Hussman Gets It

We have nothing to add to this, an excerpt from John Hussman's March 9 Market Comment (emphasis added in bold):

The misguided policy response from Washington has focused almost exclusively on squandering public money and burdening our children with indebtedness in order to defend the bondholders of mismanaged financial institutions (blame Paulson and Geithner –- I've got a lot of respect for our President, but he's been sold a load of garbage by banking insiders). Meanwhile, I suspect that the little tapes in Bernanke's head playing "we let the banks fail in the Great Depression" and "we let Lehman fail and look what happened" are so loud that he is making no distinction about the form of those failures. Simply letting an institution unravel is quite different from taking receivership, protecting the customers, keeping the institution intact, replacing management, properly taking the losses out of stockholder and bondholder capital, and issuing it back into private ownership at a later date. This is what it would mean for these banks to "fail." Nobody is advocating an uncontrolled unraveling of major financial institutions or permanent nationalization as if we've suddenly become Venezuela.

Make no mistake. Buying up "troubled assets" will not materially ease this crisis, nor will it even improve the capital position of financial institutions (see You Can't Rescue the Financial System if You Can't Read a Balance Sheet). Homeowners will continue to default because their payment obligations have not been restructured to any meaningful extent. We are simply protecting the bondholders of mismanaged financial institutions, even though that bondholder capital is more than sufficient to cover the losses without harm to customers. Institutions that cannot survive without continual provision of public funds should be taken into receivership, their assets should be restructured to better ensure repayment, their stockholders should be wiped out, bondholders should take a major haircut, customer assets should (and will) be fully protected, and these institutions should be re-issued to the markets when the economy stabilizes.

The course of defending the bondholders of insolvent institutions is not sustainable. Do the math. The collateral behind private market debt is being marked down by easily 20-30%. That debt represents about 3.5 times GDP. That implies collateral losses on the order of 70-100% of GDP, which itself is $14 trillion. This estimate would include not only bank mortgage losses, but also loan losses to insurance companies, pension funds and other institutions that own private debt. Unless Congress is actually willing to commit that amount of public funds to defend the bondholders of mismanaged financials so they can avoid any loss, this crisis simply cannot be addressed through bailouts. Bondholders have to take losses. Debt has to be restructured (and can be restructured in ways that largely preserve the present value of the obligations). There is no other option –- but the markets are going to suffer interminably until our leaders figure that out.

Comments

[3 degrees o...:]

This is the way I see things as well. I do not understand all the chicken littles who think the sky will fall if we cease defending the bondholders (especially with deficit spending).

Mar 20 04:08 PM

[market ace:]

This is one of the few logical articles I have read in a long time. Until Obama figures out that Wall Street (ie Geithner & Bernanke) are just feeding him a line of BS about "saving the banks" nothing good can or will happen any time soon.

Was the S&L crisis so long ago that no one in Washington can remeber how it was handled?

Mar 20 04:13 PM

[Fred Voetsch:]

"blame Paulson and Geithner –- I've got a lot of respect for our President, but he's been sold a load of garbage by banking insiders"

I would say this applies to both presidents, Bush and Obama.

Mar 20 05:23 PM

[whidbey:]

The words we want are " final demand stimulation". Little or nothing in the Stimulus Bill moved in this direction.

Final demand growth will feed consumption, and housing.

We do need banks to
a) not fail and take out their counter parties under with them, and
b) to provide utility services to the public and consumers.

Hussman does not give us the whole picture.

Mar 20 05:51 PM

[Al-USA:]

Good article.

Let the counter parties fail. That is the capitalist solution. What we have instead is socialism, but for the rich and connected. This country can not survive by privatizing profits and socializing profits. At least, not for too long, in my opinion.

Mar 20 06:57 PM

[Leftfield:]

Exactly!

There is complete simplicity and clarity to your article. It's what I believe. This country has utterly lacked solutions that go to the root of the problem for many areas. Hence, we have layers upon layers of law, regulation and bureaucracy and problems fester and metastasize.

Bondholders don't want to take a haircut and that's where the money is, so we continue a murky, dysfunctional path (bridge?) to nowhere. Whoever is influential causes that there be no solution or clarity in the public debate so they can guide us in their general direction. Problems are not solved, they are "addressed."

Other severe problems are waiting in the wings, you've heard them. Credit card, alt-A mortgages, commercial REIT and pension defaults. Obama is on the wrong path and also pushing his wish list BEFORE solving the financial crisis.

I can only hope we have enough people of common sense left who can see principle. The largest capitalists now have their hands out and we have rudderless leadership of incumbents pulling of the largest heist in history. Please, let's wake up.

Mar 21 08:27 AM

[Erich Riese...:]

It is so tedious to read comments throwing around terms such as socialism.

Protecting bondholders at the expense of the public is not socialism, it is crony capitalism. I understood it with Bush, he got rich by being given a baseball stadium in Texas built at taxpayer sales tax expense. Perhaps Obama is paying back Wall Street which so strongly supported him.


