Leave the SIV, take the cannoli

October 16, 2007 4:24 PM

At a time when fed-up American citizens are petitioning Congress to end the imprudent financial practices that caused the housing bubble sub-prime mortgage crisis liquidity crisis impending recession -- including the banning of SIV's and refusing any bailouts for Wall Street, banks, or mortgage companies -- the United States Treasury Department has just announced the creation of a giant-mega-ultra SIV called "M-LEC" made up of assets from several of the largest American banks. Already unofficially nicknamed "Sivie Mae" (or worse, "the Frankenstein Fund"), it would be an off-balance-sheet way for these banks to pool and price the ABCP's that they've lately been having trouble pricing and thus selling -- i.e. the liquidity crisis.

But one financial blogger looks at this odd occurence using the film "The Godfather" as a reference point and concludes that something fishy is going on with Citibank, in particular. Phrases like "smoke and mirrors" and references to deck chairs on the Titanic are being thrown around the blogosphere. The suspicion grows: is the real problem facing these "too big to fail" banks "just" a temporary one of liquidity...or one of solvency? As Don Corleone might say, this wacky pseudo-bailout idea might be an offer that the Treasury Department can't refuse.

posted by Asparagirl (82 comments total)

Woah. You lost me back there around "Frankenstein fund." I was born and raised on Sesame Street and MTV. You're gonna have to ...what were we talking about again?

Ooh! Shiny!! I gotta go okthxby!
posted by ZachsMind at 4:27 PM on October 16, 2007 [1 favorite]

It's amazing how similar this situation is to the plot of Steven Brust's _Orca_ -- only without the killing.
posted by Slothrup at 4:31 PM on October 16, 2007

Don Corleone also said one lawyer with his briefcase can steal more than a hundred men with guns.
posted by Smedleyman at 4:45 PM on October 16, 2007

Isn’t this what they slaughtered the Templars over?

Chancellor: “Look they’ve been using off-balance sheet vehicles to increase their leverage, we’ve lost our liquidity and...”
Villien: “???”
King: “*tsk*...They’re in league with the devil.”
Villien: “Oh! BURN ‘EM!”
King: “Yeah, there ya go.”
posted by Smedleyman at 4:52 PM on October 16, 2007 [1 favorite]

Can someone summarize the post in English, plz? My knowledge of all this is roughly lolcats-level.
posted by Avenger at 4:54 PM on October 16, 2007 [1 favorite]

My knowledge of all this is roughly lolcats-level.

Oh, then you should see this. Especially the comments. But that just covers the consumer-level pain of the situation, which mostly revolves around mortgages and debt; I'll try my hand at the Wall Street side of the thing:

I'm in yr bank, pretending that yr bank isn't really overextended and undercapitalized.

I made a CDO for u, thinking that it would be nice stable income for yr "safe" fund, but the rising foreclosure rate eated it.

Treasury Department Kitteh is having tail pulled by Citibank cat

plz to not be crashin stock market kthxbye.
posted by Asparagirl at 5:12 PM on October 16, 2007 [40 favorites]

Someone might want to call Ghostbusters as well.

Not only are the comments on the forum link tinfoil hat’ish, most of them just expose the posters lack of understanding to begin with.

The Treasury is not behind the fund as it seems you are alluding to, nor are they succumbing to pressure to create a monster. They are facilitating a market process, which by the way, is exactly what you want them to do. The purpose of the fund they are establishing is indeed to bring liquidity to the ABCP market. While it is fashionable to lambaste ABCP, CDO’s, or any other AB security, it should at the very least be done from a point of understanding them and the processes in the markets related to them.

There are risks involved in these types of investments and that is why the vast majority of them were owned by hedge funds.

The point I am getting at is that the truth is never as bad or as good as people are led to believe, and that is why people that understand that will continue to make money off of those that don’t.
posted by preacher at 5:13 PM on October 16, 2007 [5 favorites]

In English: we had a huge property bubble, which is in the process of popping. Many banks will go bankrupt if they are forced to sell the houses they thought were good collateral for the debts.

So they are trying to gang up and game the market, to reinflate the bubble. This will do even more damage to the economy, which has already been fucked up beyond imagination by the easy money since about 1996. Whether or not it will work... over the long term, absolutely not. Over the short term... who knows?

I've been telling people for many years now that we're in dire trouble; you can take this as another data point that I'm right. The banks are panicking. They wouldn't do so if it weren't a big deal.

The whole economy is smoke and mirrors, propped up by that bubble, and as it unwinds, it will bring on the worst economic times in living memory.
posted by Malor at 5:20 PM on October 16, 2007 [2 favorites]

Don Corleone also said one lawyer with his briefcase can steal more than a hundred men with guns.

Yes, as through this world I've wandered
I've seen lots of funny men;
Some will rob you with a six-gun,
And some with a fountain pen.

--Woody Guthrie
posted by Rangeboy at 5:20 PM on October 16, 2007

As I sit here and read these links, I'm struck by the fact that I don't understand any of it. Not even a little bit.

It seems like there comes a point where you aren't dealing with money any more, you are shuffling around potential money, and money "in theory".

It freaks me out that I am so completely ignorant of something so fundamental to our country. And what's worse is that all efforts I've spent to get my head around this kind of thing, only result in me getting more confused.
posted by quin at 5:23 PM on October 16, 2007 [5 favorites]

There certainly are all sorts of Titanic deck-chair shenanigans going on these days as the ship founders and the shit flies. This latest is a little bit beyond my autodidactic small learning to parse out, though. Occasionally the speculation does tend to veer into conspiracy-theory territory, especially on the blogs, but this was a recent post on the yen carry trade (a significant cog in the merry-go-round, od course, which interests me) that I found... somewhat provocative.

Zachsmind and Avenger (on preview, and quin): I used to proudly have the same attitude -- filthy lucre, dismal economics, bah! that stuff's both impenetrable and beneath me! -- but I've spent the last few years trying to learn about it. All I can say is it's time well spent. If I'd actually put down the beer and backpack and done so twenty years ago, I think without pridefulness or exaggeration that I'd be a rich man today. Though this stuff that we're talking about is pretty abstruse, the basics are not, and the basics are all you need to start taking advantage of the fact that most people don't even bother to learn the basics, and while the system is set up to screw, blue and tattoo us normal folks, there are legal, ethical ways to work the system and emancipate yourself from wage slavery.

On preview, what preacher said in his last sentence, there, but expanded to 'people that understand the basics of how the Rube Goldberg system works, even a little'.

There are risks involved in these types of investments and that is why the vast majority of them were owned by hedge funds.

Correct me if I'm wrong (please do -- like I said, I'm trying to be a good student of this stuff), but wasn't the blithe misrepresentation of risk in the CDOs that packaged up often-bogus, unrecoverable mortgage debt part of the problem recently? Bad mortgages were sliced and diced and packaged up, sold onwards and represented as AAA low risk would buy from this seller again!!!1!, when in fact they had a significant component of subprime ARM candystore high-risk bad debt, yeah? So risk management by banks and others seems to have failed along with a whole bunch of other things in the process.
posted by stavrosthewonderchicken at 5:27 PM on October 16, 2007 [2 favorites]

Asparagirl, I don't even like the lolcats stuff anymore (dead horse dead horse dead horse) but that was great.
posted by blacklite at 5:36 PM on October 16, 2007

The Treasury is not behind the fund as it seems you are alluding to...

Uh, the New York Times says quite different: "Three of the nation’s largest banks, working together at the behest of the Treasury Department, announced this morning that they were creating a large fund to serve as a buyer of bonds and other debt at a time when many investors are avoiding them...The joint effort is a result of more than a month of negotiations between bankers and government officials in Washington and New York." This is, I'm sure I don't need to remind you, totally unprecedented.

nor are they succumbing to pressure to create a monster.

Really? Cause I'm reminded of that scene in "Blazing Saddles" where Sheriff Bart holds a gun to his own head and threatens to shoot if any townspeople come near him, with the end result that the formerly-hostile townspeople suddenly want to help him out. Only here Bart is Citibank (and possibly others) saying it to the Treasury Department, and the bullets are an inability to pay Citibank's creditors and (maybe) depositors.

