New Geography

Author: Susanne Trimbath

  • Mortgage-Backed Securities: 1/3 not backed!

    On April 3, 2009, R. Glen Ayers spoke at the American Bankruptcy Institute in Washington, D.C. Mr. Ayers is a former bankruptcy judge, now with the law firm Langley & Banack in San Antonio, Texas. He spoke on a subject I covered here on March 4 – not all mortgage backed securities are actually backed by mortgages. The rush to write more mortgages and to issue more bonds meant that mistakes were made in the paperwork.

    The Ayers speech is connected to an article he wrote with Judge Samuel L. Bufford, who had the California case I mentioned last month where the mortgage note disappeared after being transferred to Freddie Mac. In the article, “Where’s the Note, Who’s the Holder”, they drop this bombshell: “A lawyer sophisticated in this area has speculated to one of the authors that perhaps a third of the notes ‘securitized’ have been lost or destroyed.” Meaning that 1/3 of the mortgage-backed securities are not backed by mortgages!

    This is the junk that Treasury Secretary Geithner wants to finance the hedge funds to purchase. As of the end of 2008, there was $6,838.7 billion worth of government-backed mortgage bonds outstanding. An additional $178 billion were issued in the first two months of 2009.

    Scary stuff. No wonder the hedge funds are giving Geithner’s Public-Private Investment Partnership “two thumbs-down.”

  • Catching on to Buffett

    More of the so-called “mainstream press,” like the Sacramento Bee, are catching up to what we wrote here about Warren Buffett back on March 16. He supported the bailout because his investments benefited from the handouts.

    It seems obvious that Washington takes policy advice from Buffett because he has lots of money. Newsweek reporter Mark Hirsch uncovered evidence, in fact, that Buffett may have been the one that came up with the original proposal for Treasury to buy the junk bonds off the banks’ balance sheets. Given the direction that Berkshire Hathaway’s own credit rating is going, Buffett may have even more reason to support this plan – his companies will be able to invest in the junk at discounted prices after they sell the junk to the government’s partnership funds at inflated prices!

    Some of the comments at Newsweek.com believe that the article is unfair to Buffett – after all, what company doesn’t support policies that will benefit them? But to the tune of $11.6 trillion, which is what the U.S. government has committed to this bailout? We bet even Karl Marx would find that excessive. We agree with the title of a book by William Black, an economist whose work we referred to in our own research on the Savings & Loan crisis – “The Best Way to Rob a Bank is to Own One.” Professor Black discussed the financial crisis with Bill Moyers on April 3, 2009.

    Berkshire Hathaway has significant ownership stakes in more than one bank. This brings us to an article at the Mises Institute, the libertarian think-tank. The article contains a link to an article from 1948 written by Warren’s dad when he was the U.S. Congressman from Nebraska – “Human Freedom Rests on Gold Redeemable Money.” The younger Buffett has a preference for the freshly printed stuff that Treasury is doling out.

  • The Rogue Treasury

    The U.S. Treasury took enormous powers for itself last fall by telling Congress they would use it to “ensure the economic well-being of Americans.” Six months after passage of the Emergency Economic Stabilization Act of 2008 Americans are worse off. Since it was signed into law on October 3, 2008, here are the changes in a few measures of our economic well-being:

     

    Before TARP

    So Far

    National Unemployment

    7%

    8%

        Lowest state unemployment

    3.3% (WY)

    3.9% (WY)

        Highest state unemployment

    9.3% (MI)

    12% (MI)

    National Foreclosure rate (per 5,000 homes)

    11

    11

        Lowest state foreclosure rate

    < 1 in 7 states

    < 1 in 6 states

        Highest state foreclosure rate        

    68 (NV)

    71 (NV)

    Dow Jones Industrial Average

    10,325

    7,762

    “Before TARP” figures are as close to October 3, 2008 as possible; “So Far” figures are most recent available, which varies by category from February through April. Unemployment and foreclosure rates by state are available at Stateline.org

    The Troubled Asset Relief Program (TARP) was sold to Congress and the American public as an absolute necessity to save the American Dream of homeownership. Once the legislation was passed and the funds were released, however, Treasury decided to give the money to banks with no restrictions on its use – no monitoring, no reporting requirements, no nothing. We are worse off today than we were when the legislation was signed – and are likely to remain so when TARP has its first year birthday later this year.

