Buying back bad assets

[cannon_fodder]

I looked into how the basic plan announced by Timmay Geitner will work:

1) An auction will be held to unload CDO's that financial institutes can not sell on the open market.

2) Qualified bidders (not defined) can bid.

3) On any purchase, the buyer will pay 20% of the purchase price in cash.

4) The government will pay 20% of the purchase price in cash.

5) The government will loan the buyer the remaining 60% of the purchase price as a non-recourse loan*.

*non-recourse loan means if the venture is profitable, the government gets paid back.  If they lose money, it is a gift.

6) Profits will be split 50/50 between the company and the government.
- - -

Ok.  This sucks for tax payers and anyone that is not a qualified bidder.  Here's the short story on how we got here:

A company, lets call them Americans Interested in Gambling (AIG for short), decides it wants to make more money than it has the last 100 years or so.  Realizing that tax policy and the American mind tells everyone they should own a home and special treatment is given to mortgages - that is an ideal market to hop into.  They had to make a new market in this old and stable industry to make their killing.

To do this AIG (and others, of course) took a ton of otherwise loans and bundles them together, gets them regulated as mortgages, graded as high grade investments, and sells them off to people restricted to high grade investments (retirement funds, pensions, cash reserves, etc.).   It speeds up the process of passing loans to investors.  The increase in cash flow trickles from Hedge Funds, to investment banks, to the banks that originated the loans, to mortgage brokers, real estate agents, and builders. WIN WIN WIN!

AIG then sells insurance on these new packaged debts so the companies buying them can hedge against potential loss.   In doing so the company that is buying the packaged loans essentially can't lose.  If someone pays on their loans they make money.  If they fail they collect on the insurance and they make money (there is room for loss, but outside the usual realm of return = risk of loss).  AIG then realizes more money can be made if it starts to sell insurance on the same thing to anyone that wants to bet it will fail - one loan package, 5 bets that it will fail (Credit Default Swaps).

Obviously this becomes a popular scheme, and the practice starts off pretty sound since Mortgages are scrutinized in the United States by lending institutions.  Unfortunately, the practice allows all sorts of companies to get in on the action and turn over loans more quickly. Since the loans will be packaged it becomes a volume business, but since there is always a buyer in some supermega corp. you can make loans and sell them as fast as possible.  Hence:  no credit, no down payment, no job, NO PROBLEM!   

As we all know that ended poorly.  The extra loan availability increased demand to the point of ridiculous.  The quality of the loans dropped substantially just as the amount of those loans was going way up.  The result was that previously anxious buyers realized this might be a problem and stopped buying them.  Super Mega Corp. was stuck holding the bag - the Collateralize Debt Obligations (CDO).

So now Joe Keg (fka Joe 6 Pack) bought a $500,000 house on $50,000 a year with no money down, took out an equity line and bought his new Hummer, and sat confident in his knowledge that he can flip the house for a massive profit as soon as the bills catch up with him.  Now that House is worth $350K, he lost his job and realized his Hummer is killing mother Earth.  Crap he doesn't need, with money he doesn't have.  Yay!

Super Mega Corp. is holding bundles of mortgages that are worth god-knows-what.  More and more people aren't paying on the underlying debts and the assets that secure the notes are worth less and less (if you can sell them).  The insurance underwriter is no longer reliable and the revenue stream from turning over these various new instruments. 

What we need here is some serious government money.  That way Super Mega Corp. doesn't lose money on their bets and we can help reinflate the value of Joe Kegs house towards artificially high numbers so he can enjoy his hummer.  At the same time, we better help out AIG to cover the losses they have to pay out on "insurance" policies they wrote on assets that were over inflated to people that never held them in the first place.  (did I mention the AVERAGE AIG employee in the Financial Division responsible for packaging and selling this crap made $1,600,000 a year?  400 people, that's the average.)

But here's how we get screwed as tax payers:


AIG bids on packaged mortgages (that it packaged and sold earlier) and wins with a bid of $1,000. 

AIG pays:  $200
Taxpayers:$200
Gov. Loan:$600
-----------------
..............$1000

It does this on 4 different CDO's (1-4).   So AIG is out $800, Tax payers are out $800, and AIG takes $2400 in "non-recourse loans" from the government.  What happens?

As I understand it, money goes to the capital first.  Then to repayment of the loan. So . . .

CDO 1: Collect $402.   Both AIG and the Government get $200 .  Government loses $<598> on the loan.
CDO 2: Collect $1000.  Everyone breaks even!
CDO 3: Collect $2000.  AIG and the government gets $200 + $500 in profit.  Loan repaid.
CDO 4: Collect $100.  AIG gets $50 <150>, Government gets $50 <150>.  Loan goes away <$600>. 

