Bank of America Privately Asks Gov't For Bailout?
A: This is one f**ked up environment where conspiracy theorists may actually be right! The NY Times had a story yesterday discussing the moral hazard of a gov't bailout. While in past decades wall street banks & brokerages begged governments NOT to interrupt with its progress & innovations, it has come time where now they are asking for just the opposite to get them out of the hole they dug for themselves. Michael 'Mish' Shedlock, of Mish's Global Economic Trend Analysis & Investment Advisor at SitkaPacific Cap Management, offers up some great commentary covering this very interesting read. Which do you believe...Let the tradable markets correct themselves OR aggressive government/fed sponsored bailouts & policy to stop the pain?
According to yesterday's NY Times article, "A 'Moral Hazard' for a Housing Bailout: Sorting The Victims From Those Who Volunteered":
Over the last two decades, few industries have lobbied more ferociously or effectively than banks to get the government out of its business and to obtain freer rein for “financial innovation.”In comes Mish & his very interesting commentary. After reading it, you almost can put together both how bad these problems are and how ridiculous this financial world we live in really is; will we EVER take responsibility for our actions? READ THE WHOLE POST or read some snippets here:
A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government - now that it is in trouble.
The proposal warns that up to $739 billion in mortgages are at "moderate to high risk" of defaulting over the next five years and that millions of families could lose their homes.
To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.
"We believe that any intervention by the federal government will be acceptable only if it is not perceived as a bailout of the bond market," the financial institution noted.
The government would buy the mortgages at their true current value, perhaps through an auction, at what would probably be a big discount from the original loan amount. The mortgage lenders, or the investors who bought mortgage-backed securities, would be free of the bad loans but would still have to book their losses.
My Comment: This just gets sillier and sillier. If the Government buys them at "True Value" then why don't the banks just hold them at "True Value", or sell them to someone else at "True Value"? Clearly the idea is to dump them on the government at a price far above "True Value".
"Every citizen has a dog in this hunt," said John Taylor, president of the National Community Reinvestment Coalition, a community advocacy group that has developed its own mortgage buyout plan. "The cost of spending our way out of a recession is something that everybody would have to bear for a very long time."
Mr. Taylor estimated the government might end up buying $80 billion to $100 billion in mortgages. But he said the government could recoup its money if it was able to buy the mortgages at a proper discount, repackage them and sell them on the open market.
My Comment: Mr.Taylor is clearly a complete buffoon. How the hell is the government supposed to be able to package this garbage and sell it on the free market if the banks can't?
But identifying innocent victims has already proved complicated. The Bush administration’s Hope Now program offers to freeze interest rates for certain borrowers whose subprime mortgages were about to jump to much higher rates. But the eligibility rules are so narrow that some analysts estimate only 3 percent of subprime borrowers will benefit.
My Comment: Innocent victims are easy to spot. Those who stayed out of the mess but saw property taxes soar to the moon anyway. The second set of innocent victims were those on fixed incomes who got paid a lousy 1% in their money market accounts while the Fed blew the biggest credit bubble the world has ever seen.
The House Financial Services Committee is working on various options, including a government buyout. The Bush administration may be softening its hostility to a rescue as well. Top officials at the Treasury Department are hoping to meet with industry executives next week to discuss options, according to two executives.
"There are a lot of ideas out there," said Scott Stanzel, a spokesman for President Bush, when asked at a White House press briefing on Friday about a possible buyout program. "There are many different ways in which we can address this problem and we continue to look at ways in which we can do that."
My Comment: There are indeed a lot of ideas out there and every one of them but one is a horrid idea. The only good idea is to let this play out naturally over time without the government making matters worse.