    Yet, the U.S. government has already paid out $2.9 trillion, with further commitments to raise the total to over $7 trillion – a number that Senator Max Baucus (D-MT) said “is mind-boggling, indeed it is surreal. It’s like having a second government.” The money Treasury is passing out is more than all government spending in 2008. The Senate Finance Committee, of which Baucus is chair, held a hearing on March 31 (TARP Oversight: A Six Month Update). The three parties established as monitors in the 2008 legislation were there to testify. Without exception they “are deeply troubled by the direction in which Treasury has gone.”

    Senator Chuck Grassley (R-IA) suggested [referring to former-Secretary Paulson] that Congress “was awed by a person who comes off of Wall Street, making tens of millions of dollars. … You think he knows all the answers and when it’s all said and done you realize he didn’t know anything more about it than you did.”

    As soon as Treasury got the money they decided to bailout big banks instead of helping homeowners with mortgages bigger than the market value of their homes. Since then, Paulson, Geithner, and Bernanke have refused to comply with demands to produce documents about the TARP recipients’ use of funds.

    Neil Barofsky, Special Inspector General and the one monitor with authority to pursue criminal investigations, directly solicited information from the recipients of TARP funds – all over Treasury’s objections that it couldn’t be done. Barofsky received responses from all 532 recipients. He will be summarizing the findings, but so far knows that some banks used TARP funds to pay off their own debt (including at least one bank that used TARP funds to pay off a loan to another bank that also received TARP funds); some banks made loans they couldn’t otherwise have done. Some banks monitored the funds separately from their other assets; some co-mingled the money with no effort to separate, monitor or control what they did with the TARP bailout money.

    Elizabeth Warren, Chair of the Congressional Oversight Panel, brought up the central issue: once Treasury decided not to bailout homeowners, what was the plan? “What is the strategy that Treasury is pursuing?” she asked. “We have asked this question over and over, with the notion that without a clearly articulated plan and methods to measure progress to goals, we cannot have good oversight.” Warren is still waiting for an answer. She also added that there is no bank in this country that would lend with a policy of “take the money and do what you want with it” – which is exactly what Treasury has done.

    Senator Debbie Stabenow (D-MI) put it bluntly: auto manufacturers get reorganization (through bankruptcy) while banks get subsidization. One side is being held accountable for their past bad decisions and the other side has a total lack of accountability. Her bottom line: “If we don’t make things in this country, we won’t have an economy.”

    Warren laid some of the blame with Congress, who “gave treasury significant discretion” but is unable to get real-time explanations for what is being done with the bailout money. There is no transparency when it comes to Treasury. “Without it, I’m afraid …. Congress and the American people have been cut out of the conversation”, she says. One group in Michigan is being asked to bear enormous pain and another group in New York is not – that’s the way Stabenow sees it and Warren agreed. The alternative offered by Warren is that either Congress manages to “get Treasury to get some religion and put standards in place” or Congress has to step in with new legislation.

    Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

  • Geithner’s Toxic Recycling Plan Nixed by Big Fund

    The success of Treasury Secretary Geithner’s Public-Private Investment Partnership Program depends on getting private investors interested in buying junk bonds off the banks’ balance sheets. Now it seems that at least one hedge fund is giving the plan “two thumbs-down.”

    The New York Post is reporting that Bridgewater Associates, one of the few that might qualify for Treasury’s program, decided that “the numbers just don’t add up.” Besides being a bad investment, the fund’s founder raised questions about conflicts of interest – something we find surprising. Hedge fund managers are supposed to be those free-wheeling, unregulated, we’ll-buy-anything investors – always willing to take a risk and suffer the consequences of the market outcomes.

    Bridgewater’s concern is that Geithner’s junk bond plan includes hiring asset managers – who will also be investors. There are clear conflicts of interest because these managers will “have both the government and the investors to please and because they will get their fees regardless of how these investments turn out,” wrote Bridgewater founder Ray Dalio. Imagine, a hedge fund worried about collusion among asset managers? Maybe it takes one to know one?

