Tuesday, September 30, 2008

-777 + 485 = -292 (2+2=4, it's not)

New math
Stocks made a strong recovery from the substantial sell off that, in percentage terms, was the 18th worst in the history of the DJIA. But the next day a rebound in the index, retrieved 62% of the previous day's loss.

Figures lie
We are left to wonder what spooked the markets so much yesterday (-777?) that they recovered from it so readily the very next day on no substantial new news.

This is real volatility.

Monday's sell off being unexpected explains the dramatic result. Then Tuesday's rebound is laid to the belief that Monday's sell-off was a surprise and produced an out-sized response for that reason. On Tuesday the rebound is based on the notion that Monday's event was bad but not earth shaking and that we expect Congress to do the right thing eventually. The President's speech was meant to rally Republicans to the cause they can support and give them political cover for elections in November.

Today in myriad interviews, I have been asked 1,000 ways 'WHAT IF... 'it' doesn't pass?'

My response is this.

In the story of the emperor who has no clothes, once the people knew he had no clothes on they could not go up to him and tell him how much they liked his new jacket. Similarly once the Treasury Secretary and the Fed Chairman tell us that we have a problem that requires immediate authority to spend $700bln they can't go back to say 'never mind, the fundamentals are sound'.

...not passing a bailout plan is simply not possible.

Liars figure
They played that card. They played several cards. but now they have been caught with a card up their sleeve....
  • They let us think Wachovia could absorb Morgan Stanley then they folded Wachovia into Citibank for $1.9billion!
  • They told us Fannie and Freddie were well capitalized. Then they found 'evidence of accounting irregularities.' After which they let the CEOS go with millions in bonus money and with thanks... thanks?
Nothing up my sleeve...really!
None of this reflects any sense of reality to me. It is clear we have been the audience for some great charade. That can't go back to those tricks. They have exposed their true feelings about circumstances and their fragility. Now 'they' must deliver a cure. But homeowner ire is so extreme and their own past obfuscations have been so successful that no one is quite sure what to believe any more.

Problem not solved-not even addressed
One thing is clear: all who know about our peril say that the housing sector is at the bottom of the problem and yet there is NO PLAN in place to deal with home values falling. The bail out plan is aimed at banks. The economy is getting weaker and without something to stabilize home prices the housing market will get worse and problems with securities valuations will become more dicey. Yes we have to fix the banking system, the conduit for credit. But housing still gnaws at its ankles.

And that is where we stand as we await a new 'bail-out' plan.

Mother may I accounting...A solution

Saving private Ryan's $700 Billion - and yours too...
So going back to discretionary accounting from mark-to-market is like going back to the stone age. Well, guess what? I don't agree. Wilma!! Wilma!!! (Joke)

Suppose you do it in a very public, very temporary, very limited way and make it clear why you do it and under what conditions you will go back to it?


William Donaldson Former head of the SEC said in a Bloomberg interview that there is no CDO market, so how do you mark to it? Let's start there.

Opponents of dropping mark-to-market do not want banks to have discretion in marking paper but they want them to mark to a market that does not exist. The market they have tethered banks to is so thin with bid-offer spreads so wide that the parameters for value are elusive. So which fantasy is worse: the one foisted on banks that is bankrupting them, or the one the banks guess at looking to the future-with regulators looking over their shoulder? Chairman Bernanke admits that this mark-to-market rule results in the pricing of securities at fire-sale prices. That in turn dumps losses on banks and that sends them closer to the brink of bankruptcy. Why stick to THAT??

What is so bad about allowing relief from this so clearly failed system linked to a failed market?

Here is how to try to change it:

(1) First the proper authorities need to declare the CDO market as dysfunctional and offer accounting relief.
(2) Firms wishing such relief may petition for it.
(3) The authorities will make it clear exactly WHICH markets are dysfunctional and for those the special discretionary accounting valuation will be allowed UNTIL SUCH TIME AS THE AUTHORITY DEEMS THE MARKET TO BE WELL-FUNCTIONING AGAIN.
  • With that the market for accounting exception is well defined. Participating firms are identified. Conditions for reinstatement of the mark-to-market rule are at the same time established, making it clear that this is a temporary fix.
  • Doing this I argue would make it MORE likely that in time firms will come to see the true value in CDOs and in other mortgage products (and mortgage -related products) and real markets will develop. If banks see that other banks see long term value in this paper and if asset sales don't simply drive prices lower due to mark to market rules this approach could help to revive a real CDO market...in time.
  • The tact could be very intrusive or looser, as desired. If government were so afraid of fraud, participating firms could be required to petition for the issues they want to re-mark so a record of the security ,its current mark, its last known market value and the intended new mark would go to a clearing house. This information could be kept and analyzed in a central clearing house to compare the treatment suggested by various banks (for identical cusips) to try to keep it consistent. Authorities would have override: Mother may I? NO you may not. In this way a different set of off market valuations could be developed. Models could be used applying cash flow analysis etc to double check pricing.
  • Clearly the authorities would provide more supervision. But what I am suggesting is that it is possible.
  • I am also suggesting this can be done by having banks volunteer
  • And I am suggesting it can be DONE WITHOUT SPENDING $700 BILLION IN TAXPAYER MONEY- just some careful planning and oversight sweat of the brow. It might even create some jobs for people losing their jobs in the CDO business.
(4) Participation may still have its costs. Some of the strictures involved in the bail out bill as to CEO parachutes and even allowing for some capital participation by the government could be carried over. The plan would be optional so institutions could opt in or out.

Pandora's box stays SHUT!
All in all I think this can be made very workable and kept as loose or as tight as the authorities would want. The idea that this is opening Pandora's box is an idea for the small minded

What are you willing to try to save $700 billion?

A saving of so much could allow us to apply some the $700bln we were about to 'spend' to offer help to homeowners. So far homeowners have gotten the lion's share of the rhetoric but none of the relief! I'd suggest giving banks a 50% tax credit for the amount that they reduce mortgage amounts where mortgage value exceeds house appraisal value. In that way banks could get cushions for their write-offs and use their own market acumen as to where homeowners have a chance of surviving if their debt load is lifted and terms reset.


Monday, September 29, 2008

Who is remaking the US financial system?

Dismemberment and the witless protection program

FIVE investment banks-- GONZO? GONZO!

Bear Stearns was dismembered and given over to JPMorganChaseBear (not a real name except perhaps for some Native American and not long enough to be Hawaiian).

Merrill Lynch threatened probably by AIG's coming troubles and the direct fallout that it might suffer from that and its exposure, JUMPED into the arms of LynchBoACouuntrywide (not a real name - or strategy).

Lehman is gone and its demise sent new ripples though markets and now BOND HOLDERS fear risk for the first time. That smacked the credit derivatives market and hard.

Goldman and Morgen Stanley
Goldman and Morgan Stanley SURVIVE but in new forms under the government's new WITLESS PROTECTION PROGRAM, going undercover as commercial banks. Will they stay that way when this crisis blows over? If so why didn't Goldman go after any of the treasure trove of bank deposits that have been 'on sale'? Inquiring minds want to know.

Behind the scenes...
As AIG was being dealt with, why was the head of Goldman the only private sector guy in the room? Oh he was not representing Goldman's interest? He was representing the market. Right. Let's see former Goldman Guy heads treasury. Former Goldman Guy at NY Fed's open market desk. Former Goldman guy heads what-used-to-be Wachovia. Never mind. No pattern here.

So our large stand-alone investment banks, merchant banks, are gone...

As commercial banks fail the 'government' is arranging marriages. BofA got Countrywide. JPMorganChaseBearMOOO now has Wah!-MOOoo. Citibank gets 'walk-over-ya' (CitiWachovia?). But why not Wells-Fargo? Who decides? Oh these are auctions done in secret with the FDIC..ohhh I understand.

Wasn't Wachovia supposed to have been a potential suitor for Morgan Stanley? What would that have been: the financial zombie club? or StanleyWalkOverMe?

How could that have been considered? There is more misdirection out there than at a convention of magicians.

We can see why so many are angry. Now there is some concern that because the Fed's are taking warrants in private firms, that alone means they have been anointed and are 'too something' to fail. Isn't that dangerous?

By the time the democrats gain office, even if they win the White House, the financial sector will already have been re-configured. It isn't Iraq but is the same formula. Declare a crisis and something must be done in such a hurry opposition melts away and cannot form a significant counter to your plan. Maybe they modify it but they can't stop it. Once again a brilliant move by the administration to get what it wanted. Makes you wonder though doesn't it? Governing by means of crisis. Is that the new keystone of democracy?

