What Could Possibly Go Wrong?

Morgan Stanley has this amazing plan to take a bunch of toxic crap, call it a different name, put a bow on it and sell as a magic moneymaking product. Innovative!

Morgan Stanley plans to repackage a downgraded collateralized debt obligation backed by leveraged loans into new securities with AAA ratings in the first transaction of its kind, said two people familiar with the sale.

Morgan Stanley is selling $87.1 million of securities that it expects to receive top AAA ratings and $42.9 million of notes graded Baa2, the second-lowest investment grade by Moody’s Investors Service, according to marketing documents obtained by Bloomberg News. The bonds were created from Greywolf CLO I Ltd., a CDO arranged in January 2007 by Goldman Sachs Group Inc. and managed by Greywolf Capital Management LP, an investment firm based in Purchase, New York.

Two years after the credit markets began to seize up, costing the world’s biggest financial institutions $1.47 trillion in writedowns and losses, banks are again taking so- called structured finance securities and turning them into new debt investments with top credit ratings. While the Morgan Stanley deal is the first to involve CDOs of loans, banks have been doing the same with commercial mortgage-backed securities in recent weeks.

A lot of banks and insurers “cannot buy anything but AAA,” said Sylvain Raynes, a principal at R&R Consulting in New York and co-author of “Elements of Structured Finance,” which is due to be published in November by Oxford University Press. “You’re manufacturing AAA out of not AAA, therefore allowing those people who have AAA written on their forehead to buy.”

That last paragraph is my favorite part - investors cannot buy anything but AAA, so we'll call a bunch of garbage AAA and sell it to them! Genius! And if you're still wondering why that federal buy-up of toxic assets has amounted to nothing, I guess it's because enough customers have been found for this "New and Improved Shitt With Two T's."

It says in the article that Goldman Sachs is preparing a similar sale. Matt Taibbi, you have the floor.

A New Way Forward

My assumption about the favorable market reaction to Tim Geithner's plan to buy up Big Shitpile is that the Big Money Boyz got the answer they wanted to this question:

But some executives at private equity firms and hedge funds, who were briefed on the plan Sunday afternoon, are anxious about the recent uproar over millions of dollars in bonus payments made to executives of the American International Group.

Some of them have told administration officials that they would participate only if the government guaranteed that it would not set compensation limits on the firms, according to people briefed on the conversations. The executives also expressed worries about whether disclosure and governance rules could be added retroactively to the program by Congress, these people said.

CNBC's latest Howard Beale for the overclass, Mark Haines, echoed these fears, as a paid echo is wont to do, despairing over how "scary" things are getting, what with Americans paying attention to the massive ripoff being undertaken at their expense and all.

HAINES: There were some scary stories in the paper over the weekend.

BURNETT: Mmm-hmm.

HAINES: About this kind of thing, regulating or somehow impacting executive pay, even among financial companies that didn’t take government money. It’s getting scary.

For the record, the bad asset (I'm sorry, "legacy asset". Bad framer!) plan could very plausibly fix the near-term problem while doing absolutely nothing for the long-term one. If the credit markets loosen and economic activity restarts as a result of this proposal (and I'm dubious), that would be wonderful. But if it restarts in the exact same fashion as the recent past, by allowing a small band of financial sector elites to make absurd profits, literally stolen from the taxpayer, and to keep their share of the overall economy unsustainably and unaccountably large, the long-term forecast on a host of fronts will be grim. Not only would it simply reinflate a bubble that could just as easily pop, but it would cement the viewpoint that corporate behemoths own government and took it over in a bloodless coup.

And contra Mr. Haines, what I heard this weekend were more stories of looting by the big banksters, as well as a growing impression that Goldman Sachs holds an unelected place inside the government.

Simon Johnson gets at the real problem.

The government feels that it cannot take over large banks, there is no bankruptcy-type procedure that would work, and only deference to the CEOs of major financial institutions can get us out of this mess. This is a conscious strategy decision from the very highest levels.

I’d like to say: OK, but this is absolutely the last time we will try for a solution to our banking problems involving a private sector-led approach. Of course this would not be credible and bank CEOs know this. Instead, I propose the following.

If Secretary Geithner’s scheme works, we draw the lesson that our banks became too big and we aim to make them smaller relative to the economy moving forward. The regulatory agenda currently in progress - including for discussion at the G20 next week - would do essentially nothing to reduce the political power of big banks. We need simple caps on bank size, leverage relative to the economy and - this is harder - measures of interconnected tail risk (i.e., is everyone making the same kind of crazy loans?). Design a system with this in mind: regulators get captured and super-regulators get super-captured.

