Once Again, We’ll Simply Go With The Worst (In Terms Of The Bailout)

Someone please tell me that JBR sold his WaMu puts…

Only 166 academic economists are against it?
We have more airchair economists on SS than that

Academics aren’t the only ones protesting:
http://money.cnn.com/2008/09/25/news/economy/bailout_protests/index.htm
Seems conservatives are also averse to giving Paulson’s needle exchange program the green light:
http://money.cnn.com/2008/09/25/news/economy/deal_reached/index.htm?postversion=2008092513
Don’t these people realize that without an endless supply of cheap debt, we’ll all be forced to save money and live within our means?

Actually, I wouldn’t say it is rewarding the bad behavior.
The owners (stock holders) of those banks already lost almost all their money.
And if there is no bailout, everyone will be punished, in term of economy and jobs. With bailout, at least we won’t get into Great Depression 2.
Without bailout, the chance of anyone getting any mortgage is close to nil for the next year or so. It won’t matter whether the price tanks…because it will because nobody can buy it. The renters will be locked out of the market, not by price, but by financing (or lack of).
With bailout, the price will still tank. However, buyers will hopefully get reasonable financing options, so we can actually take advantage of the situation.
I hope some people like to see others suffering…. to me, I don’t care whether others suffer. I only care if I can take advantage of the situation.

“With bailout, at least we won’t get into Great Depression 2.”
If any good is to ultimately come out of what is going to happen, it will be that people (perhaps) will stop believing in the tooth fairy of intervention and the idea that government can get fix things. It’s still amazing to me that after all these years, people still think the Great Depression happened because of a lack of government intervention. Just the opposite.
I am still holding out a little hope that after this fiasco, people will throw out their Keynesian textbooks and open up the Hayek and von Mises works.
@ enonymous – Thanks for the kind words. I’ve had a good run of luck this year in the markets. Please don’t confuse me with Paulson. I understand markets better than he does and have more experience in them than he does. He was an INVESTMENT banker – s corp fin guy. They do not understand risk at all because they are salesmen. Sort of like real estate brokers versus real estate investors. Any proprietary trader who survived long enough to get even a moderate amount of experience at a good shop could out-think that guy on markets (and Bernanke too), but perhaps not outfox him! About your question of a bailout, I’ll put up a post tomorrow morning about how to structure a $1 trillion bailout. It’s conceptually the easiest thing in the world, it would work, and that’s why it would never get done.

“if i put a gun to your head, and told you that you had to structure a 1 trillion dollar bailout, how would you do it?”
I’ll look forward to Satchel’s answer but in the meantime I’ll throw in my best shot.
The arguement is that the real economy needs credit to function (which I think is true) so I would make the $1T available to be loaned out to businesses and consumers under the following structure:
Funds would be provided as an interest earning deposit to a private financial entity who would then loan them out as they saw fit under the following conditions:
The private entities would put 20% of their own money in a first loss position, no more than 4x leverage.
All loans to be held on the entities books until maturity.
Funds go to the entity offering the highest rate of interest.
All other financial entities allowed to go kablooey.

If the bailout works, it will work because it re-instills confidence in the current economic system. Economists, even today, only really can explain about half of all economic activity.
The neoclassical model is particularly bad at modeling actual human behavior because humans don’t tend to act like the “rational man” of their theories.
The overwhelming majority of economists agree that the New Deal lessened the effect of the Great Depression, the main problem is that the stimulus was not sufficient enough. This was proven when we entered WWII and government spending rose to 50% of the economy and full employment followed. Even during the period before the war, the economy grew at an average of 9-11%, the fastest economic growth period we have ever seen outside of wartime.

“I’d add that the USG should put Fannie and Freddie into runoff mode,…”
Agree.
The government providing private mortage originators with a taxpayer funded “Heads you win, tails I lose” insurance does nothing but distort the market and encourage wild bets.
If we’re going to have a socialized mortgage market then let’s at least make sure to socialize the profits as well as the losses.

Your plan gets my vote Satchel. Boehner, Shelby and Bunning and the few in Congress who are showing some backbone might go for it too. Maybe Gingrich would pitch it too (if you could pay him enough). You should send your plan to that Houston energy trader who took out the NY Times ad bashing the bailout. But I’m afraid you are right that there is no chance of any rational plan passing now. When we start with an insane plan conceived by probably the worst Republican Administration in history and then adust it to satisfy some of the most clueless, spendthrift Democrats ever (Pelosi, Boxer, Frank), we can be assured that it will be a disaster.

So SF prices have another 10-24% to fall? And they have fallen about 10% now, quite a bit less in most good neighborhoods.
Not bad at all, especially considering what has happened all around us.

