Friday, October 3, 2008

12 Steps To Disaster

Another Roubini update, and it's a grim one. It's time to get out his now famous "12 steps to Financial Disaster" column and make that checklist, courtesy of Michael Wolf of the Financial Times:
Step one is the worst housing recession in US history. House prices will, he says, fall by 20 to 30 per cent from their peak, which would wipe out between $4,000bn and $6,000bn in household wealth. Ten million households will end up with negative equity and so with a huge incentive to put the house keys in the post and depart for greener fields. Many more home-builders will be bankrupted.
Check. Median price of a home in Orange County, California in May 2005: $639,000. Median price this week? $375,000.
Step two would be further losses, beyond the $250bn-$300bn now estimated, for subprime mortgages. About 60 per cent of all mortgage origination between 2005 and 2007 had “reckless or toxic features”, argues Prof Roubini. Goldman Sachs estimates mortgage losses at $400bn. But if home prices fell by more than 20 per cent, losses would be bigger. That would further impair the banks’ ability to offer credit.
Again, check. $250-$300 billion? We spent more than twice that just this week.
Step three would be big losses on unsecured consumer debt: credit cards, auto loans, student loans and so forth. The “credit crunch” would then spread from mortgages to a wide range of consumer credit.
Check. The credit crunch has been around for over a year now.
Step four would be the downgrading of the monoline insurers, which do not deserve the AAA rating on which their business depends. A further $150bn writedown of asset-backed securities would then ensue.
Check. That monoline insurer was Ambac, downgraded in January.
Step five would be the meltdown of the commercial property market, while step six would be bankruptcy of a large regional or national bank.
Check and check, Step 5 continues through 2008 and Step 6 was of course Bear Stearns in March.
Step seven would be big losses on reckless leveraged buy-outs. Hundreds of billions of dollars of such loans are now stuck on the balance sheets of financial institutions.
Check. Those losses continue and have since April: Bank of America's losses on Countrywide, Wachovia's losses on Golden State, etc.
Step eight would be a wave of corporate defaults. On average, US companies are in decent shape, but a “fat tail” of companies has low profitability and heavy debt. Such defaults would spread losses in “credit default swaps”, which insure such debt. The losses could be $250bn. Some insurers might go bankrupt.
Check. 3 letters for you here: AIG.
Step nine would be a meltdown in the “shadow financial system”. Dealing with the distress of hedge funds, special investment vehicles and so forth will be made more difficult by the fact that they have no direct access to lending from central banks.
Check: see the last two weeks.
Step 10 would be a further collapse in stock prices. Failures of hedge funds, margin calls and shorting could lead to cascading falls in prices.
Check. US stock markets have lost 11.8% in just the last 5 weeks. Hedge funds are on the brink right now.
Step 11 would be a drying-up of liquidity in a range of financial markets, including interbank and money markets. Behind this would be a jump in concerns about solvency.
Check. We've seen record LIBOR and TED spread numbers in the last two weeks. And finally...
Step 12 would be “a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices”.
Freefall. Endgame. And yes, Roubini now says that after this week, we have reached step twelve.
So we are now facing:

- a silent run on the huge mass of uninsured deposits of the banking system and even a run on some insured deposits are small depositors are scared;

- a run on most of the shadow banking system: over 300 non bank mortgage lenders are now bust; the SIVs and conduits are now all bust; the five major brokers dealers are now bust (Bear and Lehman) or still under severe stress even after they have been converted into banks (Merrill, Morgan, Goldman); a run on money market funds; a serious run on hedge funds; a looming refinancing crisis for private equity firms and LBOs);

- a run on the short term liabilities of the corporate sector as the commercial paper market has totally frozen (and experiencing a roll-off) while access to medium terms and long term financings for corporations is frozen at a time when hundreds of billions of dollars of maturing debts need to be rolled over;

- a total seizure of the interbank and money markets.

