Paulson's Plan Fails to Understand the Problem; Madoff Is a Perfect Example 35 comments
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Secretary Paulson’s plan to fix the economy fails because he has not understood the problem.
What has been his plan? Get money into the hands of financial institutions so that they could continue to lend. Financial institutions initially were commercial and investment banks, but have been expanded to include insurance and even corporate borrowers that are important to the commercial paper market. This solution means that he assumed the prior asset values of say late 2007 and the related financial leverage was acceptable. He believed the problem can be solved by getting more money in the financial intermediary hands and let them work out the problem. In reality, this is equivalent to giving a drunk another drink in the morning to fix his hangover.
Here is the real problem. The problem is twenty plus years of excessive monetary creation and use of leverage as an instrument to aid this monetary creation. US authorities do not even have a mechanism which measures the real money creation, as much of this is in private hands that the government does not control or monitor.
When I was a young commercial banker, banks pretty much lived with their deposits. The Fed knew what was in the banks then. But in the last 10 to 20 years we have created private equity, hedge funds, collateralized debt obligations, special purpose vehicles in banks and other entities, plus packaging and reselling mechanisms for securities such as CDOs. Then there is the still undermined effect of the $50+ trillion in US credit default swaps; when, or if, they start to collapse they will have an enormous effect on perceived monetary creation. The practical effect of these new instruments was to create an incredible amount of new money that could be used to buy financial and real assets at increasingly inflated prices. Worse, easy credit conditions have resulted in many of these new loans being fundamentally unsound.
To take a sample from this week’s news, one hedge fund placed substantial money with Bernie Madoff and then they borrowed three times this amount to increase the profits for their investors. (Should we call this Ponzi Quadrupled?) There is a total loss on the loans to the hedge funds which invested in Bernie Madoff. AIG lives on Treasury support because of the fear of systemic losses of AIG fail to pay its creditors.
Thus 2007 valuations of assets are not price levels to which we can return in the next few years. Asset values are much overvalued and they will return to some lower norm (probably much lower than today) and Secretary Paulson’s injection of trillions of dollars will not be able to stop that. This is made worse by the leverage and intrinsic bad credit that will have to be written off. For many months, the financial system has recognized that they are over leveraged and every financial institution is now deleveraging. Deleveraging reduces money supply. Reduced money supply reduces prices. Redemptions in hedge funds will have some effect on overall price levels. Reduced prices bring financial losses and a decline of business activity. A decline of business activity brings on job losses. We entered into this process of decline in late 2007. Pumping trillions of dollars into financial intermediaries will not help.
By the second half of 2009, we will probably have public recognition that much of the $7 trillion dollars committed by Paulson will simply be lost and will have to be paid by the US taxpayers. AIG, Freddie Mac, Fannie Mae, purchase of second class assets by the Fed will lead the way to trillions of dollars of losses.
Political footnote. President Elect Obama seems to understand the above. He views it as improper for his future government to criticize the current Bush government. However, we are already seeing the outlines of his focus on creating jobs. A job building roads really gets money to a needy worker and we really get a road. Much of the Paulson money is money down a rat hole which will only benefit some bankers in the short term. The Paulson money will not achieve its primary objective of creating new loans for needy businesses and persons. Obama supports the temporary bailout for the auto companies so that he can provide a comprehensive solution when he is in charge. He has been totally silent on the perceived benefits of the Paulson type actions which he apparently understands do not work. The real question here is whether even a man as competent as Obama can fix in the short term the enormous problems we have.
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This article has 35 comments:
As long as the SEC purports to protect the investor; and the investor is hit by fraud; then why not a US Gov't bailout? If the gov't gives $$'s to the farmers, ethanol, car companies, banks, insurers, etc... etc.. why not the defrauded investor? Hopefully, Obama & Co. will have a little more empathy than some of this board.
On Dec 15 06:23 AM ironpants wrote:
> Can a member of the general public file a RICO case against the SEC
> and hedgefunds?
I disagree with you on two points
Obama was for this plan. He was in the room when it was presented.
He's stated what he wants is increase Govt spending on roads (but we all know that will drive up taxes).
Question:
You mention needy workers building roads - how do you know the workers where the roads are going to be built are needy? Are we going to have some poverty test before deciding to build a road in an area, or are we going to ship poor workers to where roads are best built?
Sounds like a glorious start... a "Great Leap Forward" if you will :)
I disagree with you on two points
Obama was for this plan. He was in the room when it was presented.
He's stated what he wants is increase Govt spending on roads (but we all know that will drive up taxes).
