A reader asked what I think about the mark to market debate, bringing back the uptick rule and the government putting the screws to the ratings agencies.From where I sit these issues are more solve the world's problems issues as opposed to trying to protect or grow assets (depending on where the cycle is at the moment).
Mark to Market; In response to this question long time reader Stephen Drone joked that we should let the banks put whatever value on them they want. To the extent that happens it is obviously a problem. However to the extent that it has artificially altered capital ratios and the like that too is a problem and in the real world there is some of both.
I could be easily convinced that artificially altered capital ratios were a part of the daisy chain the lead to so many failures and near failures. Not the cause of any of the bad behavior, dumb loans or greediness but a contributing factor further down the line to stocks going to zero.
Generally the idea of suspending mark to market seems right to me if they had done it ages ago. Now the genie is out of the bottle and it is not obvious to me that suspending mark to market now would solve as many problems as some people think--I'd love to be wrong about that one.
Uptick Rule; Before the uptick rule went away there were plenty of ways around it; ETFs, put options, other derivatives and odd lots. If you did not know odd lots did not require an up tick because odd lot trades do not get reported to the tape; I realize odd lots are not much use for a hedge fund but still worth mentioning.
I have never felt there was a lot of there there, so to speak, with the uptick. One thing I am not sure of, never having been much of a short seller, is what the process is for shorting an NYSE stock away from the NYSE and of course more volume gets done away from the exchange than the old days. To short a NASDAQ stock the bid had to be an uptick not the last trade. This differs from the NYSE where the last trade had to be an uptick and the order to sell short could not itself cause a down tick. But if the bid for IBM on an electronic market is an uptick then can short sellers just keeping selling regardless of the last trade?
Anywhoo back to the subject, plenty of very smart people articulate fine arguments for the uptick being reinstated but I just think there is less than meets the eye.
Ratings Agencies; If you believe they are scumbags with no integrity who can be bought then they have lost all credibility with you. Is there anything then that the government could do to restore your faith in them (assuming you ever had faith)?
Is what they did with AAA ratings on pools of crappy loans really as despicable as some claim? Regardless of your opinion it happened and at the very least blew up or otherwise meaningfully impaired many pools of capital. What good does it do to fix them now?
Of course this need to be addressed but it in no way that I can think of contributes to whatever finally solves this crisis. If that rings true then it probably won't get the right kind of attention for a while.
The picture is on the road to the beach at Waipi'o Valley. The road down from the top is the real steep road from the other day and then it is the flat road you see today out to the water.
31 comments:
AAII Index
Bullish 18.9% 24.3% 21.6%
Bearish 70.3 55.1 56.7
Neutral 10.8 20.6 21.6
Source: American Association of Individual Investors,
Well atleast the recent data show high enough levels of bearishness that we will likely start a rally soon. When was the last time bears have outnumbered bulls by such a wide margin?
I love to find different colored beaches, so I was excited to see the black sand beach.
I ran right out. Without shoes, of course, since I like the feel of sand on my toes.
David Goldman at the Asia Times makes very good points on the need to change MTM
The main problem is that MTM is very pro-cyclical - it gives an unlimited balance sheet on the way up and a contracting balance sheet on the way down. At this point, if major banks and bank debts are wiped out ala FDIC, virtually every insurance company and pension fund will not be able to meet their obligations.
20 years of real estate bubble value cannot be written off in a few quarters -nor should it- unless Armageddon is your desire.
somehow it feels more like we are catering to the right of short sellers to grab all bank equity over any steady approach to deal with the needed deleveraging.
Goldman's blog -
http://blog.atimes.net/
Here is a good article from Goldman that shows the specifics of FASB157 requiring massive hits to the balance sheet vs. more normal loan accounting.
http://blog.atimes.net/?p=671
http://blog.atimes.net/?p=529
Goldman's bottom line -
"The right thing to do is
1) suspend mark to mark accounting for banks. Instead of deducting mark to market losses against capital, deduct expected losses on a hold-to-maturity basis
2) determine whether a bank has a positive cash flow under present and stressed circumstances (NOT, as Treasury Secretary Geithner proposes, whether the bank has adequate capital coverage against huge mark to market losses)
3) if a bank has positive cash flow and a high degree of probability of maintaining a positive cash flow, use loan guarantees and other low-cost methods to ensure that market confidence continues
4) if a bank has little prospect of maintaining a positive cash flow, turn it over to the FDIC for liquidation.
