Posted on 10/03/2008 1:24:23 PM PDT by goldstategop
The Monster Returns By John H. Cochrane
Like a monster from an old horror movie, the Treasury plan keeps coming back from the dead. Yes, we are in a financial crisis that needs urgent, determined, and clear-eyed help from the government. But this plan is fundamentally flawed. It won’t even work if we leave aside its horrendous cost and long-lasting damage to the financial system. The additions and sweeteners in the Senate version, and those on the table in the house, make it even less likely to work.
A workable plan has to be based on fundamentally different principles: recapitalizing banks that are in trouble, including allowing orderly failures, and providing liquidity to short-term credit markets. These are not new and untested ideas; these are the tools that governments have used for 100 years to get through financial turmoil. However, they have to be used in forceful and decisive ways that will step on a lot of powerful toes.
(Excerpt) Read more at freakonomics.blogs.nytimes.com ...
"Show me just what Mohammed brought that was new, and there you will find things only evil and inhuman, such as his command to spread by the sword the faith he preached." - Manuel II Palelologus
We didn’t throw $700 billion down the drain. We threw $700 billion to foreign banks to swap treasury notes for subprime mortgages at their original face value. The “crisis” was the threat by those banks to stop buying Treasury Notes and financing the Federal debt unless we took the bad mortgages off their hands.
That’s my take and I’m sticking to it. (For now)
I don’t think it was sheer panic. It was choreographed panic: socialist do that and then they get what they want.
Thank you, stupidheads!! Thank you SOOOO much for your meddling on the before and after! Geez.
That is my take as well - at least for $300 billion of it. The rest will be wasted in the U.S.
“Until they become conscious they will never rebel, and until after they have rebelled they cannot become conscious.”
- George Orwell, 1984
The bailout today, in plain sight of all Americans, was as brazen an act of stealing taxpayer money as the Kevlar-clad bank robbers in North Hollywood California calmly walking to their get-away vehicle with automatic assault rifles annihilating anything in their path, while helpless police used their standard issue pea-shooters to try to stop them.
Some good comments after that article.
One that makes me feel better about the taxpayer exposure on this:
“Though this thread is now old, a clarification is needed about the price Treasury intends to pay. Bernanke never said we should pay high prices, just that Treasury should pay between “hold to maturity” value and “fire sale” value. The phrase “fire sale” is not the same as market value; it has a real meaning and that is a sale when there’s no market. Buffett’s comment fits Treasury’s goals to pay sensible prices, meaning they examine and value securities and pay a price that should generate a reasonable return - which has a better chance of happening because the cost of the government’s investment is lower than any private investor’s cost. Get it? When they referred to paying more than “fire sale” they were referring to when there is no market, when you take whatever you can get because the merchandise is otherwise worth zilch. That is specifically NOT a plan to buy above market, but is a recognition that the market is not currently functioning and they’ll have to set one. Making the market work is the point of the plan so, if you think about it, there’s no way they could currently pay market prices because those prices don’t exist. “
Shouldn’t make you feel better at all as a taxpayer. Hold-to-maturity values are important for bonds, but not for mortgages which have the option to default, which they are doing because housing prices are falling. An MBS is an aggregation of short option positions in a falling market, which doesn’t work. See http://econlog.econlib.org/archives/2008/09/the_holdtomatur.html for a good explanation.
A market sale is the only way to balance economic interests. Seller motivation and buyer motivation determine price. When no buyer exists it’s because the asset at market is toxic in the sense that it is too dangerous to be acquired at any price. If the government buys an MBS at a price as the sole buyer, it has overpaid. The economic exchange is from the taxpayer to the bank, it’s shareholders, the homeowner, the builder, the original seller of the land...everybody who made money or extracted value in the value chain that is embedded in the MBS mortgages.
The holders of these things should have to pay the piper. If you recapitalize banks, protect depositors, and threaten to nationalize short-term debt markets (in ways that are less socialistic than this bill), you’ll get the rate through the snake much more quickly.
“Hold-to-maturity values are important for bonds, but not for mortgages which have the option to default, which they are doing because housing prices are falling.”
Bonds and mortgages have the same concept of possibility of risk of default, and partial recovery value in that default. Bonds default when the company fails to pay and goes chapter 11. In fact, there is the same concept of ratings of bond and CMOs to estimate the risk of default, AAA to C etc.
The first comment on that linked article makes that point.
