As we wrote last year, “Forget Subprime In San Francisco, But How About Alt-A?” And from Bloomberg today:

About 3 million U.S. borrowers have Alt-A mortgages totaling $1 trillion, compared with $855 billion of subprime loans outstanding, according to Inside Mortgage Finance, a trade publication in Bethesda, Maryland. Of the Alt-A borrowers, 70 percent may have exaggerated their income, said David Olson, president of mortgage research firm Wholesale Access in Columbia, Maryland.

Alt-A Mortgages Next Risk for Housing Market as Defaults Surge [Bloomberg]
JustQuotes: Forget Subprime In San Francisco, But How About Alt-A? [SocketSite]

84 thoughts on “Once again…Forget Subprime In San Francisco, But How About Alt-A?”
  1. 70%?!
    That is a pretty staggering statistic, as it means that 70% of people are more than willing to lie. I’m sure that some of those people can afford the homes they live in even if they wouldn’t have qualified based on their actual incomes, but the most probably can’t. Which means what percentage of people don’t have even the basic financial knowledge?

  2. Whether or not the buyer can make the payments is not hugely material unless they are unable to quickly sell their property once they realize they are in trouble.
    A lack of liquidity in the resale market is what leads to foreclosures.

  3. “Whether or not the buyer can make the payments is not hugely material unless they are unable to quickly sell their property once they realize they are in trouble. A lack of liquidity in the resale market is what leads to foreclosures.”
    Not entirely. It’s whether they are able to sell their property quickly **and** whether they can sell it for more than they owe on it.

  4. 70%?!
    And California has the largest concentration of Alt-A loans. If my math is right, California has about $303 BILLION of these loans, or 30% of all of them (NY Fed data).
    Wow, this should be pretty interesting to watch unravel.

  5. And this wave (which is more significant for SF imho) has just begun. I couldn’t guess how much farther down the market will go or how long it will take to get there. But it is quite clear that we are nowhere near the bottom. The ideas being bandied about by the government re Fannie and Freddie may (but likely won’t) slow the pace of the decline a bit, but to the extent they do they will also prolong the slide.

  6. On my statement this month (Alt-A) the difference between my minimum payment and my full amortized is $1000. And the rate came down again to 5.3.
    I also exaggerated my income. Not on the year previous but on the earlier years. Why because I hadn’t made much, and had started my company. I make more now than any of the numbers I gave when I bought. I put 20% down. I pay the full amount every month.
    The reset is not going to crush every one. And most self employed people “exaggerated” their income. It doesn’t mean they can’t afford there mortgage now.

  7. “And California has the largest concentration of Alt-A loans. If my math is right, California has about $303 BILLION of these loans, or 30% of all of them ”
    and as we’ve all seen, “California” has been getting hit very hard for over two years at this point

  8. “It’s still “A” paper.”
    How reassuring. It’s not like we’ve seen any paper in the debt markets that was rated “AAA” one day and was toilet paper the next.

  9. “The reset is not going to crush every one. And most self employed people “exaggerated” their income. It doesn’t mean they can’t afford there mortgage now.”
    You can say all those same things about sub prime loans. 60% are performing just fine. But the pricing pressure from the minority of loans that went bad decimated the market price in areas in which those loans were prevalent.
    No one believes that 100% of the alt-A loans are going to go bad. Not by a long shot. But alt-A loans are to SF what sub prime loans were to Stockton: they are going to bring a lot of homes back onto the market under distress conditions.
    The sub prime problem was resets: people thought they could refinance before the reset or shortly after it (if there were penalties). The teaser rate was artificially low, the later rate was higher, but if you couldn’t refinance because the LTV wouldn’t support the loan, you could just keep paying your loan. The payments were higher, but not infinite, and you weren’t likely to do any better anywhere else, so lots of people just sucked it up and kept paying.
    Contrast that with someone who stated their income on a 3/1, who, after the end of that period is expected to come up with $1M and who will never qualify. Even if they can get another alt-A loan, they will have to come up with $200K or more just for the downpayment, and more if the price has sunk. That person has no real choice. They are going to dump the home. Especially if they stretched to get it in the first place (meaning they have not had the opportunity to save up anything for a down payment because they could barely keep up with the payments) and they put nothing or nearly nothing down.
    I was looking at a $2M+ property in 2006, when a secretary bought it out from underneath me. That’s when I bailed the hell out of such a crazy market. Maybe her income has gone up like yours has, but I doubt she saved up $400K plus in the interim.
    Those people are screwed. It won’t be everyone, but you can see how they could really care less about the interest rate being lower: it could be zero and they still wouldn’t qualify.

  10. But alt-A loans are to SF what sub prime loans were to Stockton: they are going to bring a lot of homes back onto the market under distress conditions
    People like you who say things like this with such false authority are patently ridiculous. You have no idea what’s going to occur. It’s selective fearmongering and wishing down propaganda. This BBS is rife with it.
    You have all seen for over a year, nay as much as two years, that there is far more liquidity in San Francisco than any of you ever estimated. Choosing to ignore that fact — a proven ability for San Franciscans who would live in the more desirable areas to obtain cash is beyond disingenuous.

  11. To Sparky @ 8:31 a.m.: You write “I also exaggerated my income. Not on the year previous but on the earlier years.”
    Didn’t you sign and affirm on your mortgage application that all of the information you supplied on the application was true and correct under penalty of perjury? And aren’t you now admitting here on SocketSite that you have engaged in the commission of a fraud? You lied and misrepresented material facts about yourself in order to induce the other party in a business transaction to consumate that transaction on terms that the other party would not have agreed to had you not lied and misrepresented material facts about yourself.
    Do you really think so little of yourself that you value SF real estate more highly than you do your personal integrity? You say you started a company (but you’re also a self-confessed liar, so who knows if that’s true.) Please tell us the name of your company so that we can steer clear of it in the future. You’d be doing us all a favor.

  12. Please tell us the name of your company so that we can steer clear of it in the future. You’d be doing us all a favor.
    Groan. Once again SS bites the hands that feed. You all clamor for information. Yet once shared, you pare it down to insult.

  13. I actually think the 70% number is low (and in any case, how did they come up with it?).
    The alt-A stuff won’t be a problem in SF unless there’s a tech recession. I don’t know anyone in tech who is having trouble finding work. Yet. Everyone is paying lip service to “a tough market”, which you didn’t hear 2 years ago.
    Also telling: not a single commenter on the advice threads directly mentioned job loss as a risk (I may have missed it). Those still employed in tech will (generally) have no problem with any alt-A reset, as some folks have mentioned.
    Tech (generally) is unlevered, so it’s only affected when its levered customers (or investors!) cut back, and this (generally) happens last.
    In the last tech slowdown (which was trivial), I had two friends with small tech consultancies blow up almost overnight when their one- or two- customers suddenly cut back. SF is chock full of little consultancies like this, all feeding off the largess, as it were, of unlevered big tech (include big pharma, and biotech too).
    This should be interesting to watch, that’s for sure!