So at the end of the day AIG made $450.  The government lost $698.  Yay. 

Correct me if I'm wrong.  I'm just some dumbass attorney trying to figure out where my tax money goes.  But it appears the rest of us get to subsidize the gambling of these firms in an effort to clean up the consequences caused by these firms gambling.

Too big too fail needs to die as a concept.  Replace it with "too big to fail catastrophically" and I'm fine with it.  Just like the FDIC does with a bank, take it into receivership and decide if it is worth more as a whole or if it should be chopped up.  Whatever makes/losses the least money in an orderly fashion.  I'm all for contract rights and I understand the retention bonuses, but if the company was essentially dissolved then contracts are unilaterally altered.  Sucks, but financial meltdowns do.

/venting

[swake]

I looked into how the basic plan announced by Timmay Geitner will work:

1) An auction will be held to unload CDO's that financial institutes can not sell on the open market.

2) Qualified bidders (not defined) can bid.

3) On any purchase, the buyer will pay 20% of the purchase price in cash.

4) The government will pay 20% of the purchase price in cash.

5) The government will loan the buyer the remaining 60% of the purchase price as a non-recourse loan*.

*non-recourse loan means if the venture is profitable, the government gets paid back.  If they lose money, it is a gift.

6) Profits will be split 50/50 between the company and the government.
- - -

Ok.  This sucks for tax payers and anyone that is not a qualified bidder.  Here's the short story on how we got here:

A company, lets call them Americans Interested in Gambling (AIG for short), decides it wants to make more money than it has the last 100 years or so.  Realizing that tax policy and the American mind tells everyone they should own a home and special treatment is given to mortgages - that is an ideal market to hop into.  They had to make a new market in this old and stable industry to make their killing.

To do this AIG (and others, of course) took a ton of otherwise loans and bundles them together, gets them regulated as mortgages, graded as high grade investments, and sells them off to people restricted to high grade investments (retirement funds, pensions, cash reserves, etc.).   It speeds up the process of passing loans to investors.  The increase in cash flow trickles from Hedge Funds, to investment banks, to the banks that originated the loans, to mortgage brokers, real estate agents, and builders. WIN WIN WIN!

AIG then sells insurance on these new packaged debts so the companies buying them can hedge against potential loss.   In doing so the company that is buying the packaged loans essentially can't lose.  If someone pays on their loans they make money.  If they fail they collect on the insurance and they make money (there is room for loss, but outside the usual realm of return = risk of loss).  AIG then realizes more money can be made if it starts to sell insurance on the same thing to anyone that wants to bet it will fail - one loan package, 5 bets that it will fail (Credit Default Swaps).

Obviously this becomes a popular scheme, and the practice starts off pretty sound since Mortgages are scrutinized in the United States by lending institutions.  Unfortunately, the practice allows all sorts of companies to get in on the action and turn over loans more quickly. Since the loans will be packaged it becomes a volume business, but since there is always a buyer in some supermega corp. you can make loans and sell them as fast as possible.  Hence:  no credit, no down payment, no job, NO PROBLEM!   

As we all know that ended poorly.  The extra loan availability increased demand to the point of ridiculous.  The quality of the loans dropped substantially just as the amount of those loans was going way up.  The result was that previously anxious buyers realized this might be a problem and stopped buying them.  Super Mega Corp. was stuck holding the bag - the Collateralize Debt Obligations (CDO).

So now Joe Keg (fka Joe 6 Pack) bought a $500,000 house on $50,000 a year with no money down, took out an equity line and bought his new Hummer, and sat confident in his knowledge that he can flip the house for a massive profit as soon as the bills catch up with him.  Now that House is worth $350K, he lost his job and realized his Hummer is killing mother Earth.  Crap he doesn't need, with money he doesn't have.  Yay!

Super Mega Corp. is holding bundles of mortgages that are worth god-knows-what.  More and more people aren't paying on the underlying debts and the assets that secure the notes are worth less and less (if you can sell them).  The insurance underwriter is no longer reliable and the revenue stream from turning over these various new instruments. 

What we need here is some serious government money.  That way Super Mega Corp. doesn't lose money on their bets and we can help reinflate the value of Joe Kegs house towards artificially high numbers so he can enjoy his hummer.  At the same time, we better help out AIG to cover the losses they have to pay out on "insurance" policies they wrote on assets that were over inflated to people that never held them in the first place.  (did I mention the AVERAGE AIG employee in the Financial Division responsible for packaging and selling this crap made $1,600,000 a year?  400 people, that's the average.)

