The failed resolution

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Housing is only an excuse. Based on a rising market banks loaned everything they could.

On a declining market, there is less demand, and the value of assets declines.

The banks are complaining because they do not have money and they do not have customers.

Most of the loans are good, but banks leveraged future income, so they collect the payments, and forward them.

They made cash in advance on writing loans, not now.

They now have to tell the stockholders why there is no income, why the bank has no assets, but many obligations. Bank stock is worthless.

It is not a matter of losses, a hundred mortgages have a value even if 10% are in forclosure.

It is selling securities based on those mortgages, which have to be paid.

They ran the bank into debt, took huge bonuses, and now, they have maxed out the credit card, no more fun, and twenty years of working off the payments.

Banks are holding cash, because cash pays their pay check. Now they are looting income.

They were nothing but bad managers who managed to take the bank for everything they could.

They cannot give themselves another bonus in mortgages, they need cash!

Now they want to manage the tax payers into generations of debt.

Do not throw good money after bad, let it go, stop the losses.

There is so much hatred in Western societies towards their own banks. Like it or not, these overpaid monkeys represent you. Even though you may find them distasteful, they hold your assets in trust for you and should they fail then you will go down with them. Ask the Indonesians what it is like to experience massive banking failure. They are still trying to recover from what happened ten years ago when their financial system crashed and took with it the pride and confidence of a nation.

Your job would not be safe, prices would skyrocket as the supply chain gets disrupted, and all around you businesses would fall like dominos as insolvency pushes them into bankruptcy. When the dust clears, the good along with the bad would all have been chopped down. Nothing emerges except a wasteland full of frightened and bewildered people. It is hard for Americans and Europeans to envision such a reality but it happened in Asia ten years ago and some cities burned in mindless rage as the people were struck with violence to vent their unspeakable madness against the innocent and defenseless.

I love bankers as much as any of you would, but financial institutions, though they are often portrayed as repositories of sleaze and greed, occupy a special place in any society. The world cannot do without money and money must have it minders and a place to call home. Take away the architecture of finance and you remove the basis of modern life. If our society were to be based on goodness, trust and love, nothing would ever get done except that which violates the sanctity of man.

Zeno, I appreciate your very good description of markets and securitization, but you are wrong that we didn't "get" that piece. I totally do.

What you are missing in all this is the simple fact that people were given loans they should not have been given. That securitized package started out rotten at the core. THAT is what I know, that you do not. Imagine, when we decided to take out an equity loan a few years back, the response when it came time to set the amount:

Them: Your line is set at $250,000.
Us: We only want $50,000.
Them: You are qualified for $250,000.
Us: How? We know we could never pay that back. We are more comfortable setting it at $50,000.
Them: You are qualified for $250,000, and it will do better for your credit score if you take it, but draw less. It is in your best interest to sign at $250,000.

Imagine, a borrower I read about, whose real estate broker and mortgage broker all told him that house A was well within his means, and he should buy it. Then he got to the paper signing, and first discovered that the monthly payments were going to be higher than his take home pay. He decided to take a 3rd job, and signed to keep his wife from being disappointed.

The reality is that the people on the front lines were giving people credit that should never have been offerred, and then sold the loans in packages as viable, when they were not. No one was doing the due diligence, no one cared.

The market only works when you buy what you believe you are buying, and everyone is paying attention.

The market didn't work because greed caused people to turn a blind eye to the economic realities. As long as the housing market went up, they could get away with it; there was enough equity in the foreclosures to hide the mistakes. But it was always doomed to catch up with reality.

And I hold that I continue to have a right to be angry about it. I knew it was a ponzi scheme the minute I signed for that equity line (which, funny thing, we still have - all those people getting their lines cut or frozen, no one has cut ours, possibly because we continue to be smart enough to not actually use it much). That a lender could EVER say, "I don't care," when you tell them, TELL them, you can't afford a debt load is CRAZY.