  14. I love hearing that sparking put his own money in a first loss position to fund 20% of the deal.
    That may disqualify him for a place with Satchel’s heros but it makes him one of diemos’ heros. I love people who will stand behind their decisions with their own money.
    Yup, Mark D., he committed fraud but the mortgage lender was an eager and willing participant to that fraud.

  15. “How? Did the mortgage lender lie?”
    When the mortgage lenders started offering stated income and no-doc loans they were putting out a neon sign that said, “Please lie to us. We don’t care.” They could have done due diligence on the deal if they had wanted to but they didn’t. They thought they would save a couple of bucks on paperwork in the back office and that it wouldn’t matter because they had off-loaded the default risk on some sucker investors and that if things went south they could “discover” the fraud later, eliminate the no-recourse provisions and sue for the balance.
    Luckily for sparky there aren’t enough jails to hold all the people who did this and unluckily for the investors they’re going to rediscover that “you can’t get blood from a turnip”.

  16. one interjection:
    what most people forget is that the problem is NOT really the numbers of Alt A’s that blow up. The problem is the massive amount of LEVERAGE that was used in the secondary markets.
    Some of these firms are levered 30x, 40x, 60x, and even more. there are some firms that are levered 10-30x on instruments that are themselves levered 10-30x. Thus, even 1-3% losses can wipe out investors. a 3% loss on an investment that is levered 30x is 90% loss as example
    As those investors get wiped out there are fewer and fewer people willing to do the deals going forward.
    Thus, as someone mentioned, the problem is the people on the margins, because only a few of them defaulting can bring the big firms to their knees.
    There is a reason why Lehman Brothers, Washington Mutual, Wachovia Bank, and American International Group may be going the way of Bear Stearns and Countrywide and Fannie/Freddie.
    As for tech: who are some of the largest purchasers of tech?
    answer: the financial industry.
    I’ll leave the rest to your imagination.
    The wild card right now is the Federal Government. Will they truly nationalize the entire housing industry? The entire banking industry? If they do, how many losses will they be willing and able to take?
    not to be alarmist, but there was a major breakdown in the capital markets (massive unregulated leverage into untested financial instruments on a worldwide scale across all credit instruments), and it is unclear if the breakdown can be fixed. This is not to say that we will all be eating dogfood and living in shanty towns.
    However, it will be some time before we can get “business as usual” with Wall Street firms packaging (mortgage/credit card/auto loan/commercial/business loan) securities for sale on the secondary markets!

  17. @ex-SF — the rise of (tech enabled) advertising throws a monkey wrench in things. Consumer tech is larger now than it was even a few years ago (intel, etc., chips go into all those things).
    In fact, there is a (seemingly cynical) school of thought that advertising will not slow down much in this cycle because searches for “mortgage” will be replaced by those for “bankruptcy”. And folks will spend more time on facebook, etc., driving page views!
    It would be miraculous to me if advertising/tech did not slow down, but it has not happened yet.
    This explains the resilience of “the real SF” (and the google indicator), and also the lack of job-loss fear, which quite frankly is rampant, even among the bears here.

  18. Hey Mark D., I’d do it again. In this market I wouldn’t qualify for a loan for the house I bought a while back. Even with more money down. Why, because I made 10x more money in March than my whole ’07 tax return. Just due to payment cycles/job completions/retention.
    I do think some % of people will default and continue the value decline in SF. I posted earlier because the way things are often set up here it is very doom and gloom. Like the 70% people who exaggerated there income didn’t put a big chunk down, and didn’t only exaggerated 3 years ago’s income (for example). Lot’s of people with Alt-A and Option Arms will be just fine.
    Mark D., I’ll tell you what, you tell me your name and e-mail address on here and I’ll e-mail you my information. Then you can never hire me. My company name and info. on this site; no way.
    I’m sure no one will scrutinize your pristine record of never lying, fudging, exaggerating, or mis-representing.

  19. “This is not to say that we will all be eating dogfood and living in shanty towns.”
    Which brings up a fascinating point about the difference between the financial economy and the real economy. Why would anyone be living in a shanty town? House prices are falling around the country because there are TOO MANY HOUSES, more than we need to house everyone (admittedly they’re not all in places that people would prefer to live.) More than 10% of dwellings in this country are currently sitting empty.
    The only reason people would be living in shanties while homes sit empty is that the financial system has encouraged people to speculate on houses as investments and now they’re not priced properly to do their job of housing people.

  20. Sheesh Mark D., that was unnecessarily harsh on sparky.
    From what sparky states, this was exactly the ideal scenario for no-doc loans. sparky signed with good faith that he had a business plan that could support loan payments. Both sides of the contract knowingly took a risk.
    The alternative would be for sparky to apply for a mini-venture funding, providing business plans, pro-formae, etc. to the banks. What a headache ! And in the end the funder needs to go out on a limb anyway to have confidence in the business plan.

  21. “Both sides of the contract knowingly took a risk.”
    I’m have to point out that there were multiple parties to the contract, buyer, broker, investment banker, securities salesmen and investor. The investors had no clue what risks they were taking.

  22. “You have all seen for over a year, nay as much as two years, that there is far more liquidity in San Francisco than any of you ever estimated.”
    Yup, allow me to be the first to admit that the “RealSF” has held up longer than I expected. And yet, Wile E. Coyote is eventually going to look down and remember that the law of gravity is still in effect.
    The rot has started in the southern neighborhoods and it’s spreading my dear ghost.

  23. There are lots of tricky “intent” elements to fraud. Under the circumstances presented here, there has not been fraud – yet.

  24. What a tantalizing statement Publius. How can something that happens now change the “intent” that was present when the contracts were entered into?

  25. Anyone who doesn’t think tech is struggling should drive around Santa Clara for an hour. I did and it’s shocking: the large buildings are about 30% vacant. It looks like a scene out of Detroit.
    I know of at least three venture capital firms who, though they are not closing up shop, are downsizing significantly. One I know of is moving out of a 6600 square foot facility at the end of next month that has more than 20 people and is looking for a single office of 200-300 square feet: they said they were going into “hunker down mode”.
    One of my businesses that supports tech companies is off by about 2/3 over last year. We’re delivering services at a rate that’s around 6x what’s coming in. It’s surviving almost entirely on the backlog. By the end of the year we will have burned through that plus everything that comes in between now and then. We cut hiring to zero six months ago. By next summer, we’ll probably start laying people off, if normal attrition doesn’t take care of it.
    Drive around the tech company buildings in Santa Clara like I did two weeks ago. You’ll be shocked. There *is* a lot of money in this area, Mr. ghost, but it’s drying up quickly, and that is making people less willing to spend. Everyone who runs a business in Silicon Valley is witnessing it first hand.