But here's how we get screwed as tax payers:


AIG bids on packaged mortgages (that it packaged and sold earlier) and wins with a bid of $1,000. 

AIG pays:  $200
Taxpayers:$200
Gov. Loan:$600
-----------------
..............$1000

It does this on 4 different CDO's (1-4).   So AIG is out $800, Tax payers are out $800, and AIG takes $2400 in "non-recourse loans" from the government.  What happens?

As I understand it, money goes to the capital first.  Then to repayment of the loan. So . . .

CDO 1: Collect $402.   Both AIG and the Government get $200 .  Government loses $<598> on the loan.
CDO 2: Collect $1000.  Everyone breaks even!
CDO 3: Collect $2000.  AIG and the government gets $200 + $500 in profit.  Loan repaid.
CDO 4: Collect $100.  AIG gets $50 <150>, Government gets $50 <150>.  Loan goes away <$600>. 

So at the end of the day AIG made $450.  The government lost $698.  Yay. 

Correct me if I'm wrong.  I'm just some dumbass attorney trying to figure out where my tax money goes.  But it appears the rest of us get to subsidize the gambling of these firms in an effort to clean up the consequences caused by these firms gambling.

Too big too fail needs to die as a concept.  Replace it with "too big to fail catastrophically" and I'm fine with it.  Just like the FDIC does with a bank, take it into receivership and decide if it is worth more as a whole or if it should be chopped up.  Whatever makes/losses the least money in an orderly fashion.  I'm all for contract rights and I understand the retention bonuses, but if the company was essentially dissolved then contracts are unilaterally altered.  Sucks, but financial meltdowns do.

/venting

You aren't wrong here, but what you are missing is that the government is already on the hook for most of these bad loans in the form of FHA loan guarantees. The government is probably already at risk for the entire $4000. Even worse, if we don't pull these assets from banks then large numbers of banks will fail, and we also insure the assets (deposits) of the bank. In a way the government is already on the hook for these bad loans twice.

If we pull the bad assets and the banking system recovers then even if the loans that are the basis of these so called "toxic assets" fail the properties that secure these loans will recover their value. The real problem right now is a lack of credit which is killing demand for the secured asset (the house) in the loans. If banks would start to loan again then both the housing market and job market should stabilize creating new demand for houses which will shore up home values which will bring the value of the secured asset above water even if the mortgage itself doesn't recover.

[cannon_fodder]

Very good points Swake.  I understand we have to choose the least bad choice.  But it still pisses me off. 

If Freddy and Fanny would have been totally cut loose, I wonder if we would have had this problem.  As it stands, they were always there to buy crap.  Why not make more loans, you can get SOMETHING for it by selling it to the government.

And please, don't let rationale thought get in the way of the blind rage from the masses.

[USRufnex]

Somehow, I doubt most of the folks getting FHA loans were making $50k, getting approved for $500k homes, and subsequently buying Hummers....... the housing markets in most large cities were going up and up and up from the mid 90s through most of Bush's first term... remember the conservative rallying cry, "home ownership is at an all-time high"?!?... a few years back, I was told I needed to "buy now" or the housing market would make it impossible for me to be able to afford a home in Chicagoland in the future..... then there are the folks who paid their rent on time for years, watched their rent go higher and higher... only to have their buildings consistently "flipped" to the highest bidder.... then the landlord starts losing money after paying exhorbitant prices for an "investment"... because we all know housing prices don't fall, they just stop rising in times of recession....

[we vs us]

To paraphrase an econ blogger I read, "In this crisis, we can either be fair or effective.  We can't be both."

I'd reallllly like to see criminal charges pursued against some of the people who drove these companies (and our economy) over the cliff.  Not Madoff, but -- for instance -- the guy at AIGFP who bought all the CDSs without having the capital to back it up. 

Also, during the Great Depression, there was a congressional commission set up to investigate the causes of the Crash and its findings informed Roosevelt's reform efforts several years later.  I think it's crucial to determine root causes and then to address them, and I'd really like to see Congress begin something like that.   

[bokworker]

Fortunately We vs us we have the preeminent expert on the Great Depression at the helm of the Fed today... Ben Bernanke.

There is no way the amount of money being thrown at the problem will not avoid a deflationary cycle... that is the good news. The bad news? By definition the defeat of deflation requires the introduction of inflation...

[FOTD]

Stocks look dead for at least 5 years.

Let's see, inflation followed by the Fed raising rates.....only earnings will drive stocks.

Up next, commodities....

Gotta print more money for now....

[nathanm]

Gotta print more money for now....

Would you rather have massive deflation?

[FOTD]

Would you rather have massive deflation?

NO!

Reinflating the economy is essential at this point.....

Print more money....