Financial Crisis for Dummies: Lies, Bailouts, and Hank “Fudgie the Whale” Paulson (09/21/2008)

[OLD POST - LNIKS MAY NOT WORK]

The financial crisis that’s convulsing Wall Street and Washington can be offered up as Exhibit A in what we mean when we say “Literal Mayhem.”

The situation is quite literally mayhem: economically and politically.

But there’s a bigger fish to fry here: what we might call mayhem of the literal.

This crisis is, in many respects, the culmination of years and years of “perception management” and manipulation of language (by powerful, monied, self-interested parties) around key public policy issues such as “regulation,” “free markets,” “ownership society,” and “private investment.”

Our common language around these issues — and taken-for-granted understanding of their meanings — shapes how we perceive (or don’t perceive) the current calamity (and it is a calamity), as well as our instinctive responses to the language of the proposed “solutions.”

That’s the “literal” part of Literal Mayhem. It’s this manipulation of language — and consequently perception — that leads to large-scale misunderstandings of purpose, apalling lack of foresight, and piss-poor decision making… all on the part of those who are most responsible for looking out for our interests… namely ourselves.

And the current bailout plan is nothing more than a continuation of the talking-point kabuki dance that has been going on for decades.

Exhibit B: Hank “Fudgie the Whale” Paulson

Knowing how fungible meaning is in this world, my motto is: pay attention to what people do, not what they say. And in this regard, understanding the Treasury’s current bailout proposal, as well as everything Paulson and his spokespeople say about it, you have to understand who Treasury Secretary Hank Paulson is from a psychologiocal perspective.

As former CEO of Goldman Sachs, he is… a whale.

According to the DoubleTongued Dictionary: a serious, heavily funded bettor; a high roller.

According to the Urban Dictionary: a person who spends extremely large sums gambling (from hundreds of thousands to millions of dollars). Hotel and casino management will go to great lengths in the perks and luxuries they will offer whales to entice them.

And as such Hank is… he himself, the man, personally… is among the worst offenders in this sub-prime debacle.

According to a Bloomberg news article from last November:

Goldman, the most profitable investment bank, was one of 14 primary dealers of U.S. Treasuries who contributed to a three- year binge as $1 trillion of subprime mortgages were packaged and sold to investors.

Goldman ranks 10th among 118 issuers, based on the amount of subprime loans still on the market. Bonds with a face value of $484.6 billion remain from those created in the years Paulson ran Goldman.

Goldman under Paulson created 58 mortgage pools branded under the acronym of GSAMP, which originally stood for Goldman Sachs Alternative Mortgage Products, starting in July 2002. The value of the loans at risk of default is almost 50 percent for one Goldman pool, according to Bloomberg data, which includes pools identified as containing home equity financings as well as subprime mortgages.

The average delinquency rate for subprime bonds sold from May 1999 through June 2006 is 19.3 percent as of yesterday, according to data compiled by Bloomberg. Among the top 20 issuers that have more than $5 billion outstanding, Goldman’s GSAMP ranks ninth with 21.7 percent for delinquencies of 60 days or more, foreclosures or real estate that has been taken away from borrowers.

Sec. Paulson sees this “market” challenge from a whale’s perspective, and no other: they made the market, and so to Hank, he and his cronies ARE the market.

Thus, providing “liquidity” and “relief” to the “market” means propping up their shaky investments with tax payer money until they can be unloaded. Then the whales can get back about the business of sensible lending and investing, with no scars, and none the worse for wear… because their health is a mandatory pre-requisite for America’s economic health.

I call him “FUDGIE the WHALE” because his entire plan is a “fudge”…

• It avoids the real issue…

• Reward the wrong behavior (leverage and mis-pricing of risk)…

• Compensates the wrong people (speculators)…

• and basically makes him U.S. Debt Czar, with a $700 billion dollar checkbook… and no oversight of Sir. Hank… one of the top-ten culprits in this whole mess.

I also call him “FUDGIE the WHALE” because he is full of fudge.

