Curses! Foiled Again!
on October 1st, 2008 at 12:44 am
You all know the movie plot: the Evil Scientist has laced the town’s water supply with a poison. All will die unless The Antidote is added, and he holds the city to Ransom. All seems lost until the Hero rides to the Rescue with The Antidote. The Hero puts the Evil Scientist behind bars, and all is well (until The Sequel anyway).
Are there any parallels here with Paulson’s currently terminated Wall Street bailout?
Well, score one for the Evil Scientist. Henry Paulson, the architect of this Plan, was until 2006 the Chief Executive of Goldman Sachs, one of the Wall Street merchant banks that profited from Subprime lending when it was in full swing—and, tellingly, also profited on the way down by correctly guessing that the bonds that financed the lending would tank (along with American house prices).
The Ransom was certainly there—US$700 billion is a pretty cool sum of money. And a lot of it would have gone to Paulson’s old firm, which stood to make money by disposing of its holdings of toxic bonds for more than their current book value—as Michael West explained in yesterday’s SMH.
But what about Paulson also being The Hero? Here he was, riding into the distressed town, with The Antidote in his saddle.
But wait a minute… Paulson as The Hero, when he was also The Evil Scientist? Then wouldn’t he have known about the Poison when he was The Evil Scientist?…
Yes, unfortunately, the real world is even stranger than fiction. At least in the movies, the Evil Scientist knows what he is doing. In the Subprime crisis, while there were certainly some who knew it was a scam from the outset, the majority conformed to what Charles Mackay so well described long ago as “Popular Delusion and the Madness of Crowds”. Paulson, like his many buddies in Wall Street who also paid themselves enormous “wages” (Paulson paid himself US$37 million in 2005 as CEO of Goldman Sachs), deluded himself into believing that Subprime lending made economic sense.
So if he didn’t understand that it was in fact a disaster waiting to happen, why on earth should anyone think that he now knows what The Antidote to The Poison is?
Certainly, buying the bonds off financiers would have enabled them to replace their essentially worthless “assets” with real money—and they could then get back into the lending game. Without The Antidote, then sooner rather than later, they would be soon forced to record those bonds, not at “book” value, but at market value—and they could become technically insolvent and unable to lend. The world financial system could have come to a halt.
But how long would The Antidote have worked anyway? Even in the weekend that it was worked out, five major financiers failed—Wachovia in the USA, Bradford and Bingley in the UK, Fortis NV in Belgium, Hypo Real Estate in Germany, and even Iceland’s major bank Glitnir—leading to state takeovers costing well over US$100 billion. How long would a US$700 billion Antidote lasted in today’s climate?
Not long, because the root problem is not the banks’ holdings of toxic bonds, but the public’s holdings of unnecessary debt. A vast proportion of the US$41 trillion debt that America’s private sector has (almost 3 times the size of the US economy) was used to finance gambling on shares and house prices in the biggest speculative bubble in global history. That debt, ultimately, is what is driving the US economy into Depression. Unless that is attacked, then a Depression will follow, whether or not Wall Street is bailed out.
Tellingly, Paulson’s original plan made no provision to reduce mortgage debt. So Paulson wasn’t being a Hero for Main Street—though I expect he believed he was. He was instead attempting to save Wall Street from itself, as Greenspan did so many times when he was Fed Chairman—but each “save” only worked because it revived the frenzy of irresponsible lending that has defined Wall Street and American banking in general.
This time, nothing can save Wall Street. There is, after all, no-one to lend to below the Subprimes, apart from those who are already in gaol. But I have the feeling that some time in the future, many of Wall Street’s current lenders will indeed find themselves doing business behind bars.
Ruckover,
Of course Oz banks are safe – as was Lehman, AIG etc etc. Just trust the pollies & bankers & you’ll be OK because they are the experts & know best (that’s why they are pollies & bankers – get it?)
Alternatively, you could get your money out of the bank and buy gold bullion.
(and it’s possible that the gold in that coin/bar you hold in your hand could have been handled by a Pharaoh 5 thousand years ago. Maybe in a few thousand years Strange Beings will look in wonder at a AUD100 note…)
The public acts based on the information that is provided to them and that information was a stable economy, capitalized banks, stable up trending markets, assurances from (nearly) all mainstream financial commentators and advisors, media and government that their investments and these markets are a sure thing and there was further encouragement with super promotion also (interesting how much the market fell since stopping short selling, with as example, BHP having dropped up to $9). They have been engendered to be loyal investors, borrowers and home buyers and they should expect accountability for the trust put in these financial professionals. What the public should be expected to do, is get on with their lives and they should not be expected to be Einsteins to foresee the dynamic of excessive credit expansion hidden in the financial books.
