Paulson PC on Bailout

[ExiledInIllinois]

When do I get my free gas and TV ?

 

 

See. Exhibit: Hick A

 

[DC Tom]

Cushion the blow. The whole purpose of TARP is to try and buy time for deleveraging of assets to occur. Thats why everything is down...stocks, oil, gold, a different hedge fund goes belly up weekly...this is the great unwind of leverage. This will get far worse before it gets better (to use a football analogy, we're still in the 1st half). Most folks don't understand truly how bad off we really are.

 

The real underlying problem, that started the great unwind, is the declining value of housing, the underlying asset in all of this. That unwind has sparked a whole series of other unwinds. It also shined a big spotlight on areas of the financial system that could be catastrophic...CDS.

 

The only real solution is time, price discovery and deleveraging. Thats why, IMHO, in the near-term we have deflation across all asset classes. The Fed has greased the skids to try and keep the economy moving while the great unwind happens. But, if the Fed missteps, we will have massive inflation, as all their "greasing" is put into the real economy along with regular lending practices. Look at the Fed actions toward the latter half of next year, if they are removing money from the economy (or increasing bank reserves) they are doing the right thing and should be lauded for getting us through this. If not...buckle up.

 

Even with the Fed actions, there is one bubble left...if it goes, we're all f*cked....that bubble is US Treasury securities.

 

The truly KEY point you make in that post is "great unwind". There's no quick fix to this. No economic stimulus package, no homeowner bailout, no financial sector bailout is going to change the fact that there is no single point of recovery anyone can hit and make things better. It's a process that has to be gone through. And probably a rather lengthy and painful one. "The Bailout" was never going to fix anything but the credit markets, to keep them from going all to sh-- and keep all of us from bartering cow dung for firewood all winter.

[bills_fan]

So, is the Fed just pumping in money right now to cushion the deflationary aspect of the fall in housing and everytrhing that followed? And you are saying that as we find the bottom the fed should pull the money back out or else we get hit with a massive wave of inflation?

 

 

Exactly.

[ExiledInIllinois]

The truly KEY point you make in that post is "great unwind". There's no quick fix to this. No economic stimulus package, no homeowner bailout, no financial sector bailout is going to change the fact that there is no single point of recovery anyone can hit and make things better. It's a process that has to be gone through. And probably a rather lengthy and painful one. "The Bailout" was never going to fix anything but the credit markets, to keep them from going all to sh-- and keep all of us from bartering cow dung for firewood all winter.

 

 

Exactly. All the pols (especially Obama and McCain) were doing is posturing for the public... Now just Prez. Elect Obama.

[/dev/null]

But, what happens if they give you the money and you go out and take a trip to Hawaii and buy a big screen TV?

 

 

You inject cash into the airlines for the flight, local economy during your stay, the state of Hawaii for any sales tax paid while on vacation. And that's just for the trip.

 

The TV injects cash into whoever manufactured the TV and the retailer you bought from...help Poojer out and buy from CC

[bills_fan]

What about people such as myself that were responsible with their personal finances, didn't borrow more than they could repay, and actually had the silly notion of saving a few dollars?

 

Do we get $100k, or just the unselfish patriotic feeling of paying for our fellow citizens

 

 

Thats why it could never happen as a "Trickle Up" bailout. The incentive to live responsibly would be permanently destroyed and within 5 years it would happen again, this time at 4xs the cost.

[DC Tom]

Thats why it could never happen as a "Trickle Up" bailout. The incentive to live responsibly would be permanently destroyed and within 5 years it would happen again, this time at 4xs the cost.

 

Of course not. Default on your mortgage to get a better, government-backed one? My wife insists we're taking advantage of that program when the time comes.

 

Even Citigroup's recent "blanket amnesty" of people in default was questionable, I thought. Citi's a slightly different situation, in that they incur significant costs in owning foreclosed property they can't sell...but still, isn't rewarding irresponsible behavior what got us in this mess to begin with?

[Jon in Pasadena]

There's an estimated 115million households in the US. Now help me on my math, but if you give $100K to each household, is that $1.15 trillion or a little more than half what we're giving out to banks and companies?

 

I get 11.5 trillion -- I think you're off by a factor of 10.

[DC Tom]

I get 11.5 trillion -- I think you're off by a factor of 10.

 

No he's not, he's just 90% leveraged [/banking industry]

[Jon in Pasadena]

No he's not, he's just 90% leveraged [/banking industry]

Still works out to $10K / household. I wouldn't turn it down. I'll need a car soon, when my soon-to-be 16 year old Saturn finally bites the dust.

[DC Tom]

Still works out to $10K / household. I wouldn't turn it down. I'll need a car soon, when my soon-to-be 16 year old Saturn finally bites the dust.

 

It was a joke.

 

Not a good one, I know. Still just a joke.

[Jon in Pasadena]

It was a joke.

 

Not a good one, I know. Still just a joke.

Thought that went without saying...I was just economizing on posts & combined chuckle & serious reply, only I forgot the chuckle part.

