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| Trying to Fix Stupid-Crazy |
| 2008-09-30 |
| by Steve White The Burg, like most good Americans, has been discussing the 'Bailout' plan promulgated by Secretary Treasury Hank Paulson. Rantburg University has lived up to its name these past few days as we've all learned about mortgage backed securities, commercial paper, the Libor index and the depths of depravity within the soul of the Democratic Party. I appreciate what some here have said about how fixing the mess is absolutely required to prevent an economic collapse. I think that's right. I also understand those who are skeptical that we have a real crisis, and if we do, how to fix it. But I decided to see how bad things really were today in a more personal way. Most investments are continuing the decline that's been going on the last year. Yes, the market is up occasionally, even now, but it could plunge tomorrow. A great depression could on the way. Or not. I can't look at the billions and trillions of dollars being tossed about in this plan or that and not have my eyes glaze over. But I can look at the real world at people like me. A good test, I thought, would be to see how easily John Q Citizen could get a loan. So I took a look. To start, I checked eLoan and LendingTree to price rates for a new mortgage for a home in my home county (Will County, Illinois). I put in the median price for a new home here and specified 10% down with an excellent credit rating. No problem. Rates are 5.5 - 6%. I didn't click 'submit' but I'm pretty sure that if I did, a perky eLoan agent would get back to me within the promised fifteen minutes. Then I looked at auto loans. At Chase, a four year loan is 6.2%. At Bank of America the same loan is 5.8%. Those are reasonable rates by any modern historical standard. I looked into annunities. Within a half-hour I'd found a dozen annuity offers that would take my hypothetical $100K IRA roll-over and turn it into a perpetual $550 a month for life. That's about 6% a year. Maybe I should retire. And I threw out, in today's mail, three more unsolicited offers for credit cards. So in real life, I can get credit, finance things I want to buy, and prepare for the future. I can find banks and investors who are, today at least, more than happy to work with me. So where's the crisis? To apply the Glenn Reynolds rule: "I'll believe there is a crisis when the people who say that there is a crisis start acting as if there is a crisis." To their credit, Paulson, Bernanke and Bush seem to be acting as if there is a crisis. But the national banks and lenders that deal with John Q Citizen aren't, at least not yet, the Democrats certainly aren't, and a fair number of Republicans aren't either. The root core problem of the current panic, as I see it, is that the mortgage-backed securities are illiquid. We know why -- stupid Fannie/Freddie rules, bad, bad Community Reinvestment Act, crooked politicians, con-artists at ACORN and other 'community organizations', greedy investors and bankers, and inadequate oversight by the Fed, pension funds, etc. Okay, that's the problem. Nobody can tell what a typical MBS, particularly the sub-A+ tranches, is worth. So by mark-to-market rules they're worth 'zero', which plainly is stupid -- even if every mortgage in an MBS foreclosed, the homes and land would have residual value. But we have, among other stupidities, stupid accounting rules like that '157B' sucker. That's it in a nutshell. Paulson is right -- the cure is to put a value on the MBS's so as to make them liquid again. If he'd simply come out with that, and had explained why, and told us with some calm what would happen if we didn't -- and if he'd DONE THIS BEFORE FRIGGIN' SEPTEMBER OF AN ELECTION YEAR -- then we could have had a reasonable debate, no more than the usual political skullduggery, and perhaps had a solution. But Paulson is an investment banker and an arrogant jerk -- I repeat myself, of course -- so he couldn't do that. He said, "gimme the power and I'll decide what's best." Yeah, sure, Hank, we'll give 700 large to the very people who got us into this mess. So Paulson went public, and Bush had to back him up, and the press and the markets reacted as you might predict. So did the politicians, particularly the Big O, who saw a 2 point deficit in the national polls become a 5 point lead. And clueless people wonder why San Fran Nan behaved the way she did yesterday on the floor of the House. She and the Big O have what they want and they're going to ride that horse all the way to election day if only they can. The Republicans act as if they were forced to suck a very large lemon, which they did, since as is typical for them, they were completely out-played in the political arena. Whoa, that's never happened before. Now then, the adults in the room, if any are left, might point out that if we don't fix the MBS mess than the