Farewell, Sheila Bair, and thank you (and FU Paulson, Bernanke & Geithner)

Excellent interview here in the Times with this most decent of bureaucrats. She understood why the bailouts were not just wrong but unnecessary:

As she thinks back on it, Bair views her disagreements with her fellow regulators as a kind of high-stakes philosophical debate about the role of bondholders. Her perspective is that bondholders should take losses when an institution fails. When the F.D.I.C. shuts down a failing bank, the unsecured bondholders always absorb some of the losses. That is the essence of market discipline: if shareholders and bondholders know they are on the hook, they are far more likely to keep a close watch on management’s risk-taking.

During the crisis, however, Treasury and the Fed were adamant about protecting debt holders, fearing that if they had to absorb losses, the markets would be destabilized and a bad situation would get even worse. “What was it James Carville used to say?” Bair said. “ ‘When I die I want to come back as the bond market.’ ”

“Why did we do the bailouts?” she went on. “It was all about the bondholders,” she said. “They did not want to impose losses on bondholders, and we did. We kept saying: ‘There is no insurance premium on bondholders,’ you know? For the little guy on Main Street who has bank deposits, we charge the banks a premium for that, and it gets passed on to the customer. We don’t have the same thing for bondholders. They’re supposed to take losses.” (Treasury’s response is that spooking the bond markets would have made the crisis much worse and that ultimately taxpayers have made out extremely well as a consequence of the government’s actions during the crisis.)

She had a second problem with the way the government went about saving the system. It acted as if no one were at fault — that it was all just an unfortunate matter of “a system come undone,” as she put it.

“I hate that,” she said. “Because it doesn’t impose accountability where it should be. A.I.G. was badly managed. Lehman Brothers and Bear Stearns were badly managed. And not everyone was as badly managed as they were.”

Paulson, Bernanke and Geithner come across as callous SOBs when it comes to taxpayer funds, whose only concerns are for their friends in banking.

This next bit I do not agree with:

Grudgingly, Bair acknowledged that some of the bailouts were necessary. There was no way, under prevailing law, to wind down the systemically important bank-holding companies that were at risk of failing. The same was true of a nonbank like A.I.G., which the government wound up bailing out just two days after allowing Lehman Brothers to fail. An A.I.G. bankruptcy would have been disastrous, damaging money-market funds, rendering giant banks insolvent and wreaking panic and chaos. Its credit-default swaps could have brought down much of the Western banking system.

“Yes, that was necessary,” Bair said. “But they certainly could have been less generous. I’ve always wondered why none of A.I.G.’s counterparties didn’t have to take any haircuts. There’s no reason in the world why those swap counterparties couldn’t have taken a 10 percent haircut. There could have at least been a little pain for them.” (All of A.I.G.’s counterparties received 100 cents on the dollar after the government pumped billions into A.I.G. There was a huge outcry when it was revealed that Goldman Sachs received more than $12 billion as a counterparty to A.I.G. swaps.)

Bair continued: “They didn’t even engage in conversation about that. You know, Wall Street barely missed a beat with their bonuses.”

“Isn’t that ridiculous?” she said.

Yes, there would have been additional pain and panic had there been no bailouts at all, but we would also have cleared the banking system of bad debt and well into a real recovery by now, instead of this jobless GDP/QE faux recovery. When banks fail en masse, it’s not the end of the world – assets just move from weak to more competent hands. There were plenty of strong banks that were gyped of well-deserved deposits that should have fled crappy behemoths. The pre-Fed, pre-FDIC era saw the fastest growth and improvement in living standards of modern history because of this creative destruction, so it is a sign of the times that the most conservative, taxpayer-freindly politician or bureacrat with any significant power (unlike Ron Paul) is still in favor of bailouts.

Here’s a bit from a post I made in October 2008, when this was all going down:

What will happen if government doesn’t lift a finger?

The owners of McMansions will lose them to the banks or other mortgage holders, and those mortgage holders, if they bought the paper with loans of their own, will lose them to others, and so on. Almost every bank in the world will fail. They have all come to depend on deposit insurance and central banks to cover for the fact that they have been reckless and insolvent from nearly day one. There will be no bank lending at all.

What will happen to the depositors? Well, almost all of their money will be lost.