    The real question is why Geithner would set up a program putting US taxpayer money in the hands of unregulated hedge funds and then go to Europe a few days later and blame the global financial crisis (at least in part) on hedge funds and their lack of regulation? Dalio is right: it just doesn’t add up.

  • Geithner’s Reforms: More Power to the Center May Appeal to Europeans, But Won’t Work for U.S.

    There will be much talk in London about global financial regulation, particularly from the Europeans. But don’t count on it ever coming into existence.

    At a House Financial Services Committee on March 26 Treasury Secretary Geithner testified that this particular subject “will be at the center of the agenda at the upcoming Leaders’ Summit of the G-20 in London on April 2.”

    Secretary Geithner presented a 61 page proposal dealing with financial companies that pose systemic risk. Let me paraphrase the main points:

    1. Create a Uni-regulator – This idea has been around a while; it won’t hurt. We tried to do this in the U.S. during the last round of sweeping financial reforms but couldn’t make it happen, primarily due to protectionist politics among the existing regulators (SEC, FRB, Treasury, FDIC, etc.). The UK and others have done it. It didn’t prevent the financial crisis from reaching them. Still, it wouldn’t hurt to have at least one adult in charge of the financial markets when things get messy.
    2. Make companies hold more cash to back up their riskier investments – The banks already have strict national and international capital requirements. It didn’t prevent them from needing a bailout, but the big banks are still standing while the rest of the financial companies are gone. This is probably a good idea.
    3. Set size limits on unregistered fund managers – I don’t think there should be any size limits: if you provide financial services you should register. Don’t plumbers have to be licensed? Why not bankers?
    4. Figure out how to regulate derivatives – We’ve known for a long time that this was a problem. If they haven’t figured it out by now, it’s unlikely they’ll get it right; the proposal is short on details. Geithner’s plan is to bring derivatives into the same centralized system now used for stocks and bonds – consolidating the risk rather than dispersing it – definitely a bad idea. The existing U.S. centralized system has, as of December 31, 2007, only $4.9 billion to back up $5.8 billion in off-balance-sheet obligations.
    5. Have the SEC set requirements for money market fund risk management – I’m not sure why on earth anyone would want the SEC to assume this responsibility. The SEC has failed miserably at protecting investors from basic short selling schemes and even more blatant schemes like Madoff’s Ponzi. Risk management at financial institutions should be the job of the central bank – that means the Federal Reserve, not the SEC.
    6. Let the government nationalize “too big to fail” companies – They just did this with AIG. In essence, the proposed legislation would codify and make permanent authority for the government to lather, rinse and repeat. Government ownership of financial institutions inevitably leads to inefficiency and worse.

    We’ve tried creating “revolutionary” financial laws before: the Depository Institutions Deregulation and Monetary Control Act of 1980 set the stage for the Savings and Loan Crisis; the Financial Services Modernization Act of 1999 helped get us where we are now. Better laws come about in “evolutionary” ways. It starts with a generally accepted good business practice, which all market participants follow. Eventually, one or more participants find a way to advance their position by cheating, by not following that good practice. When they get caught, new laws are created to codify the original “good business practice” and some punishment is put in place for those who don’t. What was once considered just a good way to conduct business now becomes a legal business requirement.

    Geithner’s proposed legislation is law by revolution – an attempt to toss aside all previous practices. The legislation was drafted at Davis, Polk & Wardwell, the New York lawyers for the Federal Reserve Bank and advisors to Fed and Treasury on AIG, not the kind of experience I’d want on my resume this year. There is an embedded comment on page four in the pdf-document: “Can Congress write a federal statute trumping a State Constitution?” I’m not sure what frightens me more: that they want to take power away from the states or that they don’t know if they can get away with it! Now is the time to give more authority to the states, not less. By their own admission, federal authorities have proven themselves incapable of protecting investors: Treasury Secretary Geithner told the House, “our system failed in basic fundamental ways.”

    Worse yet is the idea of proposing a global financial regulator, which will be high on the agenda at the G-20 Leaders’ Summit. Designing one regulatory framework for financial services to serve the capital markets in every country is akin to looking for people in every country to “cheat” the same way. Capital markets can work anywhere in the world, but the social and cultural foundations of the system that supports these markets may be quite different. The laws and regulations will need to be quite different, too. When it comes to developing the financial institutions that provide the infrastructure for robust capital markets, there is no “one size fits all”.

