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keep-it-cool

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Re: The crumbling of the US financial system (NC)
« Reply #120 on: September 22, 2008, 12:30:35 PM »

Can anyone explain why the following is not a better solution (not mine): Make the banks extend the fixed rate periods of the ARMs they took and pay the lost interest to the banks so that people can keep their houses? 

what does ARM stand for?

adjustable rate mortgage

oh ok .. a floating rate loan ... and fixed rate periods is the number of months that instalments have to be paid?
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kban1

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Re: The crumbling of the US financial system (NC)
« Reply #121 on: September 22, 2008, 02:46:53 PM »

Can anyone explain why the following is not a better solution (not mine): Make the banks extend the fixed rate periods of the ARMs they took and pay the lost interest to the banks so that people can keep their houses? 

what does ARM stand for?

adjustable rate mortgage

oh ok .. a floating rate loan ... and fixed rate periods is the number of months that instalments have to be paid?

No, not exactly

An adj rate mortgage can be 1/1, 3/1, 5/1, 7/1, 10/1

Each has a 30 year amortization.

The first number is the number of years the consumer is locked into the initial fixed interest rate.

Once the first number is over (1 yr, 3yr, 5 yr, 7 yr or 10 yr), the rate adjusts once every subsequent year depending on the prevailing interest rate in the market. The adjustment is based on an Index (prime usually, maybe LIBOR) + a certain number of bps and is capped at a maximum and floored at a minimum usually --which means in any given year your rate cant increase more than a certain number of bps
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keep-it-cool

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Re: The crumbling of the US financial system (NC)
« Reply #122 on: September 22, 2008, 03:01:13 PM »

Can anyone explain why the following is not a better solution (not mine): Make the banks extend the fixed rate periods of the ARMs they took and pay the lost interest to the banks so that people can keep their houses? 

what does ARM stand for?

adjustable rate mortgage

oh ok .. a floating rate loan ... and fixed rate periods is the number of months that instalments have to be paid?

No, not exactly

An adj rate mortgage can be 1/1, 3/1, 5/1, 7/1, 10/1

Each has a 30 year amortization.

The first number is the number of years the consumer is locked into the initial fixed interest rate.

Once the first number is over (1 yr, 3yr, 5 yr, 7 yr or 10 yr), the rate adjusts once every subsequent year depending on the prevailing interest rate in the market. The adjustment is based on an Index (prime usually, maybe LIBOR) + a certain number of bps and is capped at a maximum and floored at a minimum usually --which means in any given year your rate cant increase more than a certain number of bps

Thanks. Understood ...so, it is essentially a fixed / floating combination that runs over a fixed period of 30 years... i.e. 10/1 would mean fixed rate of interest for first 10 years and floating thereafter.
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kban1

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Re: The crumbling of the US financial system (NC)
« Reply #123 on: September 22, 2008, 03:28:54 PM »

Can anyone explain why the following is not a better solution (not mine): Make the banks extend the fixed rate periods of the ARMs they took and pay the lost interest to the banks so that people can keep their houses? 

what does ARM stand for?

adjustable rate mortgage

oh ok .. a floating rate loan ... and fixed rate periods is the number of months that instalments have to be paid?

No, not exactly

An adj rate mortgage can be 1/1, 3/1, 5/1, 7/1, 10/1

Each has a 30 year amortization.

The first number is the number of years the consumer is locked into the initial fixed interest rate.

Once the first number is over (1 yr, 3yr, 5 yr, 7 yr or 10 yr), the rate adjusts once every subsequent year depending on the prevailing interest rate in the market. The adjustment is based on an Index (prime usually, maybe LIBOR) + a certain number of bps and is capped at a maximum and floored at a minimum usually --which means in any given year your rate cant increase more than a certain number of bps

Thanks. Understood ...so, it is essentially a fixed / floating combination that runs over a fixed period of 30 years... i.e. 10/1 would mean fixed rate of interest for first 10 years and floating thereafter.

yes sir
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RicePlateReddy

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Re: The crumbling of the US financial system (NC)
« Reply #124 on: September 22, 2008, 03:34:24 PM »

A Bad Bank Rescue

By Sebastian Mallaby
Sunday, September 21, 2008; Page B07


http://www.washingtonpost.com/wp-dyn/content/article/2008/09/20/AR2008092001059.html

With truly extraordinary speed, opinion has swung behind the radical idea that the government should commit hundreds of billions in taxpayer money to purchasing dud loans from banks that aren't actually insolvent. As recently as a week ago, no public official had even mentioned this option. Now the Treasury, the Fed and congressional leaders are promising its enactment within days. The scheme has gone from invisibility to inevitability in the blink of an eye. This is extremely dangerous.

The plan is being marketed under false pretenses. Supporters have invoked the shining success of the Resolution Trust Corporation as justification and precedent. But the RTC, which was created in 1989 to clean up the wreckage of the savings-and-loan crisis, bears little resemblance to what is being contemplated now. The RTC collected and eventually sold off loans made by thrifts that had gone bust. The administration proposes to buy up bad loans before the lenders go bust. This difference raises several questions.

The first is whether the bailout is necessary. In 1989, there was no choice. The federal government insured the thrifts, so when they failed, the feds were left holding their loans; the RTC's job was simply to get rid of them. But in buying bad loans before banks fail, the Bush administration would be signing up for a financial war of choice. It would spend billions of dollars on the theory that preemption will avert the mass destruction of banks. There are cheaper ways to stabilize the system.

In the 1980s, the government did not need a strategy to decide which bad loans to take over; it dealt with anything that fell into its lap as a result of a thrift bankruptcy. But under the current proposal, the government would go out and shop for bad loans. These come in all shapes and sizes, so the government would have to judge what type of loans it wants. They are illiquid, so it's hard to know how to value them. Bad loans are weighing down the financial system precisely because private-sector experts can't determine their worth. The government would have no better handle on the problem.

In practice this means the government would make subjective choices about which bad loans to buy, and it would pay more than fair value. Billions in taxpayer money would be transferred to the shareholders and creditors of banks, and the banks from which the government bought most loans would be subsidized more than their rivals. If the government bought the most from the sickest institutions, it would be slowing the healthy process in which strong players buy up the weak, delaying an eventual recovery. The haggling over which banks got to unload the most would drag on for months. So the hope that this "systematic" plan can be a near-term substitute for ad hoc AIG-style bailouts is illusory.

Within hours of the Treasury announcement Friday, economists had proposed preferable alternatives. Their core insight is that it is better to boost the banking system by increasing its capital than by reducing its loans. Given a fatter capital cushion, banks would have time to dispose of the bad loans in an orderly fashion. Taxpayers would be spared the experience of wandering into a bad-loan bazaar and being ripped off by every merchant.

Raghuram Rajan and Luigi Zingales of the University of Chicago suggest ways to force the banks to raise capital without tapping the taxpayers. First, the government should tell banks to cancel all dividend payments. Banks don't do that on their own because it would signal weakness; if everyone knows the dividend has been canceled because of a government rule, the signaling issue would be removed. Second, the government should tell all healthy banks to issue new equity. Again, banks resist doing this because they don't want to signal weakness and they don't want to dilute existing shareholders. A government order could cut through these obstacles.

Meanwhile, Charles Calomiris of Columbia University and Douglas Elmendorf of the Brookings Institution have offered versions of another idea. The government should help not by buying banks' bad loans but by buying equity stakes in the banks themselves. Whereas it's horribly complicated to value bad loans, banks have share prices you can look up in seconds, so government could inject capital into banks quickly and at a fair level. The share prices of banks that recovered would rise, compensating taxpayers for losses on their stakes in the banks that eventually went under.

Congress and the administration may not like the sound of these ideas. Taking bad loans off the shoulders of the banks seems like a merciful rescue; ordering banks to raise capital or buying equity stakes in them sounds like big-government meddling. But we are in the midst of a crisis, and it shouldn't matter how things sound. The Treasury plan outlined on Friday involves vast risks to taxpayers, huge complexity and no guarantee of success. There are better ways forward.

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kban1

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Re: The crumbling of the US financial system (NC)
« Reply #125 on: September 22, 2008, 03:41:14 PM »

Can anyone explain why the following is not a better solution (not mine): Make the banks extend the fixed rate periods of the ARMs they took and pay the lost interest to the banks so that people can keep their houses? 

what i understand its a bit more complex.

banks gave out low interest rates (and lost money on it). They borrowed money from other banks/institutions with the expectation that when the higher interest rate kicks in they would pay them that. Someone has to take a loss.

No, inaccurate

Loans made at lower interest rates where when interest rates were low. Banks hedged the future by locking into funding sources that would allow them to make such loans.

The problem stemmed from the adjustment. When the rates adjusted upward, the banks were not necessarily locked into a lower cost of funds because the cost of funds were also locked in for a certain period.

Hoowever, in banking, the whole principle is profit via difference in interest rates. So even after the rates went up (sometimes astronomically due to the banks greediness in setting the original contract --predatory lending), the banks had significant room to operate.

Instead, the Banks failed to see the signs. As soon as the consumers started missing payments, the Bnaks started marking loans as delinquent, which led to foreclosures. usually, this is the normal course of action.  But in this case it backfired --years of lax credit, purchase with minimal equity in homes, falling home prices meant foreclosures happened in the 1000's, flooding the market with inventory of homes.

the Banks earned nothing from these foreclosed homes because OREO (other re owned) is a non performing asset on the Bank B/S. And it exacerbated the soft market conditions because there was a glut of homes unsold (including the foreclosed ones).

So essentially, the prof is right. Had the banks been prident and far sighted as opposed to greedy, a lot of this crisi could have been worked through.

And if this bailout is applied on the consumer side, then there is still a possibility of helping everyone (by shoring up the underlying asset), except just the corporates who practically created this mess through the need to capitalize on future big bucks.
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RicePlateReddy

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Re: The crumbling of the US financial system (NC)
« Reply #126 on: September 22, 2008, 03:45:36 PM »

And Ronald Reagan is still regarded as a hero!

  • His foreign affairs policies and funding created the Taliban and armed the ISI - this there is not even an iota of doubt about.
  • His deregulation mantra fed into the Savings and Loan Scandal in the late 80s that GHW Bush had to clean up (with Fed money) and the current set of crooks are just completing his compositions.

Two deadly creations that have left a terrible lineage that persists through decades, and have demolished much that was good in the US. This gunshot tax-payer funded bail out is one of the worst things I have seen. It is ridiculous that both pres. candidates have supported it in principle. It is the worst thing to be taking such strong impact decisions with an election season looming and everyone trying to sound populist, This proposal coming from self professed Republicans is devious and utilizes the exact things that they demonize the Dem. administrations for. And the Dems. are eager to oblige.  :BangHead: :BangHead:

Unless it crashes and burns (and yes, we all will suffer), it will rear its ugly head again within a few years (as opposed to perhaps several decades).
« Last Edit: September 22, 2008, 03:49:25 PM by ShortSquatLeg »
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keep-it-cool

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Re: The crumbling of the US financial system (NC)
« Reply #127 on: September 22, 2008, 04:27:14 PM »

Can anyone explain why the following is not a better solution (not mine): Make the banks extend the fixed rate periods of the ARMs they took and pay the lost interest to the banks so that people can keep their houses? 

what i understand its a bit more complex.

banks gave out low interest rates (and lost money on it). They borrowed money from other banks/institutions with the expectation that when the higher interest rate kicks in they would pay them that. Someone has to take a loss.

No, inaccurate

Loans made at lower interest rates where when interest rates were low. Banks hedged the future by locking into funding sources that would allow them to make such loans.

The problem stemmed from the adjustment. When the rates adjusted upward, the banks were not necessarily locked into a lower cost of funds because the cost of funds were also locked in for a certain period.

Hoowever, in banking, the whole principle is profit via difference in interest rates. So even after the rates went up (sometimes astronomically due to the banks greediness in setting the original contract --predatory lending), the banks had significant room to operate.

Instead, the Banks failed to see the signs. As soon as the consumers started missing payments, the Bnaks started marking loans as delinquent, which led to foreclosures. usually, this is the normal course of action.  But in this case it backfired --years of lax credit, purchase with minimal equity in homes, falling home prices meant foreclosures happened in the 1000's, flooding the market with inventory of homes.

the Banks earned nothing from these foreclosed homes because OREO (other re owned) is a non performing asset on the Bank B/S. And it exacerbated the soft market conditions because there was a glut of homes unsold (including the foreclosed ones).

So essentially, the prof is right. Had the banks been prident and far sighted as opposed to greedy, a lot of this crisi could have been worked through.

