Lehman

[Kidlicious]

I read that past presidents have tried to fire commissioners of independent regulatory agencies, but the supreme court has ruled that unconstitutional.

The president and others can create pressure for commissioners to resign though, but a lot of people don't think thats ethical.

[Kidlicious]

Also, now McCain is saying that he only meant that he would ask for the resignation. He ****ed up again and said the wrong thing. This is the third time in about 3 months or so.

[rah]

I'd like you to speak 8 hours a day for 3 months and see how many slips you make.

[Lorizael]

Really, sometimes people just say dumb things. And more than that, most presidential candidates just aren't constitutional scholars. They don't actually know the extent of their powers because they haven't really been educated enough about the subject.

When a president takes action, he does so by going to his advisers and having them figure out how to translate his intentions into things a president is actually allowed to do. Sometimes this is well within the boundaries of constitutional authority, sometimes it's not but they think they can get away with it anyway, and sometimes it might be and they think they can make an argument to make it look legit.

No matter what, though, the president doesn't read law after law, case after case, trying to stay within the bounds of constitutionality.

[Colon™]

Come on guys, there are like a quadrillion threads dedicated to the presidential elections already...

[Agathon]

Originally posted by DanS
I have a feeling I'm not going to like this bailout one bit.

And banning short sales is crazy.

Weren't they after naked shorts originally?

I can see why those would be banned (hell, they even caused a major Wikipedia scandal).

[Zkribbler]

It's a temporary ban on the short selling of financial stocks. The idea is to stop any artifical downward pressure on those stocks until the situation is stablized.

[Kidlicious]

We don't know if DanS opposes restrictions on short selling because they are bad for the economy, or because they prevent him from "profiting off other people's misery."

[Victor Galis]

Well, if you're a neoclassical economist, the effect of short selling is anything but artificial

[MarkG]

someone please explain me, is this new plan by the us goverment supposed to be a bailout for all banks, or something?

[GePap]

http://www.nytimes.com/2008/09/20/business/20nocera.html?pagewanted=1&hp&adxnnlx=1221926427-Ly6nQwWgzvma0S1g1vRX0Q

Talking Business
Hoping a Hail Mary Pass Connects
By JOE NOCERA
Published: September 19, 2008

It was the end of the worst week for financial markets since 1929, and Treasury Secretary Henry M. Paulson Jr. looked sleep-deprived.

He had begun the week agreeing to let Lehman Brothers go bankrupt, arguing that the government had to stop putting taxpayers’ money at risk. Then, midweek, he brokered a deal to rescue the American International Group with an $85 billion loan from taxpayers — arguing that the risk to the financial system was too high to allow the world’s biggest insurer to fail.

Neither move had done anything to stop the financial tsunami. So on Friday morning, just as the markets were opening, Mr. Paulson unveiled the government’s latest attempt to stop the bleeding. Maybe it was because he was so tired, but there was none of the glass-half-full blather that is de rigueur for a cabinet secretary. Instead, his flat, just-the-facts-ma’am voice and weary body language conveyed an unusual sense of urgency.

The core issue, he said — the mistake that had led to all the other mistakes — was that “lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing.” True. As for Wall Street, toxic mortgage-backed securities had become “frozen on the balance sheet of banks and financial institutions.” He added, “The inability to determine their worth has fostered uncertainty about mortgage assets and even about the financial condition of the institutions that own them.” True again.

And that really is the crux of the matter — the financial system has seized up. But so far, the government’s actions haven’t helped. Letting Lehman go bust may have sounded good at the time, but it has had disastrous consequences.

It has led to complete chaos in the multitrillion-dollar market for credit-default swaps and was a crucial reason Morgan Stanley was forced to scramble to stay alive this week. It is also why questions were raised about the viability of Goldman Sachs, a firm with a pristine balance sheet and almost none of the bad assets that are bringing down other firms.

The rescue of A.I.G. further undermined confidence because, within the space of several days, the government did a complete about-face. The bailout suggested the Treasury Department was as confused about what to do as the rest of us.

So rather than help solve the crisis, the Treasury Department has actually contributed to the biggest problem in the market right now: an utter lack of confidence.

Nobody understands who owes what to whom — or whether they have the ability to pay. Counterparties have become afraid to trade with each other. Sovereign wealth funds are no longer willing to supply badly needed capital because they no longer know what they are investing in. The crisis continues because nobody knows what anything is worth. You simply cannot have a functioning market under such circumstances.

