Posted on 09/18/2008 5:36:23 PM PDT by JasonC
Riches created for people who personally didn't have to account for or be proud of their own decision making.
A recipe for disaster via disgruntled, prudent, and thoughtful producers who make the loans available in the first place via true and honest hard work.
Individuals are becoming obsolete in a society directed by government via political dictate.
Soon it will be realized that individual "down and dirty in the trenches" production is where prosperity is derived and then the "promise mongers" of government who promote "change" will be left holding the bag.
Lets hope that it doesn't get to that point politically.
Oh goody. Another leftist who thinks he can stop short selling.... No wonder you think Barney Frank is an example of good leadership and a fine 'technocrat'.
I knew it would take less than 5 responses to me for you to reveal your true colors.
Companies get 'shorted' because people realize they're worth far less than they say they are, and often times they're completely correct.
Next you'll be saying we should imprison people who 'go long' on companies.
As I said, you're quite mad.
L
I agree with your analysis but not your conclusions.
I’ve been discussing this all day here and had my opinions confirmed by a panel on (can’t remember, Cavuto or Hume).
The problem now is liquidity (which is why the Fed has injected some $150 B over the last three days, in addition to everything else it’s done).
Why is there a problem with liquidity?
Because the banks can’t get rid of (sell) any of these mortgage backed securities they have a value of $0.
Now obviously, the real value of these securities is not zero, but since they can’t sell them, they might as well be.
Let me try an analogy:
I lend my friend my Porsche (OK, I don’t really own a Porsche) so he can drive to Vegas. The next day, I get a call from my friend saying “Sorry d00d, got in an accident”.
At the same time, I need to sell the Porsche to meet a margin call. I tell the margin guy ‘Hey, I’ve got this Porsche I’ll give it to you to meet the margin call, but it was just in an accident.”
Margin guy: “Well, what kind of accident? What’s the Porsche actually worth now?”
Me: “Uhm not really sure since I don’t have the details.”
Margin guy: “Uhm, no thanks. Pay me in cash.”
The Porsche, like the real property backed mortgages have value. We just don’t know what that value is. Once we know what the value is we can move forward.
These mortgages aren’t tulips, they are backed be real property, real houses on real ground and mostly in areas with growing populations. Five years from now, this property will have regained any ground it lost from the housing bubble, and the mortgage securties backing them will be valued back at 100%.
Here are the worthwhile classics.
Manias, Panics and Crashes by Charles Kindleberger. If you have the time, also his Financial History of Western Europe and The World in Depression. Lombard Street by Walter Bagehot, still the classic manual on how a central bank operates.
And also, to be used with caution but still essential on these matters, The Theory of Money and Credit by Ludwig von Mises. With caution because some of his ideas on the nature of capital were untrue and unsound, and some of his ideas on currency reform inpractical and ill-advised. But his understanding of the subject is still very high. He gives the Austrian view of cycles and the role of monetary policy errors. He is quite wrong to think cycles are entirely due to recent government forms and specific monetary policy mistakes, however, as Kindleberger's abundant historical evidence, most of it from far older times, makes plain.
Kindleberger is the essential corrective to Mises' ideological excesses, being empirical, pragmatic, and sober enough to live in this world, instead of in one he only hopes for or dreams about.
It is also worth knowing the investment side of things from the likes of Ben Graham (Security Analysis, the original 1932 edition).
I hope this helps.
Very interesting idea, but I’ve got a couple of questions.
1) Is their nothing in the FR’s charter that would prevent them from acting as a competitor to the banks and investment firms?
2) If they can, why would it not apply to other “busts” the economy encounters (the oil bust of the late 90’s would come to mind)? IIRC many firms were shorted out of existence, but held long term profit potential. I just might not understand what conditions apply that would make a situation suitable for your proposed strategy.
3) Does Bernanke have the stones to even consider something like this?