Sunday, September 28, 2008

The PLAN, the tactic, the strategy


In the beginning there was the plan. It was a take it or leave it and don’t-you-dare-modify-it plan endorsed by the Fed chief and the Treasury Secretary. The plan was a tactic: all or nothing. The strategy was to help beleaguered banks but now the tactic failed, the plan is changed and the strategy is in jeopardy. The plan was presented. There was an avalanche of criticism. Senators and Congressmen called the plan and its initiators, the political appointees Bernanke and Paulson naïve, saying they, as elected officials, have to be responsive to their constituents and constituents did NOT like THE PLAN.

What crap! So now there will be blood

Not sprung full borne from the head of Zeus?

These plans do not spring full blown out of the head of Zeus or Paulson or Bernanke. These guys certainly had floated trial balloons to the key committee heads before they ‘formally’ presented this plan, you can be sure of that. B&P were not told it is a ‘nonstarter don’t even try’. But, when the backlash from constituents (you and me) rolled in, the politicians retreated and they, of course, dumped on the naiveté of Paulson (a former head of Goldman Sachs and guy who is suppose to ‘plugged in’ and politically savvy) and on Bernanke who (as a former academic and Fed chairman) may in fact be more naïve on this score. But the committee heads were in on the ground floor and let these guys try to fly this lead balloon. Why? See below:

Follow the link below to a site that keeps score of to whom financial and real estate firms contribute. Mr Dodd is very high on the List. Barney Frank is up there ($2.5 mln mark) but not so much at the top. There you will find Obama, Clinton and McCain are up at the top. Are we surprised?


THERE WILL BE BLOOD…instead of golden parachutes…

So the revised plans calls for all the things Bernanke and Paulson first said we cannot do. Apparently participants in the plan will see (1) that the government takes a capital stake of some sort so taxpayers can share in the upside. (2) Golden parachutes will be banned for executives at participating firms. (3) It appears that some sort of an insurance plan will be launched. (4)Democrats will get some sort of assistance for homeowners but nothing very dramatic and (5) there is pledge to try and help out homeownership trouble where the government holds their mortgages. This is not want Bernanke wanted at all. There also will be oversight. (6) Paulson will not be king and (7) there will be judicial review.

Now there will be so much blood and pain one wonders about participation. The cat is already out of the bag, however. You do not ask for $700bln in permission without having a big problem to mop up. So if the plan is not well-subscribed we will know the sector is still in trouble and liquidity may remain illusive.

Liquidity or solvency?

It should be clear by now (A) judging from odd Libor goings on and (B) all the special lending facilities to ‘enhance liquidity,’ and (C) with a $700bln bailout plan that: the issue all along has been SOLVENCY (!) Not liquidity. Lehman failed because liquidity problems can be fatal. It is being sold piece-meal so we can’t easily tell if it was solvent at current market prices. But others have failed or had shareholder equity all-but wiped out. Now the new plan will a be first cousin of these other plans (Bear Stearns, Freddie Fannie AIG) and will require a similar kind of pain instead of letting firms off scot-free.

No one has asked the solvency question because it is too frightening. But when $700bln is at stake how could we think otherwise? How could they think we would think otherwise after such a request? How could it be otherwise if their judgment is correct?

So, in the end that is why Wachovia, once mooted as a potential acquirer of Morgan Stanley is itself being shopped for a suitor. Who knows who is well capitalized and who will be able to stand alone - or even stand with help - when securities are properly marked to market?

While the plan makes the world safe for counterparties it does not do the same for the shareholders of principals.

Friday, September 26, 2008

Does Insurance make sense?

Life insurance: an example
First of all if you were going to underwrite life insurance you would make sure that the insured client was alive first. Wouldn't you?

The GOP Plan
We have very little to go on in this GOP plan. But it doesn't seem to add up. You can't insure losses from here on out unless you know where prices are. If you take mark-to-market prices you already know that the level is too low for banks to survive. No one knows where these hold-to-maturity prices are that the Fed is trying to discover through reverse auctions, so you can't make that price the baseline for insurance. If they are talking about insuring at par this is a bigger give-away than Paulson's plan.

It's all about MONEY
Talk is of having banks pay premia for an insurance fund based on mortgage holdings but its too late to generate enough money to cover what's out there in losses. You can't write life insurance in the middle of funeral. Moreover, private insurance already has failed, and no one has come up with enough money to even buy out WaMu ( JPMorganChase took them after bankruptcy) let alone other troubled carriers. How are we to get enough private sector money to do this? It is not realistic. Any insurance solution will take just as much public money as Paulson' plans since it must get banks on even footing.

GOP members clearly have ideological problems with a bail out and with the use of public monies as a solution. They are are seeking solutions consistent with their beliefs. There's no harm in that. But at some point reality will rear its ugly head.

...turn the other cheek, no, not that one, the one where your wallet pocket is...
Another reason for GOP disgust is that the Paulson plan originally called for public money to buy complex securities at higher than market prices with no strings attached at all. This was justified by the argument that buy-to-hold will produce a higher price and using some untried technique to get at that price. At the same time that rocket-scientists' pricing models (think CDOS and credit derivatives) have failed, it is not unreasonable to have skepticism that this plan is founded on a thin reed of academic hope.(hype?)

Was Bernanke really lured by the dark side Obi-wan?
The academic demand was for a wide a participation as possible prompting Bernanke to side with the no-strings part of the deal even though THAT by itself imbued the program with moral hazard the likes of which has never before been seen. The Chairman has said nothing about moral hazard since this plan was mooted.

I do not know what I do not know: inspector Jacques Clouseau pricing
Is it cost effective? It will be hard ever to tell if Treasury paid too much for these securities and it is not clear that buying $700bln will jump start bank lending or attract new capital to these banks that are former sink holes for losses.

Be careful about introducing disincentives
Some want to cut or ban dividends as the price of help. I would not do that. Better to take a capital stake in the firm and retain some control over dividend payouts rather than a ban. You do want these firms to be able to attract capital after the bail out. Stopping dividend payments will scare investors away. Take your pound of flesh from current shareholders only in the form of a capital stake and whatever share of dividends that might imply as they are paid out.

An even better mousetrap! FREE! taxpayer free!
Indeed the better plan is not to commit ANY public money but let banks themselves use hold-to-maturity pricing instead of mark-to-market pricing. Let each bank directly absorb that change in accounting rules and make the switch in accounting regimes, a switch that subjects the bank to some capital ownership by the Feds, CEO pay oversight etc. Keep them tracking mark-to-market prices. Bank examiners would have to use oversight to keep banks from using prices that are out of touch with reality.

It's always something...
One problem with this plan is that there is No mechanism to discover buy-and hold value universally. Each bank will make up their own valuation, but subject to oversight. Over time and as the economy improves we can expect differences in valuation to diminish.

Like the Paulson plan in impact
At least THIS plan costs no tax payer dollars. Banks that had written down CDOs the most aggressively will get he most benefit, but that is the same under the Paulson plan.

What's worth $trln in front money?
I'd rather let banks guess at value and oversee them for it than to spend $1 trn for experimentation with auctions.

If the GOP guys are having a problem with all this. Its hard to blame them.

The insertion of McCain and Obama into the mix has not been helpful. Democrats are blaming McCain for the set back to their deal. As outsiders we can't really know. McCain made a big deal about returning to Washington to participate so he should not be surprised when Democrats go after him for doing so to take back whatever push he got for seeming to put the country first. And so it goes.

Some truths
The timing with elections couldn't be worse.

The timing of the economy weakening couldn't be worse.

The do or die 'one plan or none' approach was another big mistake since no one likes to get railroaded.

Paulson and Bernanke come out this as damaged goods with both looking naive. Paulson looks like he was in a grab for funds for his buddies on Wall Street and Bernanke looks a bit like he was out maneuvered into being a perhaps unwitting accomplice.

Thursday, September 25, 2008

Bernanke sets record! Bush out-foxes foxes

Ben Bernanke could be up for a Nobel prize for his work on the proposed bail out package

This, it is believed, is the FIRST time an economist has proposed a plan and even when pressed could not come up with an alternative for it.

There will be no 'On the other hand plan.'

Some cynically think it makes the current plan just seem that much more important. If the choice is 'do or die' and there is only one plan of course you vote for 'DO.' Even if it implies stepping into deep Do Do.

It smacks of the Bush IRAQ strategy. Make it sound. pressing. Make the alternatives very distasteful.

Hey it does parallel that. But that worked didn't it?

It's working again.