  26. @tipster — good info, thanks. As I said, it would be miraculous if it didn’t trickle down to tech eventually. I just expect tech employees to be the last to know (like they were in the last minor downturn). And if it happens, I expect it to happen quickly, because I think much of tech spending is “deferrable”.
    As for my business (non-tech manufacturing wholesaler), we are seeing a mixed bag, and are preparing for the worst (e.g., not moving into larger facilities, etc). But we’ve been doing that for awhile (I’m paranoid), and are still growing, so it’s hard for me to declare apocalypse, much less come to grips with the positively dire predictions here.
    Also, santa clara has kind of looked like that since 2002, but I admit I don’t have to drive around there anymore, so maybe it’s even worse now?

  27. “Also, santa clara has kind of looked like that since 2002, but I admit I don’t have to drive around there anymore, so maybe it’s even worse now?”
    I’ve been working down in the valley since 2006 (was in SF prior to that). When I first got down there, I was shocked at the number of vacant large buildings…does not seem to have increased appreciably since then (though it certainly hasn’t gotten better either).

  28. “You have all seen for over a year, nay as much as two years, that there is far more liquidity in San Francisco than any of you ever estimated.”
    untrue. I’ve posted time and time again that SF will not fare well but that it will take many years to go through this downturn. Thus far I’d even go so far to say that San Francisco is performing almost exactly as I predicted.
    I’ve said it before: I thought it would be somewhat similar to San Diego, with a 2 year lag. San Diego is years into their downturn, and yet prices still remain aloft in the nicest of hoods (la jolla, del mar, mission hills, etc)
    the same will occur in SF I’d imagine.
    let me also clarify something: I said that TECH would be hurt in the coming downturn, not just advertising revenue. I’m not just talking about Google and Yahoo! (although they’ll be hurt). I’m also talking IBM and dell and cisco and intel and alcatel-lucent and all the other software/hardware that businesses USE to do do business like computers and telecommunications networks.
    How many firms are going to ramp up their IT capex during a recession?
    That said: there will possibly be some uptick in the tech CONSULTING firms as corporations look to minimize their fixed tech costs, but will still need functional IT infrastructure.

  29. $2 million houses going to secretarys??
    is that a figure of speech or did this really happen??

    Really happened (it was a condo). I assume she’s still living there and that if I want, I’ll be able to buy it from the bank in the next year or two.

  30. ‘How can something that happens now change the “intent” that was present when the contracts were entered into?’
    Publius was saying that we weren’t provided enough information in that story to tell if Sparky’s actions were fraudulent. And he’s right — fraud can be a tricky thing to prove.

  31. Sparky’s actions were clearly the commission of a fraud.
    Under common law, three elements are required to prove fraud: (i) a material false statement made with an intent to deceive (scienter); (ii) a victim’s reliance on the statement; and (iii) damages.
    Sparky has admitted to the first element of common law fraud (and says in his post at 10:27 a.m. that he’d do it again).
    The lending entity relied upon Sparky’s materially false statement, so the second element of common law fraud is met.
    The third element of common law fraud is also present when the lending entity under-priced the loan to Sparky based upon Sparky’s material false statements rather than upon Sparky’s true financial history. This under-pricing of the loan is damages to the lending entity.
    Therefore, notwithstanding Publius’ post at 11;40 a.m. to the contrary, there’s little question in my mind that Sparky’s actions, as Sparky himself has described them, fit the definition of common law fraud, and fraud is a crime.
    Sparky – I’m not your attorney, but if I were, here’s what my advice to you would be: It is never to your advantage to admit to the commission of a crime on a non-privileged basis, nor is it ever in your interest to state your readiness to commit a future crime, irrespective of whether such statement is privileged or non-privileged. Accordingly, at a minimum, you should stop admitting to any past crimes, and you should also refrain from asserting your willingness to commit future crimes.

  32. sparky,
    Touche again! And you told me on another thread that you were the first homebuyer I had met that wasn’t a “secret fraudster”!
    Seriously, though, notwithstanding Mark D.’s cogent analysis and advice, I’d respectfully submit that fraud would be difficult to show here. The key in my mind is element 2 in Mark D.’s analysis, the very common legal principle of RELIANCE (usually in contract claims, the idea of detrimental reliance – namely, that a party relied on a representation to his DETRIMENT). This also impacts element 1, the very common idea of MATERIALITY (the lie has to be about something important to the other party’s decisionmaking process).
    Here, the lenders set up a system that they KNEW invited fraud. There is no question about this. The lenders KNEW that borrowers were overstating income. In fact, Tanta at Calculated Risk (a former mortgage executive) has chronicled many times how the lenders went out of their way to PREVENT any examination of the actual facts and income of a borrower. They did not want to have any knowledge that the borrower was actually lying because they wanted “plausible deniability”.
    You see, if the originating lender had any information that cast doubt on the idea that – say – an “agronomist engineering specialist” (who couldn’t speak a word of English and signed the loan document with an “x”) was actually an illiterate strawberry picker, the originating LENDER would have been party to a fraud when it passed the loan off for packaging in MBS. That knowledge would have made it difficult to get that “agronomist” into a $720K house in Gilroy. And that would have meant no commission dollars, and the system just couldn’t stand for that.
    These considerations of reliance and materiality – which were common apparently – raise considerable questions as to whether the originating lender “relied” on any misrepresentation. In addition, they also raise questions as to whether the borrower withheld a “material” fact, although these questions are more subtle IMO. Arguably, the “true” income of the borrower was not a “material” fact, although I recognize that reasonable attorneys could disagree here. That’s what judges are for! (Good luck finding any solvent borrowers and lenders to really create good case law in this mess!)
    Typical fraud evident in all bubbles. Can you believe that people who ostensibly had greater than double digit IQs back in 2004-07 tried to deny that there was a bubble! As I’ve written, everyone was a secret fraudster in this fiasco, and please do not waste any sympathy on any of them as it blows up.

  33. I guess it is good to be reminded that I should not give out any information on this site. I had slipped slightly, and will not make that mistake again. I mean when I have to start hearing about what I should be telling my lawyer, I think it’s time to stop talking. This will have to include anything building, permit, and construction cost related as well, as I sure that could be spun into some sort of litigation.

  34. “Once again SS bites the hands that feed. You all clamor for information.”
    We do. We love information. But it’s good for posters to remember that we are not hanging around a bar shooting the breeze. You’re posting things to an archived and publicly available site and some discretion is a good thing.
    One of the things about the Enron scandal that struck me was how many e-mails of the form:
    Hey John!
    So how’s the illegal price fixing scheme going? The other members of the conspiracy would like an update.
    were retreived from the enron computers by prosecuters. It’s a new era, and we’re all just speed bumps on the information super highway.

  35. Sorry, for anything written on here in the last few days. My 6 year old had taken over my computer and wrote all kind of incorrect information.

