Witnessing History 11 comments
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There have been many who have suggested that FAS 157 (or 159) is to blame for the current crisis. Sorry, but that doesn’t fly. The trouble does not stem from the accounting, but from the rotten investments. High-quality liquid investments do not have problems getting priced for reporting purposes. If you can’t get a liquid price, there is a reason for that. Prices in illiquid markets jump around — that is a rule.
AIG (AIG) might survive if banks that face a lot of counterparty exposure decide to lend to them to minimize their own losses. At this point, it looks unlikely, but it is possible that banks that would have large credit exposures to AIG would make a loan to AIG. One other note, the $20 billion loan from their subsidiaries appears to be contingent on AIG getting significant help from other sources of financing. No link, but from Bloomberg — “AIG hadn’t gotten access to the New York lifeline as of about 10:30 a.m., said David Neustadt, a spokesman for state Insurance Superintendent Eric Dinallo. “It would be part of a broader deal,” Neustadt said. “If there’s no broader deal, then it doesn’t happen.” The regulators didn’t say yesterday that access to the cash would require such conditions.“
So what does the FOMC do today? My guess is that they loosen 25 basis points, or do something that gives an expectation of expanding the monetary base. I suggested that this might have to happen last month, when I saw credit stress continuing to build in the banking system.
That said, the FOMC could stand pat, and offer to take in lower grade collateral via tri-party repos in order to help keep marginal instituions afloatt, while leaving the monetary base flat. That’s been their default policy for the past year, and it may have delayed some of the credit stress, but it has not solved the basic problem of too much bad lending. Not that the FOMC can solve it without buying all the bad debt, and extinguishing it in a burst of inflation.
We ask too much of the Fed in bad times, and in good times, we don’t ask them to restrain the banks as much as we ought. The problems we face today stem from the monetary and banking laxity from the mid-90s to 2007. There’s a lot of bad debt out there, and no easy way to change it. We are witnessing history now, as leverage collapses in big complex institutions, and in small places too (home mortgages), and we realize that even the government is too small to deal with the problems that they let grow for over a decade, and we didn’t care while the good times rolled on. At present, the main open question is whether the defaults are big enough to trigger another wave of defaults. As for that question, I don’t know the answer, but will try to gauge the risks as time moves on.
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This article has 11 comments:
Focusing on the problems and not the solution can be a deadly mistake...unless the monetary aggrigate M1 starts rising were in the deep you know what. We need a concerted effort to get the job picture going...fiscal policy to get money in the hands of the public and an energy policy that will provide cheap energy so we can have surplus funds for our structured institutions such as government and education and the many social programs we fund. IN OTHER WORDS TO SOLVE OUR PROBLEMS WE NEED JOBS AND CHEAP ENERGY!!!!!! Marvin the Maven
Deadbeats signed mortgages and didn't pay them. No gun to their heads, they were just deadbeats and gamblers hoping real estate prices would grow to the sky. The fly by nights that wrote the debt - New Century for example - couldn't pay when their clients didn't, and went bust. That didn't allocate the loss. The mortgage investor speculators and funds that owned all the SIVs and borrowed on commercial paper were next in line. They didn't take the loss. Instead they dithered as their financing was pulled, then drew on their bank credit lines, then defaulted.
Everyone is talking today as though the big banks personally decided to own all this dodgy paper. They didn't. It came flooding back to them as the collateral after three successive layers of counterparties all welshed. The financial guarantee firms were then also on the hook for much of it, but more than their capital. Regulators took them out of the game to prevent outright defaults.
That is how Citi and Merrill and Bear and Lehman wound up with all this stuff. They weren't originally the owners of it, they were the sellers. The owners handed it back to them when they couldn't pay their debts.
The total loss is ballooning the entire time. It is not a fixed quantity. The earlier in the chain people accept their commercial and moral responsibility and take the hit, eat the loss, the smaller the total is, as well. The failing is that the whole system did not provide any way or any incentive for things to resolve in that fashion. Instead we got 2 years of dithering as all the original risk takers failed, and left lenders 3-4 levels below them holding the bag.
Citi wrote stand by lines of credit, not drawn on at all, for hedge funds financed by commercial paper. That was their "reckless lending". Merrill entered vanilla swaps with Lehman Brothers, an A rated major Wall Street credit, before any of it had happened.
Others backed into their share in it trying to solve the problem. Wachovia saved Golden West and is now in the critical ward for it. Bank of America is now out of ammunition, but has saved $1.4 trillion in assets for creditors, and done it at prices that were more than fair. Morgan drove a harder bargain with Bear but was the only bidder that day, and agreed to revise it upward, and made all the creditors whole at considerable risk to itself.
These were dramatically *responsible* actions, not reckless ones. A number of them were done at the behest of regulators and they were certainly in line with their wishes. That wasn't and isn't reckless lending.