They are facilitating a market process, which by the way, is exactly what you want them to do.

Funny, I thought the market was supposed to do just that. Why can't the banks and hedge funds just sell their ABCP's on the open market? Oh, because they don't like the bids coming in for the stuff -- because people have wised up that this paper is backed by mortgages that are quickly going under. The banks say there's illiquidity because there are "no" bids and things are pretty locked up, but I think we both know that's unlikely -- they mean that they don't like any of the bids coming in, that they think the bids are way too low, and so they wouldn't stoop to sell at that price -- especially because that would start the fire sale and have everyone else rush in to sell too before the paper is truly worth nothing.

Come to think of it, that's kind of like what some would-be home-sellers are doing in places where they don't think they're getting a fair-market (i.e. hugely over-priced in the past 3-4 years) bid for their home. They would rather keep their pride and pull their home off the market, or try some shady cash-back "incentives" for people to buy the house, then bite the bullet, drop the price, and actually sell. In the end they, too, are only hurting themselves and extending the pain.
posted by Asparagirl at 5:36 PM on October 16, 2007 [5 favorites]

(Also, thank you so much for that Nihon Cassandra link, Asparagirl. You would not believe how practically useful it is for me at the moment.)
posted by stavrosthewonderchicken at 5:37 PM on October 16, 2007

This is, I'm sure I don't need to remind you, totally unprecedented.

Only very literally true. Looks a goodly bit like the LTCM rescue to me.
posted by Kwantsar at 5:43 PM on October 16, 2007

The Treasury is not behind the fund in the sense they are bankrolling it or using government money to get the banks out of debt. My understanding is they are facilitating the process of getting the banks together to form the fund, somewhat like what they did very quickly when Long Term Capital Management was imploding in 1997. Some people, not necessarily you, I don't know, are tending to conflate the two. But then again, a lot of this is beyond my ken, so someone correct me if I am wrong.
posted by Falconetti at 5:45 PM on October 16, 2007

fave comment in that lolcats link:

"i can has re-fi?"
posted by quonsar at 5:51 PM on October 16, 2007

The thing to remember is that LTCM was bailed out in 1988 by the New York branch of the Federal Reserve -- which despite its nice name is, remember, technically an independent and private group and not actually part of the US government like the way the Treasury Department is. Quick run-down:

1907: J.P. Morgan (the man, not the company) steps in and helps single-handedly sort out companies who were about to go down with the "Panic of 1907". He saves the day, and the US economy, but to make sure something like this never happens again...

1913: The Federal Reserve is created -- the Ex-lax of the financial industry, created by bankers to help keep things moving in times of crisis, a la J.P. Morgan's rescue back in '07.

1988: LTCM rescue orchestrated by the New York branch of the Federal Reserve, which is in itself pretty damn unusual. They don't often choose to use their superpowers like that.

late 2007: This M-LEC creation is unprecedented because it literally is the US government -- not a private group! -- trying to get everyone around a conference table and start moving paper around and adding money and trying to unwind the mess in a slowed-down way -- but possibly just making it all so much worse. I don't think I like the government doing that; it's creepy.

So, the Treasury Department may currently be modeling its actions on the Fed's steadying actions from twenty years ago, but this is technically a whole new ballpark.
posted by Asparagirl at 6:00 PM on October 16, 2007 [4 favorites]

The banks say there's illiquidity because there are "no" bids and things are pretty locked up, but I think we both know that's unlikely -- they mean that they don't like any of the bids coming in, that they think the bids are way too low, and so they wouldn't stoop to sell at that price

You know, I agree with you broadly (and my laissez-faire cred is as good as anyone's), but this fearmongering is a bit much. Structured finance is complicated, credit markets get a bit nasty when they seize, Chuck Prince is a bit shady, and the paper probably isn't worth what Citi hopes it is. None of this means that much of the paper in question is worthless, or that it will be subject to fire sales.

All the market really needs is some time for Ken Griffin and his ilk to perform the necessary due diligence, after which liquidity will slowly return. Markets underprice risk, then they overcorrect. Thus it shall always be.
posted by Kwantsar at 6:04 PM on October 16, 2007 [1 favorite]

Here's what you need to understand.

There was a housing bubble in which idiots like Casey Serrin and greedy dummies were able to buy houses that no responsible prudent person would approach without a dual-anesthesiologist income family situation. These people took mortgages, and home equity lines which funny terms like "interest-only" and "two-year ARM" and giggled because it just meant they could finally put that Sub-Zero fridge into their new McMansion, confident that in the future everything would be okay because "houses all go up".

Also, there were mortgage lenders scouring the countryside for these idiots to put them into the houses. They may have been unscrupulous. Or just good salesmen. Whatever. It reached a crescendo in 2005. Then the fed started jacking up interest rates.

So the crap mortgages got taken, and because no financial person in their right mind wants to hold onto these dogshit loans that everyone knows is going to detonate in 2007 (they were 'two-year' ARMs, remember), they treid to resell them. But dogshit paper is dogshit paper, so they had to roll them up with better loans, sort of averaging out the risk of the package to something that looked pretty good.

And pretty good is gold for a hedge fund who's mantra is manage risk. Bank of America or Citi rolls out one of these things with a nice yeild and moderate risk, and everythign golden.

Or not.

2007 rolls around, and surprise surprise, Casey Serrin loses his house. Sorry, his houses, because he's got like seven of them. So foreclosures and mortgage defaults start building. Uh oh. All those loan packages the hedge funds have (don't worry about the lingo) are starting to explode. Did we say it had an A- rating? Ha ha ha silly us. We meant it had a fuck you rating.

But no one really knows what they have, because everythings rolled up into these packages, and the data on what's in there is 6 months old. When foreclosures are increasing 25% per quarter, six months data is ancient history. So you've got hedge funds who have these packages and no one knows what their worth because they all carry some radioactive payload.

I'm sorry, actually we know exactly what they are worth. They are wroth nothing, because nobody is going to buy them. Well no American. The Europeans ate this stuff up. I mean this literally by the way. The market for these things completely shut down.

But it gets so much better. See some of these hedge funds are actualyl operated by computers that sift through data, plug it into a model, and make trades. billions of dollars worth of trades. These quant funds stroll into August with their six month old ancient history data, and they starting buying up housing stocks and mortgage company stocks and all the toxic stocks that humans ran from sending them down 50% in the first place. But to a computer, these are good buys. So while some hedge funds are trying to figure out how much garbage they have, other hedge funds are accumulating more garbage.

So the banks freak out and the margin calls and the excuses start, but above all no one lends anyone a dime, because no one really knows what kind of collateral they're going to get.

This is the interesting bit. Unbeknownst to all of us, some of these banks were pretty darn clever, and managed to unload most of their crap in July, lock down their hedge funds in August, and get ready for the rebound. What they know is that turmoil = volume, and that the US government is never going to let homeowners lose their houses. They know the Fed is coming to the rescue, they just need to line up their shot.

So what's the aftermath? Goldman Sachs goes from $170 to $230 inside of a month, and it's shooting for 300. Goldman Sachs are the clever guys. Bank of America extends a near-death mortgage company a line of credit with more conditions on it than the contract Faust signed. Because now they will know exactly how much is good and how much is crap, and information is second only to time in value.

But poor citigroup doesn't have a clue. It's run by a regulator who was only appointed to clean up an earlier mess, and they're reluctant to fire him. So now Citigroup is crap, and Goldman shines.

And the winners magnanimously offer a hand to the losers, and agree to participate in this fund.

Because they'll get access to more information, they'll know which banks are good banks and brokerages saddled with crappy mortgage units and crappy loans, and which are jsut crappy banks.

