This is a chapter in our book on The Great Meltdown.
Quelle surprise. David Sirota made a list:
The amount of brazen corruption and conflicts of interest swirling around this deal is odious, even by Washington's standards - and polls suggest the public inherently understands that. Consider these choice nuggets:
- Warren Buffett is simultaneously advising Obama to support the deal, while he himself is investing in the company that stands to make the most off the deal.
- McCain's campaign is run by lobbyists from the companies that stand to make a killing off a no-strings government bailout.
- The New York Times reports that the person advising Paulson and Bernanke on the AIG bailout was the CEO of Goldman Sachs - a company with a $20 billion stake in AIG.
- The Obama campaign's top spokesman pushing this deal is none other than Roger Altman, who Bloomberg News reports is simultaneously "advising a group of investors who are trying to prevent their shares from being diluted in the U.S. takeover of American International Group Inc." - that is, who have a direct financial interest in the current iteration of the bailout.
Add to this the fact that the negotiations over this bill have been largely conducted in secret, and you have one of the most sleazy heists in American history.
And whaddaya know?
The corruption is totally bi-partisan.
But with a trillion dollars of free money at stake, why would anyone expect anything else?
Gee, Professor Roubini just keeps getting things right. I guess that's why, in the age of the anti-Cassandra, nobody serious listens to him. RGE Monitor:
Is Purchasing $700 billion of Toxic Assets the Best Way to Recapitalize the Financial System? No! It is Rather a Disgrace and Rip-Off Benefitting only the Shareholders and Unsecured Creditors of Banks
Whenever there is a systemic banking crisis there is a need to recapitalize the banking/financial system to avoid an excessive and destructive credit contraction. But purchasing toxic/illiquid assets of the financial system is not the most effective and efficient way to recapitalize the banking system. ...
A recent IMF study of 42 systemic banking crises across the world provides evidence on how different crises were resolved. First of all only in 32 of the 42 cases there was government financial intervention of any sort; in 10 cases systemic banking crises were resolved without any government financial intervention. Of the 32 cases where the government recapitalized the banking system only seven included a program of purchase of bad assets/loans (like the one proposed by the US Treasury). In 25 other cases there was no government purchase of such toxic assets. In 6 cases the government purchased preferred shares; in 4 cases the government purchased common shares; in 11 cases the government purchased subordinated debt; in 12 cases the government injected cash in the banks; in 2 cases credit was extended to the banks; and in 3 cases the government assumed bank liabilities. Even in cases where bad assets were purchased – as in Chile – dividend were suspended and all profits and recoveries had to be used to repurchase the bad assets. Of course in most cases multiple forms of government recapitalization of banks were used. But government purchase of bad assets was the exception rather than the rule. It was used only in Mexico, Japan, Bolivia, Czech Republic, Jamaica, Malaysia, and Paraguay. Even in six of these seven cases where the recapitalization of banks occurred via the government purchase of bad assets such recapitalization was a combination of purchase of bad assets together with other forms of recapitalization (such as government purchase of preferred shares or subordinated debt) [where we get non-voting stock warrants]. In the Scandinavian banking crises (Sweden, Norway, Finland) that are a model of how a banking crisis should be resolved there was not government purchase of bad assets; most of the recapitalization occurred through various injections of public capital in the banking system. Purchase of toxic assets instead made – in most cases in which it was used – the fiscal cost of the crisis much higher and expensive.
That's not a bug. It's a feature!
Thus the claim by the Fed and Treasury that spending $700 billion of public money is the best way to recapitalize bank has absolutely no basis or justification. This way to recapitalize financial institution is a total rip-off that will mostly benefit – at a huge expense for the US taxpayer the common and preferred shareholders and unsecured creditors of the banks. Even the addition of some warrants that the government will get in exchange of this massive injection of public money is only a cosmetic fig leaf of dubious value as the form and size of such warrants is totally vague.
