How complicated is this...?
The banks have stopped lending to business and to each other.
The Treasury Secretary, Hank Paulson, has been given $700 billion to try to turn things around. He can buy shaky loans from banks or he can buy bank stock, with a view towards providing banks with enough capital, as in Das Kapital, to begin lending again and thus solve the problem.
But which does he choose, to buy trash for cash or junque-bank stock?
If he buys trash for cash, he's an investor, a capitalist, which he's supposed to be.
If he buys stock, he's a communist.
Why?
In capitalist theory, the one that drives Wall Street, the good idea is to make greed productive by encouraging anyone with spare cash or credit to allow it to be used by someone else in the meantime, that is, pending the owner's special need to use it, so that the borrower can use it to improve his own business prospects. Later, when the owner needs it back, he can have it. The middleman in this transaction is an investment bank. You go to him and ask to borrow for your new business project that is slated to make a lot of money if only you had some to get started with. Mr. Investment Banker says, "I know just the guy who has the dough. Why don't I put you two together?" I have a brother-in-law with an indoor swimming pool and an outdoor tennis court who made out doing this. He collects a commission on each end of the deal, one for providing investors with a profitable investment vehicle, and on the other for providing borrowers with the dough they need to help get rich themselves. It's a terrific way to go.
Paulson's problem is that he must not pay too much, or too little, for the assets or the bank stock, for if he does, he's wasting money, taxpayer money.
One of the ways he can do this, according to an NPR report this morning, is by using a reverse mortgage. What's that?
Well a true auction is where there's one commodity, such as a painting by Vincent Van Gogh, which art collectors all over the world covet. So they bid up the price, each public bid having the chance to be topped by some richer collector, until the painting is sold to the highest bidder.
In a reverse auction, there's only one buyer, Paulson, and lots of banks wanting to unload their trashy mortgage-backed loans. So at the auction, when Paulson says, "I have cash to buy your trashy loans to save your backside," all the bankers can say, "Buy mine, buy mine." "Okay," says Hank, "how few dollars will you take?" "I'll sell you my hundred thousand dollar loan for ninety thousand bucks," says one. "I'll sell you mine for eighty thousand bucks," says the next banker. "Seventy," says another. "Sixty..." "Going once," says the auctioneer, "twice, no lower bids? Sold to the lowest bidder."
That's a reverse mortgage.
The article below by David Sirota explains how tricky it is to set the right price on shaky loans where the buyer has little just how shaky the so-called asset is, but the banker is in a better position to know, thus letting him walk the price down to desperation levels.
Incidentally, the idea of the government bailing out Wall Street seems like a bad dream to people who believe that people make their own fate. This means that we are responsible for our own investment decisions. If you buy stock in a company which later goes bankrupt, you are left with nothing. Tough darts is the correct response, on the theory that if the company had prospered as you'd hoped when you bought, you'd have walked away a rich man. So don't complain when you lose.
Under the current banking crisis this has been stood on its head. Here the major players lived high on the hog for years but when, largely as the result of their own bad judgment in peddling derivatives all over the world, they've managed to collapse the whole system, world-wide, they are unable to bear the loss and required government, meaning taxpayer, funds to bail the system, and them, out.
This has been called a socialist solution to a capitalist problem. Gain is privatized, but risk is socialized. Heads I, the capitalist, win, tails you, the taxpayer, lose.
What would Charlie Kramer think of this? He was my conservative economics professor at Wagner College, Staten Island, N.Y. During a course in comparative economic systems, while studying various systems, including the communist system of the Soviet Union and the mixed system of Yugoslavia, I had a bright idea. This was around 1962 when the world was divided into the Free World (us, for the most part) and the Godless Communists, or them, the stinking Commies, better known as the Reds, as in Red China, f'r instance.
So conservative Charlie is telling us about the evils of communism, which I didn't doubt. But surely there must be another side to the picture, otherwise so many millions of people wouldn't be living under communism, right? Whereever could we find a real communist, you know, someone who believed in that system, to come to the class and tell us why? Wouldn't that be cool?
My hand shot up.
"Professor Kramer," I asked, "since we're in New York City, and NYC is home to the United Nations, where a lot of communist nations have representatives, would it be a good idea to contact one of them and invite it to send someone to talk to our class and, you know, tell us how their system works and why it's so good?"
Buzz!
I must've hit a button, for Prof. Kramer kindly advised me, and the class, that he did not think that the college would regard it as a particularly good idea for us to go around inviting communists to address the students.
So we kept Wagner College free of communist influence. In a world divided in two, no stinkin' commie was going to make inroads on Staten Island. He'd probably never make it off the ferry.
But now communism is headed for Wall Street, direct from Washington.
This is difficult to understand, much less swallow.