  36. I have never exaggerated, lied, over-stated, or cheated on anything. I was just trying to get a rize out of my good friend Mark D., and it worked jokes on you. Ha Ha

  37. And now the re-invention; Sparky-the-bull uberbull waiting to jump into purchasing after the can’t come soon enough RE value nose dive.

  38. You turkeys actually think that a bank that IS getting paid back on its mortgage would somehow prosecute a responsible borrower for overstating their income? At a cost to them of … what, $100k in legal fees not to mention whatever losses they’d take on the note after it defaulted?
    You are all, officially, retarded (except Satchel), and maybe sparky who can actually pay a SF-sized mortgage so he must be good at something. All the rest of you are ‘tards.

  39. Re Sparky at 7:24 a.m.: “I mean when I have to start hearing about what I should be telling my lawyer, I think it’s time to stop talking. This will have to include anything building, permit, and construction cost related as well.”
    Not really. It’s only time to stop admitting to the commission of a past crime and to refrain from asserting a willingness to commit future crimes.
    You might not like my posts in this thread, and I can’t say that I like the name calling in your posts. But I’ve given you good free advice here, and I’m glad that you appear to be taking it.

  40. “Didn’t you sign and affirm on your mortgage application that all of the information you supplied on the application was true and correct under penalty of perjury? And aren’t you now admitting here on SocketSite that you have engaged in the commission of a fraud? ”
    After I originally read this comment from Mark D, I thought the thread just degenerated into stupidity like some threads here do. And I thought, what self-rightous, holier-than-thou, arrogant prick! I mean his comment was so off topic and just came out of nowhere.
    But the thread has turned into one of the more interesting ones, packed with some real insight.
    Anyways, back at least partly OT, it appears the federal government is refusing to rescue (or appearing to do so) Lehman Brothers by putting up real tax payer dollars like it did with Fannie/Freddie/Bear Stearns.

  41. Mark D., you cut the second half of that guy’s (“sparky”) post, I think in the first half he said he would stop admittingy to anything on here as you suggest.
    Just makes my happy that I’m a renter.

  42. mark d, with ya bad self runnin things, what’s up with ya bad breath onion rings?
    well i’m mark d and i’m back from the dead/
    callin out valuable posters like a d**h**d/
    givin valuable legal advice. you’d be wise to take notice/
    what’s your real name so i can avoid closenes

  43. You are all, officially, retarded
    wow. a little bit of a generalization? many of us on here have said nothing about sparky’s situation at all.
    are we the mute retards?
    I agree that sparky’s alleged loan document misrepresentation and the ensuing legal ramifications are boring at best. I also get tired of the “you better watch out” arguments because they suppress information. besides, if they didn’t bust Casey Serin they’re not gonna bust anybody.
    but there is a kernal of important confirmatory information held within: many people have loan documents that may or may not be fully reflective of their true credit quality and their ability to repay the note.
    This is why mortgage securitization outside of Freddie and Fannie is essentially dead. it is also why Lehman is dead. And also why Merrill Lynch, Washington Mutual, Wachovia Bank, AIG, and other firms MIGHT die.
    Nobody trusts the underlying quality of the notes anymore. Once trust is lost, it can be difficult/impossible to regain. thus, our mortgage market is slowly being nationalized.
    short term nationalization has reduced mortgage rates, but it is thus far unclear how “loose” the terms will be. longer term we’ll have to see what the political will becomes once the losses start building up on the Federal Budget. anybody who claims to understand what the govt will do in that circumstance is either deluded, a liar, or a time-traveller. as example: last year who would have guessed that the people vying for office now would be Obama/Biden and McCain/Palin?

  44. chuckie:
    we’ll just have to see what the end result of these talks will be. I’m guessing we’ll find out before asian trading opens later today, even tough china/japan are closed.
    my personal feelings is that Lehman will be left out to dry and the resolution will come without explicit taxpayer money. But as you know, there are fun ways to play with numbers so that the taxpayer money is given implicitly instead!
    the reason Lehman is going to be left out to dry is because there are bigger problems right now
    1) washington mutual. if they go down they will possibly bankrupt the FDIC and Treasury will need to bail out the FDIC (that could cause bank runs)
    2) AIG. AIG is outside of Federal Reserve/Treasury control. in fact, they are regulated by the STATE insurance boards. but the problem: the state insurance boards don’t understand Credit Default Swaps-which is what is bringing AIG down. AIG going down would be HUGE. I suspect that there will have to be “bending” of authority so that the Feds can assist.
    There is also Merrill and Wachovia coming up as well…
    so Lehman is in the unfortunate place where they thought they were too big to fail, but there are 2 bigger fish to fry right now, and then 2 more bigger fish that may jump on the hotplate as well.
    The federal government can only do so much.
    This is unraveling faster than I had thought. It’s a little unnerving.

  45. “if they go down they will possibly bankrupt the FDIC and Treasury will need to bail out the FDIC (that could cause bank runs)”
    But can you imagine what would happen if a major bank went down, the FDIC went broke and the government just shrugged it’s shoulders and said “tough cookies”? Monday morning every American would be in line to withdraw their money from every bank in the country. Which is why even the concept of the FDIC not being supported will never be floated even as a trial balloon. The printing presses will be fired up as needed to bailout the depositors.

  46. diemos: you have no argument from me. All major commercial banks will have their insured deposits covered (and likely many of the non-insured deposits as well), and if/when the FDIC runs out of money it needs to be bailed out by Treasury. There isn’t a man alive who thinks otherwise. (at least not a man alive who understands anything about banking)
    We would immediately enter the biggest depression in human history if any commercial bank the size of WaMu failed and the insured depositors weren’t made whole. Double that if the FDIC weren’t bailed out. imagine it… if FDIC failed then ALL of our money in ALL banks would be at risk. everybody in the country would immediately run to their banks to get their cash before the bank ran out of money!
    which is why I do not think that the Fed/Treasury/FDIC will allow WaMu to go down. I’m gueesing that the Fed/Treasury/FDIC have some sort of plan or trick up their sleeves to keep the big boys from falling. (Wash Mutual, Wachovia Bank, etc). But this is one reason why they are being more vocal about the banks in trouble, to allow depositors time to get under FDIC limits.
    it is also why Lehman is unlikely to get a hand. They are an investment bank and thus MIGHT be able to fail without killing our economy.
    (looks like they’re gonna go BK as I write this, but details still not out)
    chuckie: if you bought the WaMu CD they’ve been advertising of late it is FDIC insured. as is BofA’s 5% CD. (of interest: you can immediately pinpoint the banks in trouble or in need of cash by seeing who offers above-market CD rates)

  47. They are an investment bank and thus MIGHT be able to fail without killing our economy.
    Good grief, this sounds like the Viet Nam Domino Theory all over again (“sure viet nam is an obscure country but if we don’t save it, the whole world will fall to communism”: we didn’t save it, and the world was OK).
    The US economy is not so fragile that a single bank failure is going to kill it. There will be some medium sized investment bank that will spring up to takes Lehman’s place. No big deal.
    The BIGGER deal is what happens when Lehman fails and the world survives. The financial domino theory will have been proven wrong and they can then let Fannie and Freddie and the rest of them slide into the toilet.
    Other businesses will spring up to replace the ones that failed, and the world will be a healthier place. And those banks that lost money on Lehman trades will stop trading with banks that screw around or they’ll find they lose money too. And watch how quickly the financial institutions self regulate (and unload all the junk they are carrying, if they can) when that happens.

