OT, "bailout" alternative?

[jimcav]

so i was reading the thread on the bailout--interesting, and i was wondering what happens if the gov't does not buy the crap debt instruments/securities?

are they a huge part of all/most banks' holdings? and does FDIC cover much of that for joe-average? would there just be more mergers and acquisitions of troubled firms?

I was recently on a submarine and was asking this navy diver what he did before his current assignment--he said " I was a loan officer". He joined the navy later in life than most. Personally I wish all those involved in the debacle who are of age and able bodied would take their lumps and join up--all the services are having trouble meeting their numbers.

Personally, i've been doing some spreadsheets based upon future earnings and planned retirement, and figure i have about 3 years max to get rid of any "bad" debt (which i define as any credit card debt and any loans that have a balance of more than 75% the probable market value of the asset (car or house), or else i will have to really alter my plans for the future. reading about the current and probable future national debt and budget deficits just confounds me.

Will it just play out over the decades as it has--we will always have huge national debt and it will be okay? I look at my kids and wonder what they will be dealing with. I've lived to see American prestige and the dollar-centric position falter and am not hearing much of substance to see how it will reverse course.

[Ahneida Ride]

I believe that the argument goes like this ....

Much of the debt (speculative transactions) is derivative based ...
That is wrapped up in financial derivatives. Highly leveraged products.
Typically their pricing depends on math models which emulate a stable
market ..... If the market become "unstable" then the pricing algorithms
are not so hot. Ever hear of a Mortgage Backed Inverse Floater ?

Thus it is impossible to figure out what will happen if there is no
bail out. Thus the bail out.

Problem is that bailout will only foster even more dubious financial
transactions. Enter more government regulation. and we all know
what regulation of the dollar (since 1913) has produced. 98% loss
of it's purchasing power.

I sure wish the incredible preseve would bail me out when I make a poor decision.

[jimcav]

no--and i don't fully understand how widespread the investment in these weird instruments is--thus my question on if they are a major part of bank holdings, or just part of investment firms. I thought banks can always borrow from the federal reserve, and that individual (meaning small, average citizen) bank investments are insured, so I was not clear why we need to help investment firms out, or even banks--I imagine the market would result in consolidation and buyout of the bad banks by the solvent banks, and that individual deposits in banks would be secure regardless?
I'm sure there is more to it?

thanks
jim

[Ray]

no--and i don't fully understand how widespread the investment in these weird instruments is--thus my question on if they are a major part of bank holdings, or just part of investment firms. I thought banks can always borrow from the federal reserve, and that individual (meaning small, average citizen) bank investments are insured, so I was not clear why we need to help investment firms out, or even banks--I imagine the market would result in consolidation and buyout of the bad banks by the solvent banks, and that individual deposits in banks would be secure regardless?
I'm sure there is more to it?

thanks
jim
The panic that almost took hold last week was started by a run on a few mutual funds, as I understand it. Lots and lots of Americans have all sorts of money invested in mutual funds, or their pensions do, or their BANKS do. And lots of mutual funds include investments in lots of the bad loans that have been issued over the past X number of years. Mutual funds are not insured. If those all went south, it would take down banks and everyone else along with 'em, to grossly oversimplify the situation. The fact that the US government insures banks through the FDIC is meant to instill confidence. The FDIC does not have anywhere near enough money to cover the losses of a true meltdown. To the extent that the US government does, it only has it because of its ability to print money, as Ahneida has reminded us all on one or three occasions. If the US gummint had to print enough new money to cover THAT bet, it would be, uhhhh, ever so slightly inflationary.

Its far more complicated than this, of course, but the bottom line is that all sorts of savings and investments are tied together with the bad loans that have been issued over the last however many years. Combined with the various accounting tricks and investment "vehicles" used to spread those loans around to the point that nobody could really even keep track of them anymore, this thing had the potential (excuse me, HAS the potential) to take the whole ship down.

That's my layman's understanding of the mess, anyway.

