Month in Review October 2008: Part 1, “we’re all hosed”
Previous Months in Review available here: Sep 08, Aug 08, Jul 08, Jun 08, May 08, Apr 08, Mar 08, Feb 08, Jan 08]\
We’re here for the deleveraging party
For some reason worthy of study either astrological or numismatic, a surprising fraction of the world’s economic slumps have happened in October, including our two most recent: 1987’s Black Monday and 1929’s Black Tuesday. Might it have to do with Halloween, the eve of All Saints’ Day, the night when dead souls may walk the earth?
Paging the financially undead
Grim October grips the globe, so we will start a third of the world away, in
“Yawning is contagious,” I told the International Union of Housing Finance (IUHF) audience. “Sneezing is contagious. As we saw last night at the boma dinner, dancing is contagious.” Small chuckles. “Drinking is contagious.” Larger chuckles. “Risk-taking is very contagious. And for a decade or so, the world has been drunk with risk-taking, and become de-sensitized to it.”
“For most people, the critical number in buying a house isn’t the price, it’s the monthly payment. I can pay this much – how much house can I buy? That, in turn, depends on interest rates. When the market becomes inured to risk, spreads compress, so interest rates get low, so the same payment by me buys more notional value of a house. That’s where your bubble came from, and it hit housing mainly because housing is the world’s largest asset class and the one that everybody’s familiar with.”
In worrisome times, should you really stage your event with lurid blood-orange background?
In a coincidence whose deeper significance I decline to plumb, President Bush later described the situation with a metaphor eerily similar:
“There’s no question about it. Wall Street got drunk — that’s one of the reasons I asked you to turn off the TV cameras — it got drunk and now it’s got a hangover. The question is how long will it sober up and not try to do all these fancy financial instruments.”
– George W. Bush, speaking at a private fundraiser,
Preoccupying – indeed, obsessing – the IUHF attendees were the actions emanating from Washington, where first TARP was enacted, and then Treasury immediately put it to use, in an unexpected and cynically shrewd way, as I profiled in Banks, paying your rescuer: Part 1, you *will* do it, and Part 2, the fine print:
Reduction
In the event that the QFI has received aggregate gross proceeds of not less than 100% of the issue price of the Senior Preferred from one or more Qualified Equity Offerings on or prior to December 31, 2009, the number of shares of common stock underlying the warrants then held by the UST shall be reduced by a number of shares equal to the product of (i) the number of shares originally underlying the warrants (taking into account all adjustments) and (ii) 0.5.
If the bank raises as much as the Treasury money – and, presumably, uses it to pay Treasury back – then Treasury will have half as many options.
What it boils down to: you will take the money, and you should pay it off as quickly as you can
Once again, the financial rescue team has made a bold, aggressive move that’s used the bully pulpit and extraordinary executive powers to force through sweeping change. (It has other plans for the GSEs, which I’ll detail in a future post.) Just as the Treasury is banking on value, it’s forcing banks to raise their value – not necessarily for the banks’ individual interest, but for the country’s – and the world’s – economic health.
Scarcely had this bold move been executed than there came another, which caught me (and, as far as I can tell, the entire financial world) entirely by surprise, converting the into “my own private RTC”:
Now that the
Fannie, Freddie to Step Up Mortgage Bond Purchases
What? I thought. This is what got them into trouble!
Neither Fannie nor Freddie has turned a profit in the past year, accumulating $14.9 billion in combined quarterly losses, largely related to bad subprime and Alt-A mortgage assets.
Subsequent events reinforce this perception, as Fannie/ Freddie will be taking additional deep writedowns, clearing the decks for a restructuring of their asset pools.
Clear those writedowns now!
Now it was directing its new captives – Fannie and Freddie – to buy TARP assets, in a manner that doesn’t count against the TARP ceiling?
In Charlie and the Chocolate Factory, each evil child who received a golden ticket dies horribly in a gluttonous overdose of his or her previous craving. (You can imagine what might happen to Augustus Gloop.) Now the GSEs, whose recent overindulgence landed them in conservatorship, are forced to eat up everyone else’s leavings, at the rate of forty bil a month.
“I’ve got the Golden Ticket!”
[Snip]
When I wrote those words, I thought Treasury itself would be doing the restructuring … and scarce days later, Treasury declined that role, preferring instead to inject capital into quiescent banks and leave them with their own assets. But somebody has to be the subprime RTC, and if it wasn’t going to be Treasury, who could it be?
Who gets the Golden Ticket?
The GSEs are probably better positioned to do it than anybody else. Who needs a new Resolution Trust Corporation when the government already controls two entities that already bought a lot of these assets, and that are in the business of making loans – and hence, need to be in the business of fixing them?
Using the GSEs as the new RTC clearinghouse makes Willy-Wonkan sense, doesn’t it?
I also devoted a great many words to debunking cocktail-party myths about the financial crisis – we can certainly call it that now – in What the financial crisis isn’t: Part 1, the situation, Part 2, the blame game, and Part 3, the way forward:
Yesterday we knocked off a handful of things the credit crisis wasn’t:
1. Not an asset bubble … a systematic under-pricing of risk.
2. Not caused by subprime lending … although that was the miner’s canary.
3. Not principally about the GSEs … because other financial institutions are in much worse shape
4. Not just about housing … although that is the biggest asset class
5. Not specific to the
If the conventional wisdom about our situation is all wrong, what about the blame game?
B. Who or what caused it?
6. It’s not proof of ‘under-regulation’ …
… provided we have a reasonable definition of ‘regulation’.
This would never have happened if we told them not to
‘Regulation’ can mean any of the following, which we can examine in the common example of driving, which is regulated.
None of these regulatory elements existed when cars were first invented, because advances in technology – whether physical, as in cars; medical, as in drugs; or financial, as in securitization/ derivatives – always outpace both marketplace response and regulatory schemas.
That, in turn, led to commentary on an insightful and blunt mea culpa by an anonymous banker –
Billed ‘We’re All Hosed’: A Wall Street Insider on the Economic Crisis, this Yahoo Finance interview with “a veteran banker at a major Wall Street investment firm,” though anonymous, rings true – and is worth hearing as an Oh-my-God retrospective on the credit fiasco, as from the confessional: Bless us, Father, for we have royally screwed up.
Bless me, father, for I have manipulated complex derivatives
– in From the confessional: Part 1, we’re all hosed, and Part 2, I’m not greedy, what about you?
The penitent banker never addressed this, but the answer is simple – when the baby boomers retire, their pensions are going to be devalued through inflation. It is ever thus.
Q: What about the characterization that the greedy Wall Street bankers made their millions in the boom and left others holding the bag?
A: Everyone on Wall Street wants to make as much money as he can — we’re not missionaries.
Greed is my term for your taking a risk or getting a benefit I didn’t.
You think I’m greedy?
[Continued tomorrow in Part 2.]
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