Flash - Bailout package voted down

[techweenie]

Just when you thought you'd heard the worst of it, you find out about the shaky $55 TRILLION CDS situation:

http://tinyurl.com/4j9q7o

[dtw]

Have been doing some research today. The money market guarantee is now in effect, but there are strings and such. If you are currently assuming you are covered, don't. Check with your brokerage to see if they are participating in the guarantee program, and if your specific fund is going to be eligible/covered. Note that coverage is only available for the shares you had as of 9.19.08. Of note: if you had money in there on 9.19, but pulled out, you can reinvest in the same fund (up to your 9.19 level) and still be eligible for the guarantee.

There's an extremely attractive fund I track on a daily basis. They had $54B in holdings in mid-September. They are down to $22.2B today, but their yield is now over 3%. Everyone is flocking into government security funds and taking the hit on yield. Treasury bill money markets are below 1% yield, but people are buying all they can get. The brokerage I'm working with is turning down buy requests as small as $11M (that's a really small amount for an institutional customer, which I am).

One thing you may find interesting - Paulson's MM guarantee requires a not-insignificant payment for participation. That the program involves some 'sting' for banks is a good thing, IMHO. My brokerage will be paying tens of millions for coverage. They sent in their paperwork (and presumably, a big fat check) today.

[jyl]

That's interesting. If a new investor buys into that particular fund today, he/it would not be covered by the govt guarantee, correct? So I suppose the investor would have to weigh the reward of the additional 200bp yield for the next few months, versus the risk of not having the govt backstop.

[dtw]

Originally Posted by jyl

That's interesting. If a new investor buys into that particular fund today, he/it would not be covered by the govt guarantee, correct? So I suppose the investor would have to weigh the reward of the additional 200bp yield for the next few months, versus the risk of not having the govt backstop.

Correct. So the situation I find myself in, is having a large portion of excess cash in the high-yield fund. I haven't made any more purchases since 9.19, and I haven't redeemed anything either. However, we've also got a lot of excess cash in disbursement accounts, which have overnight sweeps into - natch - FNMA/FHLMC MB bonds. We had an emergency conference call today, and the first reaction was to move everything into T-bills. Ultimately, this evening I recommended keeping the existing funds in the high-yield money market. The excess cash in the sweep accounts, I recommended be moved into the T-bill money market fund. They've got an ultra-conservative fund that invests ONLY in Treasury securities - NO repurchase agreements. The yield is something like 67 bp, but get this, that's about what I'm getting on my overnight funds. So it seems like a no-brainer to me...I've been pushing to consolidate cash anyway - we've got accounts all over the place. When you get into a mode like this, where you need to know where you stand, and fast, it is a pain in the ass to have to check stacks of CUSIPs. But I digress...



Bill, I read that article start to finish. Hmmm, looks like the ghost of Enron is going to continue to spook markets for years to come. While Dubai is now the Wild Wild West of banking, it is perversely comforting to see ingenuity like this still at work in the USA. After the sensational intro to the article, which impresses with big numbers, it goes on to say that the big numbers being thrown around are on the notional amounts of the derivatives. Reality is, a very small fraction of that number would actually come due, even in the absolute worst melt-down scenario. Hedge funds would likely represent the majority of the parties left holding the bag. That makes sense, conceptually. Bed made, lie in it. The unregulated nature of the derivatives are a little scary, should that volume of CDS get triggered. Some common-sense legislation would seem to apply -

-Only parties with skin in the game can purchase instruments (this is similar to what many are currently saying about petroleum futures trading - you wanna buy futures, you gotta take delivery. While this is not practicable, the message is clear - stop diddling in the market if you don't have skin in the game - go to Vegas if you want to play games).
-Total notional positions in a given derivative should not exceed the underlying (can't have $2.5B in hedged notional on $250M of at-risk instruments). This would follow naturally from the first point.

Good to see you back on the board, Bill.

[techweenie]

Hey, Dave, thanks.