Instead, the authorities are forcing the financial institutions to absorb most of the mark to market cost of delevering the financial system — which they cannot now, as they could not have in 1981 or even 1991. Paul Volcker could explain it to them. Does anyone at the White House have his phone number?"
Great idea lets not have the banks mark to market, lets let them mark to myth.
Heck my portfolio is down 50% like those jokers at the mutual funds think it is. The market will come back, so in reality I have not lost a penny.
The same with my house it is not worth $370K like zillow says, it is still worth $577K like zillow reported a few years ago.
10:03, help me with the thought process here.
Were you planning on selling your house and now can't? If yes, then clearly you are negatively affected. If you had no plans to sell and can afford the payment (if you still have one) then was the $577k ever a real number?
In 2006 there were several similar cabins near us that sold for $300k (of course we think ours is nicer which is some sort of bias) but there has not been a regular sale since, just one foreclosure of an unfinished house. We have no payment anymore and never planned on selling so I'm not sure the $300 was ever real.
WRT to your portfolio, while I do not know your age, how important is the value today if you have enough money when you need it?
Not trying to be a wise guy as everyone copes with this sort of stuff differently.
Ratings agencies that stamped AAA on junk should be held accountable. From what I have seen on CNBC and other media, the agencies yielded to huge conflicts of interest (being paid by the companies who owned the assets they were rating). Their jobs were to see the true value of the assets and rate accordingly. Were they crooks or merely incompetent? They should be investigated in an open very public manner (obviously being given the chance to respond to allegations), and prosecuted if crooked or exposed if incompetent.
JCarr
Sortof off topic. Is anyone else here afraid for the future of our republic like I am? Or do you think people will eventually wise up and throw the bums out? Or were the bums just thrown out? I am from a poor area and people here are ecstatic about the federal government solving all their problems and providing for their needs. Have we reached the tipping point? Is this what the market is afraid of?
A letter to the editor in Friday's Arizona Republic promoted the idea of the federal government confiscating all income over 150K. What is incredible is that the letter was even published. Is the paper promoting an idealology or trying to show how radical some thought has become. Of the hundreds of letters they get, why that one?
A bit OT, but here's some news on two new ETF's from a couple of unlikely sources:
http://tinyurl.com/cvonuq
And along the lines of yesterday's topic I thought that the readers might like to get to know Clara.
http://www.youtube.com/watch?v=DuMkW35BwK8
10:03 typical sound bite response - mark to myth...
How about we enforce a rule that says now that zillow shows you to have lost 207K on your home and have essentially no net worth remaining - we should cut off any future credit to you and call in your current loans (since your personal leverage has just skyrocketed)
who cares if you can pay your bills - we need now to worship the new paradigm of no leverage
good plan.
JCarr,
they probably should but do you think doing this contributes to the ultimate solution? If not then how much energy should be devoted to something right here right now cannot fix the current problems?
Roger, having a hard time following. Which post is JCarr?
10:45
That was me, I'm not JCarr, and I am clueless as to what you said in your comments.
Right here, right now, the federal government should be helping private parties enforce contracts, the chips falling where they may.
As a business owner, I am scared silly and cannot bring myself to even consider capital improvement projects. The fear of the unknown is too great. My actions, and others like me are what drive and expanding economy.
Banks are telling some colleagues their financing is approved, but it won't be funded. WTF? They don't have money to lend, even though the borrower is solid. I have never, ever heard of this before.
"do you think doing this contributes to the ultimate solution?"
Yes, I think it would modify the future behavior of ratings agencies if past actions are prosecuted, if those actions were found to be crooked after a thorough investigation. Likewise, public exposure of incompetence, if that turns out to be the case, would also modify future behavior.