For a guy that democrats constantly say is so dumb George W Bush sure knows knows how to wrap them around his little finger, doesn't he? So in the end who is smart and who is dumb, Boys?

OOHHhh, I can't believe I ate the whole thing

$ 30 bln ummm!
$200bln ah,err...
$85Bln Burp(!)
700Bln Belch!

'Scuse me.

Oh man where is the Japanese kid who wins the hot-dog eating contests when you need him?

Sue them all (or sewage them all)
Did you see the president last night? Is he really going to go after all those securities firms and BANKS? They have been acting as public utilities without a license! They have been pumping RAW SEWAGE into our financial markets. Surely that is in violation of some environmental law?!

Or is that why we did not sign up for the Kyoto protocol? Very shifty.

Or maybe I had on the wrong channel...

THE ROAD TO ONE OPINION (or the road less traveled, by economists)

It seems that the die is cast. No one has the stomach to change accounting rules on mark to market. The reasons against it are so (not!) compelling. At not price and under no accounting convention do the banks want this stuff, (stuff they generated and at one time coveted) on their own balance sheets. OUT DAMN SPOT! But the banks are in control. Bank lobbies are in control.

DO not try and regain control of you your TV you are in the BANKING TWILIGHT ZONE...

Nothing you hear may make sense but we are going to do it because the FINANCIAL lobby pays us so much money when we run for office and we are running for office again this very year ( this is the great unsaid speech by house and senate members)! We just held TWO DAYS of TV hearings where we said the same thing over and over and over and over and over and over and over and over again .

OK. It may not have been compelling but after all that we beat the opposition into submission. Its not really important for THEM to believe this. Just for them to believe that Paulson and Bernanke believe!

It's..it's...it's...JUST LIKE IRAQ! Grainy photographs of bad mortgages Saddam inking financing deals. Just LIE to us about how much we need it and how BAD- really BAD- INCREDIBLY BAD - it will be if we DO NOT DO THIS. Do THAT and we all will buckle under. We politicians can deliver the VOTE and tell the same LIE to our constituents and say YOU SAID SO...

Of course you could do something else. but 'this' is the ONLY plan you put forward making us think it is do or die. And well given that choice, what's not to like about 'do'?

Bernanke looked like he swallowed The worst tasting medicine in the world and has been for one week without sleep. I wouldn't be surprised to find out his family had been held captive during all of this. He says all the 'right things' but he is not convincing and he has no alternate plan. How could have no no alternate plans?

IS BERNANKE FINALLY that ONE-ARMED economist who doesn't say ON THE OTHER HAND? May be they HAVE something on him? A one armed man? Maybe he KILLED RICHARD Kimball's WIFE in the FUGITIVE? IS Tommy Lee Jones LOOKING for BEN??? Is BEN wearing a prosthetic device?

Is this a first? will they revoke his PhD for having only ONE opinion? My Gosh only ONE PLAN! ??? I don't believe it. And up to this point the Fed has been so creative. Guess that's what happens when they hold your family hostage or give you poison and threaten to withhold the anitidote. C'mon you you watch "24" don;t you! Think a little...

Because the banks only want this plan. and THEY are in CONTROL.

Face it Paulson wouldn't know a good plan if it came up and bit him on the bottom. Hey how about a super SIV? What? Already tried that one? Never mind.

BUT THE ASSETS are to be sold at loopy auctions. Pay MORE than the securities are worth - give them an excuse..yeah mark to market is bad! Hold to maturity is better. Of course, many will never reach maturity. Minor detail.

Don't you try SOMETHING before you try to spend $700bln on highly experimental auctions run by the same crowd that mis-priced all those CDOs?



Never Mind

Wednesday, September 24, 2008


From mark-to-market anomalies to ROCKET SCIENTISTS blowing up on the pad

oxymron 101: Mark-it-to-market
The Fed chairman says 'they' cannot abandon mark to market rules because it could undermine the creditbity of the system...


Yet in this NEW $1trillion plan he makes a real point of saying that mark-to-market prices are distressed and hold-to-maturity prices are higher. I do get that. That has been MY ENTIRE POINT. But I DON'T GET that The Fed/TREASURY WANT TO pay the HIGHER PRICE for this paper when they buy it from banks that might HOLD IT AS MARK-TO-MARKET PRICES.

That will give them an INFUSION OF CAPITAL. Why just let them USE discretionary pricing (NOT mark-to-market) and mark it up themselves!! and keep their DANG PAPER!! Meanwhile We'll keep our $1trln!! Presto change-O!.

Isn't that an admission that mark-to-market is a flawed practice? It has led to assets being undervalued?

Isn't mark-to-market THE PROBLEM far from being a source of stability or credibility for the system?? OXYMORON!!!

...and if another way of valuing these assets can be FOUND MAYBE JUST MAYBE those assets could stay RIGHT WHERE THEY ARE and rise in value? No?

I have made several suggestions as along this line I will leave it to you to connect the dots anyway you want.

IF mark-it-to-market is so great why does it work so badly? Since it works so badly why say credibility depends on keeping it? OXYMORON OXYMORON OXYMORON

Inquiring minds want to know!

oxymoron 102: ROCKETMAN
The rocket scientists got us into this mess with their packaging, credit wrapping, credit enhancing tranching of mortgages and so on. Now Ben Bernanke, Fed chairman, and a bit of a rocket scientist himself, proposes getting relief by using rocket scientists who will employ another largely untried thing, reverse auctions.

Hey FORGET THAT HUGE CYCLOTRON in SWITZERLAND. The real black hole, the real anti-matter is RIGHT HERE IN THE USA!!

It's the infamous CDO particle.

Ah yes but to use rocket scientists and their auction experimental plan you need widespread participation etc....from the fakirs, err bankers. One upshot is you don't want to 'piss-off'' the people you need to participate in auctions, reverse auctions. Experts in auctions from around the world want to come and dabble in our little $1trillion experiment with taxpayer money RIGHT HERE in Iraq. Oops did I say Iraq? Oh, I didn't mean THAT experiment. I meant the one in mortgage land across this great great county with amber waves of grain that are now being used to make petrol while taco prices soar. But let's not worry about that side-effect either. Let's buy under-priced mortgages at banks so we can pay more for them and sit and back and wait 15-20 years and see if we got our money's worth! Do not DO NOT punish the banks that made these rotten loans and do NOT DO NOT cap the salaries of the men who ran and now run these banks that WILL record an earnings surge when we pay above market value for this paper.

YES!!! ROCKET science pushes CEO pay into orbit!! I love it!!! America IS a great place where even sinners go to heaven!

Alternatively, and this is just that an alternative plan or universe if you will... if we grabbed the CEOS by the scruff of their necks and threatened them with prosecution under Gramm Leach Bliley I wonder if we wouldn't get their attention as we took capital stakes and anything else we wanted for their sorry and all but backrupted buttts?

...just an alternative version that's all...

I don't see the need to pander to these guys.

Bernanke is far too much MR Nice guy.

Paulson is lining the pockets of his buddies.

No one can get a capital stake? Guess what? Goldman is and from the Golden boy himself Jimmy Bufffet...wasting away again in Margaritaville...or OOPS sorry that's Warren Buffett. I wonder if he used his corporate money or part of that stash he was going to give to Bill and Melinda for charitable purposes?


Tuesday, September 23, 2008

I don't believe this. Do you?

This is a really bad plan...I have a better one (below)
When Paulson was asked if they had other plans that he had rejected, he sort of mumbled yes. When asked by Sen Shelby to enumerate them and say why they were worse than teh one he chose, he rambled well off topic. (i.e there was no other plan considered.)

My preference is to put in abeyance the mark to market rules. Bernanke said he was opposed to that because it would undermine 'confidence in the system'.

The camera was not on Bernanke when he said this and I could not tell if he said it with a straight face or not. How could we undermine confidence in this system by anymore? Really Mr. Chairman... Bernanke also said that there are a lot securities for which there is no active market. For them mark to market has no meaning.

Bernanke said he was opposed to eliminating the mark to market rule because it would undermine 'confidence in the system'
The camera was not on Bernanke when he said this and I could not tell if he said it with a straight face or not.

My idea of getting rid of mark-to-market is to keep banks on the hook for their loans but take their SOLVENCY concerns off the hook while doing it. Mark to market will still be used as a shadow system since banks will be striving to fix themselves up so they go back on it and go back to an ordinary or stepped down program of regulatory oversight and stricture. That would be their ultimate goal.

A BETTER plan- how it would work
Banks would have to OPT into this system that put the rule on mark to market in abeyance. They would still have to track market to market values for all securities as before. Government overseers would get veto rights over dividend payouts and corporate officer compensation while banks were on this system.