This is indeed a cardiac arrest for the shadow and non-shadow banking system and for the system of financing of the corporate sector. The shutdown of financing for the corporate system is particularly scary: solvent but illiquid corporations that cannot roll over their maturing debt may now face massive defaults due to this illiquidity. And if the financing of the corporate sectors shuts down and remains shut down the risk of an economic collapse similar to the Great Depression becomes highly likely.
This is some deadly serious stuff, folks. Next week may determine whether or not we make it through this in 2-3 years or 10-12. How does Roubini posit we get out of this mess? Nothing short of radical, radical action:
  1. A temporary six-month blanket guarantee on all US deposits (not just those below $250k) combined with a rapid triage between insolvent banks that should be quickly closed and distressed but solvent – conditional on liquidity and capital injections – banks that should be rescued.
  2. Extension of the emergency liquidity support of the Fed (both TSLF and PDCF) to a broader range of institutions in the shadow banking system, especially those directly providing credit to the corporate sector.
  3. Some members of the shadow banking system will not receive such liquidity support of the Fed (hedge funds and private equity funds) as – fairly or unfairly - there is no political sympathy for such institutions. (-Z says this means let the hedge funds hit the flo')
  4. Direct lending to the business sector from the Fed via extension of the PDCF and TSLF to the non financial corporate sector.
  5. Have a coordinated 100bps reduction in policy rates by all major advanced economies central bank and, possibly, even some emerging market economies central bank
  6. Radically redesign the Treasury TARP rescue plan – possibly after its necessary approval today - to make it effective, efficient and fair.
The actions Roubini proposes are radical. They would result in the nationalization of the good banks, and the end of the bad ones. It would be temporary, but the consequences are stark:
Thus, to avoid another Great Depression radical and unorthodox policy action needs to be taken now both in the US and in other advanced economies as the credit crisis and liquidity crisis is now becoming virulent even in Europe and other advanced economies. This credit crisis is both a crisis of confidence and illiquidity and a crisis of credit and solvency. But while the insolvent institutions should go bust we have now reached a point where many financial institutions and now non financial firms may become insolvent because of pure illiquidity; and this would lead to an extremely severe economic contraction similar to an economic depression rather than a mild recession. At this point the US, the advanced economies (and now likely even some emerging market economies) will experience an ugly recession and an ugly financial and banking crisis regardless of what we do from now on. What radical policy action can only do is preventing what will now be an ugly and nasty two-year recession and financial crisis from turning into a systemic meltdown and a decade long economic depression. The financial and economic conditions are extreme; thus extreme policy action is needed now to save the global economy from an ugly depression.
Roubini has been right at every step of the way, folks. Every. Step.

Today's bailout is meaningless. Much more vigorous action is needed to stave off a Second Great Depression, and it is needed now. Will it happen? I don't honestly know. What do I think? I think we'll be facing a sharp recession well into 2009. Roubini's worst case scenario is a massive cascade default picture: even solvent megacorporations will have to default on their obligations because there will be no capital. If that happens, the US economy will plummet. We're already looking at a situation where there will be 8-9% unemployment through 2010 or 2011.

If the next couple of weeks don't pan out, if something doesn't dissolve this clot in the circulatory system of liquidity, the heart attack it will cause could be fatal for our economy. Honestly the fate of our economy may be decided in a matter of weeks. If the cascade default scenario happens, it's game over.

How bad could it get? If there's 15% unemployment, that would be an extra ten million people out of work. 25%, the peak of the Great Depression, would mean that we would have roughly four times as many people out of work as now, bringing the total to 50 million.

Will it get that bad? Who knows? Could it get that bad? Yes.

And remember...Bush is still in charge.

Have a nice weekend.

Ladies And Gentlemen, Your UberBailout All-Star 2008 Team!

Well, so who's running the $700 billion bailout's funds, anyway? Who's in charge of actually buying up all these craptacular mortgage products?

Why, the same Wall Street managers who got us into this mess!
BlackRock Inc., Pacific Investment Management Co. and Legg Mason Inc. informally advised the U.S. Treasury in the days leading up to passage of its $700 billion financial-rescue plan and will seek to manage some of the assets, according to people familiar with the matter.

The Treasury will choose five to 10 money managers to help it acquire troubled assets from financial firms, officials said today. In the past few weeks, Treasury officials sought out executives at BlackRock, Pimco and Legg Mason's Western Asset Management unit for guidance, said the people, who asked not to be named because the discussions were private.

``It would make sense for the Treasury to go with a company that has expertise in a lot of different asset classes, like BlackRock or Pimco,'' said James Ellman, president of San Francisco-based Seacliff Capital LLC, manager of about $200 million in financial stocks.