And if this bailout is applied on the consumer side, then there is still a possibility of helping everyone (by shoring up the underlying asset), except just the corporates who practically created this mess through the need to capitalize on future big bucks.

One can see where it all went wrong ...but, this would - by itself - not have created this entire problem. I mean falling real estate prices is not a new phenomenon and banks should largely be able to ride such phases out.

The problems started with the creation of this "sub prime" category of borrowers. Essentially, banks normally are (or should be) stringent with their loans - i.e. how much to lend (what percentage of the property value being lent against), to which customers (i.e. are they credit worthy, do they have adequate earnings capacity, enough years of earning work life etc) & the amount of loans should be commensurate with ability to pay. The business conducted with borrowers who meet these criteria was the "prime" business.

Now, with easy liquidity (a large part of which came from the yen carry trade), banks created a whole new category of customer - the "sub prime" borrower .. i.e. borrowers who otherwise would not qualify for a bank loan. When they started getting loans, why wouldnt they take it and buy property - which, in turn, led to property prices going up further - again, getting in speculators (who also got their share of easy credit) - again, sending property prices higher. Needless to say, this was good for banking business.

On top of this, this entire loan book was securitised in order to create more liquidity ... so, you had the CDOs and the mortgage backed securities - ie. banks selling the stream of cash flows they were expecting from the borrowers to investors in return for cash .. which was further used for lending to the market (including sub prime borrowers) - sending real estate prices higher and more speculators entering the market - a classic case study of an asset bubble being created. The value of a whole set of assets was largely linked to just one factor - property prices. A lot of these bonds did not have an actual market - they were just being valued on the basis of theoretical models. Prick the property price bubble and all would come down in a heap.

And then the recession fears started .. jobs were lost, earnings capability started dwindling ... I suspect (though am not sure) the "prime" borrowers would have been ok to start with ... but the sub prime business felt the pinch ... speculators had to sell houses or banks had to foreclose because property prices fell below loan outstanding amounts ... in turn hurting the value of all the bonds that were created ... in turn forcing investors to seek a market - which for most of the sub prime debt backed bonds did not exist realistically - leading to the write offs.

Now, the bigger problem was that the pure investment banks (who do not have banking functions and hence access to deposits from the public) have to depend on leverage to invest ... the Japanese money came in handy here to start with but when the yen carry trade reversed (i.e. money started flowing the other way), they had a problem. Moreover, when the asset side of the balance sheet started losing value, the lenders developed cold feet ... wanting their money back .. which obviously was difficult to give because it was invested in bonds that had theoretical values but no market.

Therefore, the collapse!! Maybe a bit too simplistic ... but that is what I feel about this entire situation.

Phew .. but prfsr, I dont think extending the fixed interest rate period would help salvage the situation in any way. Not at this point. Had the regulators not been sleeping (or deliberately ignoring the signs) and not allowed liquidity to balloon beyond control, a lot of this could have been controlled.

I think the US regulators should take a leaf out of the RBI and SEBI's books!
« Last Edit: September 22, 2008, 04:28:54 PM by keep-it-cool »
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keep-it-cool

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Re: The crumbling of the US financial system (NC)
« Reply #128 on: September 22, 2008, 04:28:12 PM »

Can anyone explain why the following is not a better solution (not mine): Make the banks extend the fixed rate periods of the ARMs they took and pay the lost interest to the banks so that people can keep their houses? 

what does ARM stand for?

adjustable rate mortgage

oh ok .. a floating rate loan ... and fixed rate periods is the number of months that instalments have to be paid?

No, not exactly

An adj rate mortgage can be 1/1, 3/1, 5/1, 7/1, 10/1

Each has a 30 year amortization.

The first number is the number of years the consumer is locked into the initial fixed interest rate.

Once the first number is over (1 yr, 3yr, 5 yr, 7 yr or 10 yr), the rate adjusts once every subsequent year depending on the prevailing interest rate in the market. The adjustment is based on an Index (prime usually, maybe LIBOR) + a certain number of bps and is capped at a maximum and floored at a minimum usually --which means in any given year your rate cant increase more than a certain number of bps

Thanks. Understood ...so, it is essentially a fixed / floating combination that runs over a fixed period of 30 years... i.e. 10/1 would mean fixed rate of interest for first 10 years and floating thereafter.

yes sir

thank you
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Cover Point

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Re: The crumbling of the US financial system (NC)
« Reply #129 on: September 22, 2008, 04:54:42 PM »

Can anyone explain why the following is not a better solution (not mine): Make the banks extend the fixed rate periods of the ARMs they took and pay the lost interest to the banks so that people can keep their houses? 

what i understand its a bit more complex.

banks gave out low interest rates (and lost money on it). They borrowed money from other banks/institutions with the expectation that when the higher interest rate kicks in they would pay them that. Someone has to take a loss.

No, inaccurate

Loans made at lower interest rates where when interest rates were low. Banks hedged the future by locking into funding sources that would allow them to make such loans.

The problem stemmed from the adjustment. When the rates adjusted upward, the banks were not necessarily locked into a lower cost of funds because the cost of funds were also locked in for a certain period.

Hoowever, in banking, the whole principle is profit via difference in interest rates. So even after the rates went up (sometimes astronomically due to the banks greediness in setting the original contract --predatory lending), the banks had significant room to operate.

Instead, the Banks failed to see the signs. As soon as the consumers started missing payments, the Bnaks started marking loans as delinquent, which led to foreclosures. usually, this is the normal course of action.  But in this case it backfired --years of lax credit, purchase with minimal equity in homes, falling home prices meant foreclosures happened in the 1000's, flooding the market with inventory of homes.

the Banks earned nothing from these foreclosed homes because OREO (other re owned) is a non performing asset on the Bank B/S. And it exacerbated the soft market conditions because there was a glut of homes unsold (including the foreclosed ones).

So essentially, the prof is right. Had the banks been prident and far sighted as opposed to greedy, a lot of this crisi could have been worked through.

And if this bailout is applied on the consumer side, then there is still a possibility of helping everyone (by shoring up the underlying asset), except just the corporates who practically created this mess through the need to capitalize on future big bucks.

One can see where it all went wrong ...but, this would - by itself - not have created this entire problem. I mean falling real estate prices is not a new phenomenon and banks should largely be able to ride such phases out.

The problems started with the creation of this "sub prime" category of borrowers. Essentially, banks normally are (or should be) stringent with their loans - i.e. how much to lend (what percentage of the property value being lent against), to which customers (i.e. are they credit worthy, do they have adequate earnings capacity, enough years of earning work life etc) & the amount of loans should be commensurate with ability to pay. The business conducted with borrowers who meet these criteria was the "prime" business.

Now, with easy liquidity (a large part of which came from the yen carry trade), banks created a whole new category of customer - the "sub prime" borrower .. i.e. borrowers who otherwise would not qualify for a bank loan. When they started getting loans, why wouldnt they take it and buy property - which, in turn, led to property prices going up further - again, getting in speculators (who also got their share of easy credit) - again, sending property prices higher. Needless to say, this was good for banking business.

On top of this, this entire loan book was securitised in order to create more liquidity ... so, you had the CDOs and the mortgage backed securities - ie. banks selling the stream of cash flows they were expecting from the borrowers to investors in return for cash .. which was further used for lending to the market (including sub prime borrowers) - sending real estate prices higher and more speculators entering the market - a classic case study of an asset bubble being created. The value of a whole set of assets was largely linked to just one factor - property prices. A lot of these bonds did not have an actual market - they were just being valued on the basis of theoretical models. Prick the property price bubble and all would come down in a heap.

And then the recession fears started .. jobs were lost, earnings capability started dwindling ... I suspect (though am not sure) the "prime" borrowers would have been ok to start with ... but the sub prime business felt the pinch ... speculators had to sell houses or banks had to foreclose because property prices fell below loan outstanding amounts ... in turn hurting the value of all the bonds that were created ... in turn forcing investors to seek a market - which for most of the sub prime debt backed bonds did not exist realistically - leading to the write offs.

Now, the bigger problem was that the pure investment banks (who do not have banking functions and hence access to deposits from the public) have to depend on leverage to invest ... the Japanese money came in handy here to start with but when the yen carry trade reversed (i.e. money started flowing the other way), they had a problem. Moreover, when the asset side of the balance sheet started losing value, the lenders developed cold feet ... wanting their money back .. which obviously was difficult to give because it was invested in bonds that had theoretical values but no market.

Therefore, the collapse!! Maybe a bit too simplistic ... but that is what I feel about this entire situation.

Phew .. but prfsr, I dont think extending the fixed interest rate period would help salvage the situation in any way. Not at this point. Had the regulators not been sleeping (or deliberately ignoring the signs) and not allowed liquidity to balloon beyond control, a lot of this could have been controlled.

I think the US regulators should take a leaf out of the RBI and SEBI's books!

exactly ... the main issue is that the houses are now much lower than what people owe on them.

and these are not just the starter home types ....

we went to look at a house which was a short sale (one step before foreclosure) and the family owed about 700K on the home which was now listed at around 650K and IMO was overvalued even at that. The banks just let these people borrow THIS MUCH. This despite the fact that this family bought this house for about 625 a few years ago. So they had a bigger mortgage than they had bought the house for!!!!!!!

And what had they done with the money. Despite the fact that these people were going to lose their home they still had a full time nanny in the house (this on a saturday when we went to see the place) a beamer and a lexus in the garage. pretty much every toy anyone would want was in the house.

I find it hard to sympathize with these kinds of people. They speculated that their house would keep going up and extended their lifestyle. They have done this on interest only mortgages .... at rates of around 3%. They are obviously not building any equity in the house anytime soon.
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Re: The crumbling of the US financial system (NC)
« Reply #130 on: September 22, 2008, 05:57:52 PM »

Thanks for all the responses. What I have trouble with the bailout is that we pay for the losses and the people still lose their homes. Not that I would have loved to bail out these bozos with my money but this is a degree worse!

And CP, it is the social pressures here that induce such spending. Let's not pretend that desis do not have it. Much if what I hear at desi gatherings (not that I go to a lot of them) is comparing whose is bigger. I can imagine how much worse it is for people here.
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Cover Point

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Re: The crumbling of the US financial system (NC)
« Reply #131 on: September 22, 2008, 06:17:49 PM »

Thanks for all the responses. What I have trouble with the bailout is that we pay for the losses and the people still lose their homes. Not that I would have loved to bail out these bozos with my money but this is a degree worse!

And CP, it is the social pressures here that induce such spending. Let's not pretend that desis do not have it. Much if what I hear at desi gatherings (not that I go to a lot of them) is comparing whose is bigger. I can imagine how much worse it is for people here.

absolutely. Social pressure is actually much worse among desis (Americans just love to spend anyway). BUT thats not an excuse. It still an individual choice to buy a bigger or a smaller house. At the end of the day people have to be responsible for their own actions. No one should be bailed out.

If someone is going to buy a beamer just to compete with another person then they also should also take responsibility for their actions when they cant pay for it.
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Re: The crumbling of the US financial system (NC)
« Reply #132 on: September 22, 2008, 06:33:18 PM »

Thanks for all the responses. What I have trouble with the bailout is that we pay for the losses and the people still lose their homes. Not that I would have loved to bail out these bozos with my money but this is a degree worse!

And CP, it is the social pressures here that induce such spending. Let's not pretend that desis do not have it. Much if what I hear at desi gatherings (not that I go to a lot of them) is comparing whose is bigger. I can imagine how much worse it is for people here.

absolutely. Social pressure is actually much worse among desis (Americans just love to spend anyway). BUT thats not an excuse. It still an individual choice to buy a bigger or a smaller house. At the end of the day people have to be responsible for their own actions. No one should be bailed out.

If someone is going to buy a beamer just to compete with another person then they also should also take responsibility for their actions when they cant pay for it.

Yes. Like I said, I would rather not payt for them. But since I am paying I would like to see some real people benefit. As unworthy as they are, the fatcats at banks are worse. But I suppose this is the ultimate victory of capitalism. Take money from the masses and give it to a few. I am sure we can find ways in which the recipients "richly deserved" my money. 
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Re: The crumbling of the US financial system (NC)
« Reply #133 on: September 22, 2008, 07:00:42 PM »

Thanks for all the responses. What I have trouble with the bailout is that we pay for the losses and the people still lose their homes. Not that I would have loved to bail out these bozos with my money but this is a degree worse!