NVJ – Here is the gang of 166:
Acemoglu Daron (Massachussets Institute of Technology)
Adler Michael (Columbia University)
Admati Anat R. (Stanford University)
Alexis Marcus (Northwestern University)
Alvarez Fernando (University of Chicago)
Andersen Torben (Northwestern University)
Baliga Sandeep (Northwestern University)
Banerjee Abhijit V. (Massachussets Institute of Technology)
Barankay Iwan (University of Pennsylvania)
Barry Brian (University of Chicago)
Bartkus James R. (Xavier University of Louisiana)
Becker Charles M. (Duke University)
Becker Robert A. (Indiana University)
Beim David (Columbia University)
Berk Jonathan (Stanford University)
Bisin Alberto (New York University)
Bittlingmayer George (University of Kansas)
Boldrin Michele (Washington University)
Brooks Taggert J. (University of Wisconsin)
Brynjolfsson Erik (Massachusetts Institute of Technology)
Buera Francisco J. (UCLA)
Camp Mary Elizabeth (Indiana University)
Carmel Jonathan (University of Michigan)
Carroll Christopher (Johns Hopkins University)
Cassar Gavin (University of Pennsylvania)
Chaney Thomas (University of Chicago)
Chari Varadarajan V. (University of Minnesota)
Chauvin Keith W. (University of Kansas)
Chintagunta Pradeep K. (University of Chicago)
Christiano Lawrence J. (Northwestern University)
Cochrane John (University of Chicago)
Coleman John (Duke University)
Constantinides George M. (University of Chicago)
Crain Robert (UC Berkeley)
Culp Christopher (University of Chicago)
Da Zhi (University of Notre Dame)
Davis Morris (University of Wisconsin)
De Marzo Peter (Stanford University)
Dubé Jean-Pierre H. (University of Chicago)
Edlin Aaron (UC Berkeley)
Eichenbaum Martin (Northwestern University)
Ely Jeffrey (Northwestern University)
Eraslan Hülya K. K.(Johns Hopkins University)
Faulhaber Gerald (University of Pennsylvania)
Feldmann Sven (University of Melbourne)
Fernandez-Villaverde Jesus (University of Pennsylvania)
Fohlin Caroline (Johns Hopkins University)
Fox Jeremy T. (University of Chicago)
Frank Murray Z.(University of Minnesota)
Frenzen Jonathan (University of Chicago)
Fuchs William (University of Chicago)
Fudenberg Drew (Harvard University)
Gabaix Xavier (New York University)
Gao Paul (Notre Dame University)
Garicano Luis (University of Chicago)
Gerakos Joseph J. (University of Chicago)
Gibbs Michael (University of Chicago)
Glomm Gerhard (Indiana University)
Goettler Ron (University of Chicago)
Goldin Claudia (Harvard University)
Gordon Robert J. (Northwestern University)
Greenstone Michael (Massachusetts Institute of Technology)
Guadalupe Maria (Columbia University)
Guerrieri Veronica (University of Chicago)
Hagerty Kathleen (Northwestern University)
Hamada Robert S. (University of Chicago)
Hansen Lars (University of Chicago)
Harris Milton (University of Chicago)
Hart Oliver (Harvard University)
Hazlett Thomas W. (George Mason University)
Heaton John (University of Chicago)
Heckman James (University of Chicago – Nobel Laureate)
Henderson David R. (Hoover Institution)
Henisz, Witold (University of Pennsylvania)
Hertzberg Andrew (Columbia University)
Hite Gailen (Columbia University)
Hitsch Günter J. (University of Chicago)
Hodrick Robert J. (Columbia University)
Hopenhayn Hugo (UCLA)
Hurst Erik (University of Chicago)
Imrohoroglu Ayse (University of Southern California)
Isakson Hans (University of Northern Iowa)
Israel Ronen (London Business School)
Jaffee Dwight M. (UC Berkeley)
Jagannathan Ravi (Northwestern University)
Jenter Dirk (Stanford University)
Jones Charles M. (Columbia Business School)
Kaboski Joseph P. (Ohio State University)
Kahn Matthew (UCLA)
Kaplan Ethan (Stockholm University)
Karolyi, Andrew (Ohio State University)
Kashyap Anil (University of Chicago)
Keim Donald B (University of Pennsylvania)
Ketkar Suhas L (Vanderbilt University)
Kiesling Lynne (Northwestern University)
Klenow Pete (Stanford University)
Koch Paul (University of Kansas)
Kocherlakota Narayana (University of Minnesota)
Koijen Ralph S.J. (University of Chicago)
Kondo Jiro (Northwestern University)
Korteweg Arthur (Stanford University)
Kortum Samuel (University of Chicago)
Krueger Dirk (University of Pennsylvania)
Ledesma Patricia (Northwestern University)
Lee Lung-fei (Ohio State University)
Leeper Eric M. (Indiana University)
Leuz Christian (University of Chicago)
Levine David I.(UC Berkeley)
Levine David K.(Washington University)
Levy David M. (George Mason University)
Linnainmaa Juhani (University of Chicago)
Lott John R. Jr. (University of Maryland)
Lucas Robert (University of Chicago – Nobel Laureate)
Luttmer Erzo G.J. (University of Minnesota)
Manski Charles F. (Northwestern University)
Martin Ian (Stanford University)
Mayer Christopher (Columbia University)
Mazzeo Michael (Northwestern University)
McDonald Robert (Northwestern University)
Meadow Scott F. (University of Chicago)
Mehra Rajnish (UC Santa Barbara)
Mian Atif (University of Chicago)
Middlebrook Art (University of Chicago)
Miguel Edward (UC Berkeley)
Miravete Eugenio J. (University of Texas at Austin)
Miron Jeffrey (Harvard University)
Moretti Enrico (UC Berkeley)
Moriguchi Chiaki (Northwestern University)
Moro Andrea (Vanderbilt University)
Morse Adair (University of Chicago)
Mortensen Dale T. (Northwestern University)
Mortimer Julie Holland (Harvard University)
Muralidharan Karthik (UC San Diego)
Nanda Dhananjay (University of Miami)
Nevo Aviv (Northwestern University)
Ohanian Lee (UCLA)
Pagliari Joseph (University of Chicago)
Papanikolaou Dimitris (Northwestern University)
Parker Jonathan (Northwestern University)
Paul Evans (Ohio State University)
Pejovich Svetozar (Steve) (Texas A&M University)
Peltzman Sam (University of Chicago)
Perri Fabrizio (University of Minnesota)
Phelan Christopher (University of Minnesota)
Piazzesi Monika (Stanford University)
Piskorski Tomasz (Columbia University)
Rampini Adriano (Duke University)
Reagan Patricia (Ohio State University)
Reich Michael (UC Berkeley)
Reuben Ernesto (Northwestern University)
Roberts Michael (University of Pennsylvania)
Robinson David (Duke University)
Rogers Michele (Northwestern University)
Rotella Elyce (Indiana University)
Ruud Paul (Vassar College)
Safford Sean (University of Chicago)
Sandbu Martin E. (University of Pennsylvania)
Sapienza Paola (Northwestern University)
Savor Pavel (University of Pennsylvania)
Scharfstein David (Harvard University)
Seim Katja (University of Pennsylvania)
Seru Amit (University of Chicago)
Shang-Jin Wei (Columbia University)
Shimer Robert (University of Chicago)
Shore Stephen H. (Johns Hopkins University)
Siegel Ron (Northwestern University)
Smith David C. (University of Virginia)
Smith Vernon L.(Chapman University- Nobel Laureate)
Sorensen Morten (Columbia University)
Spiegel Matthew (Yale University)
Stevenson Betsey (University of Pennsylvania)
Stokey Nancy (University of Chicago)
Strahan Philip (Boston College)
Strebulaev Ilya (Stanford University)
Sufi Amir (University of Chicago)
Tabarrok Alex (George Mason University)
Taylor Alan M. (UC Davis)
Thompson Tim (Northwestern University)
Tschoegl Adrian E. (University of Pennsylvania)
Uhlig Harald (University of Chicago)
Ulrich, Maxim (Columbia University)
Van Buskirk Andrew (University of Chicago)
Veronesi Pietro (University of Chicago)
Vissing-Jorgensen Annette (Northwestern University)
Wacziarg Romain (UCLA)
Weill Pierre-Olivier (UCLA)
Williamson Samuel H. (Miami University)
Witte Mark (Northwestern University)
Wolfers Justin (University of Pennsylvania)
Woutersen Tiemen (Johns Hopkins University)
Zingales Luigi (University of Chicago)
Zitzewitz Eric (Dartmouth College)

I’m in agreement with the 166 on this issue – but here is a great article on the “science” of economics:
http://www.fooledbyrandomness.com/FT-Nobel.pdf

Long time listener, first time poster, so excuse the long post.
@NVJ:
Here is the petition and the list of signatories:
http://faculty.chicagogsb.edu/john.cochrane/research/Papers/mortgage_protest.htm
And seconded that there were plenty of economists (Nouriel Roubini at the head) who were screaming “housing bubble” for many years.
@satchel:
How do you see the trade deficit closing? Slowdown in the US definitely reduce imports, and increased propensity to save would certainly improve the capital account ledger (the flip side of the trade balance). But a rising dollar would tend to increase manufacturing imports and decrease exports (but would decrease the cost of oil and other commodities). My impression was that would be a net negative on the trade balance. Not so?
Regarding the JPM forecast of 44% peak-to-trough price declines (and noting that 34% of this is already in the bag), how does that square with the state of the SF market? We certainly haven’t seen 34% drops across any breadth – is the number here going to be significantly smaller, or is there a lag? Any bets on the peak-to-trough here?

It’s 90% politics and 10% economics on the bailout plan right now. The Republicans don’t see any profit in letting the Democratic Congress pass something that may save us all. If it passes and does end up helping, nobody will remember their opposition anyway so they lose nothing. If it does little or no good (the likely scenario), they can say “I told you so — big government doesn’t work,” which is the prevailing mindset among the majority anyway. And the Democrats are not going to go out on a limb and pass this thing on their own and thereby put the Republicans in that pretty good strategic position. So who knows what will pass, if anything.
This is from the AP on an 11th hour Republican alternative they are demanding to be considered: their “proposal would have the government provide insurance to companies that agree to hold frozen assets, rather than have the U.S. purchase the assets.”
Awfully short on detail. But I’ve got to say, for what is probably the first time in my adult life, I like what I see from the Republicans on a major issue. If I were the Dems, I’d take this, assuming the rest of the plan makes even a little sense. Puts them in the no-lose situation of taking credit for a “solid compromise” if it works and blaming the Repubs if it doesn’t.

@ FSBO – The book “Fooled by Randomness” by Taleb is well worth reading. Definitely his best book.
@ The Red Pill – I agree with a lot of what you wrote, except I think you are early. The dollar has a last gasp still IMO. Calls are too expensive agreed, selling puts makes a lot more sense on panic moves down. There is actually a chance that this bailout fails now (some dissention at the Fed apparently) and in any case, the market is likely to be disappointed with whatever comes out because NOTHING is enough to solve the problem. I’m sensing that we are going to get an “emergency rate cut” imminently (Fed funds are behaving very strangely and the Fed has drained a LOT of liquidity in the last few days in that market to INCREASE the rate towards the target).
@ToonArmy – I agree with your framing of the current account issue, but I think on balance that the falloff in import demand from a slowing economy and falling real wages + better terms of trade on the oil imports issue (due to rising dollar and/or falling oil) would outweigh the potential attractiveness of imports because of a stable-rising dollar. We don’t have to flip the whole balance immediately (like Indonesia did in 1998, for instance) to ensure dollar strength. And we don’t need the dollar to strengthen dramatically on a trade-weighted basis – just enough to provide enough stability that the USG can continue to fund in the sovereign markets at these wonderful “reserve currency” rates. No one wants the system to blow up, so I think we’d have a few years to totally get the c/a into balance. We don’t run huge fiscal deficits (most of Europe perennially has had higher deficits and Japan currentlyhas a higher fiscal deficit and higher total government debt) and a little restraint on the fiscal side would work wonders IMO with our creditors.

