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Krugman formulates a response to the plan and echoes concerns voiced earlier by himself and others, such as the Brookings Institute.
What…
“The Paulson plan calls for the federal government to buy up $700 billion worth of troubled assets, mainly mortgage-backed securities. How does this resolve the crisis?”
But…
“it will be crippled by inadequate capital unless the federal government hugely overpays for the assets it buys, giving financial firms — and their stockholders and executives — a giant windfall at taxpayer expense.”
So…
“if the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place.”
Encapsulation of the events…
1. The bursting of the housing bubble has led to a surge in defaults and foreclosures, which in turn has led to a plunge in the prices of mortgage-backed securities — assets whose value ultimately comes from mortgage payments.
2. These financial losses have left many financial institutions with too little capital — too few assets compared with their debt. This problem is especially severe because everyone took on so much debt during the bubble years.
3. Because financial institutions have too little capital relative to their debt, they haven’t been able or willing to provide the credit the economy needs.
4. Financial institutions have been trying to pay down their debt by selling assets, including those mortgage-backed securities, but this drives asset prices down and makes their financial position even worse. This vicious circle is what some call the “paradox of deleveraging.”
The short reaction to all this is it’s an unambiguous positive for stocks. The bad news is we’re likely to see continued volatility given the slow growth in the economy, and investors should not look forward to a ’90s style rebound.
—Russ Koesterich, Barclays’s head of investment strategy in San Francisco.
We’ve pretty much gotten valuations to the point where all this liquidity around the world is going to go to the equity market. We’ve nationalized a big chunk of the American economy. We’ve decided we don’t want to bear the brunt of economic cycle.
—James Swanson, chief investment strategist at MFS, over $200b under management.
$500 billion in writedowns and losses on securities tied to subprime mortgages since the start of 2007, according to Bloomberg. In 2007, Goldman economists predicted $400 billion of losses would cut banks’ lending by $2 trillion.
“There are deflationary events out there and debt default is one of the primary drivers. It’s what they call a debt deflation cycle, and there’s definitely one underway.”
—Jeffrey Gundlach, chief investment officer at Los Angeles-based TCW Group Inc., which oversees $90 billion in fixed-income. The percentage of Treasuries in a diversified bond fund Gundlach manages is the highest it’s ever been, he said.
“There’s a huge amount of deflationary pressure when you get this kind of capital destruction”
—Brian Edmonds, head of interest rates at Cantor Fitzgerald
- London’s financial-services industry to lose 42k jobs, about 10% of the total, according to the City of London Corp, the municipality for the U.K. capital’s main financial district.
- New York metropolitan area is forecast to lose 64k positions, or 13.5% percent, 2Q10, according Economy.com.
Economy.com to increased the forecast for job losses in the New York area by 6.6 percent following the consolidation of Merrill and the closure of Lehman.
“Pay packages for employees who keep their jobs may fall as much as 50 percent,” —Gavin Rankin, a managing director in London for Smart Cube, a financial services research firm.
Manhattan Real Estate
- The median apartment price in the area has risen an average of $54,375 a year since 1995, reaching a record $1.03 million in the second quarter.
- 2Q08 – Sales: down 22%, more than any second quarter since 1998, and
- 2Q08 – Inventory: at an eight-year high
“Prices may be poised to fall…I think it’s already happening. You’re removing high-income-producing individuals, at least temporarily, from the economy or from purchasing new homes.”
—Jonathan Miller, president of Miller Samuel Inc.
As we get to the other side of this, the dollar will get crushed,” said John Taylor, chairman of New York-based International Foreign Exchange Concepts Inc., the world’s biggest currency hedge-fund firm, which manages about $15 billion.
Bloomberg Survey
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Release Period Prior Median
Indicator Date Value Forecast
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Exist Homes Mlns 9/24 Aug. 5.00 4.94
Exist Homes MOM% 9/24 July 3.1% -1.2%
Durables Orders MOM% 9/25 Aug. 1.3% -1.8%
Durables Ex-Trans MOM% 9/25 Aug. 0.7% -0.5%
Initial Claims ,000's 9/25 Sept. 20 455 448
Cont. Claims ,000's 9/25 Sept. 13 3478 3505
New Home Sales ,000's 9/25 Aug. 515 510
New Home Sales MOM% 9/25 Aug. 2.4% -1.0%
GDP Annual QOQ% 9/26 2Q F 3.3% 3.3%
Personal Consump. QOQ% 9/26 2Q F 1.7% 1.7%
GDP Prices QOQ% 9/26 2Q F 1.2% 1.2%
Core PCE Prices QOQ% 9/26 2Q F 2.1% 2.1%
U of Mich Conf. Index 9/26 Sept. F 73.1 70.5
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“The deleveraging that’s occurring is putting a lot of big asset pools up for sale. We’re looking at one or more big opportunities.”