And CP, it is the social pressures here that induce such spending. Let's not pretend that desis do not have it. Much if what I hear at desi gatherings (not that I go to a lot of them) is comparing whose is bigger. I can imagine how much worse it is for people here.

absolutely. Social pressure is actually much worse among desis (Americans just love to spend anyway). BUT thats not an excuse. It still an individual choice to buy a bigger or a smaller house. At the end of the day people have to be responsible for their own actions. No one should be bailed out.

If someone is going to buy a beamer just to compete with another person then they also should also take responsibility for their actions when they cant pay for it.

Yes. Like I said, I would rather not payt for them. But since I am paying I would like to see some real people benefit. As unworthy as they are, the fatcats at banks are worse. But I suppose this is the ultimate victory of capitalism. Take money from the masses and give it to a few. I am sure we can find ways in which the recipients "richly deserved" my money. 

OK. We agree that we would rather that no one gets our money. Honestly fat cats or stupid idiots both are bad IMO.

BUT the question then is for the economists to figure out. IF the govt is going to do something what is more effective for the overall economy. If the govt used the same 700B and doled it out to everyone who was foreclosing or subsidized their interest rates or whatever .... what would it do to the overall market? What would it do to people like you and me who have stayed conservative and never over extended ourselves. What would it do to the overall economy.

I think (and KIC and other finance guys can explain better) the idea behind bankrolling the institutions is to keep them solvent so jobs could be saved etc etc. Can the same be achieved  by feeding the stupid idiots? I dont know ... its a question for the economists
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kban1

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Re: The crumbling of the US financial system (NC)
« Reply #134 on: September 22, 2008, 08:26:23 PM »

Quote
One can see where it all went wrong ...but, this would - by itself - not have created this entire problem. I mean falling real estate prices is not a new phenomenon and banks should largely be able to ride such phases out.

Exactly but thats not all of it.

In my post, I had alluded to the lax credit, the predatory lending, the no equity down house purchase programs, encoraging consumers to take out 2nd mortgages to cash out the equity in the home and spend, undertake expensive additions / improvements, and use existing equity to spend on consumer goods.

Which you have elaborated on in the paragraphs below:

Quote
The problems started with the creation of this "sub prime" category of borrowers. Essentially, banks normally are (or should be) stringent with their loans - i.e. how much to lend (what percentage of the property value being lent against), to which customers (i.e. are they credit worthy, do they have adequate earnings capacity, enough years of earning work life etc) & the amount of loans should be commensurate with ability to pay. The business conducted with borrowers who meet these criteria was the "prime" business.

Now, with easy liquidity (a large part of which came from the yen carry trade), banks created a whole new category of customer - the "sub prime" borrower .. i.e. borrowers who otherwise would not qualify for a bank loan. When they started getting loans, why wouldnt they take it and buy property - which, in turn, led to property prices going up further - again, getting in speculators (who also got their share of easy credit) - again, sending property prices higher. Needless to say, this was good for banking business.

Whats also not included here is the real estate as a speculative investment vehicle --not just from the financial perspective but from the real estate perspective. RE investors bought houses only to flip them around for profit, a heated re market contributing to building of paper equity and paper net worth not really present. a lot of the financial instruments were leveraged off of this.

And also, a crucial role was played by the builders in this economy. They continued building (some still are) well after the market turned sour, further exacerbating the problem of large inventory, slow moving homes, significant drop in prices.

Quote
On top of this, this entire loan book was securitised in order to create more liquidity ... so, you had the CDOs and the mortgage backed securities - ie. banks selling the stream of cash flows they were expecting from the borrowers to investors in return for cash .. which was further used for lending to the market (including sub prime borrowers) - sending real estate prices higher and more speculators entering the market - a classic case study of an asset bubble being created. The value of a whole set of assets was largely linked to just one factor - property prices. A lot of these bonds did not have an actual market - they were just being valued on the basis of theoretical models. Prick the property price bubble and all would come down in a heap.

And then the recession fears started .. jobs were lost, earnings capability started dwindling ... I suspect (though am not sure) the "prime" borrowers would have been ok to start with ... but the sub prime business felt the pinch ... speculators had to sell houses or banks had to foreclose because property prices fell below loan outstanding amounts ... in turn hurting the value of all the bonds that were created ... in turn forcing investors to seek a market - which for most of the sub prime debt backed bonds did not exist realistically - leading to the write offs.


Now, the bigger problem was that the pure investment banks (who do not have banking functions and hence access to deposits from the public) have to depend on leverage to invest ... the Japanese money came in handy here to start with but when the yen carry trade reversed (i.e. money started flowing the other way), they had a problem. Moreover, when the asset side of the balance sheet started losing value, the lenders developed cold feet ... wanting their money back .. which obviously was difficult to give because it was invested in bonds that had theoretical values but no market.

Exactly!!

Quote
Phew .. but prfsr, I dont think extending the fixed interest rate period would help salvage the situation in any way. Not at this point.


Disagree to an extent

I believe the bailout should be tied to several factors -- yes a certain writedown of debt is needed and required so that the balance sheets reflect true asset values. But that should hardly be limited to the financial investor side.

Some of it should apply to the consumer side --which includes consumer debt restructuring because without that, these assts will keep geting added to the OREO pile (non performing assets), thereby delaying the market recovery by years and continued exacerbation of the current problem.

Not to mention the fact that a bailout of one sector, which actually benefitted from the naivette of another sector (and no, the majority of the problem is with financially illiterate consumers rather than the ones in CP's example -- I agree, not much sympathy can be wasted there) is rewarding the side which benefitted anyways for their shortsightedness and wrong business practices.

Quote
Had the regulators not been sleeping (or deliberately ignoring the signs) and not allowed liquidity to balloon beyond control, a lot of this could have been controlled.

True

Quote
I think the US regulators should take a leaf out of the RBI and SEBI's books!

Please elaborate on this.
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prfsr

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Re: The crumbling of the US financial system (NC)
« Reply #135 on: September 22, 2008, 08:28:09 PM »

Paul Krugman in NYT:

http://www.nytimes.com/2008/09/22/opinion/22krugman.html?_r=1&oref=slogin

Cash for Trash
 
By PAUL KRUGMAN
Published: September 21, 2008

Some skeptics are calling Henry Paulson’s $700 billion rescue plan for the U.S. financial system “cash for trash.” Others are calling the proposed legislation the Authorization for Use of Financial Force, after the Authorization for Use of Military Force, the infamous bill that gave the Bush administration the green light to invade Iraq.

There’s justice in the gibes. Everyone agrees that something major must be done. But Mr. Paulson is demanding extraordinary power for himself — and for his successor — to deploy taxpayers’ money on behalf of a plan that, as far as I can see, doesn’t make sense.

Some are saying that we should simply trust Mr. Paulson, because he’s a smart guy who knows what he’s doing. But that’s only half true: he is a smart guy, but what, exactly, in the experience of the past year and a half — a period during which Mr. Paulson repeatedly declared the financial crisis “contained,” and then offered a series of unsuccessful fixes — justifies the belief that he knows what he’s doing? He’s making it up as he goes along, just like the rest of us.

So let’s try to think this through for ourselves. I have a four-step view of the financial crisis:

1. The bursting of the housing bubble has led to a surge in defaults and foreclosures, which in turn has led to a plunge in the prices of mortgage-backed securities — assets whose value ultimately comes from mortgage payments.

2. These financial losses have left many financial institutions with too little capital — too few assets compared with their debt. This problem is especially severe because everyone took on so much debt during the bubble years.

3. Because financial institutions have too little capital relative to their debt, they haven’t been able or willing to provide the credit the economy needs.

4. Financial institutions have been trying to pay down their debt by selling assets, including those mortgage-backed securities, but this drives asset prices down and makes their financial position even worse. This vicious circle is what some call the “paradox of deleveraging.”

The Paulson plan calls for the federal government to buy up $700 billion worth of troubled assets, mainly mortgage-backed securities. How does this resolve the crisis?

Well, it might — might — break the vicious circle of deleveraging, step 4 in my capsule description. Even that isn’t clear: the prices of many assets, not just those the Treasury proposes to buy, are under pressure. And even if the vicious circle is limited, the financial system will still be crippled by inadequate capital.

Or rather, it will be crippled by inadequate capital unless the federal government hugely overpays for the assets it buys, giving financial firms — and their stockholders and executives — a giant windfall at taxpayer expense. Did I mention that I’m not happy with this plan?

The logic of the crisis seems to call for an intervention, not at step 4, but at step 2: the financial system needs more capital. And if the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place.

That’s what happened in the savings and loan crisis: the feds took over ownership of the bad banks, not just their bad assets. It’s also what happened with Fannie and Freddie. (And by the way, that rescue has done what it was supposed to. Mortgage interest rates have come down sharply since the federal takeover.)

But Mr. Paulson insists that he wants a “clean” plan. “Clean,” in this context, means a taxpayer-financed bailout with no strings attached — no quid pro quo on the part of those being bailed out. Why is that a good thing? Add to this the fact that Mr. Paulson is also demanding dictatorial authority, plus immunity from review “by any court of law or any administrative agency,” and this adds up to an unacceptable proposal.

I’m aware that Congress is under enormous pressure to agree to the Paulson plan in the next few days, with at most a few modifications that make it slightly less bad. Basically, after having spent a year and a half telling everyone that things were under control, the Bush administration says that the sky is falling, and that to save the world we have to do exactly what it says now now now.

But I’d urge Congress to pause for a minute, take a deep breath, and try to seriously rework the structure of the plan, making it a plan that addresses the real problem. Don’t let yourself be railroaded — if this plan goes through in anything like its current form, we’ll all be very sorry in the not-too-distant future.

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prfsr

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Re: The crumbling of the US financial system (NC)
« Reply #136 on: September 22, 2008, 08:36:22 PM »

http://www.prospect.org/cs/articles?article=paulsons_folly

Paulson's Folly
 
The current Wall Street rescue plan has some serious failings. Will congressional Democrats (and Republicans) stand up to the treasury secretary? 
 
Robert Kuttner | September 22, 2008 | web only 
 
Treasury Secretary Henry Paulson's $700 billion rescue plan puts the two presidential candidates in a curious position. One or both could end up voting against it, at odds with their respective parties.

There is a backlash among some rank-and-file members of both parties against giving Wall Street a blank check, even as most congressional leaders are reluctantly concluding that some kind of bailout is necessary to prevent a financial cataclysm. John McCain spent the week repositioning himself as a born-again populist, railing against Wall Street greed. And by Sunday afternoon, Barack Obama issued a tough set of principles for a bailout, including "No Blank Check for Wall Street"; help for homeowners; and an economic-stimulus plan for working families.

Thus, the stage is set for an epic game of chicken, against a very tight deadline. Will the Democrats insist on some serious help for Main Street and constraints on Wall Street as the price of a deal? Nothing would better highlight the differences between the two parties, or better strengthen Obama's hand. Or will Paulson reject anything other than his own approach -- possibly leaving both candidates to vote against the deal?

As Paulson testifies before key congressional committees Tuesday and Wednesday, and Democrats (and some Republicans) express indignation about the one-sided character of the deal, Wall Street could shudder -- leading Paulson to double down yet again and warn his critics that their hesitancy is leading the economy off a cliff. But there is more than one way to do this deal.

Paulson spent Sunday morning making the round of talk shows, insisting on a "clean" bill uncluttered by regulatory reforms, caps on executive windfalls, refinancing assistance for homeowners, or anything other than unprecedented authority for himself to relieve financial institutions of up to $700 billion in securities that nobody else wants to buy. Paulson spoke as if he had all the cards.

So the key question is what conditions congressional Democrats will extract in return, and whether they will have the political nerve to fight, especially if financial markets grow more panicky with each passing day. At this writing, Nancy Pelosi seems determined to insist on a second stimulus package on the order of $100 billion, including greater relief for homeowners, but there is growing sentiment for some kind of cap on executive pay as well as more assurance that taxpayers, one way or another, will get something back.

The Democrats will be joined by some odd bedfellows. Many leading Republicans in Congress are very skeptical of this deal -- though most want less bailout for Wall Street rather than more relief for Main Street. Rep. Jeb Hensarling, a Republican from Texas, told The Wall Street Journal that a number of Republican conservatives "may very well" oppose the plan. Rep. Mike Pence of Indiana said Friday, "Now's the time for us to be dealing with the root causes of this economic downturn and not simply opening the cash window at the Federal Reserve and writing one bailout check after another."

Speaking on CBS' "Face the Nation" Sunday morning, House Financial Services Committee Chairman Barney Frank said he would want to add several features to the Paulson plan, including relief for homeowners, a new stimulus package, and limits on CEO compensation. Said Frank, "It would be a grave mistake to say that we're going to buy up the bad debt that resulted from the bad decisions of these [private sector] people and then allow them to get millions of dollars on the way out. ... It's kind of hard to tell the average American that we're going to continue to have foreclosures that destabilize neighborhoods and deprive cities of revenues they need, but we're going to buy up the [banks'] bad paper."