President George W. Bush today signed into law a measure authorizing the government to buy distressed assets from financial institutions buried by record home foreclosures. The program, formed after a year of sustained bond-market losses and stepped-up withdrawals by investors, could help boost revenue for the managers the government selects.

The Treasury's first attempt to hold an auction to buy troubled assets from financial firms will take at least four weeks to set up. Managers will be evaluated based on the cost and scope of services they offer. The Treasury is still working out a conflict-of-interest policy and details for guidelines on compensation.

So yes, the government is going to pay the foxes to watch the henhouse. And of course Congress thought this was a good idea. They might even make money on doing this.

Great way to do business, yes? No chance of cronyism or abuse here, not with billions of taxpayer dollars at stake, right? Course not.

Treasury Secretary Henry Paulson is hiring as many as 10 asset-management firms to join the lawyers and bankers he is recruiting to jumpstart the government's new $700 billion bank-rescue program.

The Treasury began implementing the plan within an hour of the House of Representatives vote giving Paulson the extraordinary powers he had sought to combat the U.S. financial crisis. Paulson is seeking to assemble a team to determine which toxic securities to target, how to value them and how to arrange purchases.

``This is something that, for a typical company, would take no less than five years,'' said Lynn Turner, a former chief accountant at the Securities and Exchange Commission. ``Anyone who thinks they can do this in two weeks is insane.''

Already, BlackRock Inc., Pacific Investment Management Co. and Legg Mason Inc. are seeking to become money managers for the program, people familiar with the matter said. The three firms have been informally advising the Treasury as it negotiated the bailout package with Congress, the people said.

Ed Forst, the former Goldman Sachs Group Inc. executive Paulson hired to head the transition team, started work last week and is charged with helping establish the new Office of Financial Stability.

``Paulson did not want to lose precious days waiting,'' said Howard Glaser, a former chief legal adviser of the Department of Housing and Urban Development.

Treasury officials said Forst, who was given a contract worth $5,000, is likely to stay for several weeks before returning to Harvard University, where he sits on the board that oversees the $34.9 billion endowment.

I cannot wait to be rid of these guys. Of course...I'm sure the guys that will replace them will be honorable...But suck it up! The US government's in the hedge fund business now, and it'll be run with the same attention to detail that our government is known for!

Asshattery On McSameCare

The Atlantic's Ross Douthat believes in Magical Wage Goblins and stuff.
That McCain's plan will tax employer provided health insurance, which is worth roughly $12,000 for a typical family, which in turn will lead many employers to stop offering said health insurance; meanwhile, the plan will give the same family a tax credit worth only $5,000 to pay for the same plan they used to have through their employer. This makes the whole thing sound like a pretty rotten deal, but it also begs a pretty big question: What happened to that extra $7,000 that employers were spending on health care under the old dispensation? To hear Biden tell it, it'll just vanish into thin air. But that's just absurd. Right now, that $12,000 plan is part of your compensation; it's just that the current tax code incentivizes employers to pay you in health insurance rather than in cash, because the health insurance is tax free. But that doesn't mean that if health insurance stops being tax free and employers stop including it in your package of salary and benefits, they'll suddenly cut everyone's compensation by $12,000; they'll cut it by the cost of the tax deduction, presumably, and wages will rise to roughly where they would have been if employers had never been incentivized to pay their workers in health care. So the typical family will get their $5,000 credit from the government, and something like the remaining $7,000 they need to buy health insurance will show up in their paycheck. Except that a lot of Americans will actually come out ahead, rather than just breaking even, since McCain's plan offers a flat credit regardless of income, whereas under the current system the dollar value of your tax deduction - and thus the compensation your employer is incentivized to give you - goes up as your income rises.
In a world where the economy was improving, this might be true. Maybe. But right now our economy sucks balls.

And in a world where CEOs are making hundreds of times the wages of average workers, and unemployment is sharply on the rise, a company that suddenly has the option of labor costs on employees drop by $12,000 per head per year isn't going to give that money back to employees. That company will pocket the difference faster than you can say "mass layoffs." Shareholders will applaud the move. Stock prices will rise. What CFO wouldn't do this in a heartbeat in this economy?

