Have you thought about it this way…?

January 21, 2009

I. Regarding the auto bailouts: here is the real story, the one you won’t hear on the news:

As you now know, after weeks of downplaying the issue, Treasury, a few days before the bailout was finalized,  hinted it may actually be willing to use TARP funds to fund a short-term bail-out for the Big Three. You may ask yourself why the reversal.

If you remember, GM brought in the BK attorneys about a week before ‘to consult’. This move was aimed at squarely at the capital markets: GM has roughly $1 trillion in outstanding credit default swaps.

There are tens of trillions in unresolved CDS out there. The problem of unwinding these swaps in the absence of a CDS exchange (to monitor liquidity or carry out liquidations to cover positions) is at the heart of this financial crisis. As many of the original readers (pre-wordpress) remember me saying over a year ago, this crisis has little to do with mortgages. This is a capital markets crisis.

This is why reorganization through a BK court has not seriously been entertained.

If a BK court was allowed to resolve credit default swaps, it would rattle the financial markets beyond the control of the central banks. The decisions of the BK court would set precedent that could then be used to challenge CDS agreements in court. Further, these precedents would stand in other BK proceedings (think Lehman) and major financial institutions (already functionally insolvent) would collapse.

That’s the play.

And it appears to be working, from the Fed’s perspective.  As with TARP, your elected representatives cannot stop this, even if they wanted to.  As with TARP, the letters, emails and phone calls against the auto bailouts was somewhere north of 100:1.

So much for implied consent…


It’s not that BK court trumps Treasury or the Fed, per se. They just perform different tasks. Treasury and the Fed cannot overtly unwind a contract. They cannot overtly liquidate a company’s assets or force them to take any specific action. All they can do is give them money, perhaps with some pre-agreed-upon strings attached.

A BK court, however, has the power to compel action. A BK court can force a company to liquidate assets; it can unwind contracts (supplier, labor, or financial contracts), etc. Behind any court’s decisions, ultimately, is the power of the state to compel by force.

In fact, any court has the power to trump contracts unless otherwise restricted to do so by legislation (that is not challenged as unconstitutional).  Similarly, courts trump the other branches of government. If legislation is passed, or an executive order decreed, that is found by the Supreme Court, for example, to be unconstitutional, then it can be unwound by the court. Treasury decisions are trumped by the Supreme Court. Technically, a challenge could be filed with the Supreme Court regarding allocation or TARP funds, or the whole concept of TARP, though I doubt it would. The extent to which Federal Reserve decisions are subject to review by the Supreme Court is unclear, as it is untested. The Constitution does not address the Federal Reserve as it is a fairly new super-governmental institution- a private corporation operating under the guise of a government entity, but is not subject to any direct balancing by any branch of government.

The problem as the banks (including the Fed) perceive it, with allowing a BK court to set precedent in unwinding CDS is that it poses a “systemic risk” (aren’t we growing weary of hearing that term?) to the capital markets, and to the institutions on various sides of a $40+ trillion dollar universe of CDS. This is not a direct threat to Treasury or the Fed, but it adds another layer of systemic risk that, ultimately, both Treasury and the Fed will work to prevent, as we have seen, even if it means handing out vast sums of money to financial companies that are deeply underwater as it regards the market value of their CDS. What the Fed wants to prevent is instability. In an unstable environment, the Fed wants to limit uncontrolled instability. As for Treasury, it’s really just an arm of the Fed. Anyone who doubts this hasn’t been paying attention. The financial companies, with support by both Treasury and the Fed, are trying to prevent the great unwind or, more precisely, an ‘uncontrolled’ unwinding of CDS.

Take CDS out of the equation and you have a very straightforward manufacturing company that has creditors, union contracts, facilities, suppliers, equipment, etc. It’s tangible and can be reorganized in court.

With the financial issues as they exist, suddenly there are many other (larger) players with great interest in preventing the more complicated derivatives to be unwound by a court.


The bottom line: the “auto” bailouts had nothing to do with either cars or jobs. 



II. The  modern bank: and we call what Madoff had a “ponzi scheme”


You put your money in a bank. You invest your money in the bank rather than put it in a safe. It’s more convenient. Plus they pay you a fixed rate of interest. They are “insured”. By the “government”.  Nobody asks how they are able to pay you that rate of interest on your deposit.

One day you decide to withdraw all of your money from the bank.
So they give you somebody else’s money. Or whatever money they keep on hand in any given day.