-Ray

[ti_boi]

If we are going to bailout the credit card companies and auto loan corps, then why not just pay-off the loans for the public?

the moral hazard of just paying off a bunch of citizens bills is just as great as if we hand a private corporation a check and bail them out.

[1centaur]

If we are going to bailout the credit card companies and auto loan corps, then why not just pay-off the loans for the public?

the moral hazard of just paying off a bunch of citizens bills is just as great as if we hand a private corporation a check and bail them out.

So far we are not bailing out credit card companies; we'll have to see about auto loan companies. The moral hazard of paying off bills is much worse, because those citizens will build up bills again and expect a bail out. The organizations will not be allowed to do that (I suspect they'll figure out other bad stuff within 20 years). BTW, not handing a private corporation a check - we are buying assets and trying to maximize their value.

[ti_boi]

So far we are not bailing out credit card companies; we'll have to see about auto loan companies. The moral hazard of paying off bills is much worse, because those citizens will build up bills again and expect a bail out. The organizations will not be allowed to do that (I suspect they'll figure out other bad stuff within 20 years). BTW, not handing a private corporation a check - we are buying assets and trying to maximize their value.


My stimulus package doesn't pass muster?

OK, try this....what 'if' nothing happens...what 'if'....the bailout does not occur?

[1centaur]

To jimcav's original question:

Without the government stepping in to buy assets that nobody wants (in part because they don't have the staff to analyze them), the banks that hold these assets would have to write them down to the very low bids of those few parties willing to bid at all, or to some approximation of such. That loss of capital would make some banks insolvent, banks would fail, there would be runs on banks, lending of various sorts would dry up, investors would flee risk and we'd have a bad time while the government raised the funds to pay off depositors at the max rate of $100k per institution - one way or another a lot of savings would be wiped out and it would take quite a while to recover - my best guess. Many think it would rival the Great Depression.

With the government stepping in to buy assets at a price to be determined, the banks will preserve more capital, people will believe in the quality of the remaining balance sheets, banks won't fail in as great a number and our economy will continue to function, lend, take risks, invest, and all the things that make us strong, free and occasionally happy. Meanwhile, the losses on those houses will have to work their way through the economy one way or another. A stronger economy will mean fewer people defaulting on their loans which will mean the securities the government is buying will be worth more. There will be a spike in default rates and then a decline and tail off, allowing everybody to grow confident that the remaining value of the mortgage-backed securities is solid. As that occurs, others will be willing to pay a fair price for those securities from the government. That process will be helped by the money managers I presume the government will hire to manage and sell these securities. Those firms have the right models and analysts to understand value, and will be able to explain that value to others. Assuming we are emerging from a recession in 12-18 months, risk appetites will increase and investors will comb the government's portfolio looking for bargains.

That's the theory.

[ti_boi]

1centaur........... :beer:

[Ahneida Ride]

Banks really don't "Borrow" from the fed.

The fed is there to securitize their debt. That is create frns (fed reserve
non notes) outa thin air to "loan" to the banks when they get into problems
from the practice of fractional reserve. The fed discount window is
really a counterfeit machine. We get diluted. Prices go ballistic with the
introduction of Phony Money.

The derivative market can get quite mathematical, that is the pricing
algorithms, and who really knows if those Math algorithms are really correct.
The pricing algorithm/models are only logical under "stable" conditions.
Hence the real concern if all heck breaks loose. A real night mare is
possible. Bankrate.com allows one to estimate the health of one's
bank.

Remember Long Term Capital Management. It had the "Best" and
"Brightest" and still went under. :p

And yes ... the major bank (Citibank, JP Morgan) are heavily involved
in derivative products.

FDIC has 5 Billion in liquid funds .... 45 Billion in government assets.
small stuff. They are relying on the fed to create it's frns outa
thin air in case they run into problems.

That is the purpose of a central bank. Bail out questional financial
practices by creating "notes" outa thin air. The public will never
understand the dilution concept. And our politicians can stay clean,
cause the fed did it with fed notes and not with United States Notes.

