Ponzi Scheme, Credit Default Swaps in 2004 vs. 2008
September 23, 2008 3:46 AM   Subscribe

"As no rational agent would be willing to take part in the last round in a finite economy, it is difficult to design Ponzi schemes that are certain to explode. This paper argues that if agents correctly believe in the possibility of a partial bailout when a gigantic Ponzi scheme collapses, and they recognize that a bailout is tantamount to a redistribution of wealth from non-participants to participants, it may be rational for agents to participate, even if they know that it is the last round. We model a political economy where an unscrupulous profit-maximizing promoter can design gigantic Ponzi schemes to cynically exploit this "too big to fail" doctrine."

Sounds like something written this month in New York? Nope. The correct answer would be Bloomington, Indianna in 2003

Utpal Bhattacharya wrote On the Possibility of Ponzi Schemes in Transition Economies in 2001, but the above quote is from The Optimal Design of Ponzi Schemes in Finite Economies in 2003.

Bhattacharya's proof works only where more than half the population takes part (hmm... How many people own homes?)

Despite the Enron collapse and the published works of scholars like Bhattacharya, The $3.5 Trillion CDS market was still viewed this way in 2004.

The current (collapsing) $64 Trillion CDS market is viewed a little differently in 2008.

BTW, as of Yesterday, New York is going to try to regulate the CDS market. Good Luck NY.
posted by Rafaelloello (57 comments total) 23 users marked this as a favorite

 
We model a political economy where an unscrupulous profit-maximizing promoter can design gigantic Ponzi schemes to cynically exploit this "too big to fail" doctrine."

Is this a thing that is necessary to "model"? The word strikes me as the slimmest of figleaves.
posted by aeschenkarnos at 4:20 AM on September 23, 2008


Doh ... sorry. Missed the "written in 2003" thing. At which point, it can be said to have existed, but it's reasonable to expect the researchers to not be certain of that fact.
posted by aeschenkarnos at 4:21 AM on September 23, 2008


As I might have earlier noted: Adam Smith's "Invisible Hand" is not only now made visible but has given us the Finger via Congress and our President...
[...A clue to what we can expect can be found in the congressional response to the 1999 Gramm-Leach-Bliley Act, which helped pave the way for the current economic crisis.

This now infamous piece of legislation repealed part of the Glass-Steagall Act, passed in 1933 in response to the banking collapse of the Great Depression. Glass-Steagall enforced a firewall between investment banks, commercial banks, and insurance companies, in order separate high-flying Wall Street risk-takers from the banks where Americans keep their money in checking and savings accounts.[...
and the Democrats? how did they act then?
see: http://www.motherjones.com/mojoblog/archives/2008/09/9826_wall_street_vs_democrats.html

That was then; and how will they act now.....?
posted by Postroad at 4:29 AM on September 23, 2008 [1 favorite]


Here is the link Postroad referred to above.
posted by Daddy-O at 5:12 AM on September 23, 2008


I'll buy that for two pigeon feathers and a bottle cap.
posted by y2karl at 5:33 AM on September 23, 2008 [2 favorites]


Bhattacharya's proof works only where more than half the population takes part, and although the credit bubble looked very Minsky-ish, it never included the levels of outright fraud necessary for a true Ponzi scheme.

A Ponzi scheme usually offers abnormally high short-term returns in order to entice new investors. The high returns that a Ponzi scheme advertises (and pays) require an ever-increasing flow of money from investors in order to keep the scheme going. The system is doomed to collapse because there are little or no underlying earnings from the money received by the promoter.

Large loans given to people with dodgy income secured by overvalued assets, repackaged and sold as AAA-rated, mortgage-backed securities is not fraud?

The only difference is that in a real Ponzi scheme people don't know they're being fleeced. All of these highly paid investment bankers should have known - and I would bet did know - better.
posted by three blind mice at 5:33 AM on September 23, 2008


tbm, wouldn't you say that our entire economy could be characterized in much teh same way? I mean, if it's not growing, it's collapsing, right?

As I understand Marx (which is doubtless not well), his key insight is that the effect of capital can be multiplied if you move it quickly and far enough, and that he foresaw the collapse of the capitalist system as arising when there was no longer anyplace to move capital. It seems to me that late capitalism is fundamentally reliant on that marxist insight. We've proven positively ingenious at finding new places and ways to shift our capital. But eventually we must run out of alternate dimensions into which to plot our derivatives. (Mustn't we?)
posted by lodurr at 6:34 AM on September 23, 2008


Successful economies as we know them generally require endless growth that factors endless population to avoid a start over. When this problem comes up, the reply is usually that technological achievement must stay ahead of the problem, which sort of sounds like humanity becoming the Borg.
posted by Brian B. at 7:08 AM on September 23, 2008


But eventually we must run out of alternate dimensions into which to plot our derivatives. (Mustn't we?)

Always more dimensions. Springsteen explained it accurately (and succinctly): "poor man wanna be rich, rich man wanna be king, and a king ain't satisfied til he owns everything."

Greed has no limits.
posted by three blind mice at 7:10 AM on September 23, 2008


Good answer!
posted by lodurr at 7:53 AM on September 23, 2008


somewhat related:

How Should We Use Entropy in Economics? [.pdf]

Economics, entropy and sustainability [.pdf]

Thermoeconomics
posted by ornate insect at 8:14 AM on September 23, 2008 [2 favorites]


from the last link in the FPP:

Gov. David Paterson said Monday that New York will begin regulating part of the $62 trillion credit default swap market next year because a lack of regulation in that area of finance has contributed to the current credit crisis.

