The newest "Save-the-Banks" plan has been circulating the Internet with varying degrees of official sanction for a few days now, but I've so far held off on posting about it because a) I wanted to make sure I understood the gist of it, b) I wanted to make sure the more informed from whom I steal my opinions had time to understand the gist of it, and c) I'm generally getting a little bored of the whole "here's another trillion dollar plan that is just as indispensable and sure to work as the other trillion dollar plan and come on you know it's totally different this time" routine.
But after much back-and-forth over the new Geithner plan (more back than forth, I've noticed), here's what it comes down to: the government is going to buy the so-called "toxic" assets from the banks.
If you think that sounds an awful lot like the first Paulson plan in which the government was also going to buy the so-called "toxic" assets from the banks, that's because you're a philistine and do not properly understand the intricacies of modern finance.
Let me illustrate with a really shitty parable*:
Once upon a time, the house we all call America faced a terrible trouble. While in golden days past water had flown through its pipes cool, sweet, and abundant, now there was nothing for those who thirsted for that salubrious liquid(ity) but dust from the tap and a terrible groaning behind the walls.
At the end of their collective wits, the residents of America called Plumber Paulson to investigate. After negotiating a handsome fee, Plumber Paulson determined that America's pipes were blocked most terribly.
"But what is it that blocks our pipes so?" cried the denizens of America house. "Surely it must be the waste which we have been depositing there for near-now a decade with reckless abandon!"
"Heavens no!" Plumber Paulson chortled with giddy amusement. "It is not feces that impedes the flow of your pipes, but gold! Pure, unadulterated gold! And, for a handsome fee, I shall put very much of your money down the toilet and in doing so dislodge that gold which I can then place upon your mantle for all to enjoy."
Rejecting Plumber Paulson's scheme as an absurdity, the Americans sought another opinion on the matter. Finding Handyman Geithner available, they brought him into America house to examine the pipes. After much careful consideration and deliberation (in which time the plumbing system began to back up quite aggressively and with disagreeable results for everyone), Handyman Geithner summoned the residents of America house and announced his plan. The room was hushed and with much empathy and warmth in his eyes, Handyman Geithner spoke:
"I have concluded that it is not feces that impedes the flow of your pipes, but gold! And, for a handsome fee, I shall put very much of your money--"
But before the handyman could finish, there was an uproar amongst the people of America house. Perplexed and wounded, Handyman Geithner waved his hands and plead for time to explain further.
"You see, my plan is quite different from Plumber Paulson's. If you only you will hear of it in its entirety."
Suspicious though they were, the Americans were nonetheless a reasonable group of people, and so allowed Handyman Geithner to continue.
"As I was saying," the handyman said with evident irritation and hurt-feelings, "For a handsome fee, I shall put very much of your money into the hands of a dear friend of mine Fund Manager Chad who will in turn retrieve that gold and, after taking a handsome fee, will place it upon your mantle for all to enjoy."
Recognizing that the plan was indeed quite different, the Americans were nonetheless confused by such complicated matters. "But what if the blockage is not gold, but waste as we have assumed all along?" One asked incredulously." We do would not then want it to be placed upon our mantle."
"And what of your dear friend Fund Manager Chad?" Another asked. "What shall happen if he does not use the money in an effective manner? Will he still be rewarded a fee, and if so, who is to pay it?"
But Handyman Geithner simply laughed with much merriment. "Leave the details to me," he said with confidence and a wave of the hand. "I know what I'm doing."
*For an actual explanation, click here.
Showing posts with label Collateralized blah blah. Show all posts
Showing posts with label Collateralized blah blah. Show all posts
Tuesday, March 24, 2009
Monday, February 16, 2009
Another Thing That is Trying to Kill Our Economy
Now that the financial crisis has finally moved on to bigger and better things, infecting the good ol' economy of us regular folks with higher unemployment, home foreclosures and state government budget cuts, maybe you're thinking that the exclusionarily complex, initial-heavy world of investment banks, derivative trading and hedge funds is just so last September.
Well think again, square! Old is the new new, black is last month's red, and incompetently rated asset backed securities are this weeks Chapter 11 bankruptcies (actually, Chapter 11 is still around too, but its probably unfashionably depressing to talk about because it doesn't have a cool acronym):
This is basically the same story that got bandied around the news a lot last summer when everyone was desperately trying to figure out where the world's economy went. Except the cast has changed ever so slightly--by one letter actually. Last year's revelation that the leading rating agencies categorically failed to properly identify the risk in CDOs (financial packages full of different bonds backed by different loans made to different little people who were trying to buy little houses and little cars and little college tuitions), has been replaced with the shocking bit of news that, by the way, those same rating agencies also failed to identify similar risk in CLOs (financial packages full of different bonds backed by different loans made to different big people who are trying to buy big factories and big regional banks and big CDOs).