Question:
You mention needy workers building roads - how do you know the workers where the roads are going to be built are needy? Are we going to have some poverty test before deciding to build a road in an area, or are we going to ship poor workers to where roads are best built?
Sounds like a glorious start... a "Great Leap Forward" if you will :)
On the other hand, if Paulson can get the present locked up banking system to restart lending, this lending will lower the cost of capital (improved efficiency) and some of it will make its way into the hands of real money creaters (inventors, manufacturers and the like). It is these people that create new opportunities for money and lower the cost of capital by making better more cost effective products.
I believe we must do both Paulson and your plan but if I had my choice of in which one to emphasis my preference would be Paulson's for the immediate term and rebuilding infrustructure second.
Can you tell me the flaw in this logic?
Not like Bush has any idea what he is doing either.. so you have 2 imbeciles, one playing president until mid-januray, the other studying hard of the shows of "west wing" to figure out how to look presidential, but in reality is completely ignorant.
the same stuff that happened with the financials is now happening with politicians, no one asked Madoff any hard questions, no one asked Obama any hard questions... once the koolaide wears off, the ignorance of the american people in voting for this ignorant fraud will be the running joke all across the world.
cars can't be sold to consumers because banks don't make loans.
car mfrs can't ship product to dealers because cars can't be sold.
car mfrs can't buy raw materials because product, if made, can't be shipped.
result: everybody goes out of business (except paulson).
> jack
On Dec 15 08:21 AM tdillian wrote:
> while I did enjoy reading this article... the author seems to be
> seriously deluded about the fraud known as Obama, the only reason
> Obama is not getting involved and saying "one president at a time",
> is that the man has no freaking clue what he is doing.
>
> Not like Bush has any idea what he is doing either.. so you have
> 2 imbeciles, one playing president until mid-januray, the other studying
> hard of the shows of "west wing" to figure out how to look presidential,
> but in reality is completely ignorant.
>
> the same stuff that happened with the financials is now happening
> with politicians, no one asked Madoff any hard questions, no one
> asked Obama any hard questions... once the koolaide wears off, the
> ignorance of the american people in voting for this ignorant fraud
> will be the running joke all across the world.
You state:
The real question here is whether even a man as competent as Obama can fix in the short term the enormous problems we have.
WHERE IS THERE EVIDENCE OF COMPETENCY PLEASE?
Other than in giving speaches... tell me about Illinois' achievements under Obama.
Oh yea he gets it... Hey Jim, I'm makin coolaide... you want pink or lemmon buddy
My view of the problem and actions :
The $7-10 trillion "invested" by Treasury ( and they have insisted that they are investing not spending) is MOSTLY A REPLACEMENT FOR PAST DEBTS held by US corporations, and/or to REPLACE LOST FUNDS ALREADY INCURRED BY SOME BANKS. So these TARP and Fed transactions are just recognizing these debts ( corp and banks) onto the US balance sheets. The market is not allowing any corporation and banks to expand their debt levels, while these Treasury and Fed actions are underway.
.
We need to to look at the total basket of corp debts and bank Tier 1 assets as the balance sheet of the U.S nation. As the fed lowers rate, the banks earn more. As the corporations log profits each quarter or sell assets to foreign companies, they will be deleveraging. So as a nation, the bank earnings and the corporation profits will help to deleverage the U.S. balance sheet.
At the personal budget level, from our salary, we will also be either saving more or paying back debt. This will also help in the deleveraging process.
Oh yeah, these pesky CDS ( 50 Trilliion liability). Look at it this way, by minimizing corp and banks going bankrupt, the CDS liability goes down as time elapses. The CDS buyers will be fatigue or they with an upswing they will panic and liquidate some of their bets.
Liongterm:
When the fed gets to lend NET NEW MONEY to the banks n corporations, without taking any old debt instruments or bank shares, then these steps would be growth stocking actions. But until now, the "Treasury investments" are just buying U.S. time to deleverage. Paulson did tell us : "we need to delverage" and that is what he and the WW market is driving U.S. to do.
So for now, let's try
1 to tally how much total debt we have
2 estimate our total earnings each quarter
3 assume that we use 80% of our colletive profits to pay down debt
4- estimate how much assets that we can sell externally - at right time at the right price
5- By adding 3 and 4 above, we can estimate the time needed to deleverage the US balance sheet.
Once we can see the end-date for deleverage, then we plan to grow the pie again SLOWLY by controllng both our spending and debt growth rates.