Banks would not like it but they would no longer be in jeopardy of solvency. The approach would ELIMINATE COUNTER PARTY RISK. Instead of being bailed out and whole, they would be on probation and closely watched.

Banks on this program would be able to reserve against their security-holdings' value short fall from a true market to market value and do so at their own speed. This shadow system would dissuade banks from foreclosing on mortgages willy-nilly since to do that would be to destroy the value of underlying loans which would force the bank itself to deal with that shortfall. Banks would, therefore, get a built-in incentive to work with homeowners.

This program puts time on the banks' side. Given time, these various assets will come back in value. The process of banks planning to reserve more for value shortfalls and the fact that housing assets will rise in value as the economy improves will eventually allow banks to heal themselves. At that point they can opt out of the system that lets them stop marking to market their securities knowing that it has now sufficient reserves to cover any shortfall and that asset prices had come back to a large extent.

Banks can choose their own speed for doing this. It creates a built in incentive to help homeowners.

As a plan this is MUCH BETTER than the Treasury plan.

It would cost the tax payer NOTHING.

It would protect the banking system

It would provide some benefit to struggling homeowners. .

It would subject banks to more intensive oversight and regulation until they had dealt with their problem

It would ELIMINATE the current plan's problem with moral hazard and what a problem that is! No one is reminding you of this, but if you bail out the banks like this this time there will be another time and next time it will be worse.


Monday, September 22, 2008

Dr Jekyll and Mr Hyde

A regulator can be of two minds about things but he can't be schizophrenic. Despite an ability to see two sides to a story a regulator needs to choose ONE course of action and have one underlying philosophy to govern actions. Changing persona's in mid crisis is odd. But with the switch in the front-man for the regulatory fix-up we are seeing a brand new philosophy take root.

Fed's Dr. Jekyll to Paulson's Mr Hyde
Under Hank Paulson the the MAP (Market Assistance Plan) has come 180 degrees. The Fed led MAP put the hammer to shareholders and fired CEOs. It treated the failing institutions as having a failed plan and failed management. It punished them as well as the shareholders, opting to protect the financial system by cushioning the blow of their failure on the economy. Under Paulson the MAP treats financial institutions as VICTIMS. I suppose the criminals are the short sellers who have attacked them. Short selling of the shares of these financial firms has come to be banned. The SEC has finally donned its white hat and ridden to the defense of those financial firms that the Fed used to treat as scoundrels.

From 'Kill 'em all and let God sort 'em out' to 'Pay 'em all and let God sort 'em out'
Financial firms are still troubled. They are actually loaded with nonperforming assets. Short-sellers were not clueless in selling their shares. In some real-world sense everything is not OK. But apparently the firms with troubled assets and their management teams are not to be made accountable for this ('this' being their poor performance and their poor business plans). Instead, they are slated to get monies from the Paulson MAP with no punitive actions. Paulson wants no prohibition placed on corporate executive bonuses for participating firms or any other stricture as far as I can tell. He does not want to discourage banks from participating. This brings up he question: what is Hank's objective?

Fed MAP: The Fed's objective was to stabilize the teetering financial institution and protect the financial sector from any fallout that a weakened institution might create. It also wanted to eliminate moral hazard so it made sure that the institutions it helped paid a steep price for assistance. The Fed did not fix them and send them back into the fray, with the exceptions of Fannie Mae and Freddie Mac, where government obligations were special.

Paulson MAP: In contrast, the Paulson plan is to take an injured player off the field and send him back into the game as soon as possible. Heal him by any means: surgery or steroids and don't worry about long run health just get him right back into the game.

On the road to perdition- not Morocco
The Paulson plan is not concerned with long run health only short run health. That statement is a reference to moral hazard. Since there is free money being doled out to make repairs and remove troubled assets from the balance sheet, and no punishment is meted out, moral hazard under the Paulson Plan is about as great as it can be. The institution is not punished, shareholders are not punished, the management team is not punished- nothing/no one is. Indeed, they were all paid out for their past performance which turned out badly and now they are being bailed out, instead of paying the piper. This is a reward for a job poorly done.

Eating for dinner the goose that laid the golden eggs
Paulson wants the economy back on its feet. But it's still not so simple. Markets are not cheering this plan. Stocks did rise sharply last week on word of a bailout. But as the plan is being fleshed out stocks are uneven, the dollar is weaker and commodity prices are up strongly. The Fed's approach had created positive and beneficial reactions from other markets as oil and gold prices fell and the dollar strengthened. The Paulson plan creates just the opposite effects. Of course, the stock market eventually fell sharply under the Fed's hand, but putting an end to short selling stopped that more than anything else.

No alternative...Do or Die
Paulson asserts that his plan must be done. But unlike Bernanke who thought long and hard to come up with ideas to stabilize the economy, Paulson's plan is just to just throw money at it. It is as old school Wall Street as can be. There is nothing modern or sophisticated about it. Because of the macroecomic fallout it is not clear that this plan, a plan that is geared to put everbody right back inthe game as soon as possible, will work. Remember these are the guys that got us into the mess to begin with. And then there is the economy itself...

The economy stupid! Fuuggetabbouddit
One problem is that Paulson's plan does nothing for the economy. It saddles the government and its taxpayers with a ton of debt, roughly another $1 trillion. It does not help the embattled homeowner but instead the banker who has been paid in 'full' for the homeowner's liability while the homeowner is still on the hook for his entire debt. The housing market remains troubled so even healthy banks are unlikely to lend too much there. House prices will continue to fall. The economy will remain weak. Exactly what is supposed to make this plan work and worth the $1 trillion we are spending on it?

Sunday, September 21, 2008

Stupid DictatorTricks?

There is nothing like an emergency to get policymakers to suspend the usual rule or to override basic economic freedoms. Dictators use the trick all the time, then they never give the power back to people.

I am getting a really odd feeling about what is going on with this BAIL OUT PLAN.

No one can value these assets, so it has become a game of 'get what you can'. Some banks want the purchase prices for assets to be used to determine value; THE PURCHASE price not current price.What the heck is going on?

Everyone has a new bargaining trick for MY MONEY and YOUR MONEY!

IF it's so bad why was the stock market so resilient?
EVEN at its worst the DJIA was above 10,000. I don't know why if banks problems are this deep were were able to see the markets trade as well as they did. THE DJIA and S&P and NASDAQ each fell from their respective peaks by about 20% but until last week not by much more (including last week, not by much more either).

I do not want tricks or gimmicks used to funnel tax dollars base on capricious schemes. But we do not have a good way to set value for the assets the government plans to buy. Moreover, it is clear that this plan is intended to funnel money to banks. Banks view it as a hand out. As I have repeatedly argued, if Government buys their assets at true value, how do you help them? Everyone assumes that government is going to overpay for them so banks are now trying to construct formulas most advantageous to them for a payout. The discussant/lobbyists say time is too short to worry over details. Only thing is that the main detail is how is this: ONE TRILLION DOLLARS of my tax money going to be spent and what am I going to get for it?

The world is a changed place again
I am having a hard time reconciling prebail-out market behavior with post bail out financial demands.

While I do not mean to diminish the attacks of 9/11 there is something about this that is like that, at least to me.

The day those planes crashed into the World Trade Towers, the world changed. I was in disbelief. And the day the government offered this huge bail out something changed too. I am still shaking my head in disbelief as I read of some of the proposals. Are these people serious?

You can't pull the planes out of the trade center and bring them back up and restore the lives that were lost. But you can be more careful of the monies you funnel to banks in this instance. You can void making this another sort of day that will live in infamy.

Are you just GIVING our money away??
I am no partisan but the democrats are on to something when they want to restrict CEO payouts. Paulson says this is not about being punitive. But everything up to this point has been punitive: Bear Stearns, Lehman, Fannie, Freddie shareholders lost all or most of their equity and CEOS were replaced. So now if you are part of the PACK you get a prize at the bottom of your Cracker Jacks along with your bail out money? How are those vanquished firms different from the ones you are going to gift with my money now? Aren't you going to get any restriction on them? NOT PUNITIVE!!??

The 'BAILOUT' should be a participatory plan. Firms should be able to sign on or avoid it. If they sign on there should be conditions. You do not just transfer a trillion dollars of the public's money and put no strings on it.

This plan is fast becoming a huge boondoggle. The assets that are being set up to get funded are no longer going to be (necessarily) mortgage related apparently. Language that was going to restrict payouts to US firms is apparently being changed, too.

