And I thought it was illegal to buy votes in the US….

February 18, 2009

Apparently, the Obama administration is going to subsidize $75 billion in mortgage payments to nine million American households in the name of debt relief. So now we now have a government put-option aimed to help speculators in the event that they paid for too much on the speculation and can’t dump it off at a profit. Aside from the fact that the government is encouraging speculative behavior with this outrageous subsidy,  how important are nine million votes (mortgaged for 30 years) in national elections? For the first time in history, we might have a situation where the term on someone’s mortgage isn’t related to a household economic decision but a ploy to keep the allegiance of a group of voters.


Paulson’s ‘Mandarin’ plan to deal with toxic debt

January 16, 2009

Henry Paulson’s connections with the Chinese elite, nortured by more than 70 visits to the mainland as a private banker, have been widely acknowledge by the media. Perhaps that explains why Paulson latest plan to dump financial system’s toxic assets into a single ‘aggregator bank’ looks eerily similar to the Chinese effort in the late 90s to dump nonperforming loans into state-financed ‘asset management companies’ (AMCs). In a paper titled “The Chinese Conundrum: External Financial Strength, Domestic Financial Weakness”, Brad Setser, now a fellow at Council on Foreign Relations, elaborates on the Chinese model:

In 1999, RMB 1400 billion ($169 billion at 1999 exchange rates) in bad loans—roughly 20 percent of total loans at the time—were taken off the banking system’s books and given to four asset management companies.

Furthermore,

In addition to taking the banks’ bad assets, AMCs also assumed some of the banks’ liabilities to the People’s Bank of China. As a result, both the central bank and the SCBs ended up with large claims on the AMCs. Early recovery rates on the bad loans transferred to the AMCs were around 30 percent of book value, but recovery rates subsequently fell to 15 to 20 percent of the book value. Formally, the finance ministry has not guaranteed AMC bonds (Ma, 2006)—but there is little doubt that taxpayers ultimately will need to bailout the AMCs.

The gov’t will probably take the ‘carve-out’ approach, which means that they will purchase toxic assets at book value (or higher, possibly at par) and thus avoid write-downs on equity (or  to recapitalize by cash inject if they are to buy at par).

Presumably, the government does not have to mark its assets to market if the public does not demand strict supervision. But if the recovery rate is low and if the Dem. congress uses this as a tool to further impair the assets  in order to bail out the segment of the constituents facing default, the ultimate cost will be levied on all taxpayers.

footnote:

Setser, Brad. (2006),  The Chinese Conundrum: External Financial Strength, Domestic Financial Weakness (May),  CESifo Economic Studies. <http://cesifo.oxfordjournals.org/cgi/rapidpdf/ifl005v1.pdf&gt;


Going down the road of socialism

January 13, 2009

Responding to an article that appeared in the Boston Globe about the need to address foreclosures, I wrote the following post on 9/24/08:

While I agree that some carefully selected measures to help debtors may be successful, they are not without some major risks and long term issues. For one, this would set a precedent for the government to be able to step into a contract where one party is not able to perform, tear up a perfectly legal contract (whether it’s perfectly moral is not the question here), and restructure the terms of the contract, arguably just to score some votes come election time. To do that you would have to have the consent of the creditors, or this country would certainly be going down the socialist road for sure.

It appears for now that the gov’t does in fact have the consent of the creditors by the virtue of the fact that the gov’t is the majority owner of the banks.

This is David Goldman’s perspective at Inner Workings:

Take sub-prime mortgages, for example. After hitting a low of $32.5 in mid-November, the ABX 2007 vintage AAA index of sub-prime mortgage-backed securities rose to $45 at the end of December, before tumbling back to $37.5 today. The proximate cause for the reversal was Friday’s agreement among Congressional Democrats to “cram down” mortgage payments in the event of bankruptcy, a prospective change in law that in enacted will impair mortgage cash flows.

It increasingly looks like that the bailout is not merely a passive investment but a nationalization in the true populist sense of the word.