The plan also does not address the need to recapitalize those financial institutions that are badly undercapitalized: this could have been achieved by using some of the $700 billion to inject public funds in ways other and more effective than a purchase of toxic assets: via public injections of preferred shares into these firms; via required matching injections of Tier 1 capital by current shareholders to make sure that such shareholders take first tier loss in the presence of public recapitalization; via suspension of dividends payments; via a conversion of some of the unsecured debt into equity (a debt for equity swap). All these actions would have implied a much lower fiscal costs for the government as they would have forced the shareholders and creditors of the banks to contribute to the recapitalization of the banks. So less than $700 billion of public money could have been spent if the private shareholders and creditors had been forced to contribute to the recapitalization; and whatever the size of the public contribution were to be its distribution between purchases of bad assets and more efficient and fair forms of recapitalization (preferred shares, common shares, sub debt) should have been different. For example if the private sector had done its fair matching share only $350 billion of public money could have been used and of this $350 billion half could have taken the form of purchase of bad assets and the other half would have taken the form of injection of public capital in these financial institutions. So instead of purchasing – probably at an excessive price - $700 billion of toxic assets the government could have achieved the same result – or a better result of recapitalizing the banks – by spending only $175 in the direct purchase of toxic asset. And even after the government will waste $700 billion buying toxic assets many banks that have not yet provisioned for such losses/writedowns will be even more undercapitalized than before. So this plan does not even achieve the basic objective of recapitalizing undercapitalized banks.
See, that's where Roubini's professional integrity kicks in. He just can't get his head around the idea -- even after calling it a "rip off" -- that the plan is pure theft by a criminal gang. It's not a bailout -- it's a bust out.
The Treasury plan also does not explicitly include an HOLC-style program to reduce across the board the debt burden of the distressed household sector; without such a component the debt overhang of the household sector will continue to depress consumption spending and will exacerbate the current economic recession.
Again, that's not a bug, but a feature. What's not to like about debt servitude?
Thus, the Treasury plan is a disgrace: a bailout of reckless bankers, lenders and investors that provides little direct debt relief to borrowers and financially stressed households and that will come at a very high cost to the US taxpayer. And the plan does nothing to resolve the severe stress in money markets and interbank markets that are now close to a systemic meltdown. It is pathetic that Congress did not consult any of the many professional economists that have presented - many on the RGE Monitor blog forum - alternative plans that were more fair and efficient and less costly ways to resolve this crisis. This is again a case of privatizing the gains and socializing the losses; a bailout and socialism for the rich, well-connected and Wall Street. And it is a scandal that even Congressional Democrats have fallen for this Treasury scam that does little to resolve the debt burden of millions of distressed home owners.
What do you mean, "even" Congressional Democrats?
NOTE Cannonfire, back at ya:
Remember how Bush's slimey confederates turned the Katrina clean-up to their advantage? That's what's happening with this bail-out. Just like the Bush administration, the Dems are enabling the chiselers who hope to profit from a crisis. In partnership with the Bush administration, the Dems are striving to combat any regulations that might keep thieves from thieving.
Yeppers. Shock doctrine -- profit from the crisis. This time with the help of our tribunes of the people, the Democrat Party!
NOTE Via the Confluence, here's a link to the IMF study [PDF]
UPDATE How could I forget Hank!
[Caveat that I know very little about finance or Wall Street. However, since the Wall Street just managed to collapse the financial system, they don't know much about those things either. What they do know, apparently, is politics, since they just managed to loot a trillion dollars from the public purse.--lambert]
Never an explanation of why, why a trillion, why NOW NOW NOW, and universal agreement by teh serious that the deal needs to be made. So, no accountability for past failure at all. That means to me: (1) The fail is massive (otherwise they'd explain it); (2) They're all in on it (otherwise they'd find one of their number to throw under the bus); and (3) since this is arguably the most important political issue this year, that when push comes to shove, there's no meaningful difference between the Democrat leadership and the Republican leadership in policy terms at all, since the Paulson plan ("give my golfing buddies a trillion") forms the basis of the deal (as opposed to, say, HOLC). Bloomberg:
U.S. lawmakers said they made a breakthrough in talks on a $700 billion plan to revive the credit markets and expect to announce an agreement on legislation later today.