Let's see, the passengers in first class have been fooling around in the bilges and have now opened a hole in the hull. Water is flowing in. Bouyancy is flowing out.
And now they're asking the passengers in steerage to bail out the ship?
And the passengers, having no choice but to drown, pitch in.
When the boat is saved, who owns the ship? The former owners? The passengers in first class? Those of us in steerage?
One of Paulson's options is, when putting money into these sinking ships, meaning banks, to take ownership up to 80%.
Seems only fair to me that he does, in the name of the taxpayer.
Which brings to mind an ancient principal of fairness explained to me years ago by an admiralty lawyer, called the law of general averages, that goes back to the Phoenicians, if not earlier.
Suppose several merchants are shipping grain, olive oil, ingots of tin or copper, amphorae of wine and other merchandise aboard a sailing ship from port to port in the Mediterranean when a storm comes up. In order to save the ship, the captain orders that some of the cargo be thrown overboard. All the jars of wine are thrown overboard and this saves the ship.
Who bears the loss? The wine-merchant? Or all of the merchants whose cargo was thus saved?
Under the principal of the general average, the rule has come down that fairness dictates that all of the merchants whose property was thus saved by the sacrifice of one, must bear the loss together as a risk of doing business at sea. One merchant doesn't bear the entire loss, but all bear part of the loss proportionately to something, the value of their respective cargoes, I presume.
I wouldn't call that socialism, would you? Or maybe it is exactly the principal of socialism, sharing the risk in common.
Under the law of salvage, I understand, the savior of a sinking ship can claim ownership of it, for having taken the risk of putting his own vessel in harm's way. If we don't watch out, someone is liable to claim to own us.
At any rate, we seem to be throwing cargo overboard at a high rate, these days.
Paul Krugman also warns that time is growing very short indeed for the U.S. to step in and provide effective financial leadership to unblock the world's credit market and stem the panic that is causing stock shares to free-fall, as some put it. He says this weekend is the moment of truth, and today is Friday.
See the articles by Sirota and Krugman, below.
Will Henry Paulson bring recovery or disaster?
Friday, October 10, 2008
Is Henry Paulson a crony communist or a businessman? The answer could be the difference between economic disaster and recovery. Understanding Paulson's role in stopping - or fueling - the credit
crisis requires a review of two axioms from Economics 101: 1) A credit
crisis occurs when banks stop lending and 2) The amount banks can lend
is a multiple of the capital in their vaults. Therefore, ending a
credit crisis means prompting new lending - and that means maximally
increasing bank capital. Enter Paulson, the former Goldman Sachs executive and current
Treasury secretary. The bailout he fear-mongered through Congress aims
to waste almost a trillion taxpayer dollars buying banks' bad mortgages
- a scheme all but ensuring a disastrous outcome. If Paulson pays banks exactly what their mortgages are worth, he
will not increase banks' capital (or their lending ability) - he will
merely convert one asset (mortgages) into another (cash), making no
impact on the credit crisis. If, to protect taxpayers, he buys
mortgages at lower prices than banks list them, banks will have to
write down their capital and consequently contract lending - and the
credit crisis will worsen. If Paulson overpays for mortgages, he may
marginally augment bank capital, but also incur massive taxpayer losses
when he later resells the mortgages at their real price. The silver lining is a little-noticed provision in the bailout bill
allowing Paulson - if he chooses - to buy ownership stakes in banks.
According to Robert Johnson, the Senate Banking Committee's former
chief economist, this would cost roughly $375 billion less than the
mortgage-buying plan - and, better yet, more aggressively attack the
credit crisis. Mortgages may be underpriced today, but they retain some value on
banks' books. So rather than purchasing mortgages (a capital-neutral
transaction), Paulson could buy bank stock, infusing banks with new
capital on top of their mortgages. That would exponentially increase
lending capacity, prevent taxpayers from buying toxic assets, give the
public a share of future profits, and grant regulators ownership
leverage to restructure bank management. This is where Paulson's personal proclivities come in. A crony communist looking to socialize risk and privatize gain
would consider these options and choose to buy mortgages - that is,
choose to ignore the credit crisis, reward discredited executives and
permit banks to keep any subsequent profits - all while inhibiting a
potential government-mandated housecleaning of Wall Street. Indeed, the
Financial Times' Wolfgang Munchau says Paulson's mortgage-buying
program is driven by "a wish to benefit the investment banks he once
chaired, and which stand to gain handsomely from such a package." A businessman, by contrast, would limit taxpayers' exposure, give
us a stake in future gains and demand management control. He would, in
short, treat taxpayers like Warren Buffett treats his Berkshire
Hathaway shareholders when buying banks with their money. This is how Sweden successfully confronted its banking crisis in
1992, and how England is addressing its own meltdown today. In fact,
world leaders are citing our crony communism as a cautionary tale.
