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September 24, 2008

The "Bailout" Plans

Boquisucio writes:

I dunno Cass, last night I ploughed through both documents. And though I hate to admit it, Dodd's 44 page Plan makes a bit more sense, than the carte blanche that Paulson is groveling for.

...As I read Paulson’s Power Grab, he wants to have unlimited, and unreviewable powers to purchase mortgage backed securities, at his own discretion. Please read Section 2(a)(b) and Section 8. In other words, an opaque and unaccountable usurpation of power by The Executive.

First, let me say that I simply haven't had time to wade into the details of the Paulson plan. However, from what I have read so far, I couldn't disagree more. I'm puzzled that anyone would prefer the Dodd plan, which seems to me (as well as to others) to grant far more dangerous and expansive powers to the federal government:

1. Under the Paulson bill, Treasury will have the power to purchase mortgage-related assets. Under the Dodd bill, Treasury will have the power to purchase these assets and “any other financial instrument, as the secretary determines necessary to promote financial market stability.” In Davidoff's words, the Dodd bill “could allow this program to expand to credit card debt, student loan debt, market purchases of equity and even the debt of the big automakers. Basically, the entire financial system.”

I have a one word reaction to this. Unfortunately, it is not printable.

2. Under the Paulson bill, Treasury would buy assets with cash. Under the Dodd bill, Treasury would be required to obtain equity warrants as well; Sorkin says that this provision will probably end up being discretionary. So Treasury will be able to obtain equity stakes whenever it believes that doing so makes sense (presumably, so as to obtain a portion of the upside if Treasury overpays for the securities), and will have to exercise whatever control its equity interest gives it, including possibly a say in the management of the firm (think of AIG).

3. Under the Paulson bill, Treasury has no power to determine executive compensation. Under the Dodd bill, the executive compensation provision, in Davidoff's words, “basically puts the Treasury Department in the business of setting compensation and disclosure policies for much of financial America.”

If you aren't alarmed by this, I'm not sure what would alarm you.

4. Under the Paulson bill, Treasury has no power to adjust mortgages that go into foreclosure. Under the Dodd bill, Treasury is supposed to figure out some way to help homeowners whose property is subject to the securities it obtains, including reducing interest rates and principal.

So now, the American taxpayer must not only bail out failing banks, it must assume worthless loans?

As someone who has paid her bills on time and kept her debt-to-income ratio manageable so I did not get into this situation for over thirty years, this is intolerable. I am willing to take on some debt to avert a loss of confidence in banks that could well wipe out innocent people's life savings. Don't ask me to assume the bad debts of irresponsible people as well.

5. Finally, with respect to the most important discretionary item of them all – negotiating a price of the mortgage-related assets and most of the other terms of the deal – the Paulson bill and the Dodd bill identically leave it up to Paulson and his successors.

Let me remind people that the very reason the Executive branch is structured the way it is, is to facilitate swift, decisive action in times of national emergency. We have Constitutional remedies for abuses of executive power that don't hamstring the only branch of our government with the ability to respond quickly to crises.

In short, I agree with Eric Posner. The Dodd bill is a trojan rabbit from hell. If you like the idea that the federal government ought to be forced to extend not just mortgage loans but potentially all types of consumer loans at the same rate of interest, regardless of risk then Chris Dodd is your huckleberry. Perhaps while we're at it, we can just enshrine the right to credit in the Constitution now and get it over with.

I'll be at the bar. Feel free to throw peanuts at me - I plan to be too inebriated to care.

Posted by Cassandra at September 24, 2008 01:33 PM

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Comments

As one who had to pay usurious rates of interest on my late, unlamented BankofAmerica VISA card due to some incorrect information on my credit history (which we are now in the process of chiseling off my credit history through a civil suit...oh yeah. Bad faith for starters, and it gets ugly from there), and was deemed a 'risk,'
the lender setting the terms is one who can also dig themselves out of the mess they made.

I would like to know what rate of interest is being paid on these 'loans'? You could almost hear the socialists screaming victory.

I have called my congress critter and told him to vote no on a bailout.

Posted by: Cricket at September 24, 2008 03:18 PM

I wonder if the payday lenders and other financial institutions of various sorts knew that for a mere $165,000 they could buy a U.S. Senator.

Dodd's proposal is just disgusting. What's worse is the attitude that irresponsible financial behavior by individuals and firms is not their fault. No BO.....we will just see more and more of this.

Yuk.......

Posted by: Bob at September 24, 2008 03:22 PM

So how are we going to avert this sort of thing in the future?

