Saturday, September 20, 2008

20 Questions


The mega-bailout of the U.S. financial system is supposedly all about "restoring confidence." Let's examine that via 20 questions.

1. Are you confident the U.S. taxpayers' interests are being well-protected and secured by the assumption of every toxic mortgage and bad debt in the land?

2. Are you confident that housing will now leap up in price like the stock market?

3. Are you confident non-U.S. investors and central banks will buy U.S.-based mortgage-backed securities with the same abandon they did a few years ago?

4. Are you confident the new "owners" of Fannie and Freddie and AIG, i.e. your central government, will manage the firms in the best interests of the real owners, i.e. us taxpayers?

5. Are you confident that the political-influence conduit between big Wall Street donors and politicians has been severed?

6. Are you confident interest rates can stay low even as the U.S. Treasury sells a $1 trillion or more in new T-bills to fund the bailout, plus the existing $500 billion in standard deficit spending?

7. Are you confident that the ethics of Wall Street and the mortgage industry are sound, and that we can now trust these same institutions and players who ignored risk and embraced fraud and conflicts of interest for their own profit?

8. Are you confident risk will be properly priced in, despite the complete abandonment of any pretense of "moral hazard" now that the government is "backstopping" virtually all bad debt in the financial system?

9. Are you confident that all the toxic /worthless debt the government is buying/ taking on will have any value in the future, as many claim?

10. Are you confident that all the capital which is being provided by taxpayers will be allocated properly, and not mis-allocated like the trillions of capital that was lost in the easily-predicted meltdown?

11. Are you confident that politicians won't interfere in the liquidation of near-worthless assets in private capital markets?

12. Are you confident that all this taxpayer-funded "liquidity" will actually find creditworthy borrowers who will use the funds to expand real businesses?

13. Are you confident that the CEOs and investment bankers who took home billions in paychecks and bonuses during the speculative credit bubble are now chastened, despite getting to keep all their ill-gotten gains?

14. Are you confident that the trillions being promised in your name to protect stock and bondholders of insolvent banks will not be squandered, just as the first $1 trillion in bailouts and "liquidity" was squandered, to literally no effect?

15. Are you confident that banning short-selling of 799 financial companies will eliminate all the nasty horrible speculators--even though the largest speculators were the investment bankers we have just bailed out and made whole?

16. Are you confident that the U.S. consumer, even though he/she is weighed down with unprecedented amounts of debt, is now poised and anxious to borrow more money from banks?

17. Are you confident that this massive bailout has renewed foreign investors' confidence in the U.S. financial system, now that the U.S. government has taken control of the levers of that entire financial system?

18. Are you confident that banning short-selling will actually increase the value of U.S. companies even as the U.S. enters a long, deep recession?

19. Are you confident that the stock market is "forward-looking" and is rising because U.S. corporate profits are sure to soar next year despite a global recession?

20. Are you confident that the U.S. stock market is not being manipulated to persuade foreign entities and retail buyers that "it's now safe to buy and speculate in U.S. stocks, as long as you're buying on the long side"?

Special bonus question: Are you confident this bailout is legal, and that huge legal challenges stemming from systemwide fraud, conflicts of interest, etc., won't sprout like rank mushrooms and gum up the supposedly seamless works our fearless Fed and Treasury have cobbled together overnight?

The way I look at it, the very same bozos who couldn't see what has been brutally obvious for about the last 5 years (i.e. that the housing bubble was going to crash monumentally) now reassure us that they can fix it without pain. Right. You guys know exactly what you're doing!

A commenter to the above adds:

Michael Goodfellow

So looks like it's official. We are going to take the Japanese approach of trying to use the government's money to stop a depression. The best we can expect is what they got -- 15 years of stagnation, with periodic deflation. Japan also doubled their national debt.

I wonder if Congress and Paulson have the nerve to offer real "market value" for these distressed assets -- like 5 cents on the dollar, take it or leave it. I also wonder if they can resist the temptation to try and reflate the housing bubble. And I really wonder where they are going to get all the money for this!

They were already projecting a $400 billion deficit, and I don't think that included "emergency" appropriations for the wars. With the bailouts they've already done, and this new facility, we may see an actual deficit (amount of treasuries sold) of a trillion dollars. I can't see how they raise that without much higher interest rates. And I can't see how they reassure the markets that we're actually good for it without serious budget cuts. There's some market for Fed default futures. Has that reacted to this?

What's your guess as to what happens?

My response:

I think you've nailed it. Only I suspect our economy is even in worse shape than the Japanese economy due to our lack of savings and the enormous derivative positions still to be unwound. The Japanese economy looked rather simple by comparison.