Zeno, you seem to equate saving the banking system (which nobody in their right mind would object to) with saving the bankers (which, due to moral risk, must not be done) - to some extent this is a straw man argument in defence of the cash-for-trash bailout. The experience of Sweden shows that you can save the banking system while punishing the bankers, and likewise in Britain Northern Rock was saved by the government, and its shareholders were not (to a lesser extent the same approach was taken to AIG). The experience of Mexico shows that cash-for-trash can leave you with a dysfunctional banking system, debt resulting from the bailout that will take generations for taxpayers to finish paying, and banks that again lend recklessly (why wouldn't they, if the risk is borne by the taxpayer?). To say the choice is between saving bankers from their own mistakes and letting the banking system collapse is a false dilemma - what is needed is a punitive rescue of the banking system, not a cash-for-trash bailout of the bankers.

Cash for trash: that is a sound bite and a nice one too because it appears to so succinctly sum up what has been proposed. Like many short catchy snippets that American politics tend to revolve around, it fails to capture the truth and in many ways leads the electorate to make decisions based on misinformation. Let me offer another verbal equation that captures how I think about the problem.

If the bailout had not been passed, then cash is trash.

The industry wide abuses in the subprime lending industry are known to me, I used to serve that industry as part of a corporate finance team. This is not the first time that subprime lending has collapsed. The last time it happened was during the Asian financial crisis and the Russian ruble default that followed. Then as now numerous mortgage brokers went bust as the asset backed market seized up. But things were on a much smaller scale then and subprime lending was still considered an exotica in the high yield universe. The turning point in the subprime industry occurred after September 11th when Alan Greenspan lowered interest rates to 1%. Bear Stearns was the leader in this industry and the numerous articles I read with comments from their senior managing directors proclaiming praise for Greenspan’s decision made me want to puke. Can you imagine that some of these people were actually named as possible successors to be Chairman of the Federal Reserve? By forcing borrowing costs down to levels that were punitive, Greenspan ensured that the subprime lending industry and the high yield market in general would come back to life. Once it got started, the appetite for higher yields just never seemed to end.

The financial institutions that bought these securities did not really have a choice. Life insurers who wanted to sell annuities needed to get sufficiently high yields on their assets so that there would be a spread between their assets and liabilities. Health insurers, pension funds, endowments and so on needed to make sure that they were invested in securities that at least promised returns which exceeded the rate of inflation. Asset managers like hedge funds needed to earn an absolute return beyond their rivals if they were to survive. If someone is doing it, then everyone would have to do it. There has always been a very strong case to making sure that this market is properly regulated. But for reasons that had to do with the financial interests of certain politically well connected individuals, and I worked for some of them, regulation was never even contemplated.

Since the buyers had to buy the sellers did not care what it was they sold. Underwriting standards just collapsed as everyone rushed to write as many mortgages as they could. People who were called NINJAs (No INcome, Job or Assets) were offered no money down loans to purchase real estate that they obviously could not afford. But in a rising market, the lender could always rely on someone else to buy the house at a higher price and everyone down the line made money. There is no way for real estate prices to keep on increasing forever. Even in severely land constrained Singapore there is a ceiling never mind the United States where there is such a vastness of space. The music stopped playing when the real estate market stopped rising and went into reverse.

The worst of these toxic mortgages have obviously little or no value. A second mortgage made to a now unemployed man whose house has fallen by 50% in value is probably worth zero even in foreclosure. But a mortgage made to a man in a similar situation but who remains employed might be worth something if the loan gets termed out and the individual avoids bankruptcy and the job loss that financial embarrassment might entail. What is needed is to discover just how much value there is in these pools of toxic waste.