JCarr
JCarr, I might say that given what the world thinks of them the ratings agencies are already figuring how to restore their ruined reputations. the way to do that is for them to initiate changing their practices. ultimately they will be given rgualtions of course but i do not make the connection between modifying future behavior and solving the current crisis.
Good point. Yes, the ratings agencies have been exposed and have modified their behavior, or at least one so assumes. What is the probability that a AAA rated asset will default? Five years ago, I would have answered "virtually zero," or "maybe 1 in a million." Today, I don't know. Hopefully, five years from now, the answer will again be "virtually zero."
As for the question of criminality, which I would define as stamping something AAA when they knew it should be rated something less, then prosecution is still the proper course of action. And, I am not implying that criminal activity took place; I hope it did not.
JCarr
Reading your question once more, I failed to address "i do not make the connection between modifying future behavior and solving the current crisis."
I believe proper accountability for their failure(s), incompetence or criminality or something else, is necessary to restore the confidence in their ratings that will help help solve the current crisis and help prevent a future event similar to the one which recently happened.
JCarr
The cynic in me says the odds of a AAA company defaulting are zero because they get down graded a week or two before they default;->
or a less cynical way to look at it - is to say- AAA means a .01 chance to default for example - well what we find ourselves in is that .01 eventuality...
And even now, AAA subprime MBS look like they will pay 70-90%- what would have been a fair rating pre the fact of the huge fall in RE prices ? - some say well into the B's not junk.
mark to market should stand.
The issue is not mark to market it is the FASB rules requiring those assets to appear on the balance sheet.
Back to the house example. If my house is worth 50% less than last year but I can still afford my payment that should not affect my ability to purchase a car with different money as long as i can afford that payment. The solution is not to let me mark my house to "myth". The solution is to allow me to pursue my other endeavors that i can afford, using money other than what's allocated to my payment, regardless of the value of my house.
At any rate, the mark to market is a non-issue IMO. As we are finding from the AIG fiasco. The issue is not the Mortgage Backed Securities themselves. The issue is the credit default swaps that were underwritten without collateral.
Regardless of how they mark the MBS, the CDS will still sink the ship. These institutions are insolvent because they cannot pay their CDS obligations even if the MBS were marked to model.
Roger - I asked yesterday your thoughts and am smiling at the comments. It is obviously not an easy answer for any of the points.
I think the SEC failed us for many years and now we are trying to get to the perfect answer with transparency. It will not happen nor will we allow MTM to stand as written as it is driving our system into a ditch.
"The issue is not the Mortgage Backed Securities themselves. The issue is the credit default swaps that were underwritten without collateral."
Chicken vs. egg. Without a collapse in housing and therefore a collapse in the asset backing the securities, there's be no problem with the CDS.
What collateral is there normally for insurance? THe insurance company doesn't ever get your house or car.
Makes me wonder if the gov't stopped handing money to banks and just paid off every mortgage at some fair value, if we couldn't then establish a housing market bottom and solve most of this.
That idea sucks, of course. heh.
very good take by J Mauldin - http://www.frontlinethoughts.com/gateway.asp
Unintended Consequences
(Let me state at the outset that I am going to oversimplify this story to keep it from getting too long and technical, because I think it will make it far more readable and understandable to the majority of readers.)
Let me note that while I am talking about rules that do not make sense, this in no way should be seen as a criticism of the regulators. It is their job to enforce the rules, not make them. The authorities at the top (including Congress and the administration) should be taking action.
In the beginning there were ratings agencies, and they rated corporate bonds from the very highest of credit quality (AAA) down to junk (CCC).
Now AAA means that the chances of losing money are very, very low. With each level of increased incremental risk comes a lower rating. If a corporate bond was at risk for losing just one dollar, it was rated all the way down to junk. And that was fine. Everybody knew the rules of the game.
