Crocodilian

Revisiting the MBS Debate (Which We Should Already Be Past)

There's a lot of interesting argument here. Let's take the "initial premise fail" -- the question of whether the large MBS positions at ML etc, indicate that they were "eating their own dog food".

My impression is that author is correct in discounting that assertion. My interpretation of the large MBS inventories carried by the firms was that it was seen as part of the "MBS manufacturing process"-- that is, you buy up mortgages, slice them into tranches and mark them up, and sell them on, and get paid your bonuses.

My guess is that the banks got stuck with "slower-moving" inventory as the price of putting these deals together. That is, they didn't carry the inventory because they _wanted_ it, they carried it because these were the parts that they were having a hard time selling.

The Top 12 Brands Likely to Disappear

A great article. When you think about it, the sooner the cull occurs, the better. Absent Borders, Barnes & Noble may make a little money --- notice that Best Buy has done OK since Circuit City gave up the ghost. Similarly, UAL desperately needs to end its sorry life, and auction off the gates, a capacity shrink in airlines is long overdue, and will lead to more pricing power for the remaining carriers.

Its the same story with Palm, Eddie Bauer, Chrysler & Saturn-- they all represent excess capacity which, once taken out of the system, will allow the survivors to operate more profitably.

AIG Bonuses: The Tipping Point Toward Decisive Action?

On Mar 18 08:54 AM Chris B wrote:

> 1) Where were the private shareholders?

When the stock was going up, they were making money, and didn't care. And then AIGs troubles at first seemed to involve Greenburg and accounting issues, not bonuses-- that's what shareholders were looking at.

Remember: AIG was still perceived of as a AAA credit, the "world's largest insurance company" at the beginning of 2008.

The public shareholders were wiped out before they knew much about AIG Financial Products, much less could inquire or protest compensation there.

Rethinking Subsidized Finance

"But in aggregate, has banking ever been a successful industry for capital providers?"

----------------------...

It would depend on the unit of analysis. Banking is to the economy as airlines are to aircraft construction and aviation services-- a highly levered and disastrously volatile business, which supports much better businesses and useful services which enhance the public good. You want the former to run as well as it can, accepting that its a lousy business, so that the latter can function.

Think about the names of early American banks: "Farmers", "Merchants", "Corn" . . . these all reflect the very real businesses that require a bank to operate. Until recently, financial institutions tended to evolve out of other services to meet business demand (eg early paper currency were "goldsmith's certificates" -- paper reflecting gold on deposit at a goldsmith).

What has occurred with "financial innovation" is that bankers cooked up products no one actually asked for, and then marketed them to earn fees. The story of AIG Financial Products and JP Morgan -- who cooked up the idea of using AIG's balance sheet to earn a little extra by selling CDS -- is an egregious example.

We need banking, but we need banking that serves the business needs of their customers -- not their speculative appetites,

AND . . . this is a big "AND"

does NOT introduce systemic risk by writing an "implicit put" to the taxpayer (eg "you don't have to bail us out if this blows up, so long as you don't mind cratering the system")

AIG Bailout: Initial Cynicism Justified Now More than Ever

On Feb 25 02:24 PM endoftheworld wrote:

> This government can pride itself on the greatest ever re-distribution
> of wealth - from those that win and earn to those that risk &
> lose. This exemplifies the curious foundation for American society
> - capitalism when things are good, socialism when things are bad.
> And people wonder why we're hypocrites.

You might ask the question: Who is the Government bailing out when it "bails out AIG"?

They are clearly NOT bailing out AIG itself -- AIG shareholders will end up with zero.

The people who are being bailed out are AIG's counterparties on the derivatives contracts they wrote. So if, say, John Paulson bought a CDO on some toxic MBS security, underwritten by AIG-- and that MBS has collapsed . . . its payday for John Paulson.

Would be really interesting to know who who took the other side of the derivatives book that AIG wrote: they're getting 100 cents on the dollar of what AIG wrote, paid for by you and me.

AIG Bailout: Initial Cynicism Justified Now More than Ever

On Feb 25 11:58 AM FORMERclient wrote:
> Sell it
> NOW before it becomes worthless!!!!!

It actually _is_ worthless. I'm not sure why the stock trades for anything (44 cents, giving a market cap of $1 billion) , but the government explicitly owns %80, and are going to have to come up with tens of billions to keep it from going bankrupt.

There is no one who will buy the company-- Liddy has been trying to sell bits of the company since the fall, most recently, there were no takers for their Asian insurance unit-- see the WSJ story
" Any Takers for AIG's Asian Arm?
Auction of a Crown Jewel Generates Scant Interest; More Fed Headaches" (WSJ: 2/25/09)

AIG Bailout: Initial Cynicism Justified Now More than Ever

On Feb 25 11:35 AM ecliptix543 wrote:

> Absolutely brilliant. Why create a bad bank when we already have
> the largest and worst one in world history at our doorstep?!?!?<br/&g...

My point was that the AIG derivative book, and the AIG Insurance company don't belong together. AIG Insurance company is profitable, can have a future, and its operationally, legally, and functionally distinct from the derivatives book (AIG Financial Products)

The "Bad Bank" model, as it applies to AIG, means separating the derivatives from the insurance business.

Something very much like this will happen if, as rumored, they file for bankruptcy.

AIG Bailout: Initial Cynicism Justified Now More than Ever

We need a new term for AIG at this point. "Bailout" implies that there's something that might float, if you "bailed" enough water. This doesn't apply to AIG.

AIG appears to be an (historically) attractive insurance business, to which a ruinously (criminally?) bad set of bets were attached.