I actually started laughing when I read the figure of $62 trillion.

How in God's name do you "regulate" a market of that size? Answer: you don't, you can't, and that number is yet another example of how Wall Street's "financial models" are totally semantically divorced from anything even remotely resembling reality.
posted by ornate insect at 8:43 AM on September 23, 2008


ornate insect: $62 trillion isn't exactly a real number. IIRC the "$62 trillion" in the CDS market is insurance contracts on about $2 trillion of underlying actual value. You're right though that this number is divorced from anything resembling reality.
posted by rusty at 9:01 AM on September 23, 2008


Yay, I get fucked for having some economic sense and living within my means!
posted by Mister_A at 9:02 AM on September 23, 2008 [3 favorites]


It seems to me there's a bit of confusion, as there often is, between the fictional corporate entities that make up the financial system and the actual physical people who actually did all these things.

AIG, Lehman, Bear etc. etc. ad nauseum might be too big to fail, but I assure you, the members of their boards, their executive vice presidents and all the... well, personality types who were actually pushing the buttons and signing the papers that brought this about are not. They could fail quite spectacularly without destroying the world.

So if, alongside the probably necessary evil of the corporate bailout, their personal assets were seized and they were left homeless... (well, good luck with that, maybe if they were discovered hanging from lamp posts one morning with explanatory placards around their necks) perhaps we could begin to counterbalance the sense of personal invulnerability that apparently comes with being a high-ranking executive of a vital institution and start to lessen the moral hazard.

The GOP does claim to be big on personal responsibility, after all. Perhaps, to paraphrase their darling, Ann Coulter, we need to execute people like Richard Fuld in order to physically intimidate financiers, by making them realize they can be killed too. Otherwise, they will turn out to be outright traitors.
posted by Naberius at 9:20 AM on September 23, 2008


I've been watching the ongoing Senate Banking Committee hearings about the Big Bailout for the past hour or so, and here are some of my impressions:

--talking about Credit Default Swaps now; just mentioned the $62 trillion figure; blah blah blah

--Paulson and Bernanke and Cox do not seem as well prepared as they should. For instance, Paulson talks in such vague and general terms, repeating himself frequently, that it can be really frustrating: i.e. "we're making inroads...I had a meeting...we will pool experts...blah blah..."

--I would respect Hank and Ben more if they dropped the whole "this is an investment, not an expenditure" charade. It's intellectually dishonest to continue to pretend the toxic paper (i.e. the bad "assets" and complex securities/"asset classes" that the investment banks created and that have clogged up the flow of credit and will now be sold via reverse auction at fire sale to the Fed) will ever be worth anything; I would rather just debate whether the bailout is worth it, even if there is no eventual return (and there clearly will never be)...
posted by ornate insect at 9:42 AM on September 23, 2008 [1 favorite]


Paulson has mentioned several time how outmoded he thinks the Federal regulatory structure for the financial market is, but what has he done to change that up until now? Apparently nothing, but even more importantly: he's also admitted that the changes needed to re-tool that structure will be ironed out long after he's gone, and that those changes are not attached in any way to his current bailout plan. So the bailout plan addresses none of the root problems; it's just a temporary stop-gap measure to prevent catastrophe.
posted by ornate insect at 9:50 AM on September 23, 2008


In general, I have no sympathy for anyone who signed up for an ARM and took a fat wad of cash (or a bigger home) that they couldn't afford. Hope you enjoyed it; now get the hell out so someone who wasn't a moron can buy it. Life is full of situations where you have to weigh an immediate gain versus a long-term risk -- we throw people in jail for making bad calls in other circumstances all the time. Anyone who says they were "taken advantage of" by mortgage advertisements is obviously too stupid to be allowed to participate fully in society.

The words of those who felt that foreclosed individuals were not deserving of a bailout when the subprime crisis first hit keep coming back to me: the buyers should have known better and should have to suffer the consequences. It seems to me that if the top financial experts in mortgage lending (which the employees of these companies assumedly were) couldn't tell that these mortgages were a bad idea, how were these inexperienced individuals supposed to know?
posted by Mental Wimp at 11:49 AM on September 23, 2008


it's just a temporary stop-gap measure to prevent catastrophe.

maybe it's a little of this and a little of that. i mean, sure on the one hand, maybe it's a legitimate emergency measure to avert a potentially devastating long-term economic collapse (i'm actually not too skeptical about these claims--i think the potential for catastrophe is real), but maybe on the other, as a wall street veteran like paulson knows, it's also a tremendous opportunity for the financial sector as a whole to recover some of its losses and rebuild. and the fewer restrictions in the final plan, the bigger and better an opportunity it might be.

i'm not always a big fan of daily kos stuff, but one poster there recently made what seems to be a good point: so far, the administration's response to the democrat's push to require would-be bailout recipients to offer up a stake in their equity in return for the bailout has been to argue that putting a condition like this on the availability of the funds might discourage some companies that could otherwise afford to absorb the losses on their own from participating in the bailout. which of course raises the question: in what sense is it a bailout if the company on the receiving end doesn't really need it? why should we even consider bailing out companies that don't need it? discouraging companies that can survive on their own from getting a hand-out should be a feature of the plan, not a bug.

