This Time, We'll Bail Out the S&Ls without a Congressional Debate

by emptywheel

The former econ professor notes that we're already bailing out big money:

Fed to the rescue.

Aug. 10 (Bloomberg) -- The Federal Reserve added $19 billion in temporary funds to the banking system through the purchase of mortgage-backed securities to help meet demand for cash amid a rout in bonds backed by home loans to riskier borrowers.

The Fed accepted only mortgage-backed debt as collateral for this morning's weekend repurchase agreement. Losses in U.S. subprime mortgage investments have been rippling through global credit markets, driving interest rates higher and sinking share prices. The Fed also added $24 billion yesterday, the most since April, as demand for cash increased.

The New York Fed's additions lowered the Federal funds rate to 5.375 percent, according to ICAP Plc, after it began trading at 6 percent, the highest opening rate since January 2001. The Fed's benchmark overnight rate is currently 5.25 percent.

Nothing wrong with putting money into the system to lower the federal funds rate, but this is bailing out investors in a certain kind of specific and troubled asset.[my emphasis]

I'll add just a few things to this: One, by bailing out investors without a Congressional debate, BushCo allows us to avoid any discussion about the practices that got us into this mess--and the implementation of efforts to make sure they don't happen again.

And two, one of the reasons we're jumping to giving welfare to big capital without the normal interim steps is because doing anything else--putting much more money in the system--is going to revive the word "stagflation" faster than you can spit.

Wonderful. We're going to relive the 80s fiscal crisis and the 70s fiscal crisis.

Comments

[Tom in AZ]

Big donors calling in those chits, huh?

[P J Evans]

I wonder how we'll survive the experience. Renting rooms to friends? Gardening on balconies?

[Chris C]

If the economy does go down the tubes, 27% will look like up to BushCo. And an angry populace might be even more eager to get these clowns out of office. Impeachment might even sound reasonable to the Congressioonal GOP, mostly as a way to distance themselves from the mess and hopefully save their jobs in '08.

Just trying to make lemonade out of lemons here.

[David]

These people never cease to amaze. I did enjoy Jim Cramer's take on this regarding who would be bailed out and who would be left twisting in the wind.

[bmaz]

I am not so opposed to some fashion of bailout, I think it is in the interest of every citizen to some extent to see to it that the entire economy doesn't collapse. I think the NYT editorial has it right though about the wrong end of the equation being bailed out. This pains me just a bit to say, but the only candidate from either party who has seen this problem and who has had a plan (and a decent one at that) for a while now is Hillary Clinton. She has had a position paper out there, if anybody looked for it, for a long time.

[emptywheel]

bmaz

Yes, I was going to add that point--Hillary is going to look downright prescient to the DC insiders who didnt' see this coming.

And I'm all in favor of helping people avoid foreclosure. It actually would be a much better solution to the problem, since it would prevent real estate from completely tanking.

[radiofreewill]

How is this 'sweeping under the rug' any different than Enron, except this time the Thieves/Opportunistic Lenders are going to get away with it in broad daylight?

[Josiah Bartlett]

This is just like Enron. The only difference is that with Enron, the rich bailed out before the crash. Today, the Fed is propping up the market to bail out the rich investors.

They are exactly the same in that the little guys are getting hosed. With Enron they lost all of their pension and retirement funds. Today they are loosing their homes, their credit and cannot get any relief from bankruptcy.

It's only a "free market" when the rich are making all the money. The price of a "free market" is always born by the little guys.

[Gunner]

Do I have this right? the morgage Co are getting bailed out but I will still lose my house to forcloser? something is wrong with this

[qwerty]

Explaining the US economy?:
"...glorification of that sort of gambling in "clever strokes" which constitutes the very essence of theft, swindling, and all sorts of similar anti-social deeds." Peter Kropotkin comments on prison systems and relevant inmates ca. 1899

[Boo Radley]

Subprime lending

As I understand it, the hedge funds that package and resell these loans are extremely leveraged and AFAIK, that's what is causing the ripple effect through the credit markets. This kind of lending allowed people who were not very credit worthy to get into a house with as little as 5% down. That's been a boon to the housing industry, building $150,000 houses/condos. But (for example) right now that mortgage has only been paid down by a little over $7,500. It means the residential home market is massively overbuilt. It certainly looks like sub-prime lending has taken construction and engineering resources away from infrastructure projects and made them more expensive.

