September 20th, 2008

Doubts about the Paulson Plan: Price Controls seem a Better Idea

Posted in Money by ed

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The Treasury proposal to Congress — a slim two and a half pages — was publicized this morning, Saturday after the Week the World Melted.

1. I had thought the resolution trust would be a static deal.

That is: the feds buy the wounded mortgage bonds from the wounded institutions, and then hold them to maturity (or early windup), collecting whatever interest and principal they throw off, and hoping with decent cause that they return more than the current terribly depressed market values (at which they’ll be bought) suggest.

Thus, as with the RTC in the Savings and Loan scandal and with the Chrylser bailout, the feds would wind up with a profit on the deal.

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However, the plan is not for a static trust — but rather to create one of the largest bond trading desks on the planet.

Treasury wants unfettered freedom to buy and sell mortgage bonds when and where they see fit, never exceeding $700 billion at a time. While providing only semiannual reports to Congress on the operation.

But bond trading is a tricky business.  Especially during

bernanke.jpg   times of trouble when interest rates, to begin, are unstable (bond prices in secondary markets being particularly sensitive to interest rate fluctuations).

The obvious reason for active management is the hope that the macro environment will improve so quickly that a hungry market for mortgage bonds again takes shape, before the wounded classes mature, and Treasury can sell them back at a profit and close up shop early.

But one could allow for such one-time dispositions in an otherwise static deal — a far cry from the trading operation Treasury seems to have envisioned.

So where will the feds find the talent to staff this new trading desk?

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The old Bear and Lehman traders?

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The strangest thing in the short proposal is that Treasury is asking for immunity from all oversight and even judicial reach:

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Hard to imagine …

Perhaps we will see these problems addressed early in the week by Congress.

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2.  Alan Greenspan, whom many on Wall Street (now) blame for the credit bubble now burst, said today he approves the resolution trust move but not the restriction on short selling of nearly 800 financial stocks.

I don’t get that. The ban seems advisable to allow the weak institutions that remain to find partners or other solutions in an atmosphere less than panicked and piratical.  Why go to the trouble of the reso trust if, by the time it’s on its feet trading, the remaining wounded birds have been reduced by the shorts to dust?

As stands, during the ten days of protection it seems, to begin, that Morgan Stanley will merge with a big deposit bank.

And rumors were floating late in the week that Goldman Sachs may take itself private again.

Washington Mutual, which stepped onto the auction block early this week but drew no bidders, will now probably be bought by a big bank — which will then siphon off the most toxic stuff into Treasury’s resolution trust.

And Citibank — the biggest bad apple left now that AIG has been dealt with — will probably issue new common stock under cover of the short-selling ban.

One hopes all these moves will be set or done before the ban lifts on October 2, and that the feds will refuse pleas to extend it.

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Option market-makers, however, should immediately be exempted from the short-selling ban — a necessary move if one wants the option markets to function, which, for some issues Friday, they barely did.

Option market-makers have to short common stock to remain market-neutral when they sell puts or buy calls on that stock to the public.  Otherwise they’d be gambling (like the public).

E.g., the October 70 calls on State Street Bank (STT) were largely static Friday (the first day under the short-selling ban), because they were burdened with a humongous spread: bidding $1 to $2 to buy, while offering from $3 to $4 to sell.  The market maker — unable to short the common stock — didn’t feel safe to come any closer.

But if the exception for market makers appears, one would expect that $2 spread (between bid and ask) to shrink to a dime or so.

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3.   I wonder if the prohibition on shorting financials (with execption for market makers) and a stronger program to insure the money market funds might not have been enough.

That is, I confess to doubts about the very need and wisdom of the big reso trust, which introduces several large iniquities and a huge public burden.

It’s hard to think (but some do) the crisis was staged, or opportunistically nurtured and now provoked, in order for a cabal of globalizing financiers to consolidate control over Washington and american society.

But, clearly, the funnelling of the mortgage and insurance businesses into a deeply indebted Beltway already beholden to creditors are steps down that road.

And with the collapse of the five Wall Street brokers — all have been subsumed into the central banking system — all are now members or minions of the Fed — the country’s independent finance arm has atrophied to the vanishing point.  The Money Trust” has gobbled up Wall Street.

Thus centralized control — over mortgages, insurance and high finance — is certainly a result, and has been consolidated even further in the hands of the anonymous international owners of the Fed.
And this would seem to support the globalizers behind, e.g., the North American Union movement.  Their notion of replacing the Dollar with a new pan-North American currency (the Amero) may suddenly seem palatable if indeed the endgame of what’s now in motion is hyperinflation and gross devaluation of the dollar.

Then again, both the Chrysler and S&L bailouts facilities proved curative, turned a profit and were shut down with no appreciable gains for the tyrants.