The ranking Republican on the Senate Banking Committee, Richard Shelby, appearing with Frank, sounded if anything even more radical than Frank, accusing Paulson of "lurching from crisis to crisis" and helping Wall Street, but doing nothing for the homeowner. Shelby, whose support is crucial to the plan, later issued a written statement that he "remains at this point unconvinced" of the proposal's merits.

The deal proposed by Paulson is nothing short of outrageous. It includes no oversight of his own closed-door operations. It merely gives congressional blessing and funding to what he has already been doing, ad hoc. He plans to retain Wall Street firms as advisers to decide just how to cut deals to value and mop up Wall Street's dubious paper. There are to be no limits on executive compensation for the firms that get relief, and no equity share for the government in exchange for this massive infusion of capital. Both Obama and McCain have opposed the provision denying any judicial review of decisions made by Paulson -- a provision that evokes the Bush administration's suspension of normal constitutional safeguards in its conduct of foreign policy and national security.

Though the administration's line is that these securities are not trading because of a crisis of confidence, so many are ultimately backed by loans that will not be paid back that they will eventually be sold for a fraction of their face value. Firms that have marked these securities down or have otherwise gotten them off their books have valued them at around 30 cents on the dollar or less. If Paulson had proposed such a deal in his old job as CEO of Goldman Sachs -- putting $700 billion of the firm's capital at risk in exchange for junk bonds of unknown value -- he would have been fired in short order. But this is merely taxpayer money.

The differences between this proposed bailout and the three closest historical equivalents are immense. When the Reconstruction Finance Corporation of the 1930s pumped a total of $35 billion into U.S. corporations and financial institutions, there was close government supervision and quid pro quos at every step of the way. Much of the time, the RFC became a preferred shareholder and often appointed board members. The Home Owners Loan Corporation, which eventually refinanced one in five mortgage loans, did not operate to bail out banks but to save homeowners. And the Resolution Trust Corporation of the 1980s, created to mop up the damage of the first speculative mortgage meltdown, the savings and loan collapse, did not pump in money to rescue bad investments; it sorted out good assets from bad after the fact, and made sure to purge bad executives as well as bad loans. And all three of these historic cases of public recapitalization were done without suspending judicial review.

What should Congress demand in return for this deal?

Government equity in firms receiving assistance, in rough proportion to the amount of aid extended.
Limits on executive compensation paid by any firm receiving the public aid.

A recapture of the cost to the government, to be extracted from the firm's future profits.

A six-month sunset provision, so that the treasury secretary's bailout authority would expire by next April 1. Any
extension would be conditional on across-the-board re-regulation of financial institutions of all types.

Creation of a small independent board, which must review and approve Paulson's proposed deals.

A narrower treatment of court challenges to Paulson's actions.

A parallel program to refinance sub-prime mortgage loans and to provide funding to municipalities and community-based nonprofits to acquire, restore, and repopulate foreclosed properties.

At least $200 billion of new economic stimulus, in the form of aid to states, cities, and towns, for infrastructure rebuilding, more generous unemployment compensation and retraining benefits.




For nearly three decades, conservative Republicans have insisted that the cupboard is bare when it comes to
needed social outlay. Conservative Democrats have been hesitant to spend more than token amounts because of concern for the deficit. Now suddenly, spending that will increase the deficit by $700 billion is greased to slide through Congress in less than a week but only because the money is for Wall Street
.

Paulson said Sunday that the two cases are not comparable. "This is different than spending money you know you're never going to get back," he told CBS' Bob Schieffer. "This is buying assets, holding assets, and then selling assets." But that is just nonsense. Investing public funds in college education, the health of children, public infrastructure, research and development, or energy independence is money that is far more likely to produce a good return than public investments in the toxic junk of Wall Street. If the economic emergency requires deficit spending, the benefits should be spread. No self-respecting legislator should vote for this lopsided plan in its present form, and a bracing debate should shed light on what the two parties really stand for.

When you think about it, Hank Paulson is about the last person in America who should be entrusted with this emergency infusion of public capital -- because his perspective is entirely that of the bankers who created the mess in the first place. Paulson is treating the U.S. Treasury as a branch office of Wall Street. When I was a proudly liberal graduate student, I used to snicker at my radical classmates who described the government, in Marxian cant, as the "executive committee of the ruling class." Well, there is no better description of the Treasury as operated by Hank Paulson.  
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kban1

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Re: The crumbling of the US financial system (NC)
« Reply #137 on: September 22, 2008, 09:06:08 PM »

Thank you prfsr  :icon_thumleft:-- agree with the articles above, especially the point of intervention as illustrated by Krugman.

The basic point being bailing out the asset derivative market without fixing the problem ailing the underlying asset cannot solve the problem.
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RicePlateReddy

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Re: The crumbling of the US financial system (NC)
« Reply #138 on: September 22, 2008, 10:10:56 PM »

Paulson overseeing this mess is increasingly looking like a case of the wolf tending the sheep. In Dec 2006 he received the second highest yearly pay package ever for an executive. And today he is going to impartially look at limiting CEO pay and socking it to Goldman Sachs?

The tax payer bail out is not just effectively funding the massive bonuses paid out to the top brass, but also the gratuitous bonuses paid out to all the rank and file staff (associates and above) over the last few years.


And look at this nonsense:
http://www.penews.com/today/index/content/2451810164

(From last week) During a weekend scramble to shore up its finances, AIG turned down a capital infusion from a group of private-equity firms led by J.C. Flowers & Co. because an option tied to the offer would have effectively given them control of the company, an 89-year-old giant that does business in nearly every corner of the world.

The proposed option would have allowed the firms to acquire AIG for $8 billion under certain conditions. That price is just one-fourth of AIG's current market value.

J.C. Flowers didn't respond to messages seeking comment.

When AIG's board rejected the capital infusion, the company's recently appointed chairman and chief executive, Robert Willumstad, took the extraordinary step of reaching out to the Federal Reserve for help. Mr. Willumstad asked New York Federal Reserve President Timothy Geithner if the Fed could backstop some asset sales.

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kban1

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Re: The crumbling of the US financial system (NC)
« Reply #139 on: September 22, 2008, 10:44:35 PM »

No wonder then Paulson wants a "clean" bill 

 -- Govt doles out capital but without a stake  :icon_scratch:

 -- No limits to executive pay  :BangHead:

-- No benefits to the consumer (households)  >:D

-- No judicial oversight  :notworthy:

What an elegant solution. The markets have found its equilibrium and govt has played its part in the "redistribution of wealth"  [god]
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RicePlateReddy

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Re: The crumbling of the US financial system (NC)
« Reply #140 on: September 22, 2008, 11:16:46 PM »

No wonder then Paulson wants a "clean" bill 

 -- Govt doles out capital but without a stake  :icon_scratch:

 -- No limits to executive pay  :BangHead:

-- No benefits to the consumer (households)  >:D

-- No judicial oversight  :notworthy:

What an elegant solution. The markets have found its equilibrium and govt has played its part in the "redistribution of wealth"  [god]

It stinks.

Personally, I wouldn't accuse Paulson of intentional bias and/or outright corruption in making these decisions.

But having some one who was at the helm of the very institutions that caused the failure proposing a solution with marginal oversight (I am talking about financial, economic oversight with the right background -- not necessarily the posturing bozos in the legislature) is dangerous. Paulson, for all his great talents, has been moulded in the investment banking culture and is bound to have some affection for and conditioning to their ways, however much he may try to be honest, even handed and impartial. In his position of Secretary, he needs to negotiate for ownership stakes for the government, establish favorable conditions and drive a super-hard bargain with the wolves.

If I were in charge, I would plead with Warren Buffet to help out the country and devote full time chairing a committee to come up with a framework, a proposed solution to the crisis, and guidelines, while having him choose both the extent of the fed bailout (if at all) and a larger committee to make decisions.  [god]
« Last Edit: September 22, 2008, 11:18:47 PM by ShortSquatLeg »
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RicePlateReddy

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Re: The crumbling of the US financial system (NC)
« Reply #141 on: September 23, 2008, 01:28:56 AM »

Chris Dodd Stares Down Paulson
By: Ian Welsh Monday September 22, 2008 2:40 pm
http://firedoglake.com/2008/09/22/chris-dodd-stares-down-paulson/

So there was "Goldman" Hank, holding a gun on the economy and staring Congress down. "Give me the 700 billion, or the economy gets it!" he threatened. For two days it looked like he was going to get away with it, 700 billion dollars to spend on the Wall Street gang, the boys who'd already shot the economy up so bad it was in danger of bleeding to death.

Then Marshal Dodd came swinging through doors, shotgun in hand, and said "not so fast Hank. Put the gun down, and back away from the economy. We're going to do this my way."

For a moment calm reigned, then from off one side came a high pitched squeak, "you just put down that gun Dodd," said Bush as he leveled his blunderbuss "the Veto" at Dodd, "and you let my good friend Hank walk away with the money or I'll use this gun." He swivelled and instead of aiming it at Dodd, put its muzzle right against the economy's head. "I'll do it. Don't think I won't! I've killed an economy before!"

Hand still on the trigger, Dodd glanced over at Reid. The old man's fighting days, some said, were long gone. Dodd hoped Reid had one big fight left in him. If he didn't, the economy was done, and Paulson would get away, scot-free.

So yeah, the Dodd plan. Good plan. Buying up mortgages for 15% less than the current market value of the house, then reissuing a clean mortgage to homeowners helps the banks while still giving them a slight haircut (but only slight, odds are home prices will drop more than 15% before the slide is over.) It helps homeowners stay in their houses. It sets a market price so that banks know what mortgages are worth and thus what the derivatives based on houses are worth. And giving the mortgages bought to the FDIC, one of the few agencies that Bush didn't cripple, is genius.

Giving the government stock equal to the value of any bailout for the company is also only fair. If they get bailed out, taxpayers should have a chance to get their money back. If they don't like that, well, beggars, and they are beggars, shouldn't be choosers.

Having a review board is a good idea, though having the Treasury Secretary, Fed Chairman and FDIC chief on it is perhaps unwise. Still Congress chooses two of the members. I'd prefer direct oversight through the Congressional Budget Office, which reports directly to Congress, but this isn't too bad.

Clawing back compensation based on fraudulent financial reporting is a stroke of genius and may be what Dodd put in so that he could eventually trade it for something else, because fact is, almost all of these bastards have used dubious accounting to inflate their earnings and therefore their bonuses and salary. They're all guilty and they know it. Under a vigorous Department of Justice (say, oh, an Obama one) they could all be prosecuted.


Allowing bankruptcy judges to modify the terms of mortgages is both humane and reasonable, so many mortgages were sold under false pretenses. Banks really, really hate this provision, as it takes away part of the bankruptcy bill, but when they themselves are asking for all their contracts to be, in effect, modified by government (what's buying for 15% less than face when you couldn't get 30 cents on the market but modification?) they don't have a leg to stand on.

There appear to be other details, but those are the highlights. It's a good plan and it helps more than just the banks. It includes a lot of what outsiders were suggesting, especially with respect to help mortgage holders. It doesn't go quite as far as I would have liked—I would have preferred to just buy up entire failed corporations rather than their assets, but if the share program is done properly the government could wind up with effective control of many corporations anyway. This is only reasonable, if the government has to bail you out for more than half your value, the government should own you.

There is a provision that might let corporations pay off the government with superior bonds, I don't like that. However, I suspect most companies won't go for it unless they're in relatively good shape already (you want to owe more money when you might be bankrupt?)

Dodd deserves a lot of credit for putting this bill forward, as does Leahy. Leahy put back in the most important thing—no dictatorial powers for Paulson without court review. Anything Paulson or anyone else does can be reviewed by judges during or after the fact. No man should be above the law in America.

The question now is how much of this will survive negotiations and if Bush will veto a good bill. Also in question is if Republicans will vote against a good bill, handing Democrats a club to beat them with. I do wish that Dodd had put in more poison pills he could trade away, to improve his bargaining position, but in my opinion Dodd, Leahy and the Democrats still have the stronger hand here and should use it to beat the Republicans into submission. No one on Main Street liked Paulson's bill, and even most Wall Street workers, unless at the very highest levels, didn't like it either. Force the Republicans to vote for Dodd's bill or they can take huge losses in November.