[Boomer860]

See. Exhibit: Hick A

 

[/dev/null]

Get your bailout here

http://www.ustreas.gov/press/releases/repo...nguidelines.pdf

[Dan]

First off, they're not "giving" them the money, they're buying assets from the bank.

 

Second, the problem the banks have isn't non-performing consumer debt as much as securities backed by consumer debt that no longer have value. The difference is subtle, but important: if a bank holds your mortgage, and you don't pay, your mortgage is a worthless non-performing asset. If a bank holds a mortgage bond backed by your mortgage (among others), and the pool of mortgages stops paying, it not only makes the bond worthless but calls in to question all the other mortgage bonds out there. In other words, in a securitized world, if you don't pay your mortgage, you can effectively make mine worthless as well.

 

That has always been the real problem: the banks are holding assets that very, very, VERY suddenly became worthless (literally, in Bear-Stearns case, overnight.) When they're holding those assets as cash reserves - which is entirely legal for market securities - and those assets become worthless, banks can fail. Or worse: banks stop lending money, because they have none to lend...which is what happened a couple months ago that prompted this bailout.

 

Paulson's change of plans, I think, is stupid. It might be illegal - I don't know if the bill Congress passed specified the $700B can ONLY be used to buy nonperforming assets; if they did, Paulson's breaking the law. But infusing cash into banks in exchange for equity builds up the banks' cash position...but doesn't solve the problem that the banks still have assets on the books they have to write down. Taking an equity stake in banks while leaving those assets on the books means not only increased risk in the banking system, but increased government exposure to that risk.

I figured it was much more complicated than my simplistic thinking. Thank you for the explanation. I'm still not sure I know what the hell you're talking about. But I trust many that are smarter than I do. For me at least, that's one of the things most unsettling about this whole mess - my complete lack of understanding. I'll endeavor to educate myself for whatever good that'll do.

 

Thanks to all for their discussion here. I really am trying to understand just how screwed we are as I'm becoming more involved in running the business I work for.

 

 

For those that have suggested that my idea of giving people money to pay off their loans was not good for a few reasons... .well, yeah I don't really think that would work, but I was trying to simplify the situation for my mind while coming at it from the other side. Because it does still concern me that we're rewarding a few large corporations that are no more responsible with their finances than the people that some have suggested why bail them out. It was suggested that people would have no incentive to pay off their mortgages and we'd back in this mess in a few years. OK. Can you explain why any of these banks and corporations will somehow decide to run their businesses properly if they know they can be bailed out? It kinda goes both ways, right.

 

 

 

Yeah... my math could easily be off a factor of 10. I'll never claim to be a mathematician. I did use a calculator, but that's a lot of zeros.

[bartshan-83]

This will get far worse before it gets better (to use a football analogy, we're still in the 1st half). Most folks don't understand truly how bad off we really are.

 

The real underlying problem, that started the great unwind, is the declining value of housing, the underlying asset in all of this. That unwind has sparked a whole series of other unwinds. It also shined a big spotlight on areas of the financial system that could be catastrophic...CDS.

 

....

 

Even with the Fed actions, there is one bubble left...if it goes, we're all f*cked....that bubble is US Treasury securities.

I know very little about this compared to you experts, but the sections of your post I quoted were the subject of a conversation I had with my father a few weeks back. We were both commenting on how quickly all this seemingly happened (visibly at least) and how people seemed so unprepared. I suggested that the housing market collapse (and eventual mortgage disaster) was, as you said, the first sign of many things to come, but it was just such a significant event in peoples' minds, that it was hard to see it as a smaller part of yet an even bigger problem. It was like a tornado before a hurricane. People couldn't take their eyes off it long enough to see that there was something bigger waiting in the wings, and more importantly, why.

 

We pondered what the next domino to fall might be...I didn't consider US Treasury securities.

[DC Tom]

I figured it was much more complicated than my simplistic thinking. Thank you for the explanation. I'm still not sure I know what the hell you're talking about. But I trust many that are smarter than I do. For me at least, that's one of the things most unsettling about this whole mess - my complete lack of understanding. I'll endeavor to educate myself for whatever good that'll do.

 

Let's try this analogy. I have five hundred bucks. You need to borrow a hundred bucks. So I give you my hundred, and you give me an IOU for $110 (10% interest). Four other people (let's say...Steely Dan, EII, GG, and Alaska Darin) do the same - borrow a hundred, and give me an IOU's.

 

Now I have a bunch of IOUs with a face value of $550, but no cash. I can't really spend the IOUs. So I go to someone else - let's say SDS - and say "I'll sell you these IOU's for $525, you'll get $550 back when they pay." SDS buys them, I make a quick $25 bucks, and I've got another five hundred more to lend out to five more people.

 

Now I do that same thing about a hundred times. I've made $2500, and I've loaned fifty thousand of other people's money by selling them the IOUs. In turn, there's a hundred groups of five IOUs floating around out there. That's a very simple example of the mortgage bond industry: lenders package and sell their loans to people for cash. Lenders get more cash to lend. The people who buy the loans get the loan payments.

