Tuesday, September 23, 2008

Not Enough Money In the World

I was reading Roubini's post, listed here (registration required, but free), and it got me thinking about When Genius Failed and LTCM. For those who do not recall, in 1998 the NY Fed was able to arrange a de-leveraging of a large and complex hedge fund whose bets, um 'investments' (I hate this term for reasons to be described in another post), were threatening the global economy. They did so without direct usage of public funds or guarantees. Many of those involved profited.

In March, Jamie Dimon (CEO of JPMorgan Chase), knew the game and its new rules and umpires better than the bankers dared to speculate upon in 1998. He demanded a government backstop to his offer in purchasing the failed Bear Stearns and managed to secure a non-recourse loan of at least $29 billion against losses it may incur as a reuslt of the deal. Despite the fact that other bidders presented themself, Bear was shuffled off to slaughter. with a federally provided blood resevoir.

LTCM was just as intertwined and novel in it's day as Bear was in March, and the world had suffered at least two serious economic shocks in as many years at the time (1997 Asian Financial Crisis and the 1998 Russian Default). Yet, magically, the government didn't need to put up direct dollars. Certainly, there was some indirect quid pro quo for, along with increased lobbying efforts from, the banking industry. Investment banks (Bear refused to assist the Fed at the time) garnered new freedoms such as the repeal of the Glass-Steagall Act of 1933 and the Commodities Futures Modernization Act of 2000.

A strong argument can be made that the latter of these two acts is in may ways responsible for the current turmoil. The act specifically banned regulation upon credit default swaps, enabled single stock futures (an undoubtable positive), and in some significant ways led to the advancement of exchange-traded funds (also an overall positive). The point is, the market, in its contemporary dilemma does not appear to desire the assets or some of the companies in question at any price.

But, enough with the prelude: Why have we put up any public funds whatever to financial firms?
(Short answer: It is not clear.)

Bear Stearns, it was argued, was so integral to the global economy, that its failure would lead to an even worse global unraveling. If this is true, why weren't all the firms that were so very much at risk willing to keep it afloat? Why was the government relatively easily pressured into providing the backstop? We were told there simply was not enough time. On this, I call bullshit. There wasn't enough will, because the claim itself was not true.

Market participants knew that the best Lehman value was a failed Lehman; they were shady about their books and organizations who saw their L3 / fuller books were turning their backs. There were few differences between Bear and Lehman. The arguments about the significance of Bear's involvement in the repo markets and as a significant player in the CDS market simply don't hold water. Again, if a Bear death would have been so significant to so many other market participants, said market participants would have had a clear and vested interest in keeping it afloat. The did not, and taxpayers were played the fool.

Freddie and Fannie's buyout details eliminated a short term financing option of significance for many financial firms, and may have contributed to Lehman's collapse. The government attempted a 1998 style brokering, but no private buyers could be found. The market new it could live without Lehman the same way it knew it could live without Bear. There are roughly 20 primary dealers and the market knew it did not need all of them to survive in order to function. A pain in the ass to switch? Yes. Potentially expensive? Yes. A market collapsing event if one fails? No.

AIG received $85 billion plus the market received hundreds of billions in short term lending made available and a loosening of collateral standards from the Fed's various lending facilities.

Why? The Fed action is understandable and within the realm of what it is that the Fed does. But why the AIG bridge loan? $85 billion, it could be argued, was simply too much money to be cobbled together in the time span necessary. Does this mean that the government had to go in for the full $85 billion? No, not at all. A public / private arrangement could have been reached, there were offers on the table totaling tens of billions of dollars. Why the government felt compelled to be the only lender, when other lenders were available and willing is hard to understand and yet to be explained. Also, if AIG had no other options and was threatening the global economy, why leave 21.1% of the equity behind? Why pretend that the government is not responsible for AIG's solvency and maintain the sherade that AIG is off the governmetn balance sheet but at least $700 billion is required RIGHT NOW!? The answer, may be, that it's simply not the case.

The government is arguing that there is not enough money in the world to save the economy. If this is the case, than the economy must get smaller. To print enough money to fill the void does not provide clear solutions to any of the markets' problems. Especially if said money comes with higher interest rates. The problem of over-leveraging is not solved. The problem of lax regulation and limited transparency is not solved. The problem mortgage borrower default / failure is barely addressed, never-mind solved. So, at the end of the day, there are many questions:

  1. What is this bailout getting the American people that the market is incapable of providing?
  2. What are taxpayers getting that the market doesn't want?
  3. Why should taxpayers be willing to take what is being sold, if no one else is interested?
  4. If no one else is interested (severely limited demand), why is there such an enormous price tag for these undesirable assets?
The answers, if honest, are likely to be mendacious. I'm interested to know what is thought by you.


  1. Here's a start:

    Q: What is this bailout getting the American people that the market is incapable of providing?

    A: Liquidity. But there are two forms. Grants and loans. Unclear whether the former is necessary, which is what rubs people the wrong way.

    Q: What are taxpayers getting that the market doesn't want?

    A: Nothing. The market "wants" liquidity, but can't produce it at the moment.

    Q: Why should taxpayers be willing to take what is being sold, if no one else is interested?

    A: Happens all the time where, as here, the market can't achieve a critical objective, like, say, environmental regulation.

    Q: If no one else is interested (severely limited demand), why is there such an enormous price tag for these undesirable assets?

    A: Because there is an enormous amount of debt and not enough private liquidity to service it.

  2. There's plenty of money sitting on the sidelines. No one wants to use it, I'm wagering, because they're betting on the taxpayers providing it:
    "a lot of US companies have considerable cash on hand, so they should not be too badly affected by the credit crunch."

    There are lots of ways to provide liquidity, central banks have been providing hundreds of billions of dollars in liquidity. We've moved to provide insurance to the "non-bank banks" in the form of money market fund guarantees. Why, again, are we providing this very expensive proposed 'liquidity' in the form of this cockamamie debt buying scheme?

  3. Apple has cash, but Apple is not a bank. But does WaMu have cash? B of A? Citigroup? Chase? I don't know. And yes, Morgan and GS now have access to the central bank. Hard to believe they would submit to such a regime and its regulations if they had the cash to stay out of it. I just don't know.

  4. There's an article in today's NYTIMES that references what Sweden did to remedy their own economic collapse:


    Can the United States learn anything from the Swedish experience or are these two situations vastly different?

  5. Absolutely, there is plenty to learn from the Sweden scenario. I found a compelling post on this topic here.


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