If the scheme doesn’t work, we draw the exact same lesson. And, of course, we should expect Chairman Bernanke to move forward with his Plan B (or is it Plan Z?): inflation.

In any case, our top political leadership needs to really sell some version of the following message. We let the banks get out of control and the cost will be enormous; our debt/GDP ratio will in all likelihood rise from around 40% to over 80%. We cannot afford to have the same problem again. We must break the power of banks before they break us all. And if you don’t think banks can do that much damage to economies, just look around outside the United States - the world is full of countries where growth is slowed or distorted by a financial system that becomes too powerful. This is not about tweaking the existing U.S. regulatory system; it is about complete change and - in many senses - turning back the clock to a financial system that was simpler, smaller, and much less dangerous.

This is the point missing from all the back and forth about the raw details of the Geithner plan. Under not even the rosiest of scenarios would it scale back the power and size of the financial sector relative to the economy, which in the end must be the ultimate solution for now and the future. The public fumes at scenarios that maintain a status quo that failed them and caused them undue pain, especially when they can conceive of a new way forward, where banks perform their core function under a regulatory microscope, and they never grow so large that they can possibly take down the entire economy.

Digby has been asking about the need for the left to assert itself. A group of very sharp organizers are putting together a mass series of demonstrations on April 11, calling itself A New Way Forward. Rallies are already being planned for 20 cities, and beyond just showing up in the streets, there is a careful effort to tie this into a greater movement, with a mission statement and a vision for a post-bailout, post-bubble economy.

NATIONALIZE: Experts agree on the means -- Insolvent banks that are too big to fail must incur a temporary FDIC intervention - no more blank check taxpayer handouts. (see Krugman on nationalization)

REORGANIZE: Current CEOs and board members must be removed and bonuses wiped out. The financial elite must share in the cost of what they have caused. (see Simon Johnson on reorganizing)

DECENTRALIZE: Banks must be broken up and sold back to the private market with new antitrust rules in place-- new banks, managed by new people. Any bank that's "too big to fail" means that it's too big for a free market to function. (see Mike Lux on decentralization)

Big bankers ruined our economy and now they are gaming the political system so they can profit even more off the crisis they caused. They must be stopped [...]

At the personal level, we know that the smart thing to do with our money right now is generally the less flashy thing. Paying off our debts and saving for the future protects us from the risks we can't afford to take in the current market. The same rules apply to the banks. This is a time for a level-headed government to step in and steer unhealthy banks away from more risky bets, and to help them stabilize in the name of economic security for America.

Nothing tells the bankers to keep on doing what they're doing more than an endless stream of free taxpayer money. The banks know that the government considers them too big to fail; if nationalization is off the table, what incentive do they have to act in the public interest?

In a basic sense, this is a fight against corruption. Not in the sense of a quid-pro-quo (though that may be there too), but in the sense of a corrupt ideology. For the most part, the world of economists, politicians and financiers is one elite web of influence. At some point, private profit took over as the only value to consider in building an economy, and it has never subsided. This is true of the thinking from both major parties.

Forget short-term thinking. We need a long-term rejection of the Masters of the Universe mentality and a full reorganization of the economy. I think A New Way Forward is on to something.

The Stock Market Is Not The Economy

Well, Tim Geithner released his plan to buy up Big Shitpile today (a better article explaining the details is here), and the market responded with a 300-point rally, because I imagine investors quite like getting free tapayer money with no downside risk. Predictably, Drudgico connects the wrong dots.

It was bound to happen sooner or later.

Treasury Secretary Timothy Geithner – who hasn’t had many winning days in his short tenure on Pennsylvania Avenue – scored a big political victory Monday, as Wall Street traders breathed new life into his career with a stock market rally of more than 300 points.

I mean, good grief. This notion that the stock market is any kind of predictor of economic policy should have been tossed out long ago. It doesn't take a genius to realize the existence of a very visible hand at work - the biggest money in the market wants a bailout, and a bailout they're getting, essentially.

In addition, there's a media movement to ghetto-ize the critiques of the plan by the likes of Paul Krugman, painting him as a reflexively shrill hater who sees red at anything Obama proposes. There is of course no effort to actually engage with the material of his critique. I know these media stars aren't economists, but this actually isn't all that hard to understand. Heck, even Eric Cantor can come up with a Cliffs Notes version of Krugman's basic argument, which is below.

The common element to the Paulson and Geithner plans is the insistence that the bad assets on banks’ books are really worth much, much more than anyone is currently willing to pay for them. In fact, their true value is so high that if they were properly priced, banks wouldn’t be in trouble.

