Relevant and even prescient commentary on news, politics and the economy.

Shiela C. Bair Tries to Save the World–Again

Via Felix, we discover Joe Nocera at the NYT reporting that securitization professionals are not as stupid as they would have had us believe:

What [the FDIC] has discovered, said [Michael H. Krimminger, the F.D.I.C.’s special adviser to the chairman for policy], is that the contracts are rarely as constricting as investors and servicers have been portraying them. They do not allow principal reduction, for sure, but they almost never disallow interest rate reduction — or delaying principal payments for a short time. What’s more, Mr. Krimminger said, the servicer agreement simply says that the servicer’s job is to maximize the investment — which often means avoiding foreclosure.

Buyers of a security want the best return they can get. Foreclosure stops that cash flow, and bankruptcy procedures—at their best—impede those flows.

This is the rational position. So what had Nocera written that caused Bair and Krimminger to call him?:

I have quoted a number of experts and people in the securitization business who have told me repeatedly that it is nearly impossible to modify mortgages that are trapped in toxic mortgage-backed securities. The contracts, they say, don’t really have provisions for preventing foreclosures. And the servicers face terrible conflicts if they try to modify mortgages, because inevitable some of the bond investors will do better than others — depending on where they stand along the risk continuum — and under those same contracts, servicers are obliged to treat all investors alike. Finally, I’ve heard, servicers have been unwilling to lift a finger for homeowners because they have no financial incentive to do so — and they face the prospect of being sued by one of their investors if they do.

Servicers have been unwilling to lift a finger, and as such are not following the fiduciary responsibility of ensuring investors an appropriate return.

And it takes the bloody Chair of the FDIC—not the Treasury Secretary, whose former firm made piles of money for him with such securitization procedures—to understand the situation and tell the truth.

Apparently, we have to wait for some large investor and/or hedge funds whose bonds have gone into the default to sue their servicer before someone outside of the FDIC understands that investors prefer receiving some money to none.

Update: I see, via Mark Thoma, that John Hempton is being stupid. Is this a unique situation, or is he selling something? It appears to be the latter.

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Panic of 1873 Redux?

Was the Great Depression really THE Great One? Apparently not, according to Scott Reynolds Neslon, 19th century historian. The Real Great Depression was the Panic of 1873 [fixed]. The parallels to present day, he says, are unnerving and uncanny. I include practically the entire piece. It is well worth the read.

That crash came in 1873 and lasted more than four years. It looks much more like our current crisis.

The problems had emerged around 1870, starting in Europe. In the Austro-Hungarian Empire, formed in 1867, in the states unified by Prussia into the German empire, and in France, the emperors supported a flowering of new lending institutions that issued mortgages for municipal and residential construction, especially in the capitals of Vienna, Berlin, and Paris. Mortgages were easier to obtain than before, and a building boom commenced. Land values seemed to climb and climb; borrowers ravenously assumed more and more credit, using unbuilt or half-built houses as collateral. The most marvelous spots for sightseers in the three cities today are the magisterial buildings erected in the so-called founder period.
But the economic fundamentals were shaky. Wheat exporters from Russia and Central Europe faced a new international competitor who drastically undersold them. The 19th-century version of containers manufactured in China and bound for Wal-Mart consisted of produce from farmers in the American Midwest. They used grain elevators, conveyer belts, and massive steam ships to export trainloads of wheat to abroad. Britain, the biggest importer of wheat, shifted to the cheap stuff quite suddenly around 1871. By 1872 kerosene and manufactured food were rocketing out of America’s heartland, undermining rapeseed, flour, and beef prices. The crash came in Central Europe in May 1873, as it became clear that the region’s assumptions about continual economic growth were too optimistic. Europeans faced what they came to call the American Commercial Invasion. A new industrial superpower had arrived, one whose low costs threatened European trade and a European way of life.
As continental banks tumbled, British banks held back their capital, unsure of which institutions were most involved in the mortgage crisis. The cost to borrow money from another bank — the interbank lending rate — reached impossibly high rates. This banking crisis hit the United States in the fall of 1873. Railroad companies tumbled first. They had crafted complex financial instruments that promised a fixed return, though few understood the underlying object that was guaranteed to investors in case of default. (Answer: nothing). The bonds had sold well at first, but they had tumbled after 1871 as investors began to doubt their value, prices weakened, and many railroads took on short-term bank loans to continue laying track. Then, as short-term lending rates skyrocketed across the Atlantic in 1873, the railroads were in trouble. When the railroad financier Jay Cooke proved unable to pay off his debts, the stock market crashed in September, closing hundreds of banks over the next three years. The panic continued for more than four years in the United States and for nearly six years in Europe.

