The Bad Reputation of RMBS

I was in Mill Creek earlier this evening having sushi with my daughters and everytime we drive down into Mill Creek I say the same thing: “I remember when this whole place was nothing but trees!” They’ve already heard the stories about how I use to leave the house at dawn with the neighborhood boys and play in the woods all day until dinner time.  But they haven’t heard the stories about the banks.  As I was driving back up the hill, I was stopped at a horribly long stop light which gave me time to ponder the bank to my left, a Wells Fargo, and educate my children: “That bank use to be a First Interstate Bank.  Before that it was an Olympic Bank.” Before that it was something else.

With so much shock and awe over the past few days about the possible imending doom headed our way unless we quickly pass Paulson’s bailout plan, and all the taxpayer backlash on the blogs as well as being reported in the MSM, the new question becomes, well what are some other worthwhile ideas for how to get us out of this mess?  Today, Dr. Krugman suggests that we consider anything coming out of Henry Paulsen’s mouth to be a lie.  This might be a good way to solve the financial crisis extremely fast.

“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 the proposal actually did, of course, was explicitly rule out any oversight, plus grant immunity from future review. Read more here.

Want to see Henry Paulson in action? Watch this quick video. When he’s testifying, at the part where he says “I want oversight” watch his head go back and forth in a “no” motion.  I tend to believe people’s nonverbal signals over the words they say. 

The Paulson/Bernanke bailout plan details are starting to rise to the surface:

One thing is clear – something we all guessed correctly – is that the intention of the plan is to pay premium prices for troubled assets to recapitalize the banks. It’s still not clear how the price mechanism will work, and unfortunately Paulson and Bernanke are unable to describe how this will work..

This means the TARP plan would buy assets from banks at a higher price than what the banks could get if they tried to sell them at fair market value. Bernanke and Paulson believe the assets are being unfairly underpriced in the free market because of their bad reputation so instead, they’re proposing that the taxpayers subsidize the re-capitalization of the banks.

One analyst says it would take at least 5 trillion for the proposed plant to work.

Why not let the banks come clean and sell their assets at today’s prices, and we can spend taxpayer money building back up the FDIC insurance fund. Weaker banks will fail and stronger banks will buy the assets of the weaker banks from bankor from the FDIC after failure.  Big banks like WaMu could be split up into smaller entities which will be easier for many different banks to absorb. 

Eleua, a frequent commenter on this blog, has been working with a group of other like-minded individuals and he has penned an outline for a solution here:

There is a solution that costs the government nothing, eliminates “moral hazard,

180 thoughts on “The Bad Reputation of RMBS

  1. What happens if Congress does nothing?

    Let’s look at Congress’ three options. Yes, there are three options, not the two that Hank and Ben are shoving down their throats.

    First – Do nothing and adjourn. In my opinion, the market will sell off dramatically and Wall Street will further attempt to hide their sins, which will continue to erode confidence. Bottom line – continued erosion with no real ability to have a meaningful recovery.

    Second – Give in to extortion. Market rallies on solid rocket boosters for a few days, commodities rally with equities (that’s bad), then the bond market cracks and eventually dislocates, which takes other markets into the abyss. This is the scenario where people start lobbying Congress with 535 lengths of boiled rope and lampposts. People are going to be steamed enough over giving our money to Wall Street fatties, but when the market crashes in that aftermath pitchforks, torches and shotguns come out and nobody is going to be safe. These are the scenarios you read about in history books.

    With a cratering bond market, your home price is going down the pipe. That money ($700B) isn’t going to be cycled back into homes. Those that have their money trapped in the debt markets are going to sit on it. If you think the credit markets are slushy now, we are setting up a glacial environment for credit in the future.

    Third – Congress fixes the problem. Markets sell off hard and fast, but CONFIDENCE IS RESTORED. This is the underlying problem and why we keep having organizations that operate in mystery blow up as a regular feature of our financial landscape. Congress attacks the issue from a regulatory perspective, and the Wall Street piggies get it right between the eyes, Main Street winces at their 401k portfolios, but keeps their ability to restart the system.

    There is no painless way out of this. We are choosing between options that come after decades of debt excess and mispricing of risk. Getting transparency back into the system, the risks are right in your face and you can price them accordingly. It also ends the string of bailouts.

    The best time to plant a tree is 20 years ago. The second best time is today.

    We are supposed to be a free country, and that includes the freedom to fail.

    This is one of those times in American history that gets its own chapter in the text books. Pay attention, as your lifestyle over the next few decades will be determined by what happens in the next few weeks.

    Thanks, Jillayne. I appreciate the honor of commenting on your blog in this manner.

  2. The bond market sells off (yields rise) when the perceived risk rises.

    Right now, US debt is considered the safest investment on the globe. The past 6 months has been witness to an unprecedented swap of US debt for the most toxic debt imaginable. If the ratio of good to bad is very high, then the risk to the good is very low. As the ratio of the bad stuff (and in this case it is VERY bad) rises compared to the good stuff, the good stuff starts to take on the characteristics of the bad stuff.

    After all, we are on the hook to pay this off. If the US gov is sending out its debt and inhaling the bad stuff, eventually our credit rating gets impaired.

    If Microsoft has a suite of good programs, and only one dud, then we would think of MSFT as a good buy and the quality of their products as top notch. As they reduce their good programs and come out with crappy programs, the overall quality is reduced.

    In the case of the US gov, we keep giving explicit guarantees to all this toxic crap (just like we do on the Treasury complex), and the “full faith and credit” is going to be more difficult to maintain.

    If we don’t give the guarantee to this crap, we take a bath on it. That money has to come from somewhere and eventually the US taxpayer will not be able to support the load of the Treasury complex guarantee. If we give the guarantee on the toxic stuff, then we end up in the above scenario.

    All that assumes we don’t “print.”

    IF we do print, then the bond market will instantly realize they are getting paid back with nothing more than paper, rather than claims on production.

    Hope that helps.