Wrapping up 2-1/2 years of getting a new company off the ground. It's pretty consuming. And of course, we're trying to ramp up revenue while people are sketchy about their financial futures... I figure if you can launch a business in a recession, you have a winner.

So, there are a ton of moving parts to this financial mess and I read today that the Fed has authorized printing an additional $630 billion bucks. Now, correct me if I'm wrong, but isn't that an inflationary action? I mean the amount isn't overwhelming, but if the $700 billion goes through, it starts to add up to a chunk of change.

The $630 billion dilutes the currency now issued, right? The $700 billion is all borrowed, since we're running at a $438 billion deficit in this fiscal year. So that means about $1.1 trillion borrowed, not including the costs of the war(s) which are "off budget."

The debt load is staggering right now (http://mwhodges.home.att.net/) so what's another trillion or so?

As Business Week recently noted: the US' biggest export is debt.

At some point, we have to let the marketplace "reset." At some point, we have to re-regulate the financial folks in a way that keeps up with evolving financial instruments. Maybe now is the time

[911teo]

Originally Posted by techweenie

Hey, Dave, thanks.

Wrapping up 2-1/2 years of getting a new company off the ground. It's pretty consuming. And of course, we're trying to ramp up revenue while people are sketchy about their financial futures... I figure if you can launch a business in a recession, you have a winner.

So, there are a ton of moving parts to this financial mess and I read today that the Fed has authorized printing an additional $630 billion bucks. Now, correct me if I'm wrong, but isn't that an inflationary action? I mean the amount isn't overwhelming, but if the $700 billion goes through, it starts to add up to a chunk of change.

The $630 billion dilutes the currency now issued, right? The $700 billion is all borrowed, since we're running at a $438 billion deficit in this fiscal year. So that means about $1.1 trillion borrowed, not including the costs of the war(s) which are "off budget."

The debt load is staggering right now (http://mwhodges.home.att.net/) so what's another trillion or so?

As Business Week recently noted: the US' biggest export is debt.

At some point, we have to let the marketplace "reset." At some point, we have to re-regulate the financial folks in a way that keeps up with evolving financial instruments. Maybe now is the time

I agree with everything you said. Especially the last sentence. Right now it is not the time.

I am pretty sure nobody wants a depression. So the argument here is that some folks do not believe the financial crisis will lead us into a depression if left alone.

I think the risks of not intervening outweigh any possible argument about wanting free markes, "socialism", spending 0.5 of GDP.

I just want to remind everybody the consequences of the severe depression the world suffered at the beginning of the 20th century.

This is a great article you can find on today's Financial Times

http://www.ft.com/cms/s/0/0fa9d526-8eec-11dd-946c-0000779fd18c.html?nclick_check=1

It is just over three score years and ten since the Great Depression. Judged by its rejection of the plan put forward by Hank Paulson, US Treasury secretary, Congress believes it is time to risk another one. That slump was, arguably, the greatest catastrophe of the 20th century: it was, among other things, responsible for the events that led to the second world war – not least Hitler’s rise. One can only imagine what horrors a depression might bring now?

Such forebodings must seem exaggerated. So, I expect, they will be. But that dire outcome is no longer impossible, not because a slump is inevitable, far from it, but because action is needed to prevent one.

We are watching the disintegration of the financial system. Finance is the web of intermediation binding economic agents to one another, across both space and time. Without it, no modern economy can survive. Yet that is now threatened, with the ongoing collapse in trust and flight to safety. We can indeed run this experiment. But why should we?

Even before Congress rejected the plan, the spread in dollars between the London interbank offered rate and expected official rates (as shown in overnight indexed swaps) had reached more than 200 basis points, for a period as short as three months. Prior to the start of the crisis in August 2007, the spread was negligible. (See chart.) Nor is this all: on Monday short-term yields on Treasury bills were below 1 per cent; credit default swap spreads on financial institutions reached exceptional levels and credit spreads on riskier bonds were widening rapidly. In the aftermath of the plan’s rejection, all this was likely to worsen. The S&P 500 also fell by 8.8 per cent on Monday, its worst day since October 19 1987. Nothing can better demonstrate how absurd it is to believe one can punish Wall Street without hurting Main Street. The two streets meet. That is what streets do.