And then, in the grand tradition of Wall Street, the winners will eat the losers. There will be mergers, consolidation, and more money than they'll know what to do with.
posted by Pastabagel at 6:07 PM on October 16, 2007 [33 favorites]

I'm no financial expert, but here's my layman's take on it - please correct any mistakes if you know better! (on preview, a lot of this has already been said, but I spent a while writing it so i'm just go ahead, post it, and get torn to pieces)

You take out a mortgage, by borrowing money from a mortgage company then buying an asset - a house - with it. Clever people figured they could do the same thing with your mortgage. They borrow money cheaply* from various sources, and use it to buy assets - your mortgage payments, credit card payments etc, which they then loan out again, at a higher rate than they pay to buy it in the first place. In effect, your debt, or rather your promise to pay it back is another asset to be sold on to someone else. A fund doing this is a CDO or SIV.

The thing is, investors don't directly buy your mortgage. The SIV buys your mortgage payments (sort of), then earns its cut by getting others to invest in them, by slicing their asset-backed-securities into different levels of risk, over different timeframes. The higher the risk of the 'asset' repayments (i.e. you) not actually keeping coming, the greater the rate of return.

The SIVs and CDOs are middlemen between actual lenders to real people for real assets, and the banks and investors who just want a defined risk and rate of return to put money into and get interest (profit) back out of.

The problem is, everybody got greedy. SIVs and CDOs would keep buying up the promises of loan repayments, regardless of how high risk the guy they lent the mortgage to was. It just got mixed up, stamped with a risk-grade with a bunch of others (and low-and high risk mixed together, and called low risk in some cases), and pimped out to investors, pension funds and banks as a high-profit investment. The mortgage companies make ever bigger loans at higher interest rates, the houses keep going up in price because there's not enough of them to meet demand, and hey, you just take out a bigger more expensive mortgage.

* That cheap money has to come from somewhere. It comes from banks, and is known as commercial paper. It's cheap, short term borrowing. I believe the yen-carry-trade was the same trick. Very low interest yen could be bought, used to buy something worth a higher interest rate, then sold back later when the asset-backed-security it was used to buy was sold on again - with the trader pocketing the profit in the difference between the interest rates.

This is good in a way, because it gives the credit card companies and mortgages money to lend out to customers. As long as the mortgages are paid, everybody wins. The SIV uses the money it got from the investors to pay back its initial cheap borrowing (commercial paper), takes a profit chunk itself, and then borrows more cheap money and starts all over. The investors get a good rate of return on their money, which keeps the people that fund them happy.

Then the housing market crashed, partly due to interest rate rises making mortgages finally unaffordable. Bunch of mortgages stopped getting paid. Those asset backed securities that everybody was investing in via the SIV and CDO and getting high rates of returns on? quite possibly worthless. But nobody really knows until they try to sell it.Banks don't want to find out, so they stopped lending cheap money they might not get back again. Thus the liquidity crisis; nobody lending any money to each other in the short-term. This has a big impact on a bunch of other operations. Northern Rock was badly damaged because they had to go cap in hand to the Bank of England to borrow cash at a punitive interest rate to fund their day-to-day business. They had plenty of assets, just no cash, or way to borrow it. People panicked, pulled out their savings, and a perfectly solvent bank on a normal day is now significantly worse off.

No short-term cheap money? No way to buy asset-backed-securities, and mortgage companies not only have bad debt on their books, with the assets (house) backing them worth less than the mortgage in a falling price market, but nobody buying the repayments-as-assets means they also start getting cash strapped for new mortgages.

So now loads of people are holding investments in asset-backed-debts that could quite easily turn out to be worthless. Nobody is lending short-term cash to anybody else, and the bottom has dropped out of the housing and mortgage market. This also causes problems for other businesses, and with general economic malaise job-losses get worse, which is partly what caused the housing price crash in the first place. People lose their jobs, stop paying their mortgage, and the whole thing gets worse.

One way out (temporarily) is basically for the government to print money and lend it out cheaply to the banks to keep the whole thing rolling. The thing is, eventually the piper has to be paid, and these worthless investments in SIVs and CDOs will have to be sold at their real price. That will cause a lot of banks to lose a lot of money overnight, which hits stock prices, which hits pensions and other investors, businesses go bankrupt, and it all just gets worse.

The problem is, instead of taking a hit, and letting the markets re-adjust to more sane levels of debt and risk - and letting the businesses who invested poorly take the hit, as a chunk of their supposed investment assets get adjusted to near-0 value - the US federal reserve, and to an extent the EU central bank are trying to prop the whole thing up, presumbly hoping it will all go away.

This frankenstein fund is another way out. A few big banks buys all those bad investments directly, all those dodgy high-risk, and now probably worthless asset-backed-securities, and puts them in a giant box and closes the lid. The government then has a load of assets on paper, which it paid good money for, and the companies get rid of it and can resume normal operations as they can trust their partner will still be solvent next week. What happens to the fund later, with all the worthless asset investments and a whole bunch of government money used to pay for them is a good question...
posted by ArkhanJG at 6:11 PM on October 16, 2007 [3 favorites]

Correct me if I'm wrong (please do -- like I said, I'm trying to be a good student of this stuff), but wasn't the blithe misrepresentation of risk in the CDOs that packaged up often-bogus, unrecoverable mortgage debt part of the problem recently?

I don't know if there was truly misrepresentation of the risks of CDOs--every CDO prospectus I've ever seen gives a pretty clear picture of the underlying assets (ARM vs. fixed, FICOs, loan-to-value ratios, owner vs. investor/vacation properties, etc). The problem is that the buyers remained naively optimistic about the real estate bubble and Wall Street, always happy to earn a fee, kept pushing new issues down the pipe. And, of course, the buyers are actually large funds of capital managed by employees who earn a fee on short-term performance. Like most bubbles of recent times, at the root of it is an agency problem--long-term investors hiring managers and intermediaries that are motivated by short-term fee opportunities (e.g., university endowments giving money to the hot shot hedge fund manager or Wall Street banks being run by bonus-happy bankers who leave their shareholders with the long-term pain).

the bullets are an inability to pay Citibank's creditors and (maybe) depositors.

Oh please, your FPPs are pretty good until you insert this sort of speculation. This more about Citi hoping to avoid more asset writes downs and the reshuffling that it would need undertake to meet regulatory requirements if it moved all its ABCPs on balance sheet. The downside is another multi-billion dollar write-down and more drag on Citigroup's languishing stock price (which would probably cost Prince his job, which is silver lining if you're a C shareholder). That's a far cry from regular bank deposits being in danger.

As for MLEC, I guess I'm on the fence, but what's good for me may not be good for the average mefite.
posted by mullacc at 6:15 PM on October 16, 2007

The problem is that the buyers remained naively optimistic about the real estate bubble and Wall Street, always happy to earn a fee, kept pushing new issues down the pipe.

Thanks, you're right, that's a better (and less slanderous) way to put it.

God, I love the 'filter. Thanks to everyone so far who's taken the time to lay all this stuff out for us.
posted by stavrosthewonderchicken at 6:18 PM on October 16, 2007

Sorry, I failed to fully fix my last paragraph. For 'government money' read 'big bank money'. I presume they think will make more money from getting liquidity working again, than they will lose in the short term on the currently worthless or near worthless asset-backed-securities, or that once the merry-go-round gets going again, they can resell them later at a profit. This is why I'm no banker:)
posted by ArkhanJG at 6:20 PM on October 16, 2007

This more is about

Whoops. And by "this", I mean Citi's keen interest in seeing MLEC happen.
posted by mullacc at 6:22 PM on October 16, 2007

This Washington Post article/column also breaks down the issues pretty well for a lay-person.
posted by inigo2 at 6:26 PM on October 16, 2007

Here's a pretty neat 'Subprime Tidal Wave' interactive graphical thingy from the Wall Street Journal, for those of you who are more visually-oriented.
posted by stavrosthewonderchicken at 6:27 PM on October 16, 2007

Correct me if I'm wrong (please do -- like I said, I'm trying to be a good student of this stuff), but wasn't the blithe misrepresentation of risk in the CDOs that packaged up often-bogus, unrecoverable mortgage debt part of the problem recently?