    “Restoring confidence” as uttered by Hank and Ben is laughable. Their entire time in the spotlight has been witness to government complicity in expanding the opacity of the financial system. Only CNBC idiots buy their “confidence” claims. The market has been selling off since they started their shenannigans (Oct 10 ’07 was the all-time high in the stock market, and now we are down almost 33% in one year). Their plan is to further obfuscate and paper over the systemic problems that are causing all the fuss.

    When I am saying “restore confidence,” I am talking about total transparency for investors – no surprises, tricks, or overly complex methodologies for calculating value. Force people to eat their losses, rather than cloak themselves in the herd.

    Fix the problem – don’t treat the symptom.

  3. Word on the street is phone calls are running 97% against the Hank/Ben proposal.

    Congress needs an out. No matter what they do, they end up eventually implementing regulatory reform.

    Do it now, and get it over with.

  4. I disagree with Eleua regarding the value of “regulatory reform”. The reason we got into this mess in the first place is BECAUSE of government involvement in the economy (e.g. GSEs, deposit insurance, low Fed interest rates, etc), and tougher regulations will only hamper a recovery.

    The best thing the government can do is nothing. Allow the liquidation of assets to proceed unimpeeded. Sure, stocks will crash, most banks will go bust, and many tens of millions will have their savings and pensions wiped out. But this is inevitable anyway. Why dig an even bigger hole by burdening tax-payers even more (e.g. with bail-outs), or tying the hands of the financial industry that tries to rise out of the ashes?

    If the government disentangles itself from deposit insurance (i.e. allowing the FDIC, SIPC, etc, to go bust), and unloads the GSEs, they will have made HUGE steps to put the financial system on a sound footing. People will all start to take responsibility for their own investing again (i.e. because they KNOW the government won’t bail them out). It is this irresponsible saving and investing behaviour that is the root evil in our economy, and until that bear is wrestled down there is no way we can have a sound recovery.

  5. I haven’t read the comments yet, but the no oversight thing is wrong. The provision cited just prevents review by courts (judicial branch) and by administrative agencies, which are all part of the executive branch. I’m not one to thing Congressional oversight (or fact finding) is particularly useful, but the proposal didn’t rule it out.

    The second part is much more troubling–that they’ve contemplating over-paying for the assets. That would occur as a natural result of pumping that much money into buying that type of asset. I can live with that, but it bothers me. But if they’re planning on purposefully increasing the price, that I can’t live with.

  6. Eleua, re #3, I think you’re not filling in much detail on option #1. Will Ballard end up looking like Cabo San Lucas? 😉

    As to option #2, I’m not connecting up the plan to the bond market eventually cratering. Please explain.

  7. Eleua, I see you answered my question about #2 already. I guess I see that as a problem only if they don’t adjust other monetary policy as much as they can (or dump $700 billion in within too short of a time).

    You mention CNBC. When searching for Ardell’s prior opinions I found that Cramer called for buying property in Seattle back in September 2007.

    In post 73 I said that caused me concern. I think I might have to fall back on that old tried and true thing of going against whatever Cramer thinks is good, and he thinks this plan is good.

    I guess my main concern is I’m not sure you can go back from this position. Wall Street is very emotional, and Paulson in the past week has created a lot of fear.

    Oh, one other thing I’ll throw out (an off the cuff, if not off the wall, comment). 9/11/01 occurred at a time when our markets were not doing well. I don’t know if that timing was intentional or not, but if it was we’re at increased risk again. Add that to the pre-election attacks in Spain maybe 5 years ago, and again the risk of an attack goes up. There’s potentially a lot at stake here beyond just the basic economics.

  8. I view the current proposals to bail-out the financial industry/economy as akin to the treatments of medieval physicians. While the patient may indeed be very ill (i.e. in this case it is the US economy and tax-payer), bleeding them only makes things worse.

    If you don’t have any effective medicine the only thing you can do is let the disease run its course.

    Paulson & Bernanke are nothing but quacks pushing dubious cures. Heck, they even acknowledge they don’t know if their proposals will work.

  9. You know, I hear a lot of this could happen or that will happen out of this crowd, but I haven’t seen one shred of proof for any of the scenarios given. All I hear is a lot of name calling, accusations and criticism towards Paulson, Bernake and our Gov, granted they prob deserve it.

    OK, so it’s a BLOG, I get it, there may not be experts here, but I’d like to think that some of you regulars actually know something about the Capital markets and the financial system.

    So please anyone, put some freakin data/fact behind your predictions! Tell me how years of tracking market data, observing the flow of funds, understanding the mechanisms behind financial instruments have led you to believe what you believe. Or should I just turn on the TV or pick up a newspaper and regurgitate this crap too?

    Perhaps I’m just numb and not sniffing out the info reading between the lines. Sorry for being dumb.

    Taking a line out of a Few Good Men – Thank you for your expert, professional opinion.

  10. q-diddy wrote: “I hear a lot of this could happen or that will happen out of this crowd, but I haven’t seen one shred of proof for any of the scenarios given”

    And you are getting more data and facts from Paulson and Bernanke as to why their baill-out will succeed? Actually, Paulson and Bernanke sound JUST like the tin-foil hat people in the congressional hearings. They are going on and on about how apocalyptic it will be if their bail-out isn’t implemented, but they offer no facts to back it up. It’s all supposition.

  11. Q-diddy, I think the problem is it’s uncharted water. You might try to compare Japan in the 90s, or the U.S. in the 80s, but they aren’t the same.

    The thing I liked about the proposal is it didn’t just help the poorly run companies, or even the companies that make mortgage loans. But it does have obvious concerns/problems.

  12. Sniglet-

    Agreed, I’m not getting more from what Paul and Bernie are saying, but I KNOW there are things about this whole mess that most Americans don’t understand.

  13. q-diddy wrote: “I KNOW there are things about this whole mess that most Americans don’t understand.”

    Actually, the really scary thing is that I suspect there are huge aspects of this mess that NO ONE understands (not even Paulson and Bernanke). No one really knows what the land-mines are with credit-default swaps and derivatives. No one really knows who is holding all the toxic assets. No one really knows how much large numbers of entities are under-reporting their risk to asset backed securities and/or derivatives.

    In short: policy makers are flying completely blind, which certainly doesn’t increase the confidence level of their proposals.