Posted by: Cass at September 24, 2008 03:23 PM

Cass,

The fundamental problem stems from falling credit standards in the mortgage business. There is some evidence that this dates from the efforts of the Clinton administration to force more lending to people who couldn't afford to repay.

The mechanism that made this possible is securitization. This had worked perfectly well for over a dozen years, when credit standards were serious and lending to people with bad credit simply wasn't done. Securitization makes it possible to package and sell loans to others. The individual loan isn't interesting, just the behavior of the whole portfolio. That is standard finance.....no issues there.

When the portfolio consists largely of loans that are made to people who cannot make the payments, the stage is set for massive losses on those loan portfolios. In the old days, the lender making the loans (banks, S&L's....I said the OLD days) would be stuck with the losses. Now, the lender can pass bad loans on to others. When you have the minions of the White House breathing down your neck to make bad loans, the question is how to avoid being stuck with those bad loans. The answer was at hand: sell the loans to someone else (securitization).

That is the root of the problem. The fix is easy: no loans where credit standards cannot be met. Securitization isn't the problem, but it is how the problem gets shifted from the lender to the investor.

The fix means Congressional Democrats have to stop intervening to force financial institutions to lend to people who cannot qualify.

Compensation in the financial sector is a red herring.

Posted by: Bob at September 24, 2008 03:34 PM

I'm afraid you're right, Bob.

This is what scares me. We have known for literally over a decade that this was coming, but have been powerless to avert. The truly scary thing in all of this is that THIS meltdown was (I think) most likely a result of market conditions finally exposing structural problems with both the banking system and the mortgage market. IOW, it was not intentionally engineered.

How hard would it be, in current condition, to start a crippling run on our financial system that would break the fed?

What the folks who oppose a bailout haven't answer is this:

WHAT PREVENTS THIS FROM HAPPENING AGAIN... AND AGAIN... AND AGAIN? Until we go under?

Because if you seriously believe Congress is going to fix the structural problems in a hurry, you are smoking crack.

Posted by: Cass at September 24, 2008 03:36 PM

So how are we going to avert this sort of thing in the future?

Simple comrade! We will print more money until all workers are as rich as we decide!

Posted by: commissar rdr at September 24, 2008 03:37 PM

We don't have to print more money, spd. We simply create it via the fractional banking system! :p

It's the world's funniest game of musical chairs. Just don't be left standing when the music stops.

I understand all of that, Bob. But the Dems are never going to agree to that and in the meantime we have the issue of teetering banks and panicky investors. Now if no one invested in mortgage-backed securities (money market funds, etc that contain people's life savings) this wouldn't be a problem.

But last week runs were started on otherwise solvent banks. The *real* problem, IMO, isn't quite bad loans.

It is the lack of confidence that causes investors to panic, banks to topple, and the money supply to contract.

Posted by: Cass at September 24, 2008 03:44 PM

The fix means Congressional Democrats have to stop intervening to force financial institutions to lend to people who cannot qualify.

Completely agree with that.

Posted by: Cass at September 24, 2008 03:45 PM

Cass,

Two points. First, for me this predictable mess exposes the depraved indifference of Congressional politicans who have blocked efforts to reform Fannie/Freddie (yes, Chris Dodd, you and your henchmen bought and paid for by Fannie/Freddie are one very corrupt b@stards!). Whatever his failings, I find the theme in McCain's campaign of "Country First" to be the only principle that could lead ultimately to sane choices by the federal government.

Second, the disaster in Social Security and Medicare entitlements will dwarf this mess. The data is there, and the arithmetic is unassailable. Congress with complicity from this administration is once again approaching a coming financial disaster with depraved indifference.

BO seems completely unable to do simple budget math, so I have no reason to expect that if he is elected we have a ghost's chance in hell of averting far worse than we are already in for with the mortgage mess.

Three or four fingers worth in the glass?

Posted by: Bob at September 24, 2008 03:48 PM

What terrifies me is that voters seem completely unable to inform themselves on this subject.

The clock is ticking.

Posted by: Cass at September 24, 2008 03:54 PM

Cass,

If these mortgage-backed securities had not been created, we would not have this mess. However, we could have a mortgage default mess if land/house prices fell even without fraud and bad loans. That is why I focus on the mortgage origination process, not the creation of mortgage-backed securities.

The short-selling of what appeared to be sound financial institutions is due in part to marking-to-market requirements in financial accounting. The rules make sense in most settings, but not when short-sighted, panicky investors begin to act crazy. Selling into falling prices remains one of the biggest mistakes made by investors in general (your mileage may vary....)

