Patterico's Pontifications

9/25/2008

“If the conservative members of the GOP derail this deal and there is an economic collapse, no one will care that they were trying to save the taxpayers’ money.”

Filed under: General — WLS @ 10:23 pm



[Posted by WLS]

That’s from an -email to Rich Lowry over at NRO’s Corner. I think it encapsulates the problem exactly.

The collateral consequences of doing nothing extend far beyond having a few Wall Street firms fail. Frankly, I couldn’t care less if a few Wall Street firms fail — others will be created to take their place.

EF Hutton, Paine Webber, Dean Witter Reynolds? Not all Wall Street firms “fail” — some are simply taken over by more profitable enterprises when the price is right, just as Bank of America did to Merrill Lynch.

And, this article in today’s Wall Street Journal by Andy Kessler suggests the very possibility – maybe even likelihood – of a significant financial upside for the Treasury to the “bailout” plan now on the table.

The first myth that needs to be punctured is that a $700 billion plan means taxpayers are stuck shelling out $700 billion for nothing. In fact, what the money buys are collateralized securities – bonds backed by home mortgages. Any “loss” that results from these instruments will only be the difference between what the Treasury pays for the paper, and what the Treasury ultimately receives either in payment on the loans by the mortgagee if there is no foreclosure, or what Treasury sells the property for in the event of foreclosure.

There is a lot of handwringing among conservatives about how much the Treasury will pay private enterprises for these securities — this is the worry about “socializing” the losses of private industry. But the Treasury is in the driver’s seat in setting the price which it will pay for these assets. The institutions holding them – whether they be investment houses, commercial banks, or other financial institutions that bought them from Fannie/Freddie or some other seller – are in need of ridding them from their balance sheets because the UNCERTAINTY surrounding their value is preventing those institutions from being able to secure credit to continue daily operations. That is the “credit crisis” being talked about in the news media without much explication on what the phrase means.

Without question, most of these securities are no longer worth the price that the holders paid for them. But that does not mean they are worthless. The problem the credit market has right now is that due to a lack of transparency in the marketing of these instruments (thank you Fannie/Freddie), it’s hard for the holders to know, much less disclose to their creditors, the actual value of the security. Because the value is unknowable, lenders can’t evaluate the risk of lending to an institution that holds such paper on its balance sheet. Larger than disclosed debts could wipe out a company’s entire capital stake and cause it to close shop overnight. That would make any lender just another creditor to be listed on the bankruptcy petition. Lenders prefer to lend money when they have a high confidence that they will be paid back. Without such confidence, they’ll simply buy government T-Bills with their cash – which is what they have been doing now for a couple weeks.

These instruments are a conglomeration of many, many mortgage obligations. Some of them are more risky than others, some are in default, and some are in foreclosure. It requires an individual analysis of each instrument, and within each one an individual analysis of its component parts – the individual mortgages – to determine what value to place on the instrument as a whole. There isn’t enough time to do so, nor is there a mechanism for the market to validate whatever value the holder tries to establish to the satisfaction of its prospective lenders.

So, the Treasury is going to be a “lender of last resort,” so to speak. It’s going to purchase these securities with its pool of $700 billion — making it the owner of the underlying mortgage obligations. This will transfer cash to the holders of the securities, which restores their liquidity and sets right their balance sheet. It will allow financial institutions to go back to lending money, and investment houses can begin borrowing again. They’ll still have to book the losses, so shareholders are not being bailed out, except to the extent that the firms don’t otherwise go under.

In return, the government gets billions in mortgages, to go along with the $1.8 trillion in mortgages it assumed from the portfolios of Fannie and Freddie a couple weeks ago. While the “national debt” will increase by virtue of being on the hook if these mortgages are not held to maturity and paid off, or refinanced at some earlier date. But the other side of the balance sheet is that Treasury will be the “owner” of a couple trillion dollars worth of real estate as well. Think of it as the “Louisiana Purchase” all over again.

So, how might the government treat these mortgages differently than they are being treated by private industry holding them? First, the government doesn’t have to play by the same accounting rules as the finance industry. It doesn’t have to “mark to market” the loans, thereby destroying its balance sheet. “Mark to Market” for accounting purposes means the institution holding the paper must value them on its balances sheets at their fair market value, not at the value that they paid for them. The government doesn’t have to do this, so there is no collateral consequence on its balance sheet to holding distressed loans.

