Page 1 of 2 A bedside guide for Henry Paulson
By Julian Delasantellis
It was the unique genius of Woody Allen that turned Dr David Reuben's daring
(for the time, anyway) 1969 question-and-answer book, Everything You Always
Wanted to Know About Sex (but were afraid to ask) into a 1972 skit
comedy film. To illustrate the book's inquiry "Why do some women have trouble
reaching orgasm?", Allen presents the story of a modern Italian couple,
Fabrizio (played by Allen) and Gina (played by Allen's real-life former
paramour, Louise Lasser).
In response to Fabrizio describing to a worldly friend Gina's aforementioned
problem, Fabrizio is advised that perhaps what Gina needs is the spark of
danger, of risk, in their lovemaking. The pair start cautiously, making love in
a friend's house, but
before long they are locked in erotic embrace in a restaurant, even in front of
a church. Fabrizio is pleased that he has solved the couple's problem, but he
worries. He realizes that it is getting harder and harder, that he is having to
subject himself and Gina to more and more risk, in order to create a
satisfactory conclusion. What must he do next?
Lately, the US stock market is proving equally as hard to please as Gina.
Last week was a fairly average time in the financial markets, at least by
recent standards, in that the governments in the capitalist world were once
again called on to rescue and support participants in the private financial
markets. Monday led the week off with the US government's rescue of Citigroup,
as the world financial crisis had finally reached and led to the downfall of
the world financial system's ruling headpin - much like the Ostrogoths who
sacked Rome in 476 AD and thus ended the Roman Empire in the West,
The Citigroup rescue was as unexpected as a hard Saturday night partier who
calls in sick on Monday - like so many other weekends this year, the 76%
decline in the value of Citi's stock just from November 1 to 21 guaranteed that
here would be yet another weekend during which America's financial mandarins
would spend with their coffee service instead of their families.
Citi's Monday bailout carried a headline number of the potential cost to the US
government - more than $300 billion; on Tuesday, the US Treasury and Federal
Reserve played "Can You Top This" with an announcement of two new emergency
Federal Reserve lending facilities, $800 billion in total, to supply the
capital to the financial markets that private interests currently are both
unwilling and unable to provide. One, the Term Asset-Backed Securities Loan
Facility (TALF), would, with a $20 billion kicker from the Troubled Asset
Relief Program (TARP), the Treasury's now bottomless bucket of bucks, finance
up to $200 billion in consumer and small-business asset-backed securities (ABS)
that previously nobody had been willing to touch with a 10-foot pole in the
absence of any sort of Federal guarantee.
Then, the hundreds of billions of dollars flowing like cheap port in the
gutters outside a homeless shelter, another proposal was announced that day.
This was a $600 billion Federal Reserve initiative to buy mortgage-backed
securities from the portfolios of government-sponsored enterprises Fannie Mae
and Freddie Mac, nationalized in all but name in early September.
The markets' reaction to this $800 billion on Tuesday would have been very
recognizable to poor Fabrizio. When the first of the current series of big
bailouts was announced on September 18, the $700 billion program that we have
come, in all its chameleon-like metamorphoses, to know as the TARP, it caused a
1.5 day, 1,200 point rally in the Dow Jones Industrial Average. Tuesday's
post-TALF rally amounted to a very meager 36 points.
Much like Gina, it seems the government is being called to engage in ever-more
vigorous and extensive endeavors to stimulate the stock market.
With just that day the US auto industry being shown the back of the hand from
both sides of the aisle in its attempt to wrangle a bailout through Congress,
some progressive political observers, most notably Rachel Maddow of Air America
and MSNBC, noted what seemed to them to be a curious incongruity.
With the drowning financial industry being thrown a life preserver and the
equally waterlogged auto industry being thrown an anchor, the determining
factor for receiving the Federal government's blessing and bounty appeared to
be ablution-related - whether you showered in the morning, like a financial
system worker, or whether you did so in the evening, like an autoworker. The
former seem destined for rescue, the latter dammed.