The Most Dangerous Lies of All

First, the best place I have found on the web for informed, rational, hype-free, breaking analysis of these issues is a site called NakedCapitalism, especially the post called Why You Should Hate the Bailout. (And the comments are well worth reading, too.)

I am not going to get into the details of the bailout proposal, only examine its fraudulent narrative underpinnings, the goal of which seems to be keeping the public anesthetized, so that “experienced leaders” in both political parties can ram through a “solution” before taxpayers know what hit us.

These are the three big lies… the three conceptual lies at the heart of current debate, and they are all summarized in a nice little quote from Czar Hank in his interview on ABC:

“Once we stabilize the market, we need to ask ourselves how did we get here and how do we avoid getting here again.” (Watch the clip only if you can stand watching Hank bloviate without serious challenge from Boy George.)

Lie #1: We Don’t Know Why It Happened and How to Avoid It.

We know exactly why it happened:

Since the early 1990s, the Feds (the President, Congress, and various regulatory agencies) steadily abdicated responsibility for imposing sane credit/risk standards on the market — for both lending and investing.

(In this regard, some of nakedcapitalism’s quotes from insiders about the casino-like atmosphere in the financial services industry are quite illuminating.)

And avoiding a repeat requires putting toothsome regulations back in place and then enforcing them.

Lie #2: We Don’t Know How It Happened.

We know exactly how it happened. In broad scope:

1) Investment bankers figured out how to game the system: selling below-investment-grade assets with investment-grade ratings through the magic of securitization — thus creating an enormous new market for something that once only had limited appeal due to its high risk.

2) Mortgage lenders and originators rushed to meet the huge new demand from investment banks for below-investment-grade paper… making hundreds of billions of $ in bad loans to people who had no more collateral than pocket lint and a pencil eraser.

3) The new rush of cheap money led to rapid house-price inflation — rising more than 3-times the rate of overall inflation in some markets (even higher in others) — and homebuyers got greedy. They bought more than they could afford… speculating either on flipping, or on ever increasing equity of their primary residence. They bought mortgages that left them vulnerable to interest rate increases. And as prices inflated, lenders and originators could write ever more and larger loans to keep the system (bubble) growing.

4) The Fed colluded by keeping interest rates at historic lows year after year.

5) All kinds of financial companies, including the shadow banking system, took the cash flow from these shaky loans and manufactured “securities” that were then sold to other institutions and hedge funds, which often bought them with borrowed money. Many of these buyers turned around and packaged their cashflows into new “derivative” securities and sold them to investors who bought those with borrowed money. And so on, and so on… with the ultimate buyer owning a cash-flow stream that had a frighteningly low level of real assets underlying it, and was leveraged to the hilt.

6) The ratings agencies colluded by rating the “security” of the senior cash flow holders as AAA, even though the ratings were based on poorly understood default scenarios, little in the way of real assets, and layer upon layer of leverage, which amounted to double- and even triple-digits. (The speed and scope of subsequent ratings declines showed how little the ratings agencies truly understood the “risk” they were rating.)

7) These crappy “securities” were sold back into regulated financial institutions as AAA-rated debt, and institutions far and wide gobbled them up because they thought they were getting a free lunch: i.e., higher returns, without taking on commensurate risk.

There was greed, froth, and reckless disregard for risk at every step of the game, by every player, with the government fanning the flames with persistent low interest rates and lack of oversight.

Lie #3: We Don’t Know What Needs to Be Done

The idea that we need to keep the bubble bouncing for financial institutions with a $700 billion bailout because we need time to figure out what to do… is complete BS. We know exactly what needs to be done. We just don’t have the stomach for it.

And we do ourselves a disservice by using spin to hide behind the tactical complexity, obscuring what is, in reality, a very simple conceptual problem.

The problem was best summarized (if somewhat erroneously) by Princeton economist Alan Blinder, who told the New York Times:

“It’s easy to forget amid all the fancy stuff — credit derivatives, swaps — that the root cause of all this is declining house prices. If you can reverse that, then people start coming out of their foxholes and start putting their money in places they have been too afraid to put it.”