Lay it out to the employees. If you're a big company with 100,000 employees, congrats, you just cut $1.2 billion off your yearly operating costs. You're a genius. If you're a small business owner with, say, 20 people, that's still a quarter million, the difference between life and death as far as payroll for a few months.

But this way, you at least get to avoid nasty headlines in the newspaper for having to lay off thousands of workers...and your employees do remain on the job. So you're doing your part for the economy, and can say you made the best of a regrettable choice between health care and layoffs. The great thing is here Russ that if your company really IS paying workers more than the average health care benefit, the company saves that much more money. Do you think GM or Ford is going to raise wages if given the offer to cut health care?

Nope. Easy way to cut costs for businesses across the country. Axe health care, make the employees try to fight for individual rates, where they can get half the benefits for what they were paying...if they can even get covered in the first place.

20 million people out of health care in a flash. Guaranteed.

UberBailout Away!

UberBailout passes the House 263-171.

Among the 20 converts was Rep. Jesse Jackson Jr., D-Illinois, his chief of staff, Kenneth Edmonds, said.

Edmonds said Jackson was changing his vote because "he received assurances from (Sen. Barack Obama) that, if elected, his administration will aggressively use authority in the bill to prevent foreclosures and stabilize the housing market."

Rep. Howard Coble, R-North Carolina, said he plans to switch his vote because constituents began urging him to do so. He said the people he represents initially urged him to oppose the plan.

"By having waited, I think we did improve the bill," he said. "Inaction is not an option.'

Other Republicans who said they planned to change their votes to support the bill included Rep. Ileana Ros-Lehtinen of Florida, Rep. John Sullivan of Oklahoma, Rep. Jim Ramstad of Minnesota, Rep. John Shadegg of Arizona and Rep. Sue Myrick of North Carolina.

Myrick told reporters that "it's the best thing for the country.

"I don't care about politics....I may lose this race over this vote, but I don't care ... It needs to be about what's right for the country."

Stock markets are up about 1% at this hour. LIBOR is still drum tight...unless it relaxes over the weekend and into Monday morning, we're in real trouble. This bailout's not going to help the credit markets.
Even if Congress approves the plan, Fisher said, the Federal Reserve may need to take steps to stabilize the commercial paper market that companies use for short-term credit.

John Ryding, chief economist and founding partner of RDQ Economics, a research firm, said that the world's central banks should guarantee the repayment of loans between banks, a move that the Irish government took this week. Currently banks are reluctant to even lend to one another, making normal transactions difficult.

"We can stand behind these banks collectively, or we can end up bailing them out one at a time," he said.

And how many billions...or trillions...will it take to fix these?

Around The Horn On The Veep Debate

Who won the debate? NY Times:
Senator Biden did well, avoiding one of his own infamous gaffes, while showing a clear grasp of the big picture and the details. He left Ms. Palin way behind on most issues, especially foreign policy and national security, where she just seemed lost. It was in those moments that her lack of experience — two terms as mayor of a tiny Anchorage suburb and less than two years as governor — was most painfully evident.
Washington Post:
Mr. Biden, a far better-known quantity and a more experienced debater, did well in part by not messing up: He did not say anything that the McCain-Palin campaign could seize on as sexist or dismissive. Instead, Mr. Biden seemed determined not to engage with Ms. Palin but with her running mate; he was sharpest at the end as he ticked off the ways in which Mr. McCain was not a maverick but was tied to the positions of the Bush administration. Last night's debate was no train wreck for either ticket, but it left one hoping that the remaining two presidential encounters will be more illuminating on the issues.
LA Times:
In the end, Biden left voters with a more constructive vision of the government and a more compelling case for how it has failed the nation under President Bush. Palin stumbled around the question of how much to embrace and how much to reject that failed administration. She insisted that she's part of a "team of mavericks," but said little about what that team would do. It was not a reassuring night. Thankfully, the presidential candidates return to the stage next week.
Chicago Tribune:
Bottom line: We were heartened to see a respectful discussion. Biden was in his comfort zone. He was more direct. He's been where the action is. Palin clearly has not. He had the depth; she had the empathy. But she did not provide more confidence that she would be ready to step into the most demanding job in the world at a moment's notice.
Boston Globe:
Palin has shown some comfort in scripted settings and in last night's well-structured debate. She has yet to show voters she can deal with unexpected problems and less-than-friendly questions. Since McCain chose Palin five weeks ago, she has not held a single press conference. Last night's debate offered Palin a chance to put to rest some fundamental questions about her readiness to be vice president. And she failed to do so.