If the financial system ceases to function properly and a range of financial institutions collapses, everybody will be hurt, as businesses and households are starved of credit. What is occurring now is a downward spiral of panic in which liquidity-starved financial institutions dump assets, weakening themselves and others, particularly now that their balance sheets are marked to market. This reduces their ability to lend and so undermines asset prices and the economy still more, thereby further damaging asset quality.

This, then, is “revulsion” – the final stage of a bubble when, as the late Hyman Minsky argued, investors are so scarred that they can no longer bring themselves to participate in the market. Unfortunately, among today’s panic-stricken investors are banks. These even wish to avoid lending to one another. As I noted last week (“Paulson’s plan was not a true solution to the crisis”, September 23), the gross liabilities of the US financial sector have soared from just 21 per cent of gross domestic product in 1980 to 116 per cent in 2007. A huge part of these massive liabilities must be from one financial firm to another. If credit is not extended, collapse will follow. This is why the investment-banking industry disappeared within weeks.

Against this dire background, what is one to make of the failure of Congress to ratify the plan? It is both understandable and a gross error.

It is understandable because the use of taxpayer money to buy so-called “toxic” mortgage-backed securities from the greedy fools who created the crisis is hard to tolerate. It is also understandable – even creditable – that those Republicans hostile to “socialism” do not want to bail out the undeserving rich, at least before an election. It is understandable, too, because, for reasons I put forward last week, the plan is not convincing. It is designed to deal with a problem of illiquidity in what seems certain to be a growing crisis of insolvency, particularly as house prices fall and the economy continues to weaken.

Yet the rejection is grossly mistaken because the resulting ruin will hurt the weak and destroy the legitimacy of the market economy. The plan is indeed flawed. But failure to ratify it is unlikely to convince anybody that something better will be forthcoming. It will convince them, instead, that the US is choosing to be impotent. At a time of such fragility, when the insurance offered by government is most indispensable, this is the worst possible message. It is a pity Mr Paulson did not choose another plan. It is a pity, too, that a former titan of high finance was charged with bailing out Wall Street. Yet it was still a mistake to reject the plan. It was necessary, instead, to build upon it.

What now? The first effort must be to find a plan that Congress can pass. It is quite possible to find one that protects the taxpayers’ interest better, by insisting on full reimbursement, after assisted companies return to health. Buying preference shares, as Warren Buffett did in Goldman Sachs, would be a good way to do this.

Second, it seems likely that a number of significant financial institutions will find it hard to fund themselves in coming days, as their share prices weaken and interbank lending is frozen. Central banks must make every imaginable effort – and a few unimaginable ones – to make sure liquidity needs are fully met during this period. The Federal Reserve may find itself having to rescue additional institutions. So, alas, be it.

Third, Europeans (among whom I include the British) must recognise they are in the same boat. In times of such peril, even a small cut in interest rates by the European Central Bank and the Bank of England would send a helpful signal. It is now most unlikely to prove inflationary.

None of what is happening is easily palatable. The need for a rescue is hard to swallow. The emergence of bigger and even more complex financial behemoths – all too big to fail – is a harbinger of crises to come. Yet, while one must consider the long-run implications of how a crisis is resolved, one must resolve it first.

Franklin Delano Roosevelt famously said that “the only thing we have to fear is fear itself”. In truth, the economic processes unleashed by the bursting of the housing and credit bubbles are real. But fear is also a danger. When confidence collapses, a market economy cannot function. It must now be restored.

The problem is not lack of knowledge of how to do this: we know how to recapitalise and restructure damaged financial systems. The problem is lack of will. Government must start to show it is in control of events. In the twilight of a failed US administration, that may seem far too much to ask. Winston Churchill, Roosevelt’s partner, said: “The United States invariably does the right thing, after having exhausted every other alternative.” The alternatives are now exhausted. It is time for politicians to do the right thing.

martin.wolf@ft.com

[KFC911]

Originally Posted by 911teo

.... In the twilight of a failed US administration, that may seem far too much to ask. Winston Churchill, Roosevelt’s partner, said: “The United States invariably does the right thing, after having exhausted every other alternative.” The alternatives are now exhausted. It is time for politicians to do the right thing....