The EU overall has less total debt as a percentage of GDP than the United States. Germany and France are about the same, Italy is quite a bit higher and the rest of the EU is quite a bit lower.
http://en.wikipedia.org/wiki/List_of_countries_by_public_debt
No one has been deficit spending the way Bush has.
http://z.about.com/d/uspolitics/1/0/n/G/095.png
You can see when Reagan took office deficit was about 35% of GDP, he increased it to about 65%, Clinton and Gingrich got it down to 58%, then Bush and the GOP got it back up to around 70% or so.

I agree with much said here, but 2 small points
@Satchel: Reduce government spending because all government spending is CONSUMPTION
This is incorrect and you know it. There are many governmental expenditures that are investments. For example: many sensible infrastructure products (like national highways) can only feasibly be done by government, and yet they substantially improve the productivity of the private sector (hence they are investment, not consumption).
You could argue that some infrastructure products (air traffic control) can be done privately. But there is no company on earth that could privately build and maintain an extensive highway system.
Clearly I am not arguing that there isn’t waste in govt, nor that all infrastructure projects are investment (e.g. the highway to nowhere).
Also, although I am not a Keynsian, I will put one thing forward: in general they recommend governmental expenditures during recessions, and then PULLBACK in govt spending during boom times. Their advice to my knowledge has never been taken. it’s only been used “half”. During recessions political folk over spend (keynsian) to stimulate the economy… then during bad times they continue the spending (anti-keynsian). so I’m not sure the Keynsian school is “wrong” rather the application of their principles is impossible politically.
===
@John
With bailout, at least we won’t get into Great Depression 2.
Many of us aren’t sure this bailout will help versus GD2. it is true that there is a plan, and that it involves lots of money, but many of us worry that this will not achieve its objective.
It’s similar to this:
pretend you have a friend who is on fire and they’re screaming HELP ME!
the answer would be of course to put out the fire.
but what if you drafted a plan to hire a fireman?
sure it looks good on paper. but you need to throw water on the poor friend!
same thing here. we have a BIG problem that could conceivably lead to a depression. we also have a bailout plan. but the bailout plan does nothing to prevent the depression.
the problem is that there is significant disagreement about WHAT can be done. there is a large possibility that nothing can be done. I’ve used this analogy before: Stage 4 small cell carcinoma of the lung is fatal. there is no treatment. once you get it, you die. The “treatment” is to never smoke. In the same way we have a massive problem with a bunch of 3 letter words (MBS, CDO, CDS, ABS, etc). The treatment was to never allow it to happen. oh well.
now we’re in emergency mode. we’ll have to see if we can do anything about it.

NVJ,
I think you are confusing the terms “deficit” and “debt”, at least the way they are commonly used. Deficit is usually the annual governmental fiscal shortfall, while debt is the accumulated shortfalls from prior periods.
I can’t find a handy comparative table on the web (if you can, I’d love a link), but our fiscal deficit as a percent of gdp has been fairly small (almost always less than 4% of gdp, except for WW2, a few years in the 1980s (1983-86 I think), a year or two in the early Clinton years, and (maybe) 2004 and 2009. A country like Japan, for instance, was running fiscal deficits about TWICE these numbers as recently as 2002, and Europe perennially in the 1990s (for instance) had a tremendously difficult time getting to under 3% of GDP deficits in the run up to the euro (under the Maastricht treaty, which required it, but they all cheated and many missed the numbers anyway).
US government debt is not too bad (yet). While it’s gone up from 35% to 70%, interest rates have fallen dramatically and so the burden is less than HALF what it was in the 1970s, for instance (as a percent of Federal expenditure). I think Japan (just going from memory) has over 150% government debt/gdp ratios, and much of Europe is well over this 70% figure as well.
The problem was not the extra 35% debt/gdp that was added by government IMO. People tend to focus on this because they want to make ideological points (Clinton ran small surpluses for 3 years at the end of the stock bubble – of course, Bush ran a surplus too his first year!).
The problem is TOTAL debt in the US system, especially household debt in the 2000s. This cycle was started under Greenspan – it was a conscious credit inflation encouraged by the Fed – and BOTH political parties encouraged it and did nothing to stop it. The chart doesn’t lie:
http://comstockfunds.com/files/NLPP00000%5C292.pdf
IMO, the attempt to “smooth” the business cycle and “tame” recessions since the 1980-82 double dip recession was a very foolish policy. Now, we are going to get the “mother of all recessions” because the excesses of the past were not allowed to clear in smaller, more frequent downturns.

ex SF-er,
CDS is a mess. I say let it all blow up, and we’ll pick up the pieces later. There will be winners and losers, for sure. Let the bankruptcy courts sort it all out. We have plenty of safety nets, but as diemos says, life is going to get much tougher. It’s time to take our medicine, and nothing can stop that.
About government spending being “consumption”, well of course the ultimate purpose of CERTAIN government spending (such as infrastructure) can be viewed as an “investment” ultimately.
(And there can be lots of reasoned back and forth over what truly needs to be done by government versus the private sector – clearly, we need to accept the inefficiency of government control in certain areas because the economically efficient alternative would be societally worse. For instance, imagine if corporations had fleets of F-15’s and standing armies! OK, bad analogy, I guess they do 🙂 )
But the first step to ALL government spending is consumption. It CONSUMES the savings of the population. That’s where it gets the money! And, of course, every dollar consumed is one less available to be saved. This is the central theoretical problem with Keynes IMO (you’ve definitely nailed one of the practical problems). Keynes makes a large mistake in assuming that savings and debt are interchangeable as regards productive allocation of resources. It’s definitely too OT for a blog (even this one) but you should read de Soto’s critique in “Money, Bank Credit and Economic Cycles” (available on the web for free in pdf).
One way of (relatively) painlessly reducing government expenditure would be to pull all of our troops and bases out of Europe and Korea. Europe can pay for its own defense, and it’s time for Japan to re-arm anyway. Alternatively, we could charge them – say – $500M per day for the prtotection of Pax Americana. I think they’d opt to pay 🙂

Gridlock in Washington is our best hope. I hope the House Republicans can hold on and stall the vote on this plan indefinitely. The marketplace is moving ahead – look at the actions of JPM and Morgan Stanley. Let the CDS market blow up – it will sort itself out. We don’t this plan or any other plan. Paulson has been working all these weekends – he should take the next four months off and then come in and clean out his desk.

NVJ,
“the deficits that Bush has been running, which are in the 5-6% range.”
Once again, partisan ideology trumps any regard for factual analysis. I’ve become used to that in the Bay Area but it;s all in good fun…..
Here are the official numbers for the Bush years (I tracked them down). You could make some arguments that the USG is fudging accurate analysis (and in many cases I would be inclined to agree), but you are always the one who argues that USG numbers (like the deflator, GDP growth, inflation figures, etc.) are accurate, and you are always accusing me of being the conspiratorialist!
2001 1.3% (SURPLUS!!)
2002 -1.5%
2003 -3.5%
2004 -3.6%
2005 -2.6%
2006 -1.9%
2007 -1.2%
2008 -2.9% (estimated)
http://www.whitehouse.gov/omb/budget/fy2009/pdf/hist.pdf
(See Table 1.2 on page 25)
Keep in mind of course that the US was fighting two wars during much of this period, and was also recovering from the 2001-02 recession and stock mrket collapse. Don’t you advocate deficit spending in downturns? 🙂
The US would have of course qualified under Maastricht, but Italy and France would not have (but they fudged the numbers and criteria at the last minute). (I made a small fortune betting on convergence of Italian BTPs against a gigantic position (in excess of $500M) in the DM/FF forward markets when I was at a hedge fund in the mid-90s, so I know this stuff pretty well.)
“One thing that is very different in the United States is that stimulative spending here actually gets spent, where in Japan it just got put in low yielding savings accounts.”
The Japanese government spent a fortune on infrastructure projects, highways all over the place, etc. This is foolish Keynesianism of course, because all the money spent by the government was misallocated. The response of the people of Japan to all this nonsense was of course to stuff the money in mattresses, low yield savings account and to send a lot of it to seek higher returns in markets OTHER than Japan, which was being so foolishly managed. This process was the genesis of the ASEAN bubbles, which ultimately blew up in 1996-1998. (I made a much smaller fortune betting then that Japanese government bonds would rise as people lost confidence in their system.) That IMO is the cautionary tale for us.

Plan? Plan? We don’t need no stinking Plan!