paulson's plan would have the newly created reserve entity buy-up the riskiest securities at prices close to their expected value at maturity. but we already know many of those securities are likely to be completely worthless. so why shouldn't we insist on buying the securities at rates no higher than the minimum amount needed to get enough of the original holder's losses off the books to keep them well-capitalized? and in return, why shouldn't we expect to be compensated for assuming those risks? shouldn't we demand more in return for assuming such risks than the remote possibility of almost breaking-even one day?

i get the impression that, while there's not much doubt a rapid emergency response to the situation really is necessary, part of the idea here is to spread a little money around to friends and family. but if the democrats can muster up the courage to hold a firm line and insist on building common-sense limits and accountability with teeth into the plan, it might be possible to prevent this from turning into another one of those now all-too-common stories in which pallets of billions of dollars in untraceable cash disappear mysteriously, even as the wallets of certain elite republican-party faithfuls mysteriously get fatter and fatter. the democrats have the real leverage in this bargaining process. the dems just have to push the advantage quickly and decisively, and present a workable plan with all the features they'd like to see as a counter to paulson's detail-starved original proposal.

then all they have to do to win is put the republicans on-stage, make them publicly defend the 100-million-a-year pay-packages of executives at failing companies, force them to own up to their plan's virtual guarantee of massive long-term losses of tax-payer money when alternative proposals could allow those funds to be substantially recovered over the long-term if the plan succeeds. that's what needs to happen. quickly.
posted by saulgoodman at 12:14 PM on September 23, 2008 [1 favorite]


It seems to me that if the top financial experts in mortgage lending (which the employees of these companies assumedly were) couldn't tell that these mortgages were a bad idea, how were these inexperienced individuals supposed to know?

I think there's room for debate about just how much these top financial experts knew, though. I think people can justifiably suspect the lending houses of engaging in predatory practices knowing that this was the result.
posted by shmegegge at 12:16 PM on September 23, 2008


The current (collapsing) $64 Trillion CDS market...

That figure exceeds All The Money in The World™ (M3). Therefore the CDS market can collapse tomorrow and the average Joe won't give a fuck. It's all imaginary "value" anyway. The financial markets have become so abstract and the numbers involved so convoluted that even the "players" in the market can't be sure who owes what non-existent money to who. Nuke it from orbit, it's the only way to be sure.
posted by MikeMc at 12:33 PM on September 23, 2008 [2 favorites]


During his opening statement at a hearing on Capitol Hill Tuesday, Republican Sen. Richard Shelby of Alabama expressed his displeasure with the government's massive financial bailout.

*

In his opening remarks during a hearing on Capitol Hill Tuesday, Senate Banking Committee Chairman Chris Dodd, a Connecticut Democrat, laid out his criticisms of the Treasury Department's plan for the most sweeping financial bailout since the Great Depression.

*

Prepared Text of Paulson’s Statement

*

Prepared Text of Bernanke’s Statement
posted by ornate insect at 12:45 PM on September 23, 2008


Just out of curiosity...does this bailout plan specify American dollars? I'm thinking we could solve this whole market crisis with a dump truck full of Zimbabwe dollars and the American taxpayer will only be on the hook for about twelve hundred bucks.
posted by MikeMc at 12:53 PM on September 23, 2008 [1 favorite]


Yay, I get fucked for having some economic sense and living within my means!

No, you get fucked for getting on with your life and not taking enough interest in what's really going on ... just like me and pretty much everyone I know, except a few guys I went to high school with and quickly grew tired of after about a year of University (I chose Arts; they went into Commerce).

My point being: we all saw this coming, didn't we? Felt it anyway. And we probably even said something about it, like "Somebody should do something."

But nobody did and now the shit has hit the fan. Duck and cover.
posted by philip-random at 1:15 PM on September 23, 2008 [1 favorite]


Saulgoodman: why shouldn't we expect to be compensated for assuming those risks? shouldn't we demand more in return for assuming such risks than the remote possibility of almost breaking-even one day?

Paulson et al. want to exclude equity for murky reasons, even though Sweden did an equity-based bailout of a housing bubble with success in the 1990s.

Maybe he's afraid of economic socialism.
posted by benzenedream at 1:22 PM on September 23, 2008


Maybe he's afraid of economic socialism.

But it's already economic socialism if we're bailing them out. So what, it's only socialism if the people who pay the taxes spent somehow see a benefit?
posted by saulgoodman at 1:55 PM on September 23, 2008


saulgoodman: yes. It's bad leftist Frenchified Socialism if the people of the country benefit. If they don't, then it's good right-thinking apple pie patriotic National Socialism. Just like Grampy Prescott always wanted</a.
posted by rusty at 2:18 PM on September 23, 2008 [1 favorite]


Bernanke: Approve bailout or risk recession

$700 billion to avoid...recession? Depression, maybe, but I thought we were already in a recession.

What irks me is that it's the oldest sales trick in the book to rush your mark into negotiating a deal without due diligence. This problem has been festering for at least two years, and we knew by the Bear Stearns bailout last spring that something needed to be done. Now, with six weeks until an election, the Fed and Treasury put a fiscal gun to the head of Congress and demand more money? To top it off, they offer nothing in return: the entire burden of risk and downside is put on the taxpayer, and the investment banks are left off the hook entirely. It's madness.
posted by ornate insect at 2:52 PM on September 23, 2008 [3 favorites]


I would respect Hank and Ben more if they dropped the whole "this is an investment, not an expenditure" charade. It's intellectually dishonest to continue to pretend the toxic paper (i.e. the bad "assets" and complex securities/"asset classes" that the investment banks created and that have clogged up the flow of credit and will now be sold via reverse auction at fire sale to the Fed) will ever be worth anything; I would rather just debate whether the bailout is worth it, even if there is no eventual return (and there clearly will never be)...