We have not seen the last of this financial time bomb. :crap:

[Mshue]

Banks really don't "Borrow" from the fed.

The fed is there to securitize their debt. That is create frns (fed reserve
non notes) outa thin air to "loan" to the banks when they get into problems
from the practice of fractional reserve. The fed discount window is
really a counterfeit machine. We get diluted. Prices go ballistic with the
introduction of Phony Money.

The derivative market can get quite mathematical, that is the pricing
algorithms, and who really knows if those Math algorithms are really correct.
The pricing algorithm/models are only logical under "stable" conditions.
Hence the real concern if all heck breaks loose. A real night mare is
possible. Bankrate.com allows one to estimate the health of one's
bank.

Remember Long Term Capital Management. It had the "Best" and
"Brightest" and still went under. :p

And yes ... the major bank (Citibank, JP Morgan) are heavily involved
in derivative products.

FDIC has 5 Billion in liquid funds .... 45 Billion in government assets.
small stuff. They are relying on the fed to create it's frns outa
thin air in case they run into problems.

That is the purpose of a central bank. Bail out questional financial
practices by creating "notes" outa thin air. The public will never
understand the dilution concept. And our politicians can stay clean,
cause the fed did it with fed notes and not with United States Notes.

We have not seen the last of this financial time bomb. :crap:

All right, we know what your diagnosis is - what do you prescribe at this point? Not trying to be provocative - it's a serious question.

[rounder]

To jimcav's original question:

Without the government stepping in to buy assets that nobody wants (in part because they don't have the staff to analyze them), the banks that hold these assets would have to write them down to the very low bids of those few parties willing to bid at all, or to some approximation of such. That loss of capital would make some banks insolvent, banks would fail, there would be runs on banks, lending of various sorts would dry up, investors would flee risk and we'd have a bad time while the government raised the funds to pay off depositors at the max rate of $100k per institution - one way or another a lot of savings would be wiped out and it would take quite a while to recover - my best guess. Many think it would rival the Great Depression.


1centaur, I pretty much agree with everything you say. I think one of the things that hasn't really been explained very well is that banks are required to maintain minimum capital ratios (basically stockholder's equity/total assets with adjustments) and, that to operate most efficiently, keep the ratios relatively low. If they hold on to the bad assets, those banks will have to reserve for them and/or charge them off and recognize losses. Those losses may make some bank ratios fall below the minimum required capital ratios and then make those banks subject to failure.

I used to work for a large Maryland bank and that happed to us in the late 1990's. We were still reporting record earnings (because they were) even though the Comptroller of the Currency had moved in and were watching us daily because of known problems in commercial real estate loans that had not yet gone bad but soon would because the occupancy rates were below projections and would not be able to generate the cash flows needed to make the loan payments .

If the proposed federal rescue plan goes into effect, the government would buy the bad loans from the financial institutions so that they would not need to be charged off and, therefore, ding the capital ratios. That would keep many banks from failing.

That sort of makes sense to me. But, right now, am watching fox news, and Newt Gingrich is saying not so fast. His point is that Paulson has been consistently wrong on everything, so why should we listen to him now. His idea is for Bush to come up with a Plan B. He recommended that Bush surround himself with Reagan's advisors and come with an alternative plan. I understand that the financial system is based on confidence and that we need to do something fast that will make a difference. But, are you aware of anything else. My gut reaction is to come with a reasonable plan, which they already have, and try to make it work.

Anyway, just wondering.

[Ray]

I think one of the things that hasn't really been explained very well is that banks are required to maintain minimum capital ratios (basically stockholder's equity/total assets with adjustments) and, that to operate most efficiently, keep the ratios relatively low. If they hold on to the bad assets, those banks will have to reserve for them and/or charge them off and recognize losses. Those losses may make some bank ratios fall below the minimum required capital ratios and then make those banks subject to failure.

