Posts filed under “Taxes and Policy”
All financial crisis have one of three issues: Liquidity, Solvency & Capital. The current crisis has all 3. Any plan to help resolve the emergency should be tailored to address all three.
The main problem with most of the proffered solutions is they fail to address all three. Here are some of the better ideas floating around that do exactly that:
• Floyd Norris writes: "It is unsettling to see Wall Street firms that only a week ago feared
for their survival hoping to get rich off this program. It needs to be
carefully monitored to keep it from becoming a scandal of its own."
• Barron’s Mike Santoli points out that current banking regulations forbid Private Equity (and SWFs) from buying more than 20% of a bank w/o submitting the whole firm to regulation as a bank holding company. That should be waived to allow more private capital to flow into the system.
• Merrill Lynch’s David Rosenberg suggests that "the Federal Reserve step in as the repo clearinghouse for all term repo trades. For a counterparty-risk based fee the Fed would guarantee that, only in the event of counterparty failure, the surviving counterparty would receive your cash, not the collateral that was posted for the funds, back from the Federal Reserve. The Federal Reserve would own the collateral."
• Martin Wolf has 3 suggestions:
- Force banks to write down assets to market value, stop paying dividends, and raise new equity.
- Force banks to write down assets and then recapitalize them by converting debt to equity.
- Force banks to write down assets and have the government take equity stakes via preferred stock.
• Joshua Rosner, managing director of Graham Fisher, says price the paper in terms of defaults: "In structured securities, there is no coming back . . . once the underlying collateral defaults, you’ll never have recovery."
• Our own humble 30/20/10 program for private equity funds to get involved in Home Mortgage workouts.
• Miller Tabak’s Peter Boockvar points out that the $40 Billion per year in dividends the 20 largest banks pay should be suspended, and redirected towards recapitalization.
• More Floyd Norris: "The prices paid for assets should be transparent to the public, and
some way should be found to allow others to bid for them, in at least
some cases. That would help to assure that the price being paid was a
• Arnold Kling says: We don’t need to bail out Wall Street to protect Main Street. All we
have to do is make sure that sound borrowers, especially small
businesses, have access to credit. Banks can do the job, although
regulators may have to reduce capital requirements.
• Jeff Matthews asks: "How is it that Warren Buffett can cut a better
deal with the best-run financial company in America than the U.S.
Treasury can ask from the worst-run financial companies in America?
• The Public seems to be very very unhappy with all of this: "Around the country, Republican and Democratic voters are rising up in
outright opposition to the White House plan or, at the very least, to
express concern that it is being pushed through Congress in haste."
Any other good ideas out there?
Most people are unfamiliar with the evolution of financial management over the years. It began as a clubby old boys network, who you knew mattered more than what you knew. It evolved over time. Starting in the late 1970s, retail stock brokerage became a telemarketing sales business. Although that model is clearly changing, there is still trillions of assets under management today that got that way via the cold call.
The cold calling sales approach was developed and refined at Lehman Brothers (perhaps their collapse was Karma). It was encapsulated by a man named Martin D. Shafiroff, who wrote up, refined and perfected various phone techniques. These include the straight line, the first trade, the trust close. All of his various techniques were published in the book “Successful Telephone Selling in the ’80s” and subsequent editions (’90s, etc.)
Having worked on the Sell side for the first decade of my Wall Street career, I am intimately familiar with the various pitches the retail world uses to obtain clients and assets. There is not a single retail broker of my acquaintance that does not have Shafiroff’s how-to on his bookshelf.
The reason I bring this up today is due to the latest sales pitch from various people, aggressively pushing the bailout plan. The newest spin on the massively expensive plan is “Hey, its a jumbo money maker!”
The spin reminds me of the classic retail stock jockey. The guy has buried his clients in a series of bad trades, bad judgment, poor risk management — all motivated by his self-interested, commission-generating trades. The only way out of the money losing mess, pitches the broker, is a big, Hail Mary trade.
This technique is one of the last ones in the the Shafiroff book. Once an aggressive retail broker is upside down, the plea goes out for raising more money from the
mark client. “Believe me, I hate being under water more than you. I pulled in some favors, this is the trade that makes it all back for us and then some. I could even get in trouble telling you this, so don’t mention this to your pals. This is the one — but I need you to send in more capital so we can recoup the prior trades that went bad on us.”