—Laurence Fink, CEO, BlackRock, manages $1.3t in assets and recently raised $3b to invest in distressed assets
“Our single best asset in the portfolio right now is patience.”
—Mark Patterson, chairman, Matlin Patterson Global Advisors recently raised $5 billion to buy distressed companies
“Prices still need to drop dramatically. Just because prices are down doesn’t mean it’s cheap.”
—Scott Sperling, co-president of Thomas H. Lee Partners LP
More than $125 billion of junk bonds, including some of those most likely to default, will mature in the next three years, said Daniel Arbess, founder of New York-based Perella Weinberg Partners’ Xerion hedge fund.
When the bonds mature, it will be in a new credit environment in which lenders will be less likely to refinance that type of high-risk debt, Arbess said.
Default Rates
“That creates a very high likelihood of near-record defaults,” Arbess said.
Default rates for high-yield corporate debt probably will rise to 4.9 percent by the end of this year and 7.4 percent in 2008, according to a Sept. 8 report by New York-based Moody’s Investors Service.
Judge orders Cheney to preserve records
- David Addington, Cheney’s chief of staff, explained to Congress that the vice president belongs to neither the executive nor legislative branch of government. Instead, it is attached by the Constitution to Congress. What does this mean?
- Cheney asserted in 2003 that the office of the vice president is not an entity within the executive branch
$700b for the purchase of “mortgage related assets.”
—Legislative Proposal For Treasury Authority
“A $700 billion expenditure on distressed mortgage-related assets would be roughly what the country has spent so far in direct costs on the Iraq war and more than the Pentagon’s total yearly budget appropriation….more than $2,000 for every man, woman and child in the United States.”
—NYT
“There are no atheists in foxholes and no ideologues in financial crises”
“It goes a long way. It ameliorates it very substantially…It looked like we might be falling into the abyss…It’s easy to forget amid all the fancy stuff — credit derivatives, swaps — that the root cause of all this is declining house prices. If you can reverse that, then people start coming out of their foxholes and start putting their money in places they have been too afraid to put it…We’re deep into Alice in Wonderland’s rabbit hole. It may not be over.”
“The risk of ending up like Japan, with 10 years of stagnation, is now much lessened…It’s not enough…but it’s the first time they have done something that makes a difference….The recession train has left the station, but it’s going to be 18 months instead of five years. “
Criticism
“I hate to say this, but looking at the plan as leaked, I have to say no deal. Not unless Treasury explains, very clearly, why this is supposed to work, other than through having taxpayers pay premium prices for lousy assets.”
The problems of purchasing mortgage related debt
- The Treasury is lacking in two respects: it is not taking over failed assets from failed institutions at an attractive price; and it cannot conduct a dutch auction of homogenous assets that would allow it to evince the best pricce from the market of surviving institutions.
- “the affected debt instruments are quite heterogeneous, which makes setting appropriate prices and quantities very difficult. If all MBS were alike, the government could simply undertake a reverse auction,” but they aren’t.
- It lacks market discipline, entirely:
- “it provides the most help to the financial institutions that made what are, in retrospect, the worst investment decisions.” The good actors in the market would receive no benefit, while the bad actors would be bailed out.
- As a consequence of the first two observations:
- “this approach saddles taxpayers with significant downside risk but limited potential upside gain.”
“Important banks — very important banks — that spent their lives giving advice about Brazil and what we should or shouldn’t do are now broke…they were the super intelligent and we were the poor souls.”
“What crisis? Go ask Bush.”
—Luiz Inacio Lula da Silva, President of Brazil
“Part of the board thinks that, since the last meeting, there have been growing signs that activity in the rich economies is deteriorating significantly, resulting in some improvement for the global inflation outlook, partly because of a drop in commodity prices”
“the pace of domestic demand expansion, should it be sustained by factors such as the increase of income and credit, continues to pose a significant risk to the inflationary dynamics”
“As long as there is reducing of leverage you’re going to see this environment and as long as you do, banks in Brazil are going to suffer. There is no question, the banking system in Brazil is definitely one of the most profitable in the world. But the problem is, they’re in Brazil. The growth the past years in Brazil came with the commodity rally and when you have a country growing primarily because of one factor, that growth is not sustainable.”
—Simon Nocera, co-founder of San Francisco-based hedge fund Lumen Advisors
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