    “Stable financial markets through reform” has been the theme of innumerable conferences, conventions and meetings of the leaders and finance ministers of country groups from G8 to the United Nations. Two decades of experience with the “Washington Consensus” tells us that global regulation will not work any better than concentrating all power in Washington.

    Here’s the primary problem with trying to design one set of financial reforms that will serve many nations: Financial services are global not multi-national. Most other products and services sold around the world are multinational, but not global. For example, salt is a multinational product. The salt sold in Cairo is basically the same product as salt sold in Paris or London. Perhaps the label contains the word “salt” in a different language; maybe the Danes use more salt than the Swedes and the Japanese combine it with sugar. But a package of salt contains the same product and is used for the same purpose – one product, used the same way in many nations.

    Financial services are different. A share of stock in Paris has different rights, a different meaning, than a share of stock issued in Buenos Aries. Bondholders play a prominent role in restructuring companies in bankruptcy in the US; in France, debtors are protected from bondholders completely. Yet anyone anywhere can buy a share of a French company or the bond of a US company – many products, used for different investments in one world. For reasons like this, there is no one solution for regulating the banks, brokers and stock exchanges in every country.

    Economists have known for a long time that global financial regulation – or even ”sweeping” national changes – won’t work. Perhaps the lesson from the current financial crisis will be that national regulation must be supplemented with more oversight in the States. Given Geithner’s plan and his penchant for ever more consolidation of authority over financial services, it’s unlikely we’ll get the chance to find out.

    Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

  • Burnin’ Down the House! Part Two: Wall Street has a Weenie Roast With Your 401k

    Last week I wrote about the first part of my talk to the Bellevue Kiwanis Club on why our economy is in the position it is today. It is a story about good intentioned policies – like modifying credit scoring for Americans working in a cash-economy – that were bastardized in the execution – like some Americans using modified credit scoring to lie about their income. Just like there were superstar firms among the original “junk bond” companies, there were also firms like Enron and WorldCom.

    In the first part of my story: banks wrote mortgages, their broker-arms sold them to the public in the form of bonds, they paid fees to Standard & Poor’s and Moody’s to get triple-A credit ratings, and they devised crazy default protection schemes which they also sold in the public capital markets. On top of all that, they screwed up the paper work so there was no relationship between houses and the ultimate financial paper that could be used to cover potential losses.

    That’s when Wall Street staged a weenie-roast over the blazing fire of your 401k plan. They were making so much money in fees and trading profits that they decided to extend the scheme to car loans, credit card debt, and anything else they could package and sell off in capital markets around the world. When new money stopped flowing in and when the value of the underlying assets began the decline, the whole mess came falling down over their – and our – heads.

    In case after case, there are more derivatives than their underlying assets. Here’s an example of just how absurd this is: The market value of Bank of America (BofA) is $32 billion; the contracts that payoff if BofA fails are worth $119 billion. This isn’t rocket science math. It’s worth a lot more to someone to see BofA fail than it is to see them succeed. Here’s a table of some of financial companies and home builders, alongside some countries, to give you an idea of what the potential cost would be of letting them collapse – because the derivatives would have to be paid off if they collapsed. Where the market value of a company’s publicly-traded shares (or the outstanding public debt of a nation) is greater than the derivatives outstanding (a negative number in the difference column), the “market” is probably betting in favor of the company.

    Entity

    Derivatives outstanding

    Market Value or Public debt

    Difference

    BANK OF AMERICA CORPORATION

    118,689,745,334

    31,558,840,000

    87,130,905,334

    GMAC LLC

    83,556,419,908

    4,690,000

    83,551,729,908

    MORGAN STANLEY

    84,271,180,804

    24,186,940,000

    60,084,240,804

    DEUTSCHE BANK AKTIENGESELLSCHAFT

    71,011,177,628

    18,510,000,000

    52,501,177,628

    CITIGROUP INC.

