Single most misleading meme re crisis: "Bailing out Wall Street"

[HamdenRice]

I don't know how this meme has become the dominant way of understanding this crisis. I especially don't know how the proponents of the bailout have allowed their proposals to be framed this way without trying to break out of the frame.

Does everyone realize that the financial institutions that created the bad mortgage backed securities are not the same institutions that bought them?

Wall street companies purchased mortgages from mortgage originators, put them in trusts, issued mortgage backed securities against those mortgages and sold the securities on to smaller financial institutions.

It is true that some Wall Street firms retained large portfolios of the stuff they had created. But it is also true that Paulson has allowed those firms -- Bear Stearns, Lehman, Merrill -- to fail or to be swallowed up. Any program that allows the feds to have discretion about whom to purchase bad mortgage backed securities from would allow the feds to decide to not purchase them from culpable Wall Street firms.

Generally, Wall Street was a conveyor belt for the creation and sale onward of mortgage backed securities.

I realize that looking at financial statements is not very much fun -- especially if you'd rather just not think about the reality of the situation and "let it collapse" -- but I would urge you to try to look through these aggregate financial statements for the "thrift industry."

Just to backtrack. The banking sector can be (or "used to can be") divided roughly into three parts:

The investment banks primarily help corporations issue stocks and bonds (including mbs) and they also sell and trade those bonds. Traditionally, these companies were referred to as "Wall Street" banks, because they were overwhelmingly concentrated in and around Wall Street in lower Manhattan. But in most ways they were not what we think of as banks at all because they did not take deposits.

Commercial banks were spread throughout the country. They provided loans to businesses and took deposits from businesses and consumers. Originally only commercial banks could provide checking accounts. These banks including the giants like Chase, Citibank and Bank of America. The Glass-Steagall Act allowed investment banks and commercial banks to acquire each other. The recent financial crisis has seen the final swallowing up of the last independent investment banks by the commercial banks.

Thrifts were the third sector. Thrifts were divided into "savings banks" and "savings and loan associations." Originally, these banks arose to help poor and middle class people save through "thrift." Many of these banks were originally non-profit savings banks or depositor-owned cooperatives (savings and loan "associations"). The conflict between a savings and loan, and a local commercial bank, was one of the central plot points of the movie, "It's a Wonderful Life." As shown in that movie the main lending business of thrifts was to lend to consumers for home purchases.

The Depository Institutions Deregulation and Monetary Control Act passed in 1980 and the Garn-St. Germaine Act of 1982 deregulated thrifts, making them much more like commercial banks, ending the George Baily era of local community thrift banking. Further deregulation under Reagan and George the First caused massive, irresponsible lending by inexperienced local George Baily's leading to the "savings and loan crisis" and bailout of the late 1980s.

But thrifts continued to specialize in taking consumer deposits from consumers and making loans to homeowners. Because thrifts were required to hold homeowner loans as their main assets, after mbs began to be widely available about 30 years ago (yes, they've been around that long), the thrifts bought them to diversify their asset portfolios so they wouldn't be as susceptible to local down turns in the economy and real estate market.

These financials are aggregate financials of the thrifts:

http://www.iii.org/financial2/banking/thriftinstitutions/

Please scroll down to the third chart: "BALANCE SHEET OF THE FEDERALLY INSURED THRIFT INDUSTRY, 2003-2007", and check out the 2007 column. There you will see that the assets of the thrifts related to mortgages consisted of $840 billion in residential mortgages and $264 billion in mortgage backes securities -- that's about 30% in mbs. Cash and other securities total $186 billion. Almost all the other assets are loans and real estate, none of which is liquid (ie instantly saleable).

When these thrift institutions bought these mortgage backed securities they were given a document called a "prospectus" by the investment banks. The prospectus is supposed to explain all the risks and safe guards of buying these securities. They were also told in most cases by well respected ratings agencies that these mortgage backed securities were triple A rated, investment grade securities -- almost as safe as US treasury bills. It turns out that these prospectuses did not accurately predict the risks involved in the securities and that the rating agencies did not accurately rate these bonds.

Another way to look at it is that a year or so ago, this sector had $450 billion ($264 billion in mbs and $186 billion cash and other securities = $450 billion) in instantly liquid assets for paying out money to depositors, meeting inter bank lending debts, and so on.