I'm correcting you where you're wrong. First, the mortgage debt is "recoverable," in that the loans are collateralized. The quality of the collateral is at issue, as:
1. Housing prices have contracted
2. LTVs were a bit ambitious
3. Some appraisal fraud occurred

Now, 1 and 2 are broadly covered by PMI in the vast majority of mortgages, and 3, while it makes for good anecdotes, is for the most part rare. Real estate workouts are complicated, but defaulted mortgages are mostly "recoverable."

Bad mortgages were sliced and diced and packaged up, sold onwards and represented as AAA low risk would buy from this seller again!!!1!, when in fact they had a significant component of subprime ARM candystore high-risk bad debt, yeah?

Well, not exactly, no. The purpose of the CDO is largely regulatory arbitrage-- that is, reconfiguring debt obligations so the new structure offers a better ratings profile. So there is something very unseemly about the whole thing, but you're wrong to attack the senior (AAA) tranches like you are, and you're wrong to point the finger squarely at the banks. The vast majority of AAA tranches are still safe, safe, safe. Remember that a typical CLO will offer a 10-40% buffer before AAA will get attached, and that 10-40% must be totally lost. So in a simple example where the whole thing consists of corporate bonds, not only do you need to incur defaults, you also need to multiply the defaulted principal times (1 - recovery rate) to get the loss to the vehicle as a whole.

You're wrong to look only at the banks because, first of all, CLOs are complicated as anyone who buys them should know. They're priced off of all sorts of weird stuff-- DV01's, hazard rates, correlation assumptions, etc..

No one who bought a 6% AAA CDO when the treasury of the same tenor was yielding 5% had any right whatsoever to think that they were buying a totally safe investment. Have you ever read CDO docs?

So risk management by banks and others seems to have failed along with a whole bunch of other things in the process.

Mostly true, but still a bit of hand-wringing. Much of what the financial system does is transfer and price risk. Assessing risk is a probabilistic exercise. Things blow up sometimes.
posted by Kwantsar at 6:29 PM on October 16, 2007 [3 favorites]

So the crap mortgages got taken, and because no financial person in their right mind wants to hold onto these dogshit loans that everyone knows is going to detonate in 2007 (they were 'two-year' ARMs, remember), they treid to resell them. But dogshit paper is dogshit paper, so they had to roll them up with better loans, sort of averaging out the risk of the package to something that looked pretty good.

But people buy (dogshit) C-rated corporate paper for 60 cents on the dollar all of the time! There is no such thing as bad paper, only bad prices! You're missing the regulatory arbitrage concept.(pdf)
posted by Kwantsar at 6:34 PM on October 16, 2007 [1 favorite]

“The point I am getting at is that the truth is never as bad or as good as people are led to believe”

Yeah. How’s that working out for you ?
posted by Smedleyman at 6:35 PM on October 16, 2007

Thanks, Kwantsar.
posted by stavrosthewonderchicken at 6:36 PM on October 16, 2007

Stavrosthewonderchicken, you are restating what I just said with more words, so I am not sure what you point is.

Asparagirl

Funny, I thought the market was supposed to do just that.

You might what to take a look at what the Fed and the Treasury actually do. Your statement is either incredibly naive or misinformed.

Kwantsar. Thank you for saving me the time of having to type that out, and that is why those that sell these securities below their recoverable value will end up making a mint for the people that buy them.
posted by preacher at 6:39 PM on October 16, 2007

Oh please, your FPPs are pretty good until you insert this sort of speculation. This more about Citi hoping to avoid more asset writes downs and the reshuffling that it would need undertake to meet regulatory requirements if it moved all its ABCPs on balance sheet.

Okay, so maybe that was a little over the top -- but I'm hardly the only one worried about the "solvency" issue. See this comment from one of the blogs linked above, for example -- I have to trust his math without checking it, but assuming that it's correct, I thought he had some good and worrisome points to make.

As for MLEC, I guess I'm on the fence, but what's good for me may not be good for the average mefite.

Yeah, you're saying one should perhaps only be concerned if one is a Citibank stockholder, but some of us are instead Citibank customers, and that does tend to influence our concerns a bit. :-)
posted by Asparagirl at 6:40 PM on October 16, 2007

It seems like there comes a point where you aren't dealing with money any more, you are shuffling around potential money, and money "in theory".

It freaks me out that I am so completely ignorant of something so fundamental to our country. And what's worse is that all efforts I've spent to get my head around this kind of thing, only result in me getting more confused.

Welcome to the club, quin. The thing is, the Fed doesn't even really understand what's going on. Instead of saying, "Hey, something's wrong, stock prices shouldn't be doing this," they desperately tried to reinflate the market bubble. Back in 2001-2003, instead of studying why asset prices went to 100, but then the market (more) correctly valued them at 40 just two years later.... they focused instead on getting those damn prices back to 100. And in so doing, they inflated the housing and debt bubbles, which are now deflating in turn, but the system is tremendously more fragile after another five years of wild systemic excess.

House prices should not go up 20% every year for a decade. That's an insane level of inflation. It just happens to be popular. People love it and want as much as they can get... but like all inflation, it damages the economy. Combine that with historically unprecedented interest rates (actually under the TRUE rate of inflation; the government figures on that are utterly bogus), and you get a wild debt bubble to drive the property bubble. In real terms, money has been almost free, or even to the point that the government will pay you to take loans. (the official figures don't show this much inflation, but look up 'hedonic inflators' for an idea of just how bogus those numbers are. Short form: they have an amazing number of ways of ignoring price increases, which they don't like, while including price declines... even after ignoring a prior increase. Magically, it doesn't count on the way up, but then counts on the way back down again. )

Those bubbles are starting to unwind, so they're now being forced into turning a lot of the 'notional' debt dollars into real ones...which will then be magnified by the system into even more vaguely-sorta-kinda-moneyish things that will drive prices ever higher. It probably won't be HOUSE prices, but that money will go somewhere and will send prices in that thing or class of things skyrocketing.

The Fed and the government aren't willing to accept the pain of prices readjusting to sane levels. This move is another signal that they are willing to destroy the dollar to prevent a debt deflation.

If this happens, if they succeed at sparking an inflation instead of a deflation (which isn't guaranteed by any means, but is pretty likely), this will also see the end of the American Empire. Over the long span of history, empires rise and fall with their currencies.

kwantsar says: "Things blow up sometimes."

No, actually, in a sane system that's not smoke, mirrors, and lies, they really don't. You get recessions and cycles, but actual blowups are exceedingly rare. It's not normal to lurch from crisis to crisis to crisis. It's not normal to have whole countries melt down from currency problems, like Mexico, and Argentina, and Turkey. These are all symptoms of a profound disorder at the heart of the global economic system: fake dollars, and the ability to magically make more anytime we want. It means we never need discipline; if the market starts signaling pain, we just inject some nice morphine/cash to make it allllll better.

But it's not better; it means we never adjust to anything. And eventually, the morphine will kill us.
posted by Malor at 6:43 PM on October 16, 2007 [3 favorites]

They borrow money cheaply* from various sources, and use it to buy assets - your mortgage payments, credit card payments etc, which they then loan out again, at a higher rate than they pay to buy it in the first place. In effect, your debt, or rather your promise to pay it back is another asset to be sold on to someone else. A fund doing this is a CDO or SIV.

But, really, you've more or less described how a bank in a fractional-reserve system works, too.

* That cheap money has to come from somewhere. It comes from banks, and is known as commercial paper. It's cheap, short term borrowing. I believe the yen-carry-trade was the same trick. Very low interest yen could be bought, used to buy something worth a higher interest rate, then sold back later when the asset-backed-security it was used to buy was sold on again - with the trader pocketing the profit in the difference between the interest rates.

Backwards. The yen is borrowed (at a low Yen rate of interest), then sold/swapped for dollars (usually Aussie or NZ) or Króna or the like. This usually works (maybe contrary to covered interest parity theories aka International Finance 101) but is a classic example of a mode-mean trade.
posted by Kwantsar at 6:44 PM on October 16, 2007

Have you ever read CDO docs?

Nope. I'm still a minor-league dilettante in all this.

Real estate workouts are complicated, but defaulted mortgages are mostly "recoverable."