  14. The real question is:

    What is the real tride and true solution to this mess?

    Ultimately I believe it comes down to the U.S.A. getting a little selfish and starting to take care of its own people, and its own economy. To stop policing the rest of the world, and do some healing at home.

    There are a few basic ways of getting there:

    #1. Stop the wars
    #2. Raise the taxes on the rich to the equivalent of what the middle and lower class are paying
    #3. CUT spending in areas we can
    #4. Give incentives to bring all the outsourced jobs to India/Phillipines back to the U.S. and pay them a decent wage.
    #5. If property is worth significantly less than what people purchaed it for, forgive the principal, but still keep people on the hook for the property they purchased. Banks will make LESS but still make a profit.

    Bailing out the failing economy with more of our money is outrageous.

  15. Sniglet-

    I agree with you on most levels, but it doesn’t take much for the Gov to find out. They can make all types of policy to dig into any balance sheet if they desire. The problem is…how will they know how to value? Market price? Held to Maturity Price? How can they value a loan if there’s fraud involved?

  16. Here is something that is interesting.

    Hank/Ben are on The Hill trying to get money for banks – INCREASE LIQUIDITY.

    Funny thing…Ben has drained the short term bank lending pool from $190B to $65B in 4 days.

    Why would he do that? Is he trying to cause a bank to blow and intimidate Congress?

    Ask yourself, “What is the most vulnerable big bank in the USA?”

    See, Seattle is special.

  17. John wrote: “What is the real tride and true solution to this mess?”

    The answer is VERY simple: EVERYONE needs to rebuild their personal ballance sheets, reducing their debt. The crisis will be well and truly over when most of the people are living within their means (i.e. which is NOT true today).

    This is why the whole idea of trying to engineer a bail-out to avoid serious economic pain is flawed from the very start. We need a downturn precisely to get everyone’s finances back in order, and restore the saving ethic. We desperately NEED many tens of millions of personal bankruptcies, purging debt, to restore financial health. That LAST thing we should be doing is trying to keep people who are already over-extended in homes they never could really afford in the first place.

  18. This is the financial markets problem. Credit is an easier way to make money than actually doing business.
    Commerce is creating a product, selling a product, and making a profit.
    Credit is creating a contract, and collecting.
    You’re making the secondary market more complicated than it is. There is no problem with home loans. People want homes. They want to live in homes, they want thier children to live in homes, and they will pay whatever it takes to stay in the home as long as they possibly can.
    Consumer credit is the problem. Credit cards, car loans, student loans and the loans people take out to buy crappy Berkshire products.
    Those are the loans the financial markets want money for.

  19. As a seperate question I want to know why lenders are not being forced to collect on the loans they made? Why aren’t lenders forced to modify home loans that are “toxic (?)” in favor of the home owner? If lenders collect at full value, even if it takes thirty years, they still have full value on the books, and can move forward.
    If it’s a default issue then the loans should be fully assumable. It’s simple, and safe.

  20. Q-diddy,

    The pool of short term funds for banks to borrow is called “the slosh.” The FED trims the slosh by either adding or withdrawing funds to keep the prevailing interest rate (EFF) close to the Federal Funds Target (FFT). The FFT is the target that gets everyone all excited every 6 weeks when the FOMC meets. They decide to move the target up or down to match the EFF.

    Right now, the FFT is 2.00, and yesterday’s EFF was below 1.50 with a falling pool of money. Ben has been selling securities (taking in money) to defend the 2.00 target, but this lowers the available funds in the slosh pool and greatly risks a bank not being able to meet its short term funding obligations.

    For the past year, every time the EFF has dropped that far below the FFT, the FOMC has come out and dropped the FFT (cut rates). For him to be consistant, he would have come out in the past day or so and had an “emergency intra-meeting rate cut,” which in this case would likely be a 50bp cut.

    If he did that, the markets would rocket up another 500 points, while he is trying to make his case to Congress that the markets are teetering on the edge of financial collapse – tough sell.

    Intentionally trying to defend 2.00 in the environment of collapsing demand for short term commercial credit, is going to get a bank killed.


  21. I’m with Eleua on this one. A large bank going under will create consumer fear that we’re all going to lose our deposits (even if only temporarily) and then people will be back on the phones to their elected representatives yelling at them to “do something.”

    For Bernanke and Paulson to pretend like they didn’t know what was happening is insulting to me.

    This seems very well orchestrated up to this point; the timing is perfect: use the fear of the unknown, combine that with a complex concept such as securitized lending and add to that the pressure of time. But humans are irrational and perhaps the backlash from the public was far greater than they anticipated.

    I’ve been out all day. How was the testimony earlier today?


  22. Eleua wrote:

    “…but this lowers the available funds in the slosh pool and greatly risks a bank not being able to meet its short term funding obligations.”

    Are you suggesting banks can’t borrow Fed Funds or some other short term instrument? Please elaborate.


  23. The slosh is the pool of money that banks lend to each other to balance their reserves. If the slosh falls to low, some banks (the most unhealthy) are not going to be able to have the required reserves on hand per statute, because the other banks will have inhaled it. The sick banks would have to pay a higher interest rate to coax the money to them, and in the event they fail, they can be seized.

    The Federal Reserve helps trim this pool to keep the prevailing short term interest rates stable so the banks can have some form of planning to run their business. If you look at the slosh build over the past year, you will see that the FED really pumped the slosh to keep things working. Now they are draining rapidly at a point in time of market jitters and intense Congressional lobbying.


  24. It’s what banks, lenders, pass back and forth. It’s like check kiting on a large scale. Think of it today like musical chairs when every one knows the music may stop at any moment so they aren’t passing the money around.
    They lend each other money and the Fed does the same. That’s the liquidity of the market that has dried up.
    From what I understand every body has plenty of money, they are just hoarding it.
    Coporations have savings accounts, lenders have cash, the Fed can make wild trillion dollar promises because they can.
    The economy is basically strong.
    The problem is the assets are over priced. Stocks, bonds, gold, oil, Real Estate, pork bellies and oranges are all over priced.
    It’s cheaper and easier for corporations to lend each other money while driving up the price of goods than actually do business.
    It’s greed.