entire commercial paper market just might come down, and when it does companies like Boeing, Cat, GM, etc are going to be in big trouble. It is idiocy that Cat can't float its 30 day paper easily, but right now it can't. So Cat and the other big companies, from Boeing to Xerox, will delay plans, slow purchasing, lay-off employees, and in general conserve cash. So will the main street banks over time as the level of mistrust increases. Sure, I have money and you're my best customer, but that doesn't mean I'll loan it to you at any price, even for a month. That thinking will tank the economy. So for John Q Ciitzen, let me make it clear: I can find an auto loan today. But I might not be able to find one, for any price, in a few months if we don't fix the problem. Not that I'll be able to afford a car if my employer just laid off me and a thousand other people. The market is in a panic precisely because it is irrational, and you don't fix stupid-crazy by becoming even more stupid-crazy. Behaving that way leads you to goofy people in black bandannas manning the barricades in our urban centers. Our politicians will be even less well behaved. The authoritarian Left will canoodle with the Wall Street cowards which will be easy since many of the latter are already secret admirers of the former. Or not-so-secret, as the Big O's donation list attests. The end result is liberal fascism, a take over of an increasingly big part of the economy by government to be run as government -- that is, the Big O and his friends -- say. Oh, business will still be 'private', they'll just have to do as they're told. No, not for me, I'll pass. So here is what you do to fix the MBS problem and stop the liberal fascists (this time). You fix stupid-crazy by grabbing the attention of the panicked people. You might need to clobber them first -- "thanks, I needed that" -- but you then lead them to an orderly resolution. Yes, assets will be written down, some banks and investment houses will go bankrupt, some investors will go broke, some homes will be foreclosed, a few people will need temporary shelter. You can ease the pain for the small players but you make sure the bigger players remember what it was like to touch that hot stove. Review each MBS, put it up for auction, put a value on each one, and make sure government is there to grease the skids and buy those securities that no one else wants at some price that makes grown people complain but not scream. Government puts a floor under our fall; that's the key feature of any responsible plan. That ensures that people with money can put a value on illiquid securities and buy the ones they want at a price that doesn't in turn break them. You can do it as 'insurance', you can call it a 'bailout', whatever you like, but you make sure that there is a market for that which can't be marketed today. And do it now. The longer you wait, the worse it gets. The preferred alternative of conservative purists seems to be to let the markets sort it out amongst themselves. Sure, they'll do that, after a while. A long while. That's called a 'recession', and the sorting could take a few years or more of really painful consequences for John Q Citizen, and in the meantime the liberal fascists are always pointing out to John how they could do it better if he would just gave them more power. That's what they always say, and that's how we got into this mess in the first place. You fix stupid-crazy by stripping what is irrational out of the problem. You save the economy, and perhaps our country, by doing it quickly. That's being responsible. That's what adults do when confronted with panic. Are we that responsible? |
| Posted by:Steve White |
| #15 It's irrational yet logical at the same time, but even the Russians claim Soros is manipulating the global market. |
| Posted by: Danielle 2008-09-30 23:47 |
| #14 Steve, Well-written and reasoned argument. I'm not sure I buy all of it but it's a cogent defense of a pretty sound position. Agree or not, it's an excellent contribution to Rantburg U. Thanks. |
| Posted by: Jolutch Mussolini7800 2008-09-30 23:36 |
| #13 Soros already made $4 billion betting against derivatives. |
| Posted by: ed 2008-09-30 23:09 |
| #12 Steve Thanks for taking the time to write your informative and well-written essay. And thanks to everyone at Rantburg U, who shares their own perspective and gives us alternative takes for us to investigate and compare to what different economists are saying. |
| Posted by: ryuge 2008-09-30 23:07 |
| #11 Would that "someone" be named Soros, Tranquil? |
| Posted by: Barbara Skolaut 2008-09-30 23:03 |
| #10 Did I yet mention my theory that someone's manipulating the currency markets, and buying up dollars to aggravate the crisis? |
| Posted by: Tranquil Mechanical Yeti 2008-09-30 22:15 |
| #9 bad tags: If this were strictly an American problem, the dollar would be falling against the Euro, but its not. quite the opposite. |
