Affordable Housing Institute : US

[Previous Months in Review available here: Aug 08, Jul 08, Jun 08, May 08, Apr 08, Mar 08, Feb 08, Jan 08]

Tumult in the financial markets dominated my September postings, first with analysis of GSE conservatorship: what it means, and how we got here, which led directly into the hugely ironic spectacle of Treasury having so many powers it was forced to use some of them just to clarify the new rules, in GSEs, too many powers?: Part 1, chasing the bus:

 

I’ve got the powers, baby, and you don’t

 

After enactment of the landmark legislation that gave Treasury Secretary Hank Paulson the wheelbarrow full of powers he had requested:

 

Mr. Paulson started telling friends that after winning authority to intervene, he “felt like a dog who’d caught the bus and didn’t know what to do with it.”

 

Actually, as the New York Times chronology of the GSEs’ slide into conservatorship makes clear, enacting HERA gave Secretary Paulson too many powers – so many, in fact, that the potential for him to use any of them meant he had to use some of them, and much faster than he thought. 

 

Powers and abilities far beyond those of mortal markets?

 

Part 2, catching the bus, and Part 3, the bus catches you:

 

Mr. Mudd pleaded with Mr. Paulson to spare Fannie Mae, people with knowledge of the meeting said. He said that he abided last spring with regulators’ demands to raise more capital, adding that the company was in better financial health than Freddie.

 

Mr. Mudd is right on both counts – which makes Secretary Paulson’s response all the more revealing:

 

Mr. Paulson responded that Freddie was nearing a crisis and that, in the eyes of the markets, the companies were joined at the hip. He would not treat them differently for fear that similar problems, over time, would engulf Fannie Mae, but that time closer to the election. Mr. Paulson told both companies that they had no choice.

 

Gentlemen, you live by the duopoly, you die by the duopoly.

 

Putting both companies into conservatorship signals motives beyond the purely financial – and that’s very worth understanding. 

 

In a later multi-part post, I laid out The Paulson Doctrine(s): Part 1, prevent the second great depression:

 

The markets wanted rules – it’s been getting cases.  By their decisions ye shall know them, and stake by multi-billion-dollar stake, Treasury is defining the boundaries of what economic historians will come to call the Paulson Doctrines.

 

Based on what we’ve seen, here they are, in descending order of priority

 

1.  Prevent the Second Great Depression.  This is Job 1, and it’s always been Job 1.

 

That’s the lesson of the AIG loan.  Saving AIG had no explicit statutory basis – AIG is not a counterparty of the Federal government, not a regulated entity, nothing more than a gargantuan reinsurer of a myriad of risks scattered around the globe.  Treasury found some existing authority for its action – because Treasury went looking for it. 

 

We live our lives in morbid preoccupation over some remote risks and in happy ignorance of other much more severe risks all around us.  Just as we never think twice about the miracle of a cell phone call or how an email finds our Blackberry, we have faith in the pieces of paper in our wallets called money. 

 

You have to believe my signature is worth it

 

We accept that figures on a computer printout equal wealth.  We take for granted that money in the bank will be there for us when we want it – even if millions of us all want that same money at the same moment.

 

These beliefs can be shaken, and when they do, people panic. 

 

This led into Part 2, as little as possible, if that, which finished up on this metaphysical note:

 

Deism, a philosophy numbering among its prominent adherents Voltaire and Thomas Jefferson, holds that when God made the universe, He created rules and then sat back to watch it operate, as if it were a vast clockwork mechanism whose movements were equally fascinating both to men and deities.

 

We dance to God’s tune

 

A deft straddle between the Enlightenment’s need for reason and the scientific-method approach to understanding, and the corresponding religious and political need not to repudiate Christian (particularly Catholic) orthodoxy, it enabled science to advance without overthrowing dogma.

 

Markets cannot cope with omnipotence; they need rules, and they need science.  I don’t blame the troika for issuing decisions rather than writing a new financial constitution – there will be time for that.  But stake by multi-billion-dollar stake, Treasury is bounding its own powers, and binding itself to the principles of the Paulson Doctrines.

 

I resist the siren call of omnipotence

 

Finally, I finished hopefully – “it is better to travel hopefully than to arrive” at the postulate that Treasury will make a potful of money on its Troubled Assets Recovery Program, in Bailout or bonanza? Part 1: what do you do?, and Part 2: buy low:

 

And thereby is the essence of a panic price-fall: even if it’s the most valuable thing in the world, a commodity drops in price when nobody’s buying it and everybody’s selling it.

 

Why this weighs on the banks: Vermeer or velvet-Elvis?  Banks – for that matter, any public company subject to Sarbanes-Oxley and FASB regulation – are under a duty to report their assets at fair value.  The concept of ‘fair value’ is easy to comprehend when assets are standardized and freely bought and sold every day.  When the assets trade infrequently, and when they’re very particular, what are they worth?

 

As an example, consider the paintings of Jan Vermeer.  In his entire life, we know of only 35 paintings that are indubitably his.  Each authentic Vermeer is a masterpiece.

 

This is a masterpiece

 

Suppose that your bank owned a Vermeer, and was carrying it on their books at a certain value.  You would be happy – it’s rare, it’s marvelous, and the collectors would line up around the block at Sotheby’s to buy it.  You loved it so much you put it into a huge wooden crate and stored it in your vault, with a big stamp labeled VERMEER.

 

Now suppose that a bulletin is issued suggesting that nearly all Vermeers in the world are fakes painted by a celebrated Elvis-on-velvet painter.

 

This isn’t a masterpiece

 

You want to sell.  Everybody wants to sell.  The Price of Vermeer-or-velvet-Elvis plummets.

 

Worse, every Vermeer-holder in the world suffers a massive writedown in the value of its Vermeers.  Once the panic spreads, nobody’s Vermeer is believed until it’s been professionally appraised.  All the appraisers, meanwhile, are overworked, and their confidence too is shaken.

 

If all the world’s Vermeers are fakes, then most of the world’s banks are bust.  No one will buy a claimed Vermeer because no one can afford to take the risk of being inauthentic.

 

Conversely, if you know all but two of those Vermeers were the real thing, you could make an absolute killing by buying all of them, now, when the price is so depressed.

 

Who’s got that kind of money?  Who’s got that patience and guts?

 

Enter the man whose name is on the money: Treasury Secretary Hank Paulson.

 

I’m the only buyer?  What fun!

 

Mickey Kaus of Slate thought enough of the post to link to it with the since-vanished tag line, “Explains Paulson better than Paulson.”

 

Tuesday, September 30, 2008

TARP, Baby! Veteran Fannie Mae critic David Smith builds on Andy Kessler to explain why Paulson’s “troubled-asset” purchase plan may make sense. The taxpayers could even make so much money that the government could fund … national health care! (Take that, Jim Lehrer.) …

 

Kaus tries to ward off being reverse-linked by AHI

 

As usual, Smith’s post is exceptionally easy to follow for those (like me) who don’t understand fancy financials. It’s a particularly useful antidote to Krugman’s critique–which seems to assume, in at least one of its forms, that the government will only pay the current, going, distressed market price for the assets it buys. Smith argues it could pay more than this going, “immediate” “market” value and still a) be driving a reasonably hard bargain, b) boost the economy by freeing up capital, and c) make money down the road. ..

 

And that was only part of the month:

 

Just arrange the blog parts so every mule has a rider

 

[Continued tomorrow in Part 2]

Send post as PDF to