  25. Eleua and David-

    So what you both are saying is you don’t know what it’s called or how it’s traded? What about my earlier question? Who does it affect? Which institution? Which bank? Please be more specific.


  26. Q-diddy,

    “Slosh” is the correct term. It is the pool of funds the banks hold in short term instruments that they loan to each other to balance reserves.

    A bank needs to hold a certain percentage of its loan portfolio in cash. This is their reserve. If a bank has a good day, their portfolio expands and they need more money to balance their reserves. They go out to the other banks with a bid and borrow money to hold short term. If a bank has a bad day, their portfolio shrinks and they have excess reserves. They go to the market with an asking price for their money. Where those two meet is the interest rate of the short term loan. The average number is the EFF.

    The FED steps in and adds to the slosh (drive the EFF down) or drains slosh (drive the EFF up) to keep it in line with the Funds Target (FFT). If the FED is forced to add/drain too much, it will move the FFT.

    This is why you see the FED “cutting” when the economy slows. It isn’t cutting rates, but following the decline of debt origination down.

    The FFT is a thermometer, not a thermostat.

  27. Interesting analysis from PJ on Housing Wire on the President’s speech tonight:

    “Forget everything else about how the current financial mess could hurt everyday Americans, which it could. My jaw fell to the floor when I heard the President, attempting to explain the current mortgage/financial debacle to everyday Americans on Wednesday night, throw both Fannie Mae and Freddie Mac under the proverbial bus.

    “Fannie Mac and Freddie Mac … fueled the market for questionable investments,

  28. TARP is the perfecct acronym for this plan, because it throws a huge tarp on Paulsen and company as they sell out the American people to bail out a few large financial institutions. No accountability? No way!

    So, ah, Sushi Zen, or Sushi Ring? If the former wish my love to Kyoo, if the latter, to Elvis. I miss Yama-san.

  29. Eleua and David-

    What you are describing is not called Slosh, it’s called Fed Funds. It settles through a banks Fed account and hence the name. It is an UNSECURED instrument with a short term maturity usually overnight, but could go all the way out to 12 months although that is pretty rare.

    The Fed Funds Target Rate (2%) does not move unless the Fed makes a rate decision either up or down at their meetings. They however try to manage the rate banks lend to each other on an overnight basis by conducting Open Market Repos (sell or buy securities). The Fed Effective Rate is an indicator of how well or bad they have been able to manage the overnight rates. It is the average rate during any given trading day that’s why there’s always a 1 day lag to get it.

    Now that I’ve explain to you what it is and how it works, please explain to me who it affects and how/why the Fed is purposely making it harder for banks to borrow Fed Funds.


  30. Jillayne wrote:

    “Read that again. And then remember that this mess started with a private-party securitization party that left the GSEs gasping for air, and market share”

    I agree with your comments abuot Fannie and Freddy, but let’s not so quickly point to some private securitization that CAUSED the mess. I think we’re all clever enough to know it wasn’t only one thing.

    BTW, I don’t think the $700BN is a bad idea, but under it’s current form it is.

  31. Eulea in #3 : Third – Congress fixes the problem.

    When in history has the Congress fixed any problem ?
    And exactly how does Congress fix this problem ? I am wondering they even have an idea of what the problem is ? the US has too much debt with too little savings and sound assets.
    Overpriced houses are being paraded as sound assets.

    Japan has tried that solution in the 90s, and they ended up with zombie banks that still exist only on books for accounting purposes. The Nikkei and the markets never recovered from that point and Japanese companies only make money outside of Japan.

    The best would be for the Congress to adjourn and leave it to the bankers to fix this mess themselves. Perhaps a $100B / quarter with Congressional and regulatory oversight would be a middle ground solution.
    Additionally, if MBS and other debt instruments are purchased by the Fed and the Treasury from banks at “hold-to-maturity” value, then at least 25% of the difference between the discounted market-price and “hold-to-maturity” price should be issued as stock warrants and preferred stock by these banks. Otherwise no deal.

    The blackmail tactics to extort money will backfire and the bankers will have to work it out amongst themselves in their collective self-interest.

    Overpaying for weak “assets” has never worked out throughout history.

    Mumbai, India

  32. You described the Fed. The Fed is different and separate, or was, from the, you say slosh, I say slush fund. Over night bank note, rate, or float makes no difference.
    This is exactly why no one can describe the derivative market, funds, or income.
    No matter what you call it huge amounts of cash are trading on those per centage points of interest. A credit card can carry 30% interest. Home loans can carry 5% to 12%.
    1% interst may be nothing on a hundred but on a billion it adds up to dollars.
    What they are wrangling about today is consumer confidence. It all comes down to you. Will you continue to pay $4.00 for a tank of gas or ride a bicycle? Will you continue to buy prepared food at QFC or cook? This Christmas will you be shopping or knitting sweaters for gifts?
    The expanding economy has to do with what the consumer will buy.
    You’re obviously asking about a bank like WaMu. Will $700,000,000,000 fix WaMu? Heck no.
    It has a porfolio of loans, savings accounts, CDs, Murphy Favre securities, a ton of other products tied to pension funds, retirement plans, medical savings plans, insurance on deposits, or geez I can think of a thousand other products that they have sold to an unsuspecting public.
    In other words WaMu, if they would just do business as they should, they can make money. They are a money machine. They can sell a department, reinvest, turn it around, but they don’t want to.
    It is easier, and cheaper, to simply trade those per centage points of interest in over night funds. It’s an immediate profit. It looks good on the bottom line. The stock looks better.
    You like the stock market don’t you? You want the stock market to do well? It would be absolutely unAmerican to let the stock market drop to say 8,000. Then it would only be double the value of what it was in say 1996. It took forty years to hit 4,000, but we need it to be double in value now, ten years later.
    What everybody is yammering about today has to do with propping up an over priced market place. The over night bank notes have nothing to do with that. Thier function is liquidity. It has to stop.