But then investment banks asked the agencies to rate a large group of home mortgages in a pool known as a Residential Mortgage Backed Security (RMBS). The investment bank would divide the pool (the RMBS) into various tranches. The highest-rated tranche would be given a rating of AAA. Let's say that the AAA tranche was 92% of the loan pool. The AAA tranche would get the first 92% of all monies coming into the pool before the other investors were paid (again, really oversimplified, but that is the net effect). That would mean that the pool could have 16% of the home loans default and lose 50% of their value before the AAA tranche would lose even one dollar.
We all know now, though, that some of those AAA-rated tranches are in fact going to lose money. And the rating agencies are now writing down the ratings on the former AAA tranches.
I am not talking about the exotic CDOs and CDO squareds, or some of the truly toxic securitized assets which are going to zero. What I am writing about today are plain vanilla mortgages grouped together in securitized pools.
I wrote three weeks ago, "The downgrades by Moody's today of 2,446 different classes of Residential Mortgage Backed Securities will be a real blow. Moody's warned in a report last week that loss assumptions would be increased for RMBS and that downgrades could be expected. Moody's is projecting that alt-A deals originated in the second half of 2007 will experience 25.5% losses of original balance, compared to 23.9% of 1H07 deals, 22.1% for H206 deals, and 17.1% for 1H06 deals. The rating agency in May expected average losses for 2006 and 2007 vintage deals to reach 11.2% and 14.7%, respectively." (The Big Picture)
Fitch and S&P are also piling on with downgrades. Most of them see RMBS's go from AAA all the way down to junk. This has some very bad unintended consequences.
Let's say a bank has a loan portfolio of 1,000 individual mortgages valued at an average $200,000, for a total portfolio value of $200 million. The loan officers were not very good, and it turns out that 18% of the homes went into foreclosure and lost an average of 50%. That means 180 homes went into foreclosure and that the bank lost an average of $100,000 per home, or $18 million overall. The bank was charging 6% interest, so in a few years it would at least have its original investment back, although the losses would eat into capital.
To make those loans of $200 million, the bank would need at least $20 million in capital, and so would need to go raise some money or reduce its loan portfolio by selling the performing loans. The reality is that for a bank to have such a large mortgage book, it would probably be a much larger and better-capitalized bank. If it were not, it would soon be taken over by the FDIC.
Note that the remaining 82% of loans are still performing and are carried on the books at full value (again, oversimplified). There is real value in the remaining loan portfolio.
But what if the bank invested in a RMBS that was rated AAA, and 18% of the loans in the security went bad? Remember, the AAA tranche gets the first 92% of income. The loss to the RMBS is 9% of capital. The losses to the AAA tranche are only 1%. Hardly a catastrophe. Annoying, but something you can deal with. Except for some very nasty rules.
Remember, a bond is downgraded to junk if it loses even $1. Now, let's take it to the real world.
Say a bank buys a $1-million AAA portion of that large RMBS. It can use that AAA debt in its capital base, and can actually lever it up about five times, as the rules only make the bank take a 20% "haircut" on an AAA bond. But if the bond goes to CCC, the bank must now move the entire bond to its "risk-impaired" portfolio. And because most institutions cannot buy junk paper, there are very few buyers out there who will want to buy it -- mostly hedge funds and private capital. The price on that paper might easily drop to $.50 on the dollar because of the potential for a 1% loss.
The accountants, being conservative and living with new mark-to-market rules, make the bank take a $500,000 loss. This directly reduces regulatory capital by $500,000. Banks are required to have a maximum of 8% of risk-impaired assets as compared to solid capital to be considered adequately capitalized. Keeping the asset on the books means they have $1 million of risk-weighted assets. If they have to sell to get the capital required to follow the regulations, they will lose $500,000.
And they lose this on an asset that the rating agencies say might lose $1 ten years from now.
Again, at the risk of oversimplification, if they keep the security that also means that the bank loses roughly $10 million in lending capacity. They have to reduce their loan book or raise more capital.