Negotiators resolved ``our differences so we can go forward with a package to stabilize the market,'' House Speaker Nancy Pelosi told reporters when talks at the Capitol ended after midnight Washington time. Lawmakers will review a written version of the plan later today, she said. The House may vote tomorrow.
Oh, nothing on the Internet after all?
Now, I should say that, reading Nance's press release below, it sounds like the Ds have done some tinkering with Paulson's plan; they've tried to throw a big net over the lunatic -- but the lunatic is still a lunatic, and the strength of the net is quite unclear. I'd need to see the text of the actual legislation to come to any conclusion; none of the people making the deal on either side deserve any of our trust or confidence on this -- Pelosi, Reid, and Blount already betrayed us on FISA, and they'd betray us again in a heartbeat -- especially with so much more money, and power, at stake.
The plan would let the Treasury begin purchasing distressed debt securities from financial companies affected by the record number of home foreclosures.
As opposed to just buying the mortgages (HOLC), they buy the toxic waste derives from the mortgages. Let's reward the guilty! (Even Ben Stein gets this).
After five years, if there was a net loss to taxpayers, the president would have to submit a plan to Congress to recoup the funds, according to an outline circulated by congressional aides.
I like the 5 years thing. It kicks the can down the road to the next President. I beat MoCama was enthusiastic about that one.
The proposal also includes accountability provisions, limits on executive pay for participating companies, and foreclosure relief, said Senate Banking Committee Chairman Christopher Dodd, a lead negotiator.
Lipstick on Hank Paulson's pig, since he obviously didn't give a shit about any of that. We'll have to see the text, and especially if any part of Clause 8 survives.
Senate Majority Leader Harry Reid, a Nevada Democrat, sought an agreement to reassure investors before Asian financial markets open late today.
Wouldn't it be simpler if we structured the entire legislative calendar based on market timing?
Treasury Secretary Henry Paulson said the proposed deal ``will work and be effective'' in the marketplace. More work needs to be done, ``but I think we're there,'' he said.
What "marketplace"? Haven't we socialized everything?
Paulson and Federal Reserve Chairman Ben S. Bernanke said the rescue plan was necessary to revive lending and restore the flow of credit to the U.S. economy. President George W. Bush warned yesterday that legislative action was needed to avoid a ``deep and painful recession.''
What does he mean, "avoid"?
Lawmakers had resisted giving Paulson unrestricted power to buy the debt and sought controls to assuage angry constituents who bombarded congressional offices with e-mails and phone calls.
The single bright spot: Well done, voters!
Voters ``don't want a bailout of Wall Street and neither do we,'' Democratic Senator John ["Ohio Vote Theft Challenge"] Kerry of Massachusetts told reporters yesterday. ``What we are talking about is not losing 3 million jobs in a matter of weeks'' and helping ``small banks and small businesses literally keeping their doors open.''
And why is that? Was the Fed about to become illiquid? They won't say. As I said above: Massive fail, by them all, and R == D.
Senator Kent Conrad, a North Dakota Democrat who chairs the Budget Committee, said $250 billion would be immediately available and another $100 billion could be used when requested by the president for debt purchases. Congress could bar the expenditure of the remaining $350 billion only by passing a resolution to block it from being spent.
Which, of course, they will do. Unless, of course, Wall Street holds a gun to their head again. But that will never happen.
The package includes a provision aimed at ``preventing golden parachutes'' for executives of companies who leave firms that have sold troubled assets to the government, Conrad said.
We should claw back everything that was stolen.
Companies that sell debt to the government will issue stock warrants to the government so that taxpayers ``can gain as companies recover'' from economic difficulties, Conrad said.
Uh huh. The stock warrants are also non-voting, so the taxpayers get a bastard form of ownership, and put in their capital, but get no control. Ideal for Wall Street.