UrbanDigs Take: I've said this before months ago! The problems we face today are the result of ultra cheap money + lax lending standards + speculative investing in an illiquid asset using leverage + financial innovation to disperse risk using complex and often mis-understood vehicles + housing deflation. The ultra cheap money and aggressive fiscal stimulus is spurring commodity inflation as housing deflates; an awful combination. The financial innovations were rooted deep and controlled by people with a vested interest in the transaction (make my fee and pass the product down the line approach); it was only a matter of time for the market to seize up. And after years of lax lending standards and very easy money which sparked a 5 year unsustainable boom in an illiquid asset, housing, the very dynamic that powered the boom is now extinct (tightening lending standards, more expensive borrowing costs, illiquid secondary mortgage markets).
What we need is a good old fashioned slowdown to reverse the mistakes made, weed out those that made bad bets, deeply embed the pain of these mistakes in the minds of investors, self-cleansing of the financial markets that allowed this boom to occur, clean off the balance sheets of toxic waste, and prices to revert back to the mean so that we can return on a longer term path of sustainable economic growth with the lessons learned!
Government and fiscal policy needs to be very cautiously applied to these problems so as NOT to disrupt the tradable markets from fixing themselves, and punishing those that made bad bets. If policy and actions are applied too aggressively, a moral hazard will certainly set in, inflation will run rampant, and we will have to deal with potentially worse problems at a later time. What I see now, is the tradable markets working on their own in the following way to correct itself:
a) seizing up of secondary mortgage markets - the very market where banks offload mortgage backed securities is dead. This is causing lending standards to be tightened, available capital to be restricted, lending rates to rise, risk to be re-priced, and losses to be booked on the bad holdings.
b) housing deflation - the turnaround in housing is removing speculative players from the market who helped power the unsustainable boom. In addition, as housing prices fall banks are re-thinking to whom they will lend their capital to and at what rate. In short, the bullshit days of giving anybody a loan because housing goes up are gone!
These two forces are the markets way of correcting themselves. However, it seems government and the fed are doing everything possible to stop these natural forces at work. Yes, I think we need help here, but look at what we got over the past 6 months ---> 225 bps of fed cuts, fed term auction facility injections to provide liquidity to banks and ease LIBOR, gov't sponsored rate freeze plan, gov't sponsored HOPE now plan, $168 billion economic stimulus package, and a bond insurer rescue plan about to be announced! Geez, am I the only one that is seeing all this?
Do you think we need more aggressive measures or to let the markets take it from here for a while?
Posted by Barack
Sun Feb 24th, 2008 09:24 PM
With all due respect, Noah, don't you know the pain and suffering the American people are going to face if we take your invisible hand approach. Kind like Herbert Hoover.
I think it's great if the federal government gets aggresively involved and forces a soft landing for this mess.
Taking a hands off approach will surely tank the economy. Yeah, in the long run, it might be better in some respects. But in the long run, we're all dead.
Posted by Marmotton
Sun Feb 24th, 2008 09:33 PM
As you know taxes in NYC are already incredibly high.
When we bought our co-op we were not greedy, we saved for 15 years to be able to put together a 25% down-payment.
Do you think that we for a second care about people who could lose their house when we see that so many lied about their income, put no money down, bought a house for as much or more as ours but with only 1 third the income that we have? Not for a second. They need to be losing their house. They should never have been able to buy it on the first place. They only made it harder for everyone else to buy.
Housing stock needs to go down drastically so that the next generation can afford to buy a home without insane debt levels. Housing ownership numbers need to come back to historical levels. You can't keep asking the next generation to pay over-priced real-estate.
Prices must come down. Any bailout would only enrich one group and make everyone else's life harder for decades to come, particularly younger generations.
Posted by Anthony
Sun Feb 24th, 2008 11:44 PM
Brilliant post, Noah, and excellent addition, Marmotton. As for the point "Barack" is trying to make, I'm afraid that no politician in this cycle is going to have the courage to let those who contributed to this problem pay for it.
Posted by Barack
Mon Feb 25th, 2008 07:41 AM
Marmotton, you should care since these bankruptcies and forclosures could create a downward sprial that could tank the national economy. Those being able to avoid this fate will struggle to rub nickels together. Can you imagine what this will do to consumer confidence, the stock market, and the unemployment rate?
I don't know how you get your money, and frankly I don't care, but I find it hard to believe that your work and life would not at all be impacted.
We're so much about punishing people in this country. And so often, we wind up punishing ourselves. Just look at Iraq.
Yes, you should care.
Posted by Noah
Mon Feb 25th, 2008 08:15 AM
Barack - your comment is greatly appreciated and I welcome it! Everyone has an opinion on this!
Anthony makes the most REAL point. It is POLITICAL SUICIDE to say that this problem needs to correct itself, WITH SOME AID, but not too much! Any politician that says this, will never get elected.
Look, Im all for soft landings, but it is more hope than reality. How many soft landings have gov't/fed guided us through in the past century?
ZERO! Fact still remains, we have had plenty of stimulus thus far, and we are not yet in a recession as far as the NBER is concerned.
Great discussion though guys.
Posted by Noah
Mon Feb 25th, 2008 08:20 AM
let me just add one thing:
If govt bails out wall st / banks ---> moral hazard will put us back in this situation at a later point in time
If fed cuts to 1% ---> oil will go to $125, Gold will go to $1200, and commodties will continue to surge. Inflation will run wild. Wall street wont tank as much as it may have tanked, and the economy will be inflated out of the process of correcting.
I think this is an environment where we need 50/50 stimulus/market forces. We need some help, but we also need some pain!
Posted by kevin
Mon Feb 25th, 2008 09:24 AM
Why should the government help those who created all this mess (the banks) with our tax money? If they have to disapear, let them disapear. Some natural cleaning need to happen. The point is, once they are bailed out, no one will ever ask them to return the money. For me it is clear: who ever created all this mess, who ever got involved in it (irresponsable home buyers...etc) will have to face the result of its actions.
Posted by Eric Dennis
Mon Feb 25th, 2008 10:18 AM
Noah, great post. I would only add that among the factors you name for our current credit mess, one is actually fundamental (namely inflationary boom-sparking monetary policy) and the rest are consequences.
I am curious how Barack thinks that the government spending my tax dollars (present or future) to bail out irresponsible home buyers and boom-conformist banks is going to help *me*. No thanks, I'll just keep my money.
Posted by mike
Mon Feb 25th, 2008 10:25 AM
kevin - the banks won't disappear from all this. The banks will profit from a bailout, but they'll survive regardless. The difference right now is how the plan comes to fruition, not if a plan comes out. If BofA is lobbying to keep themselves in business, it's time to move to Europe and start learning a new language because this country is over.
Noah - you're right, the government can't let it play out because too many voters will vote for whoever will create the least pain for them. However, politics rarely makes the right decision.
The point where a bailout becomes reasonable is where the entire economy is at risk. If it's not just housing, but small businesses (due to spending contraction) also, then something needs to be done.
The argument for this kind of bailout, which it is, would be that if government buys securities (not repack CDOs, which should be marked to $0 at this point) at the current marked prices, forcing everyone to book losses. With little hope of principal being repaid, the government can follow through on their proposal of locking interest rates at the lower levels (this allows politicians to call it a homeowner bailout because the "do-gooder" government owns the notes instead of the banks). Since they would be buying this stuff at about $0.40 on the dollar ($400 billion buys $1 trillion of mortgages), the government would be able to use the yield on the bonds to pay down debt used to buy the loans over a short timeframe (4-5 years), leaving any return after that as profit to the government, which could be used to offset spending increases or to pay down other debt. Over time, the move could turn out to be not only beneficial for homeowners, but also for the ballooning national debt.
The problem is that, as someone stated above, we would end up in this same situation again within the next few years. Probably not in housing, but it seems like every bubble burst is fixed with another bubble inflation.
The government is not in a position where it should be so aggressive at this point, but what happens when you start to see small businesses really taking it on the chin? The government will have to respond at some point because this country can't afford the evaporation of wealth that would ensue from large scale bankrupcy at the grass roots level. If it comes to that, it's either tax money to save the system, or full-scale financial collapse. I think everyone has to pick tax payer money.