Good bank--Bad bank

[we_are_toast]

FDIC Chairman Sheila Bair is pushing to run the operation, which would buy the toxic assets clogging banks’ balance sheets, one of the people said. Bair is arguing that her agency has expertise and could help finance the effort by issuing bonds guaranteed by the FDIC, a second person said. President Barack Obama’s team may announce the outlines of its financial-rescue plan as early as next week, an administration official said.

I certainly don't have a good understanding of what the "bad bank" will do, but it seems that if they buy mortgages directly it could be a good thing, but if they buy MBS' it would be a bad thing. The MBS' might never have much value, but the mortgages will always have value. Buying the mortgages and renegotiating the terms could stop foreclosures and negate the need for judicial cram-downs. There might also be a weird effect where the gov would inflate the money supply, and some of those inflated dollars would come out of circulation through the paying off of the mortgages.

[bill]

Re: Good bank--Bad bank

Banks received capital from tarp with little or no questions asked.
Banks received tarp money are hoarding it.
Banks that received capital injections from tarp unload toxic assets in newly formed Bad Bank.
Bad Bank funding (private or tax payer?) leveraged
Insolvent Banks close, assets are picked over and remainder dumped in Bad Bank.
Inject more capital in healthier Banks expand lending.
Bad Bank assets are sold at loss over time to insiders.

[c1ue]

Re: Good bank--Bad bank

Toast,

What exactly is the difference between buying 10,000 mortgages and buying 1 MBS composed of the 10,000 mortgages?

The whole point of the 'bad bank' is to buy these loss-making mortgages.

Sure, the mortgages aren't worth zero. But the overall MBS's aren't worth zero either - it is primarily the lower tranches.

But the point is: the losses are the same.

If you buy the underlying mortgages and lose 20%, vs. buy the BBB and lower MBS tranches and lose 100% - not much difference.

The reason the market is rallying is because this announcement is tantamount to the government absorbing all the bad debt - and sticking the taxpayers with the cost.

Yay financials!

[vinoveri]

Re: Good bank--Bad bank

[quote=c1ue;72933]
The reason the market is rallying is because this announcement is tantamount to the government absorbing all the bad debt - and sticking the taxpayers with the cost.

quote]

BINGO.
And this is also why, in conjunction with the limitless expansion of the Fed's balance sheet, that things can and will (IMO) go back to near where they were 5 years ago - we may have some inflation, but not nearly as much as folks are predicting.

The fed increases the money supply to match the rate of money destruction -no deflation and limited inflation
the bad debt gets transferred onto the public
2010 - stock markets back at all time highs and hte public debt is ~$20Trillion (but who counting b/c deficits and apparently debt don't really matter.:mad:


anyone who says americans and the gov won't continue their borrow and spend habits has not been paying attention - transfer that bad debt from individuals (credit cards, student loans, car loans, mortgage holders) and the investors who hold the CDO securities onto the public debt, and give everyone new credit lines.

[grapejelly]

Re: Good bank--Bad bank

BINGO.
And this is also why, in conjunction with the limitless expansion of the Fed's balance sheet, that things can and will (IMO) go back to near where they were 5 years ago - we may have some inflation, but not nearly as much as folks are predicting.

The fed increases the money supply to match the rate of money destruction -no deflation and limited inflation
the bad debt gets transferred onto the public
2010 - stock markets back at all time highs and hte public debt is ~$20Trillion (but who counting b/c deficits and apparently debt don't really matter.:mad:

anyone who says americans and the gov won't continue their borrow and spend habits has not been paying attention - transfer that bad debt from individuals (credit cards, student loans, car loans, mortgage holders) and the investors who hold the CDO securities onto the public debt, and give everyone new credit lines.

This assumes that someone is financing all this. If the Fed finances it, won't that drive the prices of goods into the stratosphere, aka huge inflation?

Also, if this were to happen, then the moral hazard would be times ten, and there would have to be hyperinflation as people rushed to borrow to buy assets that were going up in nominal dollars.

The fed increases the money supply to match the rate of money destruction -no deflation and limited inflation

This is where I have a problem. It is too glib!

[phirang]

Re: Good bank--Bad bank

There are a few reason why I'm still a bear:

1) trade: trade is far, far from resolved. A communist country like China is already fucked. What difference doesn't it make to them if they have 15 or 20% unemployment: they still have to go degree-absolute on their people and economy. China is at the crossroads, and has to choose between either reflating US assets or preserving its sovereignty. I've seen countries do the latter, and so I wouldn't dismiss this out of hand.

