Re: Sometimes instead of doing research, I just write a post.

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... If it unfreezes the credit market ...

What is the evidence that the credit market is currently frozen? It is harder to get a loan than it was a few years ago but that is because the banks were making a lot of very stupid loans in the recent past.


Posted by: James B. Shearer | Link to this comment | 03-26-09 1:08 PM
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... Some of these toxic assets are mortgages, but quite a lot of them are these sketchy made-up derivatives and speculation. Wouldn't we just be propping up the credit defaut swap market and the other hocus-pocus markets if we underwrite these transactions?

I don't think the type of CDOs that caused the problems are currently being created because it has become obvious that no one in his right mind would buy them.


Posted by: James B. Shearer | Link to this comment | 03-26-09 1:11 PM
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Some of these toxic assets are mortgages

I might be wrong, but I don't think that's quite the case. If mortgages were the problem, then the assets could be valued easily enough through standard property appraisals and this could all be handled through typical foreclosures. The problem is that all of the mortgages have been lumped together, sliced up, and then alchemically turned into abstract investment vehicles.

Smarter people may now explain how I missed the target.


Posted by: apostropher | Link to this comment | 03-26-09 1:19 PM
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Second, if AIG and others are too big to fail, why can't they be trust-busted and forcibly broken into failable-sized businesses?

Isn't Geithner asking for authority to take over such businesses if they are failing, and wind them down? Of course I have no idea what he means by "wind them down".


Posted by: mcmc | Link to this comment | 03-26-09 1:20 PM
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... If mortgages were the problem, then the assets could be valued easily enough through standard property appraisals and this could all be handled through typical foreclosures ...

This is not quite correct. The problem is how to value mortgages on the bank's books or when a bank is selling a mortgage to another bank. It is expensive to redo all the stuff that should have been done when a mortgage was originally issued but the original appraisals and loan documentation cannot be relied on because of the amount of bad underwriting and outright fraud that occurred in recent years.


Posted by: James B. Shearer | Link to this comment | 03-26-09 1:31 PM
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And of course even an honest appraisal from the bubble period may now be seriously off.


Posted by: James B. Shearer | Link to this comment | 03-26-09 1:32 PM
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The Tabibi is pretty good.

As I understand, the CDO's and CDS's basically were used to create leverage.

You borrow $100 from Citibank, and make your payments. Under old rules, they can then make $1000 in loans based on the $100. With the "insurance" of a CDO, they were allowed to loan/borrow $10,000. And then whoa, they insured the CDO with a CDS, and leveraged that $100 to $100k.

Junk the CDO's and CDS's and Citibank's creditors say"Whoa, you are paying the nut on $100k with the cash steam from a $100 loan? Give me all my money back, today, right now." Without the derivatives, the banks are way way over-extended.

So PPiwhatver is buying the derivatives. These are not really loans or assets but leveraging-creating instruments. They are very often matched between banks, exchanged simply to pump up reserves. They are short-term, 2-3 years, and then just disappear, with no money needed to be paid back.
But without them, or without capital to replace them, the banks are insolvent. Not technically insolvent, but screamin bloody broke.

PS:Incidentally, according to Yves Smith, Citibank and BofA are out there now buying more of the garbage, as much as they can find, at above market prices, in expectation of making a killing selling it back to FDIC.


Posted by: bob mcmanus | Link to this comment | 03-26-09 1:40 PM
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The problem is how to value mortgages on the bank's books or when a bank is selling a mortgage to another bank.

(Same disclaimers as above; I only vaguely understand this stuff.)
Mortgages on the bank's books are worth the amount outstanding on the loan plus the expected interest. Mortgages in default are worth the amount the bank could get by foreclosing and auctioning the property. This is difficult, but not *that* difficult, to estimate. My understanding is that the problem is that the mortgages have been sliced and diced to the point that nobody's sure who owns what any longer.

even an honest appraisal from the bubble period may now be seriously off

Sure, but again, that's what re-appraisals are for.


Posted by: apostropher | Link to this comment | 03-26-09 1:41 PM
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in expectation of making a killing selling it back to FDIC

Shit like this makes me want to go set fire to some corporate offices and see some bankers ripped to pieces by howling crowds. Jesus, this entire situation just makes my blood boil.


Posted by: apostropher | Link to this comment | 03-26-09 1:44 PM
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The link bob refers to.


Posted by: Brock Landers | Link to this comment | 03-26-09 1:48 PM
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And yes, it was precisely a Ponzi. It was about creating "reserves" to borrow/loan from, and creating income streams/cash flow because the "reserves" were kinda fake.

2) They are contracts. Banks are not in the habit of letting borrowers, even of bullshit, default on contracts. It's principle & precedent, you know.

3) The top two guys at Banque AIG in France quit this week. We are very close to France being legally entitled to put that division into receivership, examining the books, and unleashing the hounds of hell.


Posted by: bob mcmanus | Link to this comment | 03-26-09 1:49 PM
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Finally, the fraud (now finance guys don't think it is fraud) apparently extends throughout all the divisions of AIG, including the "safe" divisions.