Are these "minimum required capital ratios" based on common sense, industry standards, or some sort of regulatory standards? Might it just be possible to relax these standards temporarily (assuming they're industry or regulatory based) if the banks are otherwise reasonably healthy? Rather than forcing a huge taxpayer bailout? I'm sure the answer is no because if it was that simple, it would have already happened. Or maybe it already has we're just that much deeper in the excrement? Dunno, just asking.

-Ray

[1centaur]

A lot of people in the industry have been thinking about this problem for weeks and months. Everything I heard mentioned looked like what was proposed, which is why the markets were so happy on Friday - it's what people think is needed, rather than a Paulson plan. The good bank/bad bank scheme has been used before so it's tried and true. If there is another way, I have not heard it proposed, but I think markets would be open to anything that took the uncertainty off bank balance sheets relatively quickly.

[1centaur]

Ray, hitting the keyboard early like me.

Banks generally keep 8%ish in capital (Tier 1 to be technical). That number was negotiated over years to reflect the balance between profitability and prudence given certain assumptions about loss rates on loans. Those assumptions are off right now. I think the question is, if mortgage backed securities are worth 20 cents on the dollar today, how much of that stuff on the balance sheet would wipe out capital at 80 cents of write down? If not wipe out, then severely reduce. If the big banks can operate at 4% capital, why not all the banks? Can everybody be comfortable with the banking system at 2-4% capital for their remaining business? I am guessing not.

What I don't know is how the capital will be propped up when the assets are bought by the government at, say, 60 cents on the dollar (40 cent write down). One way would be for the government to relax the capital standards; another would be to provide stand-by capital if needed, presumably at a super-preferred level. That detail may be out there already and I did not see it, but it's a crucial part of the equation.

[Ray]

What I don't know is how the capital will be propped up when the assets are bought by the government at, say, 60 cents on the dollar (40 cent write down). One way would be for the government to relax the capital standards; another would be to provide stand-by capital if needed, presumably at a super-preferred level. That detail may be out there already and I did not see it, but it's a crucial part of the equation.
Interesting - thanks. So the guess is that the government can get away with a lower percentage of capital just based on its size and status as a prudence-first, profit-later or never player?

What do you think about the provision in Dodd's proposed plan that would give the govt equity participation? As I understand it if the govt buys assets, it gets warrants or coupons or something that can be turned into equity if the price of the purchased assets falls. The rationale is that this both guarantees against a pure bailout of the financial firms, and opens the door to a real infusion of capital, if necessary. This is what I read from a liberal economic columnist and I'm wondering what those of you in the bidness think. I obviously don't know from adam on this, but I'm interested in how the various concerns get balanced without tossing the proverbial baby out with the bathwater. Does this somehow give the govt more protection, punish bad managers more, or is it just window dressing?

-Ray

[Mshue]

If the proposed federal rescue plan goes into effect, the government would buy the bad loans from the financial institutions so that they would not need to be charged off and, therefore, ding the capital ratios. That would keep many banks from failing.

If the government buys the bad loans below book value, won't the bank then take a hit to its earnings in the amount of the difference, which will ultimately hit the banks equity and thus its capital ratios?

[Mshue]

What I don't know is how the capital will be propped up when the assets are bought by the government at, say, 60 cents on the dollar (40 cent write down). One way would be for the government to relax the capital standards; another would be to provide stand-by capital if needed, presumably at a super-preferred level. That detail may be out there already and I did not see it, but it's a crucial part of the equation.

I haven't seen anything on this specifically either. I would think they would relax the standards as was effectively done in the early nineties. I would also think they're hoping that if they can stabilize the market values of the so-called "toxic loans" perhaps they could coax some private capital to move in from the sidelines (e.g., hearing they might relax some fo the rules that make it difficult for private equity firms to invest in a big way; perhaps also some sovereign wealth fund money).