Part of the problem is people like you are spreading the falsehood that the entire $700 billion line of credit that the Treasury is asking for will purchase assets whose value is zero. That is completely, utterly, and blatantly false. Moreover, it underlines a significant disconnect between what's actually occurring in the banking world, and what non-financial spectators think is happening.

This credit line (and that's EXACTLY what it is: a CREDIT LINE, NOT A LOAN, and not a bailout in the sense that banks are just getting free money (if the equity plan gets included)) is primarily like a Liquid Plumber for the economy. Right now, the main pipes that move money (banks) are clogged with crappy assets. If the major pipes get clogged, the rest of the economy follows. What we have here is a crisis of confidence. People who help the banks find investors/savers and spenders are saying, "We don't want to do business with you, because we don't trust that the clog won't kill you." So the Treasury and Fed are trying to remove the clog as quickly as possible, before the economy starts to feel the REAL repercussions.

Are those assets crappy? Yes. Are they worth zero? A few of them, sure. But a GREAT MANY OF THEM have real value, and will show that value once the clog goes away. Why did Lehman's bonds trade at 18 cents, and their subs trade at a penny? Because the clog is so great, no one is willing to step up to the plate. So the vultures lowball, and create a deflationary spiral.

This morning I realized who so many of the finance guys who are here on MetaFilter are now nowhere to be seen, and now these threads of full of anti-Bush bullshit. To battle every one of the inaccuracies, lies, and distortions that are presented here would be a full time job. And most of us are just trying to keep ours, as opposed to trying to correct the inaccuracies. You can't prevent people from having an opinion, but I gotta say, the finance threads around here have really taken a nose dive in the last week.
posted by SeizeTheDay at 3:27 PM on September 23, 2008


Just like Grampy Prescott always wanted...

Whoa, and the Heinz family? Well, I guess they eventually figured stealth was better than an out-and-out coup, eh?
posted by Mental Wimp at 3:36 PM on September 23, 2008


SeizeTheDay,

Admittedly I'm guilty of more than a little amateur speculation. I must admit I don't understand the deflationary risk or really what is meant by deflation in this context. It's hard for me to see how the outcome of this financial crisis would do anything other than weaken the buying power of the dollar, and in fact it seems that that outcome is a desired one. When I have mentioned inflation, it has been (at least mentally) in the context of an increasing devaluation of the dollar.

When you talk of a deflationary spiral, do you mean deflation of the value of the market and/or GDP? I can understand how that's a real problem, but it also seems like an inevitability. The proposed solution (I heard that a direct injection of $180k can cure AIDS) seems like it will have a dire effect on the purchasing power of a buck. The risk then isn't that we're going to destroy the dollar -- that damage appears to be done. The risk is somewhere between complete infrastructure failure as access to money dries up and everyone holes up with their shotguns, a forced economic revolution in the form of a mass (market) extinction event, or the perpetuation of a clearly flawed and inequitable model. A lot of people seem to favor sticking the lenders/investors with the tab and letting them go broke. Is the risk really that life as we know it would cease? Must we resort to corporate socialism to protect not only the wealthy but the supply chains that enable us to live?

Won't we just end up encouraging the risky behavior that led to this problem in this first place? Surely if everyone went bankrupt we could just figure out a way to sell off their assets and allow new companies to take their place. Is free market capitalism incapable of solving this problem?

In regard to the common conception that the $700B will be used to buy assets with no value is it not a reasonable assumption that the assets in question aren't worth nearly what we'll pay for them? Surely if the problem wasn't that bad the market could handle itself. Instead we have the economic elite screaming FIRE!!! like the whole house is coming down. I think the public is right not to have faith that $700B would be spent responsibly.

Is the clog being caused by the deleveraging of lenders due to asset revaluation? No one has any money because all their cash went to backing the loans that had previously been backed by unsound securities? Maybe the government should compel them to sell assets at fair market value to meet their obligations instead of offering a boatload of cash. There would be casualties, but if the problem is really explained as a "clog" then wouldn't their blood get things flowing again?
posted by polyhedron at 4:36 PM on September 23, 2008


SeizeTheDay: It is not a credit line or a loan, to anyone. It's a gift. Here's the proposal. Please find me the line that says anyone, the Secretary or any financial institution, has to pay anything back to anyone else.

What it actually says is:

For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses.

Any money this new bureau makes, it may keep, and use for more trading or "administrative expenses." None must be paid back.

Also, it's not $700 billion, it's $700 billion outstanding at any one time. The actual cost is unlimited in the bill.

Here is my understanding of it. Please tell me if I'm wrong, and how:

As written, the law fully allows Paulson to, for example, set a universal price of $0.50 on the dollar for trash MBSes. All his Wall St. buddies dump their crap on the new Department of Lousy Investments, and count themselves lucky to get half their value. The DLI then dumps them back on the market for $0.01 on the dollar and clears the books. Repeat over and over. The buyers at $0.01 are, by and large, the same banks that just sold them off for $0.50. They then hold those securities, which are now priced pretty much fairly, since they do contain (let's say) at least one loan out of a hundred that will pay off normally. In a while, as they mature, we see that in fact they actually pay off at a rate of abut $0.60. That becomes the market price, and Wall St. trades them at that.

