The House votes against the bailout bill but the world does not end

Why should the world end?
I am thrilled the House voted down the bailout bill.
Democracy in action.
It was a misguided idea.
I am sure Paulson will keep coming back to Congress till they vote for something.
In the meantime, the FDIC seems to be fixing this mess without any help from the proposed bailout bill. In just two days they have overseen the dispostion of two giant banks - Wachovia and Washington Mutual - at little or no cost to the taxpayer.
Jamie Dimon of JPMorgan said they would not have been able to do the WaMu deal if the bailout legislation had been in place.
Let the system work.
Paulson has been wrong about the crisis since the beginning. Enough is enough.

Wachovia and marking mortgage loans to market

Wachovia Finds Itself in ARMs' Way

By PETER EAVIS

Here's betting James Dimon isn't very popular with certain other bank chief executives right now. Particularly Wachovia's CEO, Robert Steel.

Mr. Dimon's J.P. Morgan Chase scooped up the remains of Washington Mutual after it was seized by the Feds. Lancing the WaMu boil was a boon for financial markets, but may make life tough for some of Mr. Dimon's peers.

As part of the deal, J.P. Morgan forecast large losses on $176 billion of WaMu's mortgages. Applying J.P. Morgan's projections to other large banks implies higher losses for those with WaMu-like assets.

Associated Press

Wachovia CEO Robert Steel

Wachovia looks pretty ugly under this approach.

This may be one reason why Wachovia's shares plunged Friday.

Take option-adjustable-rate-mortgages. On these, J.P. Morgan foresees additional losses equivalent to around 20% of the total. Adding losses already taken by WaMu leads gives a cumulative loss rate of 25%, according to Morgan Stanley analysts.

By contrast, Wachovia, with $122 billion of Option-ARMs, is forecasting a 12% loss-rate. Ratcheting that up to 25% implies as much as $15 billion in extra losses.

J.P. Morgan's numbers, meanwhile, imply that the loss rate on WaMu's home-equity loans could hit 31%.

Granted, investors should be careful with this approach. First, there is a potential incentive for J.P. Morgan to set loss forecasts at a high level at the time of the deal. Doing so can help make its WaMu acquisition look more profitable over time.

Also, banks might soon be able to drastically lessen their exposure to toxic mortgages by selling them to the government.

Next, investors need to remember that WaMu grew particularly fast during the mortgage boom, so its lending may have been less discriminating, leaving it with worse borrowers and higher losses than peers.

Then again, looking at Wachovia's Option-ARM borrowers, it is hard to make the case that the bank's portfolio is going to perform better. Some 20% of its Option-ARMs were made to deep subprime borrowers with FICO credit scores under 620 and another 21% had scores below 700.

Losses can't be looked at in isolation. Some banks might be able to absorb higher-than-expected credit costs because they raised surplus capital and have strong earnings coming from their healthy businesses.

What's more, banks don't mark down their loans every quarter like brokers. Instead, they build loan-loss reserves, a more incremental approach that, in theory, gives banks time to heal themselves.

But credit markets, where banks do some of their funding, are impatient. Banks that have moved quickly in this crisis have fared better than those that have dawdled. If WaMu had sold itself to J.P. Morgan in the spring, it wouldn't have been seized this week. And Merrill Lynch now looks smart for selling out to Bank of America.

Wachovia is in preliminary deal talks with several suitors. But to deal with Wachovia's balance sheet, a buyer needs to be strong, not just big.

Median home prices to median family income

September 3, 2008, 1:38 pm

Home-Price Bottom May Still Be a Year Away

Home Depot Inc. CEO Frank Blake told a Goldman Sachs retail conference that some recent housing trends indicate “we’re getting awfully close to the bottom” of the current correction, but economists at Credit Suisse say that one of the major metrics — home prices — aren’t going to reach lows for at least a year.

Blake pointed to trends showing private residential investment has fallen to about 3.5% of gross domestic product at the end of the second quarter from a peak of about 6.25% at the end of 2005. Other housing data, such as mortgage equity withdrawal rates, also indicate “a lot of the over-exuberance in our market is getting squeezed out,” Blake said. “We don’t think we’re at the bottom yet, but we think you can see it from here,” he said.

However, any bottom call in housing will hinge on the direction of prices, which have been on the decline for three years. Finding the low point for home prices is difficult, as there isn’t just one index to track, but at least three major gauges — the S&P/Case-Shiller index, the Ofheo home-price index and the National Association of Realtors median existing-home price data — that all have advantages and shortcomings. Economists at Credit Suisse looked at the different indexes compared to several metrics and see equilibrium being achieved in 12 to 18 months.

One of the key comparisons was the NAR median existing-home price (seasonally adjusted by Credit Suisse) to median family income. The ratio maintained a relatively narrow range from 1981 to 2000, when it started to explode. Assuming that trends in prices and incomes remain constant, Credit Suisse forecasts that home price will return to the historical range some time late next year.

“What’s evident is that a substantial down payment on the housing adjustment has already been made, although there still appears to be wood left to chop,” Credit Suisse said in it research report. –Phil Izzo

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Financial Crisis

As far as the financial crisis goes, Mr Paulson has been wrong about the crisis since it began and he is wrong now. It is not the end of western civilization as we know it, but the normal functioning of the economic cycle. There are always booms and busts in capitalist systems - does anyone remember the dot com boom and bust? This is just the busting of the housing boom in America with the added twist of the explosion of subprime mortgages and their securitizaton and spread all over the financial system. Paulson does not need $700 billion to buy all the toxic assets. Let the banks write them off and raise new capital. Paulson is just a drama queen and is trying grab more power for the US Treasury.

