Posts filed under “Taxes and Policy”
As Lehman Brothers (LEH) turns into a single digit financial midget on its way to zero, as Washington Mutual (WM) works its way towards a buck, as Wachovia (WB) drops more than 80% over a year, as Fannie Mae (FNM) and Freddie Mac (FRE) become divisions of the United States of America, and are now priced in pennies — we need to reflect upon the ongoing lessons learned from all these interventions by Treasury, Congress and the Federal Reserve.
The lesson from the Bear Stearns’ bailout — $29 Billion in Federal Reserve bad paper guarantees — are quite stark:
• Go Big: Don’t just risk your company, risk the entire world of Finance. Modest incompetence is insufficient — if you merely destroy your own company, you won’t get rescued. You have to threaten to bring down the entire global financial system. The fear and disruption caused by a Bear collapse is why it was saved. (AIG has the right idea on this)
• If you cant Go Big, Go First: Had Lehman collapsed before Bear, then the same fear and loathing of the impact to the system might have worked to their advantage. But having been through this once before, the sting is somewhat lessened — especially for a smaller, lets interconnected firm like LEH. (First mover advantage!)
• Threaten your counter-parties: Bear Stearns had about 9 trillion in its derivatives book, of which 40% was held by JPMorgan (JPM). Some people have argued that the Bear bailout was actually a preventative rescue of JPMorgan. Its a good strategy if your goal is a bailout — risk bringing down someone much bigger than yourself.
• Risk an important part of the economy: If your book of derivatives is limited to some obscure and irrelevant portion of the economy, you will not get saved. On the other hand, if Mortgages are important, credit cards and auto loans are too. Securitized widget inventory is not. To use a dirty word, Lehman’s exposure is "contained."
• Balance Sheets Matter: Focus on the media, complain about short sellers, obsess about PR. These are the hallmarks of a failing strategy — and a grand waste of time. Why? Its call insolvency. ALL THAT MATTERS IS THE FIRMS’ BALANCE SHEET. Lehman’s liabilities exceed its assets, and they are now toast. Merrill Lynch got a lot of the junk off of its books, and got a takeover at 70% premium to its closing price. And Credit Suisse, who dumped much of its bad paper many quarters ago, is in a better tactical position than most of its peers.
• Unintended Consequences lurk everywhere: When the Fed opened up the liquidity spigots via its alphabet soup of lending facilities, the fear was of the inflationary impacts. But the bigger issue should have been Complacency. The Dick Fulds of the world said after Bear, these new facilities "put the liquidity issue to rest." Lehman got complacent once liquidity was no longer an issue — perhaps they acted to slowly to resolve their insolvency issue in time.
Unfortunately, Moral Hazard has created terrible lessons in 2008 — via Bear Stearns (BSC), Lehman (LEH), Fannie Mae (FNM) and Freddie Mac (FRE).
Goldman Sach’s Jon Hatzius just published an interesting Brookings Paper on the inter-relationship between falling home prices, the credit crunch, and real GDP.
I found some interesting theories and arguments worth chewing over in the paper. (A link to the full paper and the abstract are below).
Here are the four main points I took away from his analysis:
1) The "best case scenario" during the the credit downturn would be a "couple of years of stagnation or mild recession in the broader economy;" and that’s only, according to Hatzius, if the GSE’s continue expanding their books of business (i.e., keep buying up mortgages).
2) On the other hand, if the "GSEs were to stop growing their book of business . . . it "would also raise the risk of substantial adverse feedback effects
between the real economy, the housing market, and the financial
Um, news flash: The feedback loop (in a negative direction) between housing, credit and the economy is not a risk, its a reality. That is precisely what we are in the early stages of experiencing. Its here, its now, and it looks to be getting worse.
3) Now’s where things get interesting: "The specter of such a feedback loop was likely an important reason for the Treasury’s decision to take the GSEs into conservatorship on September 7."
I would argue that the adverse loop was already visible to the Treasury (and the Fed), and their concern was a rapid expansion of this negative (duh) inter-relationship between credit, housing and the economy. Its the only half-decent economic explanation I have heard so far to justify the conservatorship.
4) "Macroeconomic policies may need to remain unusually expansionary during the adjustment of the financial system to the housing and credit market downturn."
Um, yeah. At this point, a tighgtening is off the table for the Tuesday Fed meeting. I expect by next Summer’s fishing trip, rates will be down to 1.5%.
A few charts and the ABSTRACT are after the jump . . .
Beyond Leveraged Losses: The Balance Sheet Effects of the Home Price Downturn
Brookings Papers, September 10, 2008
Here are the official statements on the Fannie & Freddie bailouts:
Statement by Secretary Henry M. Paulson, Jr. on Treasury and Federal
Housing Finance Agency Action to Protect Financial Markets and Taxpayers:
Good morning. I’m joined here by Jim Lockhart, Director of the new independent regulator, the Federal Housing Finance Agency, FHFA.
In July, Congress granted the Treasury, the Federal Reserve and FHFA new authorities with respect to the GSEs, Fannie Mae and Freddie Mac. Since that time, we have closely monitored financial market and business conditions and have analyzed in great detail the current financial condition of the GSEs – including the ability of the GSEs to weather a variety of market conditions going forward. As a result of this work, we have determined that it is necessary to take action. (continued after jump)
-Treasury Department, September 7, 2008
Treasury Department Reports: