Institutionalized Fraud - Ben Bernanke Style(Market Ticker)

"Sept. 23 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke signaled that the government should buy devalued assets at above-market values to make its proposed $700 billion rescue package most effective in combating the financial crisis.

``Accounting rules require banks to value many assets at something close to a very low fire-sale price rather than the hold-to-maturity price,'' Bernanke said in testimony to the Senate Banking Committee today. ``If the Treasury bids for and then buys assets at a price close to the hold-to-maturity price, there will be substantial benefits.''"

These "hold to maturity" prices are fictions. Let's take the "average" $700,000 house in California. The buyer made perhaps $100,000 a year, or $8,333 gross (before taxes.) Removing FICA and a 25% marginal tax rate from the gross leaves you with about $5,500; the payment is $4,630.11.

Can you survive with less than $900 a month for car payments, food, utilities, homeowners and car insurance and electricity? Good luck.

So instead nearly all of these people took Option ARM mortgages and in many cases they also took a "piggyback" second mortgage to get around "maximum LTV" restrictions on the Option ARM.

But the house was overvalued by 150%, selling at nine times average incomes instead of three and a half times. It has now fallen in value from $700,000 to $500,000, but has another 30-40% to go, and will eventually bottom out in the $300,000 range.

The first mortgage is in fact worth about 70 cents now, but will be worth 40-50 cents in a few years. The second is a zero, because until the first is paid off, its worth nothing, and the first has no chance of ever being paid off.

If Paulson does what Bernanke said he will (and should) the taxpayer will suffer hundreds of billions of dollars in losses - guaranteed.

Of course Bernanke said that if the bailout isn't passed the economy will contract. What he didn't say, but should have, is that it is going to contract anyway (bailout or not), and in fact already is. We are in a recession now and this is in fact unavoidable as the bad debt must be defaulted.

Throwing cold water on the "bailout now!" mantra, Berkshire announced it is going to invest $5 billion dollars this evening into Goldman Sachs:

"Berkshire is buying $5 billion of perpetual preferred shares, New York-based Goldman said today in a statement. Goldman, which this week transformed itself from the biggest U.S. securities firm to the fourth-largest bank by assets, also plans to raise at least $2.5 billion by selling common stock in a public offering."

But wait! Didn't Bernanke and Paulson just get done saying a few hours prior that private capital would not invest?

Well Comrade Paulson and Comrade Bernanke? It appears that indeed private capital will invest, if the terms are good and the company sound.

Heh heh heh, a free market solution! Warren comes in and sticks a big wad of cash into Goldman Sachs - something that you said wouldn't happen without you offloading all of this bad debt onto the back of the taxpayer.

I love it when one of the most-storied investors of our time turns our Treasury Secretary and Chairman of The Fed into a liar just hours after their "Armageddon Story" is run on national television.

Asking for authority to implement one of my three planks to actually solve the problem, Chris Cox stepped up today:

"Sept. 23 (Bloomberg) -- U.S. Securities and Exchange Commission Chairman Christopher Cox said Congress should ``immediately'' grant authority to regulate credit-default swaps amid concern the bets are fueling the global financial crisis. "

1. Rescind the 2004 order that permitted leverage to exceed 12:1. It took only an administrative action to drop the regulation, so you can put it back in force the same way. 2. Implement the requirement to disclose all Level 3 assets in specificity along with their marking model (in total) every quarter in the corporate 10Qs and 10Ks. This should be able to be done administratively as well, but if it is not, a one-paragraph bill will fix that problem.

Finally, we learned today that The White House was planning this little piece of financial dictatorship for quite some time:

"Fratto insisted that the plan was not slapped together and had been drawn up as a contingency over previous months and weeks by administration officials. He acknowledged lawmakers were getting only days to peruse it, but he said this should be enough."

If this was being prepared for "some time" then the "emergency" status was manufactured. Instead of bringing this before Congress "months and weeks" ago for consideration where it could be debated and passed, ready if necessary, The White House and Treasury instead back-pocketed their plan and then sprung it on Congress with an outrageous and ill-advised "bump in the night, Freddy Kreuger style" scare campaign at the last possible minute in an attempt to give Treasury dictatorial power over our entire financial system.

Do not pass the $700 billion "No Wall Street Banker Left Behind" bill that will simply further destabilize the markets and impoverish America, never mind the obvious echoes of "The Enabling Act" in March of 1933 - in Germany.

http://market-ticker.denninger.net/archives/589-Institutionalized-Fraud-Ben-Bernanke-Style.html

What I have not seen is the cost of doing nothing. Certainly some (many?) banks will go out of business when their capital is eroded by bad debt write offs. At that point, the FDIC picks up the pieces for the account holders. But, the FDIC is not anywhere close to having sufficient assets to cover even one large bank failure. In this case, the FDIC “borrows” from the treasury. Since the treasury doesn’t have a vault full of spare money, as in Scrooge McDuck fashion, the treasury will get it the same place the $700B will come from — borrowing.

I’m not at all happy about the deal that up before Congress, but before I can form an opinion, I need to see a reasonable estimate of the alternative.

Jack

“No Wall Street Banker Left Behind”.

That nails it.

“The market prices are not in fact wrong”.

Nails it again.

