Charlie's Diary

I work in the Uk for a major bank, and I run a Team that writes reports which decide whether the bank needs to raise provisions in relation to personal mortgage debt, where our customers are in arrears.

I have to say that I agree 100% with your comments (aimed as the US as they are). Prudent lenders do not get into the position that the majority of the Usub prime market have. We took over a US bank 18 months ago, and I've seen some of these issues first hand.

Subsidising mortgage payments by struggling mortgagors would make far more sense than bailing out the lenders; it addresses the basis affordability issue, and if Banks are getting their repayments then they don't have problems either.

In fact, given that this is an issue of getting capital repayment rather than profits, I think that Bank's should reduce interest rates on loans where there are problems, if government help for the borrowers were to arrive. They have gotten themselves into the situation; why shouldn't they contribute to it's solution?

Tim

If anything, you're being kind here. $0.7T to be doled (ha! I said "dole") out at whim. To the people Paulson is going to be looking to for a job in a few months. And I'm sure that any entities that aren't heavy RNC donors will have an equal shot at the loot. And that Fratto quote! It's so outrageous that I'm not sure if it would be better or worse if he's lying.

Sober-minded liberals have said "yes, Bush is a terrible President. But he's not the worst ever. It's not like he's caused a (domestic) civil war or a great depression." Apparently Bush took this as a challenge.

That last line is a corker:

"Fratto noted that some firms holding troubled securities are otherwise successful. “They were not necessarily irresponsible players, and so you have to be careful how you deal with them,” he said."

Yeah, be very careful cos otherwise, tings might go badly for yuh!

But seriously, the whole financial structure is a trainwreckopoly; making money off the credit fault swaps DEPENDS on the debtors defaulting. So who's holding all these CDS's and stands to gain humungously? Do we know?

To quote Teresa Nielsen Hayden, "I hate the way the current US government makes me feel like a tin-foil-hat wearing paranoid."

Something I am really wondering about is the fact, that the burst of this bubble was known to be coming for years. Why didn't the US government and/or banks act sooner on it?
From passing new legislation, banks changing interest rates, to subsidizing lenders - there would have been enough ways to prevent it from getting that bad.

Most people I know were aware of this problem for years, at my company even took it into consideration in our business plans some years ago. Why did the responsible parties over in the US not do something?

The answer to that questions says a lot more about their goals than the things they do now.

Flushing up to 10% of the US population down the homeless toilet is the real screw-up...

Well, that's a bit melodramatic. Homeowners who are in danger of default were renters before they were homeowners and they'll be renters again if they do default.

The real question is whether it is possible to bail out these borrowers. They're not really that distressed. They have no skin in the game. They got into the house with a close-to-zero down payment and they can abandon the property for the cost of a moving van and a ding on their credit rating (said ding highly unlikely to affect their ability to rent a different property). That's not distress; that's inconvenience.

Now, if you reset the principle to the current market value and reset the interest to something affordable, you can probably incent these borrowers to stay put. That has some value, in that it keeps yet another foreclosure off the market and therefore doesn't make the crash in real estate values any worse. But it has no value to the CDO of which the mortgage is a part, because you've explicitly reduced the value of the CDO when you renegotiated the loan.

In contrast, let's remember what's causing the Recent Unpleasantness. If I borrowed a bunch of money to buy that CDO and I now want to borrow more money to maintain my operations, the lender thinks, "I don't want to loan to that guy because he's got a bunch of CDOs and if they get marked down to the prevailing market price, he'll be insolvent and won't be able to pay back my loan." So, since everybody has this crappy paper, nobody wants to lend to anybody and it's the end of the world as we know it. To prevent that, not only do you need to pony up some sucker (in this case it's Uncle Hank) to buy the CDOs, but he has to buy them at a large enough premium so that the write-down by the seller doesn't make the seller insolvent.

Yes, the seller was a dipshit to have borrowed money to buy the CDO in the first place. And yes, I as a taxpayer am getting screwed to save the dipshit's ass, which enrages me. Neither of these facts, however, prevents me from realizing that my overriding self-interest lies in preventing the dipshit from causing a cascade failure of the whole system.

After you get the CDOs safely into Uncle Hank's Monster, I think it makes all kinds of sense for the feds to renegotiate with the borrowers. But that renegotiation has nothing to do with averting a nonexistent humanitarian crisis and everything to do with stabilizing the real estate market and rehabilitating the CDOs so that they're marketable to non-dipshits out in the big wide world, thereby getting the US Treasury out of banking business as quickly as possible.

As a somewhat nerdy person, who's interested in probability, one of the things that I find so intriguing about this is the way that the securitization has failed. The idea is simple --- you sell the risk around and everybody gets a small slice of it. Just like in other insurance, only a small proportion of the risk goes sour, and everybody wins (minus the small cost of paying off the bad risk).

The problem is that this depends on the failure events being independent. One thing, of course, is that the financial disaster is like a hurricane --- there's a lot of non-independent failures.

The other interesting thing is the role of leverage. If everyone's borrowing heavily from each other to do these credit swaps, then suddenly nothing is independent any more. If some of my securitized loans go sour, and I borrowed to make them, then I have to call in my credit, which may cause someone else to call in his, causing some other loans to collapse, etc., etc.

I'm not a big expert on these strange financial instruments, but it seems like a lot of effort went into making baroque structures that were unsound at their base...

I may be misunderstanding things, but from what I've heard, the underlying reason for the $700B loan is not any of the reasons discussed above, but to provide the grease necessary to keep our credit markets running *at all*. If the credit market fails and there is no way for anyone to borrow money in the short, medium, or long term then we start having real problems.

As TheRadicalModerate mentioned above, your statements about making 10% of the population homeless were nonsensical. But there are a few other things to point out.

The first is to pay attention to who's opposing the bailout and who's pushing for it, in Congress. Hint - the Democrats aren't opposing it, they're attempting to make it bigger.

The second is to understand what really happened here. The problem was that these investment banks were way over-leveraged. An ordinary bank that you or I would go borrow money from, that the government insures deposits at, was restricted to, I think, being leveraged 10-1. These investment banks were all leveraged 30-1, 50-1 or even higher. If the government is going to backstop this (and it appears we the people are), then the same leveraging requirements should apply to them.

I think Dubjay has the right take on this: "From Minister Paulson"

Markus:
Why did the responsible parties over in the US not do something? Irresponsibility, of course.

Maybe I've become terminally cynical, but I just can't dig out any surprise that the Bush administration's only response to the crisis, once they were willing to admit there was one, was "Give me all your money." They must have been getting desperate looking at all that loot they haven't yet been able to steal from the US, and time getting so short. vice Teresa.

Mike:
So who's holding all these CDS's and stands to gain humungously? Do we know?

As far as I can tell, no one knows. There was no requirement for tracking transactions* of CDS's and so even the institutions who bought and sold them didn't keep records. The thing is, no one knows what they're really worth, either. No one will ever recover face value from them; I could make a case that the "Paulson Maneuver" is intended primarily to jack the price up so the good ol' boys who created this ratf*ck don't lose too much of their ill-gotten gains.

* Let me rephrase: there was a requirement there be no tracking.

TheRadicalModerate @7: you missed the bigger picture. The dipshits lose their mortgaged property. They need to move somewhere and rent. But (a) a chunk of the underlying problem is that a lot of new-built suburbia in the US is uninhabitable without cheap gas (20 mile commutes to/from work only work if you can afford the fuel bill), (b) a lot of the houses that are being foreclosed on are being vandalized or stripped (and not just by their former occupiers), and (c) having up to 10% of your population looking for somewhere to rent at the same time is ... not good.

(Also note: the dipshits with the silly mortgages are also taxpayers.)

If your government were to buy up those mortgages and switche the former owners into tenants paying rent, at least they could then stabilize the situation, keep trickling liquidity to the banks, and keep roofs over folks heads. Hopefully over a long period -- longer than the normal term of a mortgage -- they'll make enough of a profit on the rental situation to break even, and then maybe begin backing out of the housing market.