Let the CDS market blow up – it will sort itself out
It’s hard to respond to this and do it justice. Let me just say this: nobody- not you,not me, not anybody, knows what will happen if we allow $63T (and counting) of CDS to blow up
it is possible (who knows?) that it could take down EVERY major national and regional bank as well as every investment bank and many of the insurance carriers. We could take that maybe one by one… but all at once?
sure it WILL sort itself out, but it could take MONTHS to sort out and during that time ALL involved parties would NOT KNOW if they were solvent or not.
The problem with a cascading cross default situation is that it is possible in theory for everybody to be bankrupt immediately together, or at least for everybody to NOT KNOW if they are solvent or bankrupt together. It is similar to how Lehman imploding caused a money market fund to break the buck, but on a grander scale.
how would we have commerce if EVERY bank went down together? And it could take months to figure out who was really insolvent and who survives.
Imagine if we let it all fail, and then suddenly tomorrow ALL of your credit cards are rejected, ALL of your cash cards stop working, ALL of your banks are closed as they sort out if they are solvent or not. and this could go on for months as forensic accountants sift through the toxic pile of the CDS market to see who lost money, who got money and collects, and who got money but fails to collect since their counterparty failed.
this is the very scary thing that nobody wants to confront. we really do have a serious, possibly unsolveable, monster out there. And it’s not mortgages or WaMu or AIG either. It’s the CDS market.
This is why (I think) Paulson wants a blank check to use at his discretion. Because with that blank check he can punish the hell out of anybody on the short side of the CDS market. If he does it again and again then in theory it can stop the losses in the CDS market and then the CDS market can be slowly and carefully unwound. but he can’t say this for political reasons. (imagine him saying “I will preferentially slaughter the shorts of certain firms only” he can’t say that).
That’s what they’re talking about in back rooms.
all of course, IMO.
on a side note: this is why AIG was bailed out (they wrote significant amounts of CDS) and Lehman was not.
on a side side note: the Fed/Treasury “learned” how difficult it was to create a “clearing house” when they tried it with Lehman… it was a complete and utter debacle.

ex SF-er – Good points, but I’m not sure that I buy them. I certainly place very little faith in anything coming out of the mouths of Paulson and Bernacke. Even in a worst case scenario, I can’t image that it would take months (or even weeks) to get most things functioning again. If the markets are so polluted by these undecipherable instruments, then the private parties should start the cleansing process now – without delay and with absolutely minimal govt intervention. Govt oversight OK – but no taxpayer infusions.
Just my opinion.

@Satchel,
Piling on a little here, but you are using the “unified” deficit numbers. That’s fair for comparing overall government financial position (taking account of the supplemental appropriations, as others have noted – saying we’re paying for wars but not including them in calculating the deficit is, well, “conservative” :-).
However, much of Europe (and Japan’s) fiscal deficits are due to demographics (aging population, with less immigration than the US has had).
As the baby boom generation ages, the long-term liabilities change the social security trust fund contribution to the unified budget from the recent (actuarially necessary) surplus to a deficit. So a fairer picture of fiscal rectitude is the on-budget (excluding SS) deficit (in the same table).
Forward projections of the budget situation are trickier due to the subterfuge of time-limited tax cuts designed to dress up the budget projections while being politically impossible to expire quietly.

Brutus & NVJ,
I of course know that supplemental “war” funds have been allocated to fight the Iraq and Afghanistan wars. I thought these were included in the unified on budget figures in that budget document I linked to, but perhaps I’m worng?
The large distinction that makes comparisons tricky across countries is what ToonArmy references, namely that our “unified” budget includes transfers from social security excesses (I do think ToonArmy makes the case a little too stringly, though. Our demographics are bad, but nowhere near as bad as Japan or most of Europe, which is of course committing siucide slowly. We do retain the ability to attract and assimilate immigrants – at least we used to be able to assimilate them! – so this helps our organic demographic issues.)
You can see the transfer mechanism in the table I referenced as well, and it has been consistently reported throughout the years (at least since 1974, and earlier periods were restated to reflect the new convention). For instance, if you look at the “on budget” figures from the Clinton years, you will see that he ran deficits EVERY SINGLE YEAR, except for 2000 when there was balance (no surplus, once you exclude the transfer payments).
About whether the Iraq and Afghanistan war supplementals are included, please provide me with a cite that explains it because I thought they WERE included in the “total” budget when presented historically. You guys seem pretty sure of yourselves here, so it should be easy to point to it.
Also, let’s not get carried away. NVJ said that Bush ran 5-6% budget deficits, which is of course wrong. The war costs in 2003, 2004, 2005, 2006, etc. were always less than 1% of GDP. Even today, they are less than 1% of GDP. So far, I’ve seen estimates that we have spent $580B on Iraq so far over 4 or 5 years. That’s less than 4% of GDP TOTAL, or way less than 1% per year.
So, NVJ (brutus did not make the claim) how do you get to “5-6%” deficit figures under Bush? Could you provide a link or cite?

@Diemos I like you idea to get the credit markets functioning.
@Satchel The WM takeover has JPMorgan taking over all the WM loans as well. It wasn’t just the deposits. As for you being smarter than Paulson- I really don’t know. Goldman is a lot more than a sales shop, their prop trading is huge. I agree that Paulson is not as smart as everyone makes him out to be. I have not seen a lot of evidence of deep thought.
As for you guys and your love fest over Shelby. Gime a break. you know he is going to probably end up voting for the bill anyway right? The guy talks out of two sides of his mouth on every bill.
He’s partisan trash just like Reid is. Both sides are crap including Shelby.
As for that list of “economists” who are against the plan. Man David Beim was my finance professor at CBS. He is not an economist, he’s a former investment banker (dillon Read(sp) I believe. Really good professor tho.
I like the idea about some sort of government insurance that the GOP guys have put forward. I really dont like 700 b to the banks. I think it’s too much cash for us to dish out and it won’t be enough to work.
What if the Fed guaranteed loans based on discounted cash flow, then paid for it by insurance fees that would be put in place on all origination starting in say 18 months. So the government would be essentially loaning money to this insurance fund to be paid out of the fund in the future. I really don’t like the idea of the taxpayer bailout and having the US taxpayer pay for it.

Here is a graph I found that contains accurate information about the total increase in the United State’s debt over the last seven years:
http://en.wikipedia.org/wiki/Image:Reported_Deficits_vs._Debt_Increases_-_2007.png
As you can see, the increase in debt was $600B in 2004, when the GDP was $11.75T, which is well over 5%. It looks like it was closer to 4% in 2007, though it is sure to be higher this year, especially when the cost of all the bailouts is included.
An apple to apples comparison of EU vs. United States debt and deficit spending requires you to pull out Social Security surpluses, because that is how they calculate deficit.

I am frankly a little surprised to find you so vigorously defending Bush’s disastrous economic policies. I thought you were more of a “small government” kind of guy and as I am sure you know, Bush engaged in the largest government growth since Johnson.

I am not sure if non-subscribers can access this page, but this is where I am getting overall budget deficit numbers from outside the US:
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=12304922
As you can see, the EU region is running a 0.9% overall deficit this year, with many countries, including Germany, the biggest economy, in surplus.

@NVJ-
Deficit to GDP, is not the same thing as debt to GDP. Deficit fluctuates quite a bit.

Cooper,
I don’t have time right now to delve into it, but I think the Fed’s Z1 flow of funds report breaks it down (going by memory here).
Something like 30-40% of that 350% debt/gdp figure is the increase in mortgage debt alone after 2000. In other words, if you think that 150-200% is sustainable and trend-normal (I’d agree with that), fully 1/4 to 1/3rd of the increase debt load was taken on for wholly unproductive assets. I suspect credit card, auto, and other consumer debt is a big slug too.
Check out the Z1 and let us know what you find!

Satchel, you just answered that question like an investment banker.
I know what two sectors have driven the increase…i know how to read charts. I am looking for a paper that explains what all that debt is being used for. for example is there X % of an increase to finance short term payroll #s?
Perhaps if we knew the duration of the debt. i.e. short term vs long term then compared % in 1980 vs the current situation. There has to be some fed paper somewhere that looks at this huge increase and explaisn what changes in the modern economy has forced this. thats what i am looking for. It’s a chart Iv’e watche for years and im tired of not understanding it.

Satchel–
I was like –in those threads man. i already know hat you’ve said in the past. You just point out the graphs and debt% levels. I am looking for an economic paper on the topic. There must be one the fed has done. I’ll search around myself.
As for your point not to worry about the government debt. That’s way too polyanna. Yeah debt service is low because interest rates are low now but it’s not like the treasury is issuing 30 years now instead of t-bills up the butt. the rates could go up in a month.
we are a hop skip and a jump from having to issue debt in yen or Euros. or What happens if interest rates go back up, say to 8%, or worse 15%? All very possibe. And in those instances, debt service would go through the roof.