I had been thinking (muzzily, granted) that we saw a) a surge of ARM mortgages given to a (relatively, recently speaking) large number of people who were unable to repay (through the kind of shellgame salesmanship Pastabagel was talking about, and through things like no-income-statement loans), b) an awful lot of those homes being bought were significantly-to-wildly overpriced depending on region, given historical real estate appreciation trends, c) somewhere around half of new homes being bought in 2004/5 being 'second homes' (for speculative purposes or whatever) and that a collapse in housing prices could end up meaning a perfect storm that would literally mean that a significant percentage of those loans, on the ground, would literally be unrecoverable as interest rates rose, businesses dependant on the housing boom wents tits-up, people went bankrupt or at least curtailed their consumer-spending because there was just no money left, the economy slowed, the Fed became less willing to lower rates again and inflation got out of control, and it all went kablooie....

I'm still on training wheels with this stuff to an extent, though, and I may be using words with very specific meanings to a pro in ways that aren't accurate.

Stavrosthewonderchicken, you are restating what I just said with more words, so I am not sure what your point is.

I was agreeing with you!
posted by stavrosthewonderchicken at 6:48 PM on October 16, 2007

The suspicion grows: is the real problem facing these "too big to fail" banks "just" a temporary one of liquidity...or one of solvency?

The USA's gold reserves represent about 0.002% of fiat money, if I'm using my terms correctly.

Basically, for each buck of gold there is about fifty thousand dollars of fiat currency.

Solvency? No bank is solvent.
posted by five fresh fish at 6:50 PM on October 16, 2007

No, actually, in a sane system that's not smoke, mirrors, and lies, they really don't. You get recessions and cycles, but actual blowups are exceedingly rare... if the market starts signaling pain, we just inject some nice morphine/cash to make it allllll better.

Hey, man, you wanna rally against fiat money, I'm right beside you. I'm sure that we'll be lonely, but what the hell. I'll even agree that the bareknuckles creative destruction we'd see in Malor's ideal economy would be far preferable to the monetary purgatory of the past forty years. But I don't see how you can believe that we wouldn't have some fierce, fierce market events in any conceivable economic system.

And, mullacc, your agency cost post is a home run.
posted by Kwantsar at 6:56 PM on October 16, 2007 [1 favorite]

Pastabagel: There was a housing bubble in which idiots like Casey Serrin and greedy dummies were able to buy houses that no responsible prudent person would approach without a dual-anesthesiologist income family situation.

Would it not be more fair to say there were idiots like [name bank here] who encouraged high-risk loan-taking? Why the hell were your lenders failing to do due diligence? WTF made them think an unemployed idiot could pay for a million-dollar home?

IMO the lenders are, more than the borrowers, responsible for this meltdown. Greedy people figured they could get rich lending money to paupers and cons. They got burned, wholly predictably.
posted by five fresh fish at 7:00 PM on October 16, 2007 [1 favorite]

stavros, everything you wrote there is true, and likelier (due to sticky prices and 90% LTVs) to happen with real estate than with just about any other asset, but I think you underestimate the dynamism of the global economy.
posted by Kwantsar at 7:01 PM on October 16, 2007

But people buy (dogshit) C-rated corporate paper for 60 cents on the dollar all of the time! There is no such thing as bad paper, only bad prices! You're missing the regulatory arbitrage concept.(pdf)
posted by Kwantsar at 9:34 PM on October 16

The difference is that the paper was worth nothing because (a) it contained a numberr of loans for which the borrower would have every incentive to default on an no incentive to pay (rapidly increasing foreclosure risk in an already declining housing market) and (b) for a time no one was buying them, so the value was in effect zero.

The problem became worse when banks could no longer receive interbank loans because the CDO's they put up as collateral in the past were no longer acceptable - what is the value of something that is worthless as collateral.

The credit infusions corrected this acute, short term problem, but now we have another - markets flooded with money, and a fed that is cutting rates right when the economy can afford the inflation the least.
posted by Pastabagel at 7:05 PM on October 16, 2007

Would it not be more fair to say there were idiots like [name bank here] who encouraged high-risk loan-taking? Why the hell were your lenders failing to do due diligence? WTF made them think an unemployed idiot could pay for a million-dollar home?

Because banks don't have to hold the risk, they can manage their risk, etc. They have ten thousand mortgages, you have one house. It's not the banks job to tell me what risk I can and can't handle.
posted by Pastabagel at 7:08 PM on October 16, 2007

The problem is that nobody wants to buy ABCP because nobody knows what the underlying asset-backed securities are worth, so everyone is pessimistically estimating $0. Well, that's not any more correct than the earlier optimism was, so the MLEC is supposed to re-create a market for the higher-quality securities with the idea that the junk will fall out and we'll know what the damage is.

Right now, nobody wants to buy anything, and financial institutions that would actually be fine if their assets were correctly priced are in trouble.
posted by Mr. President Dr. Steve Elvis America at 7:13 PM on October 16, 2007 [1 favorite]

WTF made them think an unemployed idiot could pay for a million-dollar home?

I think it got to a situation where that frequently wasn't actually much of a consideration in making loans, if I understand things correctly.
posted by stavrosthewonderchicken at 7:14 PM on October 16, 2007

You get recessions and cycles, but actual blowups are exceedingly rare... if the market starts signaling pain, we just inject some nice morphine/cash to make it allllll better.

Hey, man, you wanna rally against fiat money, I'm right beside you.

Guys, google "Panic of" The system used to blow up constantly.

And do you really want commodity backed currency? Wouldn't that simply shift all of the economic power in to the world to that handful of companies that mine this stuff?
posted by Pastabagel at 7:16 PM on October 16, 2007 [1 favorite]

It's not the banks job to tell me what risk I can and can't handle.

Eh? It's the lender's job to manage its risk. They're not obligated to loan you money. I can not figure out why the lenders would ignore their risk calculations and give money to people who were almost certain to default.

It's a pretty scary thing: even the longest-term institutions are excessively focused on short-term gains. It is leading to plain ol' crazy thinking.
posted by five fresh fish at 7:25 PM on October 16, 2007 [1 favorite]

Yes....in the 1800s, when the economy was very small. The last 'panic of' was 1907.

Small economies are unstable. Large ones, in general, are not.

And, if you'll note, none of those 'Panic Ofs' were really that big a deal, over the long haul. Only the Great Depression was truly major -- and that resulted from prior monetary mismanagement and a stock market bubble. 1929 parallels 2000 in many ways; the major difference being that the Fed went all-out with money-printing in 2000, which wasn't an option in 1929. I think, ultimately, we will find that 1929 would have been the preferable outcome.

And do you really want commodity backed currency? Wouldn't that simply shift all of the economic power in to the world to that handful of companies that mine this stuff?

It strikes me that this insane financial system we've arrived at, which is sucking the life out of the real economy, would not be possible if we couldn't wave more dollars into circulation at will.

I don't know what the commodity would need to be, but I think we need something.
posted by Malor at 7:27 PM on October 16, 2007

Wouldn't a commodity-backed currency constrain a "real" economy? Wouldn't the supply of the commodity limit real growth?
posted by Mr. President Dr. Steve Elvis America at 7:39 PM on October 16, 2007

Yes....in the 1800s, when the economy was very small. The last 'panic of' was 1907

Because we changed the name from "panic" to depression. Then recession. Then correction. And those panics triggered multi-year depressions. The system finally broke in the 30's, and only the war got us out of it.

And people starved, froze, and died in the depression's crippling poverty. The system as it exists now is designed to prevent that from ever happening again, and it has been remarkably successful.

It strikes me that this insane financial system we've arrived at, which is sucking the life out of the real economy, would not be possible if we couldn't wave more dollars into circulation at will.

And yet we can wave more people into existence with no problem at all.
posted by Pastabagel at 7:41 PM on October 16, 2007 [2 favorites]

So you've got hedge funds who have these packages and no one knows what their worth because they all carry some radioactive payload.

I'm sorry, actually we know exactly what they are worth. They are wroth nothing, because nobody is going to buy them.

Great post.

Objectively, though, they're not worth nothing; if M-LEC buys them at a price closer to their true value than what spooked investors are willing to pay, good for them: it will have propped the whole thing up, and eventually the mess will go away.