I am thinking the only thing worse than socialism is socialism for the wealthy/powerful. I notice no one is suggesting the investment bankers who made billions (collectively) selling the taxic risky debt be taxed or suffer any civil penalties. oops, now take the debt off our hands seems to be playing OK with the "responsible" MSM.

I think we're in the midst of a financial hurricane without precedent and no one knows how it will play out, only that it will end badly.

Michael then added:

The more I think about it, the more amazed I am that anyone in the markets think this is good news. And it's not just U.S. investors, but worldwide. They must think the U.S. government is just made of money, with no credit limit!

I was talking to a friend about this today, and he's sure that Congress can't just leave it with some simple bailout. He thinks they will inevitably start "saving" their favored industries (like autos), making the economy even more political. Supposing we avoid that though, how will this new RTC decide what to buy, and at what price?

The old RTC got assets because the S&L went bankrupt, then they sold them for whatever they could get. This new one is going to be picking and choosing things to buy. That amounts to picking winners and losers. I can see banks being bailed out, but not hedge funds or something along those lines. Politically unpopular industries will suffer.

I also wonder if companies will now offload the really toxic stuff to subsidiaries, with the aim of letting them go bankrupt and be bailed out by the feds. I can't see how they will resist the temptation, if the Fed makes it clear they are cleaning up the worst cases first.

And of course, if they do offer pennies on the dollar for these assets (as they should), then doesn't that leave the banks insolvent? Or at least so far under their minimum capital requirements that they can't loan money? There were other comments today about "recapitalizing the banking industry", by which I think they mean the banks will sell shares to the Fed. I'm not sure how that makes an insolvent company solvent unless the Fed is paying too much. Which would be another political decision, with no respect for the economics of the situation.

Perhaps they can come up with something that impresses everyone, gets passed by Congress without a lot of fiddling and add ons, and actually works without needing a ridiculous amount of money. Or perhaps it isn't impressive, Congress balks, or the bill is just too high for foreign treasury buyers. Then I assume all hell breaks loose.

The press are still covering this as "another weird event in the world of finance!", not as "hey, the economy is collapsing. Here's the latest attempt to stop it." And I do wonder if Congress, Obama and McCain realize that if they do pass an expensive bailout, they can kiss any future expenditures goodbye. ( Emphasis added: CHS) The next administration (or three) will be about budget cuts, not new programs. McCain will find he can't fund his wars, and Obama will find he can't fund healthcare. Congress will really be under pressure to stop the pork spending. No fun for anyone in politics.

My second response:

I agree completely--the free-borrowing days are ending. Nobody seems to have noticed that the drop in oil has cut the Oil Exporters' free cash flow, and China is slowing down too, meaning less free billions floating around looking for a home.

The main issue now is: OK, so the banks are "recapitalized" by Federal gifts/bailouts; now who wants or needs to borrow money as the economy slides into recession? People are paying off debt and/or defaulting, not seeking to borrow more. So exactly how will these banks be profitable? Nobody seems to be asking that key question.

The answer seems obvious: once the flow of transactions slows to a dribble, then the fees which flow from transactions also plummet. Banks are essentially limited to making commoditized loans in a shrinking economy. Regardless of the bailout, I see a lack of profitable business as crippling the survivors.

I read somewhere that total banking system deposits are $6.7 trillion, and total banking system loans are just a shade greater. Which means that every single dime of deposits (and a little more) in this country are lent out. There's nothing whatsoever in the banks in the way of reserves. They are insolvent. A $700B bailout would merely bring banks up to a (somewhat) sane 10% reserve ratio.

Of course, the idea that the government can just do whatever the hell it wants regardless of what bondholders, foreign creditors, and others think is just pure farce. One way or another, this trainwreck is still going to happen. All we're doing is deploying airbags around the most crucial parts of the system. The panic will simply move from the financial/mortgage sector to the government bond sector, resulting in crippling interest rates and a plunge in the dollar. Eventually we'll reach a point where the government will be forced to throw in the towel and we'll enter a deep recession/depression with the banking system somewhat intact, and with the government finally making ruthless cuts to its own spending (except for interest payments and whatever is necessary to keep the banks liquid). In addition to the discipline imposed by creditors, there will be the added factor that voters taking oceans of pain in the private sector will finally be damned if they're going to let public employees/pensioners/unions/featherbedders/bureaucrats and other parasites skate while they suffer. People will finally favor the firing (or drastic cutting of pay) of the dead wood over keeping whatever "services" it is that they were allegedly providing.

In short, the government has made far, far too many fiscally impossible promises to far, far too many people, and these promises are going to be defaulted on.

At any rate, all the current actions will provide some needed "plausible deniability" to the politicians of both parties. Hey, they tried, and eventually there was nothing they could do.

Who knows, maybe this depression will result in changes that are the mirror image of what happened during the last one.

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