Will this latest round of proposals end the crisis? I know the stock market reacted joyously on Friday, but I’m not hopeful. One solution being promoted by the Securities and Exchange Commission — to make life more difficult for short sellers — is a shameful sideshow. A second solution, which Mr. Paulson announced Friday morning, requires money market funds to create an insurance pool to cover themselves against losses.

That may provide comfort to investors who equate money funds with savings accounts, but it is fraught with moral hazard.

And the third solution — the big megillah — is Mr. Paulson’s plan to create a new government mechanism to buy mortgage-backed securities from big banks and investment houses. Once they are off those companies’ books, life can return to normal — or so Mr. Paulson hopes.

He acknowledged that it would likely cost taxpayers “hundreds of billions of dollars.” I think it will cost more than $1 trillion.

It is a weird tribute to the scale of this crisis that Mr. Paulson felt he had no choice but to rush this proposal out, because as the day progressed it became increasingly clear that the Treasury Department didn’t yet know how this mechanism was going to work. It is an idea of a plan more than an actual plan. In football, they would call it a Hail Mary pass. Sometimes, of course, a Hail Mary pass is completed for a touchdown. But most of the time they fail.

Let’s take a closer look at the government’s latest response.

KILL THE SHORT SELLERS It’s understandable why people get upset at short sellers in tough times. As President Bush put it Friday, short sellers are “intentionally driving down particular stocks for their own personal gain.” But that perception is more myth than fact, and in any case, it’s not the dynamic here. Stocks are falling because companies made huge mistakes that have caused them a heap of trouble. Indeed, in July and August, short interest in financial stocks declined by 20 percent. Why did the stocks continue to go down? Because there were too many sellers and not enough buyers: it’s that confidence thing again. Blaming the shorts is classic blame-the-messenger behavior.

The S.E.C. jihad against short sellers, which includes the banning of short selling on 799 stocks and forcing disclosure of large short positions, is nothing more than playing to the crowd. It is simply appalling that as one firm after another vaporizes — firms, let’s remember, that the S.E.C. was supposed to be regulating — the only thing the agency can think to do is flog the shorts.
There were so many better moves it could have made.

After Bear Stearns fell, it could have sent SWAT teams into all the other financial firms to assess their mortgage-backed paper. It could have then announced to the world the health of each firm, which would have helped the market regain some confidence. It could have forced firms to disclose their mortgage-backed holdings so that counterparties could evaluate them. It did none of these things.

Then again, maybe the S.E.C. is trying to cover up its own culpability in this crisis. Four years ago, the agency pushed through a rule that allowed the big investment banks to take on a great deal more debt. As a result, debt ratios rose from about 12 to 1 to more like 30 to 1. Guess what Lehman’s debt ratio was when it went bust? Yep: 30 to 1.

SAVE THE MONEY MARKET FUNDS The precipitating event here was the news that the Reserve Fund, a money market fund that caters to institutions, had “broken the buck” and was paying investors 97 cents on the dollar. That is only the second time that’s ever happened, and it had to scare investors, because most of us have come to think of money market funds as being the equivalent of bank savings account — perfectly safe.

In the aftermath, investors in the various Reserve money market funds pulled $58 billion out in the space of a week, leaving the firm with only $7.1 billion. If that same fear had spread across other money funds, it could well have led the funds to stop accepting short-term commercial paper. That would have been a disaster, because big companies rely on the commercial paper market to finance their day-to-day needs.

Under the circumstances, insuring the money market funds probably makes sense. It will calm investors and keep the commercial paper market functioning. But think about the moral hazard! It bails out poorly managed money funds — the ones most likely to break the buck — at the expense of funds that haven’t taken the extra risk that causes a sudden drop in value.

And then there’s this: If you have your money in a bank account, only $100,000 is insured. But if you have it in a money market fund — which usually has a slightly higher yield precisely because it has a small element of risk — you now have unlimited insurance. It’s the world turned upside down.

THE BIG MEGILLAH For the last few weeks, a growing chorus of voices has called for the establishment of a new Resolution Trust Corporation, the entity the government devised in the wake of the savings and loan crisis to take over, and eventually sell off, the assets of failed S.& L.’s. On Wednesday, that chorus got its most powerful voice, when Paul Volcker, a former Federal Reserve chairman, co-authored an op-ed article in The Wall Street Journal.

That crisis, however, was very different from this one. Most of the assets in the S.& L. crisis were real estate — which are always going to have value. And the government didn’t have to acquire them; it simply took them over and, over time, sold them. This time, the assets are complex derivatives of uncertain value that the big firms will actually be selling to the government.