So, in the above, they lose 50% instead of 99% on one end, and then they make 5900% on the other end. Not too shabby.

But it gets even better! Because the law sets up American banks as the sole beneficiaries of this DLI largesse. Wall St. knows that $0.50 is the going rate. So they buy up whatever shit they can overseas at $0.40, or however low they can manage to drive it, and immediately turns that stuff over at the guaranteed $0.50 rate to the DLI. So the whole time they're losing a little money on their own crap, they're raking it in hand over fist on foreign crap.

"But can't Paulson just lower the going rate when this starts to happen?" No! That's the beauty of it. Because American banks will immediately start buying crap to replace or even greatly expand their own crap holdings, as soon as Paulson lowers the offer price, he leaves them in either the same or a worse state then they are now! This doesn't solve the crisis -- it makes it the permanent state of our economy.

Until, of course, every penny that the Full Faith and Credit of the United States of America is worth to the entire world has been transferred to investment bankers. Then the whole system ends, and last one out shut off the lights.

Now, perhaps it'll get amended with something requiring Paulson to hold whatever he buys. Just remove it from circulation entirely, and wait to see what level it pays off at. That eliminates the two biggest problems: the likelihood of the same guys who made these bad investments profiting by the bailout, and the infinite cost issue. If they have to be held, then it's just $700 billion and that's it (until Paulson comes asking for more, of course).

It it also comes with a salary cap applied to any company taking the deal, that may help restrict the takers to only the ones most direly in need.

So, I'm willing to grant the possibility that the amendments being discussed could save this hideous power grab. But I doubt it.
posted by rusty at 4:40 PM on September 23, 2008



When you talk of a deflationary spiral, do you mean deflation of the value of the market and/or GDP?

Look up the paradox of deflation. (I understand the explicit conflict of interest between the author and a deflationary cycle. Read it as a primer to understand economics, and try not to shoot the messenger.) This is just one source. Look up the "lost decade" of Japan as well.

The risk then isn't that we're going to destroy the dollar -- that damage appears to be done. The risk is somewhere between complete infrastructure failure as access to money dries up and everyone holes up with their shotguns, a forced economic revolution in the form of a mass (market) extinction event, or the perpetuation of a clearly flawed and inequitable model.

This is completely ridiculous all or none scenario. I'll give you an example. Hurricane Ike came last weekend. Now, in many areas of the southeast, there is a gas shortage. Was it because refiners were knocked out for a time? Yes. Was it also because people started hording gas as it if were the apocalypse? YES. And that's the problem. You can try to control a system deleveraging. What you can't control is a mass panic and bank run. That's what the Fed and Treasury are trying to do now. Very, very smart institutional investors don't trust the banks. They NEED to trust the banks, because otherwise the economy seizes and everyone runs for the exits. This crisis has not yet created a serious problem for businesses. But what happens when banks, trying to shore up capital, spike the interest rate 10% and only lend to people who can put 50% down? Depression. That's not a threat. That's not a scare tactic. That's a very, very real phenomenon. 10-15% unemployment, the government printing even more dollars to compensate for a lack of private spending, and interest rates spiking through the roof because now no one thinks that dollars are worth anything.

Won't we just end up encouraging the risky behavior that led to this problem in this first place? Surely if everyone went bankrupt we could just figure out a way to sell off their assets and allow new companies to take their place.

Severe, significant regulation is coming. I promise you that. The FDIC, the Federal Home Loan Bank, Fannie and Freddie, and significant, significant bank regulation like Glass-Steagal all came after the Depression (but years later). It'll come again. The banks really fucked up this time, and there are some very, very mad Congressmen who now have to explain to their constituents that they couldn't afford a prescription drug plan, but they could afford to pay off Wall Street.

Maybe the government should compel them to sell assets at fair market value to meet their obligations

If they did that, most, if not all, banks would be technically insolvent, causing a run on the banks. The ways banks capitalized themselves is very technical, and in some ways shady, so telling them to own up to it all immediately is not an option. What if you went to your bank tomorrow and they told you, "Sorry, until we get our shit sorted out, you can't get access to your checking account." What would occur if that happened to even 10% of the population? Panic, just like the gas shortage caused by the fear of Hurricane Ike.

rusty, I've read the proposal. I've even commented on it here. Most of what you just said is now just rhetorical horseshit, since the Treasury has already stipulated to most of the Democrats' changes that they're asking for. So if you're looking for a strawman, keep looking. The Dodd plan, with the equity swap, new oversight board, and monthly Congressional reporting is a good start. I think that by the time they're done, it should be a far more taxpayer-friendly proposal. My theory about Paulson's plan is this: like most of politics, you gotta ask for a mile to get an inch. And in this case, he asked for two miles, because the Bush Administration has cried wolf too many times and the Democrats REALLY, REALLY want to stick it to them this time.

I've laid out a lot of these issues in previous comments. I've only written like 20 or so in the past 10-15 days, and at least 30% were mildly intelligent, so I'd dig back into those, polyhedron.
posted by SeizeTheDay at 5:10 PM on September 23, 2008 [1 favorite]


Here's a halfway decent, if very opinionated, comment I wrote a couple days ago about deflation.
posted by SeizeTheDay at 5:27 PM on September 23, 2008


Part of the problem is people like you

You have me all wrong: I'm a solution person.