3) This isn’t quite on the same subject, but since you mentioned it, is the bulk of the mortgage losses actually due to the small ($100,000 range) borrower or more of the larger mortgages up to the $417,000 jumbo limit? All the data I have seen shows the worst losses in some of the most affluent areas, particularly suburbia. I’m just curious, I’ve not been able to find a breakdown of the mortgage losses based on income levels.
Thanks for the post, it is certainly food for thought.
You are free to realize that a company is worth a lot less than its current quote and short it - and if it has to pay 14% to borrow money, it may indeed be dead meat. But if its bonds are so well bid it can borrow at 6%, it may entirely sound and profitable and worth a lot more than you thought it was, when you shorted it because its bonds were trading at 14%.
But I don't want to imprison shorts. I want to take all their money in the open market, fair and square.
BM for later
It has been interesting to see the treasuries rise and demand for the dollar go through the roof. Musical Chairs on an epic scale
The conditions that need to apply are that the company whose debt is purchased has to be profitable or viable long term, and thus a sound credit, if it can borrow at normal undistressed rates - that is one. And two, the market must have a high demand for dollars and an aversion to risk at the time. You could not possibly do this sort of thing in 1980 with T-bills at 14% and upward, and inflation in double digits. They can get away with it now because the threat is deflation, and T-bills are at zero, and everyone is scrambling to get *into* cash, not out of it. This means the extra dollars they create when they buy securities net, will not be repudiated by the public, and so won't simply stoke price increases and interest rates.
So, there is a company specific requirement of soundness if it can get financing at reasonable rates. For instance, GM or Ford today would not obviously meet such requirements, because they were losing billions even at normal interest rates. Nor would airlines regularly going in and out of bankruptcy, due to competition and overcapacity. And then there is a market cycle or timing or monetary policy situation requirement, that the threat be deflation not inflation, and the rates on new dollars issued very low rather than very high. Call it a micro and a macro economic requirement. Both are met right now.
On 3, yes Bernanke definitely has the stones to consider something like this. He cut his teeth studying Fed misteps in the great depression. He is sometimes ridiculed as "helicopter Ben" for the idea that deflation can be prevented by just creating money aggressively enough - dropping it out of helicopters. In fact he was quoting none other than arch-monetarist Milton Friedman on that point. Even Friedman agrees the Fed screwed up in the 1930s by being so insanely tight, at the wrong time.
But yeah, if he thinks the alternative is a deflationary collapse of banks, money supply, and dragged by them, demand, Bernanke is exactly the kind of guy who would do something like this. He has already shown himself far more willing to use new and unorthodox means to address this crisis, and precisely to use more targeted interventions, instead of the blunderbuss of just leaving rates near zero forever and waiting for the market to come around.
On the where and amount of losses, the answer is mixed. Most *foreclosures* are to quite marginal buyers of quite low priced structures, often very old ones, that no one else wants when the previous owner defaults. There are large numbers of foreclosures in Detroit, distressed areas of Cleveland and the rest of the industrial midwest, and some in the rural south, that are of this character. There are also large losses and many foreclosures in the cheaper inland areas of the California valley, where prices are a fraction of what they are in the rest of CA, but high by the standards of the lower end of markets elsewhere. What I mean is you can have poor working families, including many recent immigrants, in run down places with $250,000 price tags, in that area. And foreclosures there have certainly been high.
But the largest mortgage *losses* have happened in coastal Califonia and Florida, as both overpriced and overbuilt, and in inland boom towns of the past decade like Las Vegas and Phoenix, where prices moved up from quite low levels, well below Northeast levels e.g, but could not sustain those levels because new houses on cheap desert land could be produced rapidly to meet any demand. You got houses outside both that went for $325000 at the top that can't ind buyers at half that today - with others farther away from the city centers built late and not filled, sitting empty with price tags $25,000 lower.
