Saturday, January 24. 2009
TARP Part Deux? Do It Right Or Don't Do It
Virtually everyone agrees on two things right now.
- The second part of the TARP, $350 billion, will not go to Wall Street bankers (in the main)
- $700 billion isn't anywhere near enough to clear the credit markets.
The second statement is axiomatic (remember, for more than a year I've said this is a $2.5-3 trillion problem just in residential real estate) while the first is one that appears to be inevitable in any event simply because the first half was squandered and stolen, and the people aren't going to tolerate that a second time. Washington is (rightfully) concerned about a true pitchfork-and-torch brigade if, now knowing that this happened, they go ahead and allow it a second time.
The Washington Post has an interesting article on the mess, in which they say:
The situation is urgent. Home prices are plummeting and are projected by some financial analysts to lose a third of their peak value before the market recovers. Foreclosures have skyrocketed, with an estimated 8 million families expected to lose their homes over the next four years. Meanwhile, the jobless rate jumped to a 16-year high of 7.2 percent in December and is forecast to climb higher. Auto and credit card loans are also increasingly defaulting, raising the pressure on the banking system.
"Conditions are eroding far more rapidly than anyone anticipated," said Mark Zandi of Moody's Economy.com, one of three economists who addressed Senate Democrats on Thursday. "The job market is now consistently losing 500,000-plus jobs per month, something you couldn't have envisioned eight to 12 weeks ago. Losses in the banking system over the last week or two have been much larger than people had been expecting. We're coming to the realization that these things are self-reinforcing and the problems aren't developing in a linear way. They're getting worse very rapidly."
The escalating crisis has pushed the days-old Obama administration to a critical point: Obama must quickly choose a course of action, and he must choose correctly because the options are so expensive that he is unlikely to get a second chance, lawmakers and economists said.
Let's dissect this piece-by-piece.
-
"Home prices will lose a third of their peak value" - uh, more than that. Closer to half guys. This is not bad, it in fact is good. The key is affordability, not price. In a nation where there has been little wage appreciation (nor can there be when we outsource the "making" part of our economy to China, India and Vietnam) you cannot have asset-price appreciation in things people need for very long. More on this below (the math, that is); the focus on price is not only idiotic, it's backwards. Notice that all the programs put in place to "stop home price depreciation" in fact have done nothing but toss money down a rathole? That's because the issue is in fact affordability, and until homes are 2.5-3x incomes (median in both cases) the spiral will not stop - no matter what you do. That appreciation occurred due to making credit available at a below-market price for the risk taken on, and that cannot be sustained. Math never lies but politicians and hucksters of all stripes nearly always do.
-
"Conditions are eroding far more rapidly than anyone anticipated". Uh, no they're not. I anticipated this quite clearly, as did a lot of other people. Mark Zandi needs to be fired for uttering that crap, along with everyone else in the media or industry who has the audacity to say anything other than "we blew it and we accept responsibility for doing so, because the math was clear and we intentionally ignored it."
-
"He must choose correctly" - yep. Obama gets exactly one shot at this, and if he gets it wrong there is a risk not only of economic depression (a near-certainty at this point) but political and economic failure of The United States Federal Government.
Now let's look at another statement:
"A healthy banking system is critical to the broader economy because consumers and businesses count on credit to pay bills, create jobs and fuel other economic activity. Without lending, the economy would grind to a halt."
Unwittingly, The Washington Post just pointed out the root of the issue and why listening to the malfeasors and fools in DC and on Wall Street will not only fail, it will destroy our nation.
You can't use credit to pay bills in a sustainable fashion. That is, pulling forward demand is destructive to the economy and paying principal and interest ("Bills") with the issuance of yet more credit is suicidal.
Again, I return to the math. I have seen many complex derivations of various credit models, most of which rely on integration and differential equations. While all of this is cute (and I actually understand most of it where the "Average Joe" on the street does not) the fact remains that when it comes to economics and monetary theory all this hand waving is a bunch of noise intended to obfuscate, not inform.
In fact the economic issues can be simply explained through exponents, as I have repeatedly pointed out.