On preview: MPDSEA got it.
posted by magic curl at 7:54 PM on October 16, 2007

When I wrote "they are worth nothing" that was intended to mean, at the time of the crisis, i.e. August 2007, no one would buy them. This fund will restart this market (that has already restarted since August). The short term crisis has passed. Now we have to prepare for the long term one.
posted by Pastabagel at 8:23 PM on October 16, 2007

Stavrosthewonderchicken

I was agreeing with you!

My bad. Like I said, I was not sure what you were getting at, but your response had some major flaws.

Pastabagel

I'm sorry, actually we know exactly what they are worth. They are wroth nothing, because nobody is going to buy them.

You could not be more wrong. Lots of investors will buy them and make substantial money off doing so. They will only buy them at enough of a discount where they can get an excellent return on them.
posted by preacher at 8:25 PM on October 16, 2007

Pastabagel

The system as it exists now is designed to prevent that from ever happening again, and it has been remarkably successful.

Exactly my original point to Asparagirl. The ‘system’ is the Fed and Treasury adjusting rates, performing open market operations, and various other things in order to maintain stability in the system. Throwing stones at the Treasury for facilitating stability in the overall markets is akin to thinking you are a genius because you believe it would ‘much mo’ betta’ to just slide into a depression.
posted by preacher at 8:32 PM on October 16, 2007

I don't know what the commodity would need to be, but I think we need something.
posted by Malor

Chirping crickets! Or how about Oak Leaves.

Reminds me of the tulip craze way back when.
posted by Balisong at 8:39 PM on October 16, 2007

adding to recent activity cos this is great stuff
posted by bonaldi at 8:39 PM on October 16, 2007 [1 favorite]

My bad. Like I said, I was not sure what you were getting at

Well, to be fair, I was just agreeing after preview with your last sentence.

but your response had some major flaws

As I said in that comment and have reiterated throughout this thread, I have been and continue to try to learn about this. If there were major flaws in what I said that haven't been pointed out already, I would ask you to do me a favour and tell me what you reckon they are, if you're so inclined. It would be a great help to me.
posted by stavrosthewonderchicken at 9:30 PM on October 16, 2007

Wouldn't the supply of the commodity limit real growth?

Well, that's arguable. Greenspan argued, many years ago, that it would constrain growth somewhat, but would prevent exactly the kind of bubble and crash we're trying to have now. (he was, and remains, in favor of the gold standard.) My argument would be that REAL growth would be similar; what we wouldn't have is all the FAKE growth, like what's been happening for the last ten years.

Over the last, well, really, about twenty years, the Fed has progressively disconnected the economy from the reality of globalization. Globalization is a powerful deflationary force on labor -- and, as Pastabagel pointed out the last time we talked about this, a likely inflationary force on most raw materials. So we have this wicked cross-current thing going on. Prices shouldn't be at all stable in that kind of an environment; wages should be dropping, and goods should be getting more expensive. That's the reality on the ground.

I don't know if the Fed directly understands this, or just sees the effects in the economy, but they've had us on a strongly inflationary monetary path since about 1996, probably trying to fight off the deflation they see. But the deflation is _real_, and printing money to try to prevent it is like injecting morphine for a broken bone. You can get up and start walking right away, but you haven't dealt with the problem. And we've been getting worse and worse and worse; with the tremendously easy money available, we've run up gigantic debts for non-productive assets. A house is necessary consumption; a giant house is not, and a house that costs you twenty times your yearly wage is not. We can't use the properties to pay off the debt to buy them, and wages haven't come even close to keeping up with house prices. Only the ridiculously easy lending standards have allowed the prices to get so insanely high.

We have, in other words, gone into massive inflation and massive debt at the same time, but we conveniently don't define house pricing as inflation. And we did this, I believe, because we're trying to fight off the reality on the ground; the simple fact that the American worker is not worth a thousand times as much as a Chinese worker, or a hundred times as much as an Indian one. Yes, we're more productive (although the productivity numbers are seriously hoodoo as well), but we're not THAT MUCH more productive.

So, we've completely disconnected from the reality of labor deflation, and have instead gone the other way. For the last twenty years, we should have been sweating and straining and struggling and barely keeping our heads above water, trying to compete with cheap Chinese labor... but we'd be healthy and strong for the struggle. I have no doubt that we could have learned to compete in a financial system that wasn't being centrally managed.

But, at this point, we've loaded up with staggering amounts of debt because of the cheap and easy money available, and our labor is still not worth that much; in fact, it's worth less than it would be if we'd been struggling all these years instead.

We have, basically, been doped up on morphine while our body rotted out from underneath us. We are starting to wake up, and our muscles and skeleton have wasted away from the abuse; we're incredibly weak and flabby from decades of never seeing bad times, ever. And the Chinese are hungry, taut, healthy, and raring to compete. They don't have the skill we do, but they'll work for such a tiny fraction of what we'll work for that it doesn't matter.

We could have gotten used to this slowly, and built strength; instead, we're entirely unable to dig ourselves out of the mess we're in. Everywhere you look, things are wildly out of balance; any one of the problems (consumer debt, government debt, huge trade deficit) would have been a big problem to deal with, but by insulating ourselves from reality, suddenly we have to deal with all of them at once. It didn't have to be this way.

Centrally-managed economies are always bad, whether it's the Fed or the Politburo doing it.
posted by Malor at 9:44 PM on October 16, 2007 [4 favorites]

Basically, for each buck of gold there is about fifty thousand dollars of fiat currency.

Solvency? No bank is solvent.

i think first you'd better ask yourself whether civilization runs on gold or oil

i'm well familiar with what the gold bugs say - but with tens of thousands of dollars for every ounce of gold in existence, one has to ask this - how does one do something as simple as buy a kid a coke and a candy bar with gold based money? gold itself? - you'd need a damn microscope - something like a certificate redeemable in gold by a bank or a government holding a buck in gold for every paper buck?

why you'd have to trust them, first, wouldn't you?

well, do you? - not any more or less than you trust the idea right now that if you get a dollar bill you can get a dollar's worth of stuff somewhere - last time i checked, which was about 11 o clock tonight, it worked well for me

i don't see the difference - and if you're talking about the gold standard, you're going to have to explain what's so special about gold - and why it's more special than the stuff you put in your car, heat your house with or power your factories with (one way or another)
posted by pyramid termite at 9:52 PM on October 16, 2007 [1 favorite]

Chirping crickets! Or how about Oak Leaves.

I saw an interesting idea that we could use pure water as currency, but the side effects of that could be a problem, and, of course, it evaporates. I've seen energy thought of in that sense, but the problem there is that energy at 3pm is worth a lot more than energy at midnight, and it doesn't store well.

Whatever we arrive at, it would need to be not easily destructible, not easily consumed in a way that makes it unrecoverable, and easy to store. It would need to be divisible, and any bit of it needs to be the same as any other bit. That's probably going to be a metal of some kind.

Alternately, if we could work out some way to prevent governments from abusing fiat money, that could work too... but politicians are always, always tempted to meddle with the money supply. They do that even when you HAVE a commodity standard -- but the size of the hole they can dig is constrained more by Mr. Market.

Ludvig von Mises, the father of Austrian economics, was of the opinion that money is just another commodity; it's just the most marketable thing. He believed that managing the money supply was silly, in the same way that managing the soap supply is silly. The reason governments always want to meddle is because it gives them power, not because it's actually necessary.

His prescription would probably be to abolish legal tender laws and let the market figure out what it wanted to use as money, and possibly provide gold and silver coinage as a service. (he also liked metallic money standards.) But I don't know his thinking well enough to be certain, so you'd probably have to check what Rothbard thinks. (Murray Rothbard is probably the leading Austrian-school economist.)

on preview: pyramid termite, I suppose oil could work as money. But it gets consumed and goes away, so that's a problem, and I don't think it lasts that long, just a few years in storage. (hmm, well, crude oil obviously lasts for millions of years, so maybe we could use it as money in crude form.) But not all oil is the same either; light sweet crude is worth more than the kinds with sulfur in them.