Even if you look at the Japanese economy, it is not as bad as you think.
@John: you misunderstand me. I believe that the Japanese situation might be the BEST possible outcome for us. In other words, we do what Japan did, which will allow the zombie banks to recapitalize over decades. I worry that we will not be able to pull off the Japanese feat however because they were a creditor nation and a net exporter whereas we are a debtor nation and a net importer. if it works: we have time to recapitalize our banks. If it doesn’t: the banks continue to refuse to lend to one another and we get frozen markets.
===
I certainly place very little faith in anything coming out of the mouths of Paulson and Bernacke
@FSBO: agreed. I listen to NOTHING that’s coming out of their mouth. In fact, if you look at my posts, you’ll see I’m most concerned about what they’re NOT talking about: the CDS market. I think that Bern. and Paulson are terrified of the CDS market but are unable/unwilling to talk about it.
But I DO believe the words that come out of some of my economic mentors… and they all agree that NOBODY understands what is going on in the CDS market. NOBODY. (that includes Bernanke and Paulson and me and Satchel). it could be really bad folks. Or it could be like Y2K, no big deal. but the problem: nobody knows.
Even in a worst case scenario, I can’t image that it would take months (or even weeks) to get most things functioning again
it took YEARS to iron out Fannie’s books. They STILL don’t have totally updated financials for this decade.
the CDS nightmare will be 1000x worse as you will have hundreds if not thousands of different firms with different positions. worse, there will be countless litigation based on decisions made.
as example: you as a firm have a CDS contract with company X, who is now bankrupt. The clearing house abriter decides to give bankrupt Company X’s assets to company Z… but X also owes you… and you need X’s money so that you can pay the money you owe Company R. so you sue to get some of company X’s assets from company Z to pay company R… see the problem?
======
@Lurker: I’m sure Satchel predicted this YEARS (not months ago), as did many people including me. however, I still disagree with a few of the finer points of his current argument. for instance, I think that the the real problem is not “easy” to fix… but I see the “real” problem as the CDS market as I elucidated above, not the simple issue of the freeze in credit markets which can be obviated by Satchel/Diemos’ hybrid plan.

USG credit default swaps show a higher probability of default that those of McDonald’s.
China has called for a “deal” to stop panic selling of US debt.
With recessions looming world-wide, it’s not clear (to me at least) why foreigners will choose to continue spending their savings on financing USG debt, vs. spending in their own economies, *especially* if the USG insists on infecting its own balance sheet with the virus that has already brought down every major investment bank, adnd is threatens to reduce the # of commercial banks to 3 (BAC, WFC, JPM).

Imagine if we let it all fail, and then suddenly tomorrow ALL of your credit cards are rejected, ALL of your cash cards stop working, ALL of your banks are closed as they sort out if they are solvent or not. and this could go on for months as forensic accountants sift through the toxic pile of the CDS market to see who lost money, who got money and collects, and who got money but fails to collect since their counterparty failed.
I think this is actually Satchel’s dream scenario. Correct me if I am wrong here. 🙂

Thanks ex SF-er – that was very informative and helpful. I now understand how the $65T could arise from a much smaller amount of “actual” bonds. I don’t know how this insurance was priced – but it seems like you’d have to consider the riskiness of the primary bond (Ford in your example) plus the riskiness that the CDS seller would actually be capable of paying off in the event that Ford couldn’t. So AIG and other big sellers of CDS now can’t pay off – and most parties can’t even compute where they stand on a net basis since most where buying and selling. And guys like Taleb say their pricing models weren’t worth a damn anyway. Wow, I can see where this entire house of cards could come down and the collateral damage that this could cause – but really shouldn’t we just let it happen? If it is a house of cards, it needs to fall. The profiteers and architects could pay up or declare bankruptcy and maybe end up in court. Yeah it’s a mess and it impacts us all – but, if I had the choice, I wouldn’t spend one dime of my money to preserve this system. Imagine if every taxpayer had a line item veto on their tax return – the Iraq war would probably get more voluntary funding than this plan. I wonder if $700B will be enough? Thanks for the tutorial.

FSBO:
There are 2 “systems” here. I don’t THINK it’s about saving the CDS system. in fact, the current CDS system will not survive. The reason: too many people now understand that risk was never eliminated as previously thought (duh), but was instead spread in such a way that it causes massive systemic risk.
The system “they” are trying to save is the financial system (there is argument if the US financial system is worth saving or not)
So the CDS system will likely go back to its original intent (a small practical system of insurance), but there is a difference between allowing something to collapse, and unwinding something. An example might be a wire under high tension connected to a winch. You could just cut it, and it would whip around and do some serious damage maybe killing you. Or you could unwind the winch a little, removing tension, and then cut the wire safely.
A lot of the CDS have durations on them (specifically, they expire when the underlying securities mature). so if you can hold things together long enough and NOT allow more CDS writing, much of the current CDS will expire over time. (using my example above: Ford’s $10B in bonds will eventually mature. at that time the CDS contracts go away!). The longer dated CDS can slowly be matched up and cancelled out in an orderly fashion.
A side note: I’ve been saying for about 1.5 years on Socketsite now that the RE bubble wasn’t really a RE bubble, it was a credit bubble. And if you recall, I’ve often told people that we aren’t going back to “normal” (2002-2007) anytime soon because it takes years for a credit bubble to unwind. Hopefully everybody understands why that is now. And now you see why (without govt intervention) we will not be seeing easy lending any time soon again. It can take years and even decades to repair credit bubbles.
.

“is it worth the risk? (honest question).”
I say yes, even though of course I do not know the exact windup of what will happen.
(BTW, nice description of the CDS market-casino, ex SF-er. The only thing you left out is the impossibility of hedging. The CDS market is so large that it dwarfs the subject securities. A seller of CDS insurance would traditionally short the underlying security in a delta neutral way when things got dicey. However, because the CDS are so large – say $50B of swaps (payout value in the event of default) on a company with a debt capitalization of $5B – there is no way to sell enough secutities short to hedge the CDS writer’s risk.)
IF the problem is so large that it’s a systemic issue, than $700B will not solve it. The USG can only fool the market for so long, and the game is ending.
How will things like “suspension of the mark to market rules” help engender trust? How will a game like injecting a bit of cash into the CDS market (which “cash” BTW has to be taken from somewhere else!) to keep the wobbling top from falling over fool particpants into thinking this is all going to work out? Any games like this (as Japan found out) lead to increased distrust among market participants, and lending would plummet anyway. Even healthy participants will be tainted by the suspicion that they are being propped up, and will not want to enter into deals with other particpants whom the healthy ones fear might be being proppped up.
As firms go belly up, and insolvency proceedings are instituted, AT THAT POINT the USG can come in if necessary and either (1) provide standard “debtor-in-possession” financing to the bankrupt entity in exchange for all the equity (assuming that the CDS liabilitie would chew through the entire capital structure) or (2) in extraordinary circumstances (perhaps like an AIG) the USG could exercise emergency controls under the Commerce Clause and suspend the bankruptcy proceedings and take direct control of the subject company and deal with the creditors on a case by case basis (this would require an Act of Congress I’d assume, but if we’re really facing Armageddon, that shouldn’t be too hard to do). This sort of dealing with the “problems” would cause the potentially solvent CDS players to find religion FAST, and unwind this mess privately if possible. Perhaps we need a “stimulus” package to hire bankruptcy attorneys and judges!
There are no good “solutions” to the mess we are in, which is of course the natural result of repeated and successful attempts to avoid recession by stuffing the system with debt by artificially forcing the cost of credit below its equilibrium rate for at least 15 years. Periodic recessions and even depressions are NECESSARY, as we are finding out. The first step to fixing this mess is accepting that premise. All these financial firms were heavily REGULATED entities. As would be expected, they simply bought off the regulators (just why was the CDS market “unregulated”? why were firms “allowed” to play off-balance sheet games?).
Karl over at Market Ticker had a worthwhile piece with some specific suggestions about the CDS market that proposed forcing all derivatives contracts onto a transparent exchange over a specificied short period. Something like that – combined with a case-by-case bankruptcy/USG intervention like I suggested above – might work.
http://market-ticker.denninger.net/archives/593-CONGRESS-STOP-AND-THINK!.html
The key again in my view is to accept the obvious conclusion that we are going into a deep downturn, and that lending is not going to – and SHOULD NOT – return to anything like what we’ve seen in the last 10 years. Quickly airing this dirty laundry, and allowing asset prices and incomes to collapse (as they must) would ensure that this downturn is cathartic and quick, and would allow us to get back on a sustainable economic path as fast as possible.