I guess Paulson read the book in the early days of his career. That line of bullshit is identical to what the public is now being fed. A series of OpEds in the Washington Post and the Wall Street Journal (and who knows where else) are all pushing the same nonsensical line: The bailout plan is a big money maker:
Andy Kessler in the WSJ:
“My analysis suggests that Treasury Secretary Henry Paulson (a former investment banker, no less, not a trader) may pull off the mother of all trades, which could net a trillion dollars and maybe as much as $2.2 trillion — yes, with a “t” — for the United States Treasury…
Now Mr. Paulson is pitching Congress for $700 billion or more to buy distressed loans and CDOs from the rest of Wall Street, injecting needed cash onto balance sheets so that normal loans for economic activity can be restored. The trick is what price he will pay. Better mortgages and CDOs are selling for 70 cents on the dollar. But many are seriously distressed (15-25 cents on the dollar) because they are the last to be paid in foreclosures. These are what Wall Street wants to unload the quickest.
Firms will haggle, but eventually cave — they need the cash. I am figuring Mr. Paulson could wind up buying more than $2 trillion in notional value loans and home equity and CDOs for his $700 billion.”
Mr. Gross said there was nothing wrong with that advocacy because Pimco had no official role in formulating the plan to rescue Fannie Mae and Freddie Mac.
“We had a role on CNBC,” he explained, “in that every time we were asked, or I guess every time that The New York Times would call, they would say, ‘What are you doing?,’ and we would say: ‘Well, we want safe, agency-guaranteed mortgages. We don’t want to take a lot of risks in subprime space.’ ”With the liquidity crisis extending into virtually every sector of the investment markets, any firm in a position to advise the Treasury on its rescue plans would have potential conflicts of interest, Mr. Gross said.
“There’s fewer of them here than anywhere else,” he added. “Simply because we saw the crisis coming and we don’t have much of this paper.”
The Pimco trading floor is less like the cacophonic pits that cable news channels usually use to illustrate stories about financial market turmoil, and more like a library. The sound of clacking keyboards often drowns out the low murmur of conversation among portfolio managers. Mr. Gross, a lanky 64-year-old who practices yoga and who sometimes speaks so softly that co-workers lean toward him, as if on an E. F. Hutton commercial, drifts around the room, an unknotted pale blue Hermès tie draped around his neck like a scarf, his gray and brown hair extending down over his ears, a style reminiscent more of the 1970s than today.
Pimco’s headquarters building sits on a bluff overlooking the Pacific Ocean, where on a clear day the view extends westward beyond Catalina Island, which sparkles like a jewel in the midday sun.
The windows on the Pimco trading floor, however, where Mr. Gross spends most of his time, face in the opposite direction – eastward, toward Wall Street and Washington, two arenas where Mr. Gross and his firm carry outsized influence.
That is why some investors might be keen to hear Mr. Gross’s thoughts about the Treasury’s rescue plan. He favors broader relief for homeowners and others weighed down by unmanageable debt and recommends that foreign banks should be allowed to take part in the program. But he also argues against any measures that would try to restrict executive compensation.
“I don’t even know if it’s legal,” he said of attempts to limit executive pay. “And so I think that complicates the situation. That’s not to defend those that are making big checks, but I don’t think it should be attached to this.”
Mr. Gross is also skeptical of proposals to have the Treasury take ownership stakes in banks that sell troubled assets to the government.
Buying a pool of subprime mortgages is not like buying part of a company, he said. The Treasury will own something – the mortgages themselves, which if they pay the right amount for those loans, could earn the Treasury a return of 12 to 13 percent.
“So that’s 100 percent equity in these pools they’ll be buying, and they can take capital gains on them because they own them and all the capital gains will accrue to the Treasury,” he said. “There’s tons of equity here. It’s just that it’s very difficult for American taxpayers to understand.”
The key, of course, is price, which is where the Treasury’s adviser would come in. Much of the opposition to the plan has come from a misunderstanding that the Treasury would buy troubled mortgage bonds for their face value, Mr. Gross said.
On the contrary, Mr. Gross said he would advise the Treasury to pay something closer to 65 or 60 cents on the dollar for the mortgage bonds.
“If the price is right, the Treasury’s going to make money,” Mr. Gross said. “They made money on Chrysler. They can make money on this.”