Then you say, "well, do you? - not any more or less than you trust the idea right now that if you get a dollar bill you can get a dollar's worth of stuff somewhere - last time i checked, which was about 11 o clock tonight, it worked well for me"

... but what's a dollar worth? It's a guarantee.... of what, exactly? At one time, that dollar was worth 1/35th of an ounce of gold; since 1971, what are you guaranteed in exchange for your dollar?

Modern fiat money isn't an asset in the same way that it was when it was gold-backed. (and, again, it was abused even when it was gold-backed; that's what caused the whole crisis in the 70s, so gold is not a panacea for all things.)

Anyway, a modern dollar isn't an a direct hard asset, it's a claim on future production of the economy. It's a form of debt; the economy owes you something, but exactly what isn't determined until you exchange it. When you hold dollars, you are a creditor of the US, and I would suggest that being a creditor of the United States is an exceptionally poor idea these days.

I've said this many times, but it bears repeating:

U.S. Dollar, n: A politician's promise to pay nothing on demand.
posted by Malor at 10:11 PM on October 16, 2007 [1 favorite]

Or, another way of putting that whole argument: if dollars were real, there's no way we could be running a two billion dollar a day trade deficit with China. As is, we send them two billion a day, they send some back, and keep some... the ones that they keep, we just replace with brand new money, so no signal gets sent to the economy to stop consuming.

With commodity backing, we couldn't handwave dollars into existence. A good chunk of that commodity would end up in China, and we'd be forced to curtail our consumption habit naturally, because we would have to send things to China to get the commodity back before we could buy more stuff.
posted by Malor at 10:48 PM on October 16, 2007

Not having something real backing your currency means trusting your government to not hose the country. I see that as a whole lot more risky than trusting a well-regulated banking system to actually have their claimed reserve cache.
posted by five fresh fish at 10:50 PM on October 16, 2007

pastabagel wrote: And yet we can wave more people into existence with no problem at all.

Actually, that is a problem.
posted by Avenger at 11:30 PM on October 16, 2007

... but what's a dollar worth? It's a guarantee.... of what, exactly?

about seven ounces of good beer

what, you think i need more than that?

Anyway, a modern dollar isn't an a direct hard asset, it's a claim on future production of the economy.

say "near immediate production of the economy" and i think you have it

where i'm at, it's pretty hard to accumulate a significant sum of currency, but at the least i can buy with it what i need or want within limits and be reasonably certain what i'm going to have to spend for it

now if you've got significant wealth, keeping it in dollars probably isn't your best idea - but just what is there that's really safe? - a look at the gold market doesn't really give one the impression that you're going to necessarily make money over time by investing in gold

and for basing your monetary system on it all you're really doing is exchanging the politician's promise that you'll get something for that dollar for a promise he's got the gold to back that dollar up

why should you trust him to give a buck's worth of gold for a buck when you don't trust him to give anything for that buck right now?

people trusted fdr to do that - what happened?

people trusted nixon to do that - what happened?

i certainly can't say that you should trust helicopter ben and his pals either - but who are you going to trust? - not what, who? - fdr took away everyone's gold, don't think someone else couldn't

one thing to consider - is money just something tangilble - or is it a type of information, a means of communication?
posted by pyramid termite at 11:41 PM on October 16, 2007

Do they have a few hundred trillion dollars in it? That's what they're gonna need... Get out now, while your bucks still buy something...
posted by ronin21 at 11:49 PM on October 16, 2007

a look at the gold market doesn't really give one the impression that you're going to necessarily make money over time by investing in gold

Except in unusual circumstances, you really don't.... you preserve wealth, but you don't 'make money', since it just sits there, not doing anything or earning any interest. If you get lucky and catch it going into a bubble, like in the 1970s, you can make fabulous profits. In this bubbly, currency-flooded economy, that's not impossible, but I wouldn't call it 'likely'.

for a promise he's got the gold to back that dollar up

Well, see, that was OUR fault, because we didn't monitor what they were doing. It's easy to figure this stuff out, you just inventory your gold and your notes in circulation.

If you'll note, in prior times when money was abused, they weren't able to keep it up for as long as they would have with fiat currency. We still had problems, terrible problems in the case of the Depression, but it's my belief that the upcoming adjustment will be worse than that. It'll play out differently, but we're far, far, FAR more maladjusted now, after 25 years of boom and less boom, than we were in 1929, with roughly a decade of monetary disorder.

But it's pretty easy to monitor this stuff. If you require all new paper currency every few years, and stop honoring the old notes, you avoid the 'loss creep'. (every year, a certain number of notes are assumed destroyed, even if they aren't turned in as damaged, so extra replacements are printed.) The money looked the same for a long, long time, so that let them gradually print more and more and more of the stuff against too few gold dollars backing it. De Gaulle called our bluff and started cashing in his dollars for real gold, forcing Nixon to ultimately take us off the gold standard. This set off the terrible problems of the 1970s. This wasn't the fault of the gold standard, but rather a virtue; it prevented Nixon from hiding the economic problems any longer. Johnson's Great Society idea was a disaster, but economics is slow, and it took that long for the bill to come due. Had we been on fiat currency, the bill would still have come due, but we'd have been able to put it off far longer, running up a much higher 'debt', meaning that when the adjustment DID come, it would be far worse.

The Mint process can be entirely straightforward and transparent, easily citizen-monitored. It's really not a hard problem.

fdr took away everyone's gold, don't think someone else couldn't

Of course they could. It might potentially be ruled unconstitutional, but in this era of authoritarianism, they'd just say 'a terrorist used gold to move money' and that's all the Supreme Court would need to take it all away. But if they do that, they also implicitly give it value; they break the conditioning of 'barbarous relic', so I'm not sure they'd go that route.

We could go on a gold standard tomorrow, we just have to say that dollars are worth X to the ounce, but the rsulting shock to the economy -- from the endless stream of money suddenly drying up -- would be intensely painful, much like rehab. I'm not sanguine about the people's reaction to the sudden hard times.

The alternative, I think, is worse.... if we stay on our cash drug, we will eventually die of it.
posted by Malor at 12:29 AM on October 17, 2007 [1 favorite]

This is a great thread.

Just to add some corroboration: if you crunch the numbers yourself, for nearly any set of economic data, you notice that right around 1973 everything goes completely wild. Nixon Shock. Or like Malor said, the bluff was called. Like the Wikipedia page says, this is all tied up with the fact that Vietnam was a gigantic money sink, and it was so easy to print money.

So: In February 1973 the Bretton Woods currency exchange markets closed. And then, in October, Egypt and Syria rolled into Israel to reclaim the land they lost in the Six-Day War. Like we are all used to now, the US helped with money and arms. Instant oil embargo, and I think we all know how that went.

Perfect storm, and I really think since then it's been one pile of loans after another. Since the US dollar is so globally tradeable (i.e. liquid), it's used to finance all sorts of things, but it's become another matter of calling bluffs – and the subprime crisis is just the latest in a series of indications that (if I were anyone with USD) people might want to start thinking about calling in their loans.

Calling in their loans, when you're dealing with securities and currency, means selling: and that's what's happening. (Big text table, scroll to the bottom for the grand totals.)

Pyramid termite, you are right, gold is a shitty idea just like everything else is, but at least it is a physical thing you can touch, and so fraud is a little more difficult. But someone will always have control of currency, no matter what it is, so it may as well be dollars, since we at least have (theoretically) a fairly transparent system to regulate it. The Federal Reserve was independent precisely so that we wouldn't have profiteering and jiggering. Unfortunately it didn't really take into account governments willing to run up $9-trillion in debt.

Anyway, I am emphatically not a CDO pro, but I think the point of M-LEC is that, if you own all of the CDOs, you can shuffle things around between them and be fairly certain you are minimizing risk as best you can, keeping all of the CDOs within their guidelines – this happens (I think) by trading the underlying obligations – but no one wants to do that right now because no one really wants to deal with the CDOs in any way. Everyone's scared of the ratings being off, of A and BBB credit defaults, and then you're just holding the bag: thousands of depreciating houses.