To make up an example, AIG Fire Insurance of Japan and AIG Life Insurance of Taiwan would borrow $25 billion dollars from each other, count them as assets and cash flow, and then use them to get leverage. And everybody was using AIGFP as a fountain of money.

It is a fetid swamp.


Posted by: bob mcmanus | Link to this comment | 03-26-09 1:57 PM
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Mortgages on the bank's books are worth the amount outstanding on the loan plus the expected interest. Mortgages in default are worth the amount the bank could get by foreclosing and auctioning the property. This is difficult, but not *that* difficult, to estimate. ...

It is partially a question of trust. Citigroup may say all their mortgages are just fine but who is going to believe them without checking and checking is difficult and expensive.


Posted by: James B. Shearer | Link to this comment | 03-26-09 1:58 PM
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"So PPiwhatver is buying the derivatives. "

Not quite, well not CDOs anyway. There are three aspects to the plan announced on Monday.

1. PPIP for loans: the government provides up to 6-1 non-recourse leverage and 50% equity to buy up unspecified but implied to be real estate related loans directly from banks in auctions. Resi mortgages, commercial mortgages. Maybe some unsecured corporate loans as well.

2. PPIP for securities: Government provides 50% equity and much lower leverage (max 2-1) to funds which will go out and buy up RMBS, CMBS and ABS wherever they can.

3. Expansion of the TALF, an existing but only just started programme which provides long term, non-recourse cheap finance to investors buying securitisations. Previously it had only covered newly originated AAA ABS in certain asset classes (eg credit cards, auto loans). This week the programme was expanded to include pre-existing securitisations including RMBS originally rated AAA, and CMBS and ABS currently rated AAA.

Some of these toxic assets are mortgages, but quite a lot of them are these sketchy made-up derivatives and speculation. Wouldn't we just be propping up the credit defaut swap market and the other hocus-pocus markets if we underwrite these transactions?

The whole point is to prop up these markets. I think it's a bad idea overall, but it seems like they've decided it's the only thing they can do given the refusal to nationalise and the inability to get more TARP money. Basically the programme is structured to stretch a relatively small amount of TARP money ($100bn) into $500bn to $1tn of market support.

Now, while I don't like the plan, my reasons are fairly complicated (and I'm on deadline at the moment). But not propping up the market for underlying securities won't really hasten the end or deleveraging of the CDS market. CDS have fixed terms, and pay out only on a credit event. Either the underlying assets will default or they won't. Movements in the underlying asset prices (and in the spread of the counterparties) affect the mark to market of the CDS, but they don't do anything to trigger a payout. Fairly obviously, the more likely an asset is to default, the more a protection buyer will want to keep hold of its protection and resist unwinding the trade. Now you could hasten the end by letting all the counterparties go bust, making the protection more or less valueless, but that's rather cutting off your nose to spite your face.

Realistically the CDS mountain is only going to be reduced through compression of offsetting trades (several trillion dollars of this has already happened), leaning on counterparties to commute trades (although this will result in cash/capital hits) and waiting for the CDS to run out or the underlying securities to default.


Posted by: Ginger Yellow | Link to this comment | 03-26-09 2:02 PM
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... My understanding is that the problem is that the mortgages have been sliced and diced to the point that nobody's sure who owns what any longer.

I don't think that is the main problem, the main problem is that CDOs and the like can be very sensitive to the exact default rate. On a simple mortgage pool the difference between 10% defaults and 20% defaults is only about 10% but for a CDO it can basically mean the difference between worthless and full value.


Posted by: James B. Shearer | Link to this comment | 03-26-09 2:03 PM
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I have great expectations for PPIP. Just as good, really, as Pip's were.


Posted by: md 20/400 | Link to this comment | 03-26-09 2:18 PM
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1: The anecdata from news stories is that both small business owners and individuals with very good credit ratings can't get loans.


Posted by: Sir Kraab | Link to this comment | 03-26-09 3:06 PM
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||

to the HPV vaccine post.

|>


Posted by: heebie-geebie | Link to this comment | 03-26-09 3:31 PM
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17: I can add to that anecdata from (nigh-)personal experience that small businesses that represent basically zero risk can't get loans right now. The issue is that all the upstream money is in t-bills and other ultra-safe things (assuming there are any?) because people are freaking out. Or because they're fucking the government. Who knows.

As to the rest of heebie's post... I feel like there's a lot to unwind. The hocus-pocus per se may or may not be the problem, all the toxic assets are based at some level on mortgages, there may be more toxic assets which aren't mortgages if things don't get rolling again sooner, and the process of breaking big businesses into smaller ones is really complicated and expensive.

Y'know, listen to This American Life, and past that, buh?


Posted by: Sifu Tweety | Link to this comment | 03-26-09 3:36 PM
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The TED spread has recovered, so apparently banks are willing to lend to each other again. Banks' not doing this was a sign of really serious problems, so this is good.

Are there a non-anecdotal indexes of credit availability? The velocity of money gets mentioned as being relevant, but it cannot be directly measured. Just keeping current with basic facts on this takes work.