If you have economic growth of 3% over 10 years your economic output grows to 1.34 times its original size (not 1.30.) If consumer debt grows by 5% over the same 10 years the debt load grows to 1.62 times the original size (not 1.50.) The longer this disparity goes on the worse the situation gets.
The following chart shows what has happened with consumer credit over the last 30 years (credit to "Chart Of The Day")
Notice a few interesting points - in every recession prior to the 2000-03 one consumer credit took a dive. Why is this important? Because those "dives" clear out the bad debt in the system, allowing it to "reset" to a (mostly) sustainable state.
The exponential function guarantees that this has to take place or you will (not might) have a detonation of the monetary system and government involved. This is not open to question or debate - it is a statement of mathematical fact.
The problem we face today and have since the summer of 2007 when the bubble burst is that Washington DC, heavily-influenced by the bribery of campaign contributions and lobbying from those on Wall Street and elsewhere in the very system that led to the creation of this excess credit have done their level best to convince a bunch of Representatives, Senators, and the White House that the math can be cheated, because to admit the truth of the mathematics means that those very people are the ones who will suffer most.
See, unlike past recessions this time the overcapacity and over-expansion didn't happen in "Main Street" - most of it happened on Wall Street among the bankers, and what they "overmanufacturered" was the false "economic expansion" brought about not by mining, manufacturing or growing (the only three true growth drivers) but instead by pushing paper - an act that doesn't grow anything and in fact siphons off economic growth to feed itself.
Again, back to some of the "first principles" I've espoused in previous Tickers, such as you can find here from October of 2007:
"Let's look at this from a simple pricing model.
Let's say you have some form of debt which, on a risk-adjusted basis, should "price" at 2% higher in interest rate than the 10 year treasury bond - both 10 year obligations.
Well, if it should price at 2% higher, then that's where it does price if its honestly rated, right?
But if I'm an investment banker, and the risk is really priced at 2% over the 10, then there's no money for me to make. The market insures this; if the price is too high (return too low) then nobody will buy, and if the price is too low (return too high) then the originator of the debt doesn't need me; they'll take the extra return directly from the market.
In point of fact, this is how banks for years made mortgages! They priced their risk according to your risk of not paying them back, and then held the loan on their own books. The risk of "getting it wrong" was theirs - the free market prevented them from raping you, because you could always shop around. If they overpriced your risk, you simply would not buy. If they under priced, they lost money. Thus the price of money tended to reasonably approximate the actual risk of you not making the payments.
All this has now changed, but the efficient market has not.
So how does Mr. Investment Banker make money, if the efficient market prohibits it?
He has to find a way to misprice the risk on purpose!
If he can get someone to claim that the risk over the 10 is only 1%, when in fact it is 2%, he can pocket the extra 100 bips. Of course the people who make that happen want some of the "cheese", so perhaps he only gets 50 bips, with the rest spread around the other guys who help him out.
But unfortunately the risk-adjusted price really is 2% over Treasuries. The "bad results" don't come for months or even years later, but when they do, they are relentless - and punishing.
Once that happens we find out that in fact the risk was mispriced. The default rates are in fact higher than the claimed risk "grade" said they would be.
This is not an "unanticipated event" for those who priced the risk. In fact it is not only an expected event, it is the only way those who priced the risk could have made money from the process!
Now I ain't a lawyer, and I don't play one on the Internet, but I did run a business for more than 10 years.
When you intentionally misrepresent something in order to make a profit this nasty word that starts with "F" comes to mind.
This is the gist of all of it guys and dolls, as I laid out more than a year ago - repeatedly. Absolutely none of this was an accident, it was an inherent and necessary part of the systematic and organized fraud that Wall Street and Washington DC perpetrated upon the public and now they want us to pay for it.
Well guess what - one way or another, you're going to.
But let's do this the right way, so that the Wall Street fraudsters don't get a disproportionate benefit.
There are many who are calling for an RTC-style structure to the solution. That's good - provided we actually follow it.
The RTC closed and liquidated the failed S&Ls. If the Banks of Wall Street (and elsewhere) are going to have their bad debt taken up by the taxpayer then we must first seize and liquidate those institutions just as done during the S&L crisis.
Yes, this means the stockholders get zero. It means the bondholders get recovery value, such as it is (and if it is) and the only people who are truly protected are depositors.