So, that is what we are looking at: every bank failing, zero bank lending, almost all the money in the world going to heaven. How is that not the end of the world? Simple: It is a reverse split. In 2006, let’s say, there was a million dollars in total bank deposits. Then in 2008 all the banks go under. All that is left is the cold cash in people’s pockets, let’s say $100,000 in all.

That remaining cash becomes extremely valuable. It has to work where one million did before. If you had $10 in your pocket and $90 in the bank, you now treat each dollar as if it were ten. The key is that so does everyone else. The world still has its unit of account and medium of exchange, we have just moved the decimal point over on all prices. (Note: gold and silver would rapidly re-enter circulation and quickly become the preferred money, as they always do until government outlaws them).

Of course, deflation on this scale makes debts unpayable, so essentially all debt is defaulted upon, but of course most creditors are bankrupt too. Contracts have to be renegotiated or annulled. No big deal, really. The assets are all still there, just the same as before. Nothing has burned down. A car bought on credit still gets the same mileage as before its loan went bad, a house keeps you just as dry.

Trust the prudent and smart, not bankers and politicians.

Such an event brings about a massive transfer of wealth from the reckless to the prudent and farsighted, who are exactly the people you want making the decisions about what to do with money and assets after the crash. They are statistically and philosophically the best equipped to decide what will generate the highest returns with the lowest risk. Life goes on. There is nothing to rebuild because nothing was destroyed. It is all just reordered in a more sensible fashion. The house in the desert is scrapped for materials. The Lehman mortgage traders find something productive to do, like drive cabs.

But that outcome is so quaint, so 1800s, so gold standard. We’re more scientific today. Bernanke is a wise economist. Congress is benevolent. War is peace, and lies are truth.

Key 2007 email sums up the mortgage situation. It’s not from Goldman.

Forget the middlemen – the real criminals are those who betray their oaths of office.

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Via the Motley Fool, here is an email from someone inside John Paulson’s hedge fund:

It is true that the market is not pricing the subprime RMBS [residential mortgage-backed securities] wipeout scenario. In my opinion this situation is due to the fact that rating agencies, CDO managers and underwriters have all the incentives to keep the game going, while ‘real money’ investors have neither the analytical tools nor the institutional framework to take action before the losses that one could anticipate based [on] the ‘news’ available everywhere are actually realized.

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This guy was on the right track. Incentives are everything when you’re looking for explanations. The only things this guy left out were the role of government and the fact that managers did have the tools (google, for one) to figure out that there was a housing bubble.
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Government provided low-interest credit through Fannie and Freddie, which passed off much of the risk here to the taxpayer through their implied (later realized) guarantee. There was also the tremendous moral hazard of “too-big-to-fail,” which was always just a cover story to justify whatever taxpayer theivery the banks wanted to undertake. FDIC is also another massive risk-transfer scheme that encourages reckless lending by both bankers and depositors.
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Also key is the fact that the incompetent rating agencies, Moody’s, S&P and Fitch, only got that way after the government made them a cartel and removed market forces from their industry. If all rating agencies were paid by investors (rather than issuers) and had to compete on the basis of their performance, like Egan Jones, they would actually do some analysis.
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Goldman is a scapegoat. In the final analysis, they may be untrustworthy (who didn’t know that anyway), but they are just middlemen, and they didn’t force anyone to buy their bonds. They didn’t create the demand for junk credit — interest rates and spreads were very low during the bubble years, and huge institutional buyers with very highly paid managers simply failed to do their job of understanding what they were buying. Without their demand for junk mortgages, there could be no giant bubble. In the case of public pension funds like Calpers, this demand was partly the result of unrealistic promises made to unions which required very high annualized rates of return.
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For anyone who had read any economic history, the situation was plain as day (houses were selling for record multiples of incomes and rent, prices were way above trendline, credit was ridiculously easy, and speculation was rampant). If I saw it as a 20-something kid using google, how could the big shots miss it? The reasons are similar those in any mania, with heavy doses of moral hazard, group-think and extreme optimism. It’s all clear in retrospect, but back then only the weirdos, historians and Austrians were removed enough from the zeitgeist to see it.
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If you want to single out firms and individuals for retribution, look at those who betrayed their oaths of public service during the bubble and the Heist of ’08: Tim Geithner, Hank Paulson, Ben Bernanke, Alan Greenspan, Chris Dodd, Barnie Frank, Nancy Pelosi, Chris Cox, etc. Forget the middlemen – these are the real criminals, the people who lie into cameras for a living and deploy force against the citizenry (as a taxpayer you are forced under threat of imprisonment to absorb the losses on bad mortgages you neither bought nor created).
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The bankers can buy this power, but only because it’s for sale. Bankers don’t even have to violate the law to lock savers into their paper money cartel and pass off risks to the taxpayer — their lackeys have fixed it all for them.