“I’m not too worried yet because I’ve always expected the Fed to engage in some limited “printing” to offset the collapse in the “shadow” money supply of easy credit.”
Me too. You should be able to support some money printing to offset the shrinking credit base without igniting general inflation. If I was Heliben I’d be watching the price of oil to gauge how much stimulous I could get away with.
I’m still not expecting any significant wage inflation though.

Yeah, excellent stuff on the CDS mess. The fantastic irony is that the entire premise of a CDS is a concern that the company behind the underlying debt will go broke and be unable to pay the debt — thus expressly recognizing the risk of such an event. But in buying a CDS and thinking they have now eliminated all risk, they discounted by 100% the risk that the counterparty would go broke!

Satchel Said “Since I always post about the Fed’s policy on printing money, I though I should give everyone a heads up on something potentially very worrying.
http://research.stlouisfed.org/publications/usfd/page3.pdf“
No. That’s everybody buying tbills instead of holding cash and or banks wanting to hold bills instead of lending cash to other banks.
That’s why the Tbill rate is so low.

If the CDS market were regulated like insurance — which is what it is — it could be a viable tool but it would be several orders of magnitude smaller as an industry. State insurance regulators are quite good and quite conservative. If an insurer wants to write something where the risk cannot reasonably be valued using accepted actuarial standards, they won’t let you write it. In addition, regulators do not permit insurers nearly the leverage that we’ve seen in the financial mess. Capital requirements are very stringent. As a general rule (varies from state to state and line to line), you can write about 3X in policies as you have surplus on hand. The types of investments in which you can place that surplus is also tightly regulated (the result of the junk bond fiasco in the early ’90s that brought down some big insurers). Reinsurance can be obtained only from those who also meet strict requirements — so you can’t just buy a CDS-type financial instrument from some hedge fund and do an end-run around all the regulations.
On top of all that, insurers are all on the hook for one another (to some extent) through legally-mandated guarantee funds. So if one carrier starts getting into some funny lines of business or investments, their competitors will be quick to notify the regulators about it and put a halt to it.
This is all done at the state level and it works well — recall that not a single insurer went under after Hurricane Katrina. AIG’s insurance subs are all just fine. If the AIG parent would have stuck with regulated insurance and avoided the unregulated financial services that it bet big on and lost, the company would still be a trillion dollar independent company today. Because the states do such a good job, I wouldn’t be surprised if the end result of all this chaos is new law removing insurance from state oversight and placing it under a federal insurance regulator.

ex SF-er,
Great explanation. It is true that this could unravel. But if we prop up the market, wouldn’t that just cause people to continue the process?
If there is less perceived risk because the government will step in and backstop everyone, why wouldn’t I just start selling $5B in CDS tomorrow? Certainly my counterparties would have no problem buying from me (in spite of the fact that I don’t exactly have $5B lying around) because it is really the government from which they are purchasing insurance, not me, I just collect the payments. And if the government really is backstopping everything, my risk of loss is pretty low.
So if you have a bail out, and everyone does what is in their best interests, doesn’t the problem get even worse?
And as for Satchel’s alarming hockey stick graph, how does the disappearance of the extra $400B in Lehman assets announced on Friday, and the disappearance of the equity and bonds in WaMu play into that increase? Doesn’t it serve to cancel it out, at least partially, if not more, as an inflationary force?
Man, if I were half as smart as you guys, I wouldn’t have to ask all these questions. I have almost everything in Treasuries and now I’m even starting to worry about that. But when you search around, all you find are articles on how you should learn how to grow your own food and buy cars in which the seats fold back so you can sleep in them.

cooper,
I don’t think you are right on this.
All “dollars” are a liability of the Federal Reserve, not an asset.
The base is currency in circulation plus bank reserves (basically). Any dollars that are “taken out” of the system by the banks and placed “on deposit” with the Fed just reduces currency in circulation by the same amount the “deposited” amount would go up. It would be base neutral. Anyway, why in the world would private banks “buy” treasuries and then deposit them on SOMEONE ELSE’s balance sheet? (The USG “sells” treasuries, not the Fed, except of course when the Fed engages in its open market operations, which are never on this scale!)
The “assets” of the Federal Reserve are usually treasuries. However, they’ve lent most of them out and now a lot of toxic crap is sitting there in their place. If it had any left, it could have sold them to the marketplace and absorbed the cash and then advanced that cash to AIG. But it doesn’t (or at least its inventory is low enough that it feels it doesn’t have the flexibility).
Since all dollars are a Fed liability, the increase in base money has to reflect the Fed growing its balance sheet. How did it purchase those treasuries with which to expand its asset base? It “printed” them (actually it’s all just digits on a computer somewhere).
At least that’s how I have always understood the process. Maybe someone on this board who understands it better than we do could explain it better?

Satchel-
1. I told you the Fed could give money to any company or even an individual if it chooses. You told me I was wrong and they needed congressional approval. Now that you’ve seen the crisis unfold, do you doubt I was 100% right and you were wrong?
2. I told you that your last graph on fed lending was misleading because it invluded the investmen bank bailout. After checking your facts, turns out you were wrong which you admitted.
3. You are incorrect on monetary base not including the cash reserves held on the balance sheet of the Fed, Or any central bank. Adjusted money supply includes dollars (or whatever the home currency is at the central bank).
For your reference see below:
Investopedia Says:
—————————–
For example, suppose country Z has 600 million currency units circulating in the public and its central bank has 10 billion currency units in reserve as part of deposits from many commercial banks. In this case, the monetary base for country Z is 10.6 billion currency units.
For many countries, the government can maintain a measure of control over the monetary base by buying and selling government bonds in the open market.
—-
for someone who does not like investment bankers- and thinks he is smarter than Paulson (which may or may not be true). I bet Paulson knows what adjusted monetary base is and doesn’t throw panic charts around without understanding whats in them eh? you’ve lost my vote for treasury secretary.

By Satchel
“The fed has not “given” one dime to anyone, as far as I can tell. It has only lent. I have always said that the Fed can lend to anyone under its 13(3) powers. Can you point to 1 single entity that the Fed has “given” anything to in this crisis? If not, then a simple “You’re right, Satchel” will suffice. Be careful with your words – don’t be sloppy like most fools.”
Uh what about the purchase of 80% of AIG which is not even a bloody bank or regulated by the Federal Reserve. They can do a loan or equity and already have to people that have nothing to do with the Federal Reserve.They just decided to do it because they felt they needed to which they have the right to do under statute by Congress.
So no I’m not blind, and I think the AIG example proves which one of us is. How you see that as “disinformation” is puzzling but it’s the same accusation I have of you. The difference is, the AIG equity infusion is an example I have, and you don’t have one to back up what you are saying.
2. Your statement claiming that treasury purchases and sales are “base neutral” confirms you don’t understand that that’s the tool the Fed or any central bank uses to add or subtract to the money supply –its not base neutral. Check the rest of money supply–commercial paper and other “money like” instruments are crashing. Everyone is storing their money at the Fed.
You claim to be so much smarter than Paulson and demean his investment banking experience as “sales” but you are just as imprecise as any investment banker I have seen. You post these graphs but don’t seem to understand or even want to understand them.
Oh and I still think the Asia/Russia crisis has similarties here. And while I have been saying that asset prices in real estate need to come down for a while –I think excessive panic spread by people at this point is unproductive. The world is not coming to an end, and we are not all going back into the stone age.
If you don’t enjoy the interchange that stop posting panic graphics that you don’t understand.
An

“Uh what about the purchase of 80% of AIG which is not even a bloody bank or regulated by the Federal Reserve.”
LOL Satchel got owned.