There are many problems with allowing the market to do the job of figuring out what these securities are worth. Unlike say the equities market, the mortgage market has always been murkily opaque. Despite its size and its importance, there is very little public information with which anyone can rely upon to make an informed decision. This is one reason why mortgage traders at investment banks have earned such handsome profits because they quite literally have an informational edge over others. In fact, if the market were allowed to work out the problem, then the very same people who created this sickening mess will also be the ones who profit from it as they are the only people who know how much these assets are truly worth. Their profit will come at the expense of the financial institutions which many people rely upon. What you are really advocating is the wholesale rape of the common man who did nothing more than to trust in a financial institution because he has no choice but to do so. The people who are most exposed to these high yielding securities are not foreigners, they are Americans. The largest foreign holder of American fixed income securities is China and they buy almost no securities beyond Treasuries and very high grade agency debt. The present crisis and the sharp increase in the price of Treasuries have probably benefited China.

Clearly it cannot simply stop at just throwing $700 billion into the septic tank. Much work will be needed to properly regulate the market and the abusers of the previous regime must be brought to justice. But without an explicit and proactive show of support by the government, markets face pulverization. With the loss of market confidence so will go a great deal of stupidity and evil. Those who oppose the bailout are right in their diagnosis of what is wrong, but gravely mistaken in their prescription of what is so urgently needed.

My assessment of what happened.

What goes up must come down.

Houses did not go up, the dollar fell, the same people with the same job were no longer making $12,000 a year, but $40,000, and their house was not the $18,500 they bought it for, but $225,000.

The stock market went from 7,000 to 14,000 and it was the same in dollars.

There is no problem fixing the value of anything in current dollars.

The problem for banks, mortgages, the stock market, is the economy is slowing, those who were saving, investing, are now withdrawing.

All of the stock managers are saying ride it out, and all of the people are withdrawing their money, and putting it in T-Bonds.

When I say sell, they have to pay me. So they have to sell what is mine, and give me cash.

Based on my stock carried in the Street Name, they made loans, they still have them, but not the asset that they were based on.

The market run up from 10,000 to 14,000 was fast, gold was $340, now around $900, so dollars are down, and with them the price of stock and housing, and real wages.

It is just a slight of hand. In 1998 dollars, the market should be 25,000, it peaked at 14,000 which shows a declining value. Now it is under 10,000 whch is about right if valued in gold.

Housing is doing the same. Besides it's gold value, it was over built, the market is glutted, the demographic is changing, and fair value is being sought.

$500,000 houses are selling for $300,000, there is a backlog of unsold, more foreclosures, which are being logged as sales, and the price keeps falling.

What is Fair Value? I think $200,000. What is fair value for stocks? A lot of companies are being exposed as having lived on rising debt and falling earnings. They have assets of $200 million, and debts of $2 Billion. What is Fair Value for their stock?

They are not only in debt for ten to twenty times earnings, their credit is being reduced, Please pay $1 Billion by the First of next month, we do not wish to continue your debt, Thank You.

On the way up they lived just making interest payments on their debt, now it is coming due.

Just slowing consumer spending would put them under, they have that and their loans being called.

Safeway, Sears, J C Penny are in that boat. Should we bail them out? They are all being pounded by the Walmart Superstores. It is what they and the malls did to Main Street years ago, and now it is being done to them.

Those who bet the price would always go up now own mortgages worth half of face. Those who bet year over year sales would always grow are going out of business after this Christmas.

States are seeing less sales tax, income tax, and the national government gets the same, plus they fund unemployment, wars, and cannot raise taxes.

It was nothing but a bubble built on debt. The government voted against the will of the people for a bailout, for they are part of the bubble. The people then voted by selling off their stocks, withdrawing their money in money market accounts, and when the 401K is worth what went in it, there are no taxs on selling it off.

I wish to close my account, sell everything and send me cash.

Our cash will pay down our debt, we will spend less, and I do expect my Social Security.

45,000,000 of us are retiring, so the largest chunk of income tax will vanish.

Our Social Security is the biggest payout in the history of government.

The government owns bad mortgages. They want to buy more.

Withdrawing our funds will cave in the banks, the stock market, and the government.

All businesses that are not solvent will fold.

We the People will have cash, buying power, and the vote.

90% of the banks will stay in business.

As the stock market drops stocks will hit a price where the assets are worth more than the money, and people will buy. Some companies have no value, time to sell them off and get them out of the market.

