Credit risk pollution Superfund is born, market soars

[EJ]

Credit risk pollution Superfund is born, market soars

April 2006 in "Risk Pollution: Financial Markets Polluted with Risk" I compared the era of unregulated lending to the period of the unregulated chemical industry. The latter polluted the environment with chemical toxins and the former with toxic debt. The article contains the first use of the word "toxic" that you will find on the internet in connection with mortgage and other debt.

In that article I made the following forecast:

In truth, no one knows who will be left holding the bag when defaults on loans made using these innovations occur. But we can be fairly certain it won’t be the institutions that made the money selling them. Most likely, it will be the same folks that paid for the Super Fund projects that cleaned up after the chemical industry -- you and I.

And here it is, two years later, a credit toxins superfund paid for by you and I.

Stocks surge on report of entity for bad debt
September 18, 2008 (Tim Paradis, AP Business Writer)

Wall Street soars on report that federal govenment will create entity to hold banks' debt

NEW YORK (AP) -- Wall Street had a stunning late-session turnaround Thursday, shooting higher and hurtling the Dow Jones industrials up more than 400 points after a report that the federal government may create an entity that will take over banks' bad debt.

The report on CNBC said Treasury Secretary Henry Paulson is considering the formation of an entity like the Resolution Trust Corp. that was set up after the failure of savings and loan banks in the 1980s.

Investors were cheered by the notion of a huge federal intervention like the establishment of RTC to acquire the real estate debt that has hobbled financial institutions and led to the intense volatility in the markets this week.

AntiSpin: If I could see the development of a toxic debt superfund by the government more than two years ago, what do I think of it now that it's here?

A superfund is at this point in the process of the dissolution of the FIRE Economy a desperate last stand. It takes an equally desperate optimist to believe that the government can continue to pile securities that have no value onto its balance sheet without doing serious harm to the nation's currency.

See today's commentary DJIA falls 7% while gold rises 14%: DJIA/gold ratio reversion continues ($ubscription) for details.

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[we_are_toast]

Re: Credit risk pollution Superfund is born, market soars

How in the world would this work?

Surely, the gov wouldn't and can't simply take the toxic stuff off the banks hands. The banks are going to have to pay a price, what will it be? So far, the gov bail outs have been either buy-outs, or arrangements for controlled implosion. My guess is wall street is going to face reality tomorrow and it's not going to be pretty.

[phirang]

Re: Credit risk pollution Superfund is born, market soars

Having just sold off my agency REITs today, I am getting very, very worried about the ability of the US to service its obligations abroad.

Foreign gov's have stopped purchasing our "insured" mortgages because they KNOW they won't get paid back.

Hence, we can only resort to selling them to people who are too dumb to demand getting paid back: the american taxpayer.

I dont see any way that the 10 yr can remain under 5% for much longer...

[JoeSixpack]

Re: Credit risk pollution Superfund is born, market soars

Excellent points, taxpayer holds the bag again...

But i have to say i somehow dont like the article headline "X happens, market does Y". Thats soooo CNBC.

You know that in this environment, news is a catalyst but not the REASON for market moves. Large rallys are the characteristic of bear markets.

From todays news you can pick one of multiple execuses for a reversal:
-FSA bans shortselling
-Superfund and bailout news
-Merger talks between the blind and one-eyed (MS + Wachovia)
-Oil went up a buck and then down a buck, yawn (the classic)

And you can hardly argue fundamentals changed during lunchtime.

So the real "reason" might just be that tomorrow is triple witch expiry and the big dogs played some games. Who cares.

[D-Mack]

Re: Credit risk pollution Superfund is born, market soars

An opinion piece by Volcker & Brady in the WSJ from 9/17

Resurrect the Resolution Trust Corp.
By NICHOLAS F. BRADY, EUGENE A. LUDWIG and PAUL A. VOLCKER


...

The fact is that the financial system needs basic, long-term reform, but right now the system is clogged with enormous amounts of toxic real-estate paper that will not repay according to its terms. This paper, in turn, is unable to support huge quantities of structured financial instruments, levered as much as 30 times.

Until there is a new mechanism in place to remove this decaying tissue from the system, the infection will spread, confidence will deteriorate further, and we will have to live through the mother of all credit contractions. This contraction will undercut the financial system, and with it, the broader economy that so far has held up reasonably well.


....

Such a stabilizing mechanism would accomplish four much-needed tasks:

- First, by buying paper that otherwise is effectively not trading, it would help restore liquidity to the marketplace and help markets to function more fluidly again.

- Second, by warehousing the troubled paper for a longer period than, for instance, the Fed's discount window typically should or could, it would allow for a more orderly liquidation of this paper, and the chance for much of it to recover a portion of its value.

- Third, by giving the agency the ability to manage mortgages with flexibility to keep people in their homes and businesses running, it should lessen the number of foreclosures. This, in turn, would help moderate the decline in real estate values and the deterioration of neighborhoods, thus supporting house prices that in fact lie at the heart of the crisis.

- Fourth, where necessary, like the RTC of the 1980s, this new mechanism can assist the Federal Deposit Insurance Corporation in resolving sick institutions that are so clogged with the troubled paper they cannot continue as independent entities. However, we would hope that purchasing the mortgage-related paper will minimize the need to provide emergency, short-term assistance to solvent banking institutions.