If you have an MBS product with a large number of mortgages, each with a 10% chance of default and 50% writedown on defaulted loans should it default, gives you say a 5% hit on total value from the hold-to-maturity face value.
But if the MBS market itself is untrusted the market itself cannot work (ie its impossible to know if the real chance of default is 10% or 40% in this basket). As such, the products are illiquid and the valuations are so discounted that the banks balance sheets are impaired.
Financial crisis in a nutshell is that these estimates were made in a way that underpredicted the probability of a steep fall in housing prices.
Hold-to-maturity, and an appropriate risk-adjusted valuation of it, is important because it is the case that in this market the paucity of buyers reflects more the condition of disrepair of the market than of actual ROI of the investment itself. This is a classic case of a market, like a deep bear market, where there may be ‘good values’ but no buyers due to lack of trust. So why not private buyers? Actually, some smart and deep pockets like Warren Buffet is showing up. But remember, we’ve got many hedge funds and the *entire* investment banking industry in the US so deep in these already they are tapped out.
I feel better in that comment because I *dont* want the Govt to overpay, and had thought Bernanke was touting overpaying vs market. That’s not quite right. pay based on Govt estimate of value is the real guideline. This is no different than you or I buying a house. When you appraise a house, only *one* appraisal method is based on market value. When I look at commercial RE investment I *IGNORE* the ‘market value’ I could care less, I want to know my return on equity; if the property doesnt work I am not going to pay X because it is ‘cheap’ to the market, it means the market is out-of-whack to underlying value. We offer what we think it is worth to us. There is no ‘liquid’ market for a single house nor a simple definition of market value; only comparables. The real definition of “it has overpaid” is if the $700 billion investment in MBS products gives a negative return on investment, ie returns less than $700 billion. So long as the Govt based the purchases on understanding the correct estimates of underlying value, then the Govt will make money.
What would you think of the idea of allowing holders of MBS's the option of consolidation by lottery? Suppose there's a tranche of twenty mortgages, shared 20 ways. Five people choose to exercise the consolidation-by-lottery option.
Five mortgages are chosen from the tranche entirely at random and given to the five participants who took the option. The method of choosing is selected to be demonstrably free from bias (there are ways of assuring that). Each 1/20 share of the twenty mortgages would become a 1/15 share of the remaining 15.
The random allocation would mean that, on average, neither those who exercised the option, nor those who did not, would stand to gain or lose anything. Further, those who exercised the option later would have neither an advantage nor disadvantage over those who did so earlier.
What the random allocation would do, however, would be to put some of the mortgages in the hands of people who could actually do something with them. As it is, they are otherwise useless.
San Diego County being one of the hardest hit in the country, at least we had a congressional delegation that 4 out of 5 voted no on the bailout, one was even a Democrat, Filner.
A lot of the mortgages that have been written in the last few years are downright fraudulent. I would not be surprised if the default rate on $300,000 NINJA loans is over 99%, nor if the average recoverable value is less than 25 cents on the dollar (especially considering cash-out options).
If I am looking to buy a product, I may be willing to accept a certain percentage of units that happen to be defective. I will generally(*) be very unhappy if I discover that my supplier has knowingly thrown in defective units in the hopes that I will buy them and not notice.
The way to improve trust in the markets would be to start prosecuting people for fraud. Otherwise, the message is that the thieves will still be out there in the market, waiting to steal more money.
(*)Someone told me of his employer ordering 1,000,000 chips from a company in Japan, with a specification that there be at most six defective units. When the order arrived, six chips were in a bag separate from the rest. When the company was asked why, they said those were the "defective" ones. In that particular situation, I'd be happy to get the defective chips, since I would still be getting 99.9994% of what I paid for, and since I wouldn't spoil any other product as a consequence of the defective chips.
The government has no right to come in and save idiots from themselves or financial institutions that made bad loans.
The banks should fail and the real estate squaters should be thrown out in the street with the forclosures being sold for whatever the market will bring.
If it’s 10 cents on the dollar, so be it.
I will say I went overboard on the last one I bought, I paid 20 cents on the dollar.
“The government has no right to come in and save idiots from themselves or financial institutions that made bad loans.”
Obama has promised 100% the opposite with his socialist buddies the Democrats in Congress, and unless you and I stop him from winning, arguing with me (who agree with you) is pissing in the wind, since we will be voiceless victims of the socialist cr8p sandwitch steamroller.
Food for thought on the priorities.
McCain/Palin 08!
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.