Matteo, you (and others) know far more about these things than I do, but that last part hits home. I simply do NOT trust our "leaders" to do the right thing anymore. Are we at that point where they are/will? I truly don't know . BTW, did you work for Wachovia or BOA? Just curious... I personally don't think Wachovia (First Union) went down in one afternoon...imo it was a "house of cards" that was 20 years in the making and was simply unsustainable. That's why I maintain that all of this mess can be traced back to the banking deregulation of the 80s that allowed the mega-banks to emerge.

[911teo]

Keith

I never worked for either Wachovia or BoA. I manage a fixed income hedge fund.

Me saying that Wachovia went down in an afternoon was a bit tongue in cheeck. But it was just a question of solvency. They were strapped for cash and nobody would lend it to them. And when I said it happened in one afternoon it was because the day before other banks were willing to lend to them, but the next day they closed the tap.

Certainly this plan is flawed. But we need to avoid a meltdown at all costs. And if there is even a little probability of getting back to the 20s I say take the plunge.

We'll deal with the consequences later.

We'll reform the banking/financial industry, we'll make sure banks will never be able to hold everybody at ransom like this time around.

We'll make sure they are extracapitalized and we'll force them to keep a llow profile.

We'll tax them so much so that they will repay every single penny.

[KFC911]

Sorry about that Matteo. Knowing you lived in Charlotte, I just made an assumption, and I'm now an a$$(ume)

[911teo]

Not at all . I would have done the same!

[techweenie]

Matteo, I really appreciate the thoughtful dialog. We agree the plan is not perfect.

I think the stumbling point for me is that we are potentially giving more money to the people who got to this point through a series of poor decisions.

[Jim Richards]

And who's to say that they will do any better with this debt off their books?

[911teo]

Originally Posted by Jim Richards

And who's to say that they will do any better with this debt off their books?

Nobody.

But today it seems GE is feeling the pain. The credit default swaps on GE have widened dramatically and the stock was down around 8% at 9:30.

You see what I am trying to say that random corporations will be hit next. Whover shows weakness in getting their financing done will face a shut down.

Now GE may have taken part to the sub-prime frenzy. But I would not classify them as the evil bankers responsible for this mess.

In another thread Competent One points to the 1st muni bonds going bust. Again this could have been avoided if we had restored confidence in the markets.

I hear your points about the banks being to leveraged and counties being too much in debt etc. I agree there is need for a reform, so that we can avoid a bunch of greedy people jeopardize the entire economy.

But to me right now the balance of risk is pending in favor of using $700bn to buy some bad assets vs seeing the economy implode.

This morning the ISM (an index that gives an idea of how well/bad the economy is going) printed a level not seen since 2001...

ISM showed only 6 of 18 industries growing vs 5 of 18 last.
ISM showed 12 of 18 industries CONTRACTING vs 7 of 18 last.


New orders fell to 38.8 from 48.3
Export orders fell to 52.0 vs 57.0
Production at 40.8 vs 52.1
Employment at 41.8 vs 49.7

GDP growth in 3Q-2008 is tracking closer to +0.4%, but FALLING to -1.35% in 4Q-2008.

On Friday we'll have the Non Farm payroll which will give us another clue on wether Wall Street is hitting Main Street. The forecast is for a LOSS of 105k jobs in the month of August.

[911teo]

Originally Posted by techweenie

Matteo, I really appreciate the thoughtful dialog. We agree the plan is not perfect.

I think the stumbling point for me is that we are potentially giving more money to the people who got to this point through a series of poor decisions.

The problem is that they are holding the rest of the economy at ransom.

Is this right? NO and we certainly need to do something when this is over.

But right now I am afraid this is the only solution.

