks. Let me repeat that. The problem is not with banks. Only IndyMac has failed or required a buyout and only Washington Mutual is on the short list for possible closing or buyout in the short term. The problems have occurred largely in the financial sector other than banks. And that's a key point because banks - and thrifts - are regulated while the institutions that have got into difficulty - and have caused difficulties - are unregulated. That is a point that cannot be over-emphasized.
Third, there's a ton of financial instruments out there going under the general heading of derivatives that most people even in finance simply do not understand. (And for the record, I'm a full prof. of finance at a major research institution with an extensive consulting practice and even I don't understand all of them.) Unregulated financial institutions have been playing in these markets often with little understanding of the risks involved or understanding how the derivatives were related to the underlying assets. This point is key to understanding the general lack of liquidity. Suddenly there has been a recognition that some of these financial instruments don't have quite the properties - in particular the risks - that people thought. Thus, they have become illiquid, and thus we have a liquidity crisis.
However, there are a couple of key points that make me extremely concerned that the fundamental underlying issue has not been addressed, and since it has not been addressed could see the situation dramatically worsen even if Paulson's plan goes through without problem.
Go back to the start of the recognition of the problem in the summer of 2007. At that point pretty much everyone clued in knew that there was a liquidity crisis in particular relating to mortgages and deriving at that time primarily from so-called Alt-A and sub-prime mortgages. Institutions like IndyMac and Countrywide were in serious trouble. And the "solution" was to encourage Fannie Mae and Freddie Mac to aggressively enter the sub-prime mortgage market. Up to that point, while they may have had accounting issues and have been undercapitalized, they had also generally stuck to conventional mortgages. Nevertheless, they entered the sub-prime market, perhaps much too enthusiastically. They provided liquidity. And now they're effectively gone, sucked dry of any liquidity. Bottom line? There is an incredibly large pool of illiquid assets and Fannie and Freddie couldn't provide sufficient liquidity and it's not clear that the Fed and the Treasury - with the current proposal - can provide sufficient liquidity. That is a concern that, quite frankly, scares me. You're talking $700B in a market of over $40T. How much "toxic waste" is out there?
The key question should be what are the assets underlying any of these financial instruments and what are they worth? As long as the housing sector is heading south, property values declining, foreclosures increasing, ... then any derivative based on mortgages is going to be "problematic." I don't think that there's any accounting for what part of that $40T is based on housing, but I would be very surprised if it were less than $20T. (Yes, that's a multiple of all the mortgages in the U.S. but were talking about packaging and repackaging.) There's clearly some very sound mortgage-related financial instruments still out there. However, my point is simply that there's also likely a huge amount of stuff that's problematic.
In addition, you have what economists call a moral hazard problem. Suppose you're a bank - again, regulated and relatively safe - and you've a healthy demand for mortgages. You may have more than you can fund from internal sources, e.g. deposits and may choose to sell some. What are you going to sell? Clearly, you'll keep the best and sell that which is most likely to pose future problems. If you've got a portfolio of people borrowing, say some at 80% and some at 60% of the price, you'll sell off the 80% crew and keep the 60% crew. The 80% crew may still meet all the standard packaging criteria, but if there's trouble, it will likely occur there before hitting the 60% crew. Moral hazard is another reason why the problems are more severe at particular types of financial institutions.
I must admit that I'm absolutely and totally opposed to the present statement of the plan. First, the lack of oversight should scare the ?#@?*&! out of everyone. The Treasury Secretary answers to no one on any and all decisions. Second, the fiscal implications of this are absolutely incredible. What we as a country can do at the Federal level will be incredibly constrained for the foreseeable future. (And this certainly is Noquist's idea of constraining government either.) Third and perhaps most importantly, the plan doesn't address what would appear to be a drop in the value of the assets underlying the derivatives. Why is there a bailout for the financiers and not for the underlying assets, e.g. houses & homeowners? One can argue - as Poulson and Bernanke have done - that the cost of having a financial system collapse is just too great to bear. However, they haven't addressed the question of whether it's less expensive to bail out the financiers than to bail out the underlying assets. And fourth, what happens if it doesn't work? Then what?
Kevin, I have trouble finding avenues to sent e mails to Frank and Dodd. Maybe you can help. In this bailout program tie stock brokers, bankers, real estate folks, financial folks, etc. salaries to no more the 15 time the average salary of teachers, firemen,soldiers and policemen. Once sure way to bind and squezze the republicans. And it would magically improve the quality of the financial side and the educational and security sides.
Good point tom, though I would suggest that every company we bailout be forced to have every employee work at a government salary.
Rich, let us also remember that if McCain should win in November we will be talking about Treasury Secretary Phil Gramm with a $700b blank check.
Roy, Fair enough working at federal salaries. This is how the Swiss have some of the best people in their government jobs. Public sector pays as well if not better the the private sector.
Kevin, you write: "Maybe by taxing extremely high incomes at higher rates. (Hell, taxing extremely high incomes at normal rates would be a start.)"