But how is the government going to assess these securities — and what price will it pay for them? In many cases, these securities aren’t being sold because they are still overvalued on a firms’ books. That is, their mark-to-market price is unrealistically high. Will the government buy it at the too-high price? If it does, the firms won’t have to take additional write-downs — but it will constitute a huge, unjustified bailout of Wall Street. (More moral hazard.)

But what if the government drives a hard bargain, and gets the securities for what they are really worth — 20 cents on the dollar, say, instead of 50 cents? In that case, the firms would have to take yet more enormous write-offs, which would further damage their balance sheets, and they would have to raise billions more in capital. Maybe the removal of these bad assets would allow the firms to raise the capital. But maybe not — meaning one or more could conceivably have to file for bankruptcy, creating yet another spasm of financial turmoil. It’s a huge roll of the dice by the government.

Finally, there is the question of how much it will ultimately cost. “Institutions so far have written down $550 billion globally of bad debt,” said Daniel Alpert, managing director of Westwood Capital. “We think that when you add up all the problems in the residential housing market still to come — further erosion of housing prices, mortgage foreclosures and so on — we are going to need another $1 trillion of write-downs.”

In other words, for all the toxic securities that Wall Street has acknowledged holding, there will be yet more mortgage-backed paper that will go bad as the housing market continues to fall. As much as we all hope the worst is over, it’s probably not.

And as much as we might hope that the government finally has the answer, it probably doesn’t.

[Kidlicious]

On Bill Moyer's last night they were talking about the growth of these complex derivatives over the last couple of decades. I remember my economics professor warning us about these in the 90's. A lot of people aren't suprised to see people with these investments getting bailed out when they were never intended to be bailout securities. Greenspan and others watched all this develop and did nothing. And they knew what was going on.

[Barnabas]

Did Bush really say something like: "For every dollar you invested you will get a dollar back"


I have heard presidents say that in the past, but I never thought I would see the USA president saying that.

[Kidlicious]

Actually that's true. Still bankers are making out with our money. That's the way the system works.

[Colon™]

The financial crisis
What next?

Sep 18th 2008
From The Economist print edition
Global finance is being torn apart; it can be put back together again

Illustration by Oliver Burston


FINANCE houses set out to be monuments of stone and steel. In the widening gyre the greatest of them have splintered into matchwood. Ten short days saw the nationalisation, failure or rescue of what was once the world’s biggest insurer, with assets of $1 trillion, two of the world’s biggest investment banks, with combined assets of another $1.5 trillion, and two giants of America’s mortgage markets, with assets of $1.8 trillion. The government of the world’s leading capitalist nation has been sucked deep into the maelstrom of its most capitalist industry. And it looks overwhelmed.

The bankruptcy of Lehman Brothers and Merrill Lynch’s rapid sale to Bank of America were shocking enough. But the government rescue of American International Group (AIG), through an $85 billion loan at punitive interest rates thrown together on the evening of September 16th, marked a new low in an already catastrophic year. AIG is mostly a safe, well-run insurer. But its financial-products division, which accounted for just a fraction of its revenues, wrote enough derivatives contracts to destroy the firm and shake the world. It helps explain one of the mysteries of recent years: who was taking on the risk that banks and investors were shedding? Now we know.

Yet AIG’s rescue has done little to banish the naked fear that has the markets in its grip. Pick your measure—the interest rates banks charge to lend to each other, the extra costs of borrowing and of insuring corporate debt, the flight to safety in Treasury bonds, gold, financial stocks: all register contagion. On September 17th HBOS, Britain’s largest mortgage lender, fell into the arms of Lloyds TSB for a mere £12 billion ($22 billion), after its shares pitched into the abyss that had swallowed Lehman and AIG. Other banks, including Morgan Stanley and Washington Mutual, looked as if they would suffer the same fate. Russia said it would lend its three biggest banks 1.12 trillion roubles ($44 billion). An American money-market fund, supposedly the safest of safe investments, this week became the first since 1994 to report a loss. If investors flee the money markets for Treasuries, banks will lose funding and the contagion will suck in hedge funds and companies. A brave man would see catharsis in all this misery; a wise man would not be so hasty.
The blood-dimmed tide

Some will argue that the Federal Reserve and the Treasury, nationalising the economy faster than you can say Hugo Chávez, should have left AIG to oblivion. Amid this contagion that would have been reckless. Its contracts—almost $450 billion-worth in the credit-default swaps market alone—underpin the health of the world’s banks and investment funds. The collapse of its insurance arm would hit ordinary policyholders. At the weekend the Fed and the Treasury watched Lehman Brothers go bankrupt sooner than save it. In principle that was admirable—capitalism requires people to pay for their mistakes. But AIG was bigger and the bankruptcy of Lehman had set off vortices and currents that may have contributed to its downfall. With the markets reeling, pragmatism trumped principle. Even though it undermined their own authority, the Fed and the Treasury rightly felt they could not say no again.