The "bad bet book" dwarfs the insurance company, to the extent that the insurance company doesn't really matter; of all the cases for a "bad bank" solution, AIG is among the most compelling.

U.S. Debt Watch: Paths to Repudiation

Its worth observing that this article has lots of words, lots of opinions, but no numbers. Not a single one. That's a remarkable achievement in an essay about a subject for which lots of numbers are available, and where no meaningful discussion is held without reference to data, ever.

When I read an essay about macroeconomic issues, I expect to find relevant _data_. "House of cards" isn't data. Its an assertion. Might be true, might not be. There's no data to support it, so how would anyone know?

In a basic macroeconomics class, an answer without reference to any facts might, charitably, get you a D.

"Show your work".

Shock and Awe: Government Raises Citi Warrants' Strike Price to $20

"Disclosures: Author is long AIG, BAC, C, FNM and FRE."

Um. Gosh. No RBS?

At this point whether the common of any of these issues ever has any value is really a question of whether or not the government wants the common to have any value-- these common issues are "Tsarist Bonds" -- they look to the political winds, not financial strength, for whatever value they will have.

I don't know what an investor can do in these stocks . . . its a political speculation, and at some price its an attractive gamble, but its not for an investor.

Misunderstanding the Great Recession

Bernacke chooses his words carefully-- this essay seems to misunderstand his thoughtful modifier "proximate".

The "proximate cause" is not the same as the "root cause" -- its the "what tipped the cart over" question, and not "how did we ever load such a poorly balanced cart" question.

Essay author Hansen lists lots of factors which may have contributed to the current difficulty: its certainly reasonable to cite "failure to invest in technology", debt, and employment as factors which contribute to the severity of this crisis -- but not as a "proximate cause"

"Proximate" means the "nearest". If you fall down a flight of stairs and break your hip, the fall is the "proximate cause" of your broken hip. Your osteoporosis, and balance disorder certainly are factors-- but they're not the "proximate cause".

I think Bernancke's statement is accurate. The turn of the housing cycle and associated delinquencies is the "proximate cause" of the crisis. All of the other factors cited were present before housing turned down, but without causing a collapse-- once house prices began to decline, their impact was significant.

Secretary Paulson’s Endgame for Fannie and Freddie

"He purposely did not ask Congress for an explicit government guarantee of Fannie and Freddie debt and MBS because he did not want to lose the discipline of private sector credit evaluation."

Ummm. That's not such a convincing argument, given the feeble performance of "private sector credit evaluation".

How about this alternative explanation:
Making the guarantee explicit would have required the Government to put the guarantees on _its_ balance sheet.

As to your thesis on the GSE preferreds, we're now in the domain of "political investing", where the numbers and the business logic don't matter, and financial outcomes are decided politically.

The GSE Preferreds are thus like the old Tsarist bonds . . . you had to make a judgment about whether a Russian government would ever decide to pay them off. . . a lot of money can be made that way, but its political speculation, not investing.

What Do We Need In 2009? More Failure

"But Bailout Nation doesn't believe in failure so much anymore."

Not clear that that is a true statement. We've had lots of corporate bankruptcies, but our system has assumed system-wide leverage that was not ready for a severe stress. Add to that, the painful reality is that we don't have the systemic resources to process a major failure -- say, a GMAC or WAMU.

If you want to "make room for failure" in the system, the system architecture needs to be robust. Venture backed firms go bust all the time; but they are funded with equity, not debt, and nothing much bad happens when a startup become a shutdown. Paradoxically, we give significant tax incentives to debt (which is payable out of pre-tax income) over equity (which pays dividends out of after tax income); we should not be surprised that a whole financial industry developed to replace equity with debt. More equity and less debt would leave us more room to let things fail.

Second, financial institutions have to be designed to, as software architects say, "degrade gracefully". Institutions like the investment banks degraded catastrophically-- pull one thread, somewhere in the system, and they rapidly fail. Not only do they fail, but as we saw with Lehman Brothers, they fail in a way that threatens to force the failure of their entire web of business counterparties.

Third, there should never again be such a thing as an "implicit guarantee"; obligations need to go on the books as explicit, or stay off the books and be disclaimed. The bizarre chimera structure of the GSE's was a most pernicious contributor to a system that was ambivalent about failure.

AIG Now Fed's Vehicle for Buying Toxic Assets

thanks for this very thoughtful article. One of the great tragedies here is the opacity of the transactions, and as you note, the absence of the price discovery that an arm's length trade would have given.

You make a very subtle point in observing that ABK and MBIA's counterparties were forced to take a significant markdown because solvency was a question for the monolines; the notion that the very fact of the Fed involvement in AIG makes their negotiating position paradoxically worse-- well that's a great point, not obvious, but once understood, very important.

3 Things America Needs to Do to Get the Economy Back on Track

"Cultural changes at our banks and securities firms are required."

Its not about "culture" -- its about "structure". If they're permitted to sell risky debt, they _will_ sell risky debt. Think of hospitals. There's long been a problem of people hooking up the the wrong hose to the wrong plug-- if the Oxygen mask gets plugged into the CO2 outlet, you have a problem.

There are two approaches to the solution: training-- get everyone to recognize the deadly danger.

Or design: make sure the Oxygen tube connector doesn't fit into the CO2 port.

Solutions that affect design, which make it impossible to make mistakes, are preferable. That's what we did after the crash: created three categories of banking institutions
investment banks
commercial banks
savings banks

Each was permitted to engage in a limited range of transactions, with a limited leverage, and limited counter-parties.

There were efficiency costs to this arrangement, but "by design" it prevented the nightmare chimeras we're trying to control today.