Sunday, January 25, 2009

TARPs 3 and 4? At Least. And Maybe Up To TARP 10 Until We Get It Right.

If you'd asked my opinion based on all the economists that I read, I likely would have responded, "A $750-billion stimulus package? More likely a $3-4 trillion stimulus will be required before we are out of the CheneyanBushes." (The current sum being bandied about now is up to $850 billion, and McCain has already departed from his much-advertised bipartisanship by saying he's going to vote against it.) See bottom of essay for details on TARP 3 and 4. As I've said before in a variety of venues, I don't believe for one second that the brilliant Rethuglican/NeoCon financial "gurus" were ignorant of what they were wreaking on the inattentive (or just naive) populace (all over the world) to their own enormous benefit. Or that Bernie Madoff acted alone or without a lot of connected aid and advice. If anyone believes that fantastic scenario, seeing the results as they exist just now from the sham credit-squeeze bailout (see figure), we might as well roll up the sidewalks and get out our guns immediately (see the right-wing gun sales for an example of what people do who fear the future) as nobody should be trusted to be smart enough to fathom the correct rescue measures. (And I own several bridges in Brooklyn that I'd like to sell them at a bargain price!) I'm also still scratching my head over the thought that Obama knows of only one person (one who has committed what in any earlier time would be easily seen as intentional fraud in his personal taxpaying schemes) whom he perceives as the best qualified in the whole country to perform the role of Treasury Secretary, and that this person just happened to be involved in touting the original schemes that brought us to this fiscally-challenged abyss, not to mention that he had Robert Rubin and Larry Summers as mentors ( and especially after Paulsen was finally swept out the door, trailing billion-dollar bills still being snatched by the cartoonish hands of his friends and past Goldman Sachs colleagues, as they played to the open-mouthed astonishment of the enthralled audience). Why? Are they blind? Or has so much occurred in such a short time that everyone's shell shocked and walking around still dazed? It frightens me that so many in D.C. still seem to know or care so little about economics and finance. Doesn't anyone remember that the book written on the men (and only men) surrounding JFK, who brought on the debacle of the Vietnam War and couldn't stop their activities even when it was obvious that they were headed down a path to infamy, were called The Best and the Brightest as irony? (Sheila Bair is the only one truly qualified on the national stage as far as I can see who would actually be a candidate of change in the position of Treasury Secretary - but she's a girl and for some reason (still) disqualified from consideration, I guess.) But I may be accused of being too dramatic about the choices that are directly in our path, although, for examples of the continuing blindness running amuck in the country, you only need to read some desultory quotes from Frank Rich today. John Thain, the chief executive of Merrill Lynch

was lionized as a rare Wall Street savior as recently as September, when he helped seal the deal that sped his teetering firm into the safe embrace of Bank of America on the same weekend Lehman Brothers died. Since then we’ve learned that even as he was laying off Merrill employees by the thousands, he was lobbying (unsuccessfully) for a personal bonus as high as $30 million and spending $1.22 million of company cash on refurbishing his office, an instantly notorious $1,405 trashcan included. . . . Most economists failed to anticipate the disaster, after all, and our tax-challenged incoming Treasury Secretary may prove as evanescent as past saviors du jour. As we applauded Thain in September, we were also desperately trying to convince ourselves that Warren Buffett’s $5 billion investment in Goldman Sachs would turn the tide, and that Hank Paulson, as Newsweek wrote in a cover story titled “King Henry,” would be the “right man at the right time.” . . . Yet the values of the bubble remain entrenched even as Obama takes office. In the upper echelons, we can find fresh examples of greed and irresponsibility daily even without dipping into the growing pool of those money “managers” who spirited victims to Bernie Madoff. . . . In less lofty precincts of the American economic spectrum, the numbers may be different but the ethos has often been similar. As Wall Street titans grabbed bonuses based on illusory, short-term paper profits, so regular Americans took on all kinds of debt wildly disproportionate to their assets and income. The nearly $1 trillion in unpaid credit-card balances is now on deck to be the next big crash. . . . If we’ve learned anything since the election, it is this: We have not remotely seen the bottom of this economy, and no one has a silver bullet to arrest the plunge, the hyped brains in the new White House included. . . . Last weekend, Bob Woodward wrote an article for The Washington Post listing all the lessons the new president can learn from his predecessor’s many blunders. But what have we learned from our huge mistakes during the Bush years? While it’s become a Beltway cliché that America’s new young president has yet to be tested, it is past time for us to realize that our own test is also about to begin.