In addition, the government can work with mortgagees to restructure the terms of their mortgages so that they can stay in their houses and resume making their mortgage payments. This will require writing down the value of the homes –- no one is going to want to get back on the hook for a $500,000 loan, even on favorable terms, for a house now worth only $400,000. So, the government can foreclose that person out and have one more empty house sitting on the market waiting for a buyer, or it can bite the bullet and rework the deal to make it affordable to the homeowner. If the government bought the mortgage for only $250,000, rewriting it to $350,000 puts the government $100,000 to the good.

But the biggest difference the government can make is to restructure all these ARMs into fixed-rate 30-year mortgages, thereby easing the wave of foreclosures that happens each time interest rates on these ARMs reset. But they have to do so based on traditional underwriting requirements. It doesn’t do any good to give someone a mortgage when that person doesn’t have the financial ability to repay it, and it makes no difference if their mortgage is an ARM or a 30-year fixed rate conventional. If the best a particular homeowner could do was a “no down, interest only, ARM” then that person is really a renter and not a homeowner by any normal risk profile.

As these mortgages are returned to stability –- or at least the stable ones are identified through an orderly process that is possible with the government standing in for companies that would otherwise fail –- the securities in which they are packaged will regain their value. Once that happens, the securities can be resold. Or, the Treasury could eliminate the securities, and simply resell the performing loans back into the private market. If the Treasury bought a performing loan at 60% of its book value, and could then establish that it was a solid loan with little risk of default, it could easily resell that loan at a substantial profit.

If Treasury bought non-performing loans at 30%, but then reworked the terms of the mortgage so as to bring them back to performing, then the government will see a nice profit. Same for mortgage loans currently in default, which the Treasury is going to be able to buy at a steep discount. If the loan was rewritten to be a more affordable fixed rate, 30-year mortgage, and the homeowner keeps the loan current, the loan could then resold by the Treasury into the private market at a substantial profit to the taxpayer.

Is this outcome guaranteed? Of course not. But it has the benefit of buying not just assets, but also the time with which an orderly market can be restored.

Which takes me back to the quote in the caption. The truth is that John McCain was right last week when he said the underlying fundamentals of the economy are strong. But the economy runs based on financing. Right now it’s the financial sector of the economy that is ailing. That’s like getting blood poisoning. Sooner or later it is going to spread throughout the healthy tissue of the body if it’s not fixed.

People won’t care that $700 billion in taxpayer money was not spent if they watch their pension/retirement funds crater and small businesses close due to a lack of available financing to keep their operations going.

— WLS

18 Responses to ““If the conservative members of the GOP derail this deal and there is an economic collapse, no one will care that they were trying to save the taxpayers’ money.””

  1. Well said. The bailout buys time and that’s what these markets need right now.

    This bailout is arguably similar to large corporations that buy their employees’ houses when many employees are transferred out at the same time. Especially in smaller towns, it’s harder for a transferred employee to get a fair sales price for his house when many people are transferring out of the community at the same time. That’s because the increased transfers lead to a market where there are more sellers than buyers in the short term. The housing market in that town is temporarily depressed but, over time, the market will probably come back and the corporate owner can sell at a more reasonable price.

    DRJ (c953ab)

  2. “In addition, the government can work with mortgagees to restructure the terms of their mortgages so that they can stay in their houses and resume making their mortgage payments. This will require writing down the value of the homes –- no one is going to want to get back on the hook for a $500,000 loan, even on favorable terms, for a house now worth only $400,000. So, the government can foreclose that person out and have one more empty house sitting on the market waiting for a buyer, or it can bite the bullet and rework the deal to make it affordable to the homeowner. If the government bought the mortgage for only $250,000, rewriting it to $350,000 puts the government $100,000 to the good.”

    WLS – I wanna get one of these deals. Do you know who I have to write to in order to have the government purchase my mortgage from whoever owns it right now?

    daleyrocks (d9ec17)

  3. On a short layover in Japan, and I must say I am torn on this issue. What if my investments crater? They have in the past and have come back stronger. However, I only have 15-20 years to retirement.

    On the other hand, do I really want the federal government pumping a lot of cash into the private sector? Not really – this is the main problem with the so-called privatization of Social Security. It could potentially make the US government the largest shareholder of what used to be “private” enterprise. Look at what the California retirement system can do to companies that refuse to do its bidding. They want a bone-headed shareholder proposal to pass, they may just have the power. And so the free-enterprise system will devolve into a number of state-owned enterprises. A real happy thought.

    I guess I am saying that if they do not do the plan, it might not be a bad thing. Remember- sin in haste, repent at leisure. Decisions made in haste often are bad ones. Regardless of whether or not the “taxpayers may make money”. That should not be the deciding factor.

