Monday, September 29, 2008

initial thoughts on the bailout

it appears the politicians in washington have finally pulled together some kind of mortgage bailout measure. it is late, so I must be brief, but I want to go on record doubting it will succeed.

quite simply, the bill treats only the symptom and not the cause of the problem. it allows the government to spend up to $700 billion buying toxic mortgages securities from banks ... it also restricts executive pay at banks that participate.

not surprisingly, the pay issue has received a lot of attention. one thing I am more concerned about is how much the government will pay for these bonds. on one hand, if they pay what appears to be the market price for them, it won't help. after all, why have a government program if it's going to pay the same price as the market?

instead, it seems they would have to pay some kind of price above the 10-15 cents on the dollar these things now trade for. this is a roundabout way to inject capital and solvency back into banks. given how far it is from the main objective, it makes me doubt it will work. if they want to get capital into the banks, they should focus on doing that.

on the other hand, if they want to prop up prices of anything, it should be the prices of houses, not mortgage-backed securities. after all, they continue to plunge -- especially given the huge supply exceeding 10 months currently for sale.

you can throw as much money at mortgage-backed securities as you like, but if houses continue to lose value, it will accomplish nothing. furthermore, there is good reason for these securities to trade so cheap. not only are they backed by bad collateral -- houses -- but they are also very hetergenous, with many different features and structures. hank paulson seems to have been an M&A guy, so he probably doesn't understand how people price credit: the more complexity, the cheaper the price. this is why things like ABS and sinking-fund debt always yielded more than straight corporate bonds. plain-vanilla corporates mainly have very similar characteristics in terms of maturity, covenants and callability. these mortgage bonds do not.

unlike corporates, they were never meant to be traded. they were meant to be tucked away and to generate cash flow (some of the cynics might argue their main purpose was really just to get priced, locking in fees for everyone from the loan officer to the investment bank to the rating agencies... some cynics might argue they were never meant to actually pay interest and principal.)

so, you have these securities that are hard to price and were never meant to trade. and you throw them into a market at the very worst time. how is it possible they'll be worth anything more than 10-15 cents on the dollar?

I say this is like trying to extinguish a fire by pumping water through an empty hose uphill. the money will go everywhere but the fire.

some optimists might say the bailout program will restore confidence to banks, which will restore the banking and mortgage system. fat chance of that. credit investors already know that hundreds of billions of debt needs to be repriced and come to market over the next 1-3 years -- across the spectrum of corporates and commercial mortgage backed securities. they know we're entering a recession and default rates are moving higher. $700 billion will do little to prop up the broader credit market. companies will still go bankrupt and home prices will continue to fall.

again, this is an indirect way to prop up prices. sometimes indirect methods of controlling prices work. the fed, for instances, uses interest rates to calm inflation. this tends to work, but it has a long time lag. furthermore, rate hikes have had an established track record at slowing the economy and pushing down rates since volcker's hawkish moves in the early 1980s.

this highlights at least 2 problems for the bailout. first, even if this program works, we don't have time to wait for it to creep through the banking system and make loan officers loosen standards (fat chance of that as well.)

secondly, this has no established track record. we just hope it will work.

as a general believer in free markets, I hate having to look back to FDR for wisdom.. but it's worth looking to the New Deal's agriculture policies. food prices plunged in the late 1920s, making it impossible for farmers to pay their debts, which accelerated the collapse of the banking system at the time.

the government's solution was much simpler: subsidize prices and burn excess grain. their goal was to keep prices up... we should be doing the same now. if henry paulson was around in 1930, he would have been injecting capital into the accounts of commodity traders.

I think we need to focus on supporting home prices and preventing foreclosures. bush and paulson should be meeting with governors and telling them to have their sheriffs suspend foreclosures. we should be subsidizing people whose mortgages are resetting, sharing some of the pain and also forcing the bond investors to take pre-determined, clear-cut haircuts. in some cases, the government should find ways to raze forecloses houses and take some of the inventory off the market.

I would also suggest some programs to find other uses for these houses, if possible. can they be converted into local health-clinics, for instance? while I'm on the subject, I'll add I think we'll eventually need to do something like that to deal with the looming excess supply of retail-related commercial real-estate. many of those big megastores could probably be converted into manufacturing space, which would generate jobs rather than helping to siphon cash off from our economy to help build the middle class in places like china and indonesia.

that's what I would call real leadership. it's not what we're getting from these clowns.