1Centaur, does it not make sense to suspend mark to market for the banks during a market crisis? I'm surprised we haven't heard more about doing this as it is a cost-free way to ease some of the pressure on the financials. MTM makes sense in theory, but it seems like it's exacerbating the problem in the current environment. (For the record, I'm not blaming MTM for the banks problems)

[keno]

http://www.nytimes.com/2008/09/23/opinion/23herbert.html?ref=opinion

I somtimes read NYT very liberal columnist just because, and almost never agree with him. I don't want to live in a socialist country. Nevertheless, today he makes great sense to me on the process necessary for the best shot at a good bailout plan.

keno

[Ray]

http://www.nytimes.com/2008/09/23/opinion/23herbert.html?ref=opinion

I somtimes read NYT very liberal columnist just because, and almost never agree with him. I don't want to live in a socialist country. Nevertheless, today he makes great sense to me on the process necessary for the best shot at a good bailout plan.

keno
Herbert's basic point is that we need more time, a pretty common refrain. Almost everyone agrees that something BIG needs to be done, but it might take several days to work out the details and debate the appropriate vehicle. The market got nervous again yesterday, but not catastrophically so. How much time to we really have?

The irony here is that the Bush administration might have put themselves (and the rest of us) in the all-time greatest 'boy who cried wolf' situation in modern history. If they hadn't so blown their credibility by insisting on unfettered executive power so many times before now, and abused it so badly, they might get the benefit of the doubt on this one. But they have no credibility left when they ask for a blank check TODAY. And this might be the one time they actually need it.

But who the hell knows?

-Ray

[rounder]

If the government buys the bad loans below book value, won't the bank then take a hit to its earnings in the amount of the difference, which will ultimately hit the banks equity and thus its capital ratios?

You are right. If the government buys assets at .60, the bank would have to write off .40 of the book value of those assets and hurt their capital ratios. That's bad, but not as bad as if they held on to them and then had to write off 100 percent of the bad loans.

Also, the company I worked for had two commercial bank subsidiaries. The regulators allowed us to create a third "bad bank" subidiary. All of the non-performing commercial real estate loans ($billions) were transferred from the two good banks into the bad bank. The new capital ratios of the good banks then met the required minimum ratios. The non-performing assets of the bad bank were eventually sold or charged off. After that, the bad bank was dissolved.

[keno]

who knows? We might have gotten lucky because of it. Then, again, Bush wouldn't have been Bush.

keno

[Climb01742]

has anyone heard warren buffet's take on what to do? buffet's combination of financial smarts, common sense and plain english have always impressed me. years ago i wish i'd been smart enough to buy into the best "mutual fund" of all time, berkshire hathaway. :rolleyes:

[Ray]

Then, again, Bush wouldn't have been Bush.
To some of us, that wouldn't have been such a bad thing! :cool:

-Ray

[torquer]

(I suspect they'll figure out other bad stuff within 20 years).
20 years? Seems like these crises are coming ever more frequently.
Lets see, the '87 S&L crisis occured because the "lessons" of the crash of '29 had been forgotten.
Then the tech bubble burst in 2000, only 13 years later, because there was no "institutional memory" to override the "irrational exuberance" of the markets.
Now, only eight years later, the whole subprime mortgage Ponzi scheme comes crashing down. No surprise, considering you had twenty-somethings at trading desks shuffling billions like they were playing freecell. And why not, since mid-six figure paydays were there for the taking while the real honchos (with nine figure paydays) couldn't even comprehend their companies' exposure. Edit: actually, they were paid those nine figures as a reward for finding ways of obscuring that exposure, as though that were necessary given the blind, deaf & dumb regulators they were up against.
20 years will be a major accomplishment.

[csm]

I find it interesting that the folks that look back fondly on the Clinton years forget that the good times economy credited to him was due to the tech bubble. it just burst later.

[1centaur]

20 years for a financial crisis in the system, which the Net bubble was not, and "within" was my hedge word :) I also think the regulations coming out of this one will take a long time to undo. BTW, S&L crisis was result of a regulatory change that was not thought through.

