Page 2 of 2 Back to the woodshed By Julian Delasantellis
Contrary to what the media keep saying about the MBSs, and their eternally
damnable illiquidity, occasionally these securities do move in the markets. A
few intrepid hedge funds and private equity shops have picked them up on the
cheap - actually, on the really, really cheap, at rates, say, of between five
and 22 cents on the dollar.
So, there it is, a price that the banks could start to move the MBSs at. But
the last thing that the banks want to do, and the last thing that they have
been doing, is to take 22 cents on the dollar for what might be as little as
the three cents, or as much as 15, on each of the trillion dollars in MBS and
MBS-related assets in their portfolios.
Already, US banks have been forced to acknowledge, in the form
of what are called bank "writedowns", $700 billion in MBS losses from mortgages
that have already gone fetid. Still, the market pricing of what's left at 22
cents of par means that the market thinks that there's still a lot worse to
come. Recently, Goldman Sachs opined that, when all's said and done, the total
hit to the banks will be around $3.5 trillion.
As they say in the lingua franca of the addiction recovery movement,
denial ain't a river in Egypt, and it apparently is not something the banks
want to admit that they're in. You have to assume that, while allowing the MBSs
to stay in their portfolio and eat away at their capital base, the banks
somehow still think that some Moses - be his name in actuality be George Soros,
Warren Buffett or Obama - is going to just wave his mighty staff, part the
mighty waters or financial calamity, and, in doing so, bring the MBSs back to
par.
As things get worse and worse, as the MBSs continue to lose value while the
real estate market continues to erode, the feeling in the executive suites of
America's banks (or, in the case of Merrill Lynch's John Thain - who spent
$35,000 of company money on his French antique office commode - in the
lavatories) continues to be, well, let the next bastard in this job acknowledge
reality and take the hit. Let that poor fellow suffer the indignities that will
follow to his pay packet, to his perks, or in Thain's case, to his privy.
So it's not that the MBS market is illiquid. It's just that the banks are not
willing to sell them at what the market thinks they are worth.
Here is where the US government failed in its responsibility. TARP 1 foundered
on what is delicately called the "pricing issue". The original idea was that
the MBSs would make their way from the banks to the government by using the
TARP's $700 billion to fund some manner of auction of the securities. No way,
said the banks, you take them out at par or near par, or you don't get them.
At par, with the scale of the problem then existent early last autumn (it's
even worse now, as it will be even worse next week or the month after that
without somebody addressing this problem) even $700 billion just would not have
gone that far to address the problem.
But if the MBSs are falling in value, isn't it better to get rid of them cheap
rather than see them fall in value to zero?
The banks are holding out for close to par, or for par itself. But if they
don't get it, if the MBSs continue to decline, just how bad will they be hurt?
The US government, or at least the government in the hands of George W Bush,
made it abundantly clear that, for the sake of "system stability", it would
backstop and bail out any financial supplicant that petitioned them for funds.
Little or nothing would be asked in return - no voting shares in the
institution, no enforceable commitments to engage in new lending, or in Thain's
case, not even a requirement for chief executive officers to use the regular
employee washroom.
The banks were, in essence, allowed to flip a coin and win whatever the outcome
- heads, the MBSs return to par; tails, they don't, and we (the banks) get the
big federal bailout.
In parenting literature, the conservative counter-revolution that followed on
Dr Spock, best illustrated by the corporal-punishment obsessed Reverend James C
Dobson, in 1977's Dare to Discipline, which emphasized that kids should
be raised with rules, structure and discipline. Children should not just expect
a weekly allowance; they must earn it. Here, the analogy is even worse - even
though they've done nothing to earn it, the banks still expect their bailout
allowance, even though, in essence, they've naughtily played with matches and
burned their houses down.
What was really going on was Bush weighing his role in history versus his
ideology, with ideology coming up sadly short. By last year, Bush, watching the
illusory prosperity of his presidency so quickly unraveling, must have seen
that he was in danger of being seen in history as the Herbert Hoover of the
21st century.
Hoover was the US president from 1929-33, in the early days of the Great
Depression, and, up until the conservative movement's recent attempt to send
the actual history of the period straight into George Orwell's memory hole, was
generally blamed for increasing the severity of that downturn through policy
inaction dictated by his idolatrous devotion to free-market, anti-government
intervention ideology.
Does the Obama administration realize the shortcomings of the Paulson approach
and understand the necessity of adding in a few sticks with all the carrots? Or
will The Aggregator be just more of the same, the government saying to the
banks, "I'll be back"; with the banks interpreting that classic line to mean
that it will be back with more hundreds of billions of no-strings-attached
government largesse?