I say, let them fail. The sun will shine. The crops will grow. There will be a painful contraction. But the resulting reorganization will introduce efficiency and growth. In ten years, we’ll be much better off for it.

Yup well We better save tax payer money for the FDIC. They are going to need it. This money is mostly to bail out the investment banks....Not the so much the commercial banks IMO.

That is where Paulson comes from. It is for his buddies.

How do you like the setup with Goldman Sach’s. I am guessing that they are being put in a position to buy up a bunch of the failing commercial banks. After the government takes on all of the debt of course. Goldman gets the banks dirt cheap. Same thing for Morgan Stanley is my guess. They will probably get rich quick as well. This is how Paulson is setting them up to be “Big” again. I am just guessing, but if you think like a greedy banker then you will usually be right about what is going to happen. Oh in a few days Goldman and Morgan Stanley deposits will be FDIC insured.

“No Wall Street Banker Left Behind”. That nails it.

“The market prices are not in fact wrong”.

Nails it again.

I agree 100%!!!

Let the cripples die off and be replaced with well run companies.

He makes some very valid and worthy points about the roots of the housing bubble but then is completely wrong in contending that Buffett's investment proves no rescue is needed:

But wait! Didn't Bernanke and Paulson just get done saying a few hours prior that private capital would not invest?

Well Comrade Paulson and Comrade Bernanke? It appears that indeed private capital will invest, if the terms are good and the company sound.

Folks, this is just dishonest. Buffett has publicly said that he would NOT have made the investment absent a belief that the bailout would go through:

BECKY: Does the backdrop of the Federal government potentially getting involved with a massive bailout plan for Wall Street, does that have anything to do with this deal?

BUFFETT: Well, I would say this. If I didn't think the government was going to act, I would not be doing anything this week. I might be trying to undo things this week. I am, to some extent, betting on the fact that the government will do the rational thing here and act promptly. It would be a mistake to be buying anything now if the government was going to walk away from the Paulson proposal.

http://www.cnbc.com/id/26867866

It has now fallen in value from $700,000 to $500,000, but has another 30-40% to go, and will eventually bottom out in the $300,000 range.

That's a pretty good crystal ball this fellow has. His analysis is excellent for the most part, but he hurts himself by pretending to know where the bottom is. A bottom there would take home values from 2007 to 1991 prices in Southern California, back when values where already depressed. They went up a little from 97-99, slowed down til 2002 or so, and then moved steadily up again, until they started exploding around 2004, due to low interest rates.

Unless salaries plunge by half, I would not expect values to fall below where they were in 2002, when the low interest rates started this mess in the first place. Pendulums being what they are, there is a chance that things will swing too far the other way, but not as far as this guy is saying. His scenario of doom and gloom in the market colors his prescription for a solution.

This was written before those comments were made.

Buffet is part of the program. And he obviously has inside information about this bailout going through. People with that kind of money have friends in high places. Of course he does not want people to think the bailout is not needed. You see he has just set himself up to get Rich off this bailout. Taxpayer money into the pocket of Warren Buffet. Get it now.

I think that you may be right; the point is, we don't know at this stage. In most parts of San Diego, $700,000 houses have not gone down to $500,000. More like $600,000. In some places, like Temecula and Chula Vista, maybe it has gone down that much, because they were overbuilt, new and sold to people who had no business in those homes. So, the huge number of REOs has brought prices down more than otherwise would be the case. Flush those REOs out, and it will be more like established neighborhoods with working families.

So, using the $700k house as an example, it is more like $600k now, and could drop to $450-500k if we go to 2001 or earlier. $300k would not make much sense, unless we have a major, major depression. A short term recession would not have such a devastating effect.

Once the REOs are washed out, we will have a bottom. A year or two later, when excess inventory and delayed selling is cleared out, prices can start going up again. Then, they will retrace to 2004 or so, which is when prices got out of hand. That $700k house will go back to $600k and rise with supply and demand.

So, a solution that gives the homeowner a low-interest loan at $600k would work for everyone.

The capital gains tax holiday is a good idea. One other notion that I haven't seen talked about--why not let banks with huge losses transfer those losses to entities (not just banks but any corporation) that have huge gains? The bad banks get a HUGE injection of capital, and taxpayers don't have to directly fund their survival. The indirect cost is a loss of income to the treasury, but that is better than actually printing money from the treasury to the banks, and the benefits to the macro economy will increase tax revenue.

So, Exxon pays $10b to WaMu for its $20b of losses, coming out even at its 50 percent marginal rate. Wamu is swimming in new capital, Exxon comes out even, and the treasury is out $10b in possible tax revenue, but doesn't have to buy WaMu's bad loans, or own a bunch of foreclosed properties. Has this been discussed, or is it not an option for some reason I haven't thought of?

I have to admit that is something I don’t well understand. I would guess there would be many economic and moral question in all of that. I’ll Bet the CEO’s still get there millions from those companies while the tax payer eats the loss of revenue.

As for the housing prices. Would you not guess that maybe the stuff that Paulson will buy first is the worst of the worst? In other words won’t he be buying stuff connected to that worst case housing drop you mention before he buys the rest? I have heard some first hand accounts on the web of housing prices dropping very drastically in some places out west and in Florida. It is hit and miss though per region. Things really have not changed in my area much. Except that those who ask more than what is fair are not making the sale anymore.

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