People need houses and need to buy them, it’s a necessity and it is also a relative necessity when home ownership is the norm and a relative necessity in comparison with their neighbours, and those necessities have been exploited here. If the banks and others have failed in trust and their charter, the public should expect intervention to protect their interests. The issue is not of their moral hazard but those of profit interests that ignored fundamental responsibilities, and if debt failure is systemic and not individual recklessness, people should not be evicted from their homes.
There is no such thing as a free lunch, it’s a question of who’s paying for it and again whose moral hazard are we talking about. The fact is home owners (mortgagees) have already paid a high cost for all this in interest payments on “unnecessary debt” and it’s an unnecessary drag on the whole economy and they will also feel the pain of their houses being devalued irrespectively; and the bottom line is, this credit expansion (at 20 to 30 times free lunch money) has been initiated by the banks and co and they have substantially profited by it and it’s time they paid for lunch. Imagine if instead of excessive interest payments, if that money had been put to better economic use how our economy may have looked. The disequilibrium disease (if I may put it that way for thought) of irresponsible credit expansion needs to be seen for what it is, and so, let market forces deal with the excess leveraging in necessary deflation but protect the public homeowners and depositors, through (as one idea): 1. setting up a social bank alternative that covers reasonable deposits; 2 stopping evictions; 3. with bankrupt banks, give home owners first option to buy their debts in fire sales, via government loans; or 4. if banks can survive, I agree, encouraging them to renegotiate mortgages to realistic levels.
Hyperinflation is a risk the public should be made aware of and monetary printing kept to a minimum. If reckless excessive leverage is allowed to fail as it should and the public protected in deposit protection and being freed from irresponsibly manufactured debts (i.e. excessive cheap credit expansion), society and the economy will do much better going forward.
We could try Senator Palpatine for character comparison, though some prefer Gollum Sachs with the view of greater powers at play. Still, it is not clear what part actors played, be they globalist, or nationalist, or racists, or banker elites, or deluded economists, crowds or individuals? What is for sure, the world has become debt viral, and reality and illusion blurred, a meddler’s paradise, so in the choices to be made it is time to remember what true love is, as communities and as a nation, our wellbeing and survival may depend on it.
If homeowners are to blame then we are expecting them to have the knowledge of economists and bankers!
That implies we should redistribute all the wages of the banking sector back to the homeowners otherwise the bankers & economists are being paid for no real purpose.
Point to one large banking institution that made public statements in the past 10 years like…
“Recently credit spreads have declined from the 100 year average of 9%/6% to 7%/6% and as a result there is 30% more credit inflating the price of the same assets, also as a result the 100 year default statistics will get skewed by the supply of this credit to ever weaker borrowers. As a value customer, we suggest you plan for these credit spreads to reverse and we only lend on a 50% LVR deposit.”
The public are as much to blame as the bankers, the governments and the speculators.
How many people do you know who have used leveraged stocks to borrow too much money to buy houses they could not afford. How many people do you know who are leading a lifestyle beyond their means, paying for it with leveraged borrowings.
In my view there is no gain without pain. The bail outs are delaying the day of reckoning. Everyone should be man enough to take their medicine now.
Not until this happens will we see some light at the end of the tunnel. Then regulations may be put in place to make this disease less likely to reoccur in the future.
Until this happens the causes of these problems will not disappear and the problems can not be fixed.
Simple but true.
Just a quick point that I have noticed.
It seems that the primary driver for the bailout is the interbank lending spreads – which make it difficult for banks to lend to each other.
Given that the banks control these spreads, would it not be possible for them to be delibrately manipulating the spreads and/or delibrately not lending to other banks with the sole purpose of creating a “crisis” so they can get rid of there bad debts?
E.g. They are delibrately exaserbating the problem to get $700B from the government when the situation may not actually be quite so bad.
Hell, I wouldn’t be lending to anyone over this period if it means I could wipe $X Billion of debt off my balance sheet.
What are your thoughts?
Hi Steve
I would be interested to hear your thoughts on what the former head of the FDIC proposed to address the current crisis.
http://www.theaustralian.news.com.au/story/0,,24429568-20142,00.html
Apparently this worked in the 80/90s.
While I appreciate that this does not solve the amount of debt out there. Do you think this could be a stabilising force? and even a possible solution to the gradual unwinding of debt or is this problem just too big for such a solution?
