Page 2 of 2 Crisis control fit for the TV age
By Julian Delasantellis
Essentially ignored in all this is the probable trillions upon trillions of
leveraged structured finance derivative securities whose value depends on the
original securities. Nobody really knows how much of these there are; one
estimate put the number at around $25 trillion. You can't solve a $25 trillion
problem with $700 billion. It's no wonder that Warren Buffet once called
derivatives "financial weapons of mass destruction".
The bailout plan will essentially ignore the derivative securities, thinking
that buying up the original securities solves the problem with the derivatives.
It doesn't. Even if Paulson way overpays on his purchases, say, paying 80 cents
on the dollar for securities going in the private market for less than 30
cents, many of the derivative securities were always priced for full payback,
so a big problem still remains in a very big market.
What if Paulson got the MBS on the cheap, say, at 20 cents on
the dollar? The banks wouldn't like that at all, in selling out that low they'd
finally be forced to take the actual hits on their balance sheets they've been
dreading having to declare since the crisis began.
The banks call the low, bargain basement values "fire-sale prices". They think
the stuff is worth more. Maybe it is. But accepting 20 cents on the dollar to
finally get the toxic, radioactive stuff off their books once and for all
precludes the possibility that MBS prices could get a lot worse, say to 15 or
10 cents on the dollar. That is the fear that is currently causing the world to
shun and flee its financial institutions. With the S&P 500/Case-Shiller
home price index still currently in freefall, 20 cents in the hand should be
considered a lot more attractive than whatever they think they can get in the
Obviously, paying cheap is also a better deal for the US taxpayer. There is a
clear hope that, once the markets have stabilized, the MBS can be sold back
into the markets by the government for a profit. As with any investment, paying
less at the beginning infinitely increases the probability of success when it
comes time to sell.
There are two separate dragons breathing down fire on the world financial
system. One is de-capitalization, the fact that loan losses are driving down
banks' capital bases and then their ability to lend. The other is deleveraging,
the vicious circular process whereby losses on old loans restrict the system's
ability to make new loans, which drains the system of new capital, setting up
yet another round down.
These phenomena may seem similar or identical, but they're not. Paying up for
MBS may seem to recapitalize the banks, but without slaying the deleveraging
monster the new capital will surely be sucked away and lost, as has happened to
the numerous failed attempts by sovereign wealth funds and private equity to
invest in the financial system over the past year.
Just for a moment, imagine that a huge black hole has opened in your living
room, sucking in furniture, pets, children and kitchen sink. The bank
re-capitalizers would say that all you have to do to make things right is to
replace the furniture, pets and family, then things will be normal again.
However, the people who understand deleveraging know that if you don't shut off
that huge vacuum of destruction, anything new put into the system will just go
the way of the old. That's just not going to be possible paying $700 billion to
buy only primary mortgage assets at luxury prices.
Some are saying that the self-evident unworkability and impractibility of all
these system-rescue solutions is not evidence of the inherent impotence of
government, but of another strategy. The reason it's OK that these plans don't
provide a long-term solution is that they don't have to - all they have to do
is keep the financial system intact for the 80 or so days until a new American
president is inaugurated, one not so hidebound by narrow ideological lenses as
is the present incumbent.
If that new president is Barack Obama, he may even be fortunate enough to enter
office with a significantly enhanced congressional majority, making the
prospect of the partisan gridlock that has so paralyzed Washington
decision-making for much of the past 30 years much less likely.
Whoever is the next White House incumbent, I'm sure they will greatly
appreciate it when they find that their predecessor has left for them a world
financial system in total crisis. In that case, the sweet ambrosia of victory
and power the new occupant must have hoped he would drink upon his arrival at
the epicenter of power would surely then more closely resemble a bitter and
caustic nectar from a poisoned chalice.
What options would then be available to the new president? Amazingly enough,
some, and not all; people on the political left are advocating a so-called
Swedish solution, after the strategy employed in the Nordic nation in 1992 by
then Conservative Party prime minister Carl Bildt.
The Swedish solution was essentially the nationalization of its entire
financial system, with the banks being recapitalized by means of wiping out the
value of the equity positions of the shareholders. That some in the United
States, the country that for the 15 years after the fall of the Berlin Wall
proudly proclaimed free-market capitalism as God's chosen course for the human
race, are going for a solution even Lenin, in his 1921 New Economic Program,
thought needlessly radical, just goes to show that under enough stress, any
man, and any ideology, can be broken.
A US media type reported that she was riding a skyscraper lift that had a
television placed in its control panels (yes, I've seen those as well;
capitalism's final frontier is apparently now somewhere between the 30th and
31st floors) when the news of Monday's defeat of the bailout bill was
announced. She reported that everybody onboard cheered the news; one woman
actually exclaimed, "Now they'll spend the $700 billion on education!"
What lunacy, on so many levels. The fact that someone would actually think the
$700 billion could or would be directed to schools and teachers demonstrates
that, no matter what they tell pollsters, this silly lady actually thinks that
Americans in fact care that much about schools and teachers.
What about the rest of the people who cheered the bailout's defeat? They're the
ones who act like the worlds of finance and the real economy are separate, that
they want the money going to some place called "Main Street" rather than Wall
What fatuousness. As if the rest of the country hasn't lived high off the hog
this past decade from Wall Street's new and inventive ways of creating and
packaging debt and leverage. As if American homes that don't even have indoor
toilets or running water don't now have two-meter wide plasma TVs, all paid for
through all the new ways Wall Street has devised to get America's grasping
hands on China's savings.
Maybe that's the real crisis here, certainly the root cause of the dramas
currently unfolding in the Congress. Americans still seem to think that they
can adjust 21st century economic policies simply on the basis of what they like
or dislike. Television has implanted in their heads this seductive view of the
past as being like something from out of a coffee commercial, with small-town
folks walking down small-town streets going about their small-town business,
with no crime, poverty, depravation, big government or minorities in the frame.
"If only we could get back to that, to those values," they sigh wistfully.
But modern economic crises aren't like that. If you don't believe me, just ask
the citizens of Thailand, Malaysia, South Korea and others, thrown into penury
and despair by US economic officials and dictums in 1997, as a result of an
economic crisis far less serious than what is happening to the Western world's
financial world now.
As fate would have it, I'm scheduled to be on a US commercial airliner,
cruising down the California coast, around the time of the House of
Representatives vote on Friday morning. I may not know the result until I land.
Then again, if I look out the airplane window and see hordes of newly
unemployed American Visigoths burning and pillaging the once great cities of
the US Pacific Coast, I'll know that the bill has once again failed, and the
financial markets have reacted as expected.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at email@example.com.