Good work Marshal Dodd. Now finish the job. Make sure that the Bush gang's last attempted raid on the treasury goes down in flames.
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keep-it-cool

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Re: The crumbling of the US financial system (NC)
« Reply #142 on: September 23, 2008, 04:33:43 AM »

Quote
The problems started with the creation of this "sub prime" category of borrowers. Essentially, banks normally are (or should be) stringent with their loans - i.e. how much to lend (what percentage of the property value being lent against), to which customers (i.e. are they credit worthy, do they have adequate earnings capacity, enough years of earning work life etc) & the amount of loans should be commensurate with ability to pay. The business conducted with borrowers who meet these criteria was the "prime" business.

Now, with easy liquidity (a large part of which came from the yen carry trade), banks created a whole new category of customer - the "sub prime" borrower .. i.e. borrowers who otherwise would not qualify for a bank loan. When they started getting loans, why wouldnt they take it and buy property - which, in turn, led to property prices going up further - again, getting in speculators (who also got their share of easy credit) - again, sending property prices higher. Needless to say, this was good for banking business.

Whats also not included here is the real estate as a speculative investment vehicle --not just from the financial perspective but from the real estate perspective. RE investors bought houses only to flip them around for profit, a heated re market contributing to building of paper equity and paper net worth not really present. a lot of the financial instruments were leveraged off of this.

You probably missed the speculative element I referred to in my post because it was just one word :D ...

And also, a crucial role was played by the builders in this economy. They continued building (some still are) well after the market turned sour, further exacerbating the problem of large inventory, slow moving homes, significant drop in prices.

This is fine, in my view. More houses would help keep prices down .. good for those who have not yet purchased houses. It is one of the self correcting measures that is required. Had credit been tighter, builders would automatically have stopped building because people would not have been able to over stretch their resources.

Quote
Phew .. but prfsr, I dont think extending the fixed interest rate period would help salvage the situation in any way. Not at this point.


Disagree to an extent

I believe the bailout should be tied to several factors -- yes a certain writedown of debt is needed and required so that the balance sheets reflect true asset values. But that should hardly be limited to the financial investor side.

Some of it should apply to the consumer side --which includes consumer debt restructuring because without that, these assts will keep geting added to the OREO pile (non performing assets), thereby delaying the market recovery by years and continued exacerbation of the current problem.

Not to mention the fact that a bailout of one sector, which actually benefitted from the naivette of another sector (and no, the majority of the problem is with financially illiterate consumers rather than the ones in CP's example -- I agree, not much sympathy can be wasted there) is rewarding the side which benefitted anyways for their shortsightedness and wrong business practices.


I am not at all in favour of the Paulson plan, if that is what you are referring to. As I posted earlier, it just makes the government (and indirectly all tax payers) a glorified raddiwala - who is buying bad assets without getting anything in return. Any cash infusion into these banks should be in return for equity stake or in the form of high yielding debt - I would go for the latter.

That does not mean that I am not for some help on the consumer side. My above statement was just a response to prfsr's question whether extending the fixed rate period will help solve the crisis. It will not - the problem is much bigger ... or rather has been allowed to become much bigger than that.

The restructuring / bail out on the lending side and on the borrowing side should be kept unrelated ... I am not very clear as to what kind of borrowers are defaulting, what kind of loans have they gone into, do they have collateral etc ..so, difficult to take a view on the kind of package required. But the difficulty here is bit higher because you have to make sure that those who have been vigilant while engaging in their borrowings are not unduly punished either. For instance, when the current Indian government gave its famous loan waiver, it went down very badly with those who had sold their bulls etc in order to ensure that they repaid their debt.

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I think the US regulators should take a leaf out of the RBI and SEBI's books!

Please elaborate on this.

These agencies have been much better at policing liquidity in the economy ... by tweaking small regulations here and there to ensure that things do not spiral out of control. NBFCs are much better regulated here in India than pure investment banks are regulated in the US.
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kban1

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Re: The crumbling of the US financial system (NC)
« Reply #143 on: September 23, 2008, 04:59:40 AM »

Quote
You probably missed the speculative element I referred to in my post because it was just one word  ... :D

LOL --you missed my reference to lax credit standards too. Guess we both like elaboration  ;)

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This is fine, in my view. More houses would help keep prices down .. good for those who have not yet purchased houses. It is one of the self correcting measures that is required. Had credit been tighter, builders would automatically have stopped building because people would not have been able to over stretch their resources.

Would have been fine in a normal market as corrective measure. But here, its added to the problem because the existing inventory has been more than enough to allow for market correction and benefit to buyers. What has happened with the continued building is that the market has cratered further, not helped by several builders going belly up as well when such speculative building has backfired.

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I am not at all in favour of the Paulson plan, if that is what you are referring to. As I posted earlier, it just makes the government (and indirectly all tax payers) a glorified raddiwala - who is buying bad assets without getting anything in return. Any cash infusion into these banks should be in return for equity stake or in the form of high yielding debt - I would go for the latter.

I know you were not in favor of the Paulson plan. But my take is not just on the unfettered plan but also the fact that the govt is attacking the securities issue to the exclusion of the underlying asset (See Krugman's article above).

Having been in RE finance, I can assure you the market has not hit bottom yet. So unless the bailout is strong enough (read large in $ terms) to break the vicious cycle, some support to the consumer side is imperative in steadying the market as The Dodd plan provides for (thanks to SSL for posting this) or some variant thereof -- recall, I had talked about the need to restructure the actual debt obligations on the mortgages, taking into account the actual asset value post market correction.

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That does not mean that I am not for some help on the consumer side. My above statement was just a response to prfsr's question whether extending the fixed rate period will help solve the crisis. It will not - the problem is much bigger ... or rather has been allowed to become much bigger than that.

I understand now what you were referring to.

Yes, just the extension of fixed rates wont help.

When I was affirming prfsr's statement, I was thinking of measures to shore up the consumer side, a lot of which has to do with tying commensurate debt to commensurate asset values.

Quote
The restructuring / bail out on the lending side and on the borrowing side should be kept unrelated ... I am not very clear as to what kind of borrowers are defaulting, what kind of loans have they gone into, do they have collateral etc ..so, difficult to take a view on the kind of package required. But the difficulty here is bit higher because you have to make sure that those who have been vigilant while engaging in their borrowings are not unduly punished either. For instance, when the current Indian government gave its famous loan waiver, it went down very badly with those who had sold their bulls etc in order to ensure that they repaid their debt.


While not denying that we have to be cognizant of the rights of those who played by the rules, I still believe the necessary adjustments can be made and certain relief, even if retroactively administered, provided to the ones who played by the rules and lost a lot. While this is not important from solving the crisis standpoint, it might be the socially responsible thing to do, since the govt is already in deep, anyways  :D.

However, tackling the consumer side of the balance sheet (debt vs asset values) is important fundamentally IMO. Tackling just the institutional woes does not go far enough and might not solve the problem --aside from being more expensive I suspect.

Quote
These agencies have been much better at policing liquidity in the economy ... by tweaking small regulations here and there to ensure that things do not spiral out of control. NBFCs are much better regulated here in India than pure investment banks are regulated in the US.

Gotcha, thanks.

I suspect the investment banks here will be better regulated after this Fiasco  ;D. Already (in the last 24 hours), the 2 remaining giants have changed their status to be that of Bank Holding companies, subject to stricter oversight by the FDIC.
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keep-it-cool

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Re: The crumbling of the US financial system (NC)
« Reply #144 on: September 23, 2008, 05:19:33 AM »

Kban,

Pure investment banks will not be better regulated. They have ceased to exist.

I agree with you on the need to bail out the consumer side as well ... although you may have a better sense on what will / will not work in that market. On both sides, what I am worried about is the moral hazard that this would create .. but then I guess there is not much choice at this stage.

On the builders front, I am not too sure. I am surprised builders keep building when there is over capacity anyway. They wouldn't be building if they are unable to sell. So, how are they able to sell when there are so many other houses on the market. Are the existing home owners / sellers holding on to rates that are higher than people can afford?
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kban1

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Re: The crumbling of the US financial system (NC)
« Reply #145 on: September 23, 2008, 05:35:41 AM »

Quote
Pure investment banks will not be better regulated. They have ceased to exist.

True

Quote
I agree with you on the need to bail out the consumer side as well ... although you may have a better sense on what will / will not work in that market. On both sides, what I am worried about is the moral hazard that this would create .. but then I guess there is not much choice at this stage.

yes, I am with you on the moral hazard issue as well. but I dont think there is much of a choice anyways now

Quote
On the builders front, I am not too sure. I am surprised builders keep building when there is over capacity anyway. They wouldn't be building if they are unable to sell. So, how are they able to sell when there are so many other houses on the market. Are the existing home owners / sellers holding on to rates that are higher than people can afford?

Not every builder but a good number for sure.

In some ways its a perverse logic -- speaking to them you get their explanation which is roughly as follows:

prices of materials continue to go up, so building now makes sense. And in their estimation, even in a depressed market, new homes are more likely to be sold than existing homes (say 5 -30 years old) because a significant portion of buyers like newer homes.

Why this is perverse, IMO is that this strategy backfires in this market with so many homes already on the market. A new home which in a normal market would have fetched $225K will fetch $200K now, but they dont see the stupidity in that. After all as long as their homes are moving (comparatively) faster than other homes. The problem of course is that this does nothing to the existing inventory in the market.

And their strategy is somewhat helped with people's perceptions --people who are existing homeowners trying to sell in this market. because this downturn came on the back of one of the biggest housing booms, people's perceptions of what their home is worth is still tied to prices of 2004-05 (the perception lag), and memories of prices their neighbors' houses fetched during the boom. You see houses which are grossly overpriced in this market (well priced for 2004/5, but overpriced for 2008) and these houses are sitting on the market for 4/6/8/10 months without selling because the owners refuse to mark down prices --perception, the emotional investment in an existing home, the prospect of selling at  a loss after all selling expenses and commissions are taken care of -- all of this is affecting the market correction and indirectly is allowing the builders referred to above sell their homes faster.

I am not saying this (new building) is true all across all of the US --some of the most depressed markets have seen almost zero housing starts (which is a good thing), but this phenomenon still persists in many markets.
« Last Edit: September 23, 2008, 05:37:15 AM by kban1 »
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Re: The crumbling of the US financial system (NC)
« Reply #146 on: September 23, 2008, 05:53:58 AM »

Kban,

I dont know how many buyers of homes exist in the US.

But if the current home owners are not marking down their prices and builders are not allowed to build & sell new homes, then what do these guys do? Especially in a scenario where income levels are likely to be lower and credit is tighter.
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kban1

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Re: The crumbling of the US financial system (NC)
« Reply #147 on: September 23, 2008, 06:08:00 AM »

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I dont know how many buyers of homes exist in the US.

Plenty - with job mobility and the average homeowner staying at his home for 5 yrs or less on average, the  turnover is pretty substantial --compared to India for example. People move, trade up, change jobs, get divorced, acquire properties for rentals /investment, buy 2nd or 3rd homes --all of that. However, even with that, supply in the market far outstrips demand - at present

It will take  a few years for things to normalize -- the sellers perceptions will adjust, prices will fall further and demnd will take a chunk each successive year out of the existing inventory --as long as a modicum of balance is maintained by not indulging in overbuilding (this is where builders come in)

Quote
But if the current home owners are not marking down their prices and builders are not allowed to build & sell new homes, then what do these guys do? Especially in a scenario where income levels are likely to be lower and credit is tighter.

Not in absolutes. Some current homeowners are reducing their prices --their homes are selling. But a large proprotion are not or are very reluctant to.

I am not suggesting a moratorium on new building, but I do believe its prudent self interest to lower the new building activity especially when you as a builder have several unsold yourself (remember I said their homes are moving faster only when compared to the rest of the market, not in absolute).

As far as these builders, the ones still in business made a killing in the early part of this decade. Its in their rational and economic self interest to lie low for a while and for financial institutions to insist on minimal financing for speculative home building activity (speculative = non presold or precommitted homes). This also benefits the financial institution's cause by lowering its risk exposure to such builders who continue with speculative building activities.
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prfsr

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Re: The crumbling of the US financial system (NC)
« Reply #148 on: September 23, 2008, 11:21:18 AM »

This one has a clear liberal bent. Nevetheless (;D) I found it good.

http://www.dailykos.com/storyonly/2008/9/21/9322/74248/245/602838

Three Times is Enemy Action
by Devilstower
Sun Sep 21, 2008 at 06:03:41 AM PDT

"Once is happenstance. Twice is coincidence. Three times is Enemy Action."
-- Auric Goldfinger

James Bond's wealthy nemesis may have had an obsession with gold, but he judged, quite correctly, that if people keep putting your plans awry, that was likely their intent.