After watching all the dead cat bounces on the world’s stock markets – and it is truly amazing how high a dead cat can bounce – I cannot believe that the cat will actually get up again. And yet it does. Sure, your website talks about the high levels of personal debt and massively overpriced housing (is it just Australia that has not suffered a crash?), but perhaps we are immune, as the excerpt from today’s Australian seems to suggest (can all these economists be wrong?):
All eyes on Reserve Bank to rescue market
Turi Condon, Property Editor | October 02, 2008
‘The unemployment rate is currently 4.1 per cent. As job growth slows, BIS Shrapnel forecasts a rate of 4.8 per cent by mid next next year. But that’s still a pretty low rate.
On the upside is pent-up demand for housing, with about 140,000 dwellings a year being built and demand running at 170,000. Rents are also surging and next year they will begin to push some first-home buyers back into the market.
All these factors are saying two things: that buyer sentiment is paramount; and that it will be the second half of next year before real life returns to the residential property market.
Anderson believes the housing market will get worse before it gets better. House prices fell 0.3 per cent in the June quarter and he expects two more quarters of negative growth.
And of course the worry is a slew of negative headlines.
There’s that old cliche, “it’s always darkest before the dawn”.
BIS Shrapnel forecasts zero house price growth this financial year, 5 per cent next year and 15 per cent in 2010-2011.’
Well, obviously, all is for the best in the very best of possible worlds!
Would the $700 billion be more effective if it were used to buy defaulting and foreclosed houses instead of bailing out the banks?
I have an alternative suggestion based on the 1981 movie “Escape from New York”.
Buying foreclosed houses doesnt really sove the problem, as it will aritficially inflate housing prices by creating demand.
The real problem is over supply in the housing industry. According to stats from:
http://www.census.gov/hhes/www/housing/hvs/historic/histtab8.html
There are about 129M “Housing Units” in Q1 2008. Of these a staggering 18M are vacant. Worse than that, 13M of those have been vacant for a year or more. This is why housing prices NEED to fall.
Incidently, this is why Australia is significantly different to the US, our Q1 residential vacancy rate is 1.5% – thats right, a 10 fold difference to the states (http://www.abs.gov.au/AUSSTATS/abs@.nsf/Lookup/4102.0Chapter9002008).
Or I’m reading the stats all wrong.
IF the Treasury buys the debt at firesale prices… e.g. Merrill Lynch recently sold roughly $30 Billion face value at 22 cents on the dollar… $700 Billion will buy $3.18 Trillion Face value being funded at 4 – 5%. That would represent roughly 25% of all housing mortgage debt.
I will also beg to differ on the Australian vacancy rate…
If you carefully check the ABS statistics there are roughly 10% more dwellings than occupied dwellings i.e. the vacancy rate is closer to 11.5%. I accept a huge proportion of these will be holiday houses, second residences (townhouse vs rural hobby farm) etc etc. This is the perfect example of the very poor utilization of national assets that I would expect to see at the end stages of a massive credit bubble. We don’t need more dwellings, we need to motivate more productive asset utilization.
Peter W, if the banks sold at a $2.4trillion loss they would all be insolvent. That may happen anyway.
One major effect on housing has been the small number of occupants per house, something a recession will fix fairly quickly.
I agree that a 2.4 trillion loss would imply the system (in its aggregate) is insolvent. That is not true in specific circumstances though. It does allow cleaner mergers of deposit bases into solvent banks. I suspect the broad aim is to jolly it all along for enough time that the % of solvent mortgages generate sufficient short/long spread (2% deposit rate > 5.5% mortgage rate) to earn back an aggregate overall solvency… That’s a tricky act to juggle though!
Humans are greedy by nature and will always push to the limits. Just look at the history of the world in the past couple of thousand years. And there is no cure to our human nature … The world will fail again and civilizations will vanish as they have before … the question is only when
Peter W, Thanks for pointing that out, you are quite right, my numbers were based around Rental Vacancies for Australia.
The most recent comparable numbers are from the 2006 Census (do you know of more recent numbers?). These numbers have around 8,282,280 total dwellings with 818,026 vacant (around 10%). Note i didnt include Caravans, sleepers, etc in this.
This seems a bit more realistic! But still illustrates differences in our housing market to the US (even though the vacancy rate has probably increased – although not by much given we were only at 9.1% in 1996).
I just finished watching ABC’s “Q&A”, which had Peter Costello on the panel. It was really quite interesting to see him and the others talk about the great economic and financial position Australia is in compared to the rest of the world.
Costello was reminding the audience how well he did to reduce Australia’s public debt and to finally turn it into a surplus. The greatest level of dissent was from Nicola Roxon, questioning whether some of his reforms were adequate enough.
