Sell Signal of the Day, Greenspan Edition 19 comments
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Alan Greenspan's calling a bottom:
Former Federal Reserve Chairman Alan Greenspan said financial markets and the economy will recover "sooner rather than later" from the worst turmoil in seven decades.
"Trust will eventually reemerge as investors dip hesitantly back into the marketplace," Greenspan said today in a speech at Georgetown University's law school in Washington. "From that point, history tells us, financial and economic revival sets in. I suspect it will be sooner rather than later."
Greenspan has always suffered from a surfeit of optimism -- that's what allowed him to cut interest rates well below Nairu. But he's never even pretended to be a market timer -- until now. Maybe he thinks he's being helpful, or constructive. He isn't.
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Somebody needs to shut him up.
One related reason that is really underemphasized is that it takes practice and experience to learn how to value new products. Sometimes it takes a few big stumbles. Because of those bad incentives, optimism usually wins over, until the lesson is learned. Same thing happened with Internet stocks in the '90s - now the market is much better at valuating them. Hopefully, the market will get a handle on CDOs as a result of this experience.
As for lack of transparency in valuation...anything but! Mark to market puts too much "transparency" on the valuations -- forcing banks to holler to the world that values are down to x% of initial value...when in fact the market is just momentarily disfunctional and *real* value should only be assigned farther into the future over the actual life of the asset.
This bailout only plays that game further into the ground -- by propping up bad mortgages, preventing foreclosures on bad mortgagees, and resetting bank balance sheets to enable further lending.
I feel half your pain--I'm raising just two.
What if the handle is broken after the $700 billion gets injected to the markets?
I don't know that $700 billion is enough money.
If the typical leverage on a mortgage backed security is 10:1, then for every $100 million outstanding there would be $1 trillion in counterparty and swap risk.
I don't know what the typical leverage is, though, Does anyone?
It's apparent that nobody in the government or Congress is thinking about the long term impacts of policy changes. It's all about "saving" things today.
Shen was the last time Congress thought several years out about anything except paying off today's spending?
Either that or he was smoking something before he gave that speech.
If I'm buying a used car from you, you might be the person best informed about its qualities, problems, and condition, but I'm still going to look up the blue book price and use that as a guide. I don't know you, and you have every incentive to overvalue that car. I know that in the end, the cash flows will bring everything to equilibrium anyway, but it seems that in this case we have a short-term liquidity problem in a highly volatile situation. And I don't want to risk my money on the fact that your guess about value is better than the market value. If it is, then why aren't you doubling up by buying up all the mortgage-backed securities you can?
And the fact is, neither Paulson nor Greenspan have any idea what the market value of those mortgages is. It'll change tremendously with inflation, interest rates, real estate prices, and the credit rating of the borrowers. Paulson is playing it safe and calling a panic, because that's the only way he'll get the resources before the end of the Bush administration to plug the short-term liquidity hole. Greenspan's probably just guessing that every psychologically-driven underinformed bull or bear market has to reach a peak of mania. And it looks like we're getting there fast.
jegan ;-)
Second, this bailout is a Ponzi scheme, make no mistake. We bail out the banks. This raises bank stock prices. That allows the banks to borrow more money against the higher priced stocks. We also buy up their toxic assets (at above market value, a market value which has been criticized as "fire sale prices," but is actually just the real, fair market value, similar to any other illiquid asset from farmers fields to antiques to collectible coins). They take the cash and (we hope) loan it out. Actually, they take the cash and invest it overseas just as fast as they can, and let the U.S. economy go down the tubes, but who's counting?
The banks have higher stock prices, so they borrow money from the greater fool (indirectly, the taxpayer) against the higher asset values. Then they loan out money by issuing new credit cards (haven't you received a boatload of offers in the past few months of our "crisis?") They hope the credit card holders will stretch themselves out into 20% interest, which is far more profitable than the few percent they would get on mortgages. So they don't write mortgages or make commercial loans (yet I thought those were the point of the bailout exercise).
Then the feds will figure this out, after a few months and a few more percent unemployment and mortgage defaults. They will demand that the banks make mortgage loans. The banks will do this, but only if each and every new mortgage under any terms will be bought by Fannie or Freddie (which is to say, by the taxpayers). So now they will make bad loans again, and sell the toxic paper to us while making a profit doing that. For a short time this will stabilize home prices, until the new mortgage holders start to go bankrupt due to the economic recession that is upon us and will get worse. However, the banks are off the hook. They will get rich. Only the taxpayers will suffer.
Some might say, "but wait, we can get an equity stake in the banks." First of all, that is not required by the law. Do you think Paulson is going to strong-arm his Wall Street colleagues, when chances are good he's going back there in January? Also, some of the banks are on the brink anyway. They'll milk the deal and pay their executives as much as they can. The law, contrary to the "summary" reports by talking heads, does not stop golden parachutes or large bonuses. It only stops their deduction as expenses above $500,000. There is a lot of wiggle room for the banks to pay big money, one way or another, then go under and have their executives walk away rich. But maybe that's why we call it a bailout, rather than an economic recovery package: because we know what it really is.
I don't think the new law will work. It doesn't provide incentives for loaning money. All it does is recapitalize the banks somewhat at taxpayer expense. It would have been far better, in my view, to just require the Fed to make loans to all banks through the discount window for mortgage refinancing and local commercial loans only and to capitalize the Fed with the $700 billion, except that we loan it to them at interest, not just give it for free. The Fed (a private, for-profit bank) might find that strange, because currently when the government wants to issue money, it borrows it from the Fed at interest. But turnabout is fair play, after all.
As far as Greenspan is concerned, I have nothing against him. Smart people can be wrong. But I think he should have stuck to music and left economics to those who were better at it.
Those in the public sector deemed to be compliciant by demonstrating bad judgement and dereliction of duty need to be replaced or hounded out of office. With the likes of Chris Dodd and Barney Frank at the forefront of fixing the problem when they are a major part of creating the problem (Freddie & Fannie) shows how partisan our political system has become. It's not for the good of the country first, "it's all about me."