But getting angry at folks for accepting credit on terms they didn't understand and getting into debt isn't going to help, and actively refusing to help them is going to make the situation much, much worse in both the short and the long term. The folks who are to blame are not those who accepted what they thought was the offer of a free lunch -- it was the spivs who sold it to them then offloaded the risk, and the bankers (hello? Risk management specialists?) who didn't do due dilligence on the risks they were taking on.

You want to penalize the real culprits? Here's how:

Right now the US has income tax at, IIRC, 25%, then at 40% above about $200K per year. With deductions, of course.

Go back to a progressive tax. Income above $1M a year to be taxed at 50%. Income above $10M a year to be taxed at 60%. Income above $100M a year to be taxed at 70%. Billion-a-year earners to pay 80%. I don't think anyone earns over $10Bn a year, but if they did, a marginal tax rate of 90% seems reasonable to me.

(Hint: the law of diminishing marginal utility means that they don't benefit from those extra millions nearly as much as a Walmart shelf-stacker benefits by a rise from $10K to $12K a year.)

Oh, and no tax deductions on earnings above the first million.

(Another hint: Horatio Alger mythology aside, you are not a millionaire on the basis of your income. You are probably never going to be a millionaire on the basis of your income -- earning $1M a year or above -- ever. You might be a millionaire on paper if you own a big house somewhere where the market hasn't collapsed, and you may have a middle management job paying in six digits, but you're still nowhere near the folks I'm talking about. Paying tax at 50% on earnings over $1M per year isn't something 95% of the population will ever have to worry about. But with about 3% of the population owning 30-40% of the assets, and the gap between the rich and poor wider than at any time since the 1880s, it's about time to do something to narrow the gap, and raising a few hundred billion in taxes on the hyper-rich to deal with the banking crisis seems like a runner to me.)

Let me see: should we give $700Bn to a guy who's associated both with the idiots who allowed this situation to get this far while insisting "The fundamentals are sound"* and the morons who bought and sold all this toxic paper, and expect that any large percent of it will actually be used effectively? Especially if there's no oversight, and the guy in question is a short-timer in the government, and may go back to Wall Street in 4 months? "Trust me, I'm from the government" has never been my favorite phrase; this stretches my credulity well beyond the breaking point.

* A good machine translation: "My ass makes noise"

Paulson and Bernanke have been trying to sell the situation as massive systemic failure that could cause the US to collapse, possibly drawing the rest of the world in. Literally draw dropping "end of civilization" scenarios were given to a Congressional briefing. Economists tend to agree that we could potentially have a very serious recession, possibly a depression if the banking system collapses. The question is, would the whole banking system collapse? It is becoming evident that the investment banking system might implode, but that the retail banking sector will shrink as a number of banks close and the system consolidates, somewhat deleveraging the economy and causing a contraction. The original deal looks like it was a fairly obvious attempt to hand over tax payer funds to the investment banks no questions asked, using a gobblydegook to hide that fact. Fortunately Congress is pushing back and it looks like any deal will require equity from the banks plus some humiliating concessions from the bankers - e.g. compensation cannot be greater than the highest paid government job.

The question that has not been answered is whether we even need investment banks in their current form. They have shifted their function from providing services to gambling err, proprietary trading. Whilst that has enriched a few players, it is not clear that activity serves any economic value and could just be regulated away, allowing only regulated private players like hedge funds to play that game.Perhaps banking could return to the days of the mid C20th when only mediocre minds went into banking because it was relatively simple risk management of loans.

As for saving homeowners, there is certainly a lot to be said for helping them directly. However, the expansion of mortgage financing in the US has resulted in a housing bubble, making homes unaffordable. It is arguable that house prices should fall back to their proper median incomes multiples rather than keep their inflated prices. This can only happen if the asset base is allowed to deflate. Not doing so just sustains the bubble and transfers wealth to existing homeowners from the non-owners. The US has to get its economy back to a neutral trade balance so that it does not continue to try to suck in funds to subsidize an over-consuming economy. This is going to be a painful transition and may indicate the start of the end of US global hegemony, much as Britain experienced after WWI and completed by the end of WWII.

Hey, welcome to the trickle-down economy. It's good for you, we promise! Just imagine how many pool-cleaning job opportunities will be thus created in Santa Monica next summer.

Just 8 years ago US had a budget surplus of a bit over $100Bn. Every year since it ran a deficit of $100Bn or more, with the 2003-2007 period averaging $300Bn a year. With this final $700Bn give-away, Bush is going to push up his batting average on the whole to $300Bn a year, resulting in a total cost of Bush presidency of $2.4 trillion dollar debt. That basically means that every US household lost about $30k during the past 8 years.

Now, if that's not a good reason to watch how you vote, I don't know what is.

Charlie, re. @11--

I didn't mean to imply that the dipshits were the borrowers. They're the bankers and other buyers/leveragers of CDOs. The borrowers were behaving completely rationally. Somebody was offering them something for nothing and they took the offer. However, by the same token, one can't get too exercised when pi departs from the integer value to which the lenders attempted to set it and the ersatz homeowner discovers that the deal really was too good to be true.

As for your other arguments,

a) Have fun stormin' the castle, boys. There is zero probability that US suburbs and exurbs will collapse back into high-density stuff. Jobs will come to the {sub,ex}urbs long before the people come to the cities. (BTW, there have been numerous studies recently on what regentrification of the cities is doing to low-income families. The short version: the US is starting evolve rings of close-in, very poor suburbs, a la European cities. But of course that just drives the middle class further out into the exurbs, since they can't afford the regentrified properties either.) I'd bet rather more heavily on a transportation technology breakthrough than I would on a fundamental US demographic shift.

b) I agree that the vandalism isn't making things better, but you can tear all the copper and fixtures out of a house and still only degrade its market value by a couple percent. It's a second-order effect.

c) It's nowhere near 10% of the population that's being displaced and it's not a unit-impulse displacement. It's occurring over 3-4 years. Furthermore, rental inventories go up with foreclosures, since a big chunk of the foreclosures are getting snapped up as investment property. (I'd attempt to think through the unintended consequences of a more powerful set of landlords, but I'm pretty sure my head would explode.)

Finally I'm terrified of the government making much of a profit off of the work-outs on the loans that they buy. The temptation to use an accidental sovereign wealth fund to solve all of our fiscal ills could get to be overwhelming. I don't look forward to the day, five years hence, when some senator makes a statement like, "It's true that my $100B-per-year program is an unfunded mandate, but that's OK, 'cause the treasury had a 15% return on equity last year." That will guarantee that the next collapse turns us all into a black hole.

> The money would be better spent keeping roofs over their heads (and servicing those currently-non-viable mortgages, which action would, incidentally, keep the banks liquid).

But if you keep the roofs over they heads, these poor people can still vote. If you foreclose and evict them you can then remove them from the voting rolls for failing to update their addresses. The republicans are making a national strategy out of introducing measures ostensibly to reduce voting fraud which have the effect of denying poor people the vote.

Ah, but you just don't appreciate the genius of American Capitalism.

We have guns you see.

If the "people" cause any trouble, they're already bringing home troops to "deal with any disturbances."

Might even have to have martial law in November...

Folks, wander over to Princeton's economics department and look at Hyun-Shin's "Crisis on Wall Street" slides. The AIG connections slide is sobering. The economists are afraid of a time when there's no money available for investment and, so far as I can tell, they're right to be so.

Unfortunately, the Bush administration kept the lid on this until a week before Congress adjourned and six weeks before a major election. It's depressingly likely that nothing will be done until January, and if so, things will get very bad.

Maybe it's just me, but I find this ironic. For decades US, British, and other governments have been delivering macho rants about how they will never negotiate with terrorists. How the only way to deal with people who hold the threat of destruction over the rest of us is uncompromising, unrelenting violence.

Now we are faced by a bunch of people who - between them - are holding the threat of destruction over the world (or at least US) financial system. They are saying, just like a James Bond villain, "$700 billion or the banking system gets it". But instead of dispatching Bond to despatch them, the US government is proposing calmly to hand over the money!

Could the terrorists, somehow, have gotten to the President? What hold could they have over the man?