Jim Kunstler at Clusterfuck Nation begs to disagree with Obama's further bailout plans and urges him to plot a different course. (Emphasis marks were added and some editing was necessary - Ed.)
Surely over the months of transition, someone with a clear head and a fact-laden portfolio has clued-in the new President about the reality-based state-of-the-Union - as opposed, say, to the Las Vegas version, where Santa Clause presides over a whoredom of something-for-nothing economics, and all behaviors are equally okay, and consequence has been sliced-and-diced out of the game . . . where, in the immortal words of Milan Kundera, anything goes and nothing matters.
He's pulling for Obama and hopes against hope that "Maybe the power of his rhetoric and his sheer buff physical presence can whip this republic of overfed clowns into shape."
The USA is functionally bankrupt. We have no money. The pixel "money" being emailed over to the insolvent banks has no basis in reality beyond the quiver in Ben Bernanke's voice as he announces each new injection. . . . Mr. Obama's first task taking stage in the lonely Oval Office should be to get right with his own credo of "change," meaning he'll have to persuade the broad American public that the "change" required to salvage this society runs much deeper, colder, and thicker than they'd imagine in their initial transports over hallelujah-Bush-is-Gone. Many of the familiar touchstones of the recent American experience have got to go. . . . Say goodbye to the "consumer society." We're done with that. No more fast money and no more credit. The next stop is "yard-sale nation," in which all the plastic crapola accumulated over the past fifty years is sorted out for residual value and, if still working, sold for a fraction of its original sticker price. This includes everything from Humvees to Hello Kitty charm bracelets. It will be a very salutary thing if we stop even referring to ourselves as "consumers." This degrading moniker, used for decades unthinkingly by everyone from The New York Times Nobel Prize pundits to the Econ 101 section men of the land-grant diploma mills has been such a drag on our collective development that it has extinguished the last latent flickers of duty, obligation, and responsibility for the greater good in a republic of broken communities shattered by WalMarts. The government will not have to do a thing to bring down the chain stores. History and inertia is already on that case, with the easy-credit racket terminated and new frictions arising over global trade, and even Peak Oil waiting to work its hoodoo behind the scrim of deceptively temporarily low pump prices. The larger question for President Obama is: how can we collectively promote the reconstruction of Main Street, including all the fine-grained layers of retail and wholesale trade. High tech "solutions" are not likely to avail in this.
Jim believes that the race for "happy motoring," techno-driven solutions are a blind alley and that the changes "we face in agriculture dwarf even the death throes" of the automobile. "A lot of people are likely to starve in America if we don't get our act together pronto in terms of how we produce the food we eat. Petro-agribusiness faces a set of disturbances that are certain to induce food shortages." Read the rest of this most disturbing and farsighted essay here. Louis Woodhill, an engineer and software entrepreneur, on the Leadership Council of the Club for Growth has a novel approach (some American ingenuity at its finest!) for another "Way to Deal With Toxic Assets:"
For at least four months now, it has been recognized that “toxic assets,” mostly Mortgage-Backed Securities (MBS) for which there is currently no viable market, are clogging up our financial system like plaque clogs up coronary arteries. The actions taken thus far have been piecemeal, half-hearted, and ineffective. Our economy is still in danger of a financial heart attack. Treasury Secretary Paulson was on to something when he pushed his $700 billion “Troubled Asset Relief Program” (TARP) through Congress last year. The advertized purpose of TARP was to buy up toxic assets, thus removing them from the banking system and restoring it to health. Unfortunately, shortly after the TARP funds were voted, the Treasury Department decided that the money could not be used for its intended purpose because there was no way to determine appropriate prices to pay for the toxic assets. By definition, toxic assets are those whose value is so uncertain that there is no functioning market for them. If TARP paid too little for the toxic assets it bought, the banks would not be restored to financial health. If it paid too much, the banks