  33. I think this whole thing is a ploy to prepare for WAMU, etc. going down the drain. Since they haven’t been able to sell it, the FDIC/FED/GOV need to prepare for the inevitable. As of now, they don’t have enough money/manpower at either the FDIC or FED to handle such a large failure. The $700B is a set-up that ran into a great deal of unexpected opposition. But it will pass, because the gov needs both the money and a mechanism in place when WAMU goes down. Think of it as a controlled demolition, if you will.

    In the end, it helps nothing, only prolonging the return to a more solid foundation.

    Regarding a question about the bond market- U.S. gov budget is about $3 trillion this year, plus half a trillion already in deficits for stimulus packages, etc, plus this $.7 trillion, plus another $50 billion for the automakers, plus….. Oh, I hear next year’s deficit is also already half a trillion. That’s a lot of money that needs to be borrowed. There’s only so much money floating around out there. So the government’s going to have to compete for it- by offering/paying higher interest rates. That drives rates up for everything. And housing prices down. So the cycle continues…..

  34. #45 : “I think this whole thing is a ploy to prepare for WAMU, etc. going down the drain. Since they haven’t been able to sell it, the FDIC/FED/GOV need to prepare for the inevitable.”

    WaMu miscalculated and mismanaged. They have’nt been able to sell their operations because they are asking for more than a buyer is will to pay. Korean Development Bank (KDB) was willing to pay $20/share for Lehman Brothers in August, but that moron CEO Dick Fuld wanted atleast $30/share. See where Lehman Brothers is today.

    If I mismanage my business, obviously, I am going to be bankrupt. If I try to sell my business at a price higher that what prospective buyers are willing to pay, obviously, I cannot sell it.

    Why do these big banks keep complaining when the price-discovery mechanism does not work in their favor ? If these morons do not understand this they do not deserve a bailout. It is putting good money after bad.

    There is a reason why Warren Buffett is a buyer today and these mismanaged banks are panic sellers. The only time these morons used the term “risk-management” was in fancy PowerPoint presentations.

  35. David-

    Not to bash on you buddy, but you need to go back to banking 101. On the Street it is known as Federal Funds, but obviously in your world it’s called “slosh.”

    Anyway, I’m more curious about Eleua’s theory on the Fed squeezing Fed Funds to bring down banks. I’m wondering how this is so and which bank in Seattle is being targeted.

  36. B Trader-

    They have no idea what they’re talking about, that’s my whole point. They prob learned about the recent hike in Fed Funds from reading some article or googling. Either way they don’t seem to know how it works and what it’s called, nor have they been able to answer any of my questions.

  37. B Trader wrote:

    “Why do these big banks keep complaining when the price-discovery mechanism does not work in their favor ?”

    The problem is even performing loans are being painted with the same brush. That’s why banks are relunctant to writedown the value and just add provisions instead.

    If you were holding a bag of loans and 70% is still performing (paying their monthly mortgage) and someone says I’ll give you a price based on 30% performance will you sell?

  38. Scotsman wrote:

    “I think this whole thing is a ploy to prepare for WAMU, etc. going down the drain”

    I think Eleua was trying to insinuate the same thing with the Gov squeezing Fed Funds, but haven’t heard from him how it affects WaMu.

  39. Q-diddy in #49 : “The problem is even performing loans are being painted with the same brush. That’s why banks are reluctant to write down the value and just add provisions instead.”

    Exactly. But, they have this dilemma because when the securitized these mortgages (especially starting in late 2006), they threw in the riskier ones with the low risk ones.
    They ended up packaging loans of customers with 750+ credit score with those of customers with 500+ credit score. With due help from the rating agencies, mezzanine tranches were sold as senior tranches. The thinking was that these high-risk loans would be refinanced in a couple of years and the risk would be transferred to the next buyer – basically “greater fool theory”.

    As for WaMu, they had it coming. Their crappy Alt-A toxic exposure was well-known in the short-selling trading community.
    That they haven’t filed for bankruptcy is a miracle.

  40. B Trader-

    Actually, I was talking about the on balance sheet stuff, but yeah I know what you mean.

    Had the market not gone belly up the way it has, would WaMu still be forced to sell? I’m not so sure about that…like you said it’s a miracle, or maybe somebody in their Treasury dept is actually competant. We know their executives aren’t!

  41. Share price of WaMu 26-09-2007 : $ 36 (approx).
    Share price of WaMu today : $2.10

    Shareholder loss in 1 year : 94.10%

    Why haven’t the shareholders fired the CEO Kerry Killinger ?

    Oh wait … blame the short-sellers !!

  42. It’s the overnight interbank loan market.
    Yes, I was really reaching the far corners of my econ 101 memory then looked it up.

    “We find that the share of the overnight interbank loan market represented by brokered fed funds has decreased and is now only about one-third of the total.”

    It’s the slush fund. Yes, that is the term.

    The point of my comment is that the name really makes no difference. It’s called the overnight interbank loan market.
    Loan bundling is what makes up the secondary market. The bundles are bought sold and traded.
    The problem isn’t the loans, or who pays. It is the value of the assets that the loans are secured by that is going down. When people predict the value of Real Estate will go down they mean the price of Real Estate will go down. The value is tied to the Consumer Price Index, or rental income, or intrinsic worth, such as a view, location, or the value of the dirt it sits on.
    Lenders have a bunch of loans they are collecting on that are based on a false value. When a $250K house, started getting a loan for $500K no one cared.
    The hand writing is on the wall and people don’t want to pay thirty years of interest on a house that is going down in value.
    That’s the bubble.
    If it were just houses that would be a seperate issue, contained, but it’s everything.

  43. Grabbed this from the HW, quite an interesting political mess.

    “On an interview with CNN, Senate Banking Committee chairman Christopher Dodd (D-CT) said that a new mortgage proposal from Republicans was presented in the private meeting, blindsiding Congressional Democrats. The Connecticut Democrat said the meeting went “like a rescue plan for John McCain,

  44. Chinese regulators have told domestic banks to stop interbank lending to U.S. financial institutions to prevent possible losses during the financial crisis, the South China Morning Post reported on Thursday.

    I just brought this back to prove the point about the slush fund.