In Florida is was especially condos, a large portion of them speculative investment properties or second vacation homes. In California the prices just got insane. Some of that in the northeast as well. People squeezed into more house than they could afford. Only in the NE and CA are the over $417s the bulk of the middle class market, though. All the other places readily fit below the Fannie or FHA limits.
Fewer of the pricey coast stuff is going into outright foreclosure, but there are late payers, lots of cases of large price declines or negative equity. The biggest culprit on those places were ARMs used to squeeze into more house, which goosed the prices, and cash out refinancings that levered higher and higher as the prices zoomed. Buyers and refinacers from 2006 or 2007 are defaulting in large numbers, while those who did so earlier had enough equity they mostly haven't. Some still might, though, as the economy weakens. (Job loss foreclosures or forced sales, rather than price drop induced ones, I mean).
Fine questions all. I hope the responses help.
The responses did help, particularly about Bernanke’s aversion to deflation.
I hope someone forwards this to him.
Thanks.
The loans were not originally made in the expectation that all the borrowers would stay current on them forever. That is the aspect of all this few ever discuss, because it involves math and not mere moralizing and principle, so it confuses people (lol). In fact the typical assumption for a subprime loan bundle was that around a third would default within 10 years.
Here is how the "shoulda been", planned math was expected to work. The loans weren't expected to live very long. In five years lots would sell and move and the loans would be repaid by the new buyer. Others would improve in credit standing as the house price rose and they got equity, and even if they later defaulted that equity would afford some protection. Or they'd refinance to get some of that equity out, or to lock in a lower rate once they had equity and a better credit rating, and a new lender would be on the hook, not the original one.
Others would default, a lot of them, and a few would keep paying at the higher subprime rates.
Ok, then the math is, you get a higher than normal rate on all of those but the defauling portion, and you get back principle rapidly on a lot of them. What do you lose on the third that default over 10 years? Depends on what you can sell the house for afterward. The operating assumption was that foreclosure and such would cost something like 30% of the property value.
There was typically some sliver of equity. There was frequently private mortgage insurance, which lenders expected to cover much of the difference between the equity sliver and the realized price of the house. They did not realize that if tons defaulted at once, the mortgage insurers did not have the capital to take the whole hit, themselves, so the PMI was no protection.
But leave all that aside and assume you lose 30% on the third that default. Sounds ruinous, but if it is spread over 10 years it is 3% a year defaulting and 1% a year lost. The rate on the rest more than covers that.
Such were the original assumptions. Notice, crucially, they did not have to believe there wouldn't be lots of defaults. But they did have to believe they'd be gradual, and that the house would afterwords bring most of the original loan price.
Neither assumption has proven true for the 2006 and 2007 loans. Some were for the earlier ones, 2002 to 2004, which built up equity during the bubble. But the later ones defaulted not a third of the time in ten years, but more like a third by the end of the second year. Or half. And the losses taken on them were not 30% mitigated by equity and PMI. They have been running more like 50% and upward, counting work-out costs. Sometimes 70%.
Well, if you lose 50-70% on 50% of the loans, you aren't going to make it up with a 2% higher rate on the other 50%. You are going to lose a ton of money, outright, and forever. Not 100%, but easily 20-30% *per year* as long as things stay that bad.
Next, rates you need to earn aren't standing still. Today you can invest at 10-11% in high rated corporates of disfavored sectors. If anyone is going to take the risk of a toxic mortgage bond instead of that, they need a much higher rate of return. You therefore have something that might eventually be worth 25 to 50 cents, being discounted at 15 and 20% interest rates, because of the 5 to 10 years it will take to see that 25 to 50 cents. That means they are fairly worth today maybe 5 cents and maybe 25 cents. But not 100 cents.
Not just illiquidity, but actual loss, due to the assumptions made when entered into and priced having turned out to be false.
Then the banks want to get that behind them so they write them down rapidly, with the idea they can report improved earnings later if things don't wind up that bad.