I'm not sure Bernanke has much choice about buying mortgage backed securities. No one knows just how bad the sub prime loan portfolios are (mark to market). The banks that are now foreclosing on those properties wanted to lend those funds to the equity markets, so this negatively affects mutual funds too. Best of luck to all these banks trying to resell the foreclosed properties. Also, the banks are calling in the loans from the hedge funds, but it's not clear that the banks have valued these sub-prime loans any differently than the hedge funds valued them (mark to market, sounds just like Enron). It sounds like a huge pyramid scheme, but we won't know the full damage without transparency. Wrt that, another major problem could be that a lot of the hedge funds (that have been making 30 - 35% on these sub-prime mortgages over the last few years) are incorporated in the Caymans (not sure if I am right about that). I don't think we can get that money back. My guess is that everyone in the WH is arm pit deep in hedge funds.

FWIW, iirc, the S&L crisis was front page until Saddam invaded Kuwait. I hope Congress investigates the you-know-what out of this along with asking where in the hell the damn SEC has been.

[emptywheel]

Yes, Gunner, that's right. The rich won't lose their vacation cash, but we're still packing up your home in the next weeks before they kick you out of it.

[Sojourner]

The sub-prime mortgage loan business is one major issue, of course, and I am sure that neither party wants to have fingers pointed at it (and particularly the Bushies!). I am equally concerned about the amount of consumer spending that has been taking place by people drawing equity out of their homes through home equity loans and refinancing.

By putting home equity money into the consumer spending equation, Bush has been able to keep the economy looking robust. People have paid off credit card debt with home equity loans, but then turned around and got into more credit card debt. Now they are faced with tightening credit markets.

As are corporations. Home Depot's possible sale is apparently at risk, as are other mergers, because the availability of money is suddenly up in the air.

EW, you mention the S&L debacle in this posting. If anyone wants to read a real interesting story about what happens when there is too much money chasing around (as is what appears to have happened here) looking for investments, read the book "Funny Money" by Mark Sanger. I think it is still in print. I was in the oil exploration business in the 80s, and knew some of the principals mentioned in the book. It is about the rise and fall of Penn Square Bank, and its energy lending practices. Everyone wanted to get a piece of the action. It resulted in Seattle First (SeaFirst) being closed, and Continental Illinois almost going down the toilet. If I am not mistaken, some of these actions set up the S&L debacle.

Regardless, Bush has catered to the corporate masses and has done his best to make money available to keep the economy going. That was why he wanted to tap into Social Security so much -- that would have really opened things up even more. In the meantime, he could have his little war with Iraq. Unfortunately, the wheels are getting loose and are about to fall off the wagon.

[emal]

bmaz, I'm in agreement with your sentiments and agree they needed to do something here. But to bad there isn't any sort of assistance and "bail out" of those people who can't pay their mortgages and will lose their homes. Guess that gov't bailout fails to trickle down only gets so far before it quickly turns into the era of "personal responsibility" for millions of those folks, some but not all of whom were preyed upon by people who knew better but didn't care. And you are spot on with the Hillary comment too. She is out in front of this one.

[John B.]

I don't think the banks and big mortgage companies who made bad loans to bad credit risks with questionable maket schemes should get bailed out. But I also don't think the idiots that borrowed money on ARM's and interest only loans to fuel the fake housing market should get bailed out either. Somewhere Mr. Andrea Mitchell is smiling at all the carnage.

[bmaz]