"This is not the American plan," said British Prime Minister Gordon
Brown in announcing his bank rescue. "We will have a stake in the banks
- we are not simply giving money." The bailout bill's failure to make this course of action mandatory
should have killed the legislation in Congress. But banking CEOs and
their lobbyists turned "should have" into "didn't." They love crony
communism and hate government ownership stakes because, as financial
analyst Luigi Zingales says, "Nobody likes to pay for their own
mistakes - it is much better to have the taxpayers pay." Considering the opposition, then, it is a miracle any ownership
stake language slipped into law. Whether Paulson now uses that language
will signal how deep Washington corruption runs. David Sirota is a best-selling author whose
newest book, "The Uprising," was released in June. He is a fellow at
the Campaign for America's Future and a board member of the Progressive
States Network - both nonpartisan organizations.
http://sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/10/10/ED5D13EALQ.DTL
This article appeared on page B - 11 of the San Francisco Chronicle
***
Op-Ed Columnist
Moment of Truth
Moment of Truth
Last month, when the U.S. Treasury Department allowed Lehman Brothers to fail, I wrote that Henry Paulson, the Treasury secretary, was playing financial Russian roulette. Sure enough, there was a bullet in that chamber: Lehman’s failure caused the world financial crisis, already severe, to get much, much worse.
The consequences of Lehman’s fall were apparent within days, yet key policy players have largely wasted the past four weeks. Now they’ve reached a moment of truth: They’d better do something soon — in fact, they’d better announce a coordinated rescue plan this weekend — or the world economy may well experience its worst slump since the Great Depression.
Let’s talk about where we are right now.
The current crisis started with a burst housing bubble, which led to widespread mortgage defaults, and hence to large losses at many financial institutions. That initial shock was compounded by secondary effects, as lack of capital forced banks to pull back, leading to further declines in the prices of assets, leading to more losses, and so on — a vicious circle of “deleveraging.” Pervasive loss of trust in banks, including on the part of other banks, reinforced the vicious circle.
The downward spiral accelerated post-Lehman. Money markets, already troubled, effectively shut down — one line currently making the rounds is that the only things anyone wants to buy right now are Treasury bills and bottled water.
The response to this downward spiral on the part of the world’s two great monetary powers — the United States, on one side, and the 15 nations that use the euro, on the other — has been woefully inadequate.
Europe, lacking a common government, has literally been unable to get its act together; each country has been making up its own policy, with little coordination, and proposals for a unified response have gone nowhere.
The United States should have been in a much stronger position. And when Mr. Paulson announced his plan for a huge bailout, there was a temporary surge of optimism. But it soon became clear that the plan suffered from a fatal lack of intellectual clarity. Mr. Paulson proposed buying $700 billion worth of “troubled assets” — toxic mortgage-related securities — from banks, but he was never able to explain why this would resolve the crisis.
What he should have proposed instead, many economists agree, was direct injection of capital into financial firms: The U.S. government would provide financial institutions with the capital they need to do business, thereby halting the downward spiral, in return for partial ownership. When Congress modified the Paulson plan, it introduced provisions that made such a capital injection possible, but not mandatory. And until two days ago, Mr. Paulson remained resolutely opposed to doing the right thing.
But on Wednesday the British government, showing the kind of clear thinking that has been all too scarce on this side of the pond, announced a plan to provide banks with £50 billion in new capital — the equivalent, relative to the size of the economy, of a $500 billion program here — together with extensive guarantees for financial transactions between banks. And U.S. Treasury officials now say that they plan to do something similar, using the authority they didn’t want but Congress gave them anyway.
The question now is whether these moves are too little, too late. I don’t think so, but it will be very alarming if this weekend rolls by without a credible announcement of a new financial rescue plan, involving not just the United States but all the major players.
Why do we need international cooperation? Because we have a globalized financial system in which a crisis that began with a bubble in Florida condos and California McMansions has caused monetary catastrophe in Iceland. We’re all in this together, and need a shared solution.
Why this weekend? Because there happen to be two big meetings taking place in Washington: a meeting of top financial officials from the major advanced nations on Friday, then the annual International Monetary Fund/World Bank meeting Saturday and Sunday. If these meetings end without at least an agreement in principle on a global rescue plan — if everyone goes home with nothing more than vague assertions that they intend to stay on top of the situation — a golden opportunity will have been missed, and the downward spiral could easily get even worse.
What should be done? The United States and Europe should just say “Yes, prime minister.” The British plan isn’t perfect, but there’s widespread agreement among economists that it offers by far the best available template for a broader rescue effort.
And the time to act is now. You may think that things can’t get any worse — but they can, and if nothing is done in the next few days, they will.
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