Posted on 03/26/2009 11:13:07 PM PDT by CutePuppy
So is that it? Is the downturn over? After bouncing off of 6500, or more than half its peak value, and with Citigroup briefly breaking $1, the Dow Jones Industrial Average has rallied back more than 1200 points. So, is it safe to go back in the water? Best to figure out what went wrong first -- what I like to call a bear-raid extraordinaire.
The Dow clearly got a boost from Treasury Secretary Tim Geithner's new and improved plan, announced on Monday, to rid our banks of those nasty toxic assets. The idea is to form a "Public-Private Investment Fund" to buy up $500 billion to $1 trillion worth of bad assets -- mostly mortgage backed securities (MBSs) and collateralized debt obligations (CDOs).
While it's true that private interests can conceptually help establish the right market price for these assets, the reality is Mr. Geithner's public-private scheme won't work. Why? Because the pricing paradox remains -- private parties won't overpay, yet banks believe these assets are extremely undervalued by the market. As Edward Yingling, president of the American Bankers Association, said recently on CNBC, "You have to go into the securities, examine the securities, examine the cash flow. I've seen it done, and the market is so far below what they're really worth."
The Treasury can't just keep throwing money at the problem, but needs instead to figure out what's really been going on -- the aforementioned bear-raid extraordinaire that's crushed Citigroup and Bank of America and General Electric, among others. Only then can Mr. Geithner craft a real plan to fight back.
In a typical bear raid, traders short a target stock -- i.e., borrow shares and then sell them, hoping to cover or replace them at a cheaper price. Once short, traders then spread bad news, amplify it, even make it up if they have to, to get a stock to drop so they can cover their short.
This bear raid was different. Wall Street is short-term financed, mostly through overnight and repurchasing agreements, which was fine when banks were just doing IPOs and trading stocks. But as they began to own things for their own account (MBSs, CDOs) there emerged a huge mismatch between the duration of their holdings (10- and 30-year mortgages and the derivatives based on them) and their overnight funding. When this happens a bear can ride in, undercut a bank's short-term funding, and force it to sell a long-term holding.
Since these derivatives were so weird, if you wanted to count them as part of your reserves, regulators demanded that you buy insurance against the derivatives defaulting. And everyone did. The "default insurance" was in the form of credit default swaps (CDSs), often from AIG's now infamous Financial Products unit. Never mind that AIG never bothered reserving for potential payouts or ever had to put up collateral because of its own AAA rating. The whole exercise was stupid, akin to buying insurance from the captain of the Titanic, who put the premiums in the ship's safe and collected a tidy bonus for his efforts.
Because these derivatives were part of the banks' reserve calculations, if you could knock down their value, mark-to-market accounting would force the banks to take more write-offs and scramble for capital to replace it. Remember that Citigroup went so far as to set up off-balance-sheet vehicles to own this stuff. So Wall Street got stuck holding the hot potato making them vulnerable to a bear raid.
You can't just manipulate a $62 trillion market for derivatives. So what did the bears do? They looked and found an asymmetry to exploit in those same credit default swaps. If you bid up the price of swaps, because markets are all linked, the higher likelihood (or at least the perception based on swap prices) of derivative defaults would cause the value of these CDO derivatives to drop, thus triggering banks and financial companies to write off losses and their stocks to plummet.
General Electric CEO Jeff Immelt famously complained that "by spending 25 million bucks in a handful of transactions in an unregulated market" traders in credit default swaps could tank major companies. "I just don't think we should treat credit default swaps as like the Delphic Oracle of any kind," he continued. "It's the most easily manipulated and broadly manipulated market that there is."
Complain all you want, it worked. In early March, Citigroup hit $1 and Bank of America dropped to $3 and GE bottomed at $6.66 from $36 not much more than a year ago. Same for Lloyds Banking Group in the U.K. dropping from 400 to 40. Citi CEO Vikram Pandit recently announced that the bank was profitable in January and February. (How couldn't they be? With short-term rates close to zero, any loan could be profitable). Never mind they still had squished CDOs, it was enough to get some of the pressure off, for now.
Oddly, with the new Treasury plan, these same bear raiders are still incentivized to manipulate the price of swaps to depress toxic derivative prices, especially so with the government's help to get hedge funds to turn around and buy them. Perversely, they may get rewarded for their own shenanigans.
This week's Treasury announcement of private buyers isn't going to magically change the depressed prices of these toxic derivatives. The Treasury needs to fight fire with fire. If I were Mr. Geithner, I'd pull off a bull run -- i.e., pile into the CDS market and sell as many swaps as I could, the opposite of a bear raid. If the bears are buying, I'd be selling, using the same asymmetry against them. Sensing the deep pockets of Uncle Sam, the bears will back off. Worst case, the Fed is on the hook for defaults, which they are anyway!
With the pressure of default assumptions easing, prices of CDOs should rise, which not only gives breathing room to banks, but may actually get these derivatives to a price where banks would be willing to sell them, replacing toxic assets in their reserves with cash or short term Treasurys, which ought to stimulate lending.