@17:

I think that a lot of the problems the US has with its governance stems from two causes: a lot of people (mostly poor) don't vote, so their voices aren't heard; and the wealthy do vote, most importantly with their wallets, to candidate re-election funds. You'd better believe that their voices are heard.

The United States is a wonderful country, but its method of governance makes me shake my head.

@Charlie re 12.

Law of diminishing returns. Hmmm. Once you get above a million a year, wealth is not about money, it is about power.

Morally, you are wholly right, but I doubt you will get enough support. A big part of the problem is that Americans seem to worship the rich. Take Bill Gates. He has been a major force for evil. He has substantially held back progress in the software area for decades. He has recently been forced to play the Howard Hughes trick to stop EU attacks on MS. But Americans love him and think he is a role model.

[I am British, living in London. We are not immune. Cambridge University used to turn down donations from people like Gates, now I walk past buildings there with his name on them.]

The administration that wants $700B just before the election is the same one that wanted an "authorization for use of force" just before a previous election, and also the same one that dumped the Patriot Act on Congress at the last minute. How many times has Lucy pulled this particular football away from Congress?

Recall that Paulson flat-out lied to Congress yesterday when they challenged him on the oversight missing from his original draft. A little skepticism when dealing with claims of nuclear weaponized anthrax being flown from Iraq to North America - I mean, sudden financial collapse - is called for.

I also don't think it's accurate to say that it's Congress that is trying to make the bailout bigger. Over last weekend, foreign banks with US subsidiaries and then foreign banks with significant business presence got added to Paulson's plan with little fanfare.

RadicalModerate, if you think that all the walls of a house can be knocked open and pipes ripped out while only degrading the value of the house by a couple of percent, you must know some very expensive houses or very cheap contractors.

I haven't heard of the vandalism cases around where I am, but talking to home shoppers I hear that in some post-foreclosure cases, banks are also leaving vacant property over the winter without winterizing it, and not properly treating termite infestations. That isn't "knocking a couple of percent" off, it's a tear-down.

I can't particularly sympathize with those 5% of homeowners. I'm a renter; I've never been able to afford the price of homeownership in California. Over the past decade or more, I watched the price of houses climb by a factor of several, driven upward by people who were taking overeasy credit and using it to invest in a housing bubble, confident that real estate would always climb in value. As a side effect of this bubble, I saw a steady series of condo conversions that took more and more rental housing off the market, making it harder to afford to be a renter. So from my perspective, my ability to afford housing was being threatened by a huge inflationary scam—and those 5% of defaulting homeowners you refer to were a bunch of rich people who were in on the scam and were every bit as eager to profit from it as the investment bankers were.

Let the whole thing go down, I say; let the banks take their lumps without government bailout, and let the defaulting homeowners lose their houses. The American drive to make everyone a homeowner never had any economic justification anyway; it was just part of the Republican version of socialism. People were buying houses as investments, and investments sometimes go bad. Your proposal is just another version of "socialism for the rich." And, you know, I don't mind people being richer than I am, but I seriously mind when they get or stay that way by having the government subsidize them.

Charlie--if you haven't read, "The Shock Doctrine: The Rise of Disaster Capitalism," by Naomi Klein, it well worth your time. It details how a group of economists, originally trained by Milton Friedman, continue to advise politicians and business people in how to use "perceived" crises to rush (scare) people into accepting changes favorable the rich to become richer.

While the Bush administration's solution to the current situation is pretty similar to how you describe it, trying to blame the current situation on President Bush is a bit spurious. President Bush warned that the situation was going down the toilet years ago and requested a fix - multiple times. McCain was actually one of the ones who proposed a fix. Each time the major opponents of making any change to Freddie and Fannie was a certain group of Democrats, led by the members of the NACP(including Obama) and Barney Frank.

These political elites essentially felt that credit was a civil right, forcing banks to accept risky loans, because certain minorities tend to disproportionately have bad credit, and they didn't like seeing those minorities unable to own homes.

@10:

> * Let me rephrase: there was a requirement there be no tracking (of credit default swaps).

Well, this may sound like a BAD THING (TM), but actually it is not entirely so. A CDS is some kind of insurance after all and insurances work a whole lot better, if there isn't too much specific information around. Take health-care. Health insurance simply doesn't work as a way to ensure affordable medical treatment for those who need it, if you are required to take a medical examination first and the higher the risk that you will need medical treatment (because of heart conditions or whatever) the more you pay. Which is ultimately absurd, because this means, that in the end you have to pay for your treatment all by yourself, just that now you have to add a fee for the middleman of the insurance. (In other words, yes, other, healthy people must pay for your treatment. But this is actually one of those things that a society should provide. Just like almost everyone in the west has been getting a free ride in terms of food-security from the farmers for the last few decades.)

Same with credit default. The whole point of the exercise was to spread the financial risk of default around, such that if you happen to have bad loans you won't have to pay for it all and can thus provide more credit to people with a higher risk of default, thus creating more economic activity, thus more profit. And not knowing anything about which credits exactly are hiding behind a specific CDS means that the prices for this insurance won't be prohibitive for those who have some "financial condition" (well-paying, but insecure job or whatever) and have some chance to default on their loans.

I'm still quite sure that this is a good idea, just as health insurance or a seat belt is a good idea, provided you don't take on more risk with it than without. A regulated credit environment should be able to make this work and put relatively lax criteria on who can get a loan and who can't - without ruining the bank.

(Oh yeah, and thinking twice about refinancing a house that rose in value, or teaser rates for credits might also be helpful.)

William Gibson's take on this...

http://www.williamgibsonbooks.com/blog/2008_09_01_archive.asp#4989426065727886407

As a renter who was/is being responsible about debt, I say screw those who took out mortgages they can't afford. They can go back to renting as well, there's no lack of empty apartments. And I've seen the housing they bought in Florida, if not California -- it's in the middle of nowhere. If they could live out there and drive to work, location of apartments isn't a problem.

taoist: your well of information has become poisoned with right-wing talking points.

The myth that the CRA, passed in 1977, caused this meltdown has been extensively debunked. CRA loans were less likely to default and less likely to be sold. You may wish to reflect on why you want to believe such transparent BS.

A stat more likely to be at the root of the problem is that over 50% of the people who obtained subprime loans actually qualified for prime loans. The FBI noticed a problem with mortgage fraud and predatory lending back in 2002, and asked for more budget to prevent another S&L crisis. Under the Bush administration their budget... shrank.

On a similar note, would you care to explain how the Bush/McCain reforms would have addressed this crisis? As I recall, their plan involved more deregulation.

Not that I want to raise your ire any more, but did you hear about the GOP plan to take away the vote from people who are been foreclosed on? That's right: lose your house, lose your vote.

http://www.huffingtonpost.com/2008/09/16/obama-files-suit-over-gop_n_126865.html

Charlie, while 5% of the homes are reported in default, some 20% are underwater, while the tide is still coming in. Much more interesting times lay ahead.

This meltdown is broader than just the Bush Admin's past 8 years. This started before Bush, and had the help of his politcal opponents.

In your Banker A/B model, if you're a banker deciding where/who to lend money and the US Fed Gov has promised to prop you up no matter how bad your decisions go as long as you lend lend lend to social engineer more low-income home owners, create a boom in construction business, and inflate falsely high home equity that encourages more irresponsible consumer spending: Congratulations, you're Frandie Maec. Here. Have some stock options.

Long live King Henry P the First.

FungiFromYuggoth @ 30: My good friend bought a house in Florida, with good credit, and had several lenders insisting that he get what were basically subprime loans with terrible ballooning interest rates. Even to the point of verbal abuse and repeated phone calls, which is an odd sales method IMO. He eventually got a regular 30-year fixed at a good rate, but if he wasn't a smart person it would be easy for him to be tricked.