Here is the core conceptual problem: you can’t “reverse” the problem of declining house prices.

This is a non-starter being peddled by the home-building lobby, the lending lobby, the securities lobby, and an army of other culprits. They are trying to sow and then exploit false hopes among the public that their houses are still worth what they think they are worth… when all these liars know that is not the case.

House prices reached all time highs based on increases that are ridiculous on their face. As one commenter on nakedcapitalism pointed out, at its peak, the implied rate of inflation for housing was for a compounded annual growth rate of 10% or more, which would mean that a home worth $1.5 million today would be worth $26 million by 2038.

To get back to historically rational price levels, house prices would have to fall another 15% to 20% on average. And so, the truth is, at the highest level of the problem we only have two choices:

1) The reality-based choice: bite the bullet and accept that much of the debt-fueled American economy is built on inflated housing prices; mark these underlying “assets” (houses) down to their “fair market value”; then sort out the impact.

There will be shock and pain in the financial system as layers and layers of debt unwind. A lot of firms and funds will go belly up when their “margins get called”… so to speak. And homeowners will have to take their medicine too.

But the dust would settle in short order, and we’d get a much clearer picture of where the pain is most acute. Then the Feds can structure a real bailout for legitimate victims, instead of speculators. This would ensure that taxpayer money (yours) recapitalizes the financial system in a rational way — i.e., allowing the healthiest, most sensible institutions to continue living. The benefit of this approach is that:

it’s HONEST… faces up to reality and fixes the core problem

it’s ADULT… makes each of us bear our respective and appropriate burden

it will cause sharper short-term pain but enable a faster and better targeted recovery

Then there is the other option…

2) The Mr. Hanky solution: continue the charade that housing prices will “recover”; buy a boat-load of assets that Paulson continues to assert will eventually be sold at a minimal loss; push this spiraling debt onto multiple generations; insulate his buddies from their bad behavior; and destroy the value of the dollar.

Once the dust settles on this one, we will find this “solution” to be inflated rhetoric, not reality. The whole reason that these assets are “illiquid” is because no one knows how much they are worth. The market has been unable to accurately value them. That’s why they can’t be sold.

On the other hand, there is no shortage of liquidity for the circling vultures who are willing to buy them for pennies on the dollar. Asset holders just don’t want to sell that low. They think they ought to get more, but no one in the market is willing to pay more.

So along comes their buddy Hank (with our money), who agrees to pay them whatever they want. He says that he will eventually sell these assets, but he cannot honestly tell you for how much. Any claims in that regard are PURE SPIN aimed at reducing opposition to his plan.

But most important, this approach does not fix the underlying problem: asset prices are still inflated, and leverage remains in place. Those structural issues will sink the plan eventually… if not now, then a few years from now with the same, or even worse consequences.

This disadvantages to this option:

it’s INTELLECTUALLY DISHONEST

it’s IRRESPONSIBLE and PASSES THE BUCK

it virtually guarantees to drag out this disaster for years (potentially 10 years or more), solving nothing and causing even greater pain down the road

Now We Have Seen It All…

What we have been witnessing over the past week or so amounts to a lot of talking doo-doo. A great many terms are bandied about, like “illiquid assets,” and “market correction,” and “free market solution,” etc. But the simple reality is that the US financial system is built on a big pile of worthless debt that likely will never get repaid.

Like most financial catastrophes, it started with a financial genius who had a brilliant idea, and it went straight downhill from there.

The problem will not fix itself. We have to fix it, and the first most important step in that long, surely tortuous path is to admit the truth — about what caused it and what will be required of us (not our grandkids) to right the ship.

Continuing to blur the issue with mayhem of the literal sort — fraudulent frames of reference, false choices, and linguisitc half truths — will only exacerbate the current political and economic mayhem.

And short of total linguisitc and conceptual honesty, I can only make….

One Alternative Suggestion for “Market Discipline”:

BRING BACK THE GUILLOTINE?