Posted by: lw | Link to this comment | 03-26-09 3:44 PM
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all the toxic assets are based at some level on mortgages,

I didn't think this was true. I thought credit default swaps were insurance policies that you take out on a company you think is going to fail.


Posted by: heebie-geebie | Link to this comment | 03-26-09 3:52 PM
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The Fed and other central banks provide statistics on lending, but the headline numbers can be misleading. For instance, a lot of "lending" that has been going on has been companies drawing down on already committed lines, not new loans being extended. This is a) expensive, and b) not sustainable. The real credit drought is in refinancing. Basically you can't refinance a commercial real estate loan if the LTV is above about 50%, and even then the volume of credit available is very small. For unsecured loans, typically only the biggest and strongest companies can refinance through banks, and they generally can't do so in bulk or at long maturities.

Basically, the so-called shadow banking system provided something like half the total credit in the US, and that's completely dried up (absent government programmes like the TALF and the Fed's CP purchasing programme).


Posted by: Ginger Yellow | Link to this comment | 03-26-09 3:57 PM
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"I didn't think this was true. I thought credit default swaps were insurance policies that you take out on a company you think is going to fail."

Well, generally speaking single-name corporate CDS aren't considered toxic, as the risk is tied to the default risk of the individual company, although people criticising the whole concept of CDS sometimes label them as such. The CDS typically labelled as toxic are ones involved in CDOs of RMBS or negative basis trades on over-leveraged corporate CDOs.


Posted by: Ginger Yellow | Link to this comment | 03-26-09 3:59 PM
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20:Calculated Risk follows several indicators he thinks are important, on an increasingly irregular basis now that things have settled. Just a little searching will get you the most recent post.


Posted by: bob mcmanus | Link to this comment | 03-26-09 4:00 PM
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...involved in CDOs of RMBS or negative basis trades on over-leveraged corporate CDOs.

Can't they reroute the flux capacitor through the Warp Core and reverse the polarity on the Deflector Dish to recapitalize the something something TLA hey nonny nonny KABLAM! ?

No? Pitchforks and torches it is!


Posted by: togolosh | Link to this comment | 03-26-09 4:07 PM
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Credit Crisis Indicators March 17


Posted by: bob mcmanus | Link to this comment | 03-26-09 4:08 PM
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I liked this perspective on the credit mess, and it led me to think of comparative levels of garbage/entropy.

Poorer countries have garbage pickers, right? Because garbage is still relative wealth for them. Is there a class of people who'd happily wade through the jumbled together mess of mortgages as piecework to sort this again? College graduates in India for example? Would that be deprecated because it would show the system to be insolvent rather than illiquid? Or would it be deprecated because it is an analogy?


Posted by: Megan | Link to this comment | 03-26-09 4:22 PM
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Garbage pickers have been suffering in the economic downturn.


Posted by: Sifu Tweety | Link to this comment | 03-26-09 4:25 PM
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Mortgages on the bank's books are worth the amount outstanding on the loan plus the expected interest ...

This may be true for accounting purposes if the mortgage is current but the economic value has to account for expected defaults and it is difficult to estimate expected defaults for home mortgages which are way under water (greatly in excess of the value of the house) as we don't have a lot of past data.


Posted by: James B. Shearer | Link to this comment | 03-26-09 4:30 PM
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<pitchfork-waving> Off on a tangent -- I simply don't believe the "we need to pay huge retention bonuses because no one but the people who fucked up could possibly keep even worse disasters from happening," routine. Not everyone is going to quit simultaneously in the absence of a giant retention bonus, and those who do can be replaced by other bankers -- I understand there are plenty, even quite highly trained ones, looking for work. This doesn't answer the questions about how binding the legal obligations to pay those bonuses at AIG were, but the practical argument strikes me as absolute crap; I haven't heard any justification for it except "Oooo, this is so uniquely more difficult than any other job where people leave and get replaced all the time." </pitchfork-waving>


Posted by: LizardBreath | Link to this comment | 03-26-09 4:31 PM
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Garbage just isn't the motherlode that it used to be.

(Actually a friend heard (and who knows the source) that the wastestream to landfills that take garbage from L.A. is down by a third since the recession started.)


Posted by: Megan | Link to this comment | 03-26-09 4:31 PM
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i recalled a video i watched i think here, a very adorable girl 3-4-5 yo tells a fairy tale she thought of herself and in her fairy tale there were poor people
what poor people in her tale were doing i didn't listen further, just thought how she knows about people classification/gradation at that tender age
and it shows who are the caretakers something


Posted by: read | Link to this comment | 03-26-09 4:31 PM
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19

I can add to that anecdata from (nigh-)personal experience that small businesses that represent basically zero risk can't get loans right now. The issue is that all the upstream money is in t-bills and other ultra-safe things (assuming there are any?) because people are freaking out. Or because they're fucking the government. Who knows.

Nothing is zero risk and small businesses probably tend to underestimate their risk. There is also the trust factor, nobody is taking anything for granted any more. Banks not loaning because they are more cautious is not the same thing as banks not loaning because they don't have any money.


Posted by: James B. Shearer | Link to this comment | 03-26-09 4:36 PM
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Brand Spanking New! Banana Republic Confirmed!

Simon Johnson, who sits with DeLong & Krugman to discuss Geithner Plans, has a new longish Atlantic article ...looks at first glance to be Tabibish more with econ cred.


Posted by: bob mcmanus | Link to this comment | 03-26-09 4:36 PM
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Suer, and one of the reasons they are more cautious is that the economy's going down the toilet. But another reason is that they're expecting further capital hits from writedowns on "toxic assets", broadly defined. They're hoarding capital as much as possible, and it takes capital to make a loan, even if you expect it to perform.


Posted by: Ginger Yellow | Link to this comment | 03-26-09 4:39 PM
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Banks not loaning because they are more cautious is not the same thing as banks not loaning because they don't have any money.

But it is, if I understand the term correctly, exactly the same thing as a credit freeze. Throwing more money into the system might not unfreeze it, but credit's frozen, or at least sluggish and chilly.


Posted by: LizardBreath | Link to this comment | 03-26-09 4:39 PM
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... all the toxic assets are based at some level on mortgages, ...

I don't think so. Auction Rate Securities


Posted by: James B. Shearer | Link to this comment | 03-26-09 4:41 PM
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I didn't think this was true. I thought credit default swaps were insurance policies that you take out on a company you think is going to fail.

I don't think credit default swaps are generally referred to as toxic assets.


Posted by: James B. Shearer | Link to this comment | 03-26-09 4:45 PM
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According to Teh Media, AIG employees have all received death threats and have been advised by the company not to wear any identifiable AIG paraphenalia and to travel in pairs and whatnot. At this point, they might indeed have a bit of a hard time hiring bright new talent. But of course this is all a consequence of the bonuses etc.

All of the financial people get paid too much. It's industry-wide.


Posted by: Jackmormon | Link to this comment | 03-26-09 4:49 PM
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How difficult is it to change law firms in the middle of a big law suit? How badly do they have to be fouling up the case to make firing them sensible? Seems like a somewhat comparable situation.


Posted by: James B. Shearer | Link to this comment | 03-26-09 4:49 PM
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Posted by: | Link to this comment | 03-26-09 4:53 PM
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36

But it is, if I understand the term correctly, exactly the same thing as a credit freeze. Throwing more money into the system might not unfreeze it, but credit's frozen, or at least sluggish and chilly.

Credit is tight compared to a couple of years ago but that is to be expected. I just have the bad feeling that a lot of people think returning the credit markets to "normal" means returning to the recent past which is neither possible nor desirable.


Posted by: James B. Shearer | Link to this comment | 03-26-09 4:56 PM
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I think that quite a few respectables have moved in McManus's direction in the last six months. But that's not necessarily good. It may just be rats leaving a sinking ship -- i.e., not a sign that the big people in the game might end up deciding to do the right thing, just a sign that a lot of smart people are quite rightly scared shitless.


Posted by: John Emerson | Link to this comment | 03-26-09 4:57 PM
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40: Firing your lawfirm midstream happens a fair amount -- there are circumstances where it wouldn't make sense, but they don't seem to closely resemble this kind of deal. The circumstances where you'd have a lot of trouble firing your lawyers is where you had a really fact-heavy case -- where they'd developed an intimate acquaintanceship with a roomful of boxes of documents. You can always replace the genius at the top pretty easily, the irreplaceable lawyers are the midlevel/senior associates who've been interacting with the documents to the point of being able to locate something vaguely described on a moment's notice, and point out the five other things it relates to.

I could be wrong -- I don't know much about banking -- but I don't get the impression that the sort of deals we're talking about here involve that sort of thick knowledge of factual detail.


Posted by: LizardBreath | Link to this comment | 03-26-09 4:57 PM
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At this stage, I find it hard to support any plan that doesn't begin with:

"Build a line of gibbets, 300 miles long ... "


Posted by: nattarGcM ttaM | Link to this comment | 03-26-09 4:59 PM
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One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government--a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises.

Where have I heard that before? Ignatius Donnelly? They're dusting it off again.


Posted by: John Emerson | Link to this comment | 03-26-09 4:59 PM
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Shearer is right and Apo is wrong above about the ease of valuing home loans in the current environment. I mean, Apo might be right if government had taken hold of this crisis in a really determined way, the Home Owners Loan Corporation in the 30s did actually go around and revalue everything, but he is definitely wrong today. Instead the "stress tests" are just a bunch of regulators arguing with a bunch of bank risk managers about what percentage of their loans are going to go south over the next two years, with all the key variables already at unprecedented levels.

"Toxic assets" originally meant the equity tranches of the mortgage backed securities, but the definition is much wider now. The system is rotten with bad loans, credit cards, auto loans, commerical property, you name it are all seeing high default rates going higher. And all of those were securitized. But even the loans kept conventionally on bank books are, ummm, an issue. Which is why your government will soon be purchasing them through the PPIF.



Posted by: PGD | Link to this comment | 03-26-09 5:03 PM
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I have the strong impression that we'd be much better off if anyone was " able to locate something vaguely described on a moment's notice, and point out the five other things it relates to." in the banks and mortgage companies. Since they say they can't, off with their bonuses!