Thursday, September 25, 2008

the next century?

I was just watching an infomercial for Time Life's collection of ultimate rock ballads. the tightly produced sound and slick harmonies of REO Speedwagon, Styx and Air Supply reminded me of my childhood in the 1980s, when the USA was the unquestioned dominant force in the world. it grows increasingly clear that era is ending as I write these very words, as our feeble-minded politicians debate this lame $700bln bailout proposal.

I am feeling an increasing sense of urgency to write as we head into the elections. things are coming to a head quickly and we may face some REAL problems.

first, I have to say the stock market is going lower -- in a hurry as well. the sp-500 double-topped on an intraday basis around 1220 today, sept. 25, and tuesday. that comes after it failed to break the 50day moving average on the big rally last friday, sept. 19, when Charlie Gasparino of CNBC reported hank paulson was working on an RTC-like plan.

now that scheme is going down in flames, shot full with intellectual holes by dozens of economists and other wise folk. I never knew much about it, but it never did make much sense to me why we're looking to buy up bad mortgage assets. why aren't we addressing the problem directly by trying to halt the decline in home prices? why isnt the government ordering an end to foreclosures. why isn't the Fed telling banks if they seize homes, they will be denied access to the overnight market. when people like david einhorn correctly identified the errors at lehman, why didn't ben bernanke threaten to revoke the firm's status as a primary dealer if they didn't fix their accounting?

for many years I have worried about the inefficacy of the US government. many people blame the republicans, which is easy to do, but it misses the point that our entire "democratic" system has become an unworkable mess. I have long lamented our turning away from the constitution and the way we perverted the intent of our Founding Fathers to accomplish short-term political goals. after years of governing with deceipt, lying to voters, to each other and to themselves, our politcal class is incapable of acting effectively.

what do I mean? how does the constitution have anything to do with this?

it's pretty simple... this country is not, and never has been a democracy. no variant of the word democracy (such as "democratic") appears anywhere in the constitution. it was designed as a republic, with divided powers and clearly defined duties for different branches of government.

we started breaking it almost as soon as it was created... for instance the framers of the constitution were careful to prevent the direct election of the president, so they created the electoral college. that means that each state legislature decides who gets the state's electoral votes. by the early 19th century, states allowed citizens to vote in polls for the president and then the state legislature rubber-stamped the results.

over time, this violation of the founders' principles increased and Americans came to believe they lived in a democracy. that made it easy to really ruin the entire system in 1913, when they gave people the right to vote for US senators (rather than state legislatures) and created the income tax.

these two innovations utterly transformed the country's power system and significantly weakened the founders' design for a decentralized republic. the end result of this system was that state governments lost all power over washington. they could not control the senate and they could not control the purse strings.. previously, the federal government had to collect money from the states, which raised it in their own way. because the state governments controlled the US senate and collected the revenue, they had much more power.

after the change happened, states became powerless, and the federal government became the unquestioned, supreme power. it has the ability to collect tax money directly from the citizens, funding itself, and then sends that money back to the states in the form of earmarks with thousands of strings attached -- this is how everything from medicare to no child left behind works.

the federal leviathan got even worse after 1937, then the supreme court decided that one line in the constitution -- "congress shall have the power ... to regulate commerce .. among the several states" -- essentially gave DC a blank check to regulate everything everywhere at any level desired. by the 1980s, this law was being used to mandate things like the americans with disabilities act, and even was contrued somehow to affect things like endangered species and people growing marijuana for their own consumption.

on top of that, the supreme court inverted the meaning of the bill of rights so that it allowed the federal courts to control the actions of state and local government -- even though the bill of rights was explicitly meant to protect the states again federal intrusion.

all of this might sound crazy and seem to have nothing to do with the bailout. but it has much to do with the bailout. for years as americans, we have lied to ourselves about our own country. we have played games, deliberately ignoring the truth. politicians took oaths to uphold the constitution, then immediately sought to pervert its every word for their own selfish goals. instead of voting them out of office, we tolerated the lies and relished the deception.

well, I've got news for you america: as de tocqueville said, people get the government they deserve. we are a country that's unworthy of the republic we were given. we would take pains to follow the nuances of a business contract or feel obligated to pay our debts as people, but we take the constitution -- the most important document in the entire land -- much less seriously.

at this point, after years of a dishonest lying government, this is what we get... a bunch of fumbling morons who will be incapable of rescuing us from this financial mess. they have made careers of doing nothing and winning votes (which is exactly why the Founders didn't make this a "democracy" -- they knew it was a bad form of government by itself).