Nathan @ 31: It may be unpleasant, but the GOP is following the law here, while the Democrats are trying to bypass it. You vote where you live, if you lose your home you have to update your address and vote where you live now. It should really be the state's job to check on this...

taoist @ 26:

President Bush warned that the situation was going down the toilet years ago and requested a fix

All I heard was a constant refrain of "The fundamentals of the American economy are sound." so nothing needs to be done. This is a warning? And then, suddenly, the sky is falling. No, what this all reminds me of is a last-ditch ploy on the part of the early entrants of a Ponzi scheme to get the late entrants to kick in some more money.

AndrewG: where do homeless people vote in your brave new world?

Andrew G. #33 wrote:- 'My good friend ...with good credit...had several lenders insisting that he get ... basically subprime loans with terrible ballooning interest rates. Even to the point of verbal abuse and repeated phone calls... He eventually got a regular 30-year fixed at a good rate, but if he wasn't a smart person it would be easy for him to be tricked.'

Adjustable Rate Mortgages (ARMs) were pushed relentlessly and criminally, and they're going to be the gift that keeps on giving, as they'll continued to reset at higher rates than owners could ever afford and than are justifiable at present (and likely future) real esate valuations. This will continue next year in 2009, the year after that and on _at least_ out till 2011, as far as I can see, unless Washington does some drastic law-making.

I fail to see how any versions of the $700 billion bailout so far proposed will mitigate this slow-motion train wreck caused by ARMs.

And these were financial products pushed on people who were in many case quite clearly destined go into foreclosure when they couldn't pay the abruptly raised mortgage note.

To give you some idea of the problem's scale, subprime ARMs only represent 6.8% of the loans outstanding in the US, yet they represent 43.0% of the foreclosures started during the third quarter of 2007. During 2007, nearly 1.3 million properties were subject to 2.2 million foreclosure filings, up 79% and 75% respectively versus 2006. More homeowners continue to receive foreclosure notices, with one in every 519 households receiving a foreclosure filing in April 2008. As of August 2008, the U.S. mortgage market is estimated at $12 trillion with approximately 9.2% of loans either delinquent or in foreclosure

Charlie @ 35: In the US, the truly homeless would register to vote in the district where they typically reside. So wherever the homeless shelter, park, or abandoned building they sleep in is.

Identification is a bit trickier but most states have a free ID, and some cities do too. I've seen some that just say "XXX Shelter".

Though most people homeless because of losing a home would still have some valid form of ID, such as a driver license. The US is probably unique in that a large number of homeless may still own a car but have no place to live.

But just because you get foreclosed doesn't mean you don't have anywhere to live. Poor planning could result in temporary homelessness, true. But renting is affordable in the US, and there are rent subsidies for the poor as well. You'd probably end up with a smaller place renting that you would owning though, unless you rented a house.

Politics aside (if thats even possible), I have to imagine Mccain and Obama were watching this when it started thinking "You've got to be kidding me."

Who-ever wants to be the next president, raise your hand.

Charlie,

Rarely --- okay, never have I said that you got something wrong. And I'm not sure that I will here either, because I'm not sure that I understand your point. So if I am misunderstanding you, I apologize.

Financial institutions move capital around. Financial institutions have made a lot of bad loans over the past few years. The problem is that the income streams from those loans have been parcelled out among numerous complicated debt instruments, and nobody knows which ones will pay less than expected, or how much less than expected.

That means that nobody knows how good a risk it is to lend to anyone who has those instruments (or related instruments) on their balance sheets.

The problem is that could be everybody. So nobody wants to lend money to anyone. (My two cousins just got into an argument over whether they should take their company's half-million in working capital and put most of it into five different insured CDs or park 5,000 hundred-dollar bills in a safe.) Right after Lehman Brothers went under, it looked for a moment that the entire credit system would freeze up.

If that happened, then the economy would collapse.

So what the government is trying to do here is give people confidence that financial intermediaries are not about to crash and burn and take their money with them, thereby allowing credit to continue to flow.

The problem with the Bush Administration's plan is that --- I massively oversimplify --- (a) there are no punishments for the financial intermediaries that got things wrong, and (b) there is no way for the government to recoup its losses.

The Dodd plan addresses both problems. Short version: if the government sells the crap it buys from the financial institutions at more than it paid for it, nothing happens. If it sells the crap for less, it gets an equity stake in the financial institution that sold it equal to the loss. The government can then sell that stake and recoup its losses, or collect profits from the financial institutions over time, preferably the former.

Recent historical perspective: The Bush-Paulson plan resembles Mexico's 1995 bailout; the Dodd plan resembles Sweden's 1992 one.

Bailing out homeowners might work, but it would be much more expensive, and it would suffer from problems (a) and (b). I don't mean that people hit by the crisis would suffer; I mean that the people who made them the bad loans (or bought said loans later) would not.

That does not mean I don't want to help homeowners. The Obama plan would allow bankruptcy judges to cram-down reductions in mortgage payments, just as they currently do for other debts in personal bankruptcies, or all debts in corporate ones. That, however, is a necessary adjunct to the financial bailout rather than a direct part of it. (It would also help lenders --- housing value would be preserved compared to a foreclosure and auction.)

The Obama plan is a better plan, and certainly a cheaper one, then having the government buy up all defaulted properties ... which is nothing more than an indirect version of the Paulson plan, with both of that plan's major faults. If given a choice between the Paulson plan and buying up all defaulted mortgages, well, I don't know which way I would go. (Probably with Paulson, truth be told. Houses are illiquid.) But that's a false choice. The Dodd-Obama plan pretty much solves the problem at minimal cost to the taxpayer, and generates social benefits along the way.

Sometimes politicians actually know what they're doing. We've got several of them in the Senate these days, thank the Lord and the voters of Connecticut and Illinois. And one of them is running for president of the United States.

Apologies if I misunderstood you and am taking on a straw man.

There's always the libertarian solution -- let them all fail. If housing prices are rising faster than incomes, it's pretty obvious you're in a bubble.

Of course, that solution is impossible in a Democracy. Too many of those who were stupid are voters.

Andrew G: For a wonderful example of the benefits of Libertarian government, I refer you to the Great Stink (which persuaded even a minarchist night watchman government to Raise Taxes in order to Do Something). Or to present day Somalia, that well known economic powerhouse and paragon of industry and thrift.

(Libertarian: the thinking capitalist's equivalent of Leninism -- a simple, appealing ideology that just happens to rely on incorrect assumptions about human nature.)

@40

Why do libertarian solutions always sound like the goal is to create losers so that winners can stand out.

Not everyone who is in danger of default was renting before. There are a lot of people who refinanced (into loans that are now about to default), just so they could afford to send a kid to college or buy a car that wasn't a clunker, or just to lower the mortgage's interest rate from high to tolerable. And then their job went *poof*, and now they're stuck with payments they have trouble making.

PJ @ 42: Those people can still rent, if anything they're better off than those who were poor/renters before hand. They'll just have to accept that they will be renting something smaller.

Mark Pontin wrote: I fail to see how any versions of the $700 billion bailout so far proposed will mitigate this slow-motion train wreck caused by ARMs.

The Democratic plans tend to include language that would allow bankruptcy judges to 'restructure' mortgages. I haven't seen the authority spelled out in great detail, but presumably this would allow judges to restructure ARMs to fixed rate loans and/or reset the mortgage value to reflect curent housing values.

The financial sector has successfully fought similar language, and shows no signs of letting up. It seems to me that paying to bail out debacular mortgages, while undesirable, is still a better use of tax money than paying to bail out debacular banks and institutions.

Talk about tossing a stone into a pond ... ni modo.

Once the US economy collapses, I'll need something to read in between rounds of scavenging for canned goods and fighting off home invaders. That being the case, you have my permission to ignore your other contractual obligations and concentrate on THE FULLER MEMORANDUM. Thanks.

@47
I agree whole-heartedly.
I don't think its any coincidence that the next Novel I want from you (or anyone, for that matter) is the next one you want to write.

FungiFromYoggoth in #45 wrote:-
Re. ARMS, 'The Democratic plans tend to include language that would allow bankruptcy judges to 'restructure' mortgages.'

I've noted that. There needs to be more than a 'tendency to include language,' though -- the ARMs issue is central to the whole debacle and needs to be addressed. If it's necessary to attach mortgage-restructuring regulations to any bailout package, that's what should happen.