Not real good for the Sarah, looks like 4 Biden wins and 1 tie.

Job Crunch Too

We lost a staggering 159,000 jobs in September.
Employers made deeper cuts in their payrolls in September, according to the Labor Department's monthly jobs report, as the economy experienced the biggest drop in jobs in more than five years.

There was a net loss of 159,000 jobs in September, the ninth straight month the U.S. economy has lost jobs. The August job loss was revised to 73,000 jobs, taking year-to-date job losses to 760,000.

The unemployment rate remained at 6.1%, the same level as August and in line with economists' forecast.

We're on pace to now lose a million jobs by January 1, folks. That's not good. Since Bush took office, America has lost over 2 million jobs in eight years, and will most likely lose another 400k or so before 2009. Keep telling yourself that Obama/Biden are going to kill jobs, as Sarah Palin shrilly warned last night. It's the Republicans that have cost us jobs. Those are facts.

Stocks are up this morning erasing most of yesterday's losses because people figure the horrendous jobs numbers are good for making the House pass UberBailout Mark II. Should the bill go to a vote and pass today, it could be a banner day in the market.

Right until the next 400 point loss.

The State Of Our Bailouts

Forgot bailing out AIG or Lehman Brothers or Wall Street. Apparently we have to bail out the entire State of California government while we're at it.
California may need an emergency loan of up to $7 billion from the federal government within weeks, the Los Angeles Times on Friday quoted Gov. Arnold Schwarzenegger as saying in a letter to U.S. Treasury Secretary Henry Paulson.

In the letter dated October 2, Schwarzenegger called for the passage of the $700 billion financial industry bailout plan which the U.S. House of Representatives is expected to vote on Friday, the Times said.

"Absent a clear resolution to this financial crisis, California and other states may be unable to obtain the necessary level of financing to maintain government operations and may be forced to turn to the federal treasury for short-term financing," Schwarzenegger wrote in the letter, according to the paper.

The credit crisis has pretty much hit at the worst possible time for California. Missouri too is having problems issuing state bonds.
Credit market troubles have forced officials to scrap an innovative plan to fix hundreds of Missouri's worst bridges, thwarting what was to serve as a national roadmap for quickly renovating aging infrastructure.

The plan would have awarded a single contract to finance, design and build 802 bridges within five years and then maintain them for the next 25 years. The state would have made annual payments to the contractor.

The plan was hailed as a potential model for other states and a better alternative for getting repairs done that otherwise would take two decades at Missouri's current pace.

But that was before the credit market crisis caused the cost of the bridge project to spike.

Florida's problem? It can't get money for schools and roads.
A top Florida money manager says the state can't borrow the money it needs for roads and schools due to the national credit crisis.
Colorado is having problems issuing bonds as well.
The credit crunch gripping the nation is hitting municipalities across Colorado.

Bond issues have been delayed in Colorado Springs and Steamboat Springs.

A $2 billion "checking account" for 360 government agencies across the state has limited its daily withdrawal rate because of liquidity fears.

Concerns are being raised that voters next month may be wary of passing a record $2.5 billion in construction bonds for 25 school districts, as well as the ability of credit markets to sell the bonds if they pass.

As I was talking about Wednesday, the credit crunch is going to be smashing into local governments, counties, and at this point entire states are in deep trouble.

The bailout's not going to change that. Not in the least. It's a basic confidence issue and the bailout simply doesn't address the basic reasons behind the crunch. So yes, you're going to most likely see governments go under in the next few months and take thousands and thousands of jobs with them.

President Raygun

Palin's closing statement quote from Reagan was yet another completely missed point for Palin, as TNR's Jon Chait points out:
Palin's final quote was from Ronald Reagan, warning that without vigilance, "you and I are going to spend our sunset years telling our children, and our children's children, what it once was like in America when men were free."

In fact, Reagan was not warning about a general lack of vigilance about freedom, he was warning what would happen if Medicare was enacted.

Palin. Is. Not. Qualfied.