On Mar 20 06:57 PM User 270430 wrote:

> Good article.
>
> Let the counter parties fail. That is the capitalist solution. What
> we have instead is socialism, but for the rich and connected. This
> country can not survive by privatizing profits and socializing profits.
> At least, not for too long, in my opinion.
>

Mar 21 08:53 AM

[a. palmer jr.:]

Bail 'em out, don't bail 'em out, it comes down to about the same thing for most of us, we're screwed. If we do bail 'em out we pay in taxes eventually or our kids will. If we don't bail 'em out the idiots will run their companies into the ground, costing bondholders, stock holders, and other people they owe money to. Probably best to bail 'em out then put the exec's in jail.

Mar 21 10:31 AM

[Jimbo:]

I have read that Wall Street gave very much more money to Democrat candidates such as Chris Dodd and Barack Obama during the last election cycle. It looks like Wall Street knew what they were doing. Sadly, confidence in many national institutions is going into the septic tank.

Mar 21 11:45 AM

[Bjarne Jensen:]

Good article but, I believe Hussman is missing the bigger picture. And that is we simply don't have sufficient resources left to "solve' the problem. And thus, when this economic storm has passed, we will no longer hold the global economic high ground.

Can't happen here? Consider that the economic high ground has changed every 250 years for the last 750 years. The Dutch lost the economic high ground to Spain. History remembers it as the Tulip Bubble. 250 years later, Spain lost it to England and England lost it to us 250 years ago. We are in the process of losing the economic high ground to China.

Each of those economic transitions were caused by the same two conditions: The losing country had accumulated more debt than their economy could support and the losing country had such incredible hubris they were unable to see it.

I predict that in two years, we will be a third world country no longer able to save ourselves.

Mar 21 12:08 PM

[townncountry:]

I liked the comments and actually long believed that doing what Hussman suggested in his March 9 letter ("taking receivership, protecting the customers, keeping the institution intact, replacing management, properly taking the losses out of stockholder and bondholder capital, and issuing it back into private ownership at a later date") was how institutions should be unwound -- including perhaps AIG and Lehman (and Merrill, had the Treasury not convinced BoA to acquire Merrill).

As events unfolded, I'd like to know why the officials involved could not have gone the receivership route? I am aware that China and other sovereign entities and most pension funds and insurers are HUGE investors in the debts of these in the crapper and technically insolvent companies. It seems that the "rescue" of the asset base, however, is the wrong way to go about saving the bond holders. In fact, I am sure the bond holders would be more than happy to have the option to receive either: (a) 50% return of capital invested on their bonds to these troubled companies; or (b) shares or warrants in the new iteration of the received institutions, which will become effective upon repair of the received firms; or some combination of the above.

In my naive understanding of our pension and investing markets, this would be a big shock to insurance companies, pension funds and other bondholders, but the risk of poorly run companies should morally be carried by the investors in those companies, not the taxpayers and not my kids.

Mar 21 03:18 PM

[townncountry:]

Months ago, I felt that what Hussman suggested in his March 9 newsletter ("taking receivership, protecting the customers, keeping the institution intact, replacing management, properly taking the losses out of stockholder and bondholder capital, and issuing it back into private ownership at a later date") was exactly what should have been done to such firms as AIG, Lehman, and Merrill.

Why the Treasury didn't do this is beyond me. Perhaps there are legal reasons not to? Or was it fear that China and other sovereign investors in these companies would choose not to return to the capital markets as investors if they were to get burned by the collapse of the firms in whose bonds they invested so much?

I can understand the fear that losing bond investors money could have domino effect repercussions, but is that what led to the decision to buy toxic assets? Seems to my humble mind that shareholders who elected bad boards and invested in poorly run companies should bear the brunt of the fall. And that boards adn management should be replaced as quickly as possible. If there are assets at the end of the day to return to bondholders, great. What may be a better idea is to guarantee bondholders 50 cents on the dollar for their bonds, and then issue them contingent rights to invest in new shares of the reconstituted firms once they are ready to be taken out of receivership.

IMHO. Can anyone explain why this wouldn't work? Can they justify saddeling the non investing public and our kids & grand kids with the tab instead?


It just seems

Mar 21 03:28 PM

[American in...:]

I'm afraid the writer doesn't get it. However, that appears to be nothing new on this website. The issue is that the mortgage-backed securities appear to be worth more than than what the market is willing to pay for them. For example, even mortgage-backed securities whose underlying mortgages are healthy are being discounted very heavily. In other words, many mortgage-backed securities appear undervalued. That's the problem ....

Now you can argue that the market is rational and that it expects losses to emerge as variable rate mortgages reset. However, if the market was rational, then this crisis would never have occurred (it was evident many years ago that the real estate market was in a bubble and that lending standards had degenerated). So it is quite possible that this asset is undervalued due to fear ...

Second of all, you don't have time to do an orderly liquidation of these banks. Any liquidation will cause lending to fall off a cliff and turn the current recession into something much uglier. And any bank failure will wipe many of the counterparties.

No man is an island ... No bank is an island ...

Mar 21 07:47 PM

[Chris Uhlir:]

This is why I love seeking alpha. The brilliant people here who still believe that the profits afforded by the private free markets should be paid for by those who choose to take those risks. Stop the bailout madness!

Mar 22 12:21 PM