Are we propping up foreign firms? Is it because US financial firms created this mess? Are BUYERS of this paper not responsible for anything? Caveat Emptor- nevermind.

It's as if there were this white rabbit and we were chasing it down the rabbit hole and down here the rules are not what they used to be.

THIS PLAN MUST BE STOPPED before it gains more momentum.

What are they bailing out? bad credit cards? auto loans/ Mortgages? mortgage derivatives? Credit swaps? is there any end? is there a purpose?

AND you thought we went into VIETNAM WITHOUT A PLAN!!


If firms are this troubled LET THEM GO DOWN one by one and employ the rules to save depositors. Do not bailout everything,

A better plan..a non bail-out plan

Fact and Opinion… A Non bail out plan


An alternative plan that unlocks value, instead of depressing it

The Fed/Treasury have proposed a bailout plan that really isn’t a plan and may not bail anything out. The Plan is not yet fleshed out, underscoring that it is more of a marketing ploy than plan. So far Fed/Treasury actions have been ad hoc. We are led to believe they have a more systematic approach even though it has not been presented. The crux of it seems to be to dump the losses on taxpayers (a ‘bail-in’ that sloshes water out of the bank and into your basement).

Instead, I encourage you to believe that AIG ‘broke the bank’ just as money market funds ‘broke the buck.’ Bernanke almost certainly went to Paulson and said there is too much hitting the fan, the fan cannot keep operating. The Fed’s balance sheet is too stretched. So in a fit of magician’s misdirection the Fed is out of the lime light and now the ‘THE PLAN’ is in it.

If this were foreign policy it would be like Iraq or Vietnam: an effort to start something without a clue as to how to finish it, let alone how to progress. There is no mission, or objective.

This is a plan? How can you buy assets without knowing what they are worth? Yet this is the centerpiece of the RTC plan. If you pay banks what the assets are worth how does that help them? If you pay them more you harm taxpayers and subsidize shareholders. This is a plan? A plan need to unlock value!

Unintended consequences: The old RTC bought the assets of fully failed banks not chipped off portions of bad stuff from banks that remained ongoing concerns. This RTC is a different animal. We can already see the law of unintended consequences at work as the plan to BAIL OUT money market mutual funds that ‘broke the buck’ will now leave banks at a disadvantage since bank deposits are only backed up to $100,000, but MMFs are to be fully backed At each turn or new wrinkle of the law a new unintended consequence slips into gear.

A better plan, a REAL plan

A better plan is to make banks keep their assets and change the accounting rules. Eradicate the mark to market rule for securities to enable this. Then the automatic write downs will stop, even as real estate sinks. This plan unlocks the value of long run pricing. If, as the Treasury Secretary says, the fundamentals are strong, the economy will come back. So will real estate, if not all the way back. Losses can be limited, given time, and they can be made manageable. Those that made bad decisions (and their shareholders) will have to deal with them. Given the flexibility to use long run pricing the private sector can tap what the government is after using RTC: time. Earnings will suffer but bankruptcy won’t loom. Taxpayers won’t foot the bill and moral hazard will not be introduced. Presto!

Incentivize banks - A discretionary asset valuation plan (WITH REGULATORY OVERSIGHT!) would be superior by giving banks the incentive to keep troubled mortgage holders in their homes. Once someone defaulted, the mortgage would more clearly be at a loss that the bank would have to deal with. Banks automatically would be encouraged to make deals with mortgage holders to avoid this. Still banks will need to form property management arms to manage vacant properties since there will be lot of them. If RTC seized the assets then it would have to do this and I would not trust a government agent to do anything other than to sell them quickly further depressing the real estate market. RTC does not have the answers.

Use THE FORCE, LUKE, err Ben…The idea SHOULD BE to press the private market to action not to depress it and replace it. Draw it out of its immobilized state. The catharsis would be a change in how securities have to be valued. Banks could be forced to give up some of their control (like their ability to pay dividends) while they opt for the new securities valuation rule. They could opt out of it when they become ‘healthy’.

Counterparty risk! As the Treasury/Fed try plug the leaky financial dike it is all too clear that the approach remains ad hoc. Better to modify and use the system we know. The problem in this market is not liquidity as the Fed has thought. The Fed keeps increasing the dosage and it doesn’t help. The problem is counterparty risk. So give banks a chance to value assets at their long run potential and slip the noose of short term weakness off their neck. The plan could work and would be superior to whatever is being concocted in Washington.

Friday, September 19, 2008


Let try to explain this another way...

The Fed has approached the current situation with typical Walter Bagehot rules. It is to lend and lend and produce liquidity for those who qualify.

So far only so-so good.

The problem in this cycle is not really liquidity. It's COUNTER-PARTY risk. Making someone liquid does not help him if his competitors aren't sure he is going to last.

The Fed/Treasury need to do something to affect that. Buying bad assets from them may help at some point. But if you pay 'market value' for them you will just force the entity to take their full loss now, upfront. How does that help? If you pay more for the assets than they are worth, you burden the taxpayer.

Risky Business- without Tom Cruise
One way to get market players to regard other market players as less at risky is to relieve them of the burden of their risky Real Estate portfolio. Another way to do that is to STOP the practice of mark-to-market pricing. Letting firms take a longer time horizon to realizing the true value of their holdings IS IN FACT just what that government itself plans to do. So WHY NOT save the bailout and just let banks DO THAT NOW?

I do not understand the desire for this intrusive government tilt to policy when with a little tweak of accounting rules so much more could be achieved. Just let financial firms use their discretion in accounting for real estate value. Let them take a multi year approach if they want. Its sensible. When real estate is out of favor and everyone has losses and everyone is selling you depress real estate prices. Why make people mark to THAT value?

We have already seen that there is no venture captial bid for these assets. That fact should be 'proof' enough' or at least raise a red flag that these assests are selling at depressed prices, below 'true value.' Just because a price comes out of a market does not make t it right. Markets can have distortions too and this one does BIG TIME.

So solve the right problem, not the wrong one. and try not create a new problem while you are at it.

The New proposal has all sorts of side effects; a change in accounting rules would not have those side effects.


Reject this plan and start over.

12 days of bailout

On the first day of bailout Ben Bernanke gave to me a
a brand new liquidity facility!

On the second day of bail out Ben Bernanke gave to me
two discount rate chops and brand new liquidity facility

On the third day of bail out Ben Bernanke gave to me
three Fed rate cuts
two discount rate chops
and a brand new liquidity facility

On the fourth day of bailout the Ben Bernanke gave to me
a for-primary dealer credit facility!
three Fed rate cuts
two discount rate chops
and a brand new liquidity facility

On the fifth day of bailout out Ben Bernanke gave to me
$5 trillion Mac-Mae
a for primary dealer credit facility
three Fed rate cuts
two discount rate chops
and a brand new liquidity facility

On the sixth day of bailout Ben Bernanke gave to me
More than $six trillion of AIG a straying
$5 trillion Mac-Mae
a for primary dealer credit facility!
three rate Fed cuts
two discount rate chops
and a brand new liquidity facility

On the seventh day of bailout the SEC gave to me
Seven shorts no longer sinking
More than $six trillion of AIG a straying
$5 trillion Mac-Mae
a for primary dealer credit facility!
three Fed rate cuts
two discount rate chops
and a brand new liquidity facility

On the eighth day of bailout Ben Bernanke gave to me
eight ways to milk Lehman
Seven shorts no longer sinking
More than $six trillion of AIG a straying
$5 trillion Mac-Mae
a for primary dealer credit facility!
three Fed rate cuts
two discount rate chops
and a brand new liquidity facility

on the ninth day of bail out Ben Bernanke gave to me
9-times better money-market fund security!
eight ways to milk Lehman
Seven shorts no longer sinking
More than $six trillion of AIG a straying
$5 trillion Mac-Mae
a for primary dealer credit facility!
three Fed rate cuts
two discount rate chops
and a brand new liquidity facility

On the tenth day of bailout out Ben Bernanke gave to me
10s of trlns in losses leaping
9-times better money-market fund security!
eight ways to milk Lehman
Seven shorts no longer sinking
More than $six trillion of AIG a straying
$5 trillion Mac-Mae
a for primary dealer credit facility!
three Fed rate cuts
two discount rate chops
and a brand new liquidity facility

On the 11thday of bailout out Bne Bernanke gave to me
10 pipers wanting to be paid for piping
9-times better money-market fund security!
eight ways to milk Lehman
Seven shorts no longer sinking
More than $six trillion of AIG a straying
$5 trillion Mac-Mae
a for primary dealer credit facility!
three Fed rate cuts
two discount rate chops
and a brand new liquidity facility

On the 12th day of bailout the bailout guys were sent from me
12 drummers trying to drum them out of office
11pipers wanting to be paid for piping
9-times better money-market fund security!
eight ways to milk Lehman
Seven shorts no longer sinking
More than $six trillion of AIG a straying
$5 trillion Mac-Mae
a for primary dealer credit facility!
three Fed rate cuts
two discount rate chops
and a brand new liquidity facility

Sellling us all short

What to expect when you're NOT expecting...(anything)

Tell me, Mommy, what was capitalism anyway? Did it really exist?