  48. I agree with tipster here. No big deal if Lehman goes Whisky Tango Foxtrot, and it looks like that is what is going to happen. Well, maybe it’s a big deal if you are one of the 25,000 or so employees there. Practically all of them are surplus to the economy.
    The real news in the casino appears to be what is happening with Merrill (looks to be acquired by BoA) and AIG. Tomorrow should be an interesting day in the markets. The terror that the Fed is not willing to backstop the entire financial system has to be balanced against the apparent willingness of BofA and private equity groups to act as knifecatchers (perhaps with some behind the scenes support from the Fed).
    What is – and has been – missing is any inkling that the Fed is willing to “print” its way out of this, which comes as no surprise to me, and obviously no surprise to the USG debt market (rates have been falling, not rising). My gut feeling is that there is – and has been – a deal behind the scenes among the Fed, the BOJ, Bank of China and ECB regarding US money supply growth. Although people here throw the idea around that the Fed has been “printing” like mad, if that’s true, we have no evidence of it.
    In fact, narrow money supply growth rates have been trending DOWN for years now, and appear very steadily disinflationary even in the face of the obvious turmoil in the credit and asset markets. Don’t trust me – go to the Fed’s own chart:
    (Look at the long term chart of base money growth.) Any printing would show up there as an increase in base money, or I don’t understand this as well as I think I do. If anyone out there who has referred to the Fed as “printing” (NVJ?) can point to an aggregate that shows that the Fed is “printing” money, I’d love to see it. Just for reference, M3 does NOT reflect direct Fed action, so its growth would not be evidence of the Fed printing (which requires an expansion of the Fed’s balance sheet).
    I agree with those who posit that the FDIC will fail. No question about that. But again, whether the Fed will “print” currency to make everyone whole is a leap of faith. There are MANY options open to a monopoly central bank when faced with “bank runs”, including the imposition of all sorts of controls (as in the crises of the 1990s) right up to and including the granddaddy of them all pioneered by our own FDR in one of his first acts: the “Bank Holiday”.
    If China and BoJ are calling the shots, we should keep in mind that the PRIMARY goal of the USG and the Fed is not to make the population “happy”, especially because they know that it won’t work anyway (if a country could “print” its way to wealth, there would be many more wealthy countries!). Its goal is to preserve the international financial system, as the US derives immense benefits from having the reserve currency. Chief among these is the ability of the US to live beyond its means, and for the USG to fund itself at absurdly low rates. Whatever is being discussed and agreed at those behind the scenes meetings, there is one thing IMO of which you can be sure: the interests of indebted households and “ordinary” Americans are the FURTHEST things from their minds. Any belief otherwise requires, well, a giant leap of faith.

  49. How do you think The Fed gets the money into the money supply? They have to give it to someone, usually a bank, who will then circulate it. In spite of his moniker “Helicopter” Ben is not going to leave bundles of 100 dollar bills lying around. At least not ones you can get your hands on.
    Those Fed charts show a money supply growth of 1%, this in spite of all the capital that has gone to “money heaven” as you put it. There is a massive deflationary effect from the credit collapse that The Fed and Treasury are trying to counter with various types of currency intervention. So far, they have been able to do so. They still have plenty of other tools they can use at their disposal, like reducing the currency reserve requirements.
    When The Fed takes Mortgage Backed Securities that are worth 80 cents on the dollar and lets banks use them as collateral that is one way of “printing money.” They just gave the bank an interest free loan of 20% of the value of the MBS.
    There are other things they are doing as well, but that one is the one that I can think of off the top of my head.
    And I said that The Fed will just start up the printing presses before letting the FDIC fail, I never said that they have started doing it yet. If push come to shove, I am sure that they will do it before risking total financial collapse and you will know it when they start because inflation will take off like a rocket.
    Right now, it seems like Britton Woods II is still holding steady, with no doubt co-ordinated action with The Fed, BoJ, China and probably the Saudis to keep the asset bubble deflating at a measured pace. Everyone involved is interested in preserving the status quo.
    I wrote up a paragraph predicting who was going to end up bailing out whom and which banks were going to be allowed to fail, but the truth is, your guess is as good as mine.

  50. “How do you think The Fed gets the money into the money supply?”
    They do it in one of two ways. The most common is they PURCHASE treasuries or other assets on the open market, “printing” the currency to do it with. This is known as POMO (“permanent open market operation”. I don’t think they have done a POMO since March 2007, but honestly I don’t know that for sure.
    The second way is to reduce reserve requirements.
    Both of these show up in the adjusted monetary base aggregate. This series adjusts for changes in reserve requirements, so that the figures are comparable period to period.
    All the other programs (TAF, TSLF, PDCF, etc.) are LENDING facilities. They are supposed to be paid back. Will they? Well, I suspect not all of them. And that’s why I ultimately do expect some large scale printing. But I also expect much of it to be foisted onto the taxpayers, and I do not think the printing will be anywhere near enough to stave off what is coming. This is similar to what Japan did in the late 1990s and early 2000s, and was of course not enough to stave off the deflation of assets and the collapse in monetary velocity as lenders no longer want to lend. That’s always been my message for people who care about this stuff: beware leveraged assets (like real estate) and do not assume that the Fed and the USG care about YOUR well being. They have much bigger fish to fry.
    “And I said that The Fed will just start up the printing presses before letting the FDIC fail, I never said that they have started doing it yet.”
    My apologies, NVJ. The only reason I mentioned your name (with a ? mark) with regard to printing is because you wrote this, which to me sounded like you were saying the Fed is ALREADY printing:
    “The Fed will just keep printing money: so far they have successfully walked the precipice between deflation and “real” inflation, the kind where wages go up, not just prices, quite well….[snip] Posted by: NoeValleyJim at September 8, 2008 5:52 PM”
    But I can see where you probably just meant that the Fed WILL resort to printing. In that regard you and I don’t disagree. It’s just that I do not think the printing will be enough to walk that tightrope, and certainly not enough to offset the deflation in asset prices that is coming.
    Time will tell! But it’s worth noting that if one agrees with me (which I have been spouting CONSISTENTLY on SS for at least 9 months now), one would have been long treasuries, short US credit, out of real estate, flat/short US equities or at least “light” in equity exposure, out of muni bonds, short financials and short (or flat) emerging markets, and long (or at least relatively flat) the USD. That portfolio has worked very well this year I can assure you!
    An inflationary portfolio would – at the very least – have been short US treasuries and short the dollar, which for the most part would have been a very painful trade these past 9 months (particularly the last two or three). And, of course, long leveraged real estate, which would have been a mistake EVERYWHERE this year, even in the “real” SF I’m afraid (though not too bad – yet).

