What's the True Cost of the Bailout

[al_bundy]

Originally Posted by socca

When a space shuttle explodes, we don't throw $1 trillion at a bunch of engineers, and walk away thinking that we have fixed the problem. Instead, we pay $20 million to do a careful analysis to identify the problem, and then we spend a billion or so to fix the problem once identified.

I haven't heard anything coming out of Washington to make me think that anyone has really identified the problem. The bankruptcy of Goldman Sachs, Morgan Stanley, and other investment banks may not be the outcome to be avoided at all costs, but merely capitalism operating exactly as it should. Of course, with Paulson's immense emotional and financial ties to Goldman Sachs, we would expect him to do anything within his power to keep it solvent. However, what is good for Paulson and other investment bankers may not be good for the majority of taxpayers.

Where is the detailed, thorough, responsible analysis of our economic system that persuasively demonstrates that bailing out Wall Street is the correct action to take?

roubini supports it

[. . . Yrs to Go]

Originally Posted by free4now

Normally I'd trust him, but he's got a big dog in this fight. I'm assuming his duty to his shareholders to make his deal go through is more important than his duty to give taxpayers his true thoughts.

You might trust the fact that the same day he made those comments he stuck $5B into Goldman Sachs.

[audreyh1]

Originally Posted by 2B

The government will make a major fortune with the "bailout." First, they avoid the total collapse of the credit system. Therefore, home values will not plummet. Unemployment will not exceed 20%. With a stable and possibly recovering housing market and employment picture, they will avoid the distraction caused by repeated state and local bankruptcies. They will avoid the reduction of 20% of federal tax revenue. But hey, they can alway tax the rich.

Once the "mark to market death spiral" is broken every bank and financial company can mark up to market as stability returns through an orderly auction process. The value will be set by what the actual performance of the asset produces and not the worst case scenario thrown around. Stupid investments will remain stupid investments when the smoke clears. Unfortunately, everything involving mortgages are toxic. Everyone is afraid to buy anything that isn't pennies on the dollar. 95+% of all mortgages are performing. How can all mortgage backed assets be valued between 35 to 65 cents to the dollar?

This problem has been entirely caused by stupid Fed actions and other laws and policies. Mark to market is #1 followed by naked shorting which I still have trouble understanding why anyone would let someone "sell" them a stock and not deliver it as required by SEC regulations. If people can do naked shorts why can't they do naked buys. I could "buy" without committing cash and totally take over the publically traded company of my choice.

This problem needs a quick, direct action to turn the corner. It may be time to actually do things I would otherwise consider stupid like permanently banning short sales (at least until the situation improves but it has to sound permanent). Using the "bailout" as an excuse to load it up with feel-good crap will be worse than doing nothing.

I actually think that when the bozos get done there will be a workable bill that can be implemented to do what's needed. Afterwards, go in and execute those that made money off the weird derivatives, sieze their assets and sell their families into slavery. I really don't care at that point.

Great post 2B!

Audrey

[OAG]

Originally Posted by . . . Yrs to Go

Not true. "Book value" may or may not have any relation to economic value. And even "market value" is somewhat suspect in the current environment. Just because someone isn't willing to buy your house today, doesn't mean it has no value.

As it stands today, banks have to set aside reserve capital against the "assets" they hold. The more risky the assets, the more capital. If you replace those assets with cash (say at book value), you free up a lot of capital for the banks.

From the government's perspective, they hope the banks have written down the assets to below their economic value (because no market exists to price the assets at the moment). The government wins if the economic value is actually higher. They can also win because their cost of funding is so much lower then financial institutions. Many of these securities are still performing (paying interest) and yielding 20%+. The government borrows at ~4% and buys assets yielding 20%+ . . . even with a high default rate, they can still make that math work.

Thanks for your comment, it makes sense, at least to me and clears up something that was really "blocking" my understanding. However, I just hope the Treasury does not pay too much. Also that the dollars coming out of this program (the taxpayers "profit") does not get eaten up by the Congressional spenders of every political stripe. Now off to the Doctor for some anti-cynic medicine.

[HFWR]

Originally Posted by OAG

Now off to the Doctor for some anti-cynic medicine.

If you're not cynical, you're just not paying attention...

[ladelfina]

The Congressional Budget Office director yesterday told Congress that the proposed bailout may worsen the current financial crisis. “Ironically, the intervention could even trigger additional failures of large institutions, because some institutions may be carrying troubled assets on their books at inflated values,” Peter Orszag said. “Establishing clearer prices might reveal those institutions to be insolvent.”

Bailout Could Deepen Crisis, CBO Chief Says - washingtonpost.com
Think Progress » ThinkFast: September 25, 2008

Treasury explains how it came up with $700 billion: We just wanted ‘a really large number.’

Forbes writes on part of the reason that the American public is so skeptical of the Bush administration’s bailout proposal:

Think Progress » Treasury explains how it came up with $700 billion: We just wanted ‘a really large number.’
Bad News For The Bailout - Forbes.com

I wish someone were more forthcoming on the mechanisms here.. how much is supposed to go to whom and what is the expected result?