The long-term effects of the Panic of 1873 were perverse. For the largest manufacturing companies in the United States — those with guaranteed contracts and the ability to make rebate deals with the railroads — the Panic years were golden. Andrew Carnegie, Cyrus McCormick, and John D. Rockefeller had enough capital reserves to finance their own continuing growth. For smaller industrial firms that relied on seasonal demand and outside capital, the situation was dire. As capital reserves dried up, so did their industries. Carnegie and Rockefeller bought out their competitors at fire-sale prices. The Gilded Age in the United States, as far as industrial concentration was concerned, had begun.

As the panic deepened, ordinary Americans suffered terribly. A cigar maker named Samuel Gompers who was young in 1873 later recalled that with the panic, “economic organization crumbled with some primeval upheaval.” Between 1873 and 1877, as many smaller factories and workshops shuttered their doors, tens of thousands of workers — many former Civil War soldiers — became transients. The terms “tramp” and “bum,” both indirect references to former soldiers, became commonplace American terms. Relief rolls exploded in major cities, with 25-percent unemployment (100,000 workers) in New York City alone. Unemployed workers demonstrated in Boston, Chicago, and New York in the winter of 1873-74 demanding public work. In New York’s Tompkins Square in 1874, police entered the crowd with clubs and beat up thousands of men and women. The most violent strikes in American history followed the panic, including by the secret labor group known as the Molly Maguires in Pennsylvania’s coal fields in 1875, when masked workmen exchanged gunfire with the “Coal and Iron Police,” a private force commissioned by the state. A nationwide railroad strike followed in 1877, in which mobs destroyed railway hubs in Pittsburgh, Chicago, and Cumberland, Md.

In Central and Eastern Europe, times were even harder. Many political analysts blamed the crisis on a combination of foreign banks and Jews. Nationalistic political leaders (or agents of the Russian czar) embraced a new, sophisticated brand of anti-Semitism that proved appealing to thousands who had lost their livelihoods in the panic. Anti-Jewish pogroms followed in the 1880s, particularly in Russia and Ukraine. Heartland communities large and small had found a scapegoat: aliens in their own midst.

The echoes of the past in the current problems with residential mortgages trouble me. Loans after about 2001 were issued to first-time homebuyers who signed up for adjustablerate mortgages they could likely never pay off, even in the best of times. Real-estate speculators, hoping to flip properties, overextended themselves, assuming that home prices would keep climbing. Those debts were wrapped in complex securities that mortgage companies and other entrepreneurial banks then sold to other banks; concerned about the stability of those securities, banks then bought a kind of insurance policy called a credit-derivative swap, which risk managers imagined would protect their investments. More than two million foreclosure filings — default notices, auction-sale notices, and bank repossessions — were reported in 2007. By then trillions of dollars were already invested in this credit-derivative market. Were those new financial instruments resilient enough to cover all the risk? (Answer: no.) As in 1873, a complex financial pyramid rested on a pinhead. Banks are hoarding cash. Banks that hoard cash do not make short-term loans. Businesses large and small now face a potential dearth of short-term credit to buy raw materials, ship their products, and keep goods on shelves.
If there are lessons from 1873, they are different from those of 1929. Most important, when banks fall on Wall Street, they stop all the traffic on Main Street — for a very long time. The protracted reconstruction of banks in the United States and Europe created widespread unemployment. Unions (previously illegal in much of the world) flourished but were then destroyed by corporate institutions that learned to operate on the edge of the law. In Europe, politicians found their scapegoats in Jews, on the fringes of the economy. (Americans, on the other hand, mostly blamed themselves; many began to embrace what would later be called fundamentalist religion.)