would get a windfall at taxpayer expense. The Treasury Department also realized that in any price negotiation, the banks would know more about the nature and value of the assets than would the people representing TARP. Since abandoning the original concept of buying up toxic assets, TARP funds have been deployed to fight financial fires. Some of the money has even been used to bail out the U.S. auto industry. Meanwhile, the problem of toxic assets clogging up the nation’s financial arteries has remained. Fortunately, there is a way to buy up toxic assets that does not require assessing their value today. It is based upon the indisputable fact that at some point between now and thirty years from now, the value of all of today’s toxic assets will be known with certainty. The Treasury should create a “bad bank” to buy up toxic assets. Let’s call it The Bad Bank of the United States (BBUS). BBUS would buy whatever assets a financial institution wanted to sell to it, paying whatever price the institution asked, up to (say) 80% of par value. The institution would get cash. BBUS would get the toxic assets plus a special contingent variable warrant (CVW), good for common stock in the institution. BBUS would place all of the toxic assets obtained from each institution in a separate account. The cash generated by the assets would be retained in the account and invested in Treasury securities. Each account would be charged interest on the original purchase price of the assets at the Treasury’s cost of funds plus (say) 1% to cover the operating expenses of BBUS. The detailed status of each account would be posted on the Internet. BBUS would wait until all of the toxic assets in a given account had resolved themselves, either by being paid off according to terms or via some default process. At that point, there would be some amount of cash in the account. If this amount was greater than what BBUS had paid for the assets, half of the excess would be returned to the financial institution and half retained by BBUS. If the amount in the account was less than what BBUS paid for the assets, BBUS would exercise the CVW. Each CVW would give BBUS the right to demand that the financial institution that sold it the toxic assets hand over common shares equal in value to any deficit in its account at BBUS. For example, if on the date that the assets in an account were fully resolved the fund had a deficit of $1 billion, the institution would have the option of either paying BBUS $1 billion in cash or handing over common shares with a market value of $1 billion. BBUS would dispose of any shares received as soon as practical. It is possible that there would be financial institutions whose entire market capitalization would be less than the deficit in their toxic asset account at BBUS. In these cases, BBUS and the taxpayers would take a loss. These losses would (potentially) be offset by BBUS’s 50% share of the gains on the accounts that returned more than BBUS paid for the assets. It might seem strange to allow financial institutions to select the toxic assets they sell to the BBUS and to set the prices of those assets up to some maximum. However, financial institutions will have incentives to price these as accurately as they can. If they set prices too high, they forgo current tax deductions and set themselves up for involuntary equity dilution down the road. If they set them too low, they will lose money unnecessarily. Given that the government played a major role in creating the toxic asset crisis in the first place (via an unstable dollar and various laws promoting mortgage lending to sub-prime borrowers), it is not unreasonable that the government assume some financial risk. Under the BBUS plan, participating financial institutions will bear as much of the risk they can bear without impairing their ability to perform their economic function. Because the detailed status of each account at BBUS will be published on the internet, the markets will take into account the projected gains or losses in these accounts in valuing each financial institution. This will feed back into the market price of the institution’s common shares. However, because BBUS will not have recourse against the institution for anything but common stock, this should not impair the credit worthiness of the institution or its ability to raise capital via debt or preferred stock. The BBUS approach would solve the problem of toxic assets once and for all, while minimizing the costs and risks to both taxpayers and financial institutions. It would do this by side-stepping the problem of assigning prices to assets that are deemed toxic specifically because their value is currently so uncertain.