Breathe a sigh of relief if you will. TWO huge up-days in row for stocks. One snatches a huge gain from the jaws of a massive downturn.

The government has a PLAN...is it Plan "A" or Plan "B? Nevermind... It has a PLAN. It will back formerly not insured money market funds... Ride to the rescue of beleaguering bank assets! CHARGE (IT)!!

So are ALL banks deposit now insured too? Or is this this just uninsured nonbank deposits that are insured?

What about folks who lost money in any of the TEN banks that were bankrupt already this year?

As to the short-selling prohibition and its consequences...

How do the folks at AIG and Lehman feel?

How about Merrill Lynch, that jumped into the arms of a suitor because barbarians were at the gate? Or were those the GOOD speculators/short sellers?

Was AIG a rogue insurance company run by irresponsible management using too much leverage, or was it attacked by unscrupulous short sellers...

and, hey, what about Lehman?

If the short sellers are unscrupulous today what were they yesterday and the day before the 'government/SEC' came to its senses??

OOHHMahGod!! Where is the shovel? Is it time to bury capitalism?

Has the 'government' saved the economy or buried capitalism?

I'm confused?

I am not unaware of the danger that the economy is in, but are YOU aware of the danger the economy has just become hostage to?

If the government is going to acquire 'bad assets' who will set the acquisition price?

Is the Fed doing this to avoid the debt ceiling?

Is 1930 really knocking on the door?

Isn't there a better less intrusive way?


Let's USE capitalism to dig ourselves out instead of BURYING capitalism
I still think replacing the mark to market rule fore securities with a a rule of discretion would work better since it would take the automatic writes-offs out of the system and allow firms to begin to lick their own wounds. It would let them decide about how to and when to and at what price to dispose of assets when it came to that. Using discretionary pricing ultimately means you open the time horizon for evaluating them. Current rules use today's price as the only one allowable. And in making that a rule the rule itself undermines the asset's value. By opening or unlocking the time horizon you open the way to more possibilities.

Capitalism is often about the difference between the short run and the long run run. Current accounting compresses everything into the short run and that has proved to be de-stabilizing.

An accounting rule change would be FAR SUPERIOR to taking a wrecking ball to capitalism.

For those who think that the government plan is a good idea, just remember it opens the way for government to change the rules of any game in midstream.

I am not unaware of the danger the economy is in. But are YOU AWARE of the danger the economy has just become hostage to?

Ronald Reagan used to make the following a laugh line. " Hi, I'm from the government, and I'm here to help you."

Republican or Democrat you have to be suspicious of such an intrusive plan (is it really a plan or is it a plan to formulate a plan?) by the government sector. Oh yeah everyone wants to be saved, everyone wants a life preserver...including those who already have drowned.

it's become complicated. very complicated.

...and before you buy stocks up the Kazoo, remember that the economy is still weakening.

Where do you/did you/ will you/ draw the line?

Thursday, September 18, 2008

Come let's play God, or house appraiser

If Barney Frank and Richard Shelby did not like Bernanke, an unelected man making decisions to lend $85bln (to AIG) then what can we think of a plan by Senator Charles Schumer that will let every bankruptcy judge in the country decide how to reset the price on a home at bankruptcy proceedings?

Earth to Chuck, earth to chuck? Can you read me Chuck?

The more we meddle in the micro economics of this crisis the more we run the risk of muddling the entire economy. For now the economy is functioning with a financial sector that is in some trouble. But start to dig inside and reset the rules and who knows how badly you can affect how the economy works. Are you really going to keep people in their homes based on a price set by a bankruptcy court judge? What about all the people who to this time have been foreclosed? They are tax payers too - do they get recourse?

I still think the way you solve this is to try and stabilize banks by changing the way you make firms market securities to market. Schumer's plan is too intrusive.

The less that government decides (or makes the court decide under re-written rules in mid game) the better.

Sure banks made bad mortgage lending decisions. So did the people who took up those mortgages. Why favor one over the other? and why did so deeply into capitalism. Don't you know that destroys it?

The Gospel according to St Mark

When Moses came down from the mount and showed his commandments, as I recall, there were TEN of them not eleven.

There was no commandment saying 'Mark thy securities to the prices prevailing in markets or suffer the wrath of God'.

Mark to market is not a idea that has been sainted, knighted or carved in stone.

If there were ONE THING that could take the pressure off of markets it would be changing that one simple rule to let holders of securities use discretion to mark what they hold.

It was precisely this provision that been the law of the land in 1982 when banks were so capital impaired that some S&Ls were operating with certificates of capital a fiction that allowed them to keep on keeping on. The economy was punch drunk after more than two years of nearly constant recession that battered bank capital. Still that enfeebled financial sector was able to pull the economy up into recovery because as asset prices fell banks did not have to take hit after hit to capital. .

Right now mark to market creates a vicious circle vortex that drags securities prices into the abyss and threatens the viability of the financial system itself.
It is not clear that the rule even is good one.

At the time it was adopted the rule seemed to be good, but only after testing a rule in a variety of circumstances can we really evaluated it. This one has failed. It has failed the test of a down market by making it worse.

The idea originally was to keep firms from marking securities to their own firm's advantage by ignoring the prices markets put on securities. Indeed the rule did stop that. But now it is starting to create its own distortion.

At a time that no one wants more real estate exposure, troubled firms can't find buyers and as they try to sell their real estate assets they drive the prices down more. Each new sale fetches a lower price and every bank then must mark to the new lower price.

I think there is good reason to step way from this rule. There is no reason in this environment to glorify the market price.

The government (Fed) seizure (deal, wink, wink) of AIG makes it clear that there is no risk capital out there. That means distressed assets are NOT getting a fair bid. That means their prices are distressed beyond true market value. And that means that every bank is being forced to mark to a price that is too low.

In short THE RULE is creating distortions at the MACRO level instead of preventing them at the MICRO level.

Change the RULE and much of the pressure in the market and many of the fears about counter-party risk will go away. Fears about counter-parties are the real reason for the markets odd behavior This fear results in illiquidity, but its not the kind of illiquidity that the central bank can fix. The Fed can flood the market with dollar reserves and set up liquidity facilities and still not get firms to transact with each other . Change the rule and truly re-liquify the system.

Under the current accounting rules firms are just too worried that the ongoing real estate decline -- a decline that will come to and end some day and from which prices will some day rebound- could make someone else bankrupt and drag them down with it.

And after seeing how it treats them, no bank wants to be a sinner in the hands of an angry Fed.

Think about it.

Wednesday, September 17, 2008

It hits the fan: is the fan at risk?

So much of 'it' has hit the fan, that fan could soon break.

Angry politicians stamp their feet!
Politicians are angry the Fed has one guy who was not elected, Ben Bernanke, who committed $85bn to take control of AIG and they (Certainly Barney Frank is) are hopping bad. Barney Frank has an approach: he has set up hearing in about one week.

That would solve AIG's problems, wouldn't it? It's a meeting, not an action, and it will take place in one week, not today. it's a real solution...

That's the problem. Politicians and committees move SSSssslloowwww.

When financial markets go off kilter they need decisions and actions now, men and women of action, not of rhetoric.

Rhetoric is rhetoric is ZZZzzz....
What we are hearing from politicians is election year boiler plate as they are concerned about taxpayer money after having whole careers of squandering the same. But it's not a squandering they could vote on this time. Nor could they trade votes and get some pork barrel stuff for their own district in exchange for their vote. Bernanke just did it. Fait accompli.

Boy they hate that! Be careful when you cut out the middle man!

The Big Guns lurk and past decisions perc
John McCain and Barack Obama are in the process of figuring out where they stand. Both seem to be blaming regulators and it's hard to disagree with them. Market mis-judgments bad analysis- a lot of factors combined to get us where we are.