Posted by: clew | Link to this comment | 03-26-09 5:06 PM
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"Build a line of gibbets, 300 miles long ... "

We don't have resources to squander on that crossbar. I vote for impaling stakes.

Emerson's hog farm offers returns besides vast satisfaction, which has appeal.


Posted by: Megan | Link to this comment | 03-26-09 5:13 PM
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49: Put 'em in bags, and build levees?


Posted by: LizardBreath | Link to this comment | 03-26-09 5:15 PM
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"But even the loans kept conventionally on bank books are, ummm, an issue. Which is why your government will soon be purchasing them through the PPIF. "

I'm actually pretty skeptical that there will be much take-up of this part of the PPIF, unless the government leans very heavily on the stress tested banks or waves a big nationalisation stick. These loans, unless they've already experienced "other than temporary" impairment will be marked at or close to par. The PPIF is ostensibly designed to bridge the gap between market prices and book values, but I strongly doubt it will bridge the whole gap. That means any selling bank will have to take a further writedown. They'd be pretty stupid to do so in most circumstances.

Basically, if the government really wanted this to work, they'd have forced the banks to participate, and promised to make up any resultant capital shortage.



Posted by: Ginger Yellow | Link to this comment | 03-26-09 5:15 PM
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re: 49

I'm thinking economic stimulus, you know? Mebbe a transatlantic bridge from New York to Cornwall, lined with dual-purpose gibbet-turbines. Think of the jobs, the green electricity, the opening up of new and exciting ventures ...


Posted by: nattarGcM ttaM | Link to this comment | 03-26-09 5:16 PM
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The article linked in 34 is excellent.


Posted by: PGD | Link to this comment | 03-26-09 5:17 PM
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49: Put 'em in bags, and build levees?

DUDE! Dude. My friend's Taiwanese civil engineering professor used to teach his class that the Chinese forced the Red Army to be human levees. HUMAN LEVEES! They were supposed to link arms and form ranks on the banks of flooding rivers and stand there as the waters rose. If someone got plucked away or submerged, the person behind stepped up.

Don't know if I believe it, but the whole concept blows me away. HUMAN LEVEES! Holy crap. How much would it suck to know that you were about to be a levee? How would you ever walk forward in the moment?

Anyway, so what I'm saying is to keep them vertical for the additional few feet of flood height.


Posted by: Megan | Link to this comment | 03-26-09 5:28 PM
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I call shenanigans. How would that possibly be watertight?


Posted by: LizardBreath | Link to this comment | 03-26-09 5:29 PM
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Lots of lines of people? My friend claimed the guy had pictures, but no googling combinations came up with any. It would have been put up on the water blog as fast as I could, if I'd found them.


Posted by: Megan | Link to this comment | 03-26-09 5:32 PM
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If he was Taiwanese he might have pretty good reasons for believing a load of bollocks about the Red Army ...


Posted by: nattarGcM ttaM | Link to this comment | 03-26-09 5:33 PM
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27: Poorer countries have garbage pickers, right?
Um, a lot of my friends still dumpster dive to supplement their meager incomes. True, they don't get out there in the landfills and pick around, but if they were allowed to, some of them probably would.

Anecdotally, my garbage stream has shrunk significantly since I left my job. And I've been thinking I should get back into dumpster diving too, though it's been many years since I did so regularly.

It would help the planet a lot if people dumpster dived more.


Posted by: minneapolitan | Link to this comment | 03-26-09 5:36 PM
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Yes, well, that's why I specified.

BUT! It does lead to speculation about combining functions. If impaling stakes were closely set on the banks of floodprone rivers...


Posted by: Megan | Link to this comment | 03-26-09 5:36 PM
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How would that possibly be watertight?

They were all forced to chew lots of bubblegum at gunpoint, obviously. The blown bubbles will collapse and seal the seams.


Posted by: foolishmortal | Link to this comment | 03-26-09 5:37 PM
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re: 58

Our local recycling centre takes a lot of electrical equipment. A couple of times I've seen really nice vintage hi-fi equipment there -- stuff that could be fixed easily and which would i) sound good and ii) sell.

They don't allow you to take stuff away, unfortunately.


Posted by: nattarGcM ttaM | Link to this comment | 03-26-09 5:38 PM
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he is definitely wrong today

I can believe that.


Posted by: apostropher | Link to this comment | 03-26-09 5:40 PM
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It is harder to get a loan than it was a few years ago but that is because the banks were making a lot of very stupid loans in the recent past.

Yes, but that (over)reaction has caused credit to dry up to some extent. Evidence: we were buying a house with a VA loan, which has existed forever as a no-money-down loan and is backed by the U.S. government. We also have awesome credit. But it was hard as hell to even *find* a bank that would do a VA loan. We found two. One was a military credit union, which is what we ended up using; the other was Wachovia, and they wanted an absurdly high interest rate b/c it was a zero-down loan, even though it was a guaranteed VA.