Rating Agencies Gone Wild
Here's the truth. That bond should never have been rated AAA to begin with, and it shouldn't be rated CCC today. The ratings agencies took a perfectly fine corporate bond rating system and tried to bootleg it onto a security that has an entirely different set of circumstances. A corporate bond is a bond from one company or one obligor. An RMBS might have several thousand obligors. (An obligor is a person or entity that is obligated to pay back debt.)
It was very convenient for investment banks to get the rating agencies to use the corporate bond analogies, because that meant they did not have to explain a new system. Everyone knew what AAA meant, or AA or BBB. A bond buyer in Europe or at a pension fund simply looked at the rating and hit the buy button. Easy. No need for a lot of research. Make your purchases and go to lunch.
While I can't go into specifics, I have looked into these bonds with some real interest. Let's assume that you can actually buy an AAA tranche of an RMBS at $.60 on the dollar. That means that 80% of the mortgages would have to go into foreclosure and lose 50% before you would ever lose a penny.
There are AAA bonds selling at steep discounts that are composed of mortgages with 80% loan-to-value in 2005, a 7% interest rate, and 90+ percent performing loans. These loans are being called in as mortgagees take advantage of lower rates and refinance. And with Obama's new proposed lower rates, even more of these loans will be refinanced. If you buy the loan at $.60 on the dollar, and it gets refinanced, you get an immediate capital gain of almost 50%! If it keeps on being paid, you get an effective rate of about 10%.
So, why wouldn't there be a lot of institutions standing in line to buy such a dream investment? Because banks fear the danger that the security will get downgraded, just like the thousands of such instruments that have already been downgraded, and then their regulatory capital will be impaired. The technical banking term is that you would be screwed. So you don't buy what would be a very good performing asset, because of the rules.
So, who can (and does!) buy? Hedge funds and private investors with liquidity. But these "vulture capitalists" (among whom are many of my friends) know that the sellers are operating from a position of weakness. And because there are not enough of them to buy the bonds on offer, the prices of these bonds are very low. Smart money managers are raising money to exploit these distressed sellers.
So, in effect, we are giving banks taxpayer money while forcing them to sell assets that might be worth $.95 cents on the dollar in a less-stressed world. We are shoveling money in the front door while it is being pushed out the back door to my friends at the hedge funds.
How much are we talking about? US banks and thrifts have $315 billion in AAA non-agency (Fannie and Freddie) bonds, insurance companies have $190 billion, broker dealers have $75 billion. Overseas investors have $160 billion. Banks have written down about $700 billion in assets. The majority of those losses have been mark-to-market write-downs and not actual losses. Yet taxpayers are in essence paying them to sell, because the rules say they have to raise capital.
Some simple rules changes would solve a lot of this problem. First, let's recognize that the root of this particular problem is the ratings system. If an RMBS is likely to get $.95 of its capital, then it should be valued at some number below that, but don't make them assign it 100% to their risk capital. That is like making the bank with the 1,000 home loans in its portfolio write off all of them because 18% are bad. In principle, there should be no difference.
Then, the Federal Reserve should call in the rating agencies and have a "come to Jesus" meeting. They are at the heart of the problem, and they need to fix it. They need to change their ratings system for packaged securities like RMBS's.
The I-Factor
Let me throw out one idea (there are likely to be a lot better ones, but let's get some ideas on the table). Let's move away from using standard bond ratings for multi-obligor securities. Why not rate a bond by the percentage of capital likely to be returned? Let's call it the Impairment Factor, or I-Factor. If a bond is likely to lose 10% of its capital, then it would have an I-Factor of 10%. An I-Factor of 0% would mean the bond should see all its capital returned, and an I-Factor of 100% would mean that all the money will be lost.
Now, that tells investors something. That's a useful statistic, as opposed to "CCC." What does CCC mean? Am I going to lose $1 or $1,000 or all my money? CCC gives me no useful information if I want to buy or sell a bond. And without real transparency, you end up with a world in which a few very knowledgeable buyers can make a lot of money.
That is because there are a lot of AAA bonds that are going to zero, as in 100% loss. If you are on an institutional desk and would like to participate in getting some of the better values, unless you have a very sophisticated team with good analysis software, you simply can't take the risk.