[al_bundy]

no one really knows

a lot of these assets are level 3 that aren't reported because they are in off-balance sheet entities like SIV's

i think CBO is partly wrong. failure of an institution is not that scary as a failure without a backstop from the government to stop cascading failures like that which AIG could have been caused. and the big thing is too many failures at once. if they happen over several years than the market can absorb it, if it happens within a month or faster than it sends fear and people just pull everything out at once.

[Art G]

Originally Posted by 2B

The government will make a major fortune with the "bailout." First, they avoid the total collapse of the credit system. Therefore, home values will not plummet. Unemployment will not exceed 20%. With a stable and possibly recovering housing market and employment picture, they will avoid the distraction caused by repeated state and local bankruptcies. They will avoid the reduction of 20% of federal tax revenue. But hey, they can alway tax the rich.

Once the "mark to market death spiral" is broken every bank and financial company can mark up to market as stability returns through an orderly auction process. The value will be set by what the actual performance of the asset produces and not the worst case scenario thrown around. Stupid investments will remain stupid investments when the smoke clears. Unfortunately, everything involving mortgages are toxic. Everyone is afraid to buy anything that isn't pennies on the dollar. 95+% of all mortgages are performing. How can all mortgage backed assets be valued between 35 to 65 cents to the dollar?

This problem has been entirely caused by stupid Fed actions and other laws and policies. Mark to market is #1 followed by naked shorting which I still have trouble understanding why anyone would let someone "sell" them a stock and not deliver it as required by SEC regulations. If people can do naked shorts why can't they do naked buys. I could "buy" without committing cash and totally take over the publically traded company of my choice.

This problem needs a quick, direct action to turn the corner. It may be time to actually do things I would otherwise consider stupid like permanently banning short sales (at least until the situation improves but it has to sound permanent). Using the "bailout" as an excuse to load it up with feel-good crap will be worse than doing nothing.

I actually think that when the bozos get done there will be a workable bill that can be implemented to do what's needed. Afterwards, go in and execute those that made money off the weird derivatives, sieze their assets and sell their families into slavery. I really don't care at that point.

You can't stop shorting, that would in essence, stop the market from trading. Imagine a computer aged trading system where computers can't be used, and each trade will force that brokerage firm to manually go seek out someone to sell to match the buy. I guess it would slow down any free fall.
In my opinion, the mistakes were many, and backed wholeheartedly by Congress at the time. They lifted the up tick rule, that was put in place after the Great Depression, and for good reason. Why is it, we can't change an outdated Bill of Rights, but we can arbitrarily lift something as topical as an uptick rule?
We allowed Hedge Funds to classify themselves with the same rights as brokerages, and thusly were allowed to naked short 'til their hearts content. Now as the rules are changing, notice large Hedge Funds either breaking up (to hide assets?), or soon to be declaring bankruptcy (to avoid prosecution).
They've allowed for fancy accounting systems which conveniently make it possible for major corporations to "write off" bad debt.

While I am totally for the bailout, there have got to be rules. And there has got to be a team of accountants brought into these corporations to not only review the books, but to be involved in them in the future. Any company taking a bailout should not only agree to government involvement, but also must agree to wiping out all bonuses for execs for these companies, a freeze on all golden parachutes, and a plan to repay the government as soon as possible. In this way, the shareholders (and bondholders)won't be getting raped as the fat cats flee, and it just might restore some faith to the system. JMO.

[Oldbabe]

Will someone with knowledge about this bailout thesis please explain why they think it will work? I have listened to hearings and the analysts but no one can really prove that it will work.

As I understand it from an analysts explanation, the interest rate paid by commercial and other borrowers is too high now (the spread betweeen LIBOR and Treasury and the rate they have to pay is too wide) so that slows down borrowing and therefore the economy. With the $700 billion injection that will infuse enough money to narrow the spread.

So what happens after the $700 is in the system (just like the stimulus rebate checks) and it gets used up in one way or another? I have heard analysts say that it all depends on whether the housing situation improves and whether the economy improves.

I don't think the housing crisis is going away any time soon. There are still millions of option ARMs to recast in California and elsewhere. If the economy doesn't improve with this "bailout" then what? More bailout? Or a collapse anyway?

[al_bundy]

every financial institution from your neighborhood bank to Goldman Sachs is essentially a hedge fund. They borrow at lower short term rates to invest in higher yielding long term investments and use various strategies to hedge the investment.

pretty much every mortgage loan was made with borrowed money. Either short term commercial paper or your checking account or CD. if the mortgages fail they still owe money to whoever they borrowed it from.

Government buys up the loans and takes the losses. Banks get money and we have years of slower growth due to better lending standards instead of systemic financial failure where hundreds of financial institutions along with local governments fail and deflation will most likely occur for years if not decades. and with that no scientific or cultural advancement for decades.

not every loan will fail, but the defaults are at much higher levels than originally thought and what the loans were priced at. overall the foreclosure rate is still not very high by historical standards. it's just that too many institutions took too much risk with too much leverage in the last 8 years to make this a big problem

[audreyh1]

Originally Posted by Art G

In my opinion, the mistakes were many, and backed wholeheartedly by Congress at the time. They lifted the up tick rule, that was put in place after the Great Depression, and for good reason. Why is it, we can't change an outdated Bill of Rights, but we can arbitrarily lift something as topical as an uptick rule?