The BKT Weekly Special gives us this unsettling bit of financial news from abroad:
The drop in the GBP/USD this week has been nothing short of astonishing. The pair erased more than 1000 points off its price with sterling depreciating by more than 6% against the dollar. Although cable has been in decline since the turbulent markets of last fall, this latest freefall carries a whiff of true panic about it as markets fear that UK government spending schemes to rescue the country's ailing banking sector will put unsustainable stress on the Treasury. The run on the pound was triggered by Prime Minister Brown's latest proposal to spend an additional 50 billion GBP to insure toxic assets of the banks, as well as by the RBS revelation of the largest loss in UK corporate history. Those two events have greatly damaged the markets confidence in UK financial system, sending sterling plummeting as traders question the UK government's ability to successfully float so much fresh public debt as 2009 unfolds. The collapse of global capital markets turned the UK economy from boom to a bust in a blink of an eye. Despite inflation levels that remain above 3%, the BoE has lowered rates from 5.25% to 1.5% in less than 12 months as UK unemployment rolls swelled to 6.1%, and UK finance sector reeled from record losses on credit instruments. Looking forward, there is little hope on the economic horizon. The unbalanced situation of the UK economy persists and should global equities remain in a protracted bear market, the long-term damage is likely to be severe. . . . The very same reasons that felled sterling this week, may also bring down the dollar. Much like the UK economy, the US economy has relied on the financial sector for the majority of its recent economic growth. At its height the US financial sector represented more than 20% of the S&P but the double collapse of US real estate and equity markets have wiped $10 Trillion off household net worth bringing consumer spending to a standstill. With the consumer representing 70% of the US economy this sharp contraction in demand brought all economic growth to a virtual halt. . . . One of the primary suppliers of capital to the US is China and recent capital inflow data indicates that the Chinese have shifted the vast majority of their investment portfolio away from Agency bonds (such as Fannie Mae and Freddie Mac) towards Treasury securities. In other words US now finds itself in a precarious position where a significant portion of its debt resides in short-term obligations subject to rollover risk. Should the Chinese lose faith in the “full faith and credit” of the United States, the downside pressure on the dollar could be enormous as capital flight will surely ensue. To aggravate the situation further, the current stimulus plans of the Obama administration are likely to add an additional $1 Trillion of spending at a time when tax revenues are falling off a cliff. The dangerous combination of record new spending and near total reliance on foreign capital to finance such spending creates the primary risk to the dollar this year. While, the chance of an immediate global run on the greenback appears to be relatively small, since the unit continues to serve as the reserve currency to the world offering the best choice amongst many unpleasant alternatives, currency traders should not be complacent. The vicious run on the pound stands as a stark reminder of how quickly sentiment can change in the FX market. With so much debt outstanding and so much more to be issued, the dollar could indeed become the next “pound” in the currency market and traders should prepare accordingly.
TARP 3 and 4 Are on the Way - John Mauldin
There are a lot of complaints about the use of the first $350 billion in TARP money. How could (now) former Merrill Lynch Chief John Thain have been so tone deaf as to spend $1.2 million on decorating his office with the company clearly in financial trouble? And some of it apparently after the government was kicking in money? Large bonuses for select managers at the last minute before the merger and subsequent major losses? The list could go on and on. The Obama administration has plans to keep such abuses from happening. I wish them luck, because the next round of $350 billion is just a down payment. (By the way, we should remember the TARP money is intended to be a loan and not a subsidy. Taxpayers should at least have the chance to come out whole. We will see.) Professor Nouriel Roubini and his team at RGE Monitor have been noting in speeches in various venues around the world that they estimate that losses from the financial world could be as high as $3.6 trillion. That is composed of $1.6 trillion in loan losses and another $2 trillion in mark-to-market losses of securitized assets. "U.S. banks and broker dealers are estimated to incur about half of these losses, or $1.8 trillion ($1-1.1 trillion loan losses and $600-700bn in securities writedowns) as 40% of securitizations are assumed to be held abroad. The $1.8 trillion figure compares to banks and broker dealers capital of $1.4 trillion as of Q3 of 2008, leaving the banking system borderline insolvent even if writedowns on securitizations are excluded." Roubini argues that banks will need an additional $1-1.4 trillion dollars in private- and public-sector investments. Then he and colleague Elisa Parisi-Capone lay out in detail how they come up with their numbers. They argue: "Thus, even the release of TARP 2 (another $350 billion) and its use to recapitalize banks only would not be sufficient to restore the capital of banks and broker dealers to internationally accepted capital ratios. A TARP 3 and 4 of up to $1.05 trillion (assuming generously that all of TARP 2 goes to banks and broker dealers) may be needed to restore capital ratios to adequate levels." Even with all the government money added