Further, if the rating agencies do their homework to figure out what the I-Factor is, they will have all sorts of useful information that can be disclosed about the security, such as average loan balance, average loan-to-value, how many loans are at risk of default, where the loans are, and scores of other details. Armed with that information, buyers can make rational decisions.
And if you modify the rules so that banks and other institutions can use those bonds (with an appropriate haircut) as part of their regulatory capital, then you immediately get a large number of buyers into the market, and that will make prices go up and mean that banks will need less taxpayer money.
The current rules were written for a time when banks actually bought corporate bonds. They made sense back then, and still do. But applying those ratings to asset-backed securities makes no sense. We need to change those rules now.
Marking assets to market when there are no markets is illogical. I have spent some time looking at these securities. Like kids, they are all different. And some are really different. Yet we make a bank mark an asset down because one that is in the same broad class is impaired. Like giving every 13-year-old in school an "F" in math because one kid failed.
Further, we don't make a bank mark down the value of a loan on its books if interest rates increase. The loan, if sold into a market, would indeed not be sold for book value. But the bank keeps it at book value on its books, and simply realizes less interest. If we made banks mark down their assets because of interest-rate increases, we would lurch from one bank crisis to another with every interest-rate cycle.
Let me be clear. I am for full transparency. If an asset is only worth ten cents on the dollar, then mark it down. We do not need zombie banks. For whatever reason, the Obama administration seems to be afraid to use the "N" word (nationalization). If a bank is insolvent, yet deemed too big to fail, then take it over, repackage it, and sell it back to the private market with some options that will allow for taxpayers to at least have the potential to get their money back. But do it quickly rather than dithering, as is happening now, because that will just cost more in the long run.
But as a start, change the accounting rules so that we stop shoveling taxpayer money in the front door to banks and out the back door to hedge funds. That can be done quickly if the administration simply says "do it."
Let me quote this note from Gary Townsend, which I wholeheartedly agree with:
"The problem, of course, is that the MTM (mark-to-market) results have little to do with the intrinsic value to a bank of a loan or a security that it plans to hold to maturity. In a bank, the decline in a loan's value is offset with a forward-looking provision for loan losses. The decline in the loan prices net of loan loss allowances is not due to credit deterioration; it's the result of the distortions and speculation in the world's financial markets. Mark-to-market accounting isn't improving the transparency of bank accounting. It has reduced it, with enormous and growing damage to our economy and prospects.
"The Financial Accounting Standards Board has said that it will issue new guidance on the application of FAS 157. That's encouraging, but can anyone recall when the FASB has been timely? The damage from this misguided rule is already huge, widespread, and growing daily. Mark-to-market accounting creates a powerful negative feedback loop. Actual or imputed FAS 157-related losses weaken capital ratios and undermine confidence in the financial system generally, which weakens the economy and adds pressure on loan pricing, causing more FAS 157 losses, and around we go.
"This cycle needs to be broken. Mary Schapiro? Tim Geithner? Are you listening?"
And let's add President Obama, Ben Bernanke, Barney Frank, Chris Dodd, and Larry Summers to the list of those who should be listening. I know that some of my readers will have access to these people. See if you can get them to focus on this problem, and let's move on to the next problem -- housing.
As a final note, I know that some regulatory bodies are in fact paying attention to this while others are not. Good on the ones who are listening. As for the others, the adults in charge need to make sure the kids are playing nicely in the sandbox. This is an argument for a significant review and reform of our regulatory system. But right now, we need some immediate action.
Steve Leuthold (very well respected fund manager) suggests we will see SP500 at 1,000 in 2009.
See attached...
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ahZohVugqHKU
Stephen,
even if the government paid off all the mortgages at fair market value that would not solve the problem.
There is a big difference between MBS and CDS.
The mortgage backed securities are just securitized loans. Their values do not exceed the underlying mortgages.
The Credit Default Swaps on the other hand were leveraged, often at more than 100 to 1. Which means that a 1% drop in the value of the MBS would wipe out the holders of the CDS. The problem isn't housing. The problem is the leverage used in creating the derivatives.