So are hedge funds villains? Not especially. The bear raid probably saved us five to 10 years' of bank earning disappointments as they worked off these bad loans. Those that mismatched duration set themselves up to be clawed. Under cover of a Treasury bull run, banks should raise whatever capital they can and dump as many bad loans before the bear raiders come back. Let the bears find others to feast on, like autos, cellular, cable and California.
These assetts need to be sold before the full effects of Obama’s tax and regulation policies are seen , then even the holders of these securities will be glad to get $0.30 for them when the payments stop coming in.
We don't want folks trading CDS. They shouldn't even exist.
We "little people" don't want Geitner bailing out their asses. We want them tarred and feathered and their so-called banks sown under with salt.
PS the country is still head over heals in debt, at multiples of GNP that would have made your predecessor shills in 1929 mad with envy.
This is about the funniest piece of idiocy I have read all week long.
Short sellers in the market serve a purpose. They sniff out over valued stock and help prevent bubbles from being created. Generally, it is a good thing, when done legally.
What the author fails to explore here is illegal naked shorting. Traders selling shares that don't exist and that have no intention or ability to deliver. Trades that never settle. In effect, stealing shareholder value right in plain sight.
“banks believe these assets are extremely undervalued”
......That’s because they are......
The collateral is good, the paper is bad. The solution requires separating the assets from the broke holders of the paper. The banks need to be able to eliminate the middle guy holding title and directly own the asset.
The poor must go back to renting. The property must be forclosed or title given to the Bank and the former owner becomes a renter
What the author fails to explore here is illegal naked shorting. Traders selling shares that don't exist and that have no intention or ability to deliver. Trades that never settle. In effect, stealing shareholder value right in plain sight.
Correct. Any crook would love to be able to sell a non-existent item, receive payment for it, fail to produce it, and yet go unpunished for the act. This goes on thousands of times a day on Wall Street.
A short seller doesn't get paid anything until he delivers the stock.
Technically, the trade remains open. In fact, the naked short sellers are increasing the value of their already established short positions, and so each naked short sale that helps to depress the price of the stock pays off for the crook.
Only when they finally deliver the shares.
The market way to do all that is for operators with capital to buy up all tranches cheap, paying only cents for the subordinate ones to be sure, and then do deals with the senior class to recreate the original loan portfolio. Next step, triage that portfolio, all the performers repackaged and sold. All the non-performers go to workout people who can expedite all the collateral churn side of things, where right now the banks are swamped and securitization hair gums everything up.
If there were only one lender and the pols would stop monkeying with the foreclosure laws thinking they can make it all go away by just not letting anyone at the collateral, then it'd be RTC easy. But neither is true. That being the case, it may wind up that it has to be Fannie and Freddie doing the first step of the above, with public backing. Hopefully indirectly (Fed buying their debt etc).
At last.... a reasoned, succinct analysis that I can understand describing a solution.
.....The right thing is to first recreate whole loans....
Does this mean to separate out the individual loans from the tranches? Or, does it mean that the original loan has been somehow split and needs to be reassembled?
CEOs like Jeffrey Immelt like to blame market manipulators, in another era it would have been "the Jews", but the damning truth is that he used his shareholders' money to overpay for assets and assume risk for insufficient premiums. He is blaming speculators for his mismanagement, or worse.
What really happened was that over a decade, credit was extended and risks were assumed with other people's money without any underwriting standards, creating $10 trillion or so (that's everything) of unrecognized losses. Certain events exacerbated this, such as an extra trillion when Spitzer took Greenberg off the case so that Cassano could run wild.
There is nothing wrong with an unregulated CDS market. The root of the problem is other people's money. A case in point is that Wall Street firms somehow managed to survive, or morph, for a century or so until they went public. No sooner did that happen than somehow they became dens of bad underwriting and became supplicants to the public purse.
The market was exacting its own solution until government started to meddle. Stupid government action can be played by free market actors, and that is what is happening. No outrage here.
My solution? Let nature take its course. However, post Bear Stearns, post AIG, post reason, that is not going to happen. All we can do is nip at the heels of the demagogues.
SO I'm not sure now if we've made it to the 1932 moment or if the current gyrations are more like those of 1930-1931.
Also, while I agree that it is not YET anything like the Great Depression, I fear that Obummer and Co. are doing their level best to recreate the 1930s. They certainly are bringing the same big government we're the brightest and best attitude to the problem.
Um, not according to the Goldman Sachs report that flew across my desk few days ago. Banks are not carrying their debt on their balance sheets marked at 50. None of them.
Banks could still sell their toxics assets at 50 like you describe, but they won't. That would require them to take huge write-downs that they're not willing to suffer. They'll just sit on it instead - or buy their own debt and stiff the taxpayer throught the FDIC's non-recourse loan.
How would buying their own debt "stiff the taxpayer"?
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