The only saving grace on that stuff was the fact it wasn't that big a portion of overall portfolios many times the size. Subprimes were a fairly large portion of mortgages written in the last few years of the cycle top. But mortgages get written gradually. There are always lots of older ones around, mostly still paying. Sure the defaults on the prime ones have risen too - but like from 0.5% to 1.5% - a number where recoveries on the one hand and interest spread on the other, readily cover it.
The subprime losses aren't going to come back. But the total losses from all of it will only amount to $1 trillion, half of which has already been paid out of earnings or raised as new capital. Meanwhile, market prices have dropped not the remaining half a trillion, nor a couple trillion on a pessimistic view of future losses. Instead they have dropped $19 trillion, on panic and destruction caused by the fight to get away from the still unallocated portion of the original loss.
The scramble losses vastly exceed the original mortgage losses. They are primarily caused by higher interest rates, specifically higher risk spreads since the Fed has cut short rates and treasury rates have fallen across all maturities, though less on the long end. Corporate rates for non finance companies haven't fallen - the spreads they pay have widened instead. And for finance and real estate companies, the spreads have widened to junk bond levels. Double digits. People simply have no confidence the losses so far will be controlled or the end of it. And without moderate rates on the cost side, that lack of confidence can be a self fufilling prophecy.
No financial institution can survive borrowing at 12% to lend at 6%.
That, and not the original losses on mortgage paper, is now the problem. And it is much larger, because it effects not a few securities on the asset side of the balance sheet, but nearly everything on the liability side.
The deposit banks are weathering it all best because they can borrow from depositers at 3% on CDs and such. CDs can be sold at 3%, even while the same bank's bonds go begging at 10%, because the former is insured by the government and the latter are not.
We can drive that spread narrower by simply showing the confidence others are not showing, on a sufficient scale. The Fed can do that credibly, because no one can doubt the scale on which it can act, and everyone can see it can fund its own liabilities at zero, or nearly so.
Hence the proposal...
Again, agreed.
But, all these multi $ trillion numbers are based on multiples of the original risk, and are based (currently) on the idea that the original risk is worth zero (because NOTHING can be bought/sold at the moment). The fact is that the value of these is worth somewhere between 0-100%, and likely closer to 100% than to 0% (again, this is real property on real land).
Are we going to have to write down maybe 40% of the irrational exuberance of the housing bubble? Probably. But we don’t have to write down all the multiples of that 40% because it’s all based on the same thing. It’s the same 40%.
mamzing how that contribution to the sub prime burst is never mentioned but bankers tell me it’s a sizable percentage
They are traitors to the bottom of their boots, and utterly worthless parasites.
Treason is a Capital offense. You made the accusation.
Then you said this:
No no, I don't want to stop short sellers
So which is it? Are they Traitors worthy of prison or death or are they players in marginally free market whom you wish to destroy using some as yet unidentified method?
You can't have it both ways.
You are free to realize that a company is worth a lot less than its current quote and short it - and if it has to pay 14% to borrow money, it may indeed be dead meat.
And if I bet that way and was correct you'd accuse me of 'traitorous' behavior and, one must assume, you'd bring the full force of Law down upon me for doing so.
I want to take all their money in the open market, fair and square.
Then by all means do so. Daily reports as to your successes and failures would be most interesting.
In other words, put your money where your mouth is and stop the incessant idiotic postings about how the Federal Governments increasing interference in the marketplace is somehow the 'right thing' to do.
It isn't. It's only going to make things worse.
And with your man Barney Frank at the helm of it, I'll wager my money against yours that I'm right.
L
But the reason the markets are down so much more than the original loss, is they have to pay much, much more on the liability side these days. The main reason is their own scramble to get out of the way of the losses still unallocated - the solution to that is to allocate them, RTC fashion for example - and the loss of confidence in their skill and judgment because of the whole crisis to date. Also a simple fear of unknowns (CDS, derivatives, etc).
How much the collateral is eventually worth is not the issue governing whether a given bank can survive, at this time. What rate it has to pay to borrow money to carry its assets, is. Drive that too high and any private financial institution in history could be made to fail, no matter what it holds.