  51. tip/satch:
    although I agree with your ideas that Lehman is not too big to fail (read my previous posts where I said as much), I also think you overly state your case that life would just be fine if these financial institutions fail.
    nobody knows what will happen when/if these firms fail. nobody. not me, not you, not the Federal Reserve Bank. It is highly likely that Lehman’s failure will be absorbable. However, I disagree with you both: I think it is highly likely that failures of Fannie/Freddie of AIG can devastate our economy.
    note that I say likely… because these firms are a black box, and we don’t have the information.
    But Fannie/Freddie are used by central banks and sovereign wealth funds as a proxy for governmental debt. they always have been despite the obvious disclaimer that they had no explicit gaurantee. If we had let them fail and wiped out the debtholders it would be exactly one day before our government hit bankruptcy. we rely on the foreign money to pay our bills.
    AIG is a counterparty to almost everybody in a CDS market. It dwarfs any of the investment banks. If they fail, it could be months to years before our financial companies even know if they are solvent. Imagine AIG failing and then bank of america not knowing if it is bankrupt or not for over a year. to give an idea of the complexities of these companies, people STILL don’t know what Fannie and Freddies books really are-YEARS after the restatements started.
    I agree, all these investment and commercial banks can be replaced… but it takes time. You can’t just replace lehman in the next week.
    thus, the Fed is trying to engineer a slow deleveraging… this gives the financial markets time for the strong to absorb the weak, and for new players to strengthen. of course, it’s all predicated on trying to ‘save’ our financial system… a dubious cause if there ever was one.
    anyway: none of us even know what is going to happen tomorrow much less a few years out, except that the current financial setup is basically done.
    but I think you are too flippant with the idea that these firms can just fail and nobody will care. There will be immense pain (although absorbable) from Lehman failing, and we will have to wait and see where that pain ends up. Is it a hedge fund? Is it Goldman Sachs? Is it your grandmother’s pension fund? Is it the Municipal water supply of Akron, Ohio? who knows.
    but we’ll find out.

  52. FWIW:
    back to topic (gasp)
    I hope the events of today (2 of the largest investment banks of all time going away leaving only 2 left) finally impress upon you all that there will be no return to loose mortgage lending by the private sector anytime soon. (years to decades).
    now the govt on the other hand is another matter of course. but really, who wants to pay higher taxes so that people can have overly cheap mortgages? I guess we’ll find that out too!
    and of course today’s proceedings will further the possibility of recession.
    but the sun will come out tomorrow, the birds will still sing, your loved ones will still love you. in the end, there are more important things than money. un/fortunately, I think we’re all going to learn this.

  53. “Good grief, this sounds like the Viet Nam Domino Theory all over again”
    No, it’s a manifestation of the positive feedback loops that are inherent in any system that allows financial entities to invest using borrowed money.
    An asset price falls. If it’s enough to impact the entities capital ratios then they have to sell assets to bring them back into line. That causes asset prices to fall and impacts the capital ratios of other firms which then have to sell which then depresses asset prices further. If eventually the entities equity is wiped out then it can’t repay it’s leverage and you can get into cascading cross-linked defaults. A chain reaction where everything implodes.
    The more leverage financial entities are allowed to take on the easier it is to trigger the chain reaction. Limiting leverage makes the system more robust by providing each financial entity with a larger cushion of equity with which to absorb losses and break the cascade. Limiting leverage also prevents the entities from driving up asset prices and thus limits the potential losses that need to be absorbed on the downside.
    If we lived in a world where no financial entity was allowed to lever up more than 4x and thus had a 20% equity cushion to absorb losses I would agree wholeheartedly with the “let ’em fail” bunch. (and note that shareholder equity doesn’t count in this calculation, only a liability that appears on the entities balance sheet and can be written off to cancel losses on the asset side counts.) In that system you could safely let them fail without taking down the whole financial system.
    We don’t live in that world.
    Our system is highly leveraged, enough to easily support a chain reaction in my opinion. I think we already saw the initiating event when the Bear Sterns hedge fund tried to sell their CDOs last year and only got a bid of 5 cents on the dollar. Only Dr B’s alphabet soup of lending facilities prevented price discovery in the MBS market and kept the implosion in abeyance. We’ll see whether he can perform a controled de-leveraging or whether it’s going to blow up on him (and us).
    Benjamin Bernanke!
    He’s our man!
    If he can’t save us!
    Nobody can!
    and of course it goes without saying that the CORRECT solution is to never allow the system to get in this state in the first place. But now that we’re here shock therapy would kill the patient.
    If you ever saw the movie “spaceballs” there’s a scene where the commander decides that lightspeed is too slow and demands to go to LUDICROUS speed. Discovering that this is in fact too fast the commander orders his subordinate to stop the ship. He replys, “Sir! We can’t stop. It’s too dangerous. We have to slow down first.”
    I’m afraid that’s very apropo to the situation we’re currently in.

  54. Mark D. – Sorry I’ve been following my fantasy football scores and have not checked this site since your comment in response to mine. I’m afraid that Satchel already pointed out one of most prominant flaws in your analysis.
    There is another flaw in your analysis. You are also going to have a very difficult time showing any damages here as the facts given state that sparky has not missed any payments and intends to continue. You could make an argument that the lender provides a better interest rate and, therefore, losses some interest. I don’t find this argument particularly convincing especially in light of Satchel’s point regarding the business practices of the lenders providing these loans. Your conclusory analysis to the contrary there is no fraud here. Certainly not yet.
    I’m sorry. I don’t mean to be too disrespectful, but you just gave a C level answer to a first year hypothetical.

  55. What is the difference between reducing the reserve requirement and allowing a bunch of dubiously valued assets be used as reserve? Ultimately, they have the same effect, which is to allow the banks to lend more, putting more currency into the M2. There is a whole range of things that both The Fed and Treasury can do to make sure we don’t suffer a deflationary collapse. I am sure there are a bunch of things that no one has ever thought of too, which we will see more of in the coming months.
    I am not sure exactly how the Argentine hyperinflation came out, or the Brazilian or the German, but it really doesn’t matter. Whoever controls the printing press always has that option. It is always disruptive and there are some economic consequences, of course, but it happens more often than most people want to think about. In the last hundred years, I can think of two Brazilian defaults, two German defaults, two Russian defaults, one Chinese default, one Japanese default. I am sure there a raft of smaller economy defaults that I am not aware of. It seems it happens at least once every year, right now to Zimbabwe.