I could go on forever about the constitution and how we have abused it. my point is just that we've spent years liars as our leaders. how can we now expect them to act responsibly to solve our problems?

this is what I see happening. I feel the need to record it because I think the urgency is mounting:

an ineffectual congress will fail to deal with anything

the credit market will freeze up massively and companies will go bankrupt because they won't be able to refinance debt.

the government will try to fix it with deficit spending, which will cause foreigners to start dumping Treasuries, causing a collapse of the dollar and inflation hell.
I think Treasuries are already in a major bubble -- here's how it looks like other bubbles:
1-the trend is bullish... yields on the 10yr have been falling since the early 1980s.
2- the trend recently made its final move and failed to break up resistence levels around 3.3%
3- it's considered a logical "safe" asset -- like real estate in 2003-7 -- after all, houses seemed terribly sensible after the tech bubble burst.
4- the fundamentals are terrible -- they yield less than inflation now
5- more supply is coming

that means it's a bubble ... all bubbles must break.

I return to my earlier scenario, mentioned in this entry... we will see devaluation, inflation, economic stagnation and a decline of financial intermediation. I am still trying to find a good way to represent this intermediation... one economist I met in venezuela looked at something like the value of financial asset as a % of GDP. I wish I remembered his name.

it essentially showed how financial intermediation had declined in the venezuelan economy, which reduced its ability to grow. well the USA has had too much financial intermediation of late.. for instance, financial-sector debt has more than doubled as a % of GDP since 1995 alone.

all of this needs to be undone, and is in the process of being undone. this is what it looks like. this is how the american century, which really started with the destruction of europe's might in WWI, is now drawing to a close. it was fun, but it's over.

Wednesday, September 3, 2008

the palin attack

sarah palin will speak to the RNC wednesday night.

I must confess to being one of those who've been thrilled with her appearance on the national scene. her story is already so good that it seems almost impossible it won't pan out:

a young, intelligent and likeable woman emerges as the new standard bearer for the GOP and helps move the country beyond the entrenched post-cold war political order. she spends a total of 12 years in the white house, succeeding an ancient john mccain in 2012 against a resurgent hillary. she helps our country restore its prestige in the world, breaks the tangle of partisanship that george washington himself cursed. she saves social security and leaves the country self-sufficient in energy. to top it all off, she leaves a supreme court packed top to bottom with disciples of clarence thomas.

the McCain/Palin ticket also offers an outright generational challenge to the babyboomer establishment. he was born in 1936, so is a member of the elvis/korea generation. she was born in 1964, putting her at the very start of generation X.

she's not a cold warrior or a veteran of the 1960s and 1970s culture wars. she's not some republican lackey kissing up around washington looking for a job at a conservative think tank.

but here's what she is:

an attractive woman
a successful mother

but, perhaps most important, sarah palin seems to be a terribly shrewd politician. for instance, she would look much better in this vogue cover if she weren't wearing glasses. she seems to deliberately make herself look frumpy (glasses and freqently uptight hairdos). she knows she's beautiful but deliberately restrains it. she knows it can easily intimidate other women and has learned to leash herself in.

she's a master of restraining her own greatness, which means she'll be full of painful surprises for the democrats. with expectations of her already potentially negative, I think she will find a way to charm and grace americans tomorrow night.

her explosive success in alaska may indicate there is something contagious and powerful about her personality and charisma.

I see some important pieces of evidence coming together:

-the more people know her, the more they like her (alaska)
-she is a savvy political talent, perhaps of a truly historic nature

it reminds me of looking at a stock. sometimes, the chart lines up, the fundamentals line up, the timing lines up. sometimes it's just plain obvious a stock is a winner and it's going higher. it happens in every decision-making context people face... sometimes a story is just too good not to succeed.

one sarah palin comes along every 50 years or so. I think we're going to start learning that over the next 24 hours as she introduces herself to the country. (I also suspect she may prove like the kingfish in terms of presenting herself the right way to the right people at the right time. she may have his mad political genious with none of the dark corruption.)

what if she really is what she seems: a decent person AND a great politician?