    The Republicans should hammer the Democrats and Senator Doolittle on this – it was the Dems who prevented action over the past 15 years that may have prevented (or minimized) this.

    Dr. K (4e3a9a)

  4. WLS – I love that deal I highlighted in comment #2, but I don’t want to have to come up with cash to pay taxes on forgiveness of debt income. Are they going to waive IRS rules on that shit for a while?

    daleyrocks (d9ec17)

  5. If the goal is to keep the patient on life support, the patient is in no position to negotiate which machines are to be used.

    So long as the USG (us) get an overwhelming equity stake in our “investment,” AND any company that chooses to accept our cash agrees to complete access to all books by ANY duly constituted authority, I can live with this stop-gap.

    But, if this is all to the benefit of privately-held institutions, and these entities are not thoroughly forthcoming as to their culpability, screw it.

    I fully realize there is no way to fully legalize “morality.” If a rapacious capitalist wants to skirt all ethics, all the statutes and regs in the world won’t stop him/her.

    Ed (385e88)

  6. WLS: Great writing, clear exposition and thinking. Bravo.

    I lived through this in Houston in the mid-to-late 1980s and early 1990s, during the aftermath of the oil crash followed by the S&L collapse. Four-fifths of my litigation docket in those years related to workouts.

    Ultimately and overall, the RTC did an incredibly job smoothing out the peaks and valleys on a macro-economic level. On a micro-economic level, there was blood knee-deep in the streets at some times and places, but that was inevitable. Congress can’t legislate against the lethal combination of greed and stupidity, but then, as now, it can, if it must, try to mitigate the damage and head off the doomsday scenarios.

    Beldar (b0d7b6)

  7. “incredibly job smoothing” —> “incredibly good job smoothing,” as the context probably made clear I meant to say

    Beldar (b0d7b6)

  8. It’d be great to get this done now, but I want to make sure not one cent goes to Debt Counseling Centers and the like.
    I’m also worried that the end result of this will be a repeat of the Katrina FEMA trailers fiasco.
    Not to mention I have a hard time believing the Democrats would ever allow any sort of “profit” on this. Maybe if we call it a non profit and vote ourselves salaries and perks it’ll pass Democratic Party muster, but otherwise they’ll insist we give it away

    SteveG (71dc6f)

  9. Rep. McCotter’s (R-Mich) Forceful Rebuke of Bailout Plan on House Floor

    Before I was elected to Congress we used to hear that when faced with a crisis, members of Congress would invariably soil themselves, throw money at the problem and hope that it went away.

    Unfortunately, in these dysfunctional economic times, we find that this process has continued.

    As Americans face a potential meltdown of the financial sector, we have seen what I believe to be an inappropriate response starting with this Administration.

    From the time we were informed that a potential financial meltdown was going to occur, this separate equal branch of government which is the U.S. Congress was told that we had but one alternative and that if we did not pass it quickly — in the time specified *by* the executive branch — that our economy would be severely damaged.

    It has been my opinion that we were elected, by the sovereign people of the United States, to make important decisions on their behalf, to do it with the due diligence and devotion that is due and to come up with a positive solution to their situation.

    Last night, I was struck by the fact that again we were told [by the President] that again if we did not give unlimited amounts of money and unlimited powers to the Executive Branch that *we* were failing in our due diligence and responsibilities to the American people.

    I heard the President of the United States say that we do not understand the need to act.

    That statement is false. We understand the need to act.

    We heard from the President of the United States that we did not care about American families.

    That statement is false. We care very much about American families.

    What we did not hear was a recognition that a three-page document that gives to the Treasury Secretary and the Chairman of the Federal Reserve powers — the likes of which Stalin and Mao killed people for — was not an acceptable response to give to this separate, equal branch of government.

    Today, we are told that House Republicans are standing in the way of a $700 billion use of your tax dollars to bail out the very people who caused this problem!

    Guilty as charged!

    House Republicans believe there is an alternative.

    The Administration tells us that their first, last, only resort is to go to the taxpayers and bail out Wall Street. We fundamentally disagree with this!

    Wall Street should bail out Wall Street.

    House Republicans believe that the toxic assets clogging up our economy should first attempt to be recapitalized by the very people sitting on the sidelines with their money waiting for you the taxpayer to be fleeced and put it in so they are “confident that the market will work”.

    We can not re-inflate the bubble.

    The people who on Main Street invested and saved and had good credit their entire lives should not be asked to go back in to help cowboy capitalists who shot themselves in the foot.

    I have supported the President when he has been correct.

    But he is in err now.

    House Republicans stood and supported the Patreus surge.