As a result of the market for mortgage backed securities essentially coming to a standstill because no one knows what they are worth and no one will "make a market" in them, the thrifts have seen their liquidity reduced by 58%.

Remember, they have to keep the cash and "other securities" liquid for depositors -- especially now that so many depositors want to rush out and withdraw money from their local savings banks.

Other big purchasers of mbs -- all pursuant to reading prospectuses and getting triple A ratings -- were pension funds, and 401K fixed income funds.

Now, can anyone explain to me why a program to purchase mortgage backed securities from thrifts is "bailing out Wall Street"?

Can someone explain why purchasing mortgage backed securities from thrift institutions is somehow "bailing out the people who created this mess"?

[Eric J in MN]

1. Are you predicting that Goldman Sachs won't get billions?

Henry Paulson was the CEO of Goldman Sachs until he became Treasury Secretary. I'm expecting G.S. to get billions.

Also, the Chris Dodd bill lets Treasury buy any "troubled assets," not only mortgage related securities.

[HamdenRice]

2. I'm not predicting anything. I'm asking a question

Please see the OP.

[The Magistrate]

3. An Excellent Piece, Sir, And Very Helpful

The 'bailing out Wall Street' line really does distort the matter considerably. What it is proposed to 'bail out' is the market in credit obligations, which, for better or worse, most economic activity nowadays depends on. In the course of doing this, some large firms, and their managements, will escape the consequences of their malfeasance, which is certainly unfortunate. But a great many of their victims may also escape further harm.

Whether the actions proposed are the best way to accomplish the goal of restoring to some health the market in credit obligations, or even whether any government action is needed to do this, is certainly open to debate, but that debate is best conducted without the brandishing of loaded language that does not fit the actual situation.

[HamdenRice]

7. Thanks. I don't know whether it will work, but it amazes me how

so many people simply don't want to know the details, or acknowledge that there is indeed a crisis.

[PurityOfEssence]

10. It's the dark side of leftism

and it's something that's been depressingly present on this board for the last six months or so: a feeling of righteous vengeance of the wronged.

Much as I am a leftist out of a desire to see things work out for my fellow humans, and much as I equate conservatism with greedy selfishness, I can't miss the inherent stripe of a different kind of selfishness in leftist thought. It manifests itself in a different way, but it's selfishness nonetheless: the vengeful reveling in seeing those better off get a comeuppance.

Our economic system is driving a tanker truck of gasoline drunk down a crowded, fast moving freeway, and there's no way to pull over; even as its driver is spinning and blacking out and knowing that the time to find a rest stop is now, there's no exit. Those who don't see this are truly dangerous. The very looks on the faces of the most knowledgeable economists should give us a respectful pause: they're terrified, and the most honorable of them admit flat out that they don't know what's going on or how to solve it. SOMETHING needs to be done, and it needs to be done in a concerted, nurturing and continually adjusting way; it needs to be done in a liberal way, with constant monitoring and carefully modulated experimentation, accepting the premise that we are in uncharted territory. Conservatives and simpletons on the left all want some kind of simplistic off-the-rack solution, because their mindset tells them that such things exist. (Me, I just chalk it up to religion, being a bigot on the subject: we're taught that there are simple, clean answers, just as libertarians long for their 3x5 card for a tax return.)

Enough digression, though. The idea that rankles most from the "let them fry" leftists who lick their wounds and bemoan their woeful impecuniousness is that they'll be hurt the worst; we're all infinitely benefited by a sophisticated society, and when it falls apart, we're truly unprepared for the consequences.

Those who created these crappy securities based on lies and mutual distortion are the most guilty, but those who looked at them as legitimate things of worth were also culpable: it was well known that the whole thing was based on the premise of unending growth in home values, and any economist worth his/her salt knows that that ain't the way in capitalism. Many were looking over their shoulders and prodded by their overlords to cash in in ways that their demonic competitors were, and many were just driven by shortsighted greed. This is human nature, and our job as social engineers is to accommodate human failings without allowing them to simply run willy-nilly.