That said, I see that the FBI is now circling four major lenders possibly involved in predatory or fraudulent mortgage-lending. I suspect that in time-honored US political fashion what will happen is that some number of executives will be found who have engaged in fairly inarguably criminal behavior. These executives will next be convicted and used as scapegoats. Then the rest of the financial industry will claim that what's happened was simply the work of a few bad apples and, now aforesaid apples have been punished, business can simply continue in a fashion that's as close as possible to what the industry was doing before.

Ah, that's the problem with liberal democracies.

In the good old days, when the regime went bust, you'd get a civil war, and maybe a few beheadings. Mind you, it never seemed to stop them from doing it.

I really enjoyed the put-down neologism 'Glibertarian' to refer to anyone with knee-jerk libertarian views. Is this the end for the fricking Chicago School alumni? Or will they, like Communists, just keep claiming the problem is implementation not theory.

Mark@36: The value of defaulted mortgages is not zero. Rather, it's somewhere between their face value and zero.
In other words, the value of the bailout does not have to be equal to the value of defaulted mortgages (or other securities).

But the bailout can, in fact, be even smaller than the estimated losses on defaulted mortgage securities. The reason is that bailout isn't intend to prevent losses for financial institutions. Rather, it's just intended to prevent those losses from making those institutions insolvent. So it doesn't need to cover all estimated losses, but just enough of them to keep exposed financial institutions from shutting down.

Does the above make it clear how $700 billion could be enough to do the job? In fact, the bailout isn't that large; the plan just authorizes it to get that large in the short run if necessary, until the government resells the crappy assets that it buys. (As I mentioned earlier, the Dodd plan protects the taxpayer against the possibility that the government will have to sell at a loss.)

Of course, it is possible that $700 billion still won't be enough.

(Charlie, should I bother?)

So when the economy goes bust and the methane chimney outgassing hits the fan, we'll have a classic post-apocalyptic scenario. My guess is the single biggest danger to the average citizensurvivor is going to be Bank Executive Zombies wanting to eat brains, and/or 401Ks. Fending them off will be easy in the case of massive inflation before collapse: stuff a few hundred million DeutschmarksDollars into their mouths and plug them up.

Noel,

Please, bother. Your statements are a lot more clear and concice than most of what I have been reading/hearing on the subject.

There's an article in that bastion of conservative ire, the Huffington Post, that one section of the bailout exempts the Secretary of the Treasury from any review or scrutiny of his decisions. It would once again make the Shrubbites appear to be above the law. They just don't stop, do they?

Huff also says McCain wants to delay the debates on Friday. I would be very disappointed to see that happen. I don't believe McCain can think on his feet (or his arse for that matter) and I'm hoping the debates will prove that.

And Biden vs Palin. Priceless.

A brief note on the question of voting rights.

Here in the UK, the voters' list is compiled annually.

Which district you vote in is based on where you live on the qualifying date. You don't get chucked off the list because you change address later, whatever the reason.

UT econ prof Stan Liebowitz doesn't seem to blame evil capitalistic pigs nor r Wall Street fat cats for the mortgage meltdown.

Question: If US Fed Gov Policy requires a relaxation in the standards of lending practices, is that this "deregulation" that's been spoken of? Regulation Requiring Relaxation really relates to De-Regulation?

Dave@55: it's the same in most states of the U.S. You've got a grace period between moving and re-registering. Andrew may live in a state with strange rules; I really don't know.

Frex, I quite legally voted absentee in Florida after I had moved to Massachusetts. Unfortunately, my wife has been here a bit too long for her to legally vote in Pennsylvania.

Note the quirkiness of the American system that makes a presidential voter in Pennsylvania or Florida more important than one in Massachusetts or Mississippi.

At least I'll get to vote against repealing the state income tax and for decriminalizing the possession of small amount of marijuana. And I'll get to re-elect Senator John Kerry. But my presidential vote really won't matter, except perhaps morally.

Wait a sec- stuff I've been reading suggests that this 700,000,000,000 dollars* is merely the start, and many hundreds of billions more will probably be required over the next wee while.

* I like writing it out, it reminds me how large it is.

Well, it looks right now that Congress is only going to approve $150,000,000,000. Truth is, nobody knows how big (or small) this will turn out to be. Which is one of the many many reasons why oversight and prudence are needed ... something that has not been much in evidence from the White House or one of the presidential campaigns.

To be fair, Paulson and Bernanke have been, until now, handling the situation well. Bernanke, though, lost some points with one of my colleagues when he started to push the panic button in front of Congress.

Lycan: this would be the same Professor Liebowitz who does position papers for the Cato institute? Writing in the New York Post?

I begin to see what your problem is.

Noel--

Maybe you can explain something for me: Seems to me that the warrants that the Dodd plan mandates would have to be accounted for in their fully dilutive form, since you can't price the ultimate worked-out value of the CDOs when they're sold by the Treasury. In other words, just as you manage to unload the stinky CDOs from your balance sheet, Dodd requires that your shareholders' equity goes into the toilet and you're left undercapitalized again.

What am I missing?

Here's how I understand it.

The financial institution has some sludge on the asset side of the balance sheet. It swaps that sludge for cash from the federal government. No change in net worth --- just a switch in the asset portfolio from sludge to cash.

The federal government then, at some point, sells off (or otherwise liquidates) the sludge. If the government sells the sludge for a lower price than it paid the financial institution for it in the first place, then the size of that loss is multiplied by 1.25 and the government receives new shares in the institution equal to that amount at the current market value. (The bill contains provisions for valuing non-traded companies.)

You're right that the owners take a bath --- they've just seen their ownership stake diluted by however much the federal government took. But the net worth of the institution doesn't change. It's balance sheet looks exactly the way it did before the federal government exercised its warrants. So it keeps humming along, providing the financial services that businesses need, while their owners curse and shake their fists and promise themselves that they'll never ever ever be so stupid again.

The text of the bill is here.

Charlie @11, locally, a lot of counties are buying foreclosures and selling/renting them to county staff (mostly teachers and firemen) who couldn't afford to live in the county otherwise. And in the DC area, we have tons of places to rent. The problem is that they were built to be luxury condos (couldn't sell enough) and they have the rent to go with that. If someone can't make the mortgage on their everyday house/condo, they won't make the rent on the luxury apartments.

_____ @12, Obama's plan is not quite so drastic, but definitely moves in that direction.

Andrew G @33, people whose houses are in foreclosure may still be living there. Usually there's months before you're required to move, so working just from foreclosure sheets will keep people from voting who can vote legally.

When I refinanced the mortgage to pay for the new heating/AC system, the lender kept pushing ARMs, even though I'd given her the specifics of what I wanted, which included a fixed-rate mortgage. I finally said "Do you think I'm nuts?" and she stopped asking.

Our Leader is speaking in about 15 minutes. I suppose I should at least turn the TV on.

Charlie@60: I understand. One's trying to move into my neighborhood.

Noel @ 57: You're right, there usually is a grace period and you aren't kicked off the rolls automatically. But since votes are usually apportioned by district rather than pooled, it matters what district you vote in. So if you show up at your old district you can be challenged as not living there anymore. At which point you must go to your new district. However, your new district won't have a record of you if you didn't update your address so you'll have to vote on a provisional ballot pending verification.
All I really know is that people are becoming increasingly concerned about the problem: http://www.nytimes.com/2008/09/25/us/politics/25voting.html?partner=rssnyt&emc=rss

Charlie @ 42: I'm not really an expert on 19th century UK government, though I've heard a number of libertarians claim it's reputation as a laissez faire paradise is false. As to Somalia, it's hardly a libertarian nation or even anarchist. More of an anomy mixed with warlord & pirate microstates. And even then, it's better off than many African countries with strong governments. Would you rather live in Somalia or Zimbabwe or Sudan?

Noel (@62)--

I think the thing that's missing is that the dilutive event occurs when the warrants are issued, not when the feds realize the loss. (It's sorta like incentive stock options--you write them down when the option is written, not when it's exercised.)