Posted by: bitchphd | Link to this comment | 03-26-09 5:58 PM
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PS:Incidentally, according to Yves Smith, Citibank and BofA are out there now buying more of the garbage, as much as they can find, at above market prices, in expectation of making a killing selling it back to FDIC.

See here . Apparently the story originated in the New York Post.


Posted by: James B. Shearer | Link to this comment | 03-26-09 6:11 PM
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So, a few years ago a student approached me about co-supervising a dissertation on pricing portfolios of credit default swaps. I turned them down because, after I looked into it for a bit, I became convinced that there was no responsible way to do it without modeling the actual economic linkages between firms, etc., etc., and there was no way in hell the data was adequate to say anything more than "the price of a CDS should be positive". Now I wonder if I shouldn't have gone ahead with it anyway, if only to be able to say "we told you so".


Posted by: Cosma | Link to this comment | 03-26-09 6:31 PM
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63

It appears to me that the VA guarantee is only for 25% of the value of the loan. And while VA loans have existed for a long time the terms have gotten more generous. They were not originally no money down.


Posted by: James B. Shearer | Link to this comment | 03-26-09 6:41 PM
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Yeah, what a lot of people don't grasp is that there are two main elements of risk in a CDS, and they get different players in trouble in different ways.

First there is the risk of default (actually a "credit event", which covers other things like restructurings). This is what the "insurance" is for - a seller of CDS protection pays the buyer when a credit event happens. So if you're a seller (like AIG, for example), your risk goes up if the assets go down. Conversely, as a buyer, your benefit from the protection goes up.

Second, there is the counterparty risk - the risk that the seller will fail to pay out on a credit event, or that the buyer will fail to pay its premium. In practice, though, when people talk about counterparty risk in CDS, they almost always mean the seller. As a buyer, you have to take into account the chance of the seller defaulting. That's why most CDS sellers were triple-A rated (like AIG, the monolines or CDPCs), and people tended to ignore counterparty risk when they had a triple-A counterparty.

What really got people into trouble was failing to consider (or recklessly disregarding) the fact that because the sellers had large, concentrated portfolios of CDS exposure, the risk of the assets failing and the risk of the counterparty failing were highly correlated, making the protection entirely illusory (absent a government bailout as we've seen with AIG, but not other counterparties).


Posted by: Ginger Yellow | Link to this comment | 03-26-09 6:42 PM
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So Cosma escaped contumely and obloquy, and hundreds of millions along with them.

In other news, at Crooked Timber I just had a long bout with a Ari-Fleischer-level troll. I have the distinct feeling that was trying to strip me of my troll crown. He pushed me to within an inch of my life, but I survived -- though I'm sure that he's denying that as we speak.

I strongly suspect that this troll was a deputized turncoat troll hired by Kieran Healey. The Wild West is being brought under the law.


Posted by: John Emerson | Link to this comment | 03-26-09 6:44 PM
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Hundreds of millions of dollars, natch. And these look to be deflated dollars very soon.


Posted by: John Emerson | Link to this comment | 03-26-09 6:46 PM
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You know, up until about three weeks ago, I really was trying to understand the mechanics of the credit derivatives meltdown. I listened carefully to the This American Life episodes, sometimes more than once, and I even talked the matter over with some of the freelance financial journalists who write in my building.

But now? It's like those gold coins that fairies were supposed to pay with, turned back into dead leaves that are crumbling and floating away. It's hard to care about how many flying buttresses and turrets the spun-sugar castle had, now that it's totally smashed up.


Posted by: Jackmormon | Link to this comment | 03-26-09 6:48 PM
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66: Regardless, they've been zero down for as long as I've known about them, which is a pretty long time now.


Posted by: bitchphd | Link to this comment | 03-26-09 6:52 PM
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That's why most CDS sellers were triple-A rated (like AIG, the monolines or CDPCs), and people tended to ignore counterparty risk when they had a triple-A counterparty.

Goldman Sachs professes to have figured this out in real-time, and to have had essentially no exposure to AIG - even though AIG was counterparty on something like $14 billion worth of swaps (something like $6 billion of which AIG hadn't provided collateral for as of last fall.)

Presumably, Goldman hedged its exposure to AIG through transactions with some other counterparty (or counterparties) - and presumably the other counterparty sold that insurance cheaply because, hey, AIG is AAA-rated, and what could go wrong?

What I don't get is, if the feds are going to step in and pay in full for all of AIGFP's fuckups, then who cares if anybody competent is left at AIGFP?


Posted by: politicalfootball | Link to this comment | 03-26-09 7:16 PM
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64:Don't know what I can say, other than yes, I have seen skepticism expressed about the story. Ken Houghton at Angry Bear and Rittholz have also posted on it.

OTOH, "Don the libertarian Democrat", who I also see at Buiter's and Setser's, does make the point that we now own Citibank, so why should we care if they game the system and make money? Hey, it's all us, and all good.


Posted by: bob mcmanus | Link to this comment | 03-26-09 7:24 PM
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"What I don't get is, if the feds are going to step in and pay in full for all of AIGFP's fuckups, then who cares if anybody competent is left at AIGFP?"