What happens next depends on three questions. Why has the crisis lurched onto a new, destructive path? How vulnerable are the financial system and the economy? And what can be done to put finance right? It is no hyperbole to say that for an inkling of what is at stake, you have only to study the 1930s.

Shorn of all its complexity, the finance industry is caught between two brutally simple forces. It needs capital, because assets like houses and promises to pay debts are worth less than most people thought. Even if some gain from falling asset prices, lenders and insurers have to book losses, which leaves them needing money. Finance also needs to shrink. The credit boom not only inflated asset prices, it also inflated finance itself. The financial-services industry’s share of total American corporate profits rose from 10% in the early 1980s to 40% at its peak last year. By one calculation, profits in the past decade amounted to $1.2 trillion more than you would have expected.

This industry will not be able to make money after the boom unless it is far smaller—and it will be hard to make money while it shrinks. No wonder investors are scarce. The brave few, such as sovereign-wealth funds, who put money into weak banks have lost a lot. Better to pick over their carcasses than to take on their toxic assets—just as Britain’s Barclays walked away from Lehman as a going concern, only to swoop on its North American business after it failed.
The centre cannot hold

Governments will thus often be the only buyers around. If necessary, they may create a special fund to manage and wind down troubled assets. Yet do not underestimate the cost of rescues, even necessary ones. Nobody would buy Lehman unless the government offered them the sort of help it had provided JPMorgan Chase when it saved Bear Stearns. The nationalisation that, for good reason, wiped out Fannie’s and Freddie’s shareholders has made it riskier for others to put fresh equity into ailing banks. The only wise recapitalisation just now is an outright purchase, preferably by a retail bank backed by deposits insured by the government—as with Bank of America and Merrill Lynch, Lloyds and HBOS and, possibly, Wachovia with Morgan Stanley. The bigger the bank, the harder that is. Most of all, each rescue discourages investors from worrying about the creditworthiness of those they trade with—and thus encourages the next excess.

For all the costs of a rescue, the cost of failure to the economy would sometimes be higher. As finance shrinks, credit will be sucked out of the economy and without credit, people cannot buy houses, run businesses or as easily invest in the future. So far the American economy has held up. The hope is that the housing bust is nearing its bottom and that countries like China and India will continue to thrive. Recent falls in the price of oil and other commodities give central banks scope to cut interest rates—as China showed this week.

But there is a darker side, too. Unemployment in America rose to 6.1% in August and is likely to climb further. Industrial production fell by 1.1% last month; and the annual change in retail sales is at its weakest since the aftermath of the 2001 recession. Output is shrinking in Japan, Germany, Spain and Britain, and is barely positive in many other countries. On a quarterly basis, prices are falling in half of the 20 countries in The Economist’s house-price index. Emerging economies’ stocks, bonds and currencies have been battered as investors fret that they will no longer be “decoupled” from the rich countries.

Unless policymakers blunder unforgivably—by letting “systemic” institutions fail or by keeping monetary policy too tight—there is no need for today’s misery to turn into a new Depression. A longer-term worry is the inevitable urge to regulate modern finance into submission. Though understandable, that desire is wrong and dangerous—and the colossal success of commerce in the emerging world (see article) shows how much there is to lose. Finance is the brain of the economy. For all its excesses, it allocates resources to where they are productive better than any central planner ever could.

Regulation is necessary, and much must now be done to improve the laws of finance. But it must be the right regulation: an end to America’s fragmented system of oversight; more transparency; capital requirements that lean against booms and flex with busts; supervision of giants, like AIG, that are too big and too interconnected to fail; accounting that values risks better and that everyone accepts; clearing houses and exchanges to make derivatives safer and less opaque.

All that would count as progress. But naive faith in regulators’ powers creates ruinous false security. Financiers know more than regulators and their voices carry more weight in a boom. Banks can exploit the regulations’ inevitable blind spots: assets hidden off their balance sheets, or insurance (such as that provided by AIG) which enables them to profit by sliding out of the capital requirements the regulators set. It is no accident that both schemes were at the heart of the crisis.

This is a black week. Those of us who have supported financial capitalism are open to the charge that the system we championed has merely enabled a few spivs to get rich. But it helped produce healthy economic growth and low inflation for a generation. It would take a very big recession indeed to wipe out those gains. Do not forget that in the debate ahead.

http://www.economist.com/opinion/displaystory.cfm?story_id=12263158