At one point during the negotiations billionaire Warren Buffett spoke by telephone to a lawmaker involved in the talks to offer ``his best thinking about market reaction to various things,'' Conrad said. ``People are trying to reach out to the best minds that they know.''
Oh, good.
A proposal that would allow judges to modify mortgage terms for struggling borrowers in bankruptcy proceedings wasn't included, said Dodd, a Connecticut Democrat. ``We pushed very hard'' for the bankruptcy provision, ``but we feel we got good foreclosure mitigation language in there,'' Dodd said.
Dodd is a wuss on foreclosures. So is Obama.
Democratic presidential nominee Barack Obama said the plan ``appears to embrace'' his principles that the legislation include oversight by an independent board; protections for taxpayers to ensure they receive any profits; measures to help homeowners stay in their homes; and rules to make sure ``CEOs are not being rewarded at taxpayers' expense.''
Sure, Obama, after signaled that protecting homeowners wasn't a priority. No foreclosure protection, but "mitigation"? What on earth does that mean?
Democrats blamed Republican presidential candidate John McCain for encouraging the House Republicans' rebellion by traveling to Washington last week to meet with them.
The trip also included a White House meeting on Sept. 25 with Bush and congressional leaders, where a bipartisan consensus on the outlines of a deal broke down.
McCain ``only hurt this process,'' Reid complained to reporters.
Thanks, Harry. You just gave me a momentary impulse to vote for McCain.
So, it's Christmas on Wall Street! And the Democrat Party helped decorate the tree and wrap the packages! Well done, all.
NOTE Krugman: It's up to the House Republicans. I hope they scuttle it. As a prominent political figure said: Enough!
Here's (via CR) is Leader Nance's press release.
By one RDF:
Joe goes to the track and bets $2 on a horse.
Two guys standing nearby get into a discussion and Fred says to Sam, "I'll bet you $5 that Joe wins his bet."
Next to them are Bill and Bob. Bill says: "I'll bet you $10 that Fred welshes on his bet if he loses."
Next to them is Sally. Sally says: "For $3 I'll guarantee to Bill that if Bob fails to pay off, I'll make good on the bet."
Sally then goes to Mary and borrows the $7 needed in case she has to ever pay off and promises to pay back $8. She doesn't expect to every have to pay since she believes Bob will always make good. So she expects to net $2 no matter what happens to Joe.
A quick calculation indicates that there is now 2+5+10+3+7 = $27 riding on the outcome of the horse race.
Question how much has been "invested" in the horse race?
Wait for it:
Answer:
$50,000 by the owner of the horse who is expecting to recoup his investment from the winnings of the horse and other future deals. Everyone else is gambling, not investing.
So, when Hank Paulson and his golfing buddies go to the track and lose the rent money playing the ponies, we should pay up?
NOTE Readers, if you enjoyed this post, you might also like this post by Shystee on bailout vs. "bust out" (a Sopranos reference).
UPDATE If you call Speaker Pelosi's office at (202) 225-0100, a human answers! That's what I just did at 11:17 PM EDT. So, if you want to share your views on the bailout, be polite!
Or -- one of those headlines I've always wanted to write -- "down in the tranches." Via ScienceBlogs, here's an excellent explanation (caveat: I know as much about statistics as I do about finance) of the way statistics were used in all the "complex," "innovative" financial instruments that have been so much in the news lately:
ne of the big questions that comes up again and again is: how did they get away with this? How could they find any way of taking things that were worthless, and turn them into something that could be represented as safe?
The answer is that they cheated in the math.
The way that you assess risk for something like a mortgage bond is based on working out the probability of the underlying loans failing, and using that to compute the likelihood of the entire bond package to end up losing. ...
It's easiest to describe how this works by using an example. Suppose we've got a package of 100 mortgages, each of which borrowed $100,000. So we've got 10 million dollars worth of mortgages. Suppose, for simplicity, that the total interest earned on the loans was going to be 150% - so at the end of the 30 year term of the loan, the bonds were expected to pay $25 million.