If everyone decides to withdraw all their money, we have what’s called a “run on the bank”. And then the government declares a bank holiday. Why? Because the truth is that the bank does not have enough money to give everyone their money back. They say it’s because the money is “invested”. The capital is put to work, as it were.

In reality they are operating under a fractional reserve lending system whereby your 1 dollar becomes $9 in loans. With the push of a button.  Do the exponential math. But, hey, it’s insured by the “government”. In actuality, the government doesn’t have any money at all. The government only has tax receipts. So we learn that the government doesn’t have any actual money, and the banks don’t have any actual money.

And we call what Madoff was running a “ponzi scheme”…

III. Wall Street Executives: Brilliant


Our government, against overwhelming opposition by their constituents, passes TARP. TARP, we are told, will be specifically for financial institutions. It will specifically deal with “systemic risk”. It will also have oversight, and there will be strict limits on executive compensation.

And then it is spent on automobile manufacturers.

And then we change the channel.

Then we get up and go to work so we can finance this.


We complain that those running our financial institutions are incompetent.


I wouldn’t be so sure about the incompetence part. I think those investment banksters who have profited from this over the years and are now receiving government bailouts have been exceptionally competent. Frauds like this don’t just happen by accident. They happen by design.

Look at Kraus: http://latimesblogs.latimes.com/mone…ll-be-tha.html

Look at Thain: http://online.wsj.com/article/SB1228… n2008_mostpop

et al: http://www.freep.com/article/2008122…SS07/812230345

How about O’Neal with $162 million in total package after ‘losing’ Merrill untold millions.

These examples are from just one company…

My personal favorite is the Countrywide executive who took his family on a 3-week safari vacation in Africa…. on the company jet.

That’s billions of dollars in financial executive compensation and severance, not to mention compensation earned during the last several years of the boom and other packages paid out prior to 2007.

Incompetent? Hardly. These men are geniuses.

It’s the citizenry that are incompetent, and incapable of holding a minarchist Republic. 


IV: Bankruptcy “cram downs” of mortgage debt


This will be a big push in 2009.  Expect this to pass.  And expect it to be an absolute disaster.


This is an issue that many agree upon.  “It’s the right thing to do.”  It’s “consumer friendly”.  It’s part of the bailout for “Main Street”.  Right?


Absolutely wrong.  And here’s why: today, there is virtually no private money available for mortgage lending.  The mortgage industry in the United States today is essentially a government operation, with the overwhelming number of mortgages originated being backed by either FHA, or one of the “Government Sponsored Enterprises” (GSE’s): Fannie Mae or Freddie Mac.  The reason is simply that no investor is interested in purchasing mortgage backed securities (MBS) today after the collateralized debt obligation (CDO) fiasco.  There is an absence of trust given the fraudulent ratings of these securities.  As the market self-corrects, trust will return.  Securitized lending will also return, albeit in a much different form that it has existed for the past 8 or so years.


If American courts are given the authority to arbitrarily change the terms of a legal contract, what effect is that going to have on the willingness of investors to put money on the table in the form of mortgage backed securities?  What little money is gambled will be dear – manifesting in higher interest rates for borrowers.  (note: when I say “interest rates”, I am speaking to market rates, not manipulated government bond rates).


Those who support such measures suffer from two misunderstandings.  The first is basic economics, which is not our mission here.  The second is a misunderstanding of how credit markets (capital markets) work, as well as how consumer credit is created and allocated in a fiat currency economy.  Many labor under the misconception that banks “lend” their money.  In reality, this is not the case.  Banks simply put up money to guarantee MBS.  The money to lend comes from investors, with banks simply fronting the cash, or really brokering the funds, to their borrowers as a percentage of their overall assets.  In the case of a traditional bank, this is 10:1.  In the case of the investment banks, this could have been 70:1 prior to the collapse of investment banking and their transition to “bank holding companies”. 


Given this reality, those who desire a market correction, as with all things, are reminded to be the champions of minimal regulation, not additional regulation.  Bankruptcy court cram downs, while appealing to many, are an economic disaster that will only exacerbate the problem, costing taxpayers significantly more money over the long term as government continues to fill the void in private mortgage money.



2 Responses to “Have you thought about it this way…?”

  1. […] follow up on what I touched on in here, let’s take a little tour of bonuses and severance payments since the current credit crises […]

  2. Liza Says:

    I read your posts for a long time and should tell you that your articles always prove to be of a high value and quality for readers.

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