    61,875,137,002

    12,760,000,000

    49,115,137,002

    AMERICAN INTERNATIONAL GROUP (AIG)

    47,393,950,401

    2,230,000,000

    45,163,950,401

    GENERAL MOTORS CORPORATION

    43,373,996,836

    1,540,000,000

    41,833,996,836

    CENTEX CORPORATION

    41,027,349,092

    856,760,000

    40,170,589,092

    LENNAR CORPORATION

    40,426,782,677

    1,260,000,000

    39,166,782,677

    AMBAC ASSURANCE CORPORATION

    36,835,358,941

    189,580,000

    36,645,778,941

    PULTE HOMES, INC.

    38,364,111,999

    2,460,000,000

    35,904,111,999

    FORD MOTOR COMPANY

    39,618,004,718

    5,030,000,000

    34,588,004,718

    THE GOLDMAN SACHS GROUP, INC.

    80,849,691,288

    46,624,340,000

    34,225,351,288

    BARCLAYS BANK PLC

    44,579,007,183

    11,160,000,000

    33,419,007,183

    WHIRLPOOL CORPORATION

    32,665,900,751

    1,850,000,000

    30,815,900,751

    CBS CORPORATION

    32,484,932,800

    2,600,000,000

    29,884,932,800

    SOUTHWEST AIRLINES CO.

    33,766,673,423

    4,090,000,000

    29,676,673,423

    TOLL BROTHERS, INC.

    27,532,256,817

    2,590,000,000

    24,942,256,817

    SPRINT NEXTEL CORPORATION

    33,852,494,934

    10,230,000,000

    23,622,494,934

    AUTOZONE, INC.

    31,489,303,582

    8,700,000,000

    22,789,303,582

    D.R. HORTON, INC.

    19,889,587,401

    2,540,000,000

    17,349,587,401

    ALCOA INC.

    20,554,123,223

    4,620,000,000

    15,934,123,223

    AMERICAN EXPRESS COMPANY

    28,098,626,953

    13,970,000,000

    14,128,626,953

    K. HOVNANIAN ENTERPRISES, INC.

    9,458,710,459

    70,220,000

    9,388,490,459

    AETNA INC.

    15,056,041,259

    9,720,000,000

    5,336,041,259

    TIME WARNER INC.

    33,530,285,093

    29,240,000,000

    4,290,285,093

    WELLS FARGO & COMPANY

    47,902,948,043

    58,060,000,000

    -10,157,051,957

    JPMORGAN CHASE &CO.

    61,250,536,812

    86,770,000,000

    -25,519,463,188

    RUSSIAN FEDERATION

    102,631,256,656

    151,000,000,000

    -48,368,743,344

    ABBOTT LABORATORIES

    5,273,779,532

    68,720,000,000

    -63,446,220,468

    REPUBLIC OF TURKEY

    169,668,377,905

    243,747,000,000

    -74,078,622,095

    REPUBLIC OF ITALY

    157,609,796,730

    248,773,000,000

    -91,163,203,270

    BERKSHIRE HATHAWAY INC.

    18,409,990,929

    126,860,000,000

    -108,450,009,071

    UNITED MEXICAN STATES

    76,677,172,011

    320,334,000,000

    -243,656,827,989

    FEDERATIVE REPUBLIC OF BRAZIL

    113,249,393,554

    814,000,000,000

    -700,750,606,446

    Derivatives outstanding is data made available by the Depository Trust and Clearing Corporation for publicly traded credit default contracts. Market value is for public companies generally in early March 2009; public debt is for countries generally from year-end 2008. Difference is author’s calculation. The average derivatives outstanding for entities with positive differences are 22 times the value of the entity (excluding GMAC as an outlier with a multiplier of 17,816).

    In other words, you could buy all the shares of Lennar for $1.2 billion. However, if they go bankrupt, the payoff will be $40 billion for the holders of the derivative contracts. And at this point, we – the US taxpayers – are in the position of paying off on these contracts if the banks and other “too big” companies fail. This table also tells you that the “markets” think that Bank of America is significantly more likely to fail than, say, Brazil – which is probably true, if for no other reason than the fact that Brazil has an army and Bank of America doesn’t!