Now, suppose that these were really lousy loans - they expected that each loan had a 10% probability of defaulting, and that they'd lose the entire amount of the loan on a default.
By assuming that the probability of default for each of the loans is independent of the probability of default for any other loan, they can say that the probability of any particular loan defaulting is 10%. Assuming that defaults for loans are all independent, they can build an argument that probability predicts that only 10% of the loan will fail, and that it's incredibly unlikely for the rate of failure to reach higher than 20%. Based on that, they say that by using tranching to separate risk, they can claim that they're being extra careful, and put 80% of the mortgage bonds into a top tranch fund, which is supposed to be super safe.
But the probability of defaults aren't independent. Sure, there's random failures, where someone gets sick and can't work, and ends up defaulting on a loan. That kind of default generally really is an independent event. But that's not the story behind most defaults in low-quality loans. The garbage loans are almost always variable interest rate, and the most common cause of default is interest rate changes, which cause the loan payments to become too large for the borrowers to pay. When that happens, they're not independent events. The same thing that causes one loan to fail causes others to fail. Huge numbers fail at the same time, for the same cause. ...
As a result of this, tranching didn't work. They set up the tranches so that they partitioned things so that the top tranch was safe given the assumption of independence. But if independence doesn't hold - and it doesn't in these - then even an extremely conservatively structured tranching package doesn't guarantee the safety of the top tier.
Hope that helps. Like all scams, at bottom it's simple. The tranches were separated and given ratings (which determine prices) based on the idea that the values in each tranche were independent. In fact, they were all dependent and interconnected, so the ratings (and the prices) are buggered.
And we should give these fraudsters a trillion? Why? (I know: Because they'll shoot us if we don't hand over the money; it's a stick up.)
NOTE This statistical chicanery is separate from Taleb's ideas; Taleb is focused on randomness, and how "past performance is no guarantee of future results" especially when huge random perturbations are possible, which is always.
Statistics nerds and wannabes, go read this by the wonderful writer and investor Nassim Nicholas Taleb. And then if you can invent The Shorter Nassim Nicholas Taleb, report back here....
I especially like this point on empirical, historical data:
My classical metaphor: A Turkey is fed for a 1000 days—every day confirms to its statistical department that the human race cares about its welfare "with increased statistical significance". On the 1001st day, the turkey has a surprise.
Indeed.
Never let a manager near a computer. Especially one of the “safe heads from the investment banks”. The Times:
Leslie Rahl, the president of Capital Market Risk Advisors, a consulting firm [says that] the people who ran the financial firms chose to program their risk-management systems with overly optimistic assumptions and to feed them oversimplified data. This kept them from sounding the alarm early enough. ...
“There was a willful designing of the systems to measure the risks in a certain way that would not necessarily pick up all the right risks,” said Gregg Berman, the co-head of the risk-management group at RiskMetrics, a software company spun out of JPMorgan. “They wanted to keep their capital base as stable as possible so that the limits they imposed on their trading desks and portfolio managers would be stable.”
One way they did this, Mr. Berman said, was to make sure the computer models looked at several years of trading history instead of just the last few months. The most important models calculate a measure known as Value at Risk — the amount of money you might lose in the worst plausible situation. They try to figure out what that worst case is by looking at how volatile markets have been in the past.
But since the markets were placid for several years (as mortgage bankers busily lent money to anyone with a pulse), the computers were slow to say that risk had increased as defaults started to rise.
It was like a weather forecaster in Houston last weekend talking about the onset of Hurricane Ike by giving the average wind speed for the previous month.
But many on Wall Street did even worse, as Mr. Berman describes it. They continued to trade very complex securities concocted by their most creative bankers even though their risk management systems weren’t able to understand the details of what they owned.
That's the stupid. Then there's the greedy:
A lot of deals were nonstandard in many ways, “so you really had to go through the entire prospectus and read every single line to pick up all the nuances,” Mr. Berman said. “And that slows down the process when mortgage yields looked very attractive.”