Schumer is speaking the truth when he says this could cost $2.5-3 trillion dollars, and we might not be able to finance it. But if we're going to make the attempt we must do it in a fashion that in fact models the RTC - that is, those institutions must be seized.
See, the banks will not agree to sell "assets" at their free market price. If they were willing to do so the problem would already be solved as they would have been sold by now and we'd be done. No, the banks are holding out for a "higher than market" price - that is, the government eating the loss. But there is no "government", really - who eats that is you and I.
So we know in advance that the banks will not cooperate in a free market model. Therefore we must send in the examiners, mark everything to a market price, and determine who is below regulatory capital levels on that basis.
We then have two models we can follow, and frankly, while I prefer one of them as it preserves the firms and their public ownership, I'm willing to take #2 if that's what government deems appropriate:
-
We "cram down" the capital structure as I have described before by however many levels are necessary to restore the bank to double regulatory capital minimums. Why double? Because the losses aren't over - we're probably about halfway there with home price depreciation and other assets have yet to reach bottom as well.
-
We seize the institution, wiping out the shareholders and severely haircutting the bonds. The bad assets are placed in an RTC-like structure with the government acquiring them at the current market price, that money being used to pay whatever haircut-level the bonds are worth. Good assets are sold and again used to retire the debt at its "haircut" level. The firm ceases to exist entirely, and the government then "runs down" the RTC-style portfolio.
#1 involves no public money of any sort.
#2 does involve public money, but the amount would be reasonable. While the initial outlay will be huge, the fact remains that these bonds are not worth zero, and yet if acquired at market prices (in some cases 10 to 20 cents) there really isn't much further they can fall (can't go below zero!) Since a good number of them will be worth somewhere near market price today in time, running them down in this fashion "works" in that while it requires a capital outlay the losses will not constitute the entire amount put in. If we do #2 we may put up a capital outlay of a trillion dollars or more, but the ultimate losses are likely to be in the few hundred billion dollar range - bad, but manageable.
I prefer #1 for a whole host of reasons, not the least of which is that it does not detonate the institutions themselves, and it leaves the bondholders with ownership - and the ability to fire management and replace them with people who will do the right thing going forward.
#2 will work, but it detonates the companies and throws far more people out of work than #1.
What we must not do, on the other hand, is "buy out" the assets at above-market prices from the banks. That not only leaves the incompetent management in place but at the same time it guarantees horrific losses for the taxpayer and dramatically increases the risk that foreigners, who we absolutely rely on to buy our government debt, will see this as yet another instance of Ponzi Finance and tell us to bite it, precipitating a full-on currency and political crisis.
American Policymakers have operated for decades on the premise that there is no other "safe haven" and thus they can spend with impunity. This is a premise that we would be wise not to consider solid at this point in time, as we have demonstrated over the last year and a half that our government and nation in general not only have no idea what we're doing but that we will shield fraudsters, liars and thieves from failure through the application of unlimited public funds - a political and economic policy that is incongruent with being the world's reserve currency and "safe haven" play.
Quicksearch
Calendar
2008 Review, 2009 Forecast
RSS Syndication
Great Places On The Web
Get ITunes (and other spoken audio) access to The Market Ticker
Reciprocal links? Email info@cudasystems.net with your request.
Top Referers
www.stumbleupon.com (2496)
www.google.com (1371)
ml-implode.com (1186)
patrick.net (1064)
www.denninger.net (811)
www.newsgator.com (275)
www.fedupusa.org (239)
www.321gold.com (235)
my.yahoo.com (227)
Legal Disclaimer
The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions.
NO MATERIAL HERE CONSTITUTES "INVESTMENT ADVICE" NOR IS IT A RECOMMENDATION TO BUY OR SELL ANY FINANICAL INSTRUMENT, INCLUDING BUT NOT LIMITED TO STOCKS, OPTIONS, BONDS OR FUTURES.
The author may have a position in any company or security mentioned herein. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.
Looking for "The Best of Market Ticker"? Check out Ticker Classics.
Visit the forum to discuss this and other investing-related topics; see the FAQ on the forum for information about Gold Donor status.