 

NOW...let's say you can't pay the money. You don't have the $110. Neither does GG. That group of IOUs that should have paid $550 might now only pay $330. SDS looks at his IOUs and says "Well, hell, GG and Dan are deadbeats, I wonder if the other three will pay?" And suddenly he discovers he has no way of knowing. He thought he knew, but it turns out he doesn't know if Steely Dan, Darin, or EII will ever pay up. So for all SDS knows, all his IOUs are completely worthless.

 

As it turns out, I sold another group of five IOUs to Nervous Guy - from Wacka, Molson, /dev/null, Coli, and Lori. The first four are going to pay up, they have every intention of paying up, they're not going to skip out on their debts. Lori...well, when she's not clinging to her guns and religion, she's a good egg, so she most likely will too. So Nervous Guy's IOUs are pretty likely worth something.

 

Nervous Guy, however, needs some cash quick (Nervous Boy needs a new XBox, or Nervous Squirrel is loose in the house and he needs to hire a Nervous Exterminator). So instead of holding his IOUs until they pay, he thinks "I'll sell them to someone else." He approaches AiO. AiO looks at SDS's situation and says to Nervous Guy "No way I'm buying that. How do I know they'll ever pay up on their IOUs. Did you see what happened to SDS?"

 

And with that, we go from GG and Dan's IOUs being worthless, to everyone's being worthless. That is basically how the credit markets came to a near-grinding halt two months ago. That's also why Bear-Stearns saw forty billion in cash evaporate literally overnight ("Whadda ya mean, there's no market for this? THERE WAS YESTERDAY!!!")

 

Now, having seen everything come to a grinding halt, Chef Jim steps up. He's filthy stinking rich, and unlike Nervous Guy, he can hold IOUs for a while, until people pay. So he says "I'll tell you what...anyone who needs cash, I'll buy your groups of IOUs off you for...fifty cents on the dollar." SDS jumps at the chance, because he'd rather have a known $250 than an unknown future payment that might be zero. Nervous Guy thinks it over...and sells, because he really needs cash now (Nervous Boy and Nervous Squirrel both are real pains in the ass). THAT is basically the original $700B bailout plan.

 

Obviously, it's a lot more complex than this (when they're mortgages and not IOUs, and they can be sliced-and-diced into a bunch of different derivatives, and banks have cash reserve requirements that SDS and NG don't have). But if you understand the above, you have the basics.

 

Thanks to all for their discussion here. I really am trying to understand just how screwed we are as I'm becoming more involved in running the business I work for.

 

Try to get a business line-of-credit. Go to the bank, see what you can get. It might be better now, but a month ago you stood a good chance of being laughed out the door, because no one was lending, because no one had any cash to lend.

 

For those that have suggested that my idea of giving people money to pay off their loans was not good for a few reasons... .well, yeah I don't really think that would work, but I was trying to simplify the situation for my mind while coming at it from the other side. Because it does still concern me that we're rewarding a few large corporations that are no more responsible with their finances than the people that some have suggested why bail them out. It was suggested that people would have no incentive to pay off their mortgages and we'd back in this mess in a few years. OK. Can you explain why any of these banks and corporations will somehow decide to run their businesses properly if they know they can be bailed out? It kinda goes both ways, right.

 

Part of the problem with that logic is that the finances are so complex that people just assume any corporate trouble must be due to malfeasance. Sometimes it is (WaMu was a poorly run bank that deserved to implode; at work - Ginnie Mae - when the news hit, the reaction was "Well, it's about time." Ditto Countrywide - no company deserves to stay in business that has a business model of lending to people with a history of not paying back loans. Citigroup probably deserves to go next, since not only were they poorly managed before, but they're now compounding it with their "Can't pay your loan? We forgive you, just pay what you can" plan.) Sometimes it isn't - Bear-Stearns didn't just "misplace" forty billion in cash overnight.

 

And really, buying these assets at fire-sale rates isn't much of a "reward" to the companies, is it? In my above example, if Chef Jim shells out $500 to buy a thousand dollars in IOUs from NG and SDS, when said IOUs stand a likely chance of paying back $880...how are NG and SDS being "rewarded"? The banks are still likely to take a severe and prolonged hit. The government's bailout really isn't much of a bailout - it's more like a lifeguard throwing a drowning man a life vest and telling him to rescue himself.

[Dan]

Let's try this analogy.

...

Excellent analogy! and just simple enough for a non math-lovin, econophobe like me to grasp. Like you said, it's certainly more complicated, but that's about the best "summation" of the problem I've seen. Hell of a fine mess we've gotten ourselves into here. It'll be something to see if and how they dig out.

[bartshan-83]

Tom, that was an excellent, easy to understand analogy. That was a very impressive post in many ways.

 

Actually, it reminded me of a PowerPoint slide show a friend emailed me last winter about the sub-prime mortgage lending fiasco. It's funny to look back on it now and see where that path took us. Nevertheless, it is the best explanation of that whole mess I've ever seen put into a funny, layman's terms cartoon.

 

We need slide shows like this for all future financial meltdowns:

 

Sub-Primers