sojourner, Boo and EW - You are all so right; this situation is reprehensible and has a parallel track to the savings and loan crisis. It is time to take that one step further though. And where I am going will be a well worn path for most here. Specifically, the policies that put us in these dumper moments are always the result of Republicans/Conservatives gone wild. Conservative my ass, they habitually bend and break laws in order to bleed every situation past being dry. Here is the commonality between S&L and SubPrime. It wasn't that either were new or necessarily problematic or evil on their own; both had and have been around forever. It was what was allowed to be done with them by unscrupulous Republican administrations. S$Ls were great little institutions that were not only sound, they were to sound for the Republicans; there were simply tons of assets, equity and stability in them because of their inherent nature. Here is a parallel with subprime, the S&L stability was because much of their assets were land and homes. The GOP wanted this potential money out in the economy in order to cover their - wait for it- tax cuts and give aways to corporate big business. So the Reagan/Bush41 administration loosened almost every significant restriction on the S&Ls from their ownership to debt margins. Presto! They went wild and went under. I know a bit of this because the Charlie Keating/Lincoln scandal happened right here. couple of good friends were on his criminal defense team. Charlie Keating was a loathsome and despicable man; but to this day, I don't think he was guilty of any crime. What Keating did was allowed and encouraged by the government and their economic policies. doesn't mean that a decent and moral man would or should do it, only that it was not criminal. When the bottom fell out of this scam, Keating was the face put on it, partially at least to draw attention away from Neil Bush and Silverado. The same thing has occurred in the current day. The Bush Administration had to have cover for their economy wrecking and plundering policies of tax cuts and corporate give aways. There have always been sub prime and other "creative" loans; they served a useful purpose in society and were not really an issue. But the Bushies loosened the rules regarding securitization and bundling of these loans, as well as the regulations on financial markets trading and ownership of the same. Presto! An Enron ponzi like frenzy of circular trading of speculative paper put tons of virtual cash into the economy. At the same time solid citizens were badgered into wasting their equity and, indeed were forced to because of the disappearing social safety net. The same people are responsible, and the same selfish corrupt motivations and method of operation are present. These bastards will bleed any situation well beyond death. Which returns me to my constant them for the last several months. START AN IMPEACHMENT INVESTIGATION, OF SOMEBODY-ANYBODY, SO THE BRAKES CAN BE PUT ON THE MALEVOLENCE AND THE FACTS EXPOSED FOR WHAT THEY ARE.

[Davis X. Machina]

If the economy does go down the tubes, 27% will look like up to BushCo.

No.

There are fifty to seventy million Americans who will volunteer to live in a cardboard box under a bridge, with their families, and live on sparrows toasted on an old curtain rod over an open fire if you can guarantee them that the family -- gay, liberal, Muslim, immigrant, different -- in the next box over doesn't even get the sparrows.

This is the salient feature of American politics, and we forget it at our peril.

Alf Landon got tens of millions of votes in '36 -- perhaps didn't carry too many states, but tens of millions of votes -- and times were far worse then.

There will always be Reublicans.

[emptywheel]

John B

There are a ton of people who are in foreclosure off of more traditional loans. So yes, let's prioritize, those who were smart and still are in foreclosure, those people who have no other options.

But unless we bail out from the bottom up, we're talking about moral hazard for the rich, and more damage for teh economy as a whole.

[MarkH]

The Bush administration or Fed is protecting the Rich with tens of billions of dollars of aid.

Sen. Hillary Clinton plans to protect middle-class homeowners who have mortgages and their lenders with at least $1Billion.

Who will help those who've already lost their homes?

And, why isn't the largest aid to the little guys with less aid going to mortgage lenders (who went into this with open eyes) and the very Rich (hedge funds and the like) who not only went into it with open eyes they relished it, they slobbered over the opportunity -- and they shouldn't be protected from the downside of their risk-taking.

Where is the balance here?

[Mimikatz]

This isn't a "bailout" as that term is generally understood. The Fed has provided extra liquidity so that banks will not RAISE interest rates at a point when there is a credit crunch. This gets the fed funds rate back to around 5.25-5.5%, which is the Fed's target rate. It is not the same as a rate cut. That is a cut in the prime rate.

The problem with mortgage loans is twofold. One, too many mortgate lenders made subprime loans to people who didn't really qualify for home loans, such as "stated income" or "liar's loans" and "NINJA" (no job, no income or assets) loans, often with teaser rates. These are starting to reset, although the majority of the bad loans will reset next year. And some people added home equity loans on top of precarious but not subprime mortgage loans. They may not be able to pay their mortgages.

Then the mortgages were sold to investment houses who packaged them and sold them to hedge funds, who borrowed at lower rates to buy the packaged mortgages. But it is impossible after the packaging to really tell what these collateralized debt obligations are really worth. Plus, some hedge funds were levered up to 12-1.

Now there are defaults and requests for withdrawals, and this paper has to be marked to market, or marked to what it is really worth, if that can be ascertained. The leverage that brought big gains now causes big losses, so some funds are puking up stocks to meet redemptions and margin calls.

But none of this is bailed out by increasing liquidity in the money system to keep short term rates from going up above the Fed's long-time target.