But among all the confusion of the pundits and experts trying to explain the
current crisis to a general population which thinks that all they have to do to
understand modern banking is to see a schematic of an ATM machine, one new idea
is being talked about.
Many of us have had the experience of owning a used car that is breaking down
so frequently, causing so many expensive visits to the repair shop, that one
finally decides to get rid of the vehicle, for it is just not worth it to keep
throwing the good money after the bad needed to keep it running.
Over the past 18 months, America has thrown hundreds of billions on hundreds of
billions just to keep its lemon of a financial system on the road; finally,
there are some indications that the next step may just be to junk the whole
system and start anew.
What if you could just cut the Gordian knot of these problems, of saving a
financial system whose members are doing their very best to hinder all your
efforts to save them, by just nationalizing the whole system, or, at least,
just nationalizing all the MBSs from out of the banks' portfolios?
Of course, with more and more of the current financial system operating under
either an implicit or explicit government guarantee, it's almost as if that's,
albeit in slow motion, what is happening now.
Nationalization advocates are now pointing to the example of Sweden in the
early 1990s, when the government there nationalized the banks, in essence
funding the eventual recovery of the financial system by stripping bank
shareholders, who were not compensated, out the value of their equity
positions.
In his "Interfluidity" blog, Steven Randy Waldman presents an argument arising
out of the Swedish example:
By eliminating private shareholders
entirely, full nationalization permits regulators to "do what needs to be done"
to restructure the firm without having to hew to a fiduciary duty of profit
maximization in designing the new structure. Full nationalization limits the
ability of shareholders to extract windfalls from taxpayers by becoming "too
big or interconnected to fail". Finally, full nationalization makes it possible
to value assets ruthlessly, thereby eliminating market uncertainty about
whether a bank is really fixed. Either to maximize their share of a
recapitalized firm or to maximize the subsidy in a "toxic asset" purchase,
legacy shareholders will always insist on optimistic asset values. But getting
past a banking crisis requires working from an assumption of extremely
pessimistic values.
Nationalization is probably the easiest way
of getting around the MBS pricing conundrum; in hoping for par, the banks will
be forced to settle for zero. Then, any subsequent recovery in MBS values,
through real estate prices rising, or the economy recovering (perhaps because
the MBS are no longer inhibiting lending) would act to add new liquidity to the
system, a clear benefit.
But would it be that easy? The "takings cause" of the Fifth Amendment to the US
constitution prohibits the US government, or any of its branches, from seizing
property without compensation. An expanding body of "private property law" has
interpreted this clause very expansively, and that interpretation is now
frequently being codified into law by the conservative judiciary that has been
seated by presidents Reagan, Bush and Bush.
According to this philosophy, if a zoning requirement prohibits a homeowner
from building a 70-story skyscraper in a residential neighborhood, the
homeowner has been denied the full use of his property and must be compensated.
If something so simple as zoning regulations is now in dispute, it is doubtful
that bank nationalization, in essence, having the government go into the banks'
vaults and remove anything of value, would have all that much smooth sailing,
either.
Also, how would a nationalized bank act? Would it be able to follow its core
function to intermediate between borrowers and lenders for the good of the
economy, or would lending decisions fall victim to partisan political
influence?
Then again, its hard to say the private financial system was being prudent
stewards of banking probity when, just a couple of years ago, it was financing
sea to shining sea of gargantuan McMansions being bought by people with
probably more ability to bunny hop across the English Channel than to pay back
the mortgages.
Although it would probably be unconstitutional, maybe the best thing about
nationalization would be the bankrupting of the shareholders. Maybe if they are
seen to be suffering the harsh discipline of penury and destitution, future
investors will not be so quick to inflate more destructive bubbles by excess
speculation in the financial sector.
I recently saw a chart that illustrated how, even though general US stock
averages recovered to their pre-1929 crash levels by the mid-50s, the shares of
New York banks did not, in inflation-adjusted terms, recover until the early
1970s, even though that intervening, post-war period was a time of significant
US and world prosperity.
Perhaps there's a lesson there. The capitalist system needs a properly
functioning financial system, but never should it be so unregulated, so
undisciplined, that, as is currently happening, its misbehavior endangers the
entire system.
Obama, do not be afraid to "dare to discipline" the financial system. Maybe it
needs to stand in the corner for a while. Maybe it needs a timeout. In the
olden days, before ubiquitous state social workers, the days that conservatives
say they so pine for, we would be saying that the financial system needs a good
long trip to the woodshed.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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