In 1982, the same year John McCain entered the Senate, a bill was put forward that would substantially deregulate the Savings and Loan industry. The Garn-St. Germain Depository Institutions Act was an initiative of the Reagan administration, and was largely authored by lobbyists for the S&L industry -- including John McCain's warm-up speaker at the convention, Fred Thompson. The official description of the bill was "An act to revitalize the housing industry by strengthening the financial stability of home mortgage lending institutions and ensuring the availability of home mortgage loans." Considering where things stand in 2008, that may sound dubious. It should.

Seven years later, the S&L industry was collapsing. What was the cause? Garn-St. Germain handed the S&Ls a greatly expanded range of capabilities, allowing them to go head to head with full service banks, but it didn't give them the bank's regulations. Left to operate in an anarchistic gray area, S&Ls chased profits, indulged in amazing extravagances, and cranked out enough cheap mortgages to fuel a real estate boom. They also experimented with lots of complex, creative -- and risky -- investments, even though they didn't have the economic models to really determine the worth of the things they were buying. The result was a mountain of bad debts and worthless "assets."  Does any of that sound eerily (or nauseatingly) familiar?

It wasn't a foregone conclusion. In 1985, three years after the deregulation of the S&Ls, the chairman of the Federal Home Loan Bank Board saw that the situation was already looking shaky, with the potential to become much worse. He instituted a rule to limit the amounts and types of investments S&Ls could carry on their books in an effort to head off disaster. However, many savings and loans -- among them Lincoln Savings & Loan Association of Irvine, CA, which was headed by a fellow named Charles Keating -- promptly ignored these rules.

Now enters a familiar cast of characters. First to pop up was the universally beloved Fed-chief-to-be, Alan Greenspan. Greenspan argued against the loan board's new rules, and persuaded Reagan to appoint one of Keating's pals to the board to blunt the requirements. A quintet of senators, among them John McCain, began having meetings with both the management at Lincoln and the regulators at the loan board. ] Alan Greenspan also helped out with a letter to the regulators, asking that Lincoln be exempt from the new rules. With their help of Greenspan and their pet senators, Lincoln was able to stay in business an additional two years, at the end of which they failed -- taking the life savings of 21,000, mostly elderly, investors with them.

How involved was John McCain? McCain and Keating had known each other since 1981 and had become fast friends. Of all the "Keating Five," it was McCain who moved into the life of the Lincoln S&L chief. The two men vacationed together multiple times, with the whole McCain clan (babysitter included) heading out for Keating's private Caribbean property on Keating's private jet. McCain didn't think to actually report these trips, or pay for them, until the investigators were breathing down his neck. And McCain took his payment in the form of more than just vacations. Keating and other members of Lincoln's parent company padded McCain's pockets with $112,000 in campaign contributions.

In John McCain's biography, he called his meetings with Keating and regulators "the worst mistake of my life," though from the text you'd think this was a spur of the moment decision, not something that McCain did repeatedly over a space of years. Still, you might think that a "worst mistake" would stay fresh in his memory.

It certainly didn't fade quickly for the country. Following the S&L crisis, the Resolution Trust Company was formed to swallow up the debt of Lincoln and 746 other S&Ls gone wild, and taxpayers were left with the $125 billion bill. The resulting budget deficit forced cutbacks in other programs. The artificial real estate boom collapsed and housing starts fell to their lowest levels in decades. Finally, the whole nation settled in for a period nasty enough that three years later someone could still campaign around the idea "It's the economy, stupid."

Even so, by 1999 Phil Gramm -- who had entered the Senate two years after McCain and quickly become the economic guru of the Keating Five maverick -- put forward the Gramm-Leach-Bliley Act. This Act passed out of the Senate on a party line vote with 100% Republican support, including that of John McCain. (To be fair, the bill eventually passed again with a wide margin following revisions in the House.)

This act repealed part of the Glass-Steagall Act. This may sound like a bunch of Congressperson soup, but the gist of it is that Glass-Steagall was put in place in 1933 to control the rampant speculation that had helped cause the collapse of banking at the outset of the depression, and to prevent such consolidation of the banks that the nation had all its eggs in one fiscal basket.

Gramm-Leach-Bliley reversed those rules, allowing not only more bank mergers, but for banks to become directly involved in the stock market, bonds, and insurance. Remember the bit about how S&Ls failed because they didn't have the regulations that protected banks? After Gramm-Leach-Bliley, banks didn't have that protection either.

Gramm wasn't done. The next year he was back with the Commodity Futures Modernization Act, which was slipped into a "must pass" spending bill on the last day of the 106th Congress. This Act greatly expanded the scope of futures trading, created new vehicles for speculation, and sheltered several investments from regulation.

As with both Gramm-Leach-Bliley and Garn-St. Germain, large parts of this bill were written by industry lobbyists. This famously included the "Enron Loophole" that exempted energy trading from regulation and was written by (big suprise) Enron Lobbyists working with Gramm. Not coincidentally, Senator Gramm, the second largest recipient of campaign contributions from Enron, was also key to legislating the deregulation of California's energy commodity trading.

Thanks to this fortunate trifecta of Gramm-crafted legislation, Enron was able to create "EnronOnline" and trade electricity in California with absolutely no oversight or transparency. They quickly worked out how to game the system. Previously, there had been only one Stage 3 rolling blackout in the history of California. Within months, the system had been manipulated by traders to generate 38 such blackouts and wholesale electrical prices had gone up more than 3000%. Despite production capacity equal to four times the demand during winter, energy traders even engineered a blackout in mid-January.

During the confusion of these deliberate "shortages" and "price spikes," the California administration of Gray Davis -- blind to speculator manipulations because of the walls erected by Gramm's legislation -- was forced to sign energy contracts at enormous rates. There was little choice, because most of California's public utilities were on the brink of bankruptcy from the rising wholesale prices.

In a single year, Gramm's legislation allowed speculators to bring the state to its knees. Enron alone looted California of $11 billion. The manipulations of the energy market were also a major factor in Davis getting the hook, helped usher the governator into power, and they still have repercussions in California's budget battles today. By the end of that year, the depth of Enron's deception could no longer be hidden, and the whole company came crashing down in the largest bankruptcy in history -- at the time. This brought more billions lost in mutual funds and pension funds across the country, and played a major role in the economic downturn of 2001.

But that was only the second act. The combination of Gramm-Leach-Bliley and the Commodity Futures Modernization Act was a toxic cocktail whose total damage was greater than the sum of its parts.

The first Act promoted bank buyouts and mergers that reached such an insane pitch that the average consumer could only keep up by tracking the changing names on their checks and credit cards. Mercantile buys Ameribanc and Mark Twain. Firstar buys Federated and First Colonial. US Bancorp buys Mercantile and Firstar. And, because it allowed brokerages and insurance companies to mingle with banks, the Act cemented a trend that was already (and illegally) underway in which all those terms had become rather quaint. Is Wachovia a savings bank, an investment bank, a brokerage, or an insurance provider? The answer is "yes."

In allowing financial institutions to grow to Godzilla-sized proportions, Gramm-Leach-Bliley helped ensure that we would have financial entities that were "too big to fail." Rather than choosing to enforce rules that kept these institutions apart, the deregulators chose to create monster bankeragasurances whose downfall (and existence) was enough to threaten the whole system.

But if Gramm-Leach-Bliley removed the limits on size and scope, these new institutions still needed fuel. With many financial transactions operating on razor thin margins, and increasing automation sapping the profits from trading of all sorts, they needed a new way to generate the funds required to swallow their brethren in the merged fiscal corporation pond.  For that, the Commodity Futures Modernization Act was a godsend.

Among those instruments which the CFMA sheltered from regulatory scrutiny was something called the "credit default swap." A kind of insurance one bank could exchange with another, credit default swaps supposedly made it safe for banks to take on ever riskier forms of debt. The Act didn't invent these swaps, though they were relatively new. Instead, by placing them in a state where they were not only unregulated but almost perfectly opaque, credit default swaps were turned into the perfect vehicle to fuel a Wall Street revolution. No one had any idea what these things were actually worth, they were traded "over the counter" without being administered by any exchange, and even the SEC could monitor their existence only indirectly.

Who would cheer for a new kind of financial instrument that was difficult to understand, invisible to regulators, and impossible for even the whizziest of Wall Street whiz kids to value? Guess.

More recently, instruments that are more complex and less transparent--such as credit default swaps, collateralized debt obligations, and credit-linked notes--have been developed and their use has grown very rapidly in recent years. The result? Improved credit-risk management together with more and better risk-management tools appear to have significantly reduced loan concentrations in telecommunications and, indeed, other areas and the associated stress on banks and other financial institutions.
--Alan Greenspan, 2002

Get that? Greenspan loved credit default swaps. He opined again and again that such instruments would be the salvation of the industry by spreading around risks. To the mighty Greenspan, both their complexity and their lack of transparency were good things, since swaps would only be handled by the big boys who knew how to play with fire.

When questioned about his support of Gramm's legislation, John McCain called his friend (and by then, campaign co-chair) Gramm "one of the smartest people in the world on the economy" and pointed out that Greenspan also favored the acts Gramm and his coalition of lobbyists had authored. If both Gramm and Greenspan were on his side, McCain couldn't possibly be in the wrong.

Except, of course, that he could.

From the beginning, there were plenty of people in the financial community whose opinion of these unregulated credit swaps was not as rosy as that of Gramm, Greenspan, and McCain. Chief among those speaking in opposition was SEC Chairman, Arthur Levitt. Levitt argued that what the industry needed was more transparency, especially when it came to complex instruments like default swaps, and he testified to this before Gramm's Senate Banking Committee,.

"In my judgment, the risk of this regulatory approach is simply unacceptable for America's investors."
--Arthur Levitt, 1999

Gramm paid no attention.

Credit default swaps did allow the banks to share risks. So much so, that banks raced each other in an effort to find more risks. They made it possible for the down payment on homes to become 3%, 1%, 0%. Skip the credit check, avoid the employment requirements, damn the torpedoes, full speed ahead! We've got a credit default swap, we can do anything!

The encouragement and "safety" that credit default swaps provided made the sub-prime mortgage market possible. Just as with the deregulation of S&Ls in the 1980s, the market was suddenly flooded with easy credit. The result was a real estate boom, soaring home prices, and a plague of "Flip that House!" shows on cable.

As the banks piled up crappy mortgages, they heaped on ever more of the credit default swaps -- and they still had no idea how to value the things. Worse, they began to trade the swaps themselves as if they were an investment, treating them like something worth holding instead of a big bundle of cartoon bombs whose fuses were already lit. Since very few loans were falling into default at the time, owning a default swap seemed like a way to collect fees without ever paying out. Banks wanted more, and more, and more. 

A secondary market for trading swaps exploded into existence, and swaps were traded with absolutely no consideration for the nature or quality of the underlying investment. Swaps changed hands a dozen or more times, growing in "value" as they went. Worse still, no one regulated who could buy a swap, so it was (and is) perfectly possible for a company to acquire swaps that theoretically cover billions of dollars in loans, even if that company doesn't have a red cent on hand to cover those swaps should the loans default.

How big did this market become? Here's business correspondent Bob Moon and host Kai Ryssdal on American Public Media's Marketplace from back in the spring.

BOB MOON: OK, I'm about to unload some numbers on you here, so I'll speak slowly so you can follow this.

The value of the entire U.S. Treasuries market: $4.5 trillion.

The value of the entire mortgage market: $7 trillion.

The size of the U.S. stock market: $22 trillion.

OK, you ready?

The size of the credit default swap market last year: $45 trillion.

KAI RYSSDAL: That's a lot of money, Bob.

As in three times the whole US gross domestic product, Bob. And the truth is that Moon probably underestimated. The unregulated and poorly reported credit default swaps may have actually passed $70 trillion last year, or about $5 trillion more than the GDP of the entire world.

So, are you starting to get an idea of just how big a genie Phil Gramm and his pals unleashed?

With some regularity over the last eight years, fiscal whistle blowers have tried to raise their hands and register a protest. Um, sirs? Is it altogether a good idea to run up debts exceeding all the assets it's even possible to hold? But so long as no one actually had to pay off on the swaps, the party went on.  Even usually conservative (in the fiscal sense) companies like AIG started to worry that they were being left behind and leapt headlong into the swap pool.

Shortly after Greenspan's departure in 2006, the Federal Reserve took the unusual step of issued a joint statement along with the SEC to warn about the risks associated with credit default swaps. But by that point, the damage was already severe. If swaps lost their value, most of those who had played the game would find their giant firms abruptly valued in pocket change. The only solution was to cover the problem with still more swaps and keep moving.