And so the plan is to use taxpayer funds to drive the prices of bad assets up to “fair” levels. Mr. Paulson proposed having the government buy the assets directly. Mr. Geithner instead proposes a complicated scheme in which the government lends money to private investors, who then use the money to buy the stuff. The idea, says Mr. Obama’s top economic adviser, is to use “the expertise of the market” to set the value of toxic assets.

But the Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt. So this isn’t really about letting markets work. It’s just an indirect, disguised way to subsidize purchases of bad assets.

What's more, plenty of smart people actually have engaged Krugman and other liberal economists on their critiques. Christina Romer of the Council of Economic Advisors says that the Administration merely seeks to use the market to effectively price the bad assets (I'm sorry, legacy loans) and the taxpayer is protected by sharing in the rewards. I don't agree, mainly because all the subsidies artificially inflate the price in the market, but those two could easily have it out. So could Krugman and Brad DeLong, who is mildly bullish on the plan.

Q: Why isn't this just a massive giveaway to yet another set of financiers?

A: The private managers put in $30 billion and the government puts in $970 billion. If we were investing in a normal hedge fund, we would have to pay the managers 2% of the capital and 20% of the profits every year. In this case, the private managers' returns can be thought of as (a) a share of the portfolio's total return proportional to their 3% contribution, plus (b) a "management incentive fee" of (i) 0% of the capital value and (ii) between 0% (if the portfolio returns 3% per year) and 9% (if the portfolio returns 10% per year)--much less than hedge-fund managers typically charge [...]

Q: So the Treasury is doing this to make money?

A: No: making money is a sidelight. The Treasury is doing this to reduce unemployment.

Q: How does having the U.S. government invest $1 trillion in the world's largest hedge fund operations reduce unemployment?

A: At the moment, those businesses that ought to be expanding and hiring cannot profitably expand and hire because the terms on which they can finance expansion are so lousy. The terms on which they can finance expansion are so lazy because existing financial asset prices are so low. Existing financial asset prices are so low because risk and information discounts have soared. Risk and information discounts have collapsed because the supply of assets is high and the tolerance of financial intermediaries for holding assets that are risky or that might have information-revelation problems are low.

Krugman responded to DeLong, and DeLong responded back. And though all that I did discern a case that COULD plausibly be made for this plan. Even if the assets are artificially priced, at least they'll be priced at all. And then the banks will truly have to put up or shut up, either selling the assets or holding out because the spread between their imagined value and what investors are willing to pay will reveal them to be insolvent. I agree with DeLong that Swedish-style nationalization would certainly be an option should this fail, and while I prefer going ahead with taking over the insolvent banks now, that's not free, and so we cannot with certainty say what option represents the biggest tax giveaway. And the downside of screwing up receivership hasn't been priced at all (though the FDIC's facility with the practice shows that to be a somewhat low risk).

I remain dubious, but the blogospheric debate enhanced my knowledge of the issue. A task that modern media never rises to perform.

...Atrios sez everyone's overthinking it:

The Geithner plan will:

1) Funnel more government money to the banksters.
2) Allow the banksters to pretend for a bit longer that their hunks of big shitpile aren't quite as shitty as we thought by using the bullshit price that this process comes up with, allowing too big to fail businesses to stay in business for a bit longer.

This might make sense if you truly believe the magic market you believe in fervently is genuinely incorrectly pricing the assets, perhaps because you genuinely believe that if you could turn around the economy fast enough that you could massively reduce expected foreclosures.

But if you genuinely believe that, I don't think you've been paying too much attention to just what's been going on in the housing market. I don't think you paid too much attention 3 years ago when you didn't realize that it didn't quite make sense that so many people could afford $700,000+ homes in Orange County. I don't think you paid too much attention to the degree of speculation and outright fraud that was happening in parts of the country.

Of course, the Administration has several programs to mitigate foreclosures, which would mean people still making mortgage payments, which would mean that these securities aren't worthless, because every payment adds to their value. But nothing thus far has succeeded on that front.

Who's Bailing Who?

In case you were wondering, yes, we're still in the midst of a major housing crisis. Home sales are down in Southern California by 43%, for example. And foreclosure rates may be starting to stabilize, but that still means that many are losing their homes, plus the rate resets scheduled for next year could transform that trend real quick.

A lot of economists, the Treasury Department, and George Bush himself are making a lot of noise about saving people's homes. But that's not even close to what this is about. This is about bailing out banks who made a lot of horrible decisions and don't want to pay for them.

That's not the first thing you'd think when you hear this quote from St. Greenspan:

GREENSPAN: Well, I think it's important to recognize that there are a very large number of people who are in very major stress and having great difficulty in paying off their mortgages and even when they've tried exceptionally hard.

But when you think of how you come to grips with this, it's important to help those people outside -- without affecting the mortgage rates and without affecting the structure of markets. Cash is available and we should use that in larger amounts, as is
necessary, to solve the problems of the stress of this...