So long, Alan Greenspan...
A 'golden age' of de-regulation has just ended, marked by as much as anything Alan Greenspan's departure from the Fed. During his tenure with access to that 'bully pulpit' he testified loudly and often for less regulation everywhere. Arguably his own failure to enforce his own oversight responsibilities at the Fed had a lot to with how bad things eventually got. He directed one Fed governor to not investigate reports of odd goings on in mortgage lending, allowing those practices a few more years to build and percolate. A 'great experiment' with quantitative research on Wall Street has also proved a bust.

Barney Frank looked at the Fed's decision to let Lehman Bros. sink then turn around to seize AIG calling that intervening one day a great 'one day' of capitalism. He 'threatened to make it a holiday celebrating capitalism. Would Mr Frank really rather live in a world where AIG goes belly up? This is an example of the kind of vitriol and cynicism that is at work. But where the rubber meets the road -- at the Fed policy session - economic theology gives way. It is easy for Frank or Shelby to 'dis' the Fed. THEY did not have to deal with the consequences of any bankruptcies or decide if to stop them. They just get to jaw bone.

The great shadow-leaders
These guys - Shelby and Frank- are into market events. They knew Lehman and AIG were in trouble In the past they have not been unwilling to give the Fed advice on how to do things. IF they HAD WANTED TO THEY COULD HAVE called the Fed chairman and TOLD HIM what THEY wanted instead of waiting until after the fact and being critical. I'm betting they did not interfere in the pre-decision situation because they did not have an idea what to do and they did not want to be party to whatever decision the Fed, given its bad menu of choices., decided on.

Everything is in flux and no one likes what is going on - least of all the Fed, the institution with its hand on the switch..

The run up in gold today is one of the most disconcerting events. If gold is looked upon as a solution the paper money economy is in even more trouble.

Politicians are in the center of this in an election year, it's a very bad dilemma for the economy and poor timing for an election. One reason the treasury is not more aggressive is the realization that the NEXT president whoever it may be, will bear the burden. Its a tough time to be changing horses in mid-stream, especially on such treacherous footing and with such a fast moving and shifting current.

Too bad you can't solve these problems by field-dressing a moose or giving a good speech... If so, both camps would have a cake walk.

Tuesday, September 16, 2008

The Fed envelope please -- the answer is: NOTHING!

The Fed discussed things and disbanded its meeting as it issued a statement eerily akin to the one from last month, that is apart from an acknowledgment that the world was going to hell in a hand basket. Well, at least we have a basket.

Still the Fed did manage to do some things:
  • The Fed did stop naming high oil prices as a factor repressing growth. It replaced that factor with an expectation of slower exports to damp growth.
  • The Fed did not change the Fed funds rate at this meeting.
  • And Mr Fisher came back into the majority as there were no dissents this month.
  • The Fed now places equal weight on down side risk to growth and the upside risk to inflation calling them both 'significant concerns'. Hard to argue with that in a month that the Fed holds the Fed funds rate steady.
Market see, market do
The markets that were 'priced' for a rate cut although most economists said 'the Fed wouldn't do it' sold off strongly on the bitter disappointment of no sugar coating for the financial crisis. But then the stock market came back which can only lead you to wonder if a rate cut would have produced a bad result for stock prices as we had warned (as one possibility). Bond yields fell. Oil remained lower by about $4 1/2 on the day. It was a tough day for the markets but in the end markets weathered the storm and lauded a very sensible Fed decision. While the Fed funds futures contract, a contract controlled by TRADERS who bet MONEY was WRONG and ECONOMISTS who only have OPINIONS were RIGHT, "the markets" where people also BET REAL MONEY, applauded the Fed's decision in the end. What does all this mean? It means Bernanke has come of age...

You can't call me Al...
This REMINDS us that ALAN GREENSPAN is not the Chairman anymore. All of this day's events remind us of that. Mr Greenspan had a very simple notion of financial crisis: cut rates and keep cutting them. He rarely disappointed the markets and had no trick other than a rate cut up sleeve. If the headwinds of the 'credit crunch' were 70 mph, he'd cut rates by even more. If the markets were priced for a rate cut, by golly they got one. Bernanke, by contrast, is more of a surgeon than a lobotomy-meister.

The Bernanke Fed's approach
As this credit crunch has evolved the Fed has invented new mechanisms to try and fight fire with water, floods with sand bags, and hurricanes with timely evacuations. No I am not talking about real natural disasters but a targeted approach to problem-solving. The Fed does not see the game as binary: to cut or not to cut as did Greenspan. It sees this as a more complex dynamic with changing conditions like the game of rock, paper, scissors. The strategy that wins this time, could lose next time. The Fed continually is trying to take the measure of the market and give it what will help if it deems that as appropriate. And Bernanke is not afraid to do what he thinks is right even if the markets aren't looking for it. That of course, will eventually change what markets look for since they try to anticipate the Fed. Some of us also feel that the markets sometimes try to bully the Fed. Greenspan seems to have been much more susceptible to that sort of manipulation than is Bernanke.

Markets actually acted sort of, well, almost healthy...
Interestingly markets were able to close higher without AIG's problem solved. Troubled WaMu and and acquisitive B of A's shares rose while Goldman's and Morgan Stanley's shares were batted about. Economists believe that at some point prices get low enough that buyers emerge. But in this financial crisis that has not seemed to happen -- until today. Maybe Hank Greenberg's letter and posture to 'retake' AIG was a catalyst. Hank once was shunted aside and pursued as a villain by now-disgraced Elliot Spitzer. Greenberg now is emerging as a White Knight at the company where he was once was alleged to have worn the black hat.

It just doesn't get any better than this.

Too big to fail meets too dumb to survive


AIG is generally regarded as very smart sophisticated insurance firm.

But how does a firm that big and bright make such a huge and dumb bet?

Future History
What will history tell us about what is really weighing down the stock of this firm? Is it really just sub-prime guarantees or is there something else? How many bad bets did their 'rocket scientists' make on other things? Sure glad these guys weren't there calculating trajectories for Apollo 13, or Tom Hanks might not be alive today (joke). Surely sub-prime mortgages weren't the only mistake?

We always ask what happens when irresistible force meets immovable object? We are about to find out. The same dilemma arises when 'too big to fail' meets 'too-bad to survive'.

AIG is TOO big, TOO interconnected, TOO global TOO many things to fail. AND mostly it's TOO BIG AND PUBLIC AN EXAMPLE TO GET WRONG IF YOU DECIDE TO HELP IT.

So what's a government to do? A good precedent was set when the government bailed out a very beleaguered Chrysler Corp years ago. It got warrants on Chrysler stock and when Chrysler was recovered, the government exercised its warrants, sold the underlying shares, and pocketed its profits: good pay for a rescue well done.

Now if we compare this sort of thing to when we were cave men and women we can see that there is still a problem- a downside to helping. If some cave man were being attacked by a Mastodon he foolishly engaged in the open field, it would surely kill him. But if we, from the future, appeared in a time machine and saved him allowing him to come home alive and his fellow cave men thought he was a great hunter to survive (even if the Mastodon got away) or that he was favored by the 'gods' who saved him, his genes might come to dominate cave people to our demise today. We want the genes from the guy who could kill the Mastodon or plan a clever trap for it. We don't want the genes from the blithering idiot who survived by some fluke of luck or external assistance.

Plan in a nut shell
It is not just about saving AIG. It's about the signal and the incentives as well as allowing them to go on they same way they have been. A plan to save AIG must include the government getting a big portion of the upside potential on its shares as well as a pledge for change. The latter means a management change - and maybe one from the OUTSIDE. Those two things would allay our fears about moral hazard and survival of the least fit. They would set an example no firm would want to follow. Also, it would line the government's pockets with cash- eventually.

But some will still question government interference. Fair enough. I understand ideology.

How to justify it to naysayers
What we have as an excuse for government intervention is a market imperfection. I assert that most people would still agree that (1) AIG is really big and (2) AIG is really smart but (3) AIG did make a really stupid bet or two. Now with other firms having so many eggs in the same basket as AIG, no one wants to take on more of them. In this environment the government plays the role of the stabilizing speculator. The externalities here are of course many. Any bankruptcy the government saves is going to save it a lot of work, risk anguish and lost TAX REVENUES. A government 'bail out' under these conditions would put AIG stock up sharply and instantly put the government's warrants on AIG stock in the black squelching cries of wasted tax-payer money before they are uttered. Since the government is in it for the long haul, if the economy has good fundamentals the AIG guarantees will eventually become unneeded and will be 'costless' to the US. Real estate prices will rebound if the economy is on basically sound footing. . Every one will live happily ever after. AIG shareholders will avoid huge losses. Most AIG personnel will keep their jobs - not at the top however. The government will make a bundle of money. AIG will have been disciplined to mind its "Ps" and "Qs" in the future. Life as we know it will go on.