[Rick Lee]

I worked for GE's subprime branch. Believe me, they were the most conservative subprime lender around. We were always losing deals to places that took lower FICO's, didn't care about legal resident status or had lower rates. The deals we got were the ones the brokers really, really had to get done, since they knew we'd get them done as long as their folks fit into our guidelines.

[competentone]

Originally Posted by jyl

First, an analogy [on the credit crisis] that may help understanding.
- Suppose you've got a guy who is extremely obese, weak heart, diabetic, hypertensive, doesn't exercise, etc.
- Would you immediately force him into a sustained regimen of 300 calories/day, no medication, 20 miles/day forced marches?
- Probably not, because you'd have a good chance of killing him.
- Instead, you'd put him on a 1,000 cal/day diet, treat as needed w/ medication, gradually ramp up his exercise.
- Right now, we are headed for the Bataan Death March treatment regimen. If you want the patient to live, better not do that.

Your analogy has been bothering me.

The situation is more like one where a person (the economy) has swallowed poison (the economy's bad debt).

The body's natural reaction is to vomit and get the poison out of the system as quickly as possible.

If you stop the patient from vomiting, you allow the poison to be absorbed into the patient's body, creating severe damage -- perhaps irreversible -- throughout the body.

It is best to let the markets and economy "vomit" when they need to -- it's ugly, messy and painful, but if you don't get the "poison" out as quickly as possible, you create long term damage that will take decades to recover from.

[dtw]

Originally Posted by competentone

Your analogy has been bothering me.

The situation is more like one where a person (the economy) has swallowed poison (the economy's bad debt).

The body's natural reaction is to vomit and get the poison out of the system as quickly as possible.

If you stop the patient from vomiting, you allow the poison to be absorbed into the patient's body, creating severe damage -- perhaps irreversible -- throughout the body.

It is best to let the markets and economy "vomit" when they need to -- it's ugly, messy and painful, but if you don't get the "poison" out as quickly as possible, you create long term damage that will take decades to recover from.

When I was a kid with the stomach flu, my dad was apparently bored with having a sick kid. He started telling dirty jokes until I blew chunks (I made sure he paid though, he didn't quite escape the trajectory of the spew). Felt fantastic afterward, went back to school the next day.

Errrr anyway, that being said, I'm still on the fence about a bailout or lack thereof. What is this purge you speak of - depression? What kind of joblessness?

[competentone]

Originally Posted by dtw

Errrr anyway, that being said, I'm still on the fence about a bailout or lack thereof. What is this purge you speak of - depression? What kind of joblessness?

It is difficult to predict exactly how things will happen, but the credit expansion (actually created by the Federal Reserve) has "bloated" the financial sector in our economy.

There are too many people, who get up every day and go to work at their "job" of "looking for new places to borrow millions of dollars." There are too many people "pushing paper" and "making deals" using credit rather than being involved in the actual production of goods and services. The economy has become "top heavy" with "financial services."

No bailout, and the resulting contraction in credit would mean that the most jobs will be lost in the financial sector -- which is why people employed in that sector have been most vocal in calling for the bailout. Billions of newly created dollars pumped into the financial sector will keep it afloat, but keeping "bankrupt" firms running adds little to the economy.

The new dollars of the bailout will decimate savings (through the inflation it will cause); those who have tried to be conservative, live within their means and save for the future will end up paying for the excesses of those who have been living beyond their means.

No bailout, will mean that those who have been consuming more than they have been producing -- making up the difference with credit -- will be faced with the reality that their way of living cannot be sustained indefinitely. Businesses that operated in the same way, over-extending themselves with credit, will fail, but the businesses that have been operating without a heavy reliance on credit, will actually benefit as the irresponsible competition leaves the marketplace.

The biggest difference that no bailout will create, is in the speed of the recovery. The bailout will keep in place the inefficient, incompetent and corrupt financial companies that are most responsible for this mess (think Treasury Secretary Paulson's old firm, Goldman Sachs); not allowing them to go under -- and actually using taxpayer dollars to prop them up -- will create stagnation, possibly for decades.