STEPHANOPOULOS: Cash from the government?

GREENSPAN: Cash from the government, yes. In other words, if you're going to do that, it's far less damaging to the economy to create a short-term fiscal problem, which we would, than to try to fix the prices of homes or interest rates. If you do that, it'll drag this process out indefinitely.

This is not at all what it seems, however. Companies like Merrill Lynch and Morgan Stanley are taking billions of dollars in "write-downs," which basically means a total loss on a portion of their securities. Practically all of those bad securities are due to mortgages that have been defaulted on. The banking industry is in serious crisis and looking for a handout. And while they're getting it from the Federal Reserve, to the tune of $20 billion in short-term loans, and also in foreign investment (Morgan Stanley got a $5 billion dollar stake from China today), it's far more palatable to make it look like a bailout for John and Jane Doe than for Mr. $100 million dollar bonus CEO. When it would have meant something to take action, before the thousands upon thousands of foreclosures, the Fed and the Bush Administration stood mute.

Edward M. Gramlich, a Federal Reserve governor who died in September, warned nearly seven years ago that a fast-growing new breed of lenders was luring many people into risky mortgages they could not afford.

But when Mr. Gramlich privately urged Fed examiners to investigate mortgage lenders affiliated with national banks, he was rebuffed by Alan Greenspan, the Fed chairman.

In 2001, a senior Treasury official, Sheila C. Bair, tried to persuade subprime lenders to adopt a code of “best practices” and to let outside monitors verify their compliance. None of the lenders would agree to the monitors, and many rejected the code itself. Even those who did adopt those practices, Ms. Bair recalled recently, soon let them slip.

And leaders of a housing advocacy group in California, meeting with Mr. Greenspan in 2004, warned that deception was increasing and unscrupulous practices were spreading.

John C. Gamboa and Robert L. Gnaizda of the Greenlining Institute implored Mr. Greenspan to use his bully pulpit and press for a voluntary code of conduct.

“He never gave us a good reason, but he didn’t want to do it,” Mr. Gnaizda said last week. “He just wasn’t interested.”

Of course he wasn't interested. It didn't affect him or his fellow shareholders. But as soon as it did, suddenly the financial aid packages just HAD to kick in. For the good of the people, you see.

I suspect there will be a bailout of "Big Shitpile," laundered through the false "good intentions" of cash payments to homeowners. What that bailout won't go is give any incentive to the banks or the lenders to be careful ever again. Because they can always count on that yummy corporate welfare to bail them out.

OC Follies

Looks like the same county poohbahs who under-invested in their own fire safety over-invested in soon-to-be-worthless structured investment vehicles, basically a bundling of subprime mortgage debt that is about to go bust.

Twenty percent, or $460 million, of the county's $2.3 billion Extended Fund is invested in so-called SIVs that may face credit-rating cuts, said Treasurer Chriss Street. In all of its funds, the county holds a total of $837 million of SIV debt, including $152 million in its $3.5 billion of money-market funds that isn't under ratings review, said his spokesman, Keith Rodenhuis.

It's what Atrios has taken to calling "Big Shitpile," sold to municipal governments as low-risk but soon to be a de facto bailout for mortgage brokers - and crushing to these same municipal governments, who won't be able to provide services out of them.

Plus, we have a top Republican activist about to turn himself in on pedophilia charges:

Jeffrey Ray Nielsen—the well-connected Orange County conservative activist who claimed the so-called liberal media, specifically the Weekly, was out to get him by publishing a series of exposés on his pedophile activities—is expected to finally admit tomorrow that he used two boys for sex since 1994, according to law-enforcement sources.

A legal representative for Nielsen, who has extensive personal ties to Congressman Dana Rohrabacher and Orange County Republican Party boss Scott Baugh, told prosecutors early last week that Nielsen would plead guilty to two felony counts: committing lewd acts on a child under 15 years old and committing lewd acts on a child under 14 years old.

He's getting off easy, he'll probably serve 3 years instead of the 30 years he faced if convicted of all the counts in current trials.

PLUS, Hank Asher, a top business associate to Rudy Giuliani, was named in the bribery investigation of Sheriff Michael Carona. He's got the double-whammy, shady ties to America's Mayor AND America's Sheriff!

Asher, identified by the initials H.A. in Overt Act 59 of a federal grand jury indictment against Orange County sheriff Michael Carona, had handed the diamond-encrusted Cartier baubles to the wives of the sheriff and his deputy, and with that, assured himself a place in a federal indictment that was looming.

Asher is not charged with any crime in the indictment. But his expensive gifts are clearly part of the corruption investigation.

The OC! Not exactly like the TV show.