Mark to market comments have been gaining prominence, starting in the Wall Street Journal last week. Again, a regulatory change coming from Enron with unanticipated consequences. The contrary point would be that not marking toxic investments down just means the public imagines what the losses are and gets to wait to see real losses roll through as defaults mount on mortgages, in this case. Remember, insurance accounting and some bank accounting already allows for cost-based marks until assets are held for sale. I think in this case the issue is marking derivatives to market, such as credit default swaps, but I am not sure (contrary to possible perceptions, I don't spend all my work day on this part of the market).

As to an equity stake quid pro quo, I am not really clear what politicians are aiming for - spin or fairness. There are ways to reduce taxpayer risk and make sure shareholders are not enriched by government money without taking equity per se. A preferred stock, a la Fannie, would be one such way. If the government got regular equity, we might face the prospect of taxpayer-owned banks (depends on the losses that got us the equity, right?), and then those banks really would be too big to fail, since the government would want to prop itself (i.e., us voters who pay taxes) up rather than risk losing everything in a bankruptcy. If politicians are just trying to play to the mob by grabbing onto the publicly traded equity value of any bank that wants to sell bad assets, I say shame on them and careful what you ask for, since a stock that trades well is a great source of fresh capital from real investors, not taxpayers.

Latest wrinkle out there is the NY insurance commissioner suggesting that certain credit default swaps are effectively insurance and should thus be regulated by him. I am guessing his intentions are good but that there would be many unanticipated consequences from that move if it became reality.

[DukeHorn]

Frankly the "tech" bubble wasn't that bad at the workforce level. A lot of "sweat equity" disappeared but it was with the educated technology oriented workers that understood the risks of working for a start-up. This latest run-up covered a lot of poorly educated types (load officers/real estate agent/investors). Do you think it's easier to borrow against options or against the value of your house? The difference between the tech and housing "bubbles" is pretty damn big.

At least with the ****ty IPOs during the tech bubble there was some SEC regulation as opposed to this latest free for all.

[jimcav]

The regulators allowed us to create a third "bad bank" subidiary. All of the non-performing commercial real estate loans ($billions) were transferred from the two good banks into the bad bank. The new capital ratios of the good banks then met the required minimum ratios. The non-performing assets of the bad bank were eventually sold or charged off. After that, the bad bank was dissolved.

i hope there were more consequences to the parent bank than how that reads (to me).

[jimcav]

To jimcav's original question:

Without the government stepping in... Many think it would rival the Great Depression.
.

I had no idea banks had the freedom to buy and sell loans packaged as securities or whatever, let alone buy mutual funds, i thought they took investor deposits, and then used these to make loans or purchase laons but that each one was reviewed (underwriter?) and assumed there were regulations on how many loans of various risk categories they could have, and also that the interest rates on the loans were set in part to offset defaults.
I guess i have benefited by being able to buy houses, and i have never been late with a payment or had trouble paying my mortgage, but if the banks used stricter lending debt/income ratios, then likely I would not have been able to buy the homes i did. But there has to be a good way to look at ones track record with debt/income/payments, etc and make a determination that the loan is reasonable or not. but i guess there were no reasonable standards for much of these loans.
thanks
jim

[rounder]

i hope there were more consequences to the parent bank than how that reads (to me).

There were more consequences. The parent had to sell off the successful credit card operation for needed cash. Then, a bigger healthier organization bought the whole weakened company. A lot of people lost their jobs. I was just a mid-level accounting manager there.

[keno]

as I illustrated in a post on a different, but related thread, Clinton's policy of making home buying easier by easing borrowing conditions has much to do with today. http://forums.thepaceline.net/showpost.php?p=590580&postcount=38

keno

[csm]

keno, I read that. I was merely making an observation that the glorious clinton years (I am NOT a fan) were due to an over-inflated sense of importance and urgency in the tech industry with Gore's newly invented internet and the scramble to get on board. this also created regional housing bubbles but nothing like we're seeing now.