    Along the way there was a revolt during the bipartison meeting at the White House.
    This is the best thing that could happen.
    It has to stop.
    George Bush created a mess of the economy and I don’t think anyone wanted him to walk away clean before he left office.

  45. “Along the way there was a revolt during the bipartison meeting at the White House.
    This is the best thing that could happen.”

    I fully agree though I’m sad to see that the only public servants with some spine and brains turned out to be republicans. A revolt towards your own party line on the finish line to an election demands a huge amount of guts and integrity.

  46. David wrote-

    “It’s the overnight interbank loan market.
    Yes, I was really reaching the far corners of my econ 101 memory then looked it up.”

    Funny, I don’t recall learning that in ECON 101. Anyway, David take it from some who traded it…it’s not called the slush fund.

  47. Q-diddy-

    Maybe you should get around more. The term comes up repeatedly on just about all of the more informed forums, and seems to be pretty universally used and understood. Try stepping up from Yahoo to some more serious blogs, populated by more informed participants.

    Playing semantics is a poor substitute for understanding economics. Oh, and by the way, you can’t “trade it.” There is no market or exchange for the “slush fund.”

  48. Scotsman-

    Don’t tell me you fell for Eleua and David’s crap too. How do you think I traded it? Over some exchange?

    Use your brain a little more. I work for a freaking bank!

  49. QD- so what? Seriously, I won’t hold working at a bank against you. I used to work for a bank too, have a couple of degrees in econ, but wised up and moved on to greener pastures. But I’ve got to say, based on what I’ve read of your analysis/opinions here, Eleua et al have a better grasp on what’s going on than you do.

    By the way, I heard non-borrowed reserves are down to -$158B. What do you think that’s going to do to the market over the next few days? What’s going to happen tomorrow when Joe Public wakes up tomorrow and discovers we just had the largest bank failure ever? Do you think anyone/everyone who has over the FDIC insured limit in a bank is FINALLY going to go and pull it out? Will that reduce the “slosh?” How ya gonna trade it?

  50. Q-Diddy,

    Sorry that I used a non-tech term like “slosh.” If my credibility is shot, then I guess that is the price for being sloppy.

    Anyway…if the amount of repos out in the banks is drawn down during a time of incredible instability, that makes certain banks (the weak ones) scramble for the cash to meet their short term needs. As the Fed Funds (slosh) is drawn down, the interest rates will rise for the weaker banks.

    Eventually, one will not be successful in raising cash in the short term market to meet its obligatons, and the bank blows.

    This pool (FF/slosh) has had 2/3 of it removed within the past week, and lo and behold, we get the largest bank failure in history, just as was hypothesised.

    WM was going to die anyway. My buddies and I figured that out in early 2007. The timing of the failure is certainly suspect, given what is at stake and the peculiar actions of the FED.

    You bring up good points. I’m not taking that away from you. I just don’t see why you are so upset. I never said that the manipulation of those funds could target WM, but that it would put the weaker banks into a situation where they could not meet thier short term obligations. WM was the weakest large bank (S&L), IMAO, which is why I brought up Seattle. I don’t think Hank/Ben care if it is WM, WB, DSL, or BKUNA. A little bank scare is just the thing you need when you are extorting Congress for money.

    …btw, Scotsman is dead on.

  51. The Economics of Money, Banking and Financial Markets – 7th Edition
    Author : Frederic Mishkin
    Appendix to Chapter 2 (page 85)

    Federal (Fed) Funds.
    These are typically overnight loans between banks of their deposits at the Federal Reserve. The federal funds designation is somewhat confusing, because these loans are not made by the federal government or by the Federal Reserve, but rather by banks to other banks. One reason why a bank might borrow in the federal funds market is that it might find it does not have enough deposits at
    the Fed to meet the amount required by regulators. It can then borrow these deposits from another bank, which transfers them to the borrowing bank using the Fed’s wire transfer system. This market is very sensitive to the credit needs of the banks, so the
    interest rate on these loans, called the federal funds rate, is a closely watched barometer of the tightness of credit market conditions in the banking system and the stance of monetary policy; when it is high, it indicates that the banks are strapped for funds,
    whereas when it is low, banks’ credit needs are low.

    About the author : Frederic Stanley “Ric” Mishkin is an American economist and academic at the Columbia Business School. He was also a member of the Board of Governors of the Federal Reserve System from 2006 to 2008.

  52. #64 : “This pool (FF/slosh) has had 2/3 of it removed within the past week, and lo and behold, we get the largest bank failure in history, just as was hypothesised.”

    Why do you think anyone would any bank lend to WaMu at this juncture ? Adverse selection or moral hazard ? It is better to a negative bias and not lend, rather than face a moral hazard after lending.

    The funds of overnight interbank lending reflect the liquidity of the general financial system. Banks do not think it is safe to lend to each other – what does the Fed or Treasury have to do with it ?

    WaMu failed because they were asleep at the wheel.

  53. Eleua-

    “This pool (FF/slosh) has had 2/3 of it removed within the past week, and lo and behold, we get the largest bank failure in history, just as was hypothesised”

    Good hypothesis, but again, you erred. I tried hard to get you to explain why it woud affect a bank like WaMu because your analysis is speculation not fact.

    Fact 1: WaMu’s rating were cut early in the year. They already lost some ability to borrow Fed Funds then.

    Fact 2: By July, after Indymac was recieved by the FDIC WaMu’s FF lines were completely gone.

    So you see, your theory on the recent squeeze in FFs did not affect WaMu, even though you hypothesized it did.

    When I say take it from a guy who knows it’s because I worked in aTreasury Dept, traded FF along with a bunch of other short term and long term debt. In my years on the funding desk, I’ve never heard of the term slosh, but whatever.

    It’s also called Euro Dollars btw, if a bank has set up an offshore account to draw in deposits. As a matter of fact I set up the first Euro Dollar Fed Funds Account for my bank in the Caymans. It didn’t have any operations, just a brass sign hung on some Trustee’s wall. Funny how our financial system works.

  54. B Trader wrote:

    “The funds of overnight interbank lending reflect the liquidity of the general financial system. Banks do not think it is safe to lend to each other – what does the Fed or Treasury have to do with it ?”