The lesson of the Great Depression as set forth by Friedman and Schwartz in their groundbreaking "Monetary History of the United States" is that the Federal Reserve made the depression worse by allowing the money supply to contract drastically as hundreds of banks went under in the 1930s. Applied to today's crisis, that would mean that the Fed should keep lending to banks by accepting any assets they have as collateral for loans. The Fed is already doing that.

We are already in a recession and the unemployment rate will probably hit 7% in the next year. Economic cycles are a fact of life and there is no way to avoid them. By trying to avoid the consequences of the dot com bust earlier in the decade, Greenspan's Fed flooded the system with liquidity. That created the conditions for the lending boom of this decade and the subprime debacle.

Punchdrunk Paulson

There is no rhyme or reason to all the interventions from Washington.
Why save AIG, and not Lehman Brothers?
Why give JPMorgan $29 billion to buy Bear Stearns?
All this is being done on an ad hoc basis with no overarching philosophy.
A Republican administration has presided over the most far reaching intervention in the financial markets since the Great Depression in the 1930s.
Why have they forgotten the lessons that Milton Friedman drew from the Great Depression? None of the Keynesian pump priming worked. The reason the Depression was so severe was that the Fed did not know what it was doing and destroyed 30% of money supply by liquidating foreclosed banks.
The lesson for this crisis is for the Fed to keep the system liquid by injecting Fed Funds and keeping money supply stable.
The attempt to buy mortgages in an RTC Part II is misguided - it does not allow the excesses to be cleared out, and it inflates federal government borrowing.

Is Barack Obama going to make it?

A Bad Bank Rescue

This piece from Sebastian Mallaby in the Washington Post is excellent on why the Paulson bailout is a bad idea.
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/20/AR2008092001059.html


A Bad Bank Rescue

By Sebastian Mallaby
Sunday, September 21, 2008; B07

With truly extraordinary speed, opinion has swung behind the radical idea that the government should commit hundreds of billions in taxpayer money to purchasing dud loans from banks that aren't actually insolvent. As recently as a week ago, no public official had even mentioned this option. Now the Treasury, the Fed and congressional leaders are promising its enactment within days. The scheme has gone from invisibility to inevitability in the blink of an eye. This is extremely dangerous.

The plan is being marketed under false pretenses. Supporters have invoked the shining success of the Resolution Trust Corporation as justification and precedent. But the RTC, which was created in 1989 to clean up the wreckage of the savings-and-loan crisis, bears little resemblance to what is being contemplated now. The RTC collected and eventually sold off loans made by thrifts that had gone bust. The administration proposes to buy up bad loans before the lenders go bust. This difference raises several questions.

The first is whether the bailout is necessary. In 1989, there was no choice. The federal government insured the thrifts, so when they failed, the feds were left holding their loans; the RTC's job was simply to get rid of them. But in buying bad loans before banks fail, the Bush administration would be signing up for a financial war of choice. It would spend billions of dollars on the theory that preemption will avert the mass destruction of banks. There are cheaper ways to stabilize the system.

In the 1980s, the government did not need a strategy to decide which bad loans to take over; it dealt with anything that fell into its lap as a result of a thrift bankruptcy. But under the current proposal, the government would go out and shop for bad loans. These come in all shapes and sizes, so the government would have to judge what type of loans it wants. They are illiquid, so it's hard to know how to value them. Bad loans are weighing down the financial system precisely because private-sector experts can't determine their worth. The government would have no better handle on the problem.

In practice this means the government would make subjective choices about which bad loans to buy, and it would pay more than fair value. Billions in taxpayer money would be transferred to the shareholders and creditors of banks, and the banks from which the government bought most loans would be subsidized more than their rivals. If the government bought the most from the sickest institutions, it would be slowing the healthy process in which strong players buy up the weak, delaying an eventual recovery. The haggling over which banks got to unload the most would drag on for months. So the hope that this "systematic" plan can be a near-term substitute for ad hoc AIG-style bailouts is illusory.

Within hours of the Treasury announcement Friday, economists had proposed preferable alternatives. Their core insight is that it is better to boost the banking system by increasing its capital than by reducing its loans. Given a fatter capital cushion, banks would have time to dispose of the bad loans in an orderly fashion. Taxpayers would be spared the experience of wandering into a bad-loan bazaar and being ripped off by every merchant.

Raghuram Rajan and Luigi Zingales of the University of Chicago suggest ways to force the banks to raise capital without tapping the taxpayers. First, the government should tell banks to cancel all dividend payments. Banks don't do that on their own because it would signal weakness; if everyone knows the dividend has been canceled because of a government rule, the signaling issue would be removed. Second, the government should tell all healthy banks to issue new equity. Again, banks resist doing this because they don't want to signal weakness and they don't want to dilute existing shareholders. A government order could cut through these obstacles.

Meanwhile, Charles Calomiris of Columbia University and Douglas Elmendorf of the Brookings Institution have offered versions of another idea. The government should help not by buying banks' bad loans but by buying equity stakes in the banks themselves. Whereas it's horribly complicated to value bad loans, banks have share prices you can look up in seconds, so government could inject capital into banks quickly and at a fair level. The share prices of banks that recovered would rise, compensating taxpayers for losses on their stakes in the banks that eventually went under.

Congress and the administration may not like the sound of these ideas. Taking bad loans off the shoulders of the banks seems like a merciful rescue; ordering banks to raise capital or buying equity stakes in them sounds like big-government meddling. But we are in the midst of a crisis, and it shouldn't matter how things sound. The Treasury plan outlined on Friday involves vast risks to taxpayers, huge complexity and no guarantee of success. There are better ways forward.

smallaby@cfr.org