The post-panic winners, even after the bailout, might be those firms — financial and otherwise — that have substantial cash reserves. A widespread consolidation of industries may be on the horizon, along with a nationalistic response of high tariff barriers, a decline in international trade, and scapegoating of immigrant competitors for scarce jobs. The failure in July of the World Trade Organization talks begun in Doha seven years ago suggests a new wave of protectionism may be on the way.

[Italics bold mine]

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So Why Did we Give SunTrust "bailout buying" money?

Via Dr. Black, Alpha Bank and Trust of Alpharetta is now FDIC-owned.

In related news, PNC is paying about $5.6 billion for midwest-based National City, which was a major player in subprime until everyone realized they weren’t any good at it.

As noted previously, the claim was that monies given to “regional leaders” such as Atlanta-based SunTrust would be used to purchase Endangered Banking Species.

You don’t get much closer to Atlanta than Alpharetta. On the other hand, judging by contemporaneous financial analysis, SunTrust may have been more in need of bailing out than able to bail out.

So Another One Bites the Dust. And Main Street can wonder, once more, exactly what that $700 Billion is supposed to do, other than line the pockets of Hank Paulson’s friends.

*See “my” novel Atlanta Nights for details. Or, as a better idea, just check a map.

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Wasting More Money

The leadership at Wells Fargo must be royally peeved at this point:

Stable national players like Bank of America, JPMorgan Chase, and Wells Fargo are already digesting acquisitions. A second group of so-called super-regional banks are well positioned to take over their competitors, officials said, but have been reluctant to undertake or unable to complete deals.

By offering capital at a favorable rate, the government may encourage them to expand. In this category, industry analysts point to regional leaders, like KeyCorp of Cleveland; Fifth Third Bancorp of Cincinnati; BB&T of Winston-Salem, N.C.; and SunTrust Banks of Atlanta.

Now, to be polite about it, one of those last four is (imnvho) a strong contender for Worst-Run U.S. Bank That Didn’t Pay $400MM for Naming Rights (h/t Skip Sauer). Ignoring that, a quick glance at the list shows at least two—BB&T and most especially SunTrust—that would have made Wells Fargo a very happy camper in its Southern Strategy effort.

So now, having spent the money, beating Citi and saving the FDIC, Wells is going to have to watch as SunTrust eats its lunch before it has even sat down for appetizers.

This is a bad move by the Fed that will result in no new lending, a lot of window-dressing, and bigger bank failures during the second term of the “failed Obama administration.” (Video of Dave Barry appearance at the National Press Club, 12 November 1992, does not seem to be available on the Internet. C-Span?? C-SPAN???)

If anyone wants to understand “moral hazard,” just imagine being a WFC shareholder* who watched your bank do due diligence and is about to watch SunTrust snap up some weak-kneed competitor by filling out a two-page form and sending it to Hank Paulson.

Anyone who says that Paulson (1) knows what he is doing, (2) does not use the word “kleptocracy” in describing Paulson’s actions, and (3) thinks it is a Good Idea is lying or selling something.

*Full disclosure: I’m not, nor to my knowledge in anyone in my family, though I don’t read through all the Prospectus Updates of some of my wife’s Mutual Funds.

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The ‘Dr. Doom’ Prescription

by Tom Bozzo

From my inbox this morning, Nouriel Roubini says, “The world is at severe risk of a global systemic financial meltdown and a severe global depression.” (Tell me something I don’t know.) Go and read the whole article, but here’s Roubini’s plan for immediate action. Is this ‘listen to the guy who’s basically been right all along’ time?