Mr. Gross also advocates allowing foreign banks to take part in the Treasury’s program to buy troubled assets – a necessary step to keep markets liquid. “Foreign banks have branches here in Newport Beach, they have branches everywhere. And so to discriminate in terms of ownership would again cut off your nose to spite your face. It’s these foreign branches that are lending money to the American public.”
Even if the Treasury’s $700 billion program is approved and carried out under the management of the most selfless investment professionals, that is not likely to solve all of the financial sector’s problems. Asked his view of the economy here and abroad over the next year, Mr. Gross responded simply: “Not pretty.”
“There will definitely be a prolonged period of either slow growth or recession for 12 to 18 to 24 months,” he predicted. “We’re not going to get out of this easily or scot-free. It’s just gone too far to now turn around quickly and to move into a positive growth mode.”
In the meantime, a surge in regulation of the financial sectors will be unleashed, probably an inevitable result of the meltdowns and rescues of recent months. “Twelve to 24 months down the road, all of these high-flying investment banks and banks will be re-regulated and downsized,” Mr. Gross said.
“They won’t become arms of the government, but they will supervised and held on a tight leash. And in addition to the slow-growth-slash-recession that I talked about, what the American economy and the American public can look forward to is a substantially different private sector than what you saw before.”
The greater regulation should draw people back to the investment and financial markets and away from what seems to be their current strategy – stuffing their cash in a mattress.
Even Mr. Gross admits that he has been at times reluctant to commit.
“We were offered this morning a six-month sizable piece of Morgan Stanley,” he said Tuesday. “Here’s the surviving investment bank that just last night got equitized or bailed out by a Japanese bank. We were offered a sizeable piece of a six month Morgan Stanley obligation at a yield of 25 percent, O.K.?”
Pimco didn’t buy the bonds, however, “because we thought we could get it even cheaper,” Mr. Gross explained. “That’s where the fear builds in and makes for totally illiquid markets. Where no one trusts anybody; no one trusts any price. There’s a total lack of trust and confidence in the markets. And that’s what a market depends on.”
All of the bad loans made by various banks and mortgage underwriters are now being accepted by the Fed, or are potentially going to be bought by the Treasury Department. Why not us? We can’t we all turn in our crappy paper, stock in Exodus Communications or Pets.Com, and even old lawn furniture to the…Read More
A Modest Proposal: The housing crisis worsened over the summer of 2008, prompting Congress to debate various bailout proposals. But the housing market worsened, raising the default rate on mortgages. The entire inverted pyramid of derivatives built on top of the mortgage market further worsened, adding yet more pressure to the credit crisis. The bankruptcy of Lehman Brothers and the nationalization of AIG were the results.
The response to this financial crisis from the Treasury Secretary Hank Paulson borders on Insanity: An outrageous trillion dollar plus bailout, with the potential for unlimited expenditures at the behest of the Treasury Secretary. It is a terribly expensive plan, one that prevents judicial or administrative or budgetary review. It is fraught with moral hazard, rewarding bad judgment and excessive risk taking. It punishes the prudent and rewards the profligate.It focuses on all the wrong issues.
Worst of all, it is unlikely to work.
Most of the current solutions under discussion amount to throwing obscene amounts of money at the problem, rather than recognizing what the key issues are.
These approaches have several fundamental problems. The goals are less than desirable: 1) they attempt to keep people in homes they cannot afford; 2) The Paulson plan takes bad loans off of the books of poor lenders, and dumps them onto taxpayers; 3) They maintain price supports for homes that remain significantly over-priced.
At the heart of the
$700 billion dollar unlimited finance Paulson bailout is the desire to move weak performing or poorly made loans off of the books of the lenders who made them and onto the taxpayers back (likely via the FHA). To understand the folly of the this housing bailout, one must grasp the magnitude of the prior housing boom, as well as the historical norms that exists in the American housing market.
The current proposal moves bad mortgages from the irresponsible lenders to the innocent. It punishes every taxpayer who was prudent, and every homeowner that behaved in a responsible manner. It eliminates the sanctity of contracts, and allows judges to “cram down” mortgages.
These may be desperate times, but they do not call for ill thought out, desperate measures. Rather than merely criticize the
$700 billion dollar unlimited finance Paulson plan, I would instead like to propose an alternative approach, one that costs much, much less, and is more likely to be effective: The 30/20/10 Proposal.
A MODEST PROPOSAL: A MORE REASONABLE WORKOUT FOR LENDERS AND BORROWERS THAN THE TAXPAYER FUNDED BAILOUT . . .