Built on a mountain of highly leveraged debt, it had no way to go but down. Until and unless our "leaders" understand the concept of unsustainability, whatever they propose and do will fail. The US and world economies are Humpty Dumpty after the fall.
to escalate war in Afganistan, using Iraq (4-5 deployments) troops! He must be stopped. His plan to build roads is also a pie-in-the-sky because all the engineers will soak the gov't and illegals will take all the laborers jobs and cement
work, etc doesn't employ all the trades like commercial real estate does. Also,
there's a big time lag with municipalities even after approval of plans, environmental impacts, etc, so I am sure over 2 mil jobs created is wildly speculative, but he's all we got, and better than the last 8 yrs of corruption.
Also, over $100B given to AIG and it is using it for executive bonuses??? Another Huh?
Ever wonder why even abject morons do not trust big business and the gov't? Many great reasons every day, it is so very true.
Everybody knows that FASB 157 is dangerous and pro-cylical. Banks and other consumer finance companies do not want to sell their loans because the spread is wide. The spread is wide, because of credit uncertainties and forced liquidations or write-downs because of FASB 157. It's a vicious circle.
The FASB accountants can easily suspend FAS 157 and come up with new accounting rule to mark-to-market every single items on and off balance sheets for information purposes and liquidity purposes. That will provide transparency as investors demand it without destroying regulatory capital of all financial institutions.
Without FAS 157, securitization will return to normalcy, and banks will make loans again.
Bernanke and Paulson made a huge mistake allowing Lehman fail. That was why the global financial system imploded. Now, these people lack skills and foresight by supporting FAS 157. The results show!
Don't talk to me about poor retirees -- I watch them blow their S.S. checks...and I watch the payroll taxes disappear off the top of mine!! SOCIALISM MUST END for this type of economic failure to end!!!
On Dec 15 08:33 AM Michael B. Krause wrote:
> The baby boomers leave the young generation no choice but to (hyper)inflate.
> By reducing the boomers' debts in real terms, problem solved, banks
> suddenly are solvent. Unfortunately, the poor retirees who weren't
> in on the ponzi scheme will be kicking and screaming as their buying
> power goes to nothing. How sad.
B.S. -- Obama doesn't get squat. He has completely backtracked from his campaign promises on tax and overall economic policy (and I remind you, this economic crisis was *well* underway during the campaign!); and his proposed infrastructure spending of over $1 Trillion fails to address the core problem. It will create some jobs in the short term, but not for the long haul; it also is yet another instance of government growth, when what is needed is SMALLER government (government intrusion into housing is one of the big culprits in this meltdown) and drastically LOWER taxes.
You, sir, still fail to understand the main problem facing our economy: creeping socialism and excessive taxation. Our success and high standard of living were based on PRIVATE enterprise and low barriers to entrepreneurial effort. Today, our corporations are among the highest-taxed in the world, and our personal taxation is among the most onerous as well. I refer not merely to the rates, but also the types and means. Freedom and ability to innovate is lost when we are not the ones in control of our own money!! We need to abolish the government's preemptive claim on our money that is the income tax. This done, the people would have more of THEIR OWN money to spend, invest, innovate with, or pay down debt with!!
fairtax.org
Freedom and free markets are intertwined. Intervention and socialism are different names for the same beast.
How is borrowing money to build roads fundamentally different than borrowing money to build houses was in the first place? According to your argument, the empty houses of the real estate bubble should have saved our sorry butts. Afterall, building them created jobs plus we got rows and rows of them sitting around. In a very real sense, we-the-people, are owning them since we now own the banks that own the houses that nobody lives in or takes care of.
Tell me what good the roads are gonna do us if nobody has a car, gasoline or the means to obtain either??? Is that why Obama is supporting the Big-3-Bailout ya think? Or perhaps the campaign funding he received from their lobbyists or the UAW had something to do with influencing his perspective on that one?
What about this idea... What if we all started to work on figuring out how to save money rather than spend it? What if we began promoting some goodwill and cooperation instead of greed and competition starting right here at home?
If Wall Street wants to join Main Street in this endeavor, then step up. If not, then they should back up
On Dec 15 08:09 AM geoc wrote:
> Hello Mr Wood,
>
> I disagree with you on two points
>
> Obama was for this plan. He was in the room when it was presented.
>
> He's stated what he wants is increase Govt spending on roads (but
> we all know that will drive up taxes).
>
> Question:
> You mention needy workers building roads - how do you know the workers
> where the roads are going to be built are needy? Are we going to
> have some poverty test before deciding to build a road in an area,
> or are we going to ship poor workers to where roads are best built?