| Posted by: Nimble Spemble 2008-09-30 21:27 |
| #8 The root core problem of the current panic, as I see it, is that the mortgage-backed securities are illiquid. That's it in a nutshell. Paulson is right -- the cure is to put a value on the MBS's so as to make them liquid again. It is not just that mortgage backed securities are illiquid. In fact, I'd bet the Fed would accept them at par at the discount window. But I understand that bankers are afraid to discount notes at the Fed because it would be a sign of weakness. And that is what this is really all about, fear, not securities. Fear is now as out of control as greed was two years ago. And it is as malevolent. As lotp notes, the fear is expressed in banks unwillingness to lend to eachother, even over night. That is why LIBOR set a new all time record today. That is what really set the panic off two weeks ago, when the LIBOR market seized. Note that the LIBOR today was higher than the rate for your mortgage and just a tad lower than your car loan. For an overnight loan between banks. And note that LIBOR applies to banks all around the world, not just US banks. The problem is not limited to the US mortgage backed securities. European banks are failing because of European mortgages. If this were strictly an American problem, the dollar would be falling against the Euro, So the world wide problem we have here is that there has been a total loss of confidence. The bankers no longer trust eachother. Congress people don't trust their leaders, the people don't trust the government. This is a moral problem, not financial. That is why this IS 1929, really 1932. We are going to rewrite the social contract that has been in place since the New Deal replaced the contract that had been in place since the Panic of 1837. Notice how these last 80 years, an adult lifetime. The only people around who remember the Great Depression were children at the time. So we all are going to have to learn those lessons again and build a new social fabric of trust. Because business cannot be conducted without mutual trust. And that trust has been rent by unconstrained greed. Now unconstrained fear will take its place until an equilibrium can be restored. for our children's lifetimes. Steve is correct that the quicker we get it over with the better. And the government does not help. But the issues of the Panic of 1837 were not fully resolved until 1865 and the issues of the Depression of 1932 were not fully resolved until 1945. |
| Posted by: Nimble Spemble 2008-09-30 21:25 |
| #7 Yes, it will be too late. Yesterday/today the LIBOR rate averaged 6.88%. Banks cannot do a whole lot of lending at 5-6% income interest (before the cost of operations) on longterm loans if they have to borrow shortterm at two percentage points more than that. |
| Posted by: lotp 2008-09-30 21:20 |
| #6 I agree, LIBOR is more important in the world of finance. But the reason John Q. Citizen doesn't care -- yet -- is that HE can still get a loan. That's one of the reasons why the polls show the public is against this whole package. They see it as Wall Street welfare and don't yet see the connection between LIBOR and an auto loan. If the credit market locks up they will, but then it will be too late. |
| Posted by: Steve White 2008-09-30 21:01 |
| #5 My only comment for now is that your test, Dr. Steve, is misleading. You will not see consumer credit dry up *first*.  First you will see banks failing and indicators such as LIBOR (the London interbank lending rate) rise.  Check the financial news for the last two days on those fronts -- it isn't good. |
| Posted by: lotp 2008-09-30 20:55 |
| #4 I don't know what the answer is. I am, however, extremely reluctant to give a 700 billion dollar check to anyone. |
| Posted by: Deacon Blues 2008-09-30 19:51 |
| #3 Sorry I read to paulson and stopped - thinking that this was another call for bailout. I think we reached the same endpoint. |
| Posted by: flash91 2008-09-30 17:50 |
| #2 The answer is still no. Paulson is not the person to put values on anything. That's for the market to do. Right now the Market is staying away because they are overpriced - "illiquid" means unable to sell, and as you have pointed out even the land has value. This could get bad, but this isn't 1929. We have safety nets that didn't exist back then. The best answer is bankruptcy. Let the fed govt manage the closure and sale of assets, do it quickly so we can get past this crisis. |
| Posted by: flash91 2008-09-30 17:48 |
| #1 You hit the keys Steve..."insurance and mark-to-market." It is NOT penicillin, but if we can convince congress to suspect mark-to-market and provide some FDIC type of mortgage insurance. we'll see some relief and breathing room. Watching Hank Paulson run in and out of the White House with a blank check that no one will sign is disgusting. |
| Posted by: Besoeker 2008-09-30 17:16 |