The issue is fundamentally to limit the scale of the loss overall. Instead men are scrambling in the game of allocating it, as though the hit can be avoided entirely if they will only welsh and squirm enough. This includes the public and politicians squirming away from reckless criticism, which we have had in spades, at least as much as we've had reckless lending. And certainly a lot more of it, more recently.
A few politicians have put partisanship aside and acted technocratically to fix things. But the urge to play politics and spin and blame games with all of it has not been resisted nearly enough.
The allocation avoidance game is incredibly destructive. It is not simply a matter of it revealing losses here or there, it is multiplying their scale by an order of magnitude. Fundamentally useful organizations are being destroyed, capital misallocated to get it out of the way, trust is evaporating, and commercial immorality (straight unwillingness to pay one's debts) is plumming new depths.
There is blame enough to go around and it solves nothing. Any rational economist can see that the point must be to allocate the loss, to get it behind us so men can stop acting out of fear of who it will fall on, and instead and focus on repairing the damage already incurred. This is *why* we have a political system, and why it is in charge of the financial one, not the other way around. Sometimes the common good demands collective action that the market on its own cannot or will not bring about.
There needs to be dramatically less criticism of other parties and dramatically more willingness to step up and take responsibility, and blame if necessary, and to bear losses. Everyone should assume right now that anyone calling for destruction of others to save themselves, is worthless and useless in this situation, and should discount them as mindless children.
Adults need to step up and take the losses and get this over with. It is long past time to stop screeching about "bailouts". No one gets out of this intact. Everyone is going to be dinged. Face it, deal, pay the bill already, and then we move on.
When AIG
You have correctly identified the cause of our current "crisis": solvency, not liquidity --and easy-money, no-oversight Fed policies. Yet you sort of appear to be advocating for a rate cut (?), even though --by your own admission-- this cannot solve the underlying problem. In fact, too much easy-money lending was the primary CAUSE of the problem.
I agree with your basic assessment, but take some issue with the overbroad use of "we". "I" never asked the Greenspan to cut rates to 1% or to pimp option-ARMs --quite the opposite. Nor do "I" get a seat at the table where bailout money is being doled out and my family's economic future is being decided. Aside from that, a pretty decent summation of the mess "we're" in.
" On November 12, 1999, President Bill Clinton signed into law the Gramm-Leach-Bliley Act, which repealed the Glass-Steagall Act of 1933. One of the effects of the repeal was to allow commercial and investment banks to consolidate. Some economists have criticized the repeal of the Glass-Steagall Act as contributing to the 2007 subprime mortgage financial crisis.[7][8]
The repeal enabled commercial lenders such as Citigroup, the largest U.S. bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities. Citigroup played a major part in the repeal. Then called Citicorp, the company merged with Travelers Insurance company the year before using loopholes in Glass-Steagall that allowed for temporary exemptions. With lobbying led by Roger Levy, the "finance, insurance and real estate industries together are regularly the largest campaign contributors and biggest spenders on lobbying of all business sectors [in 1999]. They laid out more than $200 million for lobbying in 1998, according to the Center for Responsive Politics..." These industries succeeded in their two decades long effort to repeal the act.[9]
The banking industry had been seeking the repeal of Glass-Steagall since at least the 1980's. In 1987 the Congressional Research Service prepared a report which explored the case for preserving Glass-Steagall and the case against preserving the act.
The argument for preserving Glass-Steagall (as written in 1987):
1. Conflicts of interest characterize the granting of credit – lending – and the use of credit – investing – by the same entity, which led to abuses that originally produced the Act
2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.
3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.
4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s)."
en.wikipedia.org/wiki/......
"This is *why* we have a political system, and why it is in charge of the financial one, not the other way around. Sometimes the common good demands collective action that the market on its own cannot or will not bring about."
I have said this for a year now. I will say it again. Washington is broken. If you want to help fix it, consider running for Congress in 2012. I am working on some other projects, like RagingDebate.com and perhaps that will gain momentum, I have been told I am a pretty good media guy. Running for Congress is what I will do in 2012 and perhaps I'll win. If not, I will speak all the truth I need to and educate my district with facts and knowledge and I'll be blunt to the core. Maybe it will be like the Monty Brewster campaign in Brewster's Millions, NONE OF THE ABOVE
In between, call or see your Congressperson, talk to your Senate and vote your best bet for November. Some of the batch that created this mess are very much active in government today. Personally, which economic mental dwarf wins in November will make little to no difference. The American consumer is broke and is still largely too lazy to get off the couch so you get the government you elect.
Unfortunately, that is not accurate. In fact, it's backwards. The financial system is in charge of our political system. It's called corruption, in the form of campaign contributions and other thinly disguised bribes that keep our politicians in office.
Until we get our political system out of the grip of big money, our government will continue to serve that group.