...are spreading the falsehood that the entire $700 billion line of credit that the Treasury is asking for will purchase assets whose value is zero. That is completely, utterly, and blatantly false. Moreover, it underlines a significant disconnect between what's actually occurring in the banking world, and what non-financial spectators think is happening.

Part of the problem is people who
a) are saying things about the plan not even Paulson and Bernanke are saying
b) seem enamored of the dubious notion of financial "expertise"
c) seem to assume anyone who doubts the soundness of the plan (which includes a whole lot of economists and financial watchers) doesn't understand it
d) enjoy making sweeping caricatures of people who are skeptical about the value or potential payoff of the toxic assets in the system that the plan is going after

I watched the entirety of the Paulson/Bernanke/Cox testimony on the SBC today, and got the same impression I got when I watched the testimony on the Bear Stearns bailout in front of the same committee last spring. That impression is that the American public is being sold a great big lemon. And told to make lemonade.

non-financial spectators

This is just gratuitous; we are all spectators now, unless you have some inside information. I forgot you were a "player"?

This credit line (and that's EXACTLY what it is: a CREDIT LINE, NOT A LOAN, and not a bailout in the sense that banks are just getting free money (if the equity plan gets included) is primarily like a Liquid Plumber for the economy.

This is just semantics, like so much of what Paulson and Bernanke said today.

Right now, the main pipes that move money (banks) are clogged with crappy assets. If the major pipes get clogged, the rest of the economy follows. What we have here is a crisis of confidence.

The CEOs of Bear and JPM used the "crisis of confidence" phrase in their testimony last spring. A good salesman (I know: I was one) always wants to pass the buck this way. But a credit crisis is not just a crisis of confidence. Paulson and Bernanke and Cox all seem to admit that there are real problems here, structural, financial problems, and not just psychological ones.

Are those assets crappy? Yes. Are they worth zero? A few of them, sure. But a GREAT MANY OF THEM have real value, and will show that value once the clog goes away. Why did Lehman's bonds trade at 18 cents, and their subs trade at a penny? Because the clog is so great, no one is willing to step up to the plate. So the vultures lowball, and create a deflationary spiral.

Your capitalization reminds me of a USED CAR SALESMAN. The fact is that we don't know what the "value" of the assets is, b/c Paulson and Bernanke aren't saying. They are being cagey about this, and it appears they aren't saying b/c they don't even know. In today's hearing Paulson implied it will take some internal review to get a better handle on the complex array of "asset classes" (mortgage derivatives, mortgage securities, etc) that are here. But both HP and BB shied away from saying the taxpayer would ever make money from any of this.

This morning I realized who so many of the finance guys who are here on MetaFilter are now nowhere to be seen, and now these threads of full of anti-Bush bullshit. To battle every one of the inaccuracies, lies, and distortions that are presented here would be a full time job. And most of us are just trying to keep ours, as opposed to trying to correct the inaccuracies. You can't prevent people from having an opinion, but I gotta say, the finance threads around here have really taken a nose dive in the last week.

If the past few weeks have taught us anything it's that the "finance guys" are not the omniscient, omnipotent wizards they are so often mistaken for. Oz-like, the curtain has lifted to reveal that the best and the brightest minds of investment banking were no match for the pie-in-the-sky securities, derivative, and other hokum they engineered with speculative abandon. To continue to act as if their expertise is the golden mean by which we measure questions of how we got in this mess, given that the era of the investment banks is now very suddenly over, is like a child playing with his toys while the house is on fire.

Finance is not quantum physics. A reasonably well educated businessperson can accumulate a basic understanding of how the system is supposed to operate. Considering how skeptical mefites are of, say, academic charlatans in postmodern studies, I'm frankly amazed at how smitten so many people remain by the equivalent charlatans of high finance. A lot of business speak and finance Mandarin serves to obscure certain realities and scare away curious minds.

In my own peripatetic career I saw intimately how the dot com crash unfolded, I worked spreadsheets and pivot tables, I learned how to read an index and how to sell very expensive databases loaded with complex information, but I'm not in any way an "expert" or quantitative conjurer about the machinations and history of Wall Street. And yet I actually like the fact that I'm not an expert in this regard b/c it means that I can maintain a healthy distance while the walls come crashing down, and can form and change my opinions based both on what I read (from a wide variety of sources, financial news and otherwise) and also from what I understand to be the fundamentals of what business is. Those fundamentals are a world apart from what I increasingly see as the parasitic host creature on the real economy that Wall Street became.
posted by ornate insect at 5:58 PM on September 23, 2008 [3 favorites]


a CREDIT LINE, NOT A LOAN

Show me where they have to pay back what they take out. Show me what the penalties are for these proven failures when (not if) they don't pay back what they borrow on this "line of credit". Show me why this isn't the same damn thing as giving a mortgage to someone with no job and no assets, but allowing them to keep the home when they default. Here, I'll use the big capital letters you seem to like:

SHOW ME THE MONEY!!!

Severe, significant regulation is coming. I promise you that.

I'll take that bet.
posted by dirigibleman at 6:23 PM on September 23, 2008 [2 favorites]


This morning I realized who so many of the finance guys who are here on MetaFilter are now nowhere to be seen, and now these threads of full of anti-Bush bullshit.