BTT
A large part of the present crisis is a mere mechanical effect of dedicated shorts getting richer every time they kill another company. They made billions on Fannie and Freddie and they instantly threw those billions at Lehman and Merrill and AIG. They made billions more on Lehman and AIG and threw them instantly at Morgan Stanley and Goldman Sachs, much sounder companies. They are now operating on momentum and their firepower, and not on fundamentals. They are striving to create the fundmentals they need to justify further bankruptcies, in the form of high rates and an inability to raise equity, for financial companies.
____________________
Who is doing the massive coordinated shorting? American hedge funds? Foreign hedge funds? Russians? Iranians?
It helps very much, Jason. I’m not a complete neophyte but I am not too proud to ask guidance.
I am familiar with Hayek and Friedman. Ludwig von Mises, I need to read. More on the origins of European and American systems, as well.
Gonna get the Kindleberger book. I’m good with “Mr. Market” and I recommend “Margin of Safety” by Seth Klarman. Klarman is a Graham disciple who wrote with great clarity. Benoit Mandelbrot is great, IMO, if you care for critiques of modern portfolio theory(Gaussian Dist.)
Central banking is shadowy to me, and I’d like to improve my understanding. Thanks, again.
Half the left are traitors, but it doesn't mean I want to gas them. I just want to beat them in elections and prevent them from doing harm.
I had said "No no, I don't want to stop short sellers" --- meaning I don't want to make shorting illegal, I just want to defeat them. You know, force them to cover at twice what they sold stuff for. Will that stop them in a practical sense? Sure, they'll go broke and give it up. In a legalistic sense? No, they'll be free to give me (or the Fed) their money by shorting sound companies at prices far below what they are really worth, if they want to. Or they can wad up hundred dollar bills and light cigars with them, for all I care. But defeated, they won't be any great harm.
"whom you wish to destroy using some as yet unidentified method?"
Are you reading the thread? The method is fully specified. The Fed buys corporate bonds until the spread between corporates and treasuries closes by half, or it makes a trillion dollars profit pushing it that way.
I know that will rout the shorts. CDS quotes will move as spreads narrow. Corporate funding costs will fall. Debt will be rolled over successfully. Corporate underwriting and issuance will rise. Credit will flow to sound borrowers. Banks that are no longer afraid of spikes in their funding costs induced by panics will lend more freely, and continue dividends, and buy in stock, and raise capital on reasonable terms. All of which will utterly smash the self-fufilling manipulation schemes of the shorts, and force them to run for cover, and to buy back what they sold well above what they sold it for. Which will take their money, and with it their ammo and their case.
Simple really.
"And if I bet that way and was correct"
No see, I'm going to make your bet incorrect. Whether your bet is correct or not is not written in the stars, it is determined by the actions of others, including me and hey, whatya know, the Fed. If the Fed buys as you sell, the price isn't going to drop, and you aren't going to be right, or paid.
"one must assume"
Passive tense always betrays slippery logic. No, straw man, I want the Fed to help all of us take your money in the market. I don't need a policeman to take you away, it is enough for bankers to beat the holy tar out of you fair and square in the course of the trading day.
"Then by all means do so."
Yes but see, I don't fight fair. When I brawl physically I don't use fistacuffs by self propelled howitzers firing hundred pound shells, and when I brawl financially I'd rather get entire nations to buy the living crap out of you.
"put your money where your mouth is"
The dollar is my money. You know, the entire currency. I'll put that where my mouth is. I'm a citizen. As far as I can tell, you aren't, just a private self seeking parasite and nabob. The Fed is my instrument, mine among many and one among many of mine - the same as your broker is yours. Let's see who has deeper pockets.
And where exactly in the Constitution is that authorized?
Where exactly in the Constitution is any of this authorized?
Article and Section if you please.
I await your speedy response.
L
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