I think there is a way for this to work and to not create distortions. I believe intervention can be justified on economic grounds. There is simply no supply of capital for what AIG needs.

It's a solution that may not be ideal but it solves a lot of issues, keeps the government's nose clean and pockets full. That's better than the other way around.

Monday, September 15, 2008

Why the Fed should not cut rates

Calls for Fed rate cuts are becoming more common. And maybe the Fed will cut the Fed funds rate when it meets tomorrow. But there are more compelling reasons for the Fed to wait.

Are rate cut calls well-thought out?
Calls for a rate cut are calls to cut rates in the middle of what has become a real crisis that has spread beyond housing to Wall Street. One problem with a cut at this time is that a rate cut will muddle the message. The Fed has been carefully compartmentalizing its policymaking under Bernanke. It has created special lending facilities to help with liquidity and this week, it has taken new action by broadening its various lending facilities. Will lower rates help? Maybe. But not by much and lower rates have risks and costs.

How rate cuts help:
Rate cuts do three-things. (1) They lower interest costs by the amount of the rate cut. (2) They lead to expectations more rate cuts that can cause market rates to fall by more that the rate cut itself. (3) A rate cut inspires confidence that the Fed will turn a troubled situation around and that the direction of rates is down again, for some period of time.

How rate cuts can backfire:
But rate cuts can backfire, too. And a cut in the middle of crisis does not inspire confidence that the central bank is prudent; rather that it is panicky. Moreover, in the current situation the Funds rate is at 2% and everyone knows the Fed does not want to cut it. Indeed, Feddies have been saying for months that the next move in rates will be up, What a terrible Fed-wide public forecast! Setting that aside, the problem is that a rate cut will not be deep, it might not inspire confidence of more to come and it may not cause people to think that the trend in rates is now lower. A cut may come to be seen as a one-off event and have a very limited impact. OR it could cause markets to have a widespread adverse impact. IF the Fed move is viewed as a move that is too hasty it could stop the trend lower in long term bond yields or result in a sell-off of the dollar.

To have impact, first get attention
If the idea is to take some leadership on the direction of market rates you first need to get the market's attention. It might be better to wait for when so much is not unraveling. IF you are training a dog, for example, and if you wanted his attention for a really important trick, you would eliminate other distractions first. The Fed cannot eliminate the distractions but it can pick it's spots. If it waited for things to calm down it later could cut rates between meetings and REALLY get our attention.

A reluctant Fed
While the Fed could cut the Fed funds rate to zero, we know it does not want to cut it below 1%. Indeed, we know it does not want to cut it any more at all. The Fed can cut rates but its not going to elicit much enthusiasm for markets to expect more.. Moreover, oil prices fell sharply, gold rose and the dollar fell on Monday. A hasty Fed rate cut could reverse what has been some nice strength in the dollar. Should dollar losses speed up, commodity prices could flare again.

If it don't work why do it again?
One thing we must admit is that the last rate cuts did NOT work and they cost us more in terms of weakening the dollar and boosting commodity prices. I'm hard-pressed to urge the Fed to try it again let alone in the maelstrom markets have become.

On balance a rate cuts seem to put more at risk than it promises to help right now. That could change but in this environment rate cuts are a double edged sword. Why take the chance?

...In the end the love you take is equal to the love you make...

Perhaps the more common colloquialism is this, "what goes around comes around."

Lehman and Bear Sterns were two firm that previously had opposed participating in rescue package for the LTCM assets. Now both are gone... or at least going or gone.

Leverage anyone?
Lehman was very leveraged although I read some accounts that ask why this firm is going. It is not just the leverage you have but the stuff you leverage and if you remain fully exposed to what you carry without hedges. Think of it of lifting a weight. If it is on bar bell you can lift it efficiently. But if the same weight is the shape or a refrigerator it might be hard to get your arms around it...

So right it was wrong?
Leverage has long run amok in the markets. The Fed has been complaining of excessive risk taking and leverage for years. Is the Fed wrong to have been right? Should the Fed have put some muscle behind its mouth?

Did the Fox watch the hen house?
That is still a tough judgment. We, in the US, believe in less regulation. Over the past years with Greenspan at the Fed, it pushed a minimalist agenda of regulation. He preferred to have the market oversee itself. Well that's fine as as long as it's not the fox watching the hen house.

A new age...
Looking back that does not seem to be the case. It was something more subtle. The market overseers and the market participants seemed to have developed the same blind spots. They drank the same Kool-Aid. Those who warned about sub-primes and CDOs and the like were the gadflies of the financial markets and were swatted aside. The market was too hard-charging on a new agenda to be introspective. They thought it was a new age.

ROCKETMAN! The first church of Jesus without Christ
It is interesting to note that around the year 2000 one financial writer thought that the DOW was set to go to a huge number (30,000!) in part by giving it the multiple of a bond. He argued that we had reached a new age of 'stability' and that stocks were 'less risky'. And for a while as he wrote that crap he seemed to be on to something; maybe even right. But, of course, he really was wrong, very wrong. But even in the 'crash of the markets after that period this view of an inherently more stable financial system and of becoming the masters of risk though quantitative analysis continued unabated. We would become masters of our own fate though math and statistics...or so we thought.

NO accounting for taste..or 'screwpals'
There were some mis-steps along the way. Enron thought it could achieve Nirvana faster not using black box models or statistics but by a different form of numerology called accounting! Better living though numbers! But this, in time, revealed itself as simple fraud- or not-so simple fraud. Still, it was a sign that markets were still trying to get more blood out of a stone. And it was a sign that people 'on the outside looking in' were willing to believe that some could do the 'impossible.'

The best of the best of the best ...do the worst
The men in black took a hit and then hit after hit. The best of the best of the best were wrong after being wrong after being wrong. Soon they were in the red and not at all in the black. In the end there was not enough capital to protect some of them. Some that rode that great tsunami of leverage saw the hard landing and got out before the wave crashed on shore. But most did not. The market could not. This is known as the fallacy of composition. What one may do not all can do. Goldman Sachs escaped, few others did.

It has been an eye-opening experience.

Rocket scientists on Wall street are reminded that economics is not simply mathematics. When markets are subjected to stress, long held relationships can do funny things.

So Lehman is gone. Merrill Lynch is being bought by BofA. BofA is now the Behemoth of America and is officially 'bullish on America', one of ML's most famous ad campaigns. AIG is trying to reliquify. Others remain troubled. Wamu is now the concern du jour or soon will be.

Gary Stern and FULD's FOLLY
As Minn Fed president Gary Stern warned in his book of several years ago, moral hazard attaches itself to the sort of assistance doled out to Bear Stearns. In the Lehman episode, though, the Fed said it was to be different. It vowed to use no public money. Treasury Secretary Paulson said the same. Still everyone on Wall Street approached the Lehman issue as one that would take on more public money. But the Fed held firm. In the end, Lehman became FULD'S FOLLY. The hard charging and bargaining CEO tried to squeeze too much value out of this firms assets at every turn and assumed the Fed would be there to bail him out, or assist. When the Fed stuck by its word to stay out of it no one wanted Lehman anymore. Result? The firm goes Chapter11and many people lose their jobs. It's a steep and sad price to pay for stubbornness and the unwillingness to believe the central bank. Stern had sketched out the risk over two years ago. Maybe if Lehman had done more reading...

An over-leveraged game of chicken
But once you step into the world of offering assistance as a central bank every one thinks like lawyers- you are making precedent. There is no belief in good Samaritanism or the simple practicality of the moment. There are no isolated cases. everything is precedent. In the end Lehman's moment did not have the same pressing urgency as Bear Stearns' moment. The Fed has many backstops in place that were not there at the time Bears Stearns became troubled. The crisis has become more mature. The Fed itself had bulked up its staff and become more specialized and able to handle the emerging problems. Lehman misjudged this in a game of over-leveraged chicken and now its gone. Lehman has become the new precedent that 'undoes' the old one..

It's capitalism not socialism after all
It's a lesson that will temper the behavior of all other firms in the market that now know that the Fed is not kidding. All the financing facilities are out in the open. Everyone knows the rules for using them. And now in the wake of the Lehman collapse, there is so little time. That is the new outlook for troubled firms that can now see they are in jeopardy. Before the Fed stood up to Lehman (or faced them down) there was a queue forming around the block at 33 Liberty Street as the next and the next weakest participants were lining up cup in hand. Now they are dispersed and and huddled talking in their own board rooms set to manage their own fate with a new grimmer view of reality. And as bad as it is. That's how it should be.