This partisan-based analysis is highly misleading. Citigroup the institution,
the stock, is surviving; Citigroup's employees are not. The financial sector as
a whole has lost 130,000 jobs in two years; that does not include Citi's
announcement of a further 50,000 in cuts on November 17.
It is misleading in other ways; looking deeper, significant peril and perhaps
just a bit of promise can be seen in the current circumstance. The Federal
Reserve announced the TALF in this fashion:
The Federal Reserve Board
on Tuesday announced the creation of the Term Asset-Backed Securities Loan
Facility (TALF), a facility that will help market participants meet the credit
needs of households and small businesses by supporting the issuance of
asset-backed securities (ABS) collateralized by student loans, auto loans,
credit card loans, and loans guaranteed by the Small Business Administration
(SBA) ... New issuance of ABS declined precipitously in September and came to a
halt in October. At the same time, interest rate spreads on AAA-rated tranches
of ABS soared to levels well outside the range of historical experience,
reflecting unusually high risk premiums. The ABS markets historically have
funded a substantial share of consumer credit and SBA-guaranteed small business
loans. Continued disruption of these markets could significantly limit the
availability of credit to households and small businesses and thereby
contribute to further weakening of US economic activity. The TALF is designed
to increase credit availability and support economic activity by facilitating
renewed issuance of consumer and small business ABS at more normal interest
rate spreads.
My wife says that men cook with a different
philosophy than women. If women might tap a pinch of salt into a stew to add
flavor, men think that if one pinch is good, 10 pinches must be 10 times as
good, so out comes a very salty and otherwise spicy, and most likely inedible,
stew.
It's the same with securitization, the modern practice of rolling and bundling
up loan receivables, whether from home mortgages, credit cards or even student
and car loans, into marketable, interest-bearing bond-like securities that
investors looking for higher yields than plain old government bonds might want
to buy.
During the real-estate boom of the first half of this decade, the financial
services industry had so much fun securitizing home mortgage loans, especially
subprime mortgage loans (and setting the world up for the current crisis when
real-estate values inevitably turned down) they came to the conclusion that
anything done well would be done even better if done a whole lot more. In came
debt instruments securitized by car loans, credit-card balances, even student
loans.
It's hard enough to foreclose on a delinquent home mortgage; how do you
repossess a Caribbean cruise or a spree at the mall? How do you repossess a
student loan - attach a tow hook to some delinquent student's brain as he exits
the college library? Thus, when credit and liquidity started to recede out of
the financial system like the departing tide, it was only natural to expect
that eventually this phenomenon, deleveraging, would hit these consumer sectors
as well.
As the Fed said, in September, the securitization in these sectors essentially
ground to a halt; in October, it actually did, with absolutely no - none - nada
- zip - big goose-egg consumer securitization deals being done that month. If
this phenomenon had been allowed to continue and intensify, it would have
eventually resulted in all the trillions of the world's credit cards, even the
ones held by those with perfect credit, coming up "REJECTED" on being run
through cash registers.
It wasn't just that no new consumer sector securitization deals were being
done; the banks also couldn't get the old deals off their books. The culprit
here was the same old devil, the fact that investors at present just do not
want to hold any security, even at riotously high coupon rates, that does not
carry a fairly explicit government, preferably the US government, guarantee.
The flip side of the fact that no securitized consumer loans are moving is the
current rates you get on presumably safe US Treasury Bills - around 0.01%; on
some days, the rate is even negative. In the ever-present financial market
struggle between fear and greed, the fear of private market insolvency and
bankruptcy that is driving investors out of the securitized consumer sector
into those absurdly low Treasury Bill rates is obviously fully carrying the
day.
What the Fed is going to do is to expand its already swollen and stuffed
balance sheet by purchasing $200 billion of the consumer
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