Thursday, October 18, 2007

This Is Your Theory?

Dan Gross, writing for the Moneybox column at Slate, finds a nut:
The subprime mess has been spreading like toxic mold since the housing market peaked last year. So why did it take until now for the government to decide it should do something about it? I have a theory.
A theory? No, Dan— I read your article. You don't have a theory. You have a tenuous but firm grip on one of the few bits of reality not yet obliterated by the ongoing demolition of the financial press in the United States.

Unfortunately, you're using that grip to whack it around some more and help do more damage.
When individual borrowers began to suffer, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson didn't seem overly concerned. The market would clear out the problem through the foreclosure process. Loans would get written off; properties would change hands and be resold. When upstart subprime mortgage lenders ran into trouble, Bernanke and Paulson shrugged again. The market would clear out the problem through the bankruptcy process. Subprime companies like New Century Financial filed for Chapter 11, others liquidated or restructured, and loans made to the lenders were written down. Meanwhile, Paulson and Bernanke assured us that the subprime mess was contained.

But as the summer turned to fall, and the next several shoes dropped, their attitude changed. And that is because the next group of unfortunates to fall victim to subprime woes were massive banks. In recent years, banks in New York, London, and other financial capitals set up off-balance-sheet funding vehicles called SIVs, or conduits.
This is your theory?

You're going to be really impressed with my theory that bodies at rest tend to stay at rest. Have you heard it before? It's really very clever and revolutionary. It explains so much about how the universe works!
The entities borrow money at low interest rates for short periods, say 30 to 90 days, and use the funds to buy longer-term debt that pays higher interest rates. To stay in business, the conduits must continually roll over the short-term debt. But as they searched for higher yields, some conduits stuffed themselves with subprime-mortgage-backed securities. And when lenders became alarmed at the declining value of those holdings, they were reluctant to roll over the debt. Banks thus faced a choice. They could either raise cash by dumping the already-depressed subprime junk onto the market, or bring the conduits onto their balance sheets and assure short-term lenders they'd get paid back.

Large U.S. banks were reluctant to put the conduits on their balance sheets, especially Citigroup, which manages about $100 billion in such conduits. So Paulson sprung into action.
Or, something resembling action if you don't look too closely at it.
In September, the Treasury Department summoned bankers to suggest that they voluntarily work out some sort of arrangement among gentlemen and gentlewomen to prevent disorder in this market. (It was the same type of voluntary arrangement the New York Federal Reserve suggested Wall Street banks make during the 1998 Long Term Capital Management debacle.) The conversations bore fruit. On Monday, several banks announced the creation of a new mega-conduit that would buy some of the damaged goods from existing conduits. Voila! A federally suggested short-term bailout.
I love that phrase "a new mega-conduit" like you don't even know. That's bullshit so pure you could step all over it at 20:1 and still get $100/ounce for it on the street.

Dan. It's not a short-term bailout. It's bridge to a long-term restructuring of the mortgage securitization industry. I am, of course, trying to be careful what I say here. Progressives may want to pay careful and close attention to what's going on here, because there's a chance that what's happening in this disaster could be used to get some progressive leverage back into the hands of the middle class. These high-finance wizards have royally fnorcked themselves up here, and reconstructing the mortgage industry in the aftermath of their stupidity is an opportunity to get some things fixed that have been seriously messed up for a long time. Having the government reinsure some of these special investment vehicles could backfire on these bankers in a huge way. Let the nose of one camel into the tent, and pretty soon, you've got camels everywhere.
Today, Paulson delivered a speech in which he suggested that the mortgage industry take a cue from the big Wall Street banks and find an alternative to foreclosure, like re-adjusting rates or accepting lower payments. The industry should "get together in a coordinated effort to identify struggling borrowers early, connect them to a mortgage counselor, and find a sustainable mortgage solution." He continued: "Recent surveys have shown that as many as 50 percent of the borrowers who have gone into foreclosure never had a prior discussion with a mortgage counselor or their servicer. That must change." He announced that he was supporting an industry coalition, Hope Now, to coordinate such efforts, and declared: "I expect to see results."

These recommendations—and others he made—are all good and common-sensical. But it makes you wonder whether he's been watching birds for the past year instead of reading the headlines on his Bloomberg machine. For these measures are a little like distributing condoms at a clinic for teenage moms who are six months pregnant—good prophylactic ideas that arrived a half-year too late. Last year was a boom year for foreclosures, up 42 percent from 2005. And foreclosures have spiked sharply throughout 2007, up more than 55 percent in the first half of 2007; September 2007 foreclosures nearly doubled from September 2006. Rising homeownership rates (PDF), a success story routinely highlighted by the Bush administration, have fallen for the last three quarters.

Even as hundreds of thousands of people saw their homes dispossessed (some of them were probably speculators who may have simply walked away from no-money-down mortgages), the problem was essentially invisible to Paulson. Of course, it's doubtful Paulson knows many subprime borrowers or subprime lenders. On the other hand, the former head of Goldman Sachs is a member in good standing of the club of Wall Street CEOs. When the subprime meltdown began to disturb the CEOs' sleep, he responded with alacrity. Even as he had harsh words for the entire mortgage complex—from brokers to credit-rating agencies—and recommended far-reaching reforms, Paulson was careful to single out one class of actors for protection. He noted that the issue has been raised as to "whether greater liability should be imposed on securitizers and investors." In other words, should the Wall Street firms that peddled mortgage-backed securities that turned out to be worthless a few months later be subject to greater accountability through the legal system? His answer: "In my view, this is not the answer to the problem."
I'm shocked. SHOCKED, I say, to discover the high finance wizards of Wall Street caught red-handed with one hand in the till and the other mashing down the scale, but surely they're not the problem. No, not at all.

Fnorking wankers.

[Some links elided. See the original article for completeness.]

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