Palin vs Biden: Morning After

I thought that Joe Biden won the debate last night pretty handily, but Palin did a pretty good job as far as attacking.

Palin pros:
  • Attacked both Biden and Obama's records.
  • Gave superior delivery.
  • Smiled and looked at the camera the whole time.
  • Had answers, even if they weren't to the question at hand.
  • Did not burst into flames on stage.
Palin cons:

  • Answers were at times false/misleading and got called out by Biden.
  • Stated she wasn't going to play by the rules and dismissed Biden AND Gwen Ifill.
  • Sounded like rote repetition of stump speeches.
  • Vague across the board.
  • Skipped questions to go with ones she had answers for
Her best moments were attacking both Biden and Barack Obama on their Iraq War differences in an effort to split them ideologically. "Oh, yeah, it's so obvious I'm a Washington outsider. And someone just not used to the way you guys operate. Because here you voted for the war and now you oppose the war. You're one who says, as so many politicians do, I was for it before I was against it or vice- versa. Americans are craving that straight talk and just want to know, hey, if you voted for it, tell us why you voted for it and it was a war resolution." It was a pretty strong attack, and Biden did not respond to it.

But her worst moments were clearly her answers to Q 16 and 17 on what the VP's role should be and the Nameless One's power grab in that office. "I'm thankful the Constitution would allow a bit more authority given to the vice president if that vice president" and "Well, our founding fathers were very wise there in allowing through the Constitution much flexibility there in the office of the vice president" followed by "Yeah, so I do agree with him that we have a lot of flexibility in there, and we'll do what we have to do to administer very appropriately the plans that are needed for this nation" should scare the bejeesus out of people, because it sure did me. Not having a clear grasp on the US Constitution is pretty much a disqualifying criteria for being President OR Vice-President.

On the other side, we had Joe Biden.

Biden pros:
  • Stayed relentlessly on message.
  • Attacked John McSame, not Sarah Palin.
  • Counterattacked Palin's false/misleading answers strongly.
  • Displayed command of the subject matter at all times.
  • Clearly won the second half on foreign policy issues.
  • Answered nearly all the questions at hand.
  • Did not burst into flames on stage.
Biden cons:

  • Looked like a Senator, and acted like one in a change campaign year.
  • Was on the defensive the entire first half of the debate
  • Was brutally attacked on domestic issues.
  • Glossed over defending his record at times.
Biden's best moment was when he connected with the audience at the end, chocking up over his wife and daughter's death. It was the first time in the debate he looked like a real normal guy. "Look, I understand what it's like to be a single parent. When my wife and daughter died and my two sons were gravely injured, I understand what it's like as a parent to wonder what it's like if your kid's going to make it" and "But the notion that somehow, because I'm a man, I don't know what it's like to raise two kids alone, I don't know what it's like to have a child you're not sure is going to -- is going to make it -- I understand" were pretty powerful stuff. His strong line about John McSame is not a maverick soon after were also very well played.

But Biden's worst moment was his terrible answer on American interventionism in Darfur. "I don't have the stomach for genocide when it comes to Darfur. We can now impose a no-fly zone. It's within our capacity. We can lead NATO if we're willing to take a hard stand. We can, I've been in those camps in Chad. I've seen the suffering, thousands and tens of thousands have died and are dying. We should rally the world to act and demonstrate it by our own movement to provide the helicopters to get the 21,000 forces of the African Union in there now to stop this genocide." This is pretty much the Bush Doctrine on Iraq right there, and severely undercut his argument that Obama/Biden would be any different than Bush/Cheney on foreign policy. It's yet ANOTHER place to send US troops when we don't have them to send.

Again, I thought Biden won the debate, the polls show Biden won pretty clearly among undecideds and also won handily on the issues of change, knowledgability and being ready to assume the Presidency.

Palin may have stopped the bleeding, but the McSame campaign is still down close to double digits across the board now, and she needed a knockout just the get back in this race. That didn't happen. With the next debate on Tuesday between Obama and McSame in Nashville at a Town Hall style meeting, we'll see what happens. At best it was a wash for Palin, and unlike McSame's "at best it was a wash" performance last week when the polls were significantly closer, the Straight Talk Express needed a hell of a lot more that what Palin showed.


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