2) wage deflation: wages are going DOWN and asset-derived income is GONE. Net effect on wealth is catastrophic.

3) home prices: see #2, but basically it's a disaster.

[vinoveri]

Re: Good bank--Bad bank

This assumes that someone is financing all this. If the Fed finances it, won't that drive the prices of goods into the stratosphere, aka huge inflation?

Also, if this were to happen, then the moral hazard would be times ten, and there would have to be hyperinflation as people rushed to borrow to buy assets that were going up in nominal dollars.

The fed increases the money supply to match the rate of money destruction -no deflation and limited inflation

This is where I have a problem. It is too glib!

Why would the fed financing necessarily or even likely result in a huge inflation? I agree that it should result in some, but the mechanisms by which that happens (other than currency depreciation), are becoming more and more murky to me. Why hasn't the currency collapsed already and why can't the fed expand 10x - in a tactical manner? sure the fed just can't drop $100T on the world, but they can backstop, lend, insure, buy toxic assets etc, and control somewhat where the liquidity goes
All CBs can expand together and this will generate some inflation to be sure, but we've been living with inflation all along - not saying rampant inflation won't occur just that it may not be inevitable.

I so agree on the moral hazard point, to the point that my own view about how to stucture one's financial life has been altered by this eye opening experience and fuller understanding of our financial system. E.g., living with minimal debt and saving from earned/labor income looks to me like (notwithstanding the wisdom and common sense of this) a fool's game in our system where entities are allowed to lever up to either invest or consume and can then default and repeat the cycle while attempts to save are punished through asset inflation and the only way to have a chance to keep up is to play in the casino.

[BadJuju]

Re: Good bank--Bad bank

I so agree on the moral hazard point, to the point that my own view about how to stucture one's financial life has been altered by this eye opening experience and fuller understanding of our financial system. E.g., living with minimal debt and saving from earned/labor income looks to me like (notwithstanding the wisdom and common sense of this) a fool's game in our system where entities are allowed to lever up to either invest or consume and can then default and repeat the cycle while attempts to save are punished through asset inflation and the only way to have a chance to keep up is to play in the casino.

Like you, this crisis has radically changed my perspective on the way this world works. I would not say that I was Neo before the pill, but I was certainly drinking the Kool-Aid. It seems to me that the only way to get ahead in this world is to game the world or to create/hold real assets.

[D-Mack]

Re: Good bank--Bad bank

There are a few reason why I'm still a bear:

1) trade: trade is far, far from resolved. A communist country like China is already fucked. What difference doesn't it make to them if they have 15 or 20% unemployment: they still have to go degree-absolute on their people and economy. China is at the crossroads, and has to choose between either reflating US assets or preserving its sovereignty. I've seen countries do the latter, and so I wouldn't dismiss this out of hand.

We will see what they'll do

CURRENCY ROW

Ahead of Wen's speech, a row intensified over Beijing's exchange rate policy after new U.S. Treasury Secretary Timothy Geithner branded China a currency manipulator last week, using a term the previous administration avoided for years.

A Chinese diplomat said on Wednesday Washington had enough evidence to know China does not manipulate its exchange rate.

"I don't think it's fair all of a sudden to change the position of the U.S. government," the diplomat said in London, one of a number of European capitals Wen will visit after Davos.

Putin will meet privately with Wen in Davos to share ideas on how the powers can cooperate on addressing economic problems. No top officials from the new Obama administration are here.

http://uk.reuters.com/article/topNew...BrandChannel=0

[bill]

Re: Good bank--Bad bank

Soros bad bank plan

http://www.bloomberg.com/avp/avp.htm...9DiD2dWMHE.asf

[c1ue]

Re: Good bank--Bad bank

And this is also why, in conjunction with the limitless expansion of the Fed's balance sheet, that things can and will (IMO) go back to near where they were 5 years ago - we may have some inflation, but not nearly as much as folks are predicting.

The fed increases the money supply to match the rate of money destruction -no deflation and limited inflation
the bad debt gets transferred onto the public
2010 - stock markets back at all time highs and hte public debt is ~$20Trillion (but who counting b/c deficits and apparently debt don't really matter.:mad:

You are of course entitled to your opinion.

However, the original iTulip thesis was that no government in history has been able to exactly balance asset deflation/credit contraction with stimulus spending/money printing.