Summer school

There are still a lot of people out there who didn’t absorb last year’s course on the credit cycle, particularly the chapter on inflation and deflation. To remedy this gap in your elementary economic education, before buying resource stocks or saying that any market will go to the moon on Fed-powered rockets, you are required to read this refresher by Mish Shedlock. An except is below:

…there are practical as well as real constraints on what the Fed can and will do. Nearly everyone ignores those constraints in their analysis.

Congress in theory and practice can give away money. Indeed, Congress even does that to a certain extent. Extensions to unemployment insurance, increases in food stamps, and cash for clunkers are prime examples.

However, those are a drop in the bucket compared to the total amount of credit that is blowing up. Take a look at the charts in Fiat World Mathematical Model if you need proof.

The key point is it is the difference between Fed printing and the destruction of credit that matters! As long as credit marked to market blows up faster than handouts and monetary printing increase we will be in deflation. Deflation will not last forever, but it can last a lot longer than most think.

Also ponder this missive from the dean of Deflation U, Robert Prechter:

“The Fed’s balance sheet ballooned from $900 billion just five months ago to more than $2 trillion, by buying outright, or swapping the pristine credit of U.S. Treasury debt for the questionable paper held by troubled banks, brokerages and insurance companies. One of the marketplace’s most strongly held beliefs is that the U.S. dollar is on the verge of an imminent collapse and gold is set to soar because of the Fed’s historic and irresponsible balance sheet expansion… We agree about the irresponsible part, but not about the near-term direction of the dollar and gold. Our forecast is being borne out by the dollar, which has soared straight through the Fed’s most aggressive expansion to date. Just as Conquer the Crash forecasted, the Fed is fighting deflation but, as the book says, ‘Deflation will win, at least initially.’ The reason is that there are way more debt dollars than cash dollars, with about $52 trillion currently in total market credit. As this enormous mountain of debt implodes, it is swamping all efforts to inflate. Of course, the Fed has explicitly stated that it will keep trying. Its initial effort was akin to trying to fill Lake Superior with a garden hose. But $2 trillion still won’t do the trick of stemming a contracting pool of $52 trillion. The only real effect is that taxpayers get hosed. Obviously not all of the $52 trillion is compromised debt, but the collateral underlying this mammoth pool of IOUs is decreasing in value, placing downward pricing pressure on the value of related debt, which won’t show up in the Federal Reserve figures for many months. A reduction in the aggregate value of dollar-denominated debt is deflation, which is now occurring. Eventually the value of credit will contract to a point where it can be sustained by new production. At that point, the U.S. dollar may indeed collapse, as gold soars under the weight of the Fed’s bailout machinations. But deflation must run its course first. In our opinion, it has a long way to go…”

Also consider an oldie from yours truly  (Some Basic Points on Inflation and Deflation):

#1 The business cycle is the credit cycle.

#2 Inflation is a net increase in money and credit, not just prices (mainstream opinion) and not just money (common misconception among contrarians).

#3 Deflation is a net decrease in money and credit.

#4 There cannot be both inflation and deflation at once.

#5 The central bank and the government bring about inflation by absolving banks of the responsibility for their actions. 9:1 fractional reserve lending would not be rewarded in a free market devoid of FDIC insurance and a central bank to print the money to pay for it and other bailouts for bankers.

#6 Price increases themselves are not inflation. If you have a fixed expense budget and your grocery and energy bill goes from $500 to $700, you must cut back $200 somewhere else (for instance, many are deciding to forgo eating out).

For points 7-11, click here

Also see, Why Bailouts will Not Stop the Depression

Will the commercial paper facility work? Just google “pushing on a string.”

You can’t (shouldn’t) fight gravity.

The damage to the economy was done in the boom. The bust is simply the market’s way of taking account of what was wasted. This process cannot be stopped, but it can be twisted from something healthy into something perverse, and Bernanke and Paulson are wringing the guts out of what is left of the US economy. What is even more perverse is that everyone except the Austrian School, who saw this coming (Rogers, Prechter, Mish, Schiff, Tice, Faber, Grant, Bonner, and Ron Paul, take a bow), keep crying out “More! Harder!”