They were the 'smartest guys in the room', weren't they?
posted by jamjam at 6:28 PM on September 23, 2008 [2 favorites]


Severe, significant regulation is coming. I promise you that.

Paulson said he expects the regulation to come after he's gone, i.e. next year. But the problem is that the regulation needs to be attached to the bailout (using that term just like the NYT and WSJ use it) now. There's no reason to wait on the regulation: let's hammer at least some of it out now.
posted by ornate insect at 6:29 PM on September 23, 2008 [1 favorite]


SeizeTheDay:Well, as long as the super-smart financial masters of the universe have got things in hand, the rest of us will be glad to give you whatever you want. We only exist to serve.
posted by rusty at 6:30 PM on September 23, 2008


"Let us put the question then as simply and nakedly as possible: What is money and how does it get that way?"

Always good for a chuckle.
posted by eegphalanges at 6:49 PM on September 23, 2008


FBI investigates fraud at 24 financial firms. Just last week, FBI Director Robert Mueller put the number of large financial firms under investigation at 24. He did not name any of the companies under investigation but said the FBI also was looking at whether any of them have misrepresented their assets.

Over the past year as the housing market cratered, the FBI has opened a wide-ranging probe of companies across the financial services industry, from mortgage lenders to investment banks that bundle home loans into securities sold to investors. Mueller has previously said the FBI's hunt for culprits in the nation's subprime mortgage crisis focused on accounting fraud, insider trading, and failure to disclose the value of mortgage-related securities and other investments.

posted by Brian B. at 6:51 PM on September 23, 2008 [2 favorites]


Polyhedron - The risk is somewhere between complete infrastructure failure as access to money dries up and everyone holes up with their shotguns, a forced economic revolution in the form of a mass (market) extinction event, or the perpetuation of a clearly flawed and inequitable model.

SeizeTheDay - This is completely ridiculous all or none scenario.


Funny you should say that because you've been arguing pretty aggressively for the none resolution.
posted by Kid Charlemagne at 6:54 PM on September 23, 2008


Here's another good example of a financial crisis that was solved through government intervention. As I said upthread, I don't have the time or energy to fight every inaccuracy or argument hurled around here. I will leave with this last bit:

A lot of business speak and finance Mandarin serves to obscure certain realities and scare away curious minds.

Tell that to doctors, lawyers, accountants, plumbers, mechanics, or any other specialized industry.

There is a significant difference between understanding "finance", its instruments, its formulas, its institutions, etc. and understanding "financial economics". Plenty of people have read various introductory textbooks to get the basics of puts, calls, EBITDA, operating leverage, blah blah blah. The difference now is those on Wall Street who created this mess didn't take into account the economic affects of their actions. The securitization market exponentially added to the money supply, which in turn created jobs, companies, etc. Now that that money supply is being sucked out, you need to do it in an orderly fashion, instead of letting the market destroy itself. That's why it's not a free market. That's why we have regulators (who up until this point were asleep at the switch). Did some of them understand these risks and do it anyway, just to take home a bigger paycheck and let the government pick up the tab? Maybe. But that doesn't matter. You don't cut off your nose in spite of your face.
posted by SeizeTheDay at 7:50 PM on September 23, 2008


Bah. I'm tired. Don't cut off your nose to spite your face.
posted by SeizeTheDay at 7:52 PM on September 23, 2008


Did some of them understand these risks and do it anyway, just to take home a bigger paycheck and let the government pick up the tab? Maybe. But that doesn't matter.

So you admit that there is no mechanism to force banks to pay back on their lines of credit, or to punish them should they reneg, that this is in fact not really a line of credit, but a complete give-away of obscene amounts of money to these failures, that they are being handsomely rewarded for failing at an unprecedented scale.

You don't cut off your nose in spite of your face.

You cut off someone else's nose.
posted by dirigibleman at 8:05 PM on September 23, 2008


Kid Charlemagne, for real. I'm pretty sure I was suggesting that it wasn't actually an all or none scenario and defining a range of potential outcomes.

SeizeTheDay, you don't even argue for the perpetuation of the current system -- you insist upon it. Even if it is the only way to prevent catastrophe today, it comes at a high cost and the burden will not fall to the immediate benefactors. The argument that helping the rich helps us all is old and a frequent justification for the structure of our economic system. The fact that economics is not a science but a more philosophical interpretation of human interactivity raises the question "who defines the nature of human interaction?"

If they [compelled the banks to sell assets at fair market value to meet their obligations], most, if not all, banks would be technically insolvent, causing a run on the banks.

Doesn't that mean that they already are insolvent? Isn't that the nature of the clog? I'm sure it would be a mess, but isn't the first step to recovery admitting that you have a problem? How will the proposed bailout prevent this from recurring? Perhaps we should allow the proposed redistribution of wealth to happen the "natural" way.

I don't understand why it's so all or nothing. If it's really so dire that society is a couple weeks from crumbling people should be punished. If it's not really that dire, the Fed and the finance industry are blackmailing the country! I don't understand how the problem could be so bad that we have to pay to keep the people who engineered it in caviar and limousines.

From the article you just linked:
The Nordic effort -- similar in speed and scope to what the U.S. is planning now, though smaller in size -- did manage to end the financial crisis. At the same time, it didn't prevent a deeper recession and surging unemployment in all three countries.

Isn't that what we're told we face if we DON'T bail them out?