Quite simply, it was a joke, especially considering that they all missed the two elephants in the room: the debt/GDP ratio of 170% and the grossly inflated housing bubble. Not one word about private debt, while everyone was congratulating Costello on reducing public debt.
The primary reason why the three fundamental economic indicators (inflation, unemployment, and interest rates) are good at the moment is because of the orgy of debt-induced speculation that the Australian economy has been submitted to over the last decade or more.
No doubt Costello’s statements are in the same league as Henry Paulson’s of a few months ago: “everything is fine”, “the economy is strong”, etc. Keen is right when he says that neoclassicism places “blinkers” on economists so that they ignore private debt and see only equilibrium, rational expectations, efficient markets, etc.
I wonder if there are any other economists (orthodox or heterodox) in Australia who share Keen’s view on the impending doom. Any takers?
Australia has a ~$600B foreign debt and ~$100B foreign equity ~ 6% balance of payments deficit (excepting the recent +$1.4 Billion August trade) i.e. our banks source ~ $1 Billion per week from ‘other nations’ savings.
We are are continually subjecting our nation to… “the generosity of strangers”
This generosity has been relatively cheap and forth-comming for several decades, however there may come a time (sooner than latter) when these ‘strangers’ have to struggle with trouble from other strangers. Continued generosity toward us may come at a cost we would find very unpalatable.
A nice article http://business.smh.com.au/business/paulsons-reasons-for-delaying-day-of-reckoning-20081003-4szf.html
Ken,
That’s an interesting article, the U.S. taxpayer is going to be fleeced big-time over the coming years with the continuing de-leveraging.
You would think that Henry Paulson would stand aside, given his conflict of interest as he was the former Goldman Sachs CEO and holds a heap of stock in this firm.
The Wall Street Journal (as it’s the Journal of Wall Street) was wailing and bemoaning about the House not passing the bailout bill, though its become ever more apparent that it isn’t going to do much except line the pockets of the corporate executives.
I also saw Costello on Q&A last night (and Outback Oracle my wife had to shut the door because of bad language). He claimed that he left Australia with “no debt”.
This was a total lie because “Australia” is not just the federal government. It is the people, the corporations, the state governments as well as the federal government. That we had someone who did not understand this as a minister of state let alone the treasurer for so many years is appalling or is he just a liar.
I hope the current federal government understands that they have responsibility for the whole country which includes a ~$700Billion debt.
I also hope that they understand that they need to fix this.
What are the chances of an Australian bank going bust in this climate?
Is there a safer place than banks to save cash?
I don’t know much about economics or finance, so I phoned APRA and asked about deposit insurance. The woman on the phone said that whilst there isn’t any, Australian banks are very heavily regulated and pretty safe.
But as I understand it, because of fractional lending, and regardless of how well the bank might be doing, if depositors are spooked and there’s a run on the bank, the bank will go bust, won’t it?
Mattress Filler, if there is a run on a bank, it will have to stop trading. The assumption is that provided it was solvent the government would then continue operation of the bank until capital could be replenished. This is a strong risk with some of the smaller building societies.
At least in Australia the banks have better capital reserves so they are not going to become suddenly insolvent, though strange things are happening in the world. While the government doesn’t guarantee deposits its only option with an insolvent bank may be to take it over and guarantee the funds. Eventually, in better economic times, they sell the bank and hopefully recoup the losses.
If all else fails an investor would be unlucky to get less than 90% of their money back.
Alternatives are to buy Commonwealth and State bonds, these are returning about 2% less than term deposits with banks.
Talking about banks, Marc Faber said that Asian banks are solid. Singaporean banks are rock solid.
Why? That’s where I find amusing… haha….
Hmmm…. maybe except Bank of China. Wall Street investment banks tried to sell CDOs to Asian banks but weren’t successful.
I think Marc Faber used the word “DUMB” in the complimentary sense.
Interesting article and unusually honest for the mainstream.
http://www.theaustralian.news.com.au/story/0,25197,24442946-7583,00.html#
All very interesting…
The USA is struggling to prevent a massive 100 year depression that at its root was caused by house prices rising to roughly $20 Trillion (~ 1.5 X GDP) financed by roughly $11 Trillion (~ 0.8 X GDP)of mortgage debt.
In the lucky country we watch with a fair degree of ambivalence whilst we sit back in roughly $3.2 trillion of house prices (~ 3 X GDP) financed by roughly $1 Trillion (~ 1 X GDP) of mortgage debt.
What is it that makes this the lucky country?