Sunday, 21 September 2008

Misunderstanding the bailout

Ever since Jim Cramer had his fixed income meltdown, I can't help watching him. It is the strage mixture of arrogance, ignorance, and greed, that makes him so compelling.

In this clip, Jim says if only the US government appointed him as the head of this new bail-out fund, the US taxpayer would actually make money. Like all good salesmen, he would "buy low and sell high".

Admittedly, that suggestion was only half serious. However, Jim's understanding of how this bailout scam will work was more worrying. He thought that the new fund could buy distressed mortgage debt for 20 cents on the dollar. Later, when markets have stabilized, he could sell it at a profit.

That would defeat the object of the bail out, since the remaining 80 cents have to be recorded as a loss on bank balance sheets. The losses would have to be netted out against capital, leaving the banks crippled.

Here is the key point of this bailout; in order for it to work, the government must buy this debt close its original face value. That way, banks can maintain their current level of capital and then restart their lending activities. This scheme, if it is to work, must transfer the bulk of these mortgage losses directly to the goverment balance sheet.

This scheme is not about "buy low, sell high"; it is about "buy high, sell low".


Anonymous said...

If the fund is buying $700bn of debt at 20% of face value then the write off by the banks would be $2.8 trillion, which would still make them insolvent!


Ryan said...

The bailout is ridiculous, and not needed, and only taxes future generations. (And both candidates want to increase govt spending?) NESARA as drafted by Dr. Barnard is the only way out of our fiscal and monetary mess. Force balanced budget, abolish income and capital taxes in favor of 14% sales tax on everything else except rents, groceries, insurance, and medical services; new monetary tools to ensure 0% inflation; abolish compound interest on secured loans in favor of simple monetization fee, and require principals be paid before before banks are allowed to collect on the monetization fee. No payment no matter how small will always reduce a debt to zero, banks more willing to prevent foreclosures and will turn around funds for more loans sooner. No more of this pay for 2.5 houses just to own 1. Pay for just 1.5 and be done with it in 17 years. National debt paid off in 30 years while standard of living doubled within a generation. NESARA (not the hoax, but Dr. Barnard's original version). A 21st century engineered solution for a 21st century economy. Google the NESARA Institute.

aSteve said...

Jeremy, nice remark... Though, it rather depends upon asset pricing. Lower tranches are already heavily discounted to face-value... but if these maximally-risky assets were purchased (which would be wildly reckless) further write-off could be avoided.

I am, frankly, staggered at the ignorance of the people in the video... they talk about "where is the money coming from" - and not only fail to provide a satisfactory answer, but can't even present the question coherently.

Here are the questions we really need to ask:

1. How will the assets be valued?
2. For how long will the assets be financed by the bale-out?
3. Which party is deemed to be ultimately responsible for any losses over-and-above the valuation 'haircut'?
4. How are derivative products like CDS to be managed where affected by the bale-out?
5. How are synthetic products to be managed where affected?
6. How are the regulators going to go about avoiding a recurrence of the crisis in 2010?

When these questions are answered, maybe then we can say something meaningful about implication. Until then the bale-out consequences are entirely unpredictable.

ratfink said...

You got it in a nutshell, Alice. And in exactly the same way that Bush sold the Iraq War--no time to waste or we will all die--the Republicans are now planning to bail out all their banking chums. It is an unmitigated disgrace. But nobody gives a tinker's for disgrace in the US anymore.

Pedro said...

I apollogize for my english.
I am portuguese.
Thanks for your blog.
I am no economist . I know very little about economy.., but the US rescue plan to wall street was an eye opener for me.

Now.., I guess I understood the loan game.

Banks give loans to people.

Banks profited from such loans because they were able to sell the loans to other institutions, such as freddie mc or other banks .

Since the bank that does the loan is able to pass that loan to others ( such as freddie Mc ) , it has no incentive to really check if the person that does receive the loan can actually pay.

When the home owners start to default the wholle building came crashing down.

Banks start getting busted since the wholle castle of cards rested in the assumption that the small joe that had taken the loan was able to repay it.

For years economists talk about how bad government intervention in the economy is.
How markets should regulate themselves.

When markets start regulating the wholle banking ( casino ) , industry showing banks had done reckless finantial operations...,the banks shout help help , and are bailed out by the average tax payer.

For years , while the bankers did reckless investment decisions, they made huge profits.

They did pocket the profits.

When the wholle building did crash because the reckless finantial dealings made the government came into the rescue of a system that had bankrupt itself while the management was pocketing huge profits.

Now the US government has bought the bad loans.

The bank will continue to lend...., the management will continue to pocket millions.


Anonymous said...

If you see Gordon or his badger on TV saying "We need a UK Paulson Plan" that's the time to move your money to Jersey, Caymans and Switzerland.

They've just destroyed the USA and replaced it with the USSRA. Don't get caught out when Labour screw us the same way.


dearieme said...

How does one do that, Nick?

Anonymous said...


A few ways:
1) Hold a foreign currency account at a UK bank. For example HSBC will open a JPY account that's denominated in yen yet still covered by the FSCS.
2) is a Jersey-based and Jersey FSA-regulated bank that lets you hold your money in several currencies and also convert it into gold held in a vault in Switzerland with your name on it.

The important thing is to open the account now and do all the AML/KYC, so that it's ready to receive your money thirty seconds after Gordon opens his mouth.

You wouldn't want to be waiting two weeks for the Goldmoney to verify your identity after Gordon has just announced all UK deposit boxes are to be opened and gold confiscated.

I'm sure there's readers here who like paying tax even less than me who probably have ideas. Maybe Alice will do a post putting together the financial equivalent of the survivalist's "bug out bag" (hint)