Wow that was a sorry attempt at trying to avoid “being a gentlmen when I find out I am wrong”. So that’s two thing now we both know that are not true.
If you are going to deny preferred stock at 80% of the company is not proving you 100% wrong then I don’t think I’ll even bother trying explain it. If you don’t understand what preferred equity or warrants are then one of us is wasting time explaining it. AIG was not a regulated institutuon. As I said 9 months ago or whenever it was –the Fed can give money (lend, equity or any terms it decides even 0% interest) to any corporation, individual or entity when it deems necessary. It used that very law that was created in the great depression to do so to AIG.
Oh and we didn’t discover the bailout as included in your funds to ibanks together. I told you I thought you were wrong and then you said you weren’t then I said, look at the footnote in your own chart. After you bothered to actually read it only then when the footnote was on your own chart did you admit you were wrong.
That I think is my larger point which is you come up with these points and they are backed up by very little–just hair on fire panic. Like that’s what we need is to panic people about real estate more. Note, I was right there with you saying there would be a big crash in real esate a year ago, but now this is pointless and I don’t like seeing people over react with even more panic which is what you appear to do.
Now–to enyonymous
I gave a pretty good explanation as to what I thought was causing that increase in currency. The short version is, people are lending so there is a ton more cash sitting on the sideline.
1. Why do you think that is not occurring. I think it’s a pretty reasonable explanation for that surge. Do you think that money hording is not occuring?
2. What the hell else do you think it is? If it is creating money then there would be money going to the US treasury not to the Fed. The Treasury would issue bills straight to the fed. If it was the Aig investment as you and I think others are speculating, it wouldn’t show up in money supply since the cash would be at AIG and the Fed gets preferred stock and a note in return.
I gave an explanation as to what it possibly could be. But you “Mr. the world is going to end ” and you seem to be 100% convinced that its printing money. Exactly how and it what form?

cooper,
You know, I have to hand it to you. Stick to your guns even when you know you’re wrong.
I’ll leave aside the question about the increase in nonborrowed reserves from the earlier thread (which you said was misleading and I showed you wasn’t because loans to investment banks were a VERY MINISCULE part of what was going on – no big deal).
Your intuition about monetary base today is all wrong as well. Yes, people are lending less. They have been lending less and pulling in risk for MONTHS now. Why the sudden spike? My surmise is that is has something to do with AIG. Not too much ink has been spilled yet on this by the “professional economists”, so perhaps I’m wrong. But the idea that SUDDENLY banks started “buying” treasuries “from the Fed” is silly. (They buy them in the open market, and thre is no need to custody them at the Fed – they could keep them at any depository or even with the US Treasury itself, which is what I do with a substantial portion of my large treasuries position.)
You’re still on this thing about how you “showed me” that the Fed could buy anything from anybody without an Act of Congress. I found our original exchange, and you sounded as silly back then as you do now:
“@Satchel. The Fed does not require an act of congress to buy mortgages. If the Fed wanted to use the money to buy goods and services it could do so –it can use that money to buy aircraft, elliot spiters hookers, or whatever without an act of congress.
Posted by: cooper at March 18, 2008 8:02 PM”
Note my reasoned, humble and respectful responses to your dunb assertion, including actual cites to fed papers, etc. Also note that if I wasn’t sure, I frankly admitted it and offered to report back, which I did.
For those responses, see “Posted by: Satchel at March 18, 2008 8:22 PM”, and “Posted by: Satchel at March 19, 2008 11:10 AM”.
All these posts (including cooper’s quoted above) are from:
https://socketsite.com/archives/2008/03/justquotes_the_fed_cuts_by_075_and_sees_weakened_outloo.html
You’ll also see in that last post of mine, cooper, that I correctly predicted how this would go down, namely that the Fed would get Congress to set up an agency so that it wouldn’t have to purchase the assets that you thought they could. That’s about where we are now.
What you keep thinking about is the Fed’s authority under 13(3) of the Federal Reserve Act to LEND to anyone provided that 5 of the governors declare “exigent circumstances”. Once again, even though you posited something foolish (the Fed buying elliot spitzer’s hookers) I was reasonable and respectful and made a sincere attempt to understand what was going on.

notgreat,
Thanks. I actually spent a lot of the day setting up a new large aquarium with my 4 year old…
About whether the Fed printed up the money to buy the treasuries, or whether these were somehow given to the Fed after being auctioned off by treasury – you know, I’ve seen both reported now, and I think from trying to decipher the Treasury’s press release, that you are right. These look to have been purchased on the open market and somehow transferred to the Fed, and thus would be money supply neutral.
On reflection, I guess the spike in the base money is likely a result of these crazy bank mergers that are being forced. Perhaps somehow a huge slug of reserves is “stuck” as old TAF loans to failing institutions are unwound and the acquirers are posting reserves to cover the requirements of the failed banks.
It’s all so nontransparent, that frankly I am not sure what is up anymore. We’ll have to see where the base goes in the next month or two. That was the point of my post that got cooper’s panties all in a twist – I don’t think it was alarmist at all. I have been one of the most vocal proponents on this site that the Fed has NOT been inflating, and I have many times pointed to the adjusted monetary base figures. I felt that I owed everyone a heads up on such a sudden spike, but I guess I should have waited until I had it all figured out.
In any event, cooper’s idea that banks are “parking” treasuries at the Fed (that they bought from the Fed) is nonsensical on any number of levels. The most important being that the Fed cannot pay interest on excess reserves as far as I know (besides the fact of course that the Fed does not “sell” treasuries in the amount of $68 BILLION as part of its OMO!).
The other component of the base is currency in criculation. This is essentially CASH (and coins), ie, dead presidents. There’s no way that $60+ BILLION of cash suddenly entered into circulation (I’m pretty sure vault cash is part of currency in circulation, though not part of M1).
Honestly, I don’t know what cooper’s problem is with what I posted today on a potential change in Fed policy. I’m getting more reassured that there hasn’t been any policy shift towards printing, which has always been my contention – the Fed wants to DEFLATE us, not INFLATE us. Really, if the Fed could “buy” mortgages and “elliot spitzer’s hooker” from any entity, why is everyone going through this agonizing process right now to get CONGRESS (ie, the taxpayer) to buy all this crap!

@Satchel
The reason I’m guessing it was “borrowed” is this line in the latest H.4.1:
Deposits with F.R. Banks, other than reserve balances 142,043 + 127,677 + 130,300 187,138
U.S. Treasury, general account 5,088 + 147 + 327 5,175
U.S. Treasury, supplementary financing account 117,046 + 117,046 + 117,046 159,806
Now I really have no idea what goes into the adjusted monetary base graph you posted, so even though the 100B+ jump above roughly matches the increase in the adjusted monetary base, I’m not sure what the relationship there is.
My not-so-expert opinion for what’s going to happen here in the US is this: a deflationary economic collapse as credit contracts, along with a currency collapse, which will manifest itself in higher prices for anything that can be sold for hard(er) currencies (e.g., food & gas more expensive, manual labor & houses in stockton less). So basically, the Argentina scenario. Of course the powers that be will try to avoid this, but I don’t think it’s in our hands any more — our foreign creditors will determine the fate of the dollar.

@tipster
I personally don’t consider deflation as a force to be fought against, rather I view it as the market’s proper reaction to correct the misallocations of capital that have gone on. The economic losses suffered from building too many houses are real, so the government printing up some money won’t replace those losses, it’ll merely contribute to debasing our currency. The best thing we can do is allow the market to correct as swiftly as possible, and credit will eventually start to flow to productive channels again. What the government is doing can only delay this process, and that can’t be good for the economy.

@ notgreat – You and I see eye to eye, and I did see those H.4 numbers as well. That base graph is really just cash in the economy + reserves on deposit with the Fed. I am a little more sanguine than you are on the dollar short term – I think the world has a huge stake in getting this right because of the geopolitical/military implications – but I fear that you are right in the medium/long term.
@ FSBO – It’s even worse than you think regarding the criminality of what has been going on (e.g., Blankfein at the meeting that decided to extinguish Goldman’s competitor). Remember the Bear Stearns deal that was “brokered” by the NY Fed, in which Jamie Dimon’s JP Morgan acquired Bear Stearns for a song with an explicit backstop from the Fed? Take a close look at the Board of Directors of the NY Fed, see anything coincidental??
http://www.newyorkfed.org/aboutthefed/org_nydirectors.html
I’m ALWAYS amazed how the general population has this almost childlike faith that the Fed is “looking out for us”. They look out for themselves. It’s a cartel of private banking interests masquerading as part of the USG.

Cooper–why are you even trying?
This is some kind of ego battle and he won’t admit he is wrong. You are wasting your breath–he’s just gonna try and weasel. Just move the hell on.