Allowing the weak firms to fail, even allowing "huge" portions of our current "financial services" sectors of our economy to fall with it; will create a severe recession; perhaps lasting 12-18 months, but with the "poison" (bad debt and loose credit) out of the system, the recovery can be strong and fast.

[911pcars]

Originally Posted by competentone

It is difficult to predict exactly how things will happen, but the credit expansion (actually created by the Federal Reserve) has "bloated" the financial sector in our economy.

There are too many people, who get up every day and go to work at their "job" of "looking for new places to borrow millions of dollars." There are too many people "pushing paper" and "making deals" using credit rather than being involved in the actual production of goods and services. The economy has become "top heavy" with "financial services."

No bailout, and the resulting contraction in credit would mean that the most jobs will be lost in the financial sector -- which is why people employed in that sector have been most vocal in calling for the bailout. Billions of newly created dollars pumped into the financial sector will keep it afloat, but keeping "bankrupt" firms running adds little to the economy.

The new dollars of the bailout will decimate savings (through the inflation it will cause); those who have tried to be conservative, live within their means and save for the future will end up paying for the excesses of those who have been living beyond their means.

No bailout, will mean that those who have been consuming more than they have been producing -- making up the difference with credit -- will be faced with the reality that their way of living cannot be sustained indefinitely. Businesses that operated in the same way, over-extending themselves with credit, will fail, but the businesses that have been operating without a heavy reliance on credit, will actually benefit as the irresponsible competition leaves the marketplace.

The biggest difference that no bailout will create, is in the speed of the recovery. The bailout will keep in place the inefficient, incompetent and corrupt financial companies that are most responsible for this mess (think Treasury Secretary Paulson's old firm, Goldman Sachs); not allowing them to go under -- and actually using taxpayer dollars to prop them up -- will create stagnation, possibly for decades.

Allowing the weak firms to fail, even allowing "huge" portions of our current "financial services" sectors of our economy to fall with it; will create a severe recession; perhaps lasting 12-18 months, but with the "poison" (bad debt and loose credit) out of the system, the recovery can be strong and fast.

I'm not a financial analyst, but I think your view is too concentrated at the top. Credit affects all sectors of the economy. Your salary might be funded by a short term line of credit until payments for goods are received by your employer. If you don't get paid, it trickles down from there. For example; your mortgage payment? How does your company continue producing? How do cars and goods get sold without providing credit to consumers?

Sherwood

[Purrybonker]

Originally Posted by competentone

It is difficult to predict exactly how things will happen, but the credit expansion (actually created by the Federal Reserve) has "bloated" the financial sector in our economy.

Originally Posted by 911pcars

I'm not a financial analyst, but I think your view is too concentrated at the top.
Sherwood

No, he's smack on, in very tangible sense. Everything is fundamentally denominated not in units of production or widgets, or whatever anymore - it's denominated in hundreds of facets of financial dances. The real work - the real making of something of value increasingly takes place somewhere else in the world.

An oil company used to employ thousands of people from well hands to secretaries. Now they're well on their way to becoming simply a lump of capital, a corporate finance department and a tax department - everything else is spun to someone else, who spins to someone else until most of that spinning lands somewhere else on the planet. When I was a financial guy in oil and gas we used to take risk on oil prices, gas prices, electricity prices, customers going broke, all as being a part of our business model. No more - oil companies don't even take risk with their own customers and counter-parties without swapping, hedging or levering such exposures. It's all financial helter-skelter.

Same kinda nonsense applies to every avenue of the corporate western world. You can run an oil company you can run an auto manufacturer - every business just boils down to financial games and gambits these days.

The US has backed itself into a corner where all it has that's worth anything is it's currency and it's consumers ability to finance endless consumption. You decide how sustainable either of those are.

We once danced that soviet-style communism was dead. Now Karl Marx must be chuckling in his grave. Capitalism is pretty sick too. Seems you can't get around that stubborn human greed problem no how....