The final power is the power of the purse, when the people put their money.

Bailing out the banks, stock market, is voting a special tax on the people, and we are now voting by moving our money, at a loss, which can be carried forward for tax purposes.

There will be many trillions less income tax, and what can the government do, raise taxes? Print Money?

It only takes electing a minority in the House to vote no on all spending bills.

Cutting off the purse is the only way to cut government.

We The People own this country and rule ourselves.

Again, it is blatantly false that the only options were to buy junk bonds in exchange for nothing else and to let the banking system collapse, saying that is merely alarmist propaganda. That there are other alternatives is not mere theory, it has been done in practice. With the US rapidly heading towards Italian levels of fiscal irresponsibility, cutting costs is not only a matter of morality.



No, they chose to buy high-risk securities that promised high returns instead of more secure investments that offered lower yields, on the premise that the housing market would never fall.



They should have taken on fewer liabilities.



It was part of their job to consider risk as well.



No doubt true, and no doubt these are the same reasons why the political dwarfs in Washington did not even consider a punitive rescue (even though US actions on AIG were along the lines of what a punitive rescue would have looked like). Part of the public opposition to the bailout is surely due to distrust - who believes that no part of the 5% of US GDP price tag will be used to line the pockets of well-connected financiers?




If we're going to talk about morality, the bailout amounts to the Greediest Generation robbing its children to pay for its own mistakes and excesses (theft via deficits), and the fiscal policy of the last few years amounts to the Greediest Generation auctioning off its children's future to China to cut its own taxes. The 'common man' gets the vast majority of his income from wages, not from financial speculation. Thus saving the banking system but not the bankers doesn't harm the common man, while saving both the bankers and the banking system at taxpayers' expense is not the best option for the common man.




Unlike Wall St, China invested wisely. There were alternatives; Wall St just made the wrong decisions.



I agree that vigorous government intervention is required. The problem with relying only on regulation to curb these excesses is that people have short memories and soon the politicians will be rolling back regulations (as has happened before), bankers may find ways around regulations, or they may have unintended consequences. But losses for people who made bad decisions probably teach best.

It is late but I will explain why financial institutions do not really have a choice but to play the yield game. An insurer offering an annuity can be certain that their prospective customers will check out how competitive their offerings are. Type in ‘annuity’ into any search engine and a plethora of comparison shopping websites pop out. Most people are really indifferent to whether they buy their annuity from institution A or institution B as they cannot judge the financial soundness of these financial institutions anyway. What they focus on are the promised returns. And annuities being opaque structured products, they have no real idea whether or not these returns are built on sound investments or speculative ones. So long as one insurer plays the bad boy and uses its investments in high yielding securities to dangle higher returns on their annuity product, everyone would have to follow suit or else run the risk of losing all their business to irresponsible competitors. In other words, there is a beggar-thy-neighbor effect at work here.

The same is true for any other financial institution operating in the competitive market. This is one important reason why regulation is so important. By making sure that certain ground rules are in place, regulators can help prevent this reckless race to the bottom that inevitably ends in pain for almost everyone and untold riches for a very small number of undeserving hustlers and gamblers. Even though it is the financiers who make the money, it is always other people who get screwed. In the case of annuities, it is the guy who bought these products who thought that it would guarantee a decent retirement who ends up holding the bag. Once such behavior gets generalized across the financial system, you can see how damaging it can become.

But you are right, politicians will forget and the money which the financial services industry can throw at them will make it all but impossible to get the necessary laws in place regardless of who wins the elections. If there is to be any change, people must become informed and they must organize to make this a priority. In my opinion, reforming the financial system is far more urgent and important than coming up with laws to address environmental problems or going after race or gender equality issues. However, even though it is so important and despite the dramatic show that we have just watched, the people, like the politicians, too will forget. Financial sector reform is just not sexy. Only idiots like me will take on the quixotic task of trying to change the status quo that is so profitable for the privileged few who work the system.