This whole election cycle has been depressing, and so has the economic cycle. Now, at least we'll see who TRULY gives a fuck about his/her fellow man, and cold comfort as that may be as the world crumbles around our ears, it's perhaps time to see what people are really worth in the long run.

Thanks for the thread; this is why this place has been such a home for me for the last 7 years and the absence of this kind of thing is why it's been a place I've had little fondness for over the last 6 months or so.

Hopefully, those without selfish vengefulness will prevail, and hopefully they'll do so in a purely pragmatic way.

[many a good man]

14. Great post

I echo your sentiments 100%. Thank you for your thoughtful contribution.

The OP is fantastic, too. However it gives the impression that thrifts will be the only institutions aided. I'd like to hear more detail on whether or not this will be the case.

I wish I could think of a better term than "bailout." The people responsible for lax oversight and unethical trading are trying to get off scot free.

The primary objective has to be to restore faith in the American financial sector. Along with the equity market, people around the world have a huge stake in avoiding a meltdown. If we can't restore confidence the world is looking at a long painful readjustment that will knock the United States off its preferred perch. That outcome will only lead to greater poverty and misery here at home and should not be a cause for celebration by any sane person.

[HamdenRice]

15. Great post. Thanks.

The only thing I would disagree with is that it was not that unreasonable for purchasers of these securities to think that real estate would not go down appreciably in the medium term. That has rarely happened.

[Laelth]

22. Hear, hear!

That was a fabulous post.

:dem:

-Laelth

[Pastiche423]

23. Name one person that has stated there is no crisis

Just one!

[kirby]

4. Thrifts have shaky loans and sub-prime too...

Local thrifts also played the game of questionable appraisals and lending based on teaser rates that once they adjust the borrower will not be able to repay. To be competitive, many had to play the game.

It is called a Wall Street Bailout because the complex scheme was hatched within Wall Street. It created a new paradigm of lending where the local thrift was not as concerned about the ability of the person to repay because they knew they could eventually securitize and sell their loans. The housing bubble is the base of it, but the fancy financial instruments like credit default swaps (which Warren Buffett called a ticking time bomb 5 years ago) is the invention of Wall Street.

Banks/Thrifts lend money to one another for very short terms and even those loans are made up of AAA Commercial Paper. The rating agencies are a complete joke because that paper is not as risk free as AAA would imply.

Most banks, including Community Bankers Assoc, are really hoping for this bailout because they are hurt too.

[wilt the stilt]

5. there is a valid reason for the bailout plan

and why it has to come from government. The capitalist system is based on liquidity and trust. If everyone becomes insolvent then all capitalism falters. The private market can't guarantee it because they can default. The government has to guarantee it because it will not become insolvent. That is why T-Bills are always as good as gold. If worse comes to worse a government can print money. It will not go insolvent. That is why the government has to bail out the banking system. The financial system is the core of capitalism

[LiberalAndProud]

6. It is what it is.

If we had made low-interest government loans available to homeowners when it became clear that foreclosures were occurring in terrifying numbers, this could have been avoided.

When the foundation is already crumbling, you can't prop up the roof. The damage has already been done. We can delay it or not, but we are in for a long and bumpy ride.

[Trillo]

8. Thank you for your thoughts, and taking the time to write them.

I looked at the front page of the site you're referenced for your statistics, and it generally reads like an advertisement for the insurance industry.

[HamdenRice]

9. It is more or less pr site for insurance

but it also has lots of facts and figures, for the purpose of "helping" consumers learn about the finance industry and chose "investment products."

That doesn't mean their spread sheet on the thrifts is wrong.

[hfojvt]

11. thanks much for the link

I wish they had stats going further back. I notice a steady decline in the number of thrifts from 1,411 in 2003 to 1,251 in 2007. From 2005 to 2006 there was a drop in total assets too from 1.837 trillion to 1.769 trillion. Also a fairly substantial move away from US Treasury investments in 2006 from 5.639 billion to .9 billion.

However, that link also has stats on banks, and banks are far more substantial than thrifts. They hold 971 billion in mortgage backed securities. They also have declined in number from 7,753 in 2003 to 7,265. However, the bulk of their assets are concentrated in about 1.2% of them. The 86 banks that have over $10 billion in assets now have 74.1% of all bank assets.