>
>
> Sounds like a glorious start... a "Great Leap Forward" if you will
> :)
>
On Dec 15 08:55 AM ttown wrote:
> THe Obama plan is Roosevelt all over again. He has nothing original
> to add. The end result of more Roosevelt plans is more welfare. We
> all know how that works out. Invest in interest bearing investments.
> Obama will bring more inflation!!!!
On Dec 16 09:43 AM Malkiel wrote:
> It seems clear that the Treasury and Fed should know how much "money"
> exists in the economy; and since the organs of government have the
> capability of raking in W-2 forms from every worker and matching
> them up with the paperwork, or chasing down every villain who dares
> to withdraw $10k from their bank accounts by using small amounts,
> it should in principle be possible for them to maintain a database
> into which all loans or other products created by public entities
> such as banks or brokerages could be entered. Electronic reporting
> could be facilitated by standardizing loan forms for various transactions
> (they can vary by jurisdiction so long as essentials such as principal,
> interest format, and down payment are included). Hedge funds of course
> should be regulated just like brokerages and should be reporting
> their activity. The object is not to prevent players in the economy
> from doing what they do, the object is for the essential public players
> like Treasury to have the data needed to manage what they do. The
> argument that hedgies should be allowed to do their dirty business
> in secret or banks would be burdened by extra paperwork rings pretty
> hollow at this point--if actors in the economy can "create" money
> outside the banking system, then the agencies of government which
> protect the value of the currency the rest of us use are entitled
> to the particulars of that process, even if some of the information
> (just like tax info) is kept non-public...
seekingalpha.com/artic...
Thanks. Jim Wood
.
On Dec 16 03:45 AM Nothing from nothing wrote:
> Your argument is very similar to one I have been listening to lately
> with the exception of your political footnote.
>
> How is borrowing money to build roads fundamentally different than
> borrowing money to build houses was in the first place? According
> to your argument, the empty houses of the real estate bubble should
> have saved our sorry butts. Afterall, building them created jobs
> plus we got rows and rows of them sitting around. In a very real
> sense, we-the-people, are owning them since we now own the banks
> that own the houses that nobody lives in or takes care of.
>
> Tell me what good the roads are gonna do us if nobody has a car,
> gasoline or the means to obtain either??? Is that why Obama is supporting
> the Big-3-Bailout ya think? Or perhaps the campaign funding he received
> from their lobbyists or the UAW had something to do with influencing
> his perspective on that one?
>
> What about this idea... What if we all started to work on figuring
> out how to save money rather than spend it? What if we began promoting
> some goodwill and cooperation instead of greed and competition starting
> right here at home?
>
> If Wall Street wants to join Main Street in this endeavor, then step
> up. If not, then they should back up
>
>
>
Rebuilding roads and bridges will not restore the leveraged Financial Engineering Market (aka: "The Black Hole that is Wall Street"), but it WILL put money towards the genuinely good cause of Blue Collar EARNED income. And since there are Blue Collar workers in EVERY AREA that are in need of BOTH the employment AND the roads AND the bridges... it is therefore not a waste of time nor money. Our roads and bridges are FALLING DOWN, remember?.
However, we would be much better off, and the money would be much better spent, if we concentrated on Mass Transit efforts, such as MODERN railroads and Bus routes.
The entire lifestyle of ''Suburban Sprawl'' and ''Happy Motoring'' is DOOMED. It will not rebound. It will now forever be relegated as a burden on society and an unsustainable drain on our resources. That entire way of life is doomed to the dustbin of history.
I have always known (since the late 70's and the 1980's "answer" that was Reagan), that the Boomer Retirement via Wall Street was the biggest Ponzi Scheme of all.
Lastly, although I did not vote for Obama, I would not call him clueless or ''lacking''. HOWEVER, he IS ''owned'' and if you want to know who his ''handlers'' are, take a close look at the Clinton era appointees he is FILLING his cabinet with.
Clinton was a ''Sellout Centirst'' who gave us NAFTA, which was a huge part of the dismantling of American Manufacturing. But as I've already pointing out, all of this crap (i.e. ''the FAKE Economy'') began with Reagan. People are too busy worshiping Reagan and UN-regulated so-called ''Free Markets'', to realize where to place the blame.
The blame goes back 30 years; (and then some). And it rests on the shoulders of both our leaders in government, and the Boomer Sellouts who traded their ideals for a McMansion and a 401k Ponzi Scheme.
THIS IS NOT FIXABLE. The sooner we realize and EMBRACE that reality, the sooner we can wipe the slate clean and start over; (because that is what it will take).