So there are two consequences:

1) The dilutive event occurs at the time the feds purchase the CDOs. By itself, this event doesn't change total shareholders' equity.

2) That dilutive event reduces the price per share of the stock. If the price per share drops enough, you run the risk of panicking your investors, who then dump the stock, and then you've got a real reduction in shareholders' equity, which comes out of your capital requirements, and you've succeeded in negating the purpose of buying the CDOs in the first place.

As usual, this stuff is touchy and needs to be gamed very carefully. For example, what prevents everybody and their brother from putting long straddles on the stocks of likely bailout candidates? And will that cause enough puts to be exercised to send them into a death spiral? (This assuming, of course, that they haven't lifted the short moratorium, which is a pretty big assumption.)

It's a hell of a lot simpler if there isn't a direct coupling between the buyout and the equity market. I understand the completely justifiable desire for the taxpayers to take it out of the hide of these bozos, but we still need to adhere to the "stabilize first, kill the bozos later" principle. Of course, you could mitigate this problem by changing the accounting rules for the warrants, but that requires that FASB get in on the act immediately. Whack-a-mole, anybody?

Lycan @ 56

No, what I've been talking about, at any rate, is the deregulation of CDS instruments in 2000, which resulted in no one keeping track of how many had been sold to who by whom. So when we (SURPRISE!) discovered how toxic the hiding of risk in one piece of paper could be to all the paper around, no one had a clue even how big the whole pile was, let alone who was sitting on the juicy parts. That's why so many bankers are trying to pry open the Treasury so they can get launder their paper and get the sludge off it.

The Paulson plan is most definitely not a $700 billion dollar bailout. The exact text of the proposed bill limits the 'outstanding balance' of the bailout to $700bn at any given time. The Treasury could essentially spend an unlimited amount of money transubstantiating bad debt by buying assets at above market price, clearing the balance to zero by selling the assets at a loss, then turning around and buying more assets. Only $700bn would be outstanding at any one time, but the Treasury's losses during asset laundering would not be legally limited.

The Paulson plan also includes language exempting treasury decisions from congressional oversight and judicial review. If passed, Paulson would have essentially unconstrained power to spend as much as he wanted without being subject to any oversight whatsoever.

Read Karl Denniger's analysis for more detail.

Bruce @67: The other thing nobody is keeping track of -- the Fed stopped monitoring (and issuing updates on) the M3 money supply back in 2006, IIRC.

Not keeping track of how many dollars are in circulation smelled fishy to me at the time.

Couple it with the Paulson plan and you've got a license for them to print their way out of debt, if they felt like it, while thumbing their nose at all the overseas bond holders (and the small folks who'd be using wheelbarrows full of folding paper to pay for a tank full of gas).

Curmudgeon @68, I can see how buying high and selling low can let that $700 billion cover much more than $700 billion of bad paper.

But, when you write The Treasury could essentially spend an unlimited amount of money transubstantiating bad debt by buying assets at above market price, clearing the balance to zero by selling the assets at a loss, then turning around and buying more assets, it doesn't make sense to me.Selling at a loss cannot clear the balance, not by any rule of accounting that I've ever heard of.

You're saying they've set up near-infinite leverage on that money, and to me that looks like criminal fraud.

Presented without comment, regarding the $700bn figure:

"It's not based on any particular data point," a Treasury spokeswoman told Forbes.com Tuesday. "We just wanted to choose a really large number."
-- http://www.forbes.com/home/2008/09/23/bailout-paulson-congress-biz-beltway-cx_jz_bw_0923bailout.html

Dave Bell @ #70:

Depending exactly how the plan defines "$700 billion outstanding", it may well be possible to do it that way. If, for example, it says "at no point can there be more than $X invested in sludge-clearing instruments" (if you have $X in Instrument(s) and flog $0.5X of that, you only have $0.5X left, even if the sale only brings in a tenth of the purchase value; you've done a net loss, but...).

>>>it's better off than many African countries with strong governments.

Christ on a bike. Somalia is currently a battleground where Eritrea, Ethiopia and the US are fighting it out with local proxies, with the usual awful consequences for the civilian population. Maybe it's not worse off than Sudan or Zimbabwe (though the latter, for all it's awful problems still isn't in a civil war situation), but it's certainly not vastly superior to conditions in African or other countries where state systems still prevail. Furthermore, those parts of Somalia where some semblance of normal life is conducted, and which are not caught in the crossfires of the combatant parties, are those northern areas of the country where successor *states* exist - Somaliland and Puntland. I understand where your coming from - it's only Africa, after all. Why bother to know something about the situation before you shoot your mouth off about it?

Charlie@69: Richard Daughty's "The Mogambo Guru" newsletter has been frothing at the mouth for years now on the Money Supply and private & public debt levels. He's been downright rabid about how mass pallets of money get printed and no one cares or pays attention.

Bruce@67: Seems like you're making a valid point. I don't consider the CDS to be the smoking gun / root cause of the meltdown though. Contributing factor certainly, lots of different hands took turns gripping the murder weapon.

Overall, this meltdown has been predicted for *years* - the Treasury's been printing money like crackheads, the cumulative mortgage debt has exceeded the national income, ARM's given out like gateway drug samples.

Charlie@69: M3 isn't useful, and the calculations are so approximate as to be equally useless. (Although changes in rate of change may contain information --- I'll be damned if I know what, though.) What information do you get from it?

In point of fact, it would require only man-hours to construct an M3 index from the data the Fed still collects and publishes.

There are libertarian cranks who worry about M3 (or the lack of M3 figures), but I'm at a complete loss as to understand why you would.

RadMod@66: Here's the scenario I think you're worried about: A financial institution sells sludge to the government for cash, and stock price goes down because the financial institution now has a contingent liability --- the warrants --- that could be exercised in the future.

I'm not sure I understand why that's a problem. If the stock value tanks, so what? The financial institution is still solvent.

I'm also not sure why that would happen. It would seem to me that replacing a risky asset on the balance sheet with an equivalent quantity of cash should drive the stock price up.

I apologize, but I don't follow.

For whatever it may be worth, this is a copy of the email that I sent to my US Senators and Congressman today:

Dear Sir,

I'm deeply troubled by many facets of the proposed $700 billion financial bailout package currently receiving such extensive press coverage. While I can't claim to have a detailed solution ready for a problem of this magnitude, I would like to ask that you vote against any bill which includes or echoes the statement:

“Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.”

It seems obvious that preemptive removal of oversight and accountability in this matter would be criminally irresponsible, especially considering the contempt for regulation which helped to precipitate this mess.

respectfully yours,

Robert A. Ogden II

Andrew G, where I live, renting is only marginally less expensive than buying, for the same amount of space. The rental space available is decreasing as the rental market is increasing (decrease due to condo conversions, less expensive places being renovated into 'luxury apartments', and so on). Maybe your area is the other way around, but I wouldn't bet on it.

Also, the Republicans are investigating, in several states, any place with more than 10 people registered to vote, on the grounds that it's potential voter fraud. Most of those places are shelters for the homeless, or for battered women.
See a pattern here?

I don't think you can fairly say "securitization didn't solve the problem — if anything, it spread it around among financial institutions who weren't aware (although they should have been) that the long-term investment bonds they were buying were backed by toxic sludge" since the very nature of those securities obscures their contents. The ratings system exists for a reason and it's the mis-rating of so much of this garbage that has caused the issue.

If you've got to manage a money market fund, for example, you don't have the option to simply do nothing with the money. The money must be invested, but when nothing can be trusted anymore where do you invest it? Regulations say you have to limit yourself to certain types of low-risk high-rated investments.... like the issuing from the Maes.

The relevant section of the Paulson plan reads:

Sec. 6. Maximum Amount of Authorized Purchases.

The Secretary's authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time.

The view going around some of the econ blogs is that the letter of 'at any one time' could be met by writing down bad assets to remove them from the 'outstanding' balance. I'm not enough of a government accounting wonk to know if that's legal, but the risk is being taken seriously by some in the paranoid but not tinfoil hat paranoid crowd.