It's those big guys who are gonna benefit most from the bailout. The biggest of which is Citigroup.

Just the other day, I discovered that Citigroup owned about 28 million shares of Freddie Mac on 30 Jun 2008. It was valued at $16 a share then. Now it sells for $2, which means they lost, at least on paper, almost $400 million in Freddie Mac alone. Probably the other big guys were playing in that market as well. And Freddie Mac was selling for $50 a share something like 6 months ago, so they may have paid far more than $16 a share for it. In going from $50 to $16 with 28 million shares, they lose almost a billion dollars.

[gopbuster]

12. Just some thoughts...

Maybe off base here and any better explanation is certainly welcome

Do we really know for sure this will be limited to thrifts.

The definition of financial institution within the draft http://banking.senate.gov/public/_files/LegislativeTextofChairmansDoddsproposalfortheTreasuryBailoutplanAYO08B68_xml.pdf

any institution, including
any bank, savings association, credit union, security
broker or dealer, or insurance company, organized

2 and regulated under the laws of the United States
3 or any State, territory, or possession of the United
4 States, the District of Columbia, Commonwealth of
5 Puerto Rico, Commonwealth of Northern Marianas
6 Islands, Guam, American Samoa, or the United
7 States Virgin Islands, and having significant oper8
ations in the United States, but excluding any cen9
tral bank of, or institution owned by, a foreign gov10
ernment.¿

They are including broker dealers and insurance co's with "troubled assets"

"Any institution including"? sounds fairly broad?



Also, I think what many have a problem with is it enough over the longer term to really do the trick?

derivatives are going to be a huge problem

It would appear local and state governments may be holding toxic paper as well

see here>>>http://www.weissgroupinc.com/bailout/Bailout-White-Paper-Sept-24-2008.pdf

[hfojvt]

13. oof, the concetration is much worse than that

looking at the top 25 banks by revenue, banks #6-25 had 177.6 billion in revenue while banks 1-5 had $503.89 billion in revenue! So clearly those top five are the bulk of the top 86. They are Citi - $159.229, BOA - $119.19, JPM - $116.353, Wachovia - $55.528, and Wells Fargo - $53.593.

On the other side, WaMu was the largest thrift, with $327.9 billion in assets. Countrywide, which was bought by BOA was 2nd with $208.36, and the failed IndyMac was 8th with $32.73 billion in assets.

[HamdenRice]

16. To correct something perhaps misleading in OP-Commercial banks, not just thrifts, WILL benefit

There's no question that the commercial banks' mbs will also be bought, as they are the biggest sector, and therefore, they will proportionally sell the most to whatever federal entity is doing the buying.

My main point is that there is no necessary correlation between those who created this stuff and those who bought it. Those who created it were mostly investment banks -- including some investment banks owned by commercial banks.

I just want us to examine the misleading meme that it is exclusively the people who created this stuff (Wall Street) who are getting bailed out. That's not true.

Any eventual plan undoubtedly will leave a lot of discretion to the feds as to whose mbs to buy.

The big question is what policy will drive what gets bought. The idea is not to buy all of it; the idea is to buy enough of it so that there is liquidity in the system again. That's why Schumer's contribution to the plan was so astute. Start small, ratchet it up and see when the liquidity starts to flow again.

One possibility is that if the feds decide their main goal is to call whole series of particular issuers (to facilitate repackaging the stuff), then who gets to sell at any time will be pretty random. Another possibility is to focus on those sectors where credit is most frozen and liquidity is most desperately needed (possibly commercial and international banking). Another is to focus on uninsured money market funds. Another could be to get the housing market moving again and prevent a further collapse of housing prices (thrifts would benefit).

But the idea that it will exlusively be a buyout of investment banks is pretty preposterous.

But these questions will be answered not by some inevitable law of history such that the answer is: only the most corrupt, most elitist, most responsible possible sellers will benefit; the questions will be answered by political/policy struggles to come.

[The Magistrate]

17. Thanks Again, Sir, For Putting This Up And Tending It

It is about the best piece that has appeared in the forum on the topic....

[HamdenRice]

18. Thanks for your appreciation! nt

[bigtree]

19. k&r

:kick:

[OakCliffDem]

20. Kick

[The Magistrate]

21. Kick And Recommend