...

http://online.wsj.com/article/SB122161086005145779.html

[Spartacus]

Re: Credit risk pollution Superfund is born, market soars

How in the world would this work?

Surely, the gov wouldn't and can't simply take the toxic stuff off the banks hands. The banks are going to have to pay a price, what will it be? So far, the gov bail outs have been either buy-outs, or arrangements for controlled implosion. My guess is wall street is going to face reality tomorrow and it's not going to be pretty.

I can't even guess at practical implementation.

I suppose the theory is that if one can just HOLD ON to assets until the storm is over the assets' prices will recover - become "normal" or "sane".

Remember that in several high profile blowups the portfolio "eventually" sold for a profit - the San Diego blowup comes to mind - I don't know if this applies to the LTCM portfolio as well.

[nathanhulick]

Re: Credit risk pollution Superfund is born, market soars

- First, by buying paper that otherwise is effectively not trading, it would help restore liquidity to the marketplace and help markets to function more fluidly again.

When paper (or anything else for that matter) is not trading, it means the seller needs to lower his price. Just as when there is a "job Americans won't do", the employer needs to raise the wages he is offering to pay.

[Chris Coles]

Re: Credit risk pollution Superfund is born, market soars

So how do they pay for this? You have toxic bonds created by the investment banks representing, (to quote Institutional Investor Magazine), leverage of 15 to 20 times, IN ADDITION to the normal borrowing ratio of 6 to 8 times deposit. So there is something like as much as 160 times the number of dollars printed in toxic bonds that have been printed as normal currency, real actual Greenbacks, by the US government. So if my amateur arithmetic is correct, (please correct me if not), the dollar will depreciate to match the Credit Risk Pollution Super Fund (CRPSF).

And the second question must be:

What do they think they are going to do with the fund when it is stuffed full of toxic bonds? Set FIRE to it? (Please excuse the pun).

The only way they can get away with this is to deliver 1/160th of each dollar delivered as a toxic bond to the CRPSF back to the present holders of the toxic bonds. Am I nuts? surely the banks will not play ball?

Either that or the mighty $ is about to be diluted accordingly.

[marvenger]

Re: Credit risk pollution Superfund is born, market soars

i think what happens is the banks get liquid assets and the tax payer gets toxic stink pile. The banks can then then lend at a price the market is willing to pay and get the housing market going again and the tax payer will get paid back the lower sale price, and the bankers can carry on their game as usual....that's their plan anyway. The dollar is diluted by the difference between what the taxpayer lends out and what they get back.

[magicvent]

Re: Credit risk pollution Superfund is born, market soars

Several analysts are saying that after this artificially induced run-up ends, a crash will occur. Do you agree?

[Brooks Gracie]

Re: Credit risk pollution Superfund is born, market soars

Why aren't Sovereign Wealth Funds, the Chinese government, the oil producing countries and other bond holders initiating a massive currency run on the $? Many have worried most about the day when no longer will foreign interests fund the Treasury--wouldn't today be the start of such conditions?

[phirang]

Re: Credit risk pollution Superfund is born, market soars

Why aren't Sovereign Wealth Funds, the Chinese government, the oil producing countries and other bond holders initiating a massive currency run on the $? Many have worried most about the day when no longer will foreign interests fund the Treasury--wouldn't today be the start of such conditions?

they need to sell dollars to the US in exchange for hard assets first, then the dollar can become worthless.

...but they wont get them: they'll get student debt instead! yay!

[c1ue]

Re: Credit risk pollution Superfund is born, market soars

Don't forget - paper credit instruments in large enough piles have some similarities to gold: the sheer size itself means they'll always be worth SOMETHING.

The key is still will these piles get bigger?

The currency account deficit is ongoing, as are the government deficits. The latter are increasing daily in no small part to these bailouts.

The process of bringing $1T or $2T of total remaining losses in MBS/CDO/AIG crap/etc onto the US balance sheet is not pretty, but is still only an increase of overall debt by 10% or 20%.

Of course, the $1T/$2T are numbers I just pulled out of my a**. No idea what the real amount is.

But the end game process has absolutely begun as EJ has noted.

[GRG55]

Re: Credit risk pollution Superfund is born, market soars

When paper (or anything else for that matter) is not trading, it means the seller needs to lower his price. Just as when there is a "job Americans won't do", the employer needs to raise the wages he is offering to pay.

And when the price is lowered to zero, and there is still no bid, then what??

[Forrest]

Re: Credit risk pollution Superfund is born, market soars

And when the price is lowered to zero, and there is still no bid, then what??

The government swallows it's pride, and defaults...governments have been doing it for eons, and the US is an old hand at it. Then we go onto a gold standard, pull home our military where they are not wanted, and hence charge the going rate for protection in future directly, instead of indirectly.

The world will still sell to us, and buy from us, if they have need to do so, and, of course, if we have actually have something to sell other than bad paper.

Or, we can absorb the losses as usual, and then take part in the transportation/infrastructure/green energy bubble coming next.

Either way, things will get tense for a while, but I plan to enjoy the ride!