    Today House Republicans oppose the Paulson splurge so we can have prosperity in America in the long run.

    We will not engage in a rush to judgment that destroys the possibility of the free market and prosperity for decades to come.

    We will not walk out of this room after a forced vote waving a piece of paper in our hands claiming “fleeced in our time.”

    We *will* do the job we were entrusted with.

    JinnyB (43ad11)

  10. Nice job WLS. The downward spiral doing nothing and watching the banks fail eventually means people start losing jobs and more houses.
    Not sure why the 100 Republicans in the House want to be this obstinate but it sure sours me on the GOP – again. The more partisan pundits want to see the bank execs and the borrowers punished for accepting loans they couldn’t really afford – so narrow minded and unfocused on the bigger picture. But sounds good in the sound bites.
    The Dems own a lot of the blame as well and I think most voters get that. Stunts such as staying in DC due to the drilling issue are a great approach I applaud. But stunts that are ensuring further failures each day are beyond the pale.

    voiceofreason2 (c10c7f)

  11. That “little section” of the bailout bill that gives 20% of any repayment money to ACORN tells me this entire “emergency” is nothing more than a complete and utter scam. The founding fathers built our government SPECIFICALLY for the purpose of preventing this type of legislation from being railroaded through.

    If this is such a life-and-death matter, then why aren’t the entire proceedings being televised on all four networks? The government has done nothing to convince me that we should give even more of MY taxpayer dollars to the very people that caused the problem in the first place. This whole thing is shaping up to be the Bush-Dodd-Rangel bailout. I call BULLSH*T on this whole “EMERGENCY”.

    JinnyB (43ad11)

  12. Jinny,
    I would suggest you try reading the various financial analysises that are available at various sources, including some in this blog. Why wait for the broadcasts to tell what you should think.
    How does a ten year recession grab you? It can happen – read up on Japan’s problems in the nineties – similar banking issues were the root cause.

    voiceofreason2 (c10c7f)

  13. But the biggest difference the government can make is to restructure all these ARMs into fixed-rate 30-year mortgages, thereby easing the wave of foreclosures that happens each time interest rates on these ARMs reset. But they have to do so based on traditional underwriting requirements. It doesn’t do any good to give someone a mortgage when that person doesn’t have the financial ability to repay it, and it makes no difference if their mortgage is an ARM or a 30-year fixed rate conventional. If the best a particular homeowner could do was a “no down, interest only, ARM” then that person is really a renter and not a homeowner by any normal risk profile.

    I understand the logic, WLS…but, the paragraph above needs some fleshing out.

    Nearly EVERY one of these “democratic daisies” that were handed out as “liar loans” by lenders and their brokers…were done with a promise that the borrowere could “refinance” into a “better rate” within two years.

    Quite often the lender underwriting didn’t even meet the severely softened guidelines of the heady days of the “junk mortgage” boom.

    Babysitters and hair salon floor sweepers were having incomes listed as if they were Ivana Trump and the queen mum. And the underwriters KNEW this was a sham…(often created not by the borrower and sometimes without their knowledge).

    Moreover, a new type of loan…the pay option arm, or “neg am” loan became a tool for enticing borrowers with virtually no ability to pay once the “teaser” rate was gone or the adjustable rate recast.

    The Attorney General in California is suing Countrywide over this very issue. The allegations suggest that Countrywide intentionally disregarded even the lax underwriting standards that were designed to increase “the Democratic base” homeownership percentages.

    The “populist” notion of allowing those “locked out” of the American Dream of homeownership, led first to lax underwriting standards. Then, when these loans survived scrutiny and oversight…and were, in fact, applauded by the Democrats…Countrywide, WaMu (which has been seized by the feds and sold to JP Morgan today…another failed large institution), Downey, World Savings, IndyMac, and other sub-prime and alternative loan sellers, bulked up on junk mortgages.

    Junk bonds, dot com junk IPO’s, and junk mortgages all have one thing in common. People made a lot of money riding the roller coaster up.

    In your paragraph above, WLS…you suggest that it’s a matter of the government “selling” these loans and that ARM’s ought to be rewritten as fixed rate mortgages.

    Two problems. First, the government (the Democrats) will try to buy these at 75-80 cents on the dollar. That is what the investors want.

    But they will only be able to sell off this massive inventory to real estate bulk speculators. There aren’t enough qualified buyers to sell them off individually…even at a reduced principal price.

    They are likely to get 40 cents on the dollar. The DIFFERENCE…is going to be made up…by the same people that the Democrats hate. The top 25% income earners will be saddled with a bill, for a problem they didn’t create, they didn’t expand, they didn’t vote for and they aren’t being told the truth about now.