If you don't follow what I'm saying, the details aren't particularly important. What I think is important is that:
a) the entire point of constructing these needlessly complicated securities (CDOs and CLOs) was to reduce the risk of investment. Loaning money to one person or one company is kind of risky; maybe there is a 10% chance that that person or company will default and the lender will lose out. Loaning money to a whole bunch of people and then repackaging their loans into little, fancily titled securities was thought to be less risky; the risk that all of these loans would stop performing (the debtor would default) simultaneously is significantly less than 10%. But with lax regulation and lax oversight--i.e. rating agencies failing to recognize that the debt of 35 companies is touching perhaps half of the market--these kinds of debt security markets have only amplified rather than dampened the risk.
b) It's been said many a-time but I'll say it again: the rating agencies that evaluate the relative riskiness of these securities either need to be nationalized or to see the very foundations of that industry's business practices reformed. These are private companies that are paid per rating by the companies for whom they are doing the rating. Obviously their customers want a high rating for their bonds and the rating agencies like to retain the business of their customers. Wouldn't it be nice if the Food and Drug Administration worked that way when it decided on whether or not to approve a new anti-depressant ? Or if EPA had to compete with other agencies to evaluate the sulfur emissions of a coal plant?* It doesn't take a Nobel prize winning economist to identify the problem here. In fact, at this point its probably best if we keep the Nobel prize winning economists in the other room for now.
*For the sake of my argument and mental health I am assuming that this is not how either the FDA or the EPA work.
Well think again, square! Old is the new new, black is last month's red, and incompetently rated asset backed securities are this weeks Chapter 11 bankruptcies (actually, Chapter 11 is still around too, but its probably unfashionably depressing to talk about because it doesn't have a cool acronym):
Standard & Poor’s has highlighted that many collateralised loan obligations – which pool leveraged loans and sell differently rated investment notes with varying risk profiles – have exposure to the same group of borrowers. The default of just one of these widely held borrowers on their debt could have a negative effect on the credit quality of the portfolios of nearly 90 per cent of European CLOs, the agency said in a report.
In fact, the debt of just 35 different borrowers appears in nearly half of the 184 CLO portfolios that S&P rates. In total, those funds hold at least €90bn in assets. (Source: Financial Times)
This is basically the same story that got bandied around the news a lot last summer when everyone was desperately trying to figure out where the world's economy went. Except the cast has changed ever so slightly--by one letter actually. Last year's revelation that the leading rating agencies categorically failed to properly identify the risk in CDOs (financial packages full of different bonds backed by different loans made to different little people who were trying to buy little houses and little cars and little college tuitions), has been replaced with the shocking bit of news that, by the way, those same rating agencies also failed to identify similar risk in CLOs (financial packages full of different bonds backed by different loans made to different big people who are trying to buy big factories and big regional banks and big CDOs).
If you don't follow what I'm saying, the details aren't particularly important. What I think is important is that:
a) the entire point of constructing these needlessly complicated securities (CDOs and CLOs) was to reduce the risk of investment. Loaning money to one person or one company is kind of risky; maybe there is a 10% chance that that person or company will default and the lender will lose out. Loaning money to a whole bunch of people and then repackaging their loans into little, fancily titled securities was thought to be less risky; the risk that all of these loans would stop performing (the debtor would default) simultaneously is significantly less than 10%. But with lax regulation and lax oversight--i.e. rating agencies failing to recognize that the debt of 35 companies is touching perhaps half of the market--these kinds of debt security markets have only amplified rather than dampened the risk.
b) It's been said many a-time but I'll say it again: the rating agencies that evaluate the relative riskiness of these securities either need to be nationalized or to see the very foundations of that industry's business practices reformed. These are private companies that are paid per rating by the companies for whom they are doing the rating. Obviously their customers want a high rating for their bonds and the rating agencies like to retain the business of their customers. Wouldn't it be nice if the Food and Drug Administration worked that way when it decided on whether or not to approve a new anti-depressant ? Or if EPA had to compete with other agencies to evaluate the sulfur emissions of a coal plant?* It doesn't take a Nobel prize winning economist to identify the problem here. In fact, at this point its probably best if we keep the Nobel prize winning economists in the other room for now.
*For the sake of my argument and mental health I am assuming that this is not how either the FDA or the EPA work.
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