That's why marking the MBS to market, model or myth, would not solve the problem.
As for insurance, every insurance company, has to keep reserves on hand to be able to meet their obligations in case of an insurance payoff. AIG, as noted by the WSJ, CNBC, CNN, and others this weekend, have underwritten hundreds of billions of dollars of Credit Default Swaps without maintaining any reserves in case they needed to pay off any of those "policies". That's the collateral (poor term) I was referring to.
What AIG did is the crux of this problem. They cannot be off those "insurance policies". The investment banks are the counter-parties for most of those transactions and are thus screwed.
People blame short selling for what's going on in the market, yet everyday we peel the onion some more it stinks even more.
Dearest All,
the problem with this bubble was that the regulators totally forgot history and the fact that we are humans. We totally forgot that we had a depression after the stock market crash of '29. We all said we are smarter. It cannot happen to us. So the good legislations that was put in (security act 33) to prevent another crash and in turn a depression was now being abolished in the ’80’s and ‘90’s. I am not talking about only the uptick rule but also the fact that a bank and an insurance company and a brokerage and investment company must remain independent and none could Owen another. Because of these rules the insurance companies could not venture into brokage products, therefore life insurance linked to securities. The legislators in the ’30 wanted to keep a free market system but enacted rules and regulations because they knew that the human nature must be kept in checks for to keep it well balanced. This was extremely important because the interactions that insurance companies had with the banking and securities industries were kept to nil, a problem that was manifested during the bubble of the late ‘20’s. The legislators of the ‘80s and ‘90s totally forgot this small(but big) detail. So thinking that lazier faire without controls was better than lazier fair with controls they started to roll back the controls that were in since the 1933. Just like the 20’s where the Seigal book and thought where taking hold that stocks where safe and could give you a better return so now after the ’87 crash we started thinking that stocks where safe and so what if they go down 25% in a day they will always come back. A bubble was in the making. The public was hungry for these products. The insurance companies where there to offer life insurances linked to securities. Keo’s, 401K, pension funds, private equities, Royal funds, where invested in securities with valuations that were crazy. We looked back in the ‘20s and ‘30’s and said we are smarter we can leverage, and we can up these valuations. As this went on we became less kind to the needy, to the less fortunate. (We denounce China for capital punishment yet we still practice the death penalty.) Now we state that City Bank and Bank of America are too big to manage because of the many services and activities that they have. Well perhaps it would have been better if City Bank was 3 or 4 distinct companies. About GE, well GE could have been better if it was 5 distinct companies. We have created companies that not even the CEO and management knew what was going on like AIG. This was a lizard fair economy without any controls.
What should we do? Do not through away tax payers money to have a system that limps. Use that money to educate the people, help them understand to deal with the downturn. Instead of throwing billions at AIG, it would be better to have it fail even if it takes down other institution. Protect the value of the dollar instead of printing money like hell. Education I mean teach people how to make healthy meals at home and save instead of going to the restaurants.
As for now we may have a pop in the market, but brief. We are prolonging the making of the bottom because the legislators are investing by throwing money into a bad deal. Like throwing water to a fire. We should let it take its course and enact or re-enact good legislation, invest in educating people to help them deal with the coming of hard times. The bottom will be near when I see that the nation will start caring for their unfortunates. It will be a long process.
Best to all,
Jeff from Milan, Italy
sorry to leave a link in the comments roger, but here is a NYT article that discusses some of the issues with AIG that I mentioned earlier.
http://www.nytimes.com/2009/03/08/business/08gret.html?_r=1
Just a quick point to clarify some of the misguided discussion regarding the rating agencies. I worked there.
First, read (if you can find it) the definition of 'Aaa' (or AAA). It does not say that the (structred) bond will not be downgraded or will not lose money. (A huge internal issue: should there have been volatility estimators on the structured product ratings we issued? Politics and market share said "No." Even if we had the technology. At this point, those - self included - who advocated for volatility estimators sit smugly aside: much of the downgraded crap would have been issued with an indicator suggesting the likelihood of a downgrade in the foreseeable future. But the "No's" (and the IBanks) won, in the end, and the country (and the world) suffers for it. Presumably some of those would have who refrained from AAA* securities did buy the "toxic waste" that is now floating like flotsam on the sea of depressed balances sheets. And certainly, the reputations of the rating agencies would not be as low as it is today.)