    The bottom line is that the government has to continue to bailout these banks and large companies because many of them, including AIG which is now owned about 80% by us, are the same entities that will have to pay off the bets if the other companies fail. There’s really no way out of it now. I remain opposed to the bailouts – they create “moral hazard,” the scenario whereby it is more profitable to fail than to succeed. But: I understand why they are being done and why we have to keep doing it.

    The reason is: it matters to our 401k plans, the pension plans of teachers and firefighters, the retirement benefits of loyal, hard-working Americans. You see, the debt of insurance companies and other triple-A rated credits (AIG had a good credit rating less than 12 months ago) are required investments for money market funds, pension plans, etc. Take a look at the prospectus for any of these investments if you have them and you’ll see what I mean. It is necessary for such funds to make triple-A investments because the funds need to be able to make payments and honor withdrawals, sometimes on short notice. That means they have to hold some very safe, very easily sold investments. Investments like those issued by AIG.

    If the mutual funds holding your 401k and the pension fund supporting the school teachers and all that go broke – well, no one wants to imagine what that America would look like. Despite all the bad economic news, few Americans have run out in the streets in protest and even those who did didn’t vandalize any property, public or private. Nor did we take our CEOs hostage. In fact, I think a little civil unrest may be called for: print this story, wrap it around a hotdog, mail it to the New York Stock Exchange and tell them to enjoy their weenie-roast!

    Here’s why: the time is coming very soon when Wall Street will need us again. Uncle Sam is doling out the bailout money to the financial institutions, but even now they are devising ways to get ordinary investors to come back to the markets – and to use our own money to do it.

    Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

  • Junk By Any Other Name Would Smell

    The Treasury this week disclosed details of their plan to pump $1 trillion into the financial system by removing “Legacy Assets” from the balance sheets of banks. Wading through the multitude of documents and documents, I’m reminded of a remark by Michael Milken in a conversation with Charlie Rose on October 27, 2008 “Complexity is not innovation.”

    Since its inception, the plan has been sold to Congress and the media as one with potential positive payoffs for the public coffers. To support this idea, proponents point to the experience of the Resolution Trust Company (RTC) in resolving the Savings and Loan (S&L) Crisis. Back then, RTC took over failing S&Ls – some of which were bankrupted by bad real estate loans made worse when they were forced to sell off below-investment grade bond assets – the by-now-well-known Junk Bonds.

    Selling off today’s junk bonds will, I agree, clean up the balance sheets of the banks and make them more attractive to investors and depositors. But the investment in junk bonds now is not going to turn out like the investment in junk bonds then. For starters, the value of the junk bonds then declined as a result of the forced sell-off – Congress prohibited S&Ls from holding junk bonds on their balance sheets. When this supply was dumped on the market, the prices naturally dropped. Selling assets at depressed prices damaged a lot of S&Ls. RTC stepped in near the bottom of those prices to take control of the assets. When credit markets returned to normal, the prices of the junk bonds rose and the investments had positive returns.

    Then, junk bonds paid extraordinary rates of return – 10 percentage points above Treasuries at the peak. At that time, a 30-year U.S. Treasury bond could be paying more than 18% interest.

    Now, we are talking about junk bonds that we all know are junk – no matter fancy labels like “Legacy.” What rate of return could there be on a mortgage bond – no matter how you “slice-and-dice” it – created when mortgage interest rates were 5-6%? Add to that our knowledge of the problems underlying these assets and it is increasingly unlikely that there will be any positive payoff for taxpayers in this plan.

    On March 25, 2009, Mirek Topolanek, President of the European Union, called the U.S. economic plan “the way to hell.” His concern is that we’ll have to finance these trillion dollar bailouts with borrowing and that will ultimately further undermine global financial markets. He’s right, of course. The public-private partnerships will finance the purchase of the “Legacy Assets” by issuing debt. That debt will be guaranteed by the Federal Deposit Insurance Corporation (FDIC), the same agency that guarantees our savings accounts at the local bank. Our guarantee is backed by the payment of insurance premiums to FDIC. The guarantee on the debt used to purchase Legacy Assets will be secured by the Legacy Assets – which will be rated by the same credit rating agencies that gave us triple-A rated subprime mortgage bonds in the first place. How can this possibly turn out well? I’m sure Treasury, Federal Reserve and FDIC have good intentions, but as EU President Topolanek says, they may all end up as pavement on “the way to hell.” As NYTimes columnist Paul Krugman said of the new plan, “What an awful mess.”