    The borrower isn’t going to be “saved” from foreclosure. In fact, if the government chooses to not allow a lawsuit for fraud when it buys these loans and owns the liabilities (and there is no pocket to go after because the institution failed and is out of business, as are the brokers who wrote the loans)…then the foreclosures and short sales will continue, nobody will be qualified to buy the inventory except speculators, bulk REO sales will be run by the government instead of the banks and the shortfall between purchase/bailout price and bulk speculator buying price of nearly 100% will have to be borne by someone.

    That someone….is the taxpayer. Who pays taxes in this country? Overwhelmingly, the top 25% income earners. Statistically speaking, the very people who had absolutely nothing to do with this crisis.

    cfbleachers (991d6b)

  14. And one more issue ought to be noted.

    This printing of new money at a trillion dollars or whatever the Democrats stick this bill with…comes with a sticker price on the window. Taxes to pay for it.

    But there is an after market sale of junk too. The Treasury will have to get SOME of this back via their own internal tools. They will have to raise rates.

    We are looking at a possible hyperinflationary period if this goes through as the Democrats would like, and YOUR credit cards, YOUR borrowing tools…are likely to see hefty increases.

    Which will mean that even LESS “average” buyers will be qualified to obtain credit or would want to take on that hefty debt load.

    There is no market for the inventory of high interest financial products. There will be supply, but no demand.

    We can’t do “nothing”…but racing to save the Democrats by letting the Democrats dictate the terms will throw gasoline on a raging fire.

    And since they own the information stream, lock, stock and barrel…they will blame everyone else.

    And say the “rich” should pay for it.

    cfbleachers (991d6b)

  15. WLS, I appreciate your well written comments. However, you have presented the choice facing us as approving the Bush Administration plan with some modifications by Senate Democrats or doing nothing at all thereby allowing a severe general economic collapse.

    Newt Gingrich has suggested the Treasury lend the funds for a workout rather than purchasing $700 Billion in bad paper.

    Below is an excerpt:

    But on a practical level, if they need to open up a window to loan money to treasury plus 2 percent, and people want to come in and borrow the money and the responsibility (ph) of a workout not a bailout, and those people want to work their way out over the next three to five years. I’m comfortable saying this is a liquidity crisis; let’s meet it; let’s loan the money. But let’s make sure they are responsible for their bad debt, and they’re going to work their way out.This idea that we’re going to buy the paper and some bureaucrat in Washington is going to be responsible for $700 billion in bad paper, I think, is socialism at its worst. I can’t imagine why this administration is doing it. I think it is profoundly wrong, and I hope it is defeated if it comes to the floor in this form.

    Stu707 (7fb2e7)

  16. Does not matter whether the $700,000,000,000 gets US some securities, so we might lose a little or might get more back. The fact is that this is not the direction that I want the USA to go. I like the Republican idea, to make an over arching insurance plan to cover all the MBSecurities out there and let the damn owners hold onto them, not the federal government. Fascism happens one small step at a time.

    A Stoner (efe02f)

  17. Bailout supporters need to pick a story and stick with it. WHAT PRICE IS TREASURY GOING TO PAY? Everyone’s acting as if that’s an afterthought. But it’s crucial.

    Are they going to pay the actual (i.e., low) market price? (Which is, after all, what an auction would imply.) If so, then yes, as per the above analysis a ‘make money’ scenario is conceivable (although not inevitable..), but the scheme will not help banks at all so what would be the point of the exercise?

    Or are they going to pay a higher price they consider to be the ‘held-to-maturity’ value, as mentioned by Paulson? If so, maybe this would help banks, but then this talk of the scheme as a potential money-maker for Govt is nonsense.

    Which is it?? Honestly I don’t know because details of this ‘plan’ still seem sketchy to me. But what I do know is that, unless Treasury is going to somehow magically discover the ‘perfect’ sweet-spot price for each security (which is rubbish), you can’t have it both ways. It will either help banks free up balance sheet at non-loss-inducing prices, OR it can be discussed as a potential moneymaker for Govt.

    But not both, for crying out loud!

    Sonic Charmer (8c1456)

  18. I say this bailout is a bunch of BS! I say let wall street and the morons who bought homes they couldn’t afford suffer! Neither of them needs to be bailed out because of their own stupidity! The people that are really getting screwed are the ones who bought homes legitimately…the real, hardworking, tax paying americans who will have to pay for this bailout with their taxes!

    Shane (159fa0)


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