So some trading desks took the most arcane security, made of slices of mortgages, and entered it into the computer if it were a simple bond with a set interest rate and duration. This seemed only like a tiny bit of corner-cutting because the credit-rating agencies declared that some of these securities were triple-A. (20/20 hindsight: not!) But once the mortgage market started to deteriorate, the computers were not able to identify all the parts of the portfolio that might be hurt.
Lying to your risk-management computer is like lying to your doctor. You just aren’t going to get the help you really need.
And, of course, there's the lazy:
All this is not to say that the models would have gotten things right if only they were fed the most accurate information. Ms. Rahl said that it was now clear that the computers needed to assume extra risk in owning a newfangled security that had never been seen before.
“New products, by definition, carry more risk,” she said. The models should penalize investments that are complex, hard to understand and infrequently traded, she said. They didn’t.
Stupid. Greedy. Lazy.
And these are the experts and the consultants and the asset managers who we're going to hire to figure out how to give away Hank Paulson's trillion dollars.
I don't think so.
Don't listen to NPR this morning! Listen to this!
"... It's reasonably scary in a number of ways..."
Well, yes.
Hank Paulson's Merry Banksters:
After defeat of the financial rescue bill in the House this week, Washington sought advice and ideas from lobbyists of the same industries blamed for creating the mess.
n White House meetings and phone calls Thursday, President George W. Bush and top advisers pleaded with industry groups to help save the $700 billion financial bailout plan, following its defeat Monday in the House of Representatives.
Members of Congress also opened their doors after largely shutting out industry lobbyists earlier.
In response, lobbying groups, particularly in financial services, buried their differences and joined forces. In the process, bankers and other business interests helped shape a bill that bristles with provisions favorable to the banking industry, for example, and includes spending and tax breaks for lawmakers to tout in their districts, from Northwest toy makers to Chicago suit-makers to states stricken by disasters in the past couple of years.
In the days leading to Monday's House vote, financial-services lobbyists were shut out of tightly guarded meetings on Capitol Hill.
After the vote, stunned Republican and Democratic leaders met with the American Bankers Association, according to a lobbyist who helped arrange the meeting.
Well, well.
Yesterday, 40 organizations sent a letter to the Senate Banking, Housing and Urban Affairs Committee and the House Financial Services Committee urging members to include whistle-blower protection in the bailout legislation.
"At a minimum, any credible solution must address one of the current crisis' fundamental causes -- corruption and other abuses of power sustained by secrecy," the letter said. "Otherwise, the taxpayers could end up giving $700 billion more to repeat the same disasters. Congress must prove it has learned this lesson. Any genuine solution must be grounded in transparency, with all relevant records publicly available and best practice whistleblower protection for all employees connected with the new law."
The letter was signed by a variety of organizations from across the political spectrum. They include the American Library Association, the Union of Concerned Scientists, the Liberty Coalition, the Society of Professional Journalists, the Government Accountability Project and the Project on Government Oversight.
Good.
And if Paulson whines that it's a poison pill, then so much the better.
What if offshoring isn't the boon the corp execs expected? What if investment vehicles (read complicated boondoggles designed to move money from the middle and lower class into the upper class' pockets via expensively-furnished con jobs run out of the 'credit economy') really don't do anything useful?
Well, then you get what is happening now on Wall Street.
Which looks, to this un-initiate (thank you FSM) like the chickens coming home to roost.
Jared Bernstein is an economist. This is his take on it:
A statement from EPI senior economist Jared Bernstein on the financial market meltdown
“There’s a silver lining to this crisis on Wall Street, if we’re smart enough to recognize it. The markets are sending an unequivocal signal that we need to change the way we do business. That means greater transparency, more responsible lending standards, sensible capitalization levels, and, above all, a more balanced approach toward risk. To clean up the mess yet ignore this deeper signal would be fatal to our financial markets and our hopes for an ultimate recovery.”
Not all progress is forward, boys and girls.
Time to go back to the policies that, for nearly 70 years, kept the country solvent, methinks.
Looks like at least a few economists think so too.