The 'bad bank' may clean up the bank's balance sheets to the detriment of the taxpayer, but even that will not bring back the 'Shadow Banking' system. The reason banks were levered 30x was due to their links with said 'Shadow Banking': private equity, hedge funds, LBO operators, etc etc.

Unless all of that is replaced, PLUS the high level of debt to income reduced, then Humpty Dumpty is not getting put back together again.

The economy might return to a 1985 footing in terms of function, but we're all living in 2006 expectations.

Are you ready to go back to 1985? When the Dow was 1200? With inflation adjustments: 2600? With SGS inflation adjustments: 5200?

[we_are_toast]

Re: Good bank--Bad bank

Toast,

What exactly is the difference between buying 10,000 mortgages and buying 1 MBS composed of the 10,000 mortgages?

Like I said, I'm not at all sure about this stuff.

It seems the difference between buying the MBS' and the mortgages is the same as buying an option on a stock or the stock itself. If I buy the option, I have no say on what happens in the company. If I buy the stock, I get to go to the stockholders meeting and have some say. I can exercise the option and convert it to stock, but I don't think that's a possibility for holders of MBS'

I don't think holders of the MBS' have any say over what's going on with the individual mortgages. If the gov buys the MBS' they would be bailing out the banks, but there could be just as many foreclosures as there are now, driving down the value of the MBS' ever further. If they buy the mortgages, they can renegotiate the terms of the mortgages that are ready to default, and help the mortgage holder and the banks.

Maybe there's someone here who could help me out if I've totally misrepresented this.

[vinoveri]

Re: Good bank--Bad bank

Are you ready to go back to 1985? When the Dow was 1200? With inflation adjustments: 2600? With SGS inflation adjustments: 5200?

And the cost of a decent farm was $150k vs $500k today? You betcha. But we won't b/c the folks who benefitted from this asset inflation pull the strings.

This is the whole point c1ue; our society should not be one that's built on and depends on asset inflation - it's unsustainable and I would suggest morally corrupt -about as much sense as "spend your way to prospertiy". No one works to make anything and we are all "capitalists" flipping assets in a pyramidal scheme until the system collapses under its own weight - as we've seen in the last 6 months.

Is this your preferred system?

[c1ue]

Re: Good bank--Bad bank

Toast,

I'm not disparaging your knowledge (or lack thereof) of MBS's - I'm merely pointing out that no matter what - the bad bank ultimately only transfers losses from the previous owners of the bad debt to the US government, and from there to the taxpayer.

The MBS's are not strictly speaking derivatives as a whole. If all the tranches comprising an MBS are kept together, the effect is exactly as if you owned all the mortgages the MBS was built with.

The derivative aspect occurs when only certain tranches are isolated out.

The lower the tranche - the closer to losses the owner of the tranch is exposed to. Thus if we had an MBS of say $10M value with 10 tranches, the first 3 tranches might be equivalent to the overall MBS losing $1M of capital. This is obviously a simplification, but the point is that rather than all tranches equally sharing the losses, MBS's are set up so lower tranches take the losses first.

There are some tactical differences between buying the bad debt and just giving money to the banks, but essentially the goal is the same: drowning the bad debt with government credit.

From the example above - if the government buys the bad tranches, there will be little if any value left. Conversely if the government also gets the high level tranches, then it is possible the tranches go up in value over time as the full feared losses fail to materialize.

But I know which outcome I think will happen!

And the cost of a decent farm was $150k vs $500k today? You betcha. But we won't b/c the folks who benefitted from this asset inflation pull the strings.

This is the whole point c1ue; our society should not be one that's built on and depends on asset inflation - it's unsustainable and I would suggest morally corrupt -about as much sense as "spend your way to prospertiy". No one works to make anything and we are all "capitalists" flipping assets in a pyramidal scheme until the system collapses under its own weight - as we've seen in the last 6 months.

Is this your preferred system?

Vino,

Don't get me wrong, I am not a fan of the FIRE economy. I merely point out that the removal of credit means a lot of things are going down in magnitude.

The 150K farm you speak of: would you still want it if your income was reduced 66%? And interest rates were 15%? Because that's what 1985 was.

[vanvaley1]

Re: Good bank--Bad bank

Interesting article on http://jessescrossroadscafe.blogspot.com/ today. "Inflationists vs. Deflationists: Economics as Bread and Circuses" presents a summary of some of the ideas posted on this tread.