Well, in theory competent people would do a better job at managing AIG's portfolio and thus reducing the taxpayer's ultimate loss - generally CDS sellers took over voting rights from the bondholders they were protecting, and thus have a say in any work out of defaulted assets. And where AIG/Maiden Lane has bought the underlying assets, they clearly have voting rights. But given that a) AIG's people don't seem to have been very competent, and b) they thought they weren't taking much risk, and so probably don't have any work out expertise, I don't really see what the fear is either.


Posted by: Ginger Yellow | Link to this comment | 03-26-09 7:39 PM
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74: Also: The theoretical expertise here is in these vastly complex credit default swaps - yet the whole point of the massive CDS bailout is to remove all complexity from the swaps by just paying them off. Presumably handling the voting rights of the underlying securities is a fairly mundane bit of expertise (though, of course, it's way over my head).


Posted by: politicalfootball | Link to this comment | 03-26-09 7:50 PM
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The argument for why we need to keep the AIG people is that they will go to work for AIG's counterparties. It's closer to a lawsuit where when you fire your lawyer, he immediately goes to work for the other side.

I say let's fire them and see what happens.


Posted by: Walt Someguy | Link to this comment | 03-26-09 8:04 PM
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Is anyone (besides Walt) proposing firing everyone at AIGFP? I thought the argument was just about whether they should get their lavish bonuses (and the fear that they'll quit if they don't). I'm not in favor of firing them all (I understand most of the people we might really want to fire are already gone), but I won't cry if a few walk pouting out the door.

The argument for why we need to keep the AIG people is that they will go to work for AIG's counterparties.

I've heard this, but (1) are their counterparties really hiring?, and (2) the fear seems to be that they'll use their their knowledge of AIG to damage it further by trading against it. I'm not really a securities lawyer, but I'd be stunned if that were legal.


Posted by: Brock Landers | Link to this comment | 03-26-09 8:11 PM
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The argument for why we need to keep the AIG people is that they will go to work for AIG's counterparties.

This one I don't buy. EVERYBODY signs non-disclosure and non-competition forms--hell, I had to sign one to work at Kaplan, for Christ's sake. There's no way the AIG employment contracts didn't include some language that would penalize exworkers ten ways come Sunday should they turn around and give the competitors all of AIG's privileged information.


Posted by: Jackmormon | Link to this comment | 03-26-09 8:13 PM
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The theoretical expertise here is in these vastly complex credit default swaps - yet the whole point of the massive CDS bailout is to remove all complexity from the swaps by just paying them off.
The way it's been done so far has been by buying the underlying assets from the protection buyers, then terminating the CDS contracts. So AIG/we/Maiden Lane still have huge exposure to the assets.

Presumably handling the voting rights of the underlying securities is a fairly mundane bit of expertise (though, of course, it's way over my head).

Not at all. Managing a distressed portfolio is very different to managing a performing portfolio (especially a performing portfolio of super-senior triple-A tranches) , and requires a huge amount of analytical expertise and legwork, not to mention knowledge of the likely outcomes of different work out procedures and sheer man hours for attending all the bondholder meetings. It's way more intensive than normal investment, which is one reason why distressed debt investors look for such high yields (obviously the uncertainty of future performance is a huge factor as well).


Posted by: | Link to this comment | 03-26-09 8:15 PM
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78: those turn out to be pretty often unenforceable, I believe.


Posted by: Sifu Tweety | Link to this comment | 03-26-09 8:15 PM
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Keep the back-office folks at AIGFP. Those are the ones we need. The traders and execs get fired on a case by case basis. If it is true that the rest of AIG is rotten then do the same.


Posted by: md 20/400 | Link to this comment | 03-26-09 8:15 PM
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Gah. 79 was me.


Posted by: Ginger Yellow | Link to this comment | 03-26-09 8:18 PM
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Everybody now bring your family down to the riverside
Look to the east to see where the fat stock hide
Behind four walls of stone the rich man sleeps
It's time we put the flame torch to their keep

Elton John and Bernie Taupin, handmaidens to class warfare.


Posted by: JP Stormcrow | Link to this comment | 03-26-09 8:22 PM
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What really got people into trouble was failing to consider (or recklessly disregarding) the fact that because the sellers had large, concentrated portfolios of CDS exposure, the risk of the assets failing and the risk of the counterparty failing were highly correlated

Also, a traditional way of protecting against counter-party risk, shorting the counter-party, was taken off the table at an inopportune time.


Posted by: | Link to this comment | 03-26-09 8:23 PM
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those turn out to be pretty often unenforceable, I believe.

At least mine was written to be subject to the laws of NY State. I hear that often in these cases, the contract contains language committing both parties to arbitrate under, say, some Orthodox Court out in Yonkers or whatever, where the bondman's treason towards the master is usually frowned upon.


Posted by: Jackmormon | Link to this comment | 03-26-09 8:24 PM
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On the non-compete and related issues, before the market blew itself up, Calyon sued Mizuho for $750m after its entire CDO team defected (they were also sued), alleging that they had taken its proprietary information and defamed Calyon for losing its team. The case was eventually settled out of court, but Mizuho sacked the team shortly afterward, probably more because of the credit crisis than the lawsuit.