Now if the Fed actually lowered rates, that would be more like a bailout, but none of this really resembles the bailout of the S&L industry under Bush Sr, let alone the bailouts in the form of gov't guaranteed loans given to Chrysler and others. Nor is it really like Rnron either.

[bmaz]

Mimikatz - I wasn't saying any solution was the same as S&L or Enron, just the framework of the genesis of the problems were analogous. Additionally, and I have a hard time believing this, but I read this morning somewhere that the Fed itself is actually buying up some of these securitized packages in their effort to infuse money. That seems odd if true which, again, I question.

[Boo Radley]

"Conservative my ass, they habitually bend and break laws in order to bleed every situation past being dry.

BULLSEYE

From the Compost, but I think he makes some good points New Order Ushers in a World of Instability
By Steven Pearlstein
Friday, August 10, 2007; Page D01

"Hint to White House economic team: You might not want to have had the president repeat that numbskull prediction about a "soft landing" for housing at precisely the moment central banks were pumping $150 billion into the financial system to prevent a market meltdown over anxieties about mortgage-backed securities. Brings back memories of "Mission Accomplished."

Seriously, folks, we all need to get used to days like yesterday because there are going to be a lot more of them. In a world in which trillions of dollars have been bet on the premise that low interest rates and record-low default rates would continue forever, "repricing of risk," as the administration likes to call it, is not some minor technical event. It's more like a tectonic shift going on beneath the surface of the economy [...]

Australian analyst Satyajit Das makes the point that the main achievement of the new financial architecture has not been to spread risk so much as it has been to expand risk by vastly increasing the amount of borrowed money. Making loans to buy bonds secured by packages of other loans makes for big fees and exciting work for bankers. But as Das predicted last year in his book, "Traders, Guns & Money" -- and as we all discovered yesterday -- if the supply of credit suddenly dries up anywhere in the system, the elaborate new structure they've created can come crashing down on itself."

[Boo Radley]

Dayum Mimikatz, you really nailed it.

This was my favorite part, because it explained what I was clumsily trying to get at with "mark to market."

"Then the mortgages were sold to investment houses who packaged them and sold them to hedge funds, who borrowed at lower rates to buy the packaged mortgages. But it is impossible after the packaging to really tell what these collateralized debt obligations are really worth. Plus, some hedge funds were levered up to 12-1."

[Mimikatz]

What happened in the S&L crisis was that the money deposited in S&Ls was insured up to $100,000 by the equivalent of the FDIC. So old people put their life savings in S&Ls. But the S&Ls used the money (which they got through offering higher rates to savers) to finance increasingly risky and then fraudulent commercial real estate schemes. The loans went bad and the GOV'T had to pay up on the insurance, sometimes more than the $100,000 limit, IIRC, and it had to set up the Resolution Trust Corporation to take over the loans from the S&Ls and find someone more responsible to take them over. The real problem was that many, many people saw this coming under Reagan but they waited until after the 1988 election to do the bailout, by which time the situation had gotten much worse.

Here the people who will be hurt the most are the investors in the hedge funds because their investments are not guaranteed AND NO ONE IS BAILING THEM OUT. To the extent we have quasi-governmental operations like Fanne Mae, Freddie Mac and Ginnie Mae in the mortgage business, they have much higher loan requirements, and don't deal in subprime. The Fed is NOT buying bad loans from hedge funds.

An injection of liquidity is a fairly routine thing, although this is larger than normal and was done twice in one day, and just makes sure there is enough money available that banks don't jack up their lending rates to take advantage of the credit crunch. Congress can and perhaps should take some action to help forestall foreclosures, but they aren't going to be bailing our the hedgies, who at least now won't earn their big fees and won't have to worry about their tax rates.

[Josiah Bartlett]

Boo,

The leverage is part of the problem only because the underlying mortgages are going into default.

Through the 70's, S&L's wee only required to maintain 3% net worth to total assets. They got hammered at first by high short term interest rates, they loaned long and borrowed short. Most of the institutions that had problems then had been operating soundly and according to regulations. This plan had operated well until the environment changed but the regulations didn't. When President Carter appointed Paul Volker to the Fed, he gave him instructions to get inflation under control. This was a seismic shift in the power of the Fed. Volker proceeded to do as requested and raised interest rates to tame inflation. The S&Ls were the unfortunate victims of this environment.

The real problems came when Raygun/bush1 tried to solve the problem by desupervising the industry and let their jakals loose and others have already noted very well what they accomplished.