(Then again, there’s a book pending by trader-pundit Barry Ritholtz that argues precisely the opposite — that the ideology engendered by those successes has covertly poisoned the political culture and left us vulnerable …)

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4.  Perhaps then, just to be on the safe side …

If one deems a big solution necessary, might not the bold (ideologically) stroke of Price Controls be best — which (unlike the current proposal) would require neither fed money nor the creation of a huge risky bond trading operation.

(I’ve been saying this repeatedly since last August.  Over and over for chrissakes.  Just would not shut up. The few people who hear smile or laugh or just pat me on the shoulder like I’m the village idiot.  Who knows …)

The wounded mortgage bonds would remain on the books of the wounded institutions — transparently marked within Treasury-specified ranges — ranges based on three- or six-month trailing performance (i.e, how much interest are the bonds actually paying and how much principal are they actually losing?), adjusted across time — disregarding entirely the wildly depressed (non) market values that have pertained since last July.

To do this, Treasury or a minion would have to:

– thoroughly analyze the universe of mortgage bonds under US regulation.  Stratify them into segments by underlying asset (prime, midprime, subprime mortgages), rating at issue, perhaps vintage and geographical location, perhaps other considerations, and then

– track actual performance of these segments and issue the controlled prices.

Lots of work.  But under the current plan the same kind of work will be needed to make the huge bond trading operation viable.

I imagine the specified price ranges would be a small improvement over current (non) market values, well below face value.

And if a bank wants to sell rather than hold, it sells at a price in the specified range.

The benefits are:

– No Treasury investment.  Just a lot of spreadsheeting and hand’s-on regulation.

– The bank balance sheets will become transparent (re mortgage bonds) and more stable, and get a quick lift as the writedowns of the past year are written up a bit.  And thenceforth the playing field (re mortgage bonds) will be perfectly level.

This moderated approach (compared to the Tsy cash bailout) that emphasizes transparency should alleviate much of the pressure on the wounded banks, and make it harder for shorts to carry out rumor campaigns, giving the banks room to breath and the wounded bonds time to live out their miserable lives.

– Across time the actual losses taken by the banks, when the bonds wind up, will likely be less than the current extreme (non) market-value markdowns.

And if they’re not — if the initially written-up prices, as they adjust to short-term trailing performance, get written back down across a year or two to current levels — then that may nevertheless be the least perilous path from where we are today.

Price controls were in the toolbox throughout the postwar era.  President Kennedy used them with steel.  President Nixon used them with wages and across-the-board prices.  It was only when Laissez Faire as religion came back during the Reagan years — as the owner-operators of US, Inc. realized globalization was the ticket — that price controls were deemed devilish and cast out.

I’m not suggesting they are good general policy — only that in crises, when the market is broken, they may be necessary.  Laissez Faire has nothing to work on when there is no functioning market, and we’ve waited long enough for this one to rebound.  Keynesianism itself (as Keynes saw it) was merely a tactic.  A tool in the box.

So that’s it. No more phantom market values. An end to the protracted pretense of “price discovery” that across 14 months has dragged the global system to its knees.   The market is broken.  Humpty Dumpty.  Everybody out of the pool.

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5.  No one should think the latest bold moves mean the stock markets have surely bottomed.

Indeed, if they begin to slip this week, despite the bold moves, a genuine shrieking crash seems in the cards. For the feds have now gone All In.   Henceforth the cards speak.

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3 comments

  1. ed says:

    Here’s a follow up from the Weekend the World Waits …

    September 25th, 2008 at 5:07 pm

  2. ed says:

    And here’s a reason (massive hedge fund withdrawals in the works) to be careful about going back into the stock market waters, even after Congress passes whatever it will.

    Ie, a ton of damage has been done and the stock market is likely to take years to recover.

    NOTE PARENTHETICALLY: The stock markets did not recover from 9/11 until …

    Gee, the month we invaded Iraq. March 2003.

    And then they went straight up without correction — very odd — until last summer when the Bear Stearns (non) hedge fund failed due to mortgage bond trouble.

    Turns out Treasury was “intervening” in the markets without telling anybody in order to maintain the uptrend in support of the war.

    Same people who lied and did all sorts of other dirty things to get you in the war arranged an unprecedented Treasury campaign to keep the taxpayer happy.

    This (one might say) artificially juiced market, therefore, is all the more likely to take time to recover.

    September 28th, 2008 at 11:10 am

  3. ed says:

    A week after the first rescue plan was voted down by the House, the SEC and Financial Accounting Standards Board issue statements implying the relaxation of mark-to-market rules.

    Same-day post-bell rumors however are that this will be accompanied by … price controls (by another name of course) set by “bank regulators” and based on “performance”.

    We shall see what the morrow brings.

    October 2nd, 2008 at 6:25 pm

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