  • Geithner is Wall Street’s Lapdog

    Treasury Secretary Tim Geithner is on the cover of the April 2009 issue of Bloomberg Markets magazine. In the lead article, “Man in the Middle,” the authors refer to his time at the New York Federal Reserve Bank (FRB) as “experience as a consensus builder.” This overlooks the fact that it was easy for him to get everyone to agree, to build group solidarity, when he simply gave the banks and broker-dealers everything they wanted.

    The Primary Dealers, those broker-dealers and banks who have a special arrangement with the FRB for trading in treasury securities, agreed when Geithner let them fail to deliver $2.5 trillion of treasury securities for seven weeks in the fall; they agreed when he let them fail to deliver more than $1 trillion two years earlier; they agreed when he let them fail to deliver treasury securities even after Geithner’s own economists told him it was dangerous. By the way, last year the New York FRB’s public information department prevented those economists from speaking on the record about that research with a Bloomberg reporter.

    Now, at a hearing on March 24, 2009 before the House Financial Services Committee, Secretary Geithner and Federal Reserve Chairman Ben Bernanke lectured us on the awesome responsibilities of Treasury and Federal Reserve in the current crisis – without admitting that they had those same responsibilities while the crisis was being created.

    In a joint statement from the Department of the Treasury and the Federal Reserve they offer no explanation for their failure to fulfill their “central role … in preventing and managing financial crises.” Rather, they use the fact of that role to require that we accept whatever plan they put before us today as the best and wisest course. To convince us that their plan is the right one, they can all point to the fact that the stock markets rallied (gaining nearly 7% across the board) led by the shares of financial institutions (Goldman Sachs’ shares went from $97.48 on Friday night to $111.93 on Monday – a gain of about 15%).

    I criticized the “Public Private Partnership” when it was announced in February 2009. Calling Wall Street’s bad investments “Legacy Assets” doesn’t change the fact that they are “junk.” They could call it “the hair of the dog” because they now want to invest taxpayer money into the same junk investments that started the financial snow ball rolling in the first place.

    Just because the stock market rallied doesn’t make this “consensus building” – I call it being Wall Street’s lapdog.

  • Layout for the Bailout: $3.8 Trillion and Counting

    Bloomberg.com reporters Mark Pittman and Bob Ivry are reporting a running total of the money the U.S. government has pledged and spent for bailouts and economic stimulus payments. The total disbursed through February 24, 2009 stands at $3.8 trillion; the total commitment is $11.6 trillion. The Federal Reserve is providing the largest share at $7.6 billion, followed by the U.S. Treasury $2.2 trillion and FDIC $1.6 trillion. The Department of Housing and Urban Development (HUD) and support for Fannie Mae and Freddie Mac, combined with purchases of student loans – bailout money that comes closest to directly bailing out Main Street – total only $760 billion – less than 7 percent of the total.

    The national debt currently stands at $10.8 trillion — versus an authorized limit of $12.1 trillion.

    Last week, U.S. Treasury Secretary Timothy Geithner got into a tiff with the rest of the world (denied by President Obama) by telling them that they should spend at least 2 percent of their GDP on their own stimulus packages.

    The U.S. commitment of $11.6 trillion equals 81 percent of U.S. 2008 gross domestic product (GDP). The $787 billion fiscal stimulus is 5.4 percent of GDP. Just the two-thirds of the stimulus that represents new spending (one-third is tax cuts) is 3.6 percent of GDP. Here’s what financial institutions in various countries got from U.S. taxpayers by way of the AIG bailout:

    Country

    Bailout Benefit

    US

     $   31.1

    France

     $   19.1

    German

     $   16.7

    UK

     $   12.8

    Switzerland

     $     5.4

    Netherlands

     $     2.3

    Canada

     $     1.1

    Spain

     $     0.3

    Denmark

     $     0.2

    Italy

     $     0.2

    Serbia

     $     0.2

  • Story of the Financial Crisis: Burnin’ Down the House with Good Intentions and Lots of Greed

    Last week, the Chairman of the Federal Reserve, Ben Bernanke, told Congress that he didn’t know what to do about the economy and the repeated need for bailouts. This week, the Oracle of Omaha Warren Buffett, Chairman of Berkshire-Hathaway told the press that he couldn’t understand the financial statements of the banks getting the bailout money.

    This made it a daunting challenge the other day, when the Program Director for the Bellevue (Nebraska) Kiwanis Club asked me to talk to his group about the current state of the economy. Despite the many often outrageous examples of excessive greed and even criminality, the current debacle began with good intentions: provide opportunities for homeownership to a segment of the population that was historically left out.

    New credit rating systems had to be developed to take into consideration the fact that some immigrant groups prefer to live in extended families (multiple generations in one household). The individual income of any one may not qualify for a loan, but they would all be paying the mortgage. Yet, their family patterns meant assets are only held by the male head of household. That’s just one example, and there are many more. It’s just that banks and others came to realize that the existing systems were excluding people who would actually be very good borrowers. The original “subprime” borrowers were like the original “junk bond” companies – they didn’t fit the mold of a model credit customer. But among them were MCI and Turner Broadcasting – plus Enron and Worldcom, of course.

    Like junk bonds, the new mortgage product came to be abused by borrowers and lenders alike. This was made worse by developments that blurred the line between banks and brokers. Both parties participated in actions that allowed banks to have their in-house brokers sell off their mortgage loans to Wall Street in the form of bonds. This is called “originate and distribute”. The same bank wrote the mortgages, packaged the loans for sale and distributed the bonds to their clients – collecting fees at every stage.

    And here’s where greed entered the picture. The demand for these bonds completely outstripped the supply: senior management put pressure on the troops to write more mortgages and sell more bonds. The fees were pouring in from everywhere. The demand was so great that an average of 40% of the trades failed for lack of delivery – broker-dealers were selling more bonds than were issued. Each bond trade, whether or not there was a failure to deliver, resulted in a commission for the buying and selling broker-dealers. They didn’t have to tell the buyers that there was no delivery – the broker-dealers figured they could fix it later. This was the initial breakdown in regulatory oversight.

    The next one came when no one was watching over the credit rating agencies. According to a story on PBS (originally aired November 21, 2008), managers at Standard & Poor’s credit rating agency were pressured to give the bonds triple-A ratings in the pursuit of ever higher fees. (We’ve yet to learn all the details of the potential collusion between banks, brokers, rating agencies, etc., but more news is coming out all the time – stay tuned!)

    Along the way, it became clear that these investments in mortgage bonds were, in fact, risky – despite their triple-A credit ratings. That’s where the credit default swaps came in – credit default swaps (or CDS) are simply contracts akin to insurance policies. The bond holder pays a small premium up-front and they get all their money back if the bond goes into default which could happen, for example, if the homeowner owing the mortgage in the mortgage bond ends up in foreclosure. This was another idea with good intentions – it made the bonds more popular and sent more money back to the bank for more mortgages.

    The way the theory on structured securities was developed, if a bank can sell the mortgages they can use that cash to write more mortgages and so support local communities that need to expand housing opportunities. It should also disperse the risk, spread it around, so that some economic problem in one town, like a factory closing, won’t cause the local bank to go out of business. Losses on local mortgages would be spread out geographically, spread out over a large number of investors and over different types of investors (individuals, companies, pension plans, etc.) so that no one of them should suffer all the damage.

    Greed enters the picture again: instead of the CDS derivatives being sold only to the people who owned the bonds and only in a quantity equal to the value of the bonds that were issued, an unlimited number of swaps were sold. This is as if you have a $1 million home and someone sold you $20 million worth of insurance. The temptation to burn down the house was just too much. What you see now is arson. They are burning down “the house” to collect on the insurance. Except if it were your typical insurance it would be regulated and you would have to have “an insurable interest” in hand to buy the policy at all. This insures that there would be no more derivatives issued than there are assets. No, these CDS derivative contracts are completely unregulated and unmonitored.

    Sadly there were no video surveillance cameras in place when Wall Street was spreading around the gasoline and striking the match. Yet now we are stuck watching the house – and the economy – burn down.

    Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.