    Nothing, except try to encourage lending by flooding the system with more cash. Obviously, the banks will only lend to other top tier banks.

  55. Fascinating discussion guys. (Note some sarcasm.)

    How about a quick answer to a question for someone who doesn’t follow bank failures. When they talk about Wamu having $307B of assets, compared to Continental in 84 having $40B, what are they talking about? Loans, loans & other assets, or deposits, which are actually liabilities.

    Interesting to note that JP Morgan is saying they may or may not take advantage of the bailout. Any opinions on why they would take advantage of a plan that now is punitive (compensation limits and equity sharing)? Why would a company that is apparently strong participate on those terms?

  56. Scotsman wrote:

    “Eleua et al have a better grasp on what’s going on than you do.”

    Really, do you think making theories without fact is a better grasp? Do you think it’s constructive and logical? How much credibility would you give someone if they can’t even get the terminology correct? Or provide an explaination?

    OK, I was overly harsh and for that I apologise. With all that’s been swirling around about banking and our financial systems and the rumors, speculations and criticisms I would just hope that people offer up more facts. I know I will try my best to do the same.

    If you find my contributions meaningful, great. If you think I’m full of BS, then so be it.

  57. Kary-

    Generally speaking, should just be cash, investments, loans, allowances, fixed assets and other assets not deposits.

    JPM stated they will take a $31BN writedown. Doesn’t seem they’re going to use the bailout plan, but things are constantly changing and I think there will many more ideas down the pipe.

  58. Any idea if the ban on short sales is related to the bail out plan? With the punitive provisions of the current proposal, I’d imagine that the shorts would be all over the financials right now. Companies will have to announce that they won’t participate in order to support their stock prices.

  59. #72 :

    The ban in short sales by SEC was a knee-jerk reaction – the first line of defense to trigger a short squeeze. Banning short-sales never work, and in fact are counter-productive.
    The short-sale ban nearly threw the options markets (especially PUT writing) in chaos as nearly 40% of the options market (by volume) revolves around the market makers (they short stock when writing PUTS to create a “delta-neutral” position).
    Since then, the SEC have reversed its decision and allowed “bonafide” market makers and hedgers to sell stock short. The SEC just proved they are a bunch of bumbling idiots.

    The ban prevented new shorts from being initiated, but existing shorts were not required to be closed out as long as their broker provided the underlying stock.
    Trading had to be halted in some ETFs like the ProShares UltraShort Financials (symbol: SKF) due to the ban as they ETFs basically provided short strategies.

    The major shorts were initiated in Q3 2007 after Bernanke’s 0.5% rate-cut last September.

    “Companies will have to announce that they won’t participate in order to support their stock prices.”

    This really won’t have any impact. If the company is in bad shape or the industry itself does not have bright prospects, defending the stock prices is a futile exercise.
    The market will eventually “discover” the price.
    Companies need to provide good management, pay a decent dividend, keep their debt low to “support their stock prices”. Other antics do not work in the long run.
    Participating in the bailout plan will work for some companies, for others it may not.

    For example, GM and Ford have a decent portfolio of “shaky” loans on their books. The bailout plan might help them shake-off these loans off their books. Then what ? Do they have fuel-efficient reliable cars to sell ?
    So, it will be on a case to case basis.

  60. Sorry, this really degenerated.
    It’s hard to respond.
    Cayman Islands trading the Euro Dollar Feds Fund.

    The one thing this discussion has pointed out is the problem with our banking system. It is all about trading the paper rather than doing business.
    Today our government is going to drag out more useless paper to prop up bad business. Loans paying for loans.
    When a home owner does this it’s called irresponsible. When the government does it, it’s because it has to be done.

  61. #74 :

    The executive compensation part you bring up is a good point – I think this is a tricky onion to peel

    As you correctly pointed out – companies that do not want to dilute their equity will not participate. I am sure there will be loopholes to be exploited.
    Once the markets are awash with (new) liquidity from the bailout, such companies can always get loans from institutions that are beneficiaries of Government benevolence. So, there is no pay cut, no equity dilution and a turnaround story that deserves hefty bonuses !! 🙂

    So far there are no concrete provisions in the bailout plan on executive compensation and equity dilution.
    My knowledge of US legislative process is limited. What I cannot comprehend is how does the Fed( or Treasury / Office of Comptroller of Currency or the SEC) intend to regulate executive pay ? I mean from a legislative standpoint.

    For example( although not a directly related one), the US taxpayer regularly funds new sports arenas but never demands that the pay of the franchise’s executives and players be capped ? The tickets and merchandise are neither subsidized nor priced reasonably – but there is no demand on capping compensation in this matter although taxpayer money is used again and again. I believe the same analogy will apply to financial markets, but I may be wrong.

    It was the fiduciary duty of the board of directors and the compensation committee to decide on executive pay. They failed – now to expect the Government to fix it will turn out to be even more disastrous.

  62. David-

    There are obvious problems with our banking systems, know doubt about it, but I don’t think it’s a good idea to make blanket generalizations.

    Banks don’t just lend to one another (trade) for the sake of trading. Lending O/N is a part of the oil that keeps the financial engine going. The Fed Funds market has been around for a pretty long time and I don’t think it will go away anytime soon. It’s a very basic, simple instrument unlike CDOs and other structured products.

    I think it’s a good thing that some banks had their FF lines withdrawn. Just shows that banks won’t do business when there are signs of trouble. Especially if the security is unsecured.

  63. BT:

    Loved the analogy with stadiums and sports teams. Let’s make that a law!

    Do you think that JP got a bargain w/ WAMU? Why wouldn’t a competitor pay more?

    Also (anyone can answer, really), if the Treasury buys the paper at less than face value, won’t that cause liquidity problems, too, as the banks will be forced to write down the asset as it is sold, and then have to borrow more to replensih reserves?

    Doesn’t that suggest that the Treasury plan is to buy the paper at or near face value?

    I am not a banker, so pardon any loose finance terminology.