CDOs in theory ought to be a great way to manage risk, but that's part of the problem – it opens up cheap money to everyone. Cheap money was already a problem, but now we've figured out how to get it to trickle down to people who default, and default hard, and this is on top of a bunch of other things grinding the gears: the debt, Iraq, the economy in general, blah blah blah.

So yeah, everyone's fucked. Get a good job and make intelligent investments and try to ride the wave, I guess.
posted by blacklite at 3:42 AM on October 17, 2007

To clarify: I don't think that "everyone's fucked" because of M-LEC. I think that'll go alright. I just think that the underlying collateral is way, way too overvalued, and defaults have been underestimated, and it's going to be just another thing impinging itself on a progressively more volatile and dangerous market for the US.

I think in the long run it will be good for the world economy to iron out this wrinkle, but it's a big, big, big, big wrinkle, probably one of the biggest on the road to real globalization. I also think it will be very difficult for a lot of people.
posted by blacklite at 3:56 AM on October 17, 2007

Whatever we arrive at, it would need to be not easily destructible, not easily consumed in a way that makes it unrecoverable, and easy to store. It would need to be divisible, and any bit of it needs to be the same as any other bit. That's probably going to be a metal of some kind.

I suggest gold-pressed latinum. Sounds as real as a dollar to me right now...
posted by DreamerFi at 4:34 AM on October 17, 2007

forcing Nixon to ultimately take us off the gold standard. This set off the terrible problems of the 1970s.

An alternative theory might notice pesky details like the Yom Kippur War and subsequent quadrupling of oil prices, and the follow-on effects from that. And the other oil crunch in 1979.
posted by ROU_Xenophobe at 5:02 AM on October 17, 2007

Centrally-managed economies are always bad, whether it's the Fed or the Politburo doing it.

Serious question, Is a non centrally-managed economy even feasible in a large modern nation state?

It seems to me that throughout modern history, whoever has the power, be it the banks in a capitalist society or the government in a socialist one, have always tried to gain as much control as possible. The only way around it I can see is massive regulation, but that is just a catch-22 in that the regulators have to be centrally controlled themselves.
posted by afu at 7:02 AM on October 17, 2007

Let's look at Switzerland: house prices rise a merely 1% a year, 80% of the buying price is mortgaged (with so-called 99-years mortgage, you pay only the interests and 1% of the prime every year).

So theoretically you have a "teaser rate" situation in place and is going on since years.

So why prices are not rocketing to the sky ? Very simple, if you sell your house at a profit you pay a degressive tax on the profit, starting (depending on the state you are living) with 70% if you sell in 1 year, to 50% in 5 years, and 5% in 30 years or so.

This is the why buying a 2nd House can *only* be for income and not for reselling. And buying for income is driven by rental prices therefore no point in shelling 1 Million for a home if it brings 2% income only. (Actually rental flats sell for 16 times the rental value, a 6% income).

I believe this is a very effective measure to curb house price increase. And it has also the effect of generating a lot of property for rental purposes (that also calms down the rent prices).
posted by elcapitano at 7:54 AM on October 17, 2007 [5 favorites]

Pyramid termite, you are right, gold is a shitty idea just like everything else is, but at least it is a physical thing you can touch, and so fraud is a little more difficult.

in practicality, it's not a physical thing you can touch - how do you buy a candy bar with 85c worth of gold?

you can't in any way that wouldn't be absurdly difficult to carry out - so now we're back to someone passing out certificates that can be exchanged for gold - and history has shown, time and time again, that the temptation to bluff is too strong to resist for governments - if only 10% of your citizens are going to cash in for gold during a year, then you can print up a few extra bucks and not be caught

don't say it wouldn't happen, because it always has happened, sooner or later

in fact, thanks to modern technology, we're not even talking about paper money anymore, are we? - we're talking about 0s and 1s on hard disks

how we manage to straighten out the mess they've made with that is beyond me - and may be beyond them, too - but choosing one commodity and calling that the basis of everything isn't going to work in a modern complicated world like this

i suspect it's not a matter of the money being debt money - but it's a matter of how much there is of it - and right now, we have way too much debt, more than can be paid back

and the SIV thing just sounds like a shell game - or maybe it's more like hearts, where the black maria gets shuttled around from hand to hand - and then people play the cards so the holder doesn't paste them with it and the holder waits desperately for his opportunity to unload it on someone else - and on it goes until someone gets stuck with it and loses the hand - at which point half the cards in the deck turn into the queen of spades and everyone loses
posted by pyramid termite at 8:14 AM on October 17, 2007

how do you buy a candy bar with 85c worth of gold?

With e-gold, of course.

A gold-backed currency could work in theory, but we're such a long way from it in practice that debating it seems pretty much irrelevant for the moment. Let's just go back to having meaningful reserve requirements first, hey?
posted by sfenders at 1:59 PM on October 17, 2007

A gold-backed currency will never work. Why? Because it would mean companies like FCX and ABX would replace the U.S. Mint, because they mine gold.

Gold only worked as currency when the only people extracting it from the ground were sovereigns - kings, governments, etc. Now corporations own most of the mines that produce with any regularity.

Until someone can explain to me precisely how a gold standard would work in light of the modern reality of multinational corporate mining, this remains the stuff of free-energy and UFO conspiracies.
posted by Pastabagel at 2:29 PM on October 17, 2007

Gold only worked as currency when the only people extracting it from the ground were sovereigns - kings, governments, etc.

Seriously? One can imagine various ways of dealing with the related problems that would arise if it the money supply were today influenced more directly by gold miners, though sure enough none of them seem ideal to me. But your statement there seems mostly wrong. You're presumably aware that the gold had a monetary role in the United States until 1973 or so, and I'm pretty sure there were large private mining companies way back then too. More obviously, when the Yukon gold rush happened in 1898, the gold standard was somewhat common in the world. If anything, gold supply is much more predictable now than it was for most of the centuries past in which it was used for the dominant form of money.

Anyway, the ability to go out into the world and find some gold lying about in the ground (or belonging to some distant savages who don't realize it's money, or whatever) can't effectively be limited to agents of the state, far as I know. Instead, the King would more likely claim the exclusive license to mint coins. Much more convenient for trade than ordinary lumps of gold, and seigniorage could help ensure that the official coins maintained their position as the dominant curency. The various gold-based kinds of US dollars weren't all that different in principle.
posted by sfenders at 6:20 PM on October 17, 2007

Hempscrip. Only way to go!
posted by five fresh fish at 8:01 PM on October 17, 2007

how do you buy a candy bar with 85c worth of gold?

With e-gold, of course.

oh, yeah, the guys at the corner store are going to be real happy to take that instead of dollar bills
posted by pyramid termite at 8:49 PM on October 17, 2007

If things ever got to a state where I'd be paying in gold itself, dollar bills wouldn't be worth wiping my ass with. Not absorbent enough. And I notice that as the US dollar drops against other currencies, the value of gold is going up. Not that that helps dollar holders oen iota, but it's gotta be pleasing to the goldbugs.
posted by five fresh fish at 9:31 PM on October 17, 2007

hempscrip, on the other hand, probably makes wonderful T.P.
posted by five fresh fish at 9:33 PM on October 17, 2007

i had a fortune in hempscrip once, but it all went up in smoke
posted by pyramid termite at 10:10 PM on October 17, 2007

Follow-up: This is a MUST-WATCH VIDEO for those who are interested in the whole mortgage-meltdown/credit crunch/SIV subject matter and/or those appreciate smart and very very dry British comedy. [via]

(Warning: contains mild but annoying racial and nationalist stereotyping by old snobby British guys with posh accents against black Americans living in the South -- when really they should be railing against over-extended people of all colors in Phoenix, Sacramento, the Inland Empire of CA, condo buyers in Miami, etc. -- not to mention all the bubble speculation in their own backyards in the UK.)
posted by Asparagirl at 3:03 PM on October 20, 2007

Yeah, the stereotyping is a bit over the top, but they capture the mess perfectly.

"Sell, sell!" :)
posted by Malor at 3:33 PM on October 20, 2007