Posted by: Ginger Yellow | Link to this comment | 03-26-09 8:30 PM
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The whole thing was really mishandled. If the government is going to bail out AIG and AIG's counterparties, the way to do it was to act as the reinsurer for AIG's portfolio so that AIG didn't have to raise collateral. (This might have required some legislation, and bullying the ratings agencies, but we have a legislature and an army for a reason.) Instead, the government gave AIG money to settle its contracts early (and from what I've read, overpay in doing so) so that the government ends up holding all of the insured securities.


Posted by: Walt Someguy | Link to this comment | 03-26-09 8:47 PM
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84 was me.

The circumstances where you'd have a lot of trouble firing your lawyers is where you had a really fact-heavy case -- where they'd developed an intimate acquaintanceship with a roomful of boxes of documents.

Mortgage servicing clerks should get retention bonuses.


Posted by: Econolicious | Link to this comment | 03-26-09 9:35 PM
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Instead, the government gave AIG money to settle its contracts early (and from what I've read, overpay in doing so) so that the government ends up holding all of the insured securities.

"Overpay" is a relative term. What the feds did on the AIG CDS's is paid the counterparties exactly what the swaps were worth, assuming AIG's solvency.

So yeah, under the circumstances, sure seems as though the feds overpaid.



Posted by: politicalfootball | Link to this comment | 03-26-09 10:59 PM
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So AIG/we/Maiden Lane still have huge exposure to the assets.

Right. I wasn't contending that the exposure was removed - quite the reverse, in fact. The exposure was assumed by us/Maiden Lane. My contention was that the complexity was removed.

Not at all. Managing a distressed portfolio is very different to managing a performing portfolio (especially a performing portfolio of super-senior triple-A tranches) , and requires a huge amount of analytical expertise and legwork, not to mention knowledge of the likely outcomes of different work out procedures and sheer man hours for attending all the bondholder meetings.

I'm not saying that these are simple tasks that require no expertise. I'm saying (I'm guessing, really) that this sort of expertise is not something that's exclusive to AIGFP, and that others could take on this assignment without undue fuss. Am I wrong?


Posted by: politicalfootball | Link to this comment | 03-26-09 11:03 PM
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As for any non-compete clauses in the AIG employee contracts, this isn't an ordinary circumstance. If I were a departing employee of AIGFP, I might not fret about AIG suing me, but I think there's reason to be nervous that, if I didn't keep my nose clean, Congress might intervene.


Posted by: politicalfootball | Link to this comment | 03-26-09 11:05 PM
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Mebbe a transatlantic bridge from New York to Cornwall, lined with dual-purpose gibbet-turbines.

There is a reality in which this was done (more or less).

You can tell it's an alternate reality because that page is indexed as non-fiction, which I find oddly disturbing.


Posted by: OneFatEnglishman | Link to this comment | 03-27-09 4:06 AM
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"I'm saying (I'm guessing, really) that this sort of expertise is not something that's exclusive to AIGFP, and that others could take on this assignment without undue fuss. Am I wrong?"

Not at all. My argument was that this is precisely the sort of expertise AIG is highly unlikely to have had in any depth, at least until late 2007/2008. If they had half a brain, they'd have hired lots of people when they realised their exposures were at serious risk of default. But we haven't seen much evidence they did have half a brain, and obviously they were pretty cashstrapped in the second half of the year.


Posted by: Ginger Yellow | Link to this comment | 03-27-09 7:47 AM
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92: sadly "a transatlantic tunnel, hurrah!" doesn't really live up to the promise of its excellent title


Posted by: tierce de lollardie | Link to this comment | 03-27-09 1:11 PM
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neb, will there be an online archive of this show for those of us unable to listen?


Posted by: Robust McManlyPants | Link to this comment | 03-27-09 3:41 PM
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Well, fuck.


Posted by: Robust McManlyPants | Link to this comment | 03-27-09 3:42 PM
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i already asked that question


Posted by: read | Link to this comment | 03-27-09 3:43 PM
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Sometimes instead of reading the archives, I just comment in the wrong thread.


Posted by: apostropher | Link to this comment | 03-27-09 3:55 PM
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Sometimes instead of reading the thread, I just make a joke about the last comment.


Posted by: Sifu Tweety | Link to this comment | 03-27-09 4:09 PM
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Sometimes Kobe just swoops in to seize comment #100.


Posted by: Jackmormon | Link to this comment | 03-27-09 4:14 PM
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Damn.


Posted by: Kobe | Link to this comment | 03-27-09 4:52 PM
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I finally finished reading the Taibbi article. Not sure there was much there that wasn't already known from newspaper reporting, but it's good to have it all pulled together in one place.


Posted by: eb | Link to this comment | 03-29-09 12:45 AM
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94. Doesn't it? It's 30 years since I read it, but I agree Harrison churned out a lot of stuff by numbers. Still don't understand why it's "non-fiction" though.


Posted by: OneFatEnglishman | Link to this comment | 03-29-09 5:42 AM
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