to the banking system, net capitalization of US financial institutions may fall to as low as $30 billion, from around $1.4 trillion before the credit crisis. Let's think about what that means. This same exercise in principal works for England and other European countries. England may be down $2 trillion pounds, which is relatively much larger than the US losses. Senators at the Banking Committee hearings which looked into the appointment of Tim Geithner as Treasury Secretary (and kudos to the five who voted against approving him) were outraged at the problem of giving banks all that TARP money and other Fed commitments, and now they were not lending that money and indeed it looks like they want more! I know this will shock some of my foreign readers, but most of the Senators on the Banking Committee don't really understand the banking system. Here's the problem. The banks are lending. If you look at bank lending numbers, there is growth. The banks, per se, are not the real problem with the lack of lending. The real problem is that we vaporized an entire Shadow Banking System that bought securitized debt in a wide variety of forms: autos, homes, student loans, credit cards, etc. That industry exists no more. Banks over the last ten years became originators of loans, and not actual lenders. They would make the loans and then package them up for other institutions to buy. A pension fund in Norway (or wherever) would look at the rating from Moody's, see AAA, and buy it. Or banks would create off-balance-sheet vehicles (SIVs) to buy their debt and leverage it up, and book some nice profits. In any event, the debt did not end up on the banks' balance sheets for very long. That process was responsible for the majority of debt that was extended over the last decade. Now that process is broken, and it will not be fixed this year or next year or the year after that. We are going to have to come up with new ways of credit creation and debt processing. You can't go to Goldman and tell them to start making auto loans. They simply don't have the people to do that. Now, they used to be able to take auto loans from other actual originators and package them and sell them, but they did not make the loans. And the buyers for much of that securitized auto loan paper are gone. And they are not coming back any time soon without greater transparency and real capital guarantees and higher returns. A Moody's (or any rating agency) rating is not worth the paper, as far as the markets are concerned. In essence, we are asking the banking system, with greatly reduced capital, to do the heavy lifting that all the buyers of securitized debt did a few years ago. And if Roubini is remotely right, they simply do not have the capital to do it. Further, the banks are in a bind. The regulators, properly so, are making sure that banks have adequate capitalization and are marking assets to real market prices. But they simply have less capital to make loans, even with TARP. And the loans that many banks have made are showing higher losses than normal. Maine fishing buddy and bank maven Chris Whalen of Institutional Risk Analytics thinks that loan charge-offs will be twice the 1990 level, or around $800 billion, not far off from Roubini's number. That will force banks to loan less money and raise capital. Not exactly what the Senators want. . . . "There is no easy way out of a debt restructuring. Someone will have to bear the cost of prior bad decisions. The people who should bear the cost are those who made the bad decisions to make the loans or those who financed the people who made the loans. They intended to profit and would have profited if they were right. But they were wrong, so they should lose. The government needs to allow the losers to lose and focus their actions on minimizing the knock-on effects of their failure on people who didn't do anything wrong (to minimize systemic risk). They should then take action to minimize the future exposure of the innocent to the future dumb decisions of the small minority, because no amount of regulation will ever eliminate dumb decisions, so you have to plan for them (through much lower bank leverage limits to cushion losses, bank size limits and non-bank entities playing bank-like roles to improve diversification, safety nets to prevent losers from poisoning the whole system, etc.)."
John continues to add insights (and insults) along the line of "bad bank" scenarios:
"But if the 'bad bank' idea could work, why not create a super baaaddd bank? We could use it to get rid of all our mistakes. Writers could unload their bad novels. Businessmen could sweep their errors under its broad carpet. What the heck, let people get out of bad marriages without penalty; the super baaaddd bank could pay the alimony and divorce costs. "The hitch with the bad bank idea is so obvious even a banker could spot it. If the cost of mistakes is reduced, people might make more of them. Like the rest of us, bankers are neither good nor bad, but subject to influence. Unlike metallurgy or particle physics, banking does not have a rising learning curve. It's not science. Instead, it's more like love and gambling ... with a circular learning pattern. They learn ... and then they forget. They get carried away in the boom upswing; then they get whacked when it turns down. "So let them have a good beating. It will give them a lesson that will last a lifetime ... and give the next generation a solid banking sector."
This is what you are hearing the Republicans in Congress say. And as it's your life for the next five to ten years, it's not a joke - so everyone needs to be paying attention. And then there's that other nasty upcoming surprise (dollar devaluation or replacement or something worse) to which Joe Biden has been alluding. . . . Suzan ____________________

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