Then a funny thing happened. After years in which banks had handed out loans willy-nilly, guarded by the indestructible swap, people and companies started to really default on those loans. Credit slowed, home prices fell, and the whole snake started to eat itself tail first. Suddenly, credit default swaps were not sources of limitless cash. It turns out that an insurance policy -- even a secret, unregulated policy -- is occasionally expected to pay. Speculators started to look at the paper they were holding and for the first time realized it could all be worthless. Worse, it could (and did) represent a massive debt; one that no one had the funds to cover.

When Bear Stearns fell apart last March, it was only suspected that a big part of the effort in saving the giant investment bank was keeping their holdings in credit default swaps from unraveling and spreading to other institutions. Naturally, part of solving this problem involved creating a new credit default swap to cover Bear Stearn's potential debt. But the all-purpose swap was starting to lose its power. Shortly after Bear Stearns went belly up, AIG reported the largest quarterly loss in the company's history, taking a $11 billion hit on revaluing its holdings of swaps. The party was definitely coming to a close.

When AIG finally collapsed this week, there was no doubt about the primary cause of its failure. The previously well grounded company had "gotten itself involved with something called credit default swaps." Point of irony alert: Arthur Levitt now serves on the AIG board... or at least he did until the government had to take over most of AIG to salvage the company from the very idiocy Levitt had warned of in 1999.

This week, the Bush administration announced the beginnings of a plan to salvage what remains of the financial markets. At first glance, it appears that the plan will consist mainly of creating a kind of "garbage pit," a fund or group of funds -- cousins of the Resolution Trust that was created during the S&L crisis -- into which those people who have dabbled in bad debts can toss their problems. Only this time the cost to the taxpayers is at least $700 billion... and a big bite out of representative democracy.

The expansion of unregulated Savings and Loans in the 1980s brought on the collapse of that industry, a crippling of the economy, and left taxpayers holding the bag. Maybe that was only happenstance. Those pushing for the Garn-St. Germain Depository Institutions Act may not have known what they were doing.

The deregulation of the California electricity market, along with the protections provided to Enron through Phil Gramm's lobbyist-written legislation brought blackouts, fiscal and political chaos, and left taxpayers holding the bag. But the people who engineered that event -- people like Gramm and Greenspan -- had already seen what happened with the S&Ls. They should have known better. Still, perhaps that was only coincidence.

The sub-prime mortgage crisis that has not only come so close to utterly destroying the markets, but has ruined the value of many people's homes and left millions with mortgages they can't pay, was also the outcome of the deregulation created by these men. The very predictable outcome.  When taxpayers are left holding the bag for $1 trillion this time around, it's hard to believe it's any sort of accident.

This is enemy action. This is a bullet deliberately fired into the economy by men willing to exercise their ideology regardless of the cost to taxpayers. Men who have every expectation that they can plunder the system again and again, while the public picks up the tab. John McCain may not have had his finger directly on the trigger, but he was there. He assisted. These were his personal friends and philosophical comrades. He may not be the high priest, but he has been a loyal acolyte in the cult of deregulation.

It may come as a surprise to the champions of deregulation, but nobody likes regulation. The restrictions that were placed on banks, S&Ls, and other institutions in the 1930s weren't put there because someone thought it would be fun. They were put in place because they addressed problems that had just been clearly and painfully revealed. They were put in place because they were necessary.

It's bad enough if John McCain didn't know that. It's far worse if he did.

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prfsr

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Re: The crumbling of the US financial system (NC)
« Reply #149 on: September 23, 2008, 04:02:02 PM »

From the right-leaning WSJ

http://www.wsj.com/article/SB122178318884054675.html

McCain's Scapegoat

John McCain has made it clear this week he doesn't understand what's happening on Wall Street any better than Barack Obama does. But on Thursday, he took his populist riffing up a notch and found his scapegoat for financial panic -- Christopher Cox, the chairman of the Securities and Exchange Commission.

To give readers a flavor of Mr. McCain untethered, we'll quote at length: "Mismanagement and greed became the operating standard while regulators were asleep at the switch. The primary regulator of Wall Street, the Securities and Exchange Commission (SEC) kept in place trading rules that let speculators and hedge funds turn our markets into a casino. They allowed naked short selling -- which simply means that you can sell stock without ever owning it. They eliminated last year the uptick rule that has protected investors for 70 years. Speculators pounded the shares of even good companies into the ground.

"The chairman of the SEC serves at the appointment of the President and has betrayed the public's trust. If I were President today, I would fire him."

Wow. "Betrayed the public's trust." Was Mr. Cox dishonest? No. He merely changed some minor rules, and didn't change others, on short-selling. String him up! Mr. McCain clearly wants to distance himself from the Bush Administration. But this assault on Mr. Cox is both false and deeply unfair. It's also un-Presidential.

Take "naked" shorting, in which an investor sells a stock short -- betting that it will fall in price -- without first borrowing the shares he is selling from an investor who owns them. The SEC has never condoned the practice, and since 2005 it has clamped down on short selling in any stock that shows evidence of naked shorting. The SEC further tightened its rules against naked shorting just hours before Mr. McCain excoriated Mr. Cox for doing nothing.

The rules announced Wednesday will increase penalties and close loopholes that exempted broker-dealers from the rules against naked shorting. They also make it clear that deliberately selling short a stock whose shares cannot be borrowed is fraud under the Securities Exchange Act. That's all to the good, we suppose; fraud is fraud. But regular short selling is not fraud. It adds valuable information to the market about what investors believe to be the price direction of a stock. Demonizing short-sellers as a band of criminals, or barring short-selling outright in financial stocks, as regulators in the U.K. did Thursday, removes information from the market.

Then there's Mr. McCain's tirade against the "uptick rule," a Depression-era chestnut that investors could only short stock after a rise in that stock's price. The SEC staff studied the effect of the uptick rule on prices for years, in a controlled experiment involving thousands of stocks. It found the rule had no effect. Other studies, including those that examined the uptick rule's effect on stocks disclosing bad news, also found that it "protected" no one. The SEC's permanent staff has long supported repeal and the SEC's commissioners voted to do so unanimously in June 2007.

While he was at it, Mr. McCain added the wholly unsupported assertion that "speculators pounded the shares of even good companies into the ground." It wasn't very long ago that he blamed speculators on the long side for sky-high oil prices. Then oil prices fell. Now Mr. McCain wants voters to believe speculators are responsible for driving mismanaged financial companies to ruin. The irony is that this critique puts Mr. McCain in the same camp as some of the Wall Street CEOs who have led their firms so poorly. They also want someone (else) to blame.

In case Mr. McCain is interested, overall short interest in financial companies actually declined by 20% between July and the end of August. That's right: Far from driving this crisis, shorts were net buyers of financial stocks this summer, as they must buy stocks back to close their positions and realize their gains (or losses).

In a crisis, voters want steady, calm leadership, not easy, misleading answers that will do nothing to help. Mr. McCain is sounding like a candidate searching for a political foil rather than a genuine solution. He'll never beat Mr. Obama by running as an angry populist like Al Gore, circa 2000.

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kban1

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Re: The crumbling of the US financial system (NC)
« Reply #150 on: September 23, 2008, 04:39:32 PM »

What if the bailout plan doesn't work?

Eamon Javers



Lawmakers raised doubts Monday about what would be the largest government bailout in American history, but a bigger, more terrifying question lurked right under the surface: What if it doesn’t work?

Failure, says one insider, is not an option.

“The alternative is complete financial Armageddon and a great depression,” said a former Federal Reserve official. “Where do they go after this? Well, the U.S. government could nationalize the banking system outright.”

A few months ago, that idea would have been laughed out of the room.

But no one’s laughing anymore.

While almost no one wants to dwell publicly on the possibility that a $700 billion package could simply be too small to forestall a financial meltdown, privately some aides were already thinking of what the government might do if the Treasury plan passes but fails.

In a statement Monday, President Bush said that “the whole world is watching to see if we can act quickly to shore up our markets and prevent damage to our capital markets, businesses, our housing sector and retirement accounts.”

What the president didn’t say is that the whole world will be watching to see not just if Washington can act but whether Washington’s actions can still make a difference.

Under the current plan, the U.S. government will buy up to $700 billion in assets from private holders on Wall Street. That would help banks stabilize their balance sheets, and in theory provide an incentive for banks to begin extending credit among themselves again — a critical component of a functional financial system.

So what’s Plan B?

There really isn’t one.
If this week’s bailout doesn’t work, the government will probably have no choice but to continue to buy assets. There’s no one left to pick up the tab. “The private sector got us into this mess,” said House Financial Services Committee Chairman Barney Frank (D-Mass.). “The government has to get us out of it.”

Getting us out of it would likely mean buying up even more debt in the markets if the $700 billion fails to turn things around. That could include credit card debt, which is securitized and sold on Wall Street the same way as home mortgages, car loan debt and even commercial real estate debt, until the problem begins to recede or the taxpayers gain effective control over the nation’s banking system. 

So how will leaders know whether it’s working or not?

Traders and Washington insiders will look at credit market indicators to gauge their progress. One number in particular will be the focus of enormous attention on the day the bill passes: the difference between the interest rate offered by the federal government and the rates private banks charge when they loan money to one another.

If confidence is returning to the credit markets, the spread between the two numbers should begin to narrow as the banks’ rate — known by the acronym LIBOR — falls. But if the credit market is still in distress, the spread will widen.

In theory, traders should be able to see the results of any congressional legislation within minutes of news of the bill’s passage hitting Wall Street.

Here’s the good news: Already, just based on the news that Treasury is working on the proposal, the spread has been narrowing this week, down from the dramatic highs of last week. That means the market is pricing in an expectation that Congress will act and that the action will work.

If everything goes smoothly, it is even possible that taxpayers will profit from the deal in the long run, as the underlying assets accumulate value over the coming years and the government is able to ultimately sell them back into the market at higher prices than it’s paying now. Of course, it’s also possible that the values will never come back, in which case taxpayers would be on the hook.

The specific details of the package were a moving target on Monday, and congressional Democrats tangled with administration Republicans over the exact makeup of the bill.

Said Senate Banking Committee Chairman Chris Dodd (D-Conn.): “The last thing any of us want is to be back here in a month coming up with some new plan because this didn’t work. It’s important that we act quickly, but it’s more important that we act responsibly.”

That’s congressional code for: “Hey, wait a minute.”

The Banking Committee’s ranking Republican was of a similar mindset. “I am concerned that Treasury’s proposal is neither workable nor comprehensive, despite its enormous price tag,” said Sen. Richard Shelby of Alabama. “In my judgment, it would be foolish to waste massive sums of taxpayer funds testing an idea that has been hastily crafted and may actually cause the government to revert to an inadequate strategy of ad hoc bailouts.”

Ultimately, the negotiations will come down to doling out huge new powers, including:

• Buying Power: This is the cornerstone of the proposal — allowing Treasury to buy up to $700 billion of privately held assets in the market. The original proposal called for buying power to be limited to “mortgage-related” assets, but a later draft expanded that to allow the government to purchase any “troubled assets.” There’s a staggering difference in authority between the two phrases, and it is a moving target as of press time. The banking industry generally favors the second version, but that potentially exposes taxpayers to much higher costs.

• Managing Power: Under the Bush administration’s plan, Treasury would hire private managers to handle the hundreds of billions of dollars’ worth of assets it will soon own. But Treasury was silent on whether those managers would be able to actually negotiate directly with homeowners who hold the troubled mortgages. Democrats would go further and demand that bankruptcy judges be given the ability to renegotiate those failing mortgages on behalf of homeowners. This will be one of the more contentious sideshow fights of the negotiations.

• Global Power: Under one version of Treasury’s proposal, the government would have the power to buy assets from any institution in the world that it deemed worthy of a bailout.

• Pay Power: Democrats on Capitol Hill say they want the final plan to include restrictions on payouts to the executives of the financial institutions that take the taxpayer lifeline. Paulson says he doesn’t like this idea, but it may be tough for elected officials to oppose this populist carve-out in an election year.

• Equity Power: Democrats would like the government to get shares in the financial institutions that take federal help — effectively giving taxpayers ownership stakes in the nation’s largest banks and providing them with a huge windfall if those institutions prosper in future years.