  56. I have a technical question about credit default swaps. When one party buys a CDS from AIG, they are expecting AIG to make good in the event of a default by the primary bond issuer, right? How do they take into account the possibility of an AIG insolvency? Why pay for this insurance or option in the first place if the solvency of the other party would be in doubt (presumably from the same factors that prompted the first party to get a CDS)?

  57. FSBO, there is always counterparty risk, but AIG was AAA rated until a few years ago.
    Oh, and the Fed just announced that they’ll be accepting equities at the loan window.
    See, there is something no one has ever thought of before. How are they going to value the equities? Market value at the time of exchange?

  58. Insurance companies are heavily regulated because there are few things more profitable than selling insurance policies, pocketing the premiums, and then declaring bankruptcy the first time somebody wants to get paid. Allowing financial companies to run wild writing insurance policies that they had no means to make good on will be one of things future historians will point to when they write the analyses of what went wrong.

  59. Thanks NVJ and diemos. I guess that’s why I never bought earthquake insurance. I figured that the issuer wouldn’t be solvent in the event of a big quake. Even if they are AAA now, that might change immediately after the quake. I guess that’s why you buy insurance on the insurer in the CDS market. Derivatives seem like a fee-driven scheme.

  60. Hmmmm Let’s see.
    1. The banks have all lent out 50x their capital at 4% interest to homeowners.
    2. Most of those loans are performing.
    3. The banks borrow short term to keep those loans funded and they keep rolling over the debt.
    4. If inflation creeps up, the short term debt will get more expensive right away, while the longer term debt stays the same or gets incrementally more expensive, being subject to caps.
    Therefore, with higher interest rates, more of the banks will file for bankruptcy, as their costs exceed the money they make on the loans.
    So I think it’s pretty clear the printing of dollars will be avoided at all costs. The fed is boxed into a corner: it can’t inflate. Any other ideas?

  61. To Publius at 7:45:
    In my post earlier today, I offered up a prima facie analysis with respect to Sparky’s facts and the elements for common law fraud, and I provided a 3-prong analysis to support my argument. I think this argument could be sustained before a finder of fact; you do not. Fair enough. Materiality and damages are issues for the fact finder, which is not you. You also say that you meant not to be too disrespectful towards me. You failed.
    After being called a dick and a prick earlier on this thread and after being disrespected in your posting, this will be my last post on this thread.

  62. Mark D – Don’t be too sore.
    I just need to point out that you stated that “Sparky’s actions were clearly the commission of a fraud.” You then offered your perfunctory prima facie analysis as support for this conclusion. Now, you state that issues remain for a fact finder to determine. Therefore — by your own admission — there is not “clearly” anything here. Also, whether or not your argument could be sustained before a finder of fact is a red herring. Such an argument would never see the light of day in court.
    And to be fair, you have had some pretty definitive and harsh things to say to others on the board. Your comments regarding a “crime” being committed is what got to me most. Perhaps if you tempered your comments a bit, you wouldn’t get the response you have.
    That being said, don’t take anything I said too seriously. It was just some good-natured ribbing.

  63. I **just** sent AIG our annual premuims for 2 life insurance policies, and now I wonder if I just flushed all that premuim money away…… probably no chance of them selling off their insurance business to someone that would honor the policies written…. And of course, our mortgage is with Lehman. Sigh. (if only the loan would die like I think the AIG insurance coverage will when they go belly up…. haha)

  64. Wow, I wonder what king of trick the Fed will be pulling out of its hat tomorrow. Financials will be slaughtered. I think WAMU will be next Week-End’s story.

  65. If you have an AIG life insurance policy and you die before you can get a new policy from a different carrier, California has a state guaranty fund that supposed covers 80% of policies up to 250K. (Part of your insurance premium goes into the state fund for this purpose.)
    Unfortunately, “supposedly” is the keyword because if you call up any state guaranty fund and ask them if they cover you, they will give you the run-around with nebulous answers because they want to reserve the right to not pay out (partial or in full) when an insurance industry meltdown happens. (The states can’t print money like the U.S. can with FDIC.)
    So the best answer is if the insurance industry goes bust, you should hope your company goes bust first and you collect before the state funds run out of money.

  66. tipster:
    I disagree with your analaysis.
    I don’t like the word “printing” because it doesn’t really mean anything. what people are really talking about is money creation. there are several mechanisms through which the Federal Reserve can help the banks which also may increase money supply.
    The Fed controls short term interest rates. the banks are borrowing short term and lending long term. The Fed can, if it chooses, lower Fed Funds Rate to 0%. This will affect the short end of the curve helping banks where they need it (lowering short term interest rates). They can combine it with lowering reserve ratios.
    Lowering reserve ratios will increase the amount of money banks have to lend, and lowering the FFR will give banks lower rates in which to do it. So clearly they will benefit from this.
    The 2 tricks
    1) getting the banks to then lend out that money (the so-called “pushing on a string” theory)
    2) longer term interst rates will eventually likely go up, the fed has no control over longer dated paper.
    3) it will cause massive price inflation ELSEWHERE in the economy. (this is what caused the brakes in the current setup… too much Fed Easing too quickly spurred commodities and oil bubble)
    4) keeping our creditors happy.
    remember: the banks get the money FIRST. thus, they get more benefit of “new” money compared to people who get it later.
    ZIRP obviously won’t cure the problem… but it can buy time. it is also inflationary (monetary wise). Your argument that it cannot be done is thus incorrect IMO.
    But it’s an easy theory to test: let’s just watch and wait how long it takes before the Fed lowers the Fed Funds Rate… and also how long before a “surprise” announcement about lowering reserve ratios.
    (FWIW: I consider active slowing of monetary deflation to be the same thing as monetary inflation)
    Now that said: to date the Fed has increased liquidity to the banks BUT THEN STERILIZED that liquidity which goes back to Satchel’s point that there is no “printing” (hate that word) or monetary creation. But I fear we may be nearing the end of sterilized intervention (for example: the Fed buying equities directly… is this a step towards monetization of debt?)
    American monetary and fiscal policy is focused on deflation, because that is from where our Great Depression arose. so we tend not to worry as much about inflation. Other parts of the world worry about hyperinflation, because that is in their history (e.g. Germany/EU).
    I thus believe that our history of Deflationary Depression will color our future decision making process… so that when push comes to shove we will inflate. (heck that’s what we have been doing the last year and a half). but we will stop shy of hyperinflating if possible.

  67. Crockergal, don’t panic over (or even worry about) your AIG life policy. I am not 100% certain of the AIG corporate structure, but I suspect the life sub (there are many — SunAmerica, American General, AIG Life, others) with whom your policy is placed is in far better shape than the corporate parent or its financial subs, and the insurance subs are separately incorporated and not responsible for the parent’s debts. After the failure of Executive Life in the early 90s (bad junk bond bets — enabled Michael Milken and paid for it), state insurance regulators really stepped up their regulation and oversight of insurers and have done a good job. If only the securities regulators would have done the same.
    It’s of course possible that some insurers will fall from even indirect bets on the same garbage that is bringing other companies down. But insurers are forced to invest extremely conservatively, so I would not expect widespread problems in this segment. It’s more likely imho that insurers (inc. insurance subs of holding companies) will be an island of stability.