Wasn't this -- tax all forms of income at normal rates (plus fewer deductions) -- the essence of the 1986 tax-reform compromise worked out by the sainted Reagan and Democrats in Congress (led by Senators such as Bill Bradley)? I realize that since then, Republicans have worked relentlessly to get lower rates for capital gains and dividends and a zero rate for estates. Am I right on this 80s tax reform? Could we maybe get Republicans back to the policy of their modern Maximum Leader?
Rich - Thanks for your post.
From the leaked draft text in the NYTimes (1) Mortgage-Related Assets.--The term "mortgage-related assets" means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.
What the heck does this mean? Am I reading that the bailout money could be used to buy what are essentially gambling debts from highly leveraged bad bets that real estate prices would rise forever faster than wages or the economy in general?
What you'd really like to do is punish the people who were running the banks while all this was happening.
I want a personal investment banker (or other financial services crook) as an indentured servant. 20 years would be fair. Would be willing to timeshare. Must clean bathrooms and wash windows.
"The Giant Pool of Money," This American Life, May 9, 2008 (referenced in that CJM essay) is well-worth a listen if you need to increase your blood boil.
Bastards.
Actually the Democrats better get their act together real fast. The Republicans have handed Democrats a major issue and here it is:
George W. Bush and his Republican friends are destroying the financial credibility of the United States. John McCain has dedicated his entire career to the same economic policies as George W. Bush. McCain has no credibility despite jumping around all over the map in recent days. If McCain is elected president, expect our financial credibility to continue downward.
Democrats have been the party of financial reform since Roosevelt (actually since Wilson but not many remember that). The problems that Bush has created after 27 years of other Republicans pursuing a flawed economic philosophy are huge and will not disappear in the near term of one or two years. The best chance of restoring the credibility of the financial system of the United States in the next few weeks is electing Barack Obama, but only if the Democrats show some backbone and sufficient oversight. We can expect little from the current Republican leadership except lots of promises and lots of noise. If there is going to be credibility before January 20th, the Democrats are going to have to provide it.
Art, that thought did go through my mind and scared the *#L#(* out of me!
But there's yet another problem that I didn't touch on, again relating to moral hazard. The Treasury will be buying what from whom? If I'm Goldman or WaMu or ... I might offer the stinkiest stuff in my portfolio and I'm going to be willing to sell it for pennies on the dollar. Better stuff might be sold but it would have less of a discount and thus might be less palatable to the Treasury. Does the Treasury secretary really believe that he has the ability to sort through what constitutes the best deal? I could probably put together a bunch of different portfolios at different discounts where the lower discounts would be better deals but where the instruments would be so complex that virtually no one would be able to decipher what's really in each. I do valuation, albeit not of the "assets" that are likely to be offered. Given current market conditions, valuation of those assets is probably the toughest financial game in town.
The problem is hubris. The Treasury doesn't have the expertise to value the assets and that expertise has become one of the most scarce and thus valuable commodities around. If it was simple to value the different assets, then we wouldn't have an issue with lack of liquidity. The part of the proposal calling for hiring in part reflects this difficulty, but then Paulson will be hiring some of the same people that created the problems and paying them extremely well. The devil is in the details on this and at the moment there are no details.
The rating agencies and regulators had to see this coming, it's too blatant. This CJR article makes you wonder if this whole mess was a deliberate time bomb designed to explode during the next administration, but they cut the fuse a little too short.
Rich S, what exactly is "moral hazard"?
Anonymous, neither the rating agencies nor the regulators had a clue until relatively late in the game. The reason? They're simply outgunned.
I don't deal with the rating agencies but I do deal with regulators, different banking regulators, all the time. They simply don't have a clue - and that's deliberately present rather than past tense. It's not that they don't care or aren't concerned. It's that they're simply outgunned. You have some of the smartest people on the planet - at least in one dimension - that have worked for years to come up with the next popular derivative - dealing with a bank regulator that might have an undergrad finance degree and be a couple of years out of college. Alternately, I'm paying my analyst $2M to come up with a derivative and your $100k regulator is supposed to figure the long-term implications. (And when you do get someone really good, I'm going to hire him/her away from you!) Bottom line: as a regulator, your ability to compete is severely proscribed.
Tie financial folks salaries to be equal to policemen, firemen, teachers, soldiers, public workers etc. and that will solve the today's and future problem very quickly.
Myself, I'm waiting to see how we're going to talk the Chinese into financing this...
KD: ...what then? Hell if I know.
I'd say this guy gets it about right:
ARMAGEDDON: Bush Administration's Plan Reachs Next Plateau
[...]
American voters must realize that if the McCain / Palin administration seizes power in the White House, it will enable the next phase of the Bush administration's plan.
McCain and Palin will announce that due to the huge U.S. debt many critical programs, agencies and social services must be privatized.
Specifically,
Medicare and Medicaid Social Service Programs
Medicare Prescription Drug Program
Social Security Administration [retirement]
Veterans Administration Services
Border Patrol Management
Public Schools
Universities and Colleges
Various Federal and State Pensions Investments.
Privatization has been the Bush plan all along. It will provide endless profiteering to wealthy special interests who during the past 7 years already have made more profits than ever before. ...
If there's a bailout, let's pay for it with a wealth tax. That'll get back some of the ill-gotten gains.