Further, section 8 of the plan, which seeks to exempt the Treasury from judicial oversight:

Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

could be a backdoor to spending unlimited funds simply by preventing anyone from checking exactly how much money the Treasury has actually spent.

Curmudgeon, Charlie, everyone,

The Paulson plan appears to be dead. All the preliminary reports and leaked drafts show some version of the Dodd plan is what will pass, authorized to some number far less than $700 billion.

Where's Charlie? It seems to me that we've become so accustomed to disfunctional and arbitrary government that people don't recognize it when the ship of state navigates as it is supposed to.

This is one of those times. Props to Congress.

Noel Maurer, it does seem that the Paulson plan has been overcome by events, but the devil is in the details.

I think you're being overly optimistic, considering that I think we're only getting descriptions of the bill rather than the bill. Personally, I doubt that the most excellent equity provisions in the Dodd plan will get into the final bill in any meaningful way. I believe that there was a Barney Frank version of the bill floating around that wouldn't grant equity from reverse auctions. That seems like a rather gaping loophole, doesn't it?

In this case, I would be quite pleased to be wrong.

Fungi, it seems as though everything is now up in the air, after that train wreck of a meeting. John McCain gets involved, and suddenly House Republicans are pulling out of the deal. Very strange.

My props to Congress may have come too soon.

And now we're making more versions of the penny, when we should stop using the damn thing.

Noel @80: Where's Charlie?

The pub. OK? (I am writing a book this month. I am de-stressing the rest of the time. I am not hanging breathlessly on the blog comments every waking minute of the day.)

Not acceptable! I am writing a book too. How dare you go to the pub! Get back to work.

Actually, that sounds like a good idea. Hasta.

Down the pub sounds like a wonderful idea. Whilst I am in Canada not the US I plan on moving back to Scotland very soon. I'll take my chances with devolution and the English gutting of the auld sod over the Empire of North America any bloody day...

Does anybody else worry about the masses of private equity deals in the last 5 or so years?

The way I understand it, its been a major trend to extract hidden value from successful public companies with good balance sheets by taking them private and loading them with debt. At least in the UK, I don't know about the US.

How much of this debt is floating on money market rates. I would have thought that some of these companies are close to the edge now. This could be the area where the contagion spreads outside of the financial sector.

The deal or something like it is essential. Something has to be done before the crisis gets out of control; a bad bill now is better than a perfect one a week from now.

It's annoying that it will give some help to the people responsible for this mess, but you can't rescue the financial system without rescuing the financial institutions, whose stockholders will still be taking a massive hit.

In the long run it won't cost the taxpayers much, if anything; the securities -are- based on real property, and eventually it'll be valuable again, given that the population is expanding and people do have to live somewhere.

And it's sort of a benefit to the taxpayers not to be in breadlines, too destitute to pay any taxes at all.

The credit market is about to seize up -- it already -is- doing that -- and the consequences are potentially utterly catastrophic.

Note this is not an American problem. The Bank of East Asia just had a run; the Scandinavian banks are putting together an emergency defense package; and we all know how things are in Britain, don't we? Note how the Russian stock market tanked.

We're talking a potential drop in the Dow of thousands of points and mass bankruptcies as companies can't dip into the money market funds for short-term credit to meet payrolls and such, with knock-on consequences around the globe in a domino effect of collapse.

Washington Mutual just failed; that was a bona-fide -bank-, with $308 billion in assets and $188 billion in deposits.

It got taken over by the Fed and sold to J.P. Morgan for $1.9 (that's one-point-nine) billion.

Which is considerably less than -one cent on the dollar-.

A business worth, theoretically, just under $500 billion sold for less than 1% of its face value. Not surprisingly, WaMu stock is now down 78% and falling fast, even before Wall Street opens in the morning.

The Fed is also shovelling $188 billion -per day- into emergency loans to banks.

That's more than three times the previous daily record -- which was set the week before, at $47 billion per day.

This is a situation where if you aren't in a state of gibbering panic, you're not paying attention.

Oh well, the shit will hit the fan soon enough, we'll all have time to panic then. (or rather: it will cover us all soon enough - the hit-event for me was August last year, when GWB announced for no apparent reason that the economy was fundamentally strong. I didn't know that things were quite that bad until then.)

Meanwhile, spread the word:

Soviet socialism failed 20 years ago, American capitalism lasted until this year.

Time for something new, not a new ideology, but some common sense and less hypocrisy.

Steve @ 88: A good analysis, but I still think the hype is overblown. Corrections like this are just ways of smoothing out the market, and everyone deserves what they get. Then again, I'm someone who thinks the Great Depression was better than the New Deal, so I'm off on the libertarian side of things.

The only positive thing about the bailout is that there's a strong potential for major public backlash in a large natural correction. I wouldn't want to see even more fascistic or socialist populism further down the road.

Andrew G. Given your disgustingly ignorant comments about Somalia above, I don't give a fiddler's what you think about anything. You amadan.

O'Kane @ 91: How are my comments ignorant, or are you agreeing with Charlie that Somalia is a good example of a libertarian minarchist state? I'm saying that it's a war-torn land beyond anarchy ruled by warlords and their ilk, but even with that situation it's still better off than the worst that a strong national government can do.

I think history backs me up here as well, totalitarian regimes have been much more harmful to the people of a nation than breakdowns in public order.

1. Is it better to be in a 'war-torn land beyond anarchy ruled by warlords and their ilk', as compared to being under a 'strong national government'? The history of the past decade in Africa would not back you up; the worst horrors (3 million dead, millions of women (and men) raped) we can see occurred in the eastern Democratic Republic of Congo, which (to put it mildly) has been experiencing a breakdown in public order.

2. Somalia, after the collapse of the state in 1991, experienced a period of conflict which left well over a million dead. . . as such, in terms of being 'harmful to the people' it compares very favourably with cases of state-inflicted such as those in e.g. Sudan or DRC et cetera (and exceeds by a considerable margin the numbers killed as a result of Mugabe's action in Zimbabwe).

3. Somalia today, of course, is not a 'libertarian minarchist state'. The Union of Islamic Courts began to emerge in the late 1990s in response to the needs of the masses, and the private business sector, for some sort of new state structure. It had the potential (in spite of its obviously obnoxious Islamist ideology) to solve the problems of political order which were not spontaneously resolved by the removal of state structures. Unfortunately it ran up against the fact that it's neighbour Ethiopia has had a long-term foreign policy of keeping Somalia weak and divided, and the US policy of 'keeping the world safe for democracy'. In this case this meant US and Ethiopian backing for a 'transitional government', and a return to civil war between that government and the UIC (now backed by Eritrea). I think I already mentioned the effects this had on the civilian population.

4. Slavists and sovietologists still debate the validity and utility of the 'totalitarian' concept in relation to the USSR and its camp. Personally, I'd go with those who see the concept of 'totalitarianism' as fundamentally misleading. It is a concept that distracts from the fraught and partial nature of authoritarian rule. It's probably not a useful concept in relation to the USSR: it's definitely not useful in relation to any African situation.

5. What was the author and title of the last book and/or peer reviewed academic paper on Somalia, or any other African country, that you read?

I presume I'm not the only person who wonders exactly what the fuss is about? given that money is a figment of our imaginations, can't we just agree to vapourise a few trillion dollars of stupid lendings and leave it at that?

NickP #87- yup, that'll come back and bite us soon I am sure. It always looked to me like an odd combination of robbery and gambling.

Andrew G #65- its hard to work out how the gvt of the first half of the 19th century could be more like the ideal libertarian minarchist gvt than you could possibly require. They kept the courts, the army, and the poor in their place. Of course politics was run to a large extent by patronage, and the vote was not anonymous, moreover there was nothing like a universal franchise. The gvt did get into debt sometimes when fighting a way, but it paid it back however necessary. There were large numbers of poor displaced people, and slums, not to mention child labour and all the usual Dickensian things.

Funnily enough things only got better when 1) the working class really got organised, 2) there was a change of mind, insofar as it began to be seen as possible indeed desirable for the gvt to intervene in the public domain, whether with the Factory Acts or the establishment of schools and colleges, since it was a simple matter of fact that the laissez faire approach was not up to the job.