Posted by: Bob at September 24, 2008 03:55 PM

Cass,

Voters are ill-informed because reporters are ignorant of basic finance and economics. I include all the television nightly news anchors without exception and just about every one of the correspondents whose reports are aired (Betsy Stark is a disaster....). Local reporters are even worse.

The Wall Street Journal does a decent job, but not enough people read this. Add to the mix a Harvard lawyer with zero economics/finance credentials (and a big debt to Fannie/Freddie) who happily plays to populist sentiments, and the mix for a major national disaster is just about right.

I am pretty old school about some of these things, but in my book, leading the country in the wrong direction to win an election is a moral outrage. Trying to get a sense of which way the wind is blowing before weighing in on the issue is cowardice, another major moral failing.

Posted by: Bob at September 24, 2008 04:02 PM

What prevents this from happening over and over?

Well, you got two choices.

1) Dissolve the GSEs. If lender's are faced with the prospect of having to retain poor credit on their own balance sheets if their own loans cannot be sold on their own merits (instead of increasingly explicit backing of the US Gov't), we will see credit decision stay on the conservative side. The problems is that much of our economy isn't built on the total wealth, but rather it's movement. This will slow the economy trememdously, but like the tortoise it won't take as many 'breathers' as the hare.

2) Vote for congress critters who won't use the financial system as their pet vehicle for social engineering. The financial institutions only originated to low credit standards after the GSEs assured them they would buy them. The GSEs lowered credit standards at the direction of congress' affordable housing initiatives. "Affordable Housing" being a euphamism for "Bad Credit Decisions in the pursuit of Social Justice" as the only way to reach the correct demographic mix was to lower standards. This is probably better for the economy, but requires the voting public to stay vigilant and realize that just because your heart is in the right place doesn't mean you're right. "The road to hell" and all that.

Posted by: Yu-Ain Gonnano at September 24, 2008 04:29 PM

Can I just vote "none-of-the-above", forty days hence?

Posted by: Boquisucio-The-Chump at September 24, 2008 04:35 PM

Selling into falling prices remains one of the biggest mistakes made by investors in general (your mileage may vary....)

Nope. Not at all. But then I was always a cold-blooded one in that respect :p

Yu-Ain, I agree with you. I'm not not sure what the short term solution is. Also, I find myself increasingly concerned about two things:

1. Complexity: as systems become increasingly complex, we get to the point where the human mind just can't wrap itself around things anymore. Derivatives and risk are good examples of this. People make really big decisions based on models which (actually) may not be all that unsound.

It's just that the decision makers rarely use the models in the way they're intended to be used, nor do they understand the inherent limits of models.

2. Connectivity: in what I like to call a 'borderless world', it becomes impossible for any one entity to control or contain events, yet easy for someone to manipulate them or create problems. This refers not only the movement of people and money, but also of data and (as we saw in the market) emotion.

Posted by: Cass at September 24, 2008 07:00 PM

FWIW, Pelosi made the statement that any bill coming out was going to have controls on executive pay for companies that are now on the government teat. I believe that she has the votes on this one, and, to be honest, I have the visceral feeling that it's needed, if only as a symbol.

The morning that Bear Stearns went belly up, I was drinking coffee with the TV on but the sound down. I didn't hear any words, but there was a woman talking on the screen with a label underneath her showing her to be a VP in Bear S.
She was grinning while she talked. She participated in the destruction of that company through some combination of greed, sloth and incompetence, and she's grinning. You and I both know why.

It may be a case of shutting the barn door, but it's going to happen, and demostrations like that, along with the reports of the absolutely ludicrous sums skimmed by the upper management of these companies which now expect tax money is the reason.

Posted by: bud at September 25, 2008 11:23 AM

I fully expected that to be what the administration conceded in the Paulson plan.

If you have any brains at all, you don't put everything in your plan. You have to leave some tinkering room for the opposition so that they can "wring concessions" from you and look as though they managed to win one for the home team. Everyone knows that, or at least I thought they did.

I don't understand why people get so wrapped around the axle.

They all act as though Paulson should have come to the table with a perfect plan. If he had, it would have ended up even further to the left. If you're smart, you put your plan a bit inside where you hope to end up and then start the bargaining process. All this hysteria over 'too much executive power' really isn't addressing wiggling room and the inevitability of the final bill not resembling the plan that was put forward.

I am frustrated.

Posted by: Cass at September 25, 2008 11:30 AM

You're frustrated because your negotiations look like onions but everybody else's look like rutabegas

Posted by: Ymarsakar at September 25, 2008 04:12 PM

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