  68. I think tipster is right in the short term, ex SF-er in the long term. The key IMO in a fiat system like we have that relies on private credit creation is the overall level of debt in the economy. There is NO WAY to “force” private lenders to lend against overvalued assets, and there is NO WAY to get private employers to raise wages in real terms. Money “creation” will be hoarded by the banks to cover up their past sins. Monetary velocity will collapse, taking real output with it.
    The examples of hyperinflation have almost always happened in instances where the government was a LARGE direct employer, consumer and investor. In the US, the share of government spending (including Federal and state) is only about 20-21%. HALF of the Federal budget (more or less) is transfer payments. Access to “first money” here will do little to incent banks to reflate because in REAL TERMS the prices of assets are all TOO HIGH. Why lend when you know you CANNOT earn a return?
    IMO we will undergo a debt deflation, and I will go further to say that the Fed WANTS this. They know that ponzi schemes do not continue forever, and they have been trying to engineer this deflation before complete collapse ensues. They are trying to moderate the pace of declines so that the bulk of the loss is not sustained by the banksters. In this endeavor, they are a bit constrained by the foreign central banks and the knowledge that loss of the USD as a reserve currency would be catastrophic. The pain of the population is the LAST thing on their minds, and I simply do not understand why people have this almost child-like belief that the USG and the Fed are looking out for them. They DO NOT fear protests by the population – have you seen any so far?
    IMO, only when asset prices are lower, and there is less overall debt (either through repayment, default, retructuring, etc.), will banks and individuals respond to reflation efforts. Until then, there simply isn’t the capacity or desire to continue the debt ponzi scheme. Japan has been waiting for these “reflation” conditions for 17 years already, but I think the US will go quicker. A large scale shooting war always remains a possibility for jump starting the economy, just as it was at the end of the 1930s (that’s what brought us out of the Great Depression, NOT FDR’s New Deal).

  69. no offense, but i laught when i read the distinction between
    ‘short term’ and ‘long term.’
    well if we’re all dead in the long run anyway, that isn’t much of a prediction eh?
    deflationary delevering like this takes an eternity. maybe you wondered why the markets haven’t cratered today? well, the answer is easy. markets, by definition, exist to value things. with this latest bit of collpase and forestalling, another attempt has been made to prevent the markets from coming up with an actual, marked-to-market, value for the garbage that these companies are holding as ‘assets’ on their books.
    to be sure, lehman imploding was a step in the right direction. but the ‘orderly’ liquidiation of their ‘assets’ is just another way of saying that the other banks and the Fed and the US govt (complicitly) will allow these assets to linger, unmarked to market, until perhaps they are either worth more, or proven to be worthless (or close to it). either way, this will take a long time. this lag time will allow the other banks to delever themselves, and take incremental markdowns on their ‘assets.’ The BofA ‘merger’ with Merill was essentially a way to keep their assets from getting marked to market. The bet BofA has made is that the ‘assets’ on Lynch’s books will survive under the shield of less aggressive marking to market courtesy of BofA’s stronger balance sheet. In the meantime, BofA gets the benefit of the investment banking division. This either ends with BofA blowing up (which the Feds won’t allow – smart move there), or with BofA becoming the new King of the Hill. A bold bet to be sure. But with that bet comes the continued slowing of this deflationary collapse. Mergers like this one prevent a sudden bottom (V shaped) and gives us a longer ride to the slow and long lasting bottom.
    the slower the process, the longer this takes. the longer it takes, the more leverage the remaining banks can get off their books. in the meantime, capital is hoarded, credit is hard to come by, and ‘business as usual’ cannot resume. Real GDP will take a 10% haircut.
    Deflation, as I have said before, especially laid bare, is incredibly ugly. In this case, it is absolutely necessary. There are no other good options here.
    For the past year, the spread between TIPS and nominal bonds of same duration have narrowed, indicating very low, and falling, implied inflation expectations. This is not by accident. Deflation, on a rather impressive scale, is finally beginning in earnest. Multiple posters have claimed inflation, and thus the great value of fixed debts in our current environment. This simply is not true.
    Look around, basically every single asset class that can be levered has collapsed. Equities – check. Real Estate – check. Commodities – check. Where is the inflation?
    Of course, the Fed can inflate. They have so much expanded power to do so now, through all sorts of chicanery. Whether they will or not is a not guessing game – they will. When they will is a guessing game. Whether it will work or not is the other guessing game.
    The Fed will not inflate aggressively until they absolutely have to. Doing so risks our balance sheet, and a credit downgrade of the US, basically unthinkable years ago, is an actual theoretical possibility if they go to fast too soon.
    This will be a rather severe deflationary recession. Lasting 1-2 years. Inflation/reflation after that. Actual recovery of real gdp – probably 5-7 years away. The only way this whole process speeds up is if all of these ‘assets’ on the banks books get marked to market immediately. Doing so would cause a massive drop in the equities markets – probably of 30% or more. And we would hit bottom right away.
    That is not going to be allowed to happen. So this is what we get.
    A very long short run, and a very far away long run.

  70. Sounds like we don’t disagree, enonymous. I’ve posted a number of times that I believe the defationary period will most likely last 2-4 years. That’s of course just a guess, as all these “predictions” are. In the meantime – until I see a sustained increase in base money for a sustained period of time (say, money printing in excess of 10% for 6 months or more) I will stay long US treasuries and flat-long USD.
    What is not a guess is this: the USG and the Fed will not sacrifice the USD (and its place in the world AND the ability of the USG to fund itself at low rates) just to salve the pain of an indebted household sector. The population will be forced to EAT the loss, and it will be very painful indeed (but necessary).
    My bet is that the USG will be there to help here and there with make work programs (infrastructure, “green” technology ventures, etc.) and various forms of welfare, which will have the effect of sucking out productive capital and prolonging the downturn. All these types of activities will increase the role and power of government, which is of course what government seeks. The Fed has tremendous powers, but they do NOT have the power to stop a deflation – only to shift around the losses. If smart bureacrats could stop the fall of asset values, the Great Depression could have been avoided, to say nothing of Japan’s experience in the 1990s, Indonesia’s in 1997, Russia’s in 1998, the Chinese stock market this year, etc.

  71. I sure hope it fails! It’s a ripoff, and unnecessary. Most importantly, it will lead to decreased transparency and more hide the weenie accounting games and gimmicks, which will make the ultimate unwinding of all this foolishness even worse and more painful. So, that’s probably why it will pass.
    Karl over at market ticker did a good video today that’s really worth watching (especially on how the Fed DRAINED $125 billion from the US money markets in the last few days – I bet no one from the main stream media has reported that):

Leave a Reply

Your email address will not be published. Required fields are marked *