Have a look at the RAilway mania of the 1840's.
Possibly the only reason the minarchists don't like the 19th century UK gvt was that they could raise and lower interest rates, but then I am not so familiar with their haverings as to say what the actual reason is.

O'kane @ 93: Good points, it looks like civil wars are just as bad as state-sponsored killings. And there is a degree of overlap, it would seem.

And now that you mention it, it has been a while since I've read anything scholarly on Africa. Since college classes on African history really, 8 years now.

I hate when people use Somalia as an example of anarchy.

Somalia has a bunch of governments-some secessionist, some claiming authority over the whole country.

A lot of the glib claims about Somalian anarchy also focus way too much on Mogadishu. The current fighting between the Transitional National Government, backed by Ethiopian troops, and the Islamic Courts Union, is pretty much in Mogadishu.

One of the other problems with this is that Somalia in "anarchy" has had better economic growth than it did in the days when it had a central government. It's still a very poor country, though, albeit less than it was in the days when the Barre government was still around.

I still wouldn't recommend it as a model, but it's not "anarchy."

Noel @75--

IIRC, shareholders equity is an asset against which lending can occur for a financial institution. Consequently, if you bomb the stock price, the bank isn't allowed to lend as much money. Furthermore, if you bomb the stock price, other banks are less likely to lend to you. So diluting the stock price with the warrants works against both liquidity and trust-building, which is what this whole thing is about.

\Silly me, I almost forgot another important 19th century gvt intervention - the corn laws.

RadMod@97: not quite. There are minimum capital-asset ratios, but those are based on book value, not the market price of the stock. The confusion is understandable, but the stock price isn't relevant.

In addition, the stock price will certainly rise when the government buys the sludge. After all, any loss of equity to the government (if it occurs) will be no greater than the loss that would have occurred had the financial institution held onto the sludge.

Finally, you're missing some (subtle) arithmetic. If the government exercises its warrants, then there will be more outstanding stock for the same amount of equity. The price of an individual share will fall, but the market value of the financial institution's shares will not. And that's what you were worried about, even if you didn't need to be.

In short, the stock price doesn't matter, won't fall when the warrants are issued, and really doesn't matter because exercising the warrants won't affect the total value of the institution.

Hope that helped.

Boy, I really wish McCain hadn't done his little hissy fit. I no longer have a sense of humor about his supporters.

Guthrie@94: no need to bother. Seriously. He's not open to new information or logical deduction. I respect (albeit I don't like) hard-core libertarians who believe that their philosophy is morally right even though it will make society poorer and less equal; I throw my hands up in the air at those who stick their fingers in the air and insist economic growth will be faster in a country run under their rules. Ni modo.

Noel, there's more to libertarianism that just economics, even if that's the subject that seems to come up the most.

Personally I don't think that people could handle true liberty and freedom, but that's a failing of humanity not liberty. But I like to hope that won't always be the case, so I promote a better way. Eventually humanity will reach a point where it has to choose between totalitarianism and anarchism, and there is no middle ground.

imho, the surface of the financial crisis is due to a combination of lax regulation (put political appointees who don't believe in regulation in charge of the regulatory agencies will do that even without a change in law) and an understood promise to bail out the big boys (see the savings & loan crisis of a prior Republican administration, where it was fairly routine to compensate people beyond the $100,000/account that was actually insured), and you've got the basis of a problem. Add in a financial system based on making loans, which were immediately bundled up for sale to third parties, and you come up with this sort of risk analysis (from Martin Ward, Risks Digest Vol 25, No 35, http://catless.ncl.ac.uk/Risks/25.35.html#subj6)

"Success: My company hands off the package before it blows up. My company makes a massive profit and I end up fabulously wealthy. (Other companies make massive losses and have to be bailed out by the government, but hat is incidental).

Failure: My company ends up holding the package when it blows up. My company makes a massive loss and ends up having to be bailed out by the government. I end up extremely wealthy.

After careful consideration of all the risks and benefits, I decide to go ahead!"

Regardless of one's view on capitalism, an unsupervised free market is never going to work if the people with the most responsibility are those who are the most isolated from the penalties for failure.

Hang on a minute, how many of those mortgages in trouble are second or even third mortgages taken out to finance lifestyle purchases (cars, holidays, electronics, home remodelling, et unwise cetera)? When I lived in the UK I was shocked at how the majority of people seemed to be living on credit of some sort, whether playing credit card poker or re-mortgaging every other year, or just living off their overdrafts.

I am very sorry for poor people who were tempted into aspiring to home ownership, but from where I sit this looks more like greed than true poverty. People who were in no position to have a mortgage, people who lived off credit, people who went too far out on a limb - these are the people who will end up defaulting on mortgages. I object to my tax euros being given to somebody who built a conservatory with their third mortgage, while I beavered away at paying off my first one instead.

Hmmm. I'm a card-carrying leftie. Been so for many, many years. But I really don't see any winners in the western banking system going down the stanky. Yes, the banking system is crap in *oh so many* ways. Unfortunately, we're stuck right here, right now with the system we have.

So... do we let the banks tank? Inviting, certainly. Compelling... maybe not. Yes, there are deeply, deeply unpleasant people in banking who have been massively over-rewarded for their efforts. Those tw*ts are supported by thousands of colleagues who are, well, normal human beings. Kind of like you and me.

So... do we let the banks tank, just like the way the Tories let the manufacturing industries tank in the '80s? Inviting, certainly. Compelling..... maybe not. When "we" (this is a democracy, remember?) trashed manufacturing in the '80s, the plan was to build a brave new world based on service industries. In 2008 terms: much of the service sector is outsourced to counries with cheaper, higher skilled labour anyway.

So... do we let the banks tank? Well, frankly, no. Not if there's another option. Rescuing the banks and maintaining liquidity is still likley to be a better bet over an economic cycle than letting the banks go bust.

Don't get me wrong, I would still like to see the high-bonus-earning, speculative gambler, total tosspot banker-types up against the wall. Hand me the bullets, I'll shoot them slowly :) But punishing the rank and file employees of the retail banks for the idiocies of the high heidyins of the commercial banks is nonsense.

Col- one of the things us ordinary taxpayers have trouble with is, how come the banks can't try and separate their paper based bad debts and moronic lending decisions from their day to day lending. Try and corral them all in some way so a proper accounting can be done, whilst suspending trading in them. Meanwhile, lending can carry on to businesses based in the real world (like the ones that sell and buy things to us, or make things to make things to sell to us). Sure, the mortgage market might be damaged for a while, but given the banks have tightened up their lending already, what more damage can be done?

Few people actually want to crash the banking system, we'd rather the bankers themselves crashed after wallowing in gold at our expense for the past few years.

Paper-based bad debt is still bad debt, Guthrie. And I'm sure some of the banks are using the present climate to write off a few extra bad debts that they've been carrying for a while ;) But I'm with you on regulating banking to make it simpler and more transparent.
The banks whose business plan has been largely based on lending out money which is deposited with them by savers are significantly less vulnerable than the ones which relied on inter-bank lending for their liquidity (generally the "newer" banks and those with aggressive expansion plans - Northern Rock and, er, Bradford and Bingley spring to mind for some reason).
Much as I appreciate the terminology, unfortunately, I suspect that trying to seperate "sensible banking decisions" from "moronic banking decisions" is a judgement call, i.e. good decisions are the ones that make money, bad ones the reverse. Not easy (or possible?) to pick out the bad ones beforehand (otherwise why would the decision have been made in the first place?)

I agree with everything except this problem being the Bush Admin fault and it being run by rich people. The president only has powers given to him by congress. He was warning of this for years but congress did nothing (both Republicans when things were going good, and Democrats who did nothing when things were going bad and the evidence was there). Although that does not excuses the most recent behavior. There is a reason Bush has a better approval (36% verses 24%) rating than congress (http://www.gallup.com/poll/28741/Congress-Approval-Rises-Slightly-24.aspx). Bush will be gone in three months. Most likely most of congress who were more liable for this crises than the president ever was will be reelected are still be in office.