I don't think Congress lifted the uptick rule. I think the SEC did that all by themselves.

Audrey

[audreyh1]

Originally Posted by Oldbabe

Will someone with knowledge about this bailout thesis please explain why they think it will work? I have listened to hearings and the analysts but no one can really prove that it will work.

As I understand it from an analysts explanation, the interest rate paid by commercial and other borrowers is too high now (the spread betweeen LIBOR and Treasury and the rate they have to pay is too wide) so that slows down borrowing and therefore the economy. With the $700 billion injection that will infuse enough money to narrow the spread.

So what happens after the $700 is in the system (just like the stimulus rebate checks) and it gets used up in one way or another? I have heard analysts say that it all depends on whether the housing situation improves and whether the economy improves.

I don't think the housing crisis is going away any time soon. There are still millions of option ARMs to recast in California and elsewhere. If the economy doesn't improve with this "bailout" then what? More bailout? Or a collapse anyway?

The $700B is not like a rebate check. It is a "sovereign wealth fund" if you will. A fund that buys distressed debt for pennies on the dollar with the reasonable hope of realizing profit down the road. Since the govt doesn't have to worry about ratings or going bankrupt (since it prints the money), it can "afford" to own some of this toxic stuff while the private sector currently simply cannot. The government buys the debt cheap (hopefully). The bank that sold it to them gets it off the books and therefore its balance sheet improves. It is free to make new (hopefully better) loans. Since the govt bought the debt setting a floor on the value, other banks can mark their books with (hopefully better) numbers that makes their balance sheets look a little better. Now they also are free to make some new loans. Meanwhile, the debt the govt bought isn't worthless. The govt continues to get paid on that debt or disposes of the related property, or holds it until market conditions improve.

Audrey

[Art G]

Sorry, perhaps my punctuation wasn't clear. I was stating in a separate sentence that "they" lifted the uptick rule. Not that Congress did. My implication was that Congress backed many mistakes.

[Art G]

Mark Cuban's take....

The Bailout Alternative: Virtual Mark to Market « blog maverick

[eridanus]

Originally Posted by audreyh1

I don't think Congress lifted the uptick rule. I think the SEC did that all by themselves.

Audrey

I don't see what that has to do with the price of cheese anyway. How would that have fixed the problem we have now?

[al_bundy]

Originally Posted by Art G

Mark Cuban's take....

The Bailout Alternative: Virtual Mark to Market « blog maverick

is he on any drugs?

why have this crazy system when the market can do this for you? good for him and other rich people that have access to more information. bad for the guy on the street managing his investments

[audreyh1]

Originally Posted by eridanus

I don't see what that has to do with the price of cheese anyway. How would that have fixed the problem we have now?

Congress enacted the uptick rule in the 1930s? because that was part of what caused the depth of the 1929 market crash. True - it's purely technical. HOWEVER allowing shorts to pile on as a stock drops can result in very sudden and sharp drops. It also makes it extremely tempting for shorts to spread panicky rumors that help drive a stock price down.

Unfortunately, the ratings agencies for financial stocks also look at stock price (as a measure of confidence) for the company ratings. So as the stock price drops, the rating agencies lower ratings, leading to more price drops - a downward spiral.

Having the uptick rule still in place along with enforcing rules against naked short selling would have slowed the process down. Slowing things down in distressed market conditions is very important. It gives companies time to make deals. When things happen too fast (as it has recently), companies fail instead as everyone gets too scared to do anything.

Audrey

[Art G]

Originally Posted by audreyh1

Congress enacted the uptick rule in the 1930s? because that was part of what caused the depth of the 1929 market crash. True - it's purely technical. HOWEVER allowing shorts to pile on as a stock drops can result in very sudden and sharp drops. It also makes it extremely tempting for shorts to spread panicky rumors that help drive a stock price down.

Unfortunately, the ratings agencies for financial stocks also look at stock price (as a measure of confidence) for the company ratings. So as the stock price drops, the rating agencies lower ratings, leading to more price drops - a downward spiral.

Having the uptick rule still in place along with enforcing rules against naked short selling would have slowed the process down. Slowing things down in distressed market conditions is very important. It gives companies time to make deals. When things happen too fast (as it has recently), companies fail instead as everyone gets too scared to do anything.

Audrey

Audrey, I think you have a pretty good grasp on the situation, but you need to take a more dire view of the results. By naked shorting FNM and FRE, without any concern about covering, it caused the stock to freefall. Considering there was no uptick rule, they didn't have to concern themselves with a ratchet down in price, or even a slowing drop in price. It made them able to tank the stocks!
Now, if you're a shareholder in Fannie Mae, how long are you willing to watch that price go from $60 to $3 before you bail and take your losses?