NVJ – I am interested to read your next five year plan
regards,
the proletariat

What is this whole debate about the AIG bailout? Whether it was a “loan” or a “purchase”? Boy, this is a lot of fighting about semantics. It is true that section 13(3) only permits loans and not purchases or gifts. Actual language is that any Federal Reserve Bank is permitted “to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank.”
Under this section, loans are permitted, but purchases are not. But the dividing line between the two can be fuzzy. I don’t think one can reasonably doubt that this authority to lend includes the right to demand collateral in exchange for the loan. The AIG deal is certainly an extreme example of that. It is structured as a revolving credit facility but includes the issuance of preferred shares for the benefit of the Treasury. “Loan” or “purchase”?
There has been a lot of discussion on the law blogs about the legality of this deal. See, e.g., http://legalblogwatch.typepad.com/legal_blog_watch/2008/09/federal-bailout.html
Bottom line is that the courts are not likely to review this deal, so it doesn’t matter. But there is also likely a point where a bailout is so far removed from a loan that it does not even come close to falling within the statute’s language that a challenge might succeed. (Paying for hookers, I think, would cross the line and get shot down in a TRO).

I would second anon at 10:37AM’s comment.

notgreat,
Interesting idea about Russia. I was very involved in trading the Russia bubble and collapse in 1995 throgh 1998. I spent a good deal of time in Moscow in 1995/96 (just intemittent trips, though – I was trading out of London).
I fear you may be right. When I was in Russia, I was struck by the shattered nature of the culture. Their old people literally slunked away and died after the ruble pensions stopped meaning anything after about 1992 or so. If you spent any time at western hangouts like the “Nite-Flite” (which had then just opened) and spoke some Russian (I do), you would have been shocked at the background of the “working girls” all over the place. Solid backgrounds, educated, etc. – the society had obviously come apart.
And yet, it turns out, all the while Russia was developing its weaponry, and recently unveiled that they had developed a fourth generation nuclear sub. That sort of development takes YEARS. All along, as the society melted and life expectancy plunged, TPTB in Russia went on “business as usual”.
Different topic – thanks for the comments on my contributions. I reread what I wrote and I want to apologize to the many other good posters who have posted sensible and accurate analysis and predictions about aspects of this credit collapse, in particular ex SF-er, tipster and enonymous (and always great info and analysis on SF real estate #’s from FSBO, unlike our “friend” who played fast and loose with data). I just meant that I have been the one who has been on this idea for the longest time that the Fed’s interests are not the same as the USG’s or the population’s (but after looking at this bailout, it’s looking like the private interests promoted by the Fed are also being promoted by the Congress! Too bad, population, you lose).

I suspect the most impactful aspect of the current bailout bill is the suspension of mark-to-market rules. Now we’re setup to allow all the banks, pension funds and insurance companies to pretend that they’re solvent while the bonds slowly go bad and are written off. That will successfully kick the can quite a ways down the road. We seem to be headed down the Japanese road to zombification and a lost decade or two.

I certainly did not expect a provision allowing for the suspension of FASB 157 mark to market rules — the bill does not eliminate it but permits the SEC to suspend it on an issuer by issuer basis. I suspect this was added to permit specific companies to “fix” their balance sheets with FASB 157 suspended and thereby avoid certain catastrophic CDS triggering provisions. But I really don’t know if there was something specific in mind with this provision or if it was just a sledgehammer they wanted to give the SEC to let any banking or financial entity remain “solvent.” If this is used too often, it will do more harm than good in the stock markets since there will be no disclosure of a company’s true position. But it could provide a clever end run around some of the protections in the CDS agreements.

That’s a GREAT question you pose, EBGuy. I can’t wrap my head around the idea that the US Treasury is holding auctions of bills and then simply “giving” the proceeeds to the Fed, which looks like is whatis going on. Does the Fed have to “pay back” these proceeds?
Clearly, the rise in the base that we have been kicking around on this thread has something to do with this expansion of the Fed’s balance sheet. It looks like these dollar proceeds recived by the Fed found their way into “excess reserves” held by the banks at the Fed (from the latest H.4 release noted by notgreat).
I guess it’s “money supply neutral” in the sense that what the Treasury did is akin to a sterilized intervention by the Fed (the cash was sopped up from the market by the special bill auction). Nevertheless, these funds were apparently somehow converted directly into the monetary base without any intermediation by a depository, and in that sense it sort of looks like money “rained down from a helicopter” on someone! I have to admit I’m confused here, and I hope some people with real expertise start to question this and spill some ink on it.

SAID BY TRIP
What is this whole debate about the AIG bailout? Whether it was a “loan” or a “purchase”? Boy, this is a lot of fighting about semantics. It is true that section 13(3) only permits loans and not purchases or gifts. Actual language is that any Federal Reserve Bank is permitted “to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank.”
Under this section, loans are permitted, but purchases are not. But the dividing line between the two can be fuzzy. I don’t think one can reasonably doubt that this authority to lend includes the right to demand collateral in exchange for the loan. The AIG deal is certainly an extreme example of that. It is structured as a revolving credit facility but includes the issuance of preferred shares for the benefit of the Treasury. “Loan” or “purchase”?
There has been a lot of discussion on the law blogs about the legality of this deal. See, e.g., http://legalblogwatch.typepad.com/legal_blog_watch/2008/09/federal-bailout.html
Bottom line is that the courts are not likely to review this deal, so it doesn’t matter. But there is also likely a point where a bailout is so far removed from a loan that it does not even come close to falling within the statute’s language that a challenge might succeed. (Paying for hookers, I think, would cross the line and get shot down in a TRO).
———————————————–
Exactly Trip. To bad Satchel was not the gentleman he said he was and refused to admit he was wrong. I can’t remember the original post back in the day his whole point was the Fed needed congressional approval and didn’t even think a pure loan would be legal. i.e. he didn’t even know that statute existed and asked me to find it to prove it to him.
Given that, I don’t even understand why he brought up the loan distinction particularly when anyone who was fit to be treasury secretary would know the distinction between equity and debt is very very fuzzy.

Satchel, how can I get in touch with you ? I respect your insight and would like to discuss a scenario with you, if you’re okay with it.

Thanks. It’s right here in a quote by you:
“Well, cooper and I have gone back and forth a little on this issue of whether the Fed can buy assets from private parties, etc., without an Act of Congress. I asked if anyone had any learning on this but – who would have thought?”
AIG is a private party and they used equity instruments to buy 80% of it. It also notes how you didn’t even know of the statue and though an act of Congress was required.
Also I will note the personal attacks you have made and the apologies for your own behavior for reacting so poorly. Isn’t that a clue that you know you are wrong? The last personal attacks I recieved on this site were from someone whose name started with an F, and ended with the J and a L and U in the middle.
Oh and I have never worked at an investment bank as per your personal attack (that I think was deleted by socketsite–it was funny tho). I had a similarly funny response but it was also deleted. FYI. I’m more a venture capital/private equity guy. Altho I did spend some time in the White House for a small government stint as an economist. Other than that–all on the investor side. Doh! Wrong guess again dude! Man you are bad!

I am quite stunned the bailout is failing (barring some significant twist to get the Republicans on board). But see my post above — it’s all politics. Paulson et al knew this when they tried to rush it into law with no debate. Once those running for election started thinking it through, they realized there is little up-side to handing out $$$ to Wall Street. And re-election is all they care about.

That’s a GREAT question you pose, EBGuy. I can’t wrap my head around the idea that the US Treasury is holding auctions of bills and then simply “giving” the proceeeds to the Fed, which looks like is what is going on.
Thanks for the validation — I am guessing we might get some answers (or at least see how long the Treasury->Fed injections last) given that the bailout is going down in flames and there is still more toxic waste to deal wtih. I can’t help but think we may be over analyzing the mechanics a bit too much. Treasuries are sold all the time by the Treasury to finance our deficit and the proceeds are used to pay the bills for the US govt. How is this any different? (other than being “non-productive”, and, therefore, perhaps inflationary?)

To EBGUY-
Moral hazard is not an issue, in fact I think it’s actually made the solution here worse. There are examples of this. For example-Paulson was so confident in his effort to prevent moral hazard he took all the preferred stock in the Fannie/Freddia nationalization and eliminated all dividends.
Sounds good right–no moral hazard? Of course, it destroyed the Preferred market which wouldn’t normally be that big of a deal except that’s how banks typically raise equity. Look at Lehman–they went after that because of moral hazard. But instead of taking over Lehman, they let the thing fail which causes far more systemic problems.
Look-any company that gets wiped out passes the “moral hazard” test. But those are just two of many examples where moving around moral hazard ends up causing a lot more problems than it solves.

Why does everyone keep saying that they need “10 GOP” votes or that the “Repbulicans held strong” – look at the votes – 97 Democrats voted against it too. It’s a pretty bi-partisan group that voted for and against.
It was not popular in the polls, so every member of the House who is in a battle for their post voted it down.