At bottom the argument that the stubborn rating agencies make is "we never issued any sort of guarantees" we just compared the profile of the securities being issued to historical performance of similarly structured securities to show what would be a reasonable expectation of (for Moody's) expected losses... assuming you bought at par, and assuming the losses to date are reflected in the market price you paid (for secondary offerings).
Frankly, I'm with Rog on this: the barn's burned to the ground on this issue. The RAs are toast, and reliance on them is foolish. Yes, the documentation that requires treatment for accounting and posting purposes that is driven off the ratings makes them relevant, but barely. The clever judge that sees a way around those indentures will be doing the world a huge favor.
On the MTM issue, I stumbled on the 4.31pm Maudlin counterargument that keeps referring to "likely to" (lose capital, lose money whatever)... sez who? I agree with the baby/bathwater premise, but disagree that it is anything but simple to distinguish the babies from the bathwater, except by arbitrary determinations legally susceptible to claims of capricity.
The argument that the hedgies haven't bid up the prices "because they're too few of them" defies logic. Everyone was terrified of Paulson's TARP plan to buy assets because the POSTED PRICES WOULD RESULT IN EVERYONE HAVING TO MARK DOWN THEIR BOOKS. See? Everyone would look at the prices "printing" and see the market and treat their own books accordingly. So whether there is a two man or two hundred man auction, prices being set will affect the world. And since when is a single well funded hedge going to "decline" to bid if only bidding against a few others? What will constrain the bid is the potential profit. If the reasoning Maudlin provides is valid, then the bid will reach economic break-even as long as there are at least two bidders.
That's a dead end. Turn around a look elsewhere. (But if some flesh was put on the mechanics for establishing "I-factor" (i.e., someone could explain where the baby ends and where the bathwater starts), I think there may be mileage in that.
R in NY
(PS: we were both incompetent and colluding with the I-banks - at least to the extent that we were, in the famous last words of our former leader "a service company", and we lived to serve our customers... the I-banks.)
The counter or pro-cyclical policy effects are the ost important to consider now. On multiple fronts we have things spiraling down and on the verge of becoming out of control.
The time for banks to be conservative is when assets are rising. Now in the midst of a deep contraction further tightening by reducing leverage and marking down capital is crazy. Loosening MTM is basically an accounting means to allow them to increase leverage and fight the cycle.
Time to drop the pretense that there is enough equity capital to eat all the past sins and establish policies that give time and space to earn and inflate ourselves out of free fall.
The money from real estate inflation went to every corner of the economy, it is hardly surprising that the money to paper it over will have to come from every corner as well.
R in NY - stolen from Brontecapital blog -
"Before you go any further you might wonder why it is possible that loans that will recover 75 trade at 50? Well its sort of obvious – in that I said that they recover 75 if the recoveries are discounted at a low rate. If I am going to buy such a loan I probably want 15% per annum return on equity.
The loan initially yielded say 5%. If I buy it at 50 I get a running yield of 10% - but say 15% of the loans are not actually paying that yield – so my running yield is 8.5%. I will get 75-80c on them in the end – and so there is another 25cents to be made – but that will be booked with an average duration of 5 years – so another 5% per year. At 50 cents in the dollar the yield to maturity on those bad assets is about 15% even though the assets are “bought cheap”. That is not enough for a hedge fund to be really interested – though if they could borrow to buy those assets they might be fun. The only problem is that the funding to buy the assets is either unavailable or if available with nasty covenants and a high price. Essentially the 75/50 difference is an artifact of the crisis and the unavailability of funding. "
Very good summary of bank situation at Brontecapital
http://brontecapital.blogspot.com/2009/02/bank-solvency-and-geithner-plan.html
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