  64. I view what I call the punitive provisions to be something that’s added to make it politically palatable, even though it makes no sense. The thing that didn’t get added, that would make sense was the bankruptcy modification provisions. I don’t know what they were contemplating (modify only in Ch 13 or in Ch 7 also), or what the restrictions on modifications would be. Perhaps the provisions that the federal loans can be modified are a good substitute. I’m not sure what those provisions are either.

    My point is, a lot of these provisions are done for political reasons rather than because they’re good ideas.

  65. Roger wrote:

    “Do you think that JP got a bargain w/ WAMU? Why wouldn’t a competitor pay more?”

    Yes, a very good deal for JPM, FDIC and taxpayers. Others couldn’t pay more because they would have to writedown the bad debt (Option ARMS, Subprime). The bid from JPM had already been on the table with the FDIC for a long time. Christ, even the rating agencies knew about it given they placed WaMu on negative watch citing “possible recievership implications” a week after downgrading! Hmmm…The stall/lack of clarity on the $700BN only accelerated the deal.

    “Also (anyone can answer, really), if the Treasury buys the paper at less than face value, won’t that cause liquidity problems, too, as the banks will be forced to write down the asset as it is sold, and then have to borrow more to replensih reserves?”

    It won’t cause liquidity problems, in fact it helps liquidity – they get cash for the sale. However, the capital ratio would have been hit hard given $31BN writedown.

    “Doesn’t that suggest that the Treasury plan is to buy the paper at or near face value?”

    That was the plan-buy it at Par versus Fair Market. I have a problem with that idea too. I would have liked to see some sort of protection clause for taxpayers.

  66. #78 :
    “Do you think that JP got a bargain w/ WAMU? Why wouldn’t a competitor pay more?”

    In the long run, yes it will turn out to be a bargain. But the storm has to pass and JP Morgan has to survive the storm.
    Remember that JPM is the biggest derivatives player in the world and with something like $80 trillion (notional) exposure. So, they are the Fed’s blue-eyed boy and “too big to fail”. If JP Morgan fails, we have a full-fledged financial meltdown.

    The FDIC auctioned off the WaMu – JPM was the highest and perhaps the only serious bidder. Indymac and now WaMu will slowly add stability to JPM’s exposure.
    There are only four players in the game – JPM, Goldman Sachs, Morgan Stanley and Citibank. From what I understand, the spoils will be distributed amongst these four.
    Morgan Stanley and Goldman Sachs got their candy late last week. I am wondering where Citibank fits in this big scheme of things.

    “Also (anyone can answer, really), if the Treasury buys the paper at less than face value, won’t that cause liquidity problems, too, as the banks will be forced to write down the asset as it is sold, and then have to borrow more to replensih reserves?”

    There are two aspects to this –
    1) For more liquid instruments : For the last 3-4 quarters most banks have written down losses based on the marked-to-market value of the more “liquid” instruments. So, a decent amount of loss has already been taken on the books. If the Fed buys near (below) face value, then in fact it is a profit for these banks, as they Fed will be buying above market prices. So, for these more “liquid” instruments, banks will show a marked-to-market profit for the next quarter. However, if you consider the cumulative sum of the last 3-4 quarters, it will still be a loss. One of the tricks of marked-to-market accounting !!

    2) For lest liquid instruments : For less liquid and illiquid instruments these are more likely still accounted at face value for the last 3-4 quarters – this is what scares the banks. These are the toxic instruments that are being currently “marked-to-fantasy”. If the Fed takes it at near face value, banks as heave a sigh of relief as they do not have take huge losses in the next quarter.

    As for liquidity problems – no it will not cause liquidity problems immediately or within 6 months. The Fed can borrow or print more money to increase liquidity.
    However, it is this liquidity that will cause more problems – like inflation, bubbles, excessive speculation etc.
    The problems we are seeing are a consequence of too much liquidity from 2005 onwards.

    “Doesn’t that suggest that the Treasury plan is to buy the paper at or near face value?”
    Honestly, I wonder if the Treasury has a serious robust plan. They are figuring it out as one crisis after another hits them.

  67. Thanks for the answers. The check’s in the mail 🙂

    These are not easy concepts to grasp, much less so to translate to others.

    Re the TARP, I’d feel SO much better if Paul Krugman were in the room with the Prez, Hank and Congress.

    I know it’s lazy to place a lot of trust in one individual, but he has consistently talked sense, at least in terms that I can grasp and relate to.

    Anybody consider adding him as a link on the side, like CR does?

  68. Scotsman,

    Pls do not take this as an attack, but I’m just curious. When you said: “The term comes up repeatedly on just about all of the more informed forums, and seems to be pretty universally used and understood”, what are those blogs? I googled and the only things that came up are from TF or quotes from the financial petition site.


  69. There is no response to this; it just needed to be said.

    Again this is an excellent example of why the credit market needs to be stopped, today.
    There should be no more money given from tax payers, at all.
    Politicians who support this should be removed from office.

  70. Kary:

    Yeah, short on content, but it was mercifully short. 🙂

    I liked Roubini’s suggestion that the government buys the assets in exchange for senior preferred debt.

    “Specifically, the Treasury plan does not formally provide senior preferred shares for the government in exchange for the government purchase of the toxic/illiquid assets of the financial institutions; so this rescue plan is a huge and massive bailout of the shareholders and the unsecured creditors of the firms; with $700 billion of taxpayer money the pockets of reckless bankers and investors have been made fatter under the fake argument that bailing out Wall Street was necessary to rescue Main Street from a severe recession. Instead, the restoration of the financial health of distressed financial firms could have been achieved with a cheaper and better use of public money.”

    Sure, it dilutes (or wipes out) the equity of existing shareholders, but that seems fairer than rewarding investors for their lack of oversight while they made the profits.

    But since Roubini might be considered a bit radical, I prefer the endorsement of Paul Krugman.

  71. I just heard they passes the bailout …Thank God. We as a country were stuck between that rock and a hard place and someone had to do something. If it didn’t pass we might as well all learn how to live off the land because our comfy life as we know it would get real hard for everyone. And for the people that think property values are too high and should com down move to Ohio or Michigan or a bunch of other places where the economy stinks and buy one of their houses for $30,000.

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