30 September 2008

First of all, let me pimp an article by my friend Chris, in which he expands a bit on the theme of liquidity: "Financial Lubricants".

One of the things being stressed this afternoon in the press, even as the markets rebound a bit, is that the money market is not rebounding at all. It's almost entirely jammed up, right now. Banks are just not lending to other banks, at least, not on favourable terms. Only the central banks of various nations (including the Federal Reserve) are being more open, but of course, all that does is put taxpayers on the hook for that borrowing.

This is part of what Paulson means when Congresscritters ask him why we should be on the hook for a $700bn credit line and he retorts that that the taxpayer is already on the hook. We are, through the Federal Reserve, lending money to banks who can't get it any other way. We're taking whatever collateral they can give us (at least, so I assume), and often, it's going to be crap, because that's all they've got. Of course, most of these banks really will pay back their notes--short term lending like this is supposed to be low-risk. But there's still likely to be some crap in there.

Meanwhile, the Senate appears poised to try to take the lead over the next day or so, rather than letting the House embarrass itself again right away. The theory presumably is that if the older, wiser heads of the Senate can get something passed, it will be easier to ram it down the House's collective throats. I'm not sure I'm buying it. I think too many of the people who said "no" really mean it, and at least some of the people who said "yes" really meant "no" and will find the courage to say so. I'm also not convinced that any attempt to even talk about the bailout won't face a filibuster.


So about the bailout itself. I'm still not convinced it's the right answer, but the more I understand about what Paulson was trying to do right from the start, the more I get why he and others think it's not an awful idea, anyway.

The idea, as near as I can decipher it, is to give Treasury a line of credit--a really bloody huge line of credit--with which to purchase "distressed" assets, like mortgage-backed securities whose mortgages are in the sewer. The theory, as I think I've said before, is to get them off the books of the banks, so the banks on the one hand no longer feel like they have to hoard cash to keep their balance sheets black, so they can lend again; and on the other hand no longer only have crap mortgage-backed bonds to use as collateral for being the borrowers.

Meanwhile, Treasury, which doesn't care if it holds on to a bunch of rotting meat for years, can wait paitently for the market to improve, and sell the securities as their value improves (or at least try to get more out of them) at a more leisurely pace. The bet being made is that while many of these securities are crap right now (because they're based on mortages whose underlying property values are no longer adequate, regardless of their interest terms or forecloseability), the housing market will eventually recover. 

Therefore even if some of these properties wind up foreclosed upon, there will be greater value available, later, than there would be now. The bailout bill's line of credit would wind up repaid and might even yield a profit, even if some percentage of the distressed securities really do turn out to be irredeemable turds.


And so now we come to the real reason why the bailout is itself an irredeemable turd and really ought to be rejected a second time: the bailout is doing exactly what the market was doing. It's betting that the housing market will eventually improve to the point where these securities are actually worth something.

Now...that's not really a completely incredible bet. Yes, the housing market is still falling and it doesn't have an obvious bottom in sight, but there does have to be a bottom, and then, it will bounce and start coming up again. There will, one day, be a demand again, and demand creates value.

It's the time-frame that makes the bet a shaky one. What if it takes five years just for the market to hit bottom. Or ten. Nobody wants it to, of course, but what if it does? And then takes another five to ten years to come back up to levels where the securities are worth a damn?

Even if it doesn't take that long, we can't assume that the value of these securities won't continue to fall after the government purchases them. One thing that's been made clear is that Treasury is not going to be able to buy them at absolute firesale prices. As much as the banks want them gone, they aren't going to accept pennies on the dollar. They're going to at least want something like the current value.

And there, at last, is the rub. We don't know their current value, not for certain. Not in aggregate. To investigate that, we would need to look not only at the securities themselves but the underlying mortgages and their terms, and then the value of the property securing that mortage, for every single one of these monsters. 

That, in the end, is why Paulson asked for so damned much money. Nobody really knows how much he's going to need to make this work, even if all the other conditions work out exactly the way he wants them to. They picked a nice big number that was lower than the deeply scary $1tn mark and figured it would probably be enough to at least get things started, even in the worst case.

There are too many unknowns, here, even now. And in the time it would take to nail them down, the credit freeze's side-effects would have begun rippling outward even further. Trickle-down economics might not work for prosperity, but there's no real question that it will work for pain. Something really does need to be done that unfreezes the money market.

But this bill ain't it.

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