``In Japan, procrastination unnecessarily increased overall costs in terms of asset-price declines, damage to the fiscal position and lost economic growth,'' said Richard Jerram, chief economist at Macquarie Securities Ltd. in Tokyo. ``The U.S. seems to be responding with unusual speed and aggression.''

It sure sounds to me that forcing the lenders to sell their assets at fair market value would work just as well as paying them off. The only problem is that in that case wealth would be redistributed from the lenders amongst the public as opposed to redistributing the public's wealth to the lenders. Maybe our face is ugly anyway.
posted by polyhedron at 8:17 PM on September 23, 2008 [1 favorite]


Besides, I bank with Wells Fargo and they appear to be in a pretty good position. If the FDIC can't actually back the sparse amount of money in my bank account, if withdrawals are really threatened by this economic crisis, why shouldn't we burn these guys at the stake? I was under the impression we already had a number of institutions to protect against bank runs and their repercussions.
posted by polyhedron at 8:25 PM on September 23, 2008


Maybe this is another way to think about it:

$700 Billion is approximately $2000 per every man, woman, and child in the US.

Instead of debating why we should or shouldn't dump that amount of money in the top of the market where the fat cats get their hands on it first, consider what would happen if that amount of money was dumped into the bottom of the market: Every family of 4 gets $8000 to pay their mortgages. If you don't have a mortgage, get a mortgage, that will drive up lending and real estate prices. If you do the math from either side you will probably come up with the conclusion that it just won't fix the problem, it just keeps things running for 6 more months, then we'll be right back here again.

The downdraft that's trying to be averted simply can't.

Isn't there a saying that has something to do with throwing good money after bad?
posted by Rafaelloello at 8:37 PM on September 23, 2008


It seems to me that if the top financial experts in mortgage lending (which the employees of these companies assumedly were) couldn't tell that these mortgages were a bad idea, how were these inexperienced individuals supposed to know?

Because professional expertise isn't all it is supposed to be. Not even close. And, not in any field of practice.
posted by Chuckles at 9:02 PM on September 23, 2008 [1 favorite]


If it's really so dire that society is a couple weeks from crumbling people should be punished. If it's not really that dire, the Fed and the finance industry are blackmailing the country! I don't understand how the problem could be so bad that we have to pay to keep the people who engineered it in caviar and limousines.

Well said!
posted by Chuckles at 9:18 PM on September 23, 2008


SeizeTheDay: Thanks for posting despite all the venom flying. People are rightfully pissed at this bailout of greedy morons, and are taking it out on those who are pointing out that some sort of government intervention is necessary.

Advocating for government intervention is not the same thing as saying "we have to pay to keep the people who engineered it in caviar and limousines". The government intervention can have as much lynching as necessary loaded into it, since the alternative is bankruptcy for heavily leveraged firms. See the Swedish plan which I and SeizeTheDay linked to. It did not sound like a picnic for plutocrats. If you are outraged, contact your reps and insist on more oversight and equity for the government.

There is no way around getting housing back to historical price norms, which is why I think the support for disadvantaged homeowners is doomed. As noted in other posts, it is at best a stopgap measure and at worst will prolong the discovery of the price bottom and keep poor families paying very expensive rent.
posted by benzenedream at 11:03 PM on September 23, 2008


"Once again, the conservative, sandwich-heavy portfolio pays off for the hungry investor."
posted by sexyrobot at 12:01 AM on September 24, 2008


"Greed amasses resources to remove measures aimed at suppressing greed" - seen on a local discussion board.
posted by Laotic at 7:11 AM on September 24, 2008


also: "Matrix reloading... We apologize for the inconvenience"
posted by Laotic at 7:14 AM on September 24, 2008


I like how it's the same assholes who have been telling us for the better part of ten years to move along, there's nothing to see here who are now telling us we gotta bail their asses out or we're all doomed. Doomed, I say!

It's a crock of shit. We can provide the liquidity necessary to keep businesses buying on terms and whatever other short term financing the economy needs without taking on all the toxic waste the wizards made up with the help of the mortgage brokers.

We'd be better off pumping $700 billion into the FDIC than we would trying to hold up the rotten dead wood that is some banks. Of course, it doesn't help that the financial vultures are trying their damnedest to take out a few banks to deepen the sense of crisis (and make some money on everybody else's suffering)
posted by wierdo at 8:19 AM on September 24, 2008


It seems to me that if the top financial experts in mortgage lending (which the employees of these companies assumedly were) couldn't tell that these mortgages were a bad idea, how were these inexperienced individuals supposed to know?

Because professional expertise isn't all it is supposed to be. Not even close. And, not in any field of practice.


I agree, but is the average first-time homebuyer is an expert? That's what I'm getting at. If the people selling the mortgages aren't smart or knowledgeable enough to know good from bad, how can you blame the folks getting the mortgages?
posted by Mental Wimp at 10:47 AM on September 24, 2008


If the people selling the mortgages aren't smart or knowledgeable enough to know good from bad

Oh, they know good from bad all right.

Good==more money in their pocket.

Bad == less money in their pocket.

My understanding is that mortgage brokers received higher commissions for riskier loans. This is why so many people with *good* credit ended up with crappy ARMS and 80/20 loans with balloon payments, which were designed for riskier borrowers: brokers pushed them harder. Lower monthly payment! Little or no down payment! What they didn't point out was: Less principal paid off! Near-certain need to refinance in a few years!

There was plenty of greed up and down the line.
posted by Sublimity at 11:20 AM on September 24, 2008


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