  • Another rapid round of policy rate cuts of the order of at least 150 basis points on average globally;
  • a temporary blanket guarantee of all deposits while a triage between insolvent financial institutions that need to be shut down and distressed but solvent institutions that need to be partially nationalized with injections of public capital is made;
  • a rapid reduction of the debt burden of insolvent households preceded by a temporary freeze on all foreclosures;
  • massive and unlimited provision of liquidity to solvent financial institutions;
  • public provision of credit to the solvent parts of the corporate sector to avoid a short-term debt refinancing crisis for solvent but illiquid corporations and small businesses;
  • a massive direct government fiscal stimulus packages that includes public works, infrastructure spending, unemployment benefits, tax rebates to lower income households and provision of grants to strapped and crunched state and local government;
  • a rapid resolution of the banking problems via triage, public recapitalization of financial institutions and reduction of the debt burden of distressed households and borrowers;
  • an agreement between lender and creditor countries running current account surpluses and borrowing, and debtor countries running current account deficits to maintain an orderly financing of deficits and a recycling of the surpluses of creditors to avoid a disorderly adjustment of such imbalances.

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Fannie Mae will need a bailout (prophesy)

By Divorced one like Bush

”From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. ”If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”

New York Times, 9/30…………………………………..1999.

Who is Mr. Peter Wallison:

A codirector of AEI’s program on financial markets deregulation, Wallison studies banking, insurance, and Wall Street regulation. As general counsel of the U.S. Treasury department, he had a significant role in the development of the Reagan administration’s proposals for the deregulation of the financial services industry.

Interestingly enough, he produced a paperputting it on the dems for the mess in that they wanted “regulation” when the issue was the crap in the portfolio. He quote Greenspan at a subcommittee hearing in 2005:

“We have found no reasonable basis for that portfolio above very minimum needs.” He then proposed “a $100 billion, $200 billion–whatever the number might turn out to be–limit on the size of the aggregate portfolios of those institutions–and the reason I say that is there are certain purposes which I can see in the holding of mortgages which might be helpful in a number of different areas. But $900 billion for Fannie and somewhat less, obviously, for Freddie, I don’t see the purpose of it.” Greenspan then articulated his reasons for limiting the GSEs’ portfolios: “If [Fannie and Freddie] continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate risk aversion, they potentially create ever-growing potential systemic risk down the road.” He added, “Enabling these institutions to increase in size–and they will, once the crisis, in their judgment, passes–we are placing the total financial system of the future at a substantial risk.”[2]

And the republicans were the ones, proposing proper regulations, but Fannie went to the dems to stop it:

Thus, in January 2005, three Senators–Chuck Hagel (R-Neb.), John E. Sununu (R-N.H.), and Elizabeth Dole (R-N.C.)–had introduced tough new legislation to regulate Fannie and Freddie. The legislation was state-of-the-art at the time, and included a carefully developed “bright line” test that was intended to end Fannie’s and Freddie’s efforts to break out of the secondary mortgage market as their sole allowable field of operations. But the legislation made no mention of limiting the GSEs’ portfolios.

Sometime you just don’t know what to expect from people based on their ideology. Who knew AEI could understand the Fannie mess to the point of being a profit and yet find that calling for limits to size is not “regulation” because regulation is what the dems want.

American Enterprise Institute: The American Enterprise Institute for Public Policy Research (AEI) is an extremely influential, pro-business right-wing think tank founded in 1943 by Lewis H. Brown. It promotes the advancement of free enterprise capitalism[1], and succeeds in placing its people in influential governmental positions. It is the center base for many neo-conservatives.

An example of some of their finer work:

In 1980, the American Enterprise Institute for the sum of $25,000 produced a study in support of the tobacco industry titled, Cost-Benefit Analysis of Regulation: Consumer Products. The study was designed to counteract “social cost” arguments against smoking by broadening the social cost issue to include other consumer products such as alcohol and saccharin.

One can also use Wiki if you do not like Source Watch.

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