• Oversight Power: Treasury’s initial proposal included very little room for congressional oversight of the new effort, calling for reports to be sent to the Hill just twice per year. That isn’t flying with Democrats or many Republicans on the Hill; if a bill makes it through Congress, it will almost certainly have much stronger oversight provisions.

http://news.yahoo.com/story//politico/20080923/pl_politico/13769
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RicePlateReddy

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Re: The crumbling of the US financial system (NC)
« Reply #151 on: September 23, 2008, 05:12:01 PM »

k-i-c:

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natty

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Re: The crumbling of the US financial system (NC)
« Reply #152 on: September 23, 2008, 07:29:24 PM »

I am a bit clueless here..

Is one of the effects of the fed intervention stabilizing home prices?  I understand the intervention is dealing with lack of credit to all sectors (which is why they are doing it in order to prevent presumed collapse of lending which would lead to major problems)..  As I understand it sellers are not really willing to mark down their homes and take the loss.  In the real estate bubble deflation in Japan real estate fell by 80 per cent..  Will there be any correction at all in the US?  When will we see the bottom of the real estate market?  The huge telecom and dotcom bubble burst in the early 2000s (where 90% of startups wound up) didnt have as much of an effect as the sub-prime mess.. why?


 
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keep-it-cool

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Re: The crumbling of the US financial system (NC)
« Reply #153 on: September 24, 2008, 03:52:34 AM »

Quote
But regular short selling is not fraud. It adds valuable information to the market about what investors believe to be the price direction of a stock. Demonizing short-sellers as a band of criminals, or barring short-selling outright in financial stocks, as regulators in the U.K. did Thursday, removes information from the market.

Completely Agree!
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pipsqueak

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Re: The crumbling of the US financial system (NC)
« Reply #154 on: September 24, 2008, 11:47:52 AM »

REQUEST FOR URGENT BUSINESS RELATIONSHIP Tuesday, September 23, 2008 | 12:00 PM in Bailouts

     SUBJECT: REQUEST FOR URGENT BUSINESS RELATIONSHIP

     DEAR AMERICAN:

     I NEED TO ASK YOU TO SUPPORT AN URGENT SECRET BUSINESS RELATIONSHIP WITH A TRANSFER OF FUNDS OF GREAT MAGNITUDE.

     I AM MINISTRY OF THE TREASURY OF THE REPUBLIC OF AMERICA. MY COUNTRY HAS HAD CRISIS THAT HAS CAUSED THE NEED FOR LARGE TRANSFER OF FUNDS OF 800 BILLION DOLLARS US. IF YOU WOULD ASSIST ME IN THIS TRANSFER, IT WOULD BE MOST PROFITABLE TO YOU.

     I AM WORKING WITH MR. PHIL GRAM, LOBBYIST FOR UBS, WHO WILL BE MY REPLACEMENT AS MINISTRY OF THE TREASURY IN JANUARY. AS A SENATOR, YOU MAY KNOW HIM AS THE LEADER OF THE AMERICAN BANKING DEREGULATION MOVEMENT IN THE 1990S. THIS TRANSACTIN IS 100% SAFE.

     THIS IS A MATTER OF GREAT URGENCY. WE NEED A BLANK CHECK. WE NEED THE FUNDS AS QUICKLY AS POSSIBLE. WE CANNOT DIRECTLY TRANSFER THESE FUNDS IN THE NAMES OF OUR CLOSE FRIENDS BECAUSE WE ARE CONSTANTLY UNDER SURVEILLANCE. MY FAMILY LAWYER ADVISED ME THAT I SHOULD LOOK FOR A RELIABLE AND TRUSTWORTHY PERSON WHO WILL ACT AS A NEXT OF KIN SO THE FUNDS CAN BE TRANSFERRED.

     PLEASE REPLY WITH ALL OF YOUR BANK ACCOUNT, IRA AND COLLEGE FUND ACCOUNT NUMBERS AND THOSE OF YOUR CHILDREN AND GRANDCHILDREN TO WALLSTREETBAILOUT@TREASURY.GOV SO THAT WE MAY TRANSFER YOUR COMMISSION FOR THIS TRANSACTION. AFTER I RECEIVE THAT INFORMATION, I WILL RESPOND WITH DETAILED INFORMATION ABOUT SAFEGUARDS THAT WILL BE USED TO PROTECT THE FUNDS.

     YOURS FAITHFULLY MINISTER OF TREASURY PAULSON
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prfsr

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Re: The crumbling of the US financial system (NC)
« Reply #155 on: September 24, 2008, 03:24:37 PM »

Good one, pip.

The bill said:
"Sec. 8. Review. Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency."

Paulson, who asked for the bill to be passed immediately, explained:
"I believe these actions should be completely transparent and open to review as is the role of Congress, and it would be presumptuous of me to presume otherwise!"

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prfsr

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Re: The crumbling of the US financial system (NC)
« Reply #156 on: September 24, 2008, 03:46:55 PM »

The link below is to a panel discussion in the Economics Dept at Princeton.

http://econ.princeton.edu/news/crisis-panel.html

I found the link from Krugman's blog. 
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flute

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Re: The crumbling of the US financial system (NC)
« Reply #157 on: September 24, 2008, 03:49:28 PM »

I cannot read thru 4 pages of posts, can someone sum it up for me? will my home price recover ever?  :)
will it go down further?
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prfsr

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Re: The crumbling of the US financial system (NC)
« Reply #158 on: September 24, 2008, 03:57:58 PM »

A slightly off-topic post but I think many here will like this. As always, links in the original blog are missing here:


http://d-squareddigest.blogspot.com/2004_05_23_d-squareddigest_archive.html

Thursday, May 27, 2004
 
Update, September 2008. Hullo there Paul Krugman readers. Yes, I did say "Good ideas do not need lots of lies told about them in order to gain public acceptance", and as a general maxim I wholeheartedly recommend it. I don't necessarily, however, either endorse or whatever-the-opposite-of-endorse the specific use of that maxim in the context of Prof. Krugman's post about the Paulson bailout plan; I don't actually have a fully formed view about that plan. I do, however, wholeheartedly endorse "Development, Geography and Economic Theory", which I think is a terribly underrated economics book, and am at this moment rather starstruck at having one of my essays admired by the nearest modern equivalent to my hero JK Galbraith. Anyway, as you were; by way of context, the post below was written just as a lot of high-profile commentators like Thomas Friedman were abandoning their support for the Iraq War.

The D-Squared Digest One Minute MBA - Avoiding Projects Pursued By Morons 101

Literally people have been asking me: "How is it that you were so amazingly prescient about Iraq? Why is it that you were right about everything at precisely the same moment when we were wrong?" No honestly, they have. I'd love to show you the emails I've received, there were dozens of them, honest. Honest. Anyway, I note that "errors of prewar planning" is now pretty much a mainstream stylised fact, so I suspect that it might make some small contribution to the commonweal if I were to explain how it was that I was able to spot so early that this dog wasn't going to hunt. I will struggle manfully with the savage burden of boasting, self-aggrandisement and ego-stroking that this will necessarily involve. It's been done before, although admittedly by a madman in the process of dying of syphilis of the brain. Sorry, where was I?

Anyway, the secret to every analysis I've ever done of contemporary politics has been, more or less, my expensive business school education (I would write a book entitled "Everything I Know I Learned At A Very Expensive University", but I doubt it would sell). About half of what they say about business schools and their graduates is probably true, and they do often feel like the most collossal waste of time and money, but they occasionally teach you the odd thing which is very useful indeed. Here's a few of the ones I learned which I considered relevant to judging the advisability of the Second Iraq War.

Good ideas do not need lots of lies told about them in order to gain public acceptance. I was first made aware of this during an accounting class. We were discussing the subject of accounting for stock options at technology companies. There was a live debate on this subject at the time. One side (mainly technology companies and their lobbyists) held that stock option grants should not be treated as an expense on public policy grounds; treating them as an expense would discourage companies from granting them, and stock options were a vital compensation tool that incentivised performance, rewarded dynamism and innovation and created vast amounts of value for America and the world. The other side (mainly people like Warren Buffet) held that stock options looked awfully like a massive blag carried out my management at the expense of shareholders, and that the proper place to record such blags was the P&L account.

Our lecturer, in summing up the debate, made the not unreasonable point that if stock options really were a fantastic tool which unleashed the creative power in every employee, everyone would want to expense as many of them as possible, the better to boast about how innovative, empowered and fantastic they were. Since the tech companies' point of view appeared to be that if they were ever forced to account honestly for their option grants, they would quickly stop making them, this offered decent prima facie evidence that they weren't, really, all that fantastic.

Application to Iraq. The general principle that good ideas are not usually associated with lying like a rug1 about their true nature seems to have been pretty well confirmed. In particular, however, this principle sheds light on the now quite popular claim that "WMDs were only part of the story; the real priority was to liberate the Iraqis, which is something that every decent person would support".

Fibbers' forecasts are worthless. Case after miserable case after bloody case we went through, I tell you, all of which had this moral. Not only that people who want a project will tend to make innacurate projections about the possible outcomes of that project, but about the futility of attempts to "shade" downward a fundamentally dishonest set of predictions. If you have doubts about the integrity of a forecaster, you can't use their forecasts at all. Not even as a "starting point". By the way, I would just love to get hold of a few of the quantitative numbers from documents prepared to support the war and give them a quick run through Benford's Law.

Application to Iraq This was how I decided that it was worth staking a bit of credibility on the strong claim that absolutely no material WMD capacity would be found, rather than "some" or "some but not enough to justify a war" or even "some derisory but not immaterial capacity, like a few mobile biological weapons labs". My reasoning was that Powell, Bush, Straw, etc, were clearly making false claims and therefore ought to be discounted completely, and that there were actually very few people who knew a bit about Iraq but were not fatally compromised in this manner who were making the WMD claim. Meanwhile, there were people like Scott Ritter and Andrew Wilkie who, whatever other faults they might or might not have had, did not appear to have told any provable lies on this subject and were therefore not compromised.

The Vital Importance of Audit. Emphasised over and over again. Brealey and Myers has a section on this, in which they remind callow students that like backing-up one's computer files, this is a lesson that everyone seems to have to learn the hard way. Basically, it's been shown time and again and again; companies which do not audit completed projects in order to see how accurate the original projections were, tend to get exactly the forecasts and projects that they deserve. Companies which have a culture where there are no consequences for making dishonest forecasts, get the projects they deserve. Companies which allocate blank cheques to management teams with a proven record of failure and mendacity, get what they deserve.

I hope I don't have to spell out the implications of this one for Iraq. Krugman has gone on and on about this, seemingly with some small effect these days. The raspberry road that led to Abu Ghraib was paved with bland assumptions that people who had repeatedly proved their untrustworthiness, could be trusted. There is much made by people who long for the days of their fourth form debating society about the fallacy of "argumentum ad hominem". There is, as I have mentioned in the past, no fancy Latin term for the fallacy of "giving known liars the benefit of the doubt", but it is in my view a much greater source of avoidable error in the world. Audit is meant to protect us from this, which is why audit is so important.

And so the lesson ends. Next week, perhaps, a few reflections on why it is that people don't support the neoconservative project to bring democracy to the Middle East (a trailer for those who can't wait; the title is going to be something like "If You Tell Lies A Lot, You Tend To Get A Reputation As A Liar"). Mind how you go.


--------------------------------------------------------------------------------


1 We also learned in accounting class that the difference between "making a definite single false claim with provable intent to deceive" and "creating a very false impression and allowing it to remain without correcting it" is not one that you should rely upon to keep you out of jail. Even if your motives are noble.
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RicePlateReddy

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Re: The crumbling of the US financial system (NC)
« Reply #159 on: September 24, 2008, 11:56:40 PM »

prfsr, good links.

This was Krugman's note that referred to the above blog post you posted -- it is very clear.

Good ideas and lies
http://krugman.blogs.nytimes.com/2008/09/23/good-ideas-and-lies/

Daniel Davies, in one of the great blog posts of this era, laid down a key principle:

Good ideas do not need lots of lies told about them in order to gain public acceptance.

He was talking about the selling of the Iraq war, but it applies more generally.

So, this morning Hank Paulson told a whopper:

We gave you a simple, three-page legislative outline and I thought it would have been presumptuous for us on that outline to come up with an oversight mechanism. That’s the role of Congress, that’s something we’re going to work on together. So if any of you felt that I didn’t believe that we needed oversight: I believe we need oversight. We need oversight.


What the proposal actually did, of course, was explicitly rule out any oversight, plus grant immunity from future review:

Sec. 8. Review.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.


I’m not playing gotcha here. This is telling: if Paulson can’t be honest about what he himself sent to Congress — if he not only made an incredible power grab, but is now engaged in black-is-white claims that he didn’t — there is no reason to trust him on anything related to his bailout plan.


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