Nobody who is worthy of debt wants a loan in this environment. Where can you invest the money to generate a positive return? The commercial paper market will continue to shrink as corporations scale down with layoffs and asset sales. The Fed can’t print up a renewed appetite for debt and risk.

“To believe, to obey, to combat”

So how will we eventually reflate? Government will spend the money into circulation, not lend it, as it takes over enormous sections of the economy, more on the scale of Mussolini’s programs than FDR’s. What little wealth and savings are left will be taxed and inflated away to support the Great Common Effort, until the Effort and War have hollowed out the nation unto utter collapse.

Poor America. It is clamoring for change, and as Mencken put it: “Democracy is the theory that the common people know what they want, and deserve to get it good and hard.”

Lehman reportedly to declare bankruptcy. US futures down 3% Sunday night.

According to The New York Times Dealbook blog, the word is that nobody wanted the entirety of this gangrenous carcass without a complete Federal Reserve guarantee a la Bear Stearns, so the healthy parts are being carved off, while the Fed graciously trades some of its remaining assets for the fetid pieces:

Lehman Brothers will file for bankruptcy protection on Sunday night, in the largest failure of an investment bank since the collapse of Drexel Burnham Lambert 18 years ago.

Lehman will seek to place its parent company, Lehman Brothers Holdings, into bankruptcy protection, while its subsidiaries will remain solvent while the firm liquidates its holdings, these people said. A consortium of banks will provide a financial backstop to help provide an orderly winding down of the 158-year-old investment bank. And the Federal Reserve has agreed to accept lower-quality assets in return for loans from the government. …

How many billions of its remaining $400 billion in Treasuries is the Fed going to lose in this deal?

Lehman’s broker-deal subsidiaries would not be a part of the bankruptcy filing. Those entities must file under Chapter 7 rules, which are the procedures for liquidation, under the assumption that it is the best way to protect customers. The Securities Investor Protection Corporation would handle the liquidation of such brokerages, and bankruptcy lawyers say that customers are likely to receive their holdings back.

Boy, if I were a Lehman brokerage client, I would hate to have to wait for the bureaucrats at SIPC to get me my securities back. And what about clients with margin accounts? Will they be wiped out?

… Moreover, changes to the bankruptcy code mean that counterparties to Lehman’s credit-default swaps can seize their collateral at any time, posing an enormous potential risk to the entire financial markets. Investment banks, hedge funds and other financial players labored throughout Sunday to offset their exposure to Lehman, moving their contracts to other firms.

As of 7:30 PM in New York, traders are anticipating a nasty open Monday morning. With a Fed meeting Tuesday and options expiration Friday, this should make for an interesting week.

 

 

 

 

 

Wanna bet the Fed bails out Lehman’s creditors?

There is no way any rational buyer will take over Lehman without someone else taking the risks of holding their bad assets. With a market cap of just $2.6 billion, Lehman’s share price is not the issue. An honest valuation of Lehman’s assets would surely result in a massively negative equity figure.

The company is clearly insolvent, since it showed over $40 billion in Level III assets, $200 billion in Level II assets and $640 billion in total assets, levered on top of just $26 billion in equity. Merill’s recent sale of mortgage assets to Lonestar at 5.5 cents on the dollar gives you an idea for the true value of some huge portion of this stuff. Even writedowns of just 11% on the Level II and III assets would wipe out Lehman, without even considering the true value of the rest of its assets in this lousy environment.

Look for a Bear Stearns style giveaway of the core brokerage, advisory and money management operations to some big bank, while the Fed covers the losses on the riskiest assets. Since JP Morgan already got a handout, maybe Goldman or Bank of America is at the front of the line for these scraps.

Greenspan, Poole and Paulson have all chimed in saying that the Fed shouldn’t finance any sale of Lehman, but that is a smokescrean, because the sale itself isn’t the issue. Any Fed assistance will be to back up Lehman’s debt so that someone is willing to buy the stock ‘with their own money.’

Since there is a lot of resentment out there from the BS and GSE bailouts, our hustlers-in-chief may use some kind of obscure arrangement whereby the taxpayer’s obligation isn’t readily apparent, but is burried in the footnotes. This would allow them to redeem themselves as champions of the free market with the help of compliant editors and producers in the propaganda outlets.