Tim Oren's Due Diligence

Key Points on “Rescue” Plan From A Healthy Bank’s Perspective

This post is not my work. It's quoted from a letter from John Allison, President and CEO of BB&T (which is not a troubled bank) to all members of Congress. I think it's important enough to spread widely. Hat Tip: South Carolina Conservative.

1. Freddie Mac and Fannie Mae are the primary cause of the mortgage crisis. These government supported enterprises distorted normal market risk mechanisms. While individual private financial institutions have made serious mistakes, the problems in the financial system have been caused by government policies including, affordable housing (now sub-prime), combined with the market disruptions caused by the Federal Reserve holding interest rates too low and then raising interest rates too high.
2. There is no panic on Main Street and in sound financial institutions. The problems are in high-risk financial institutions and on Wall Street.
3. While all financial intermediaries are being impacted by liquidity issues, this is primarily a bailout of poorly run financial institutions. It is extremely important that the bailout not damage well run companies.
4. Corrections are not all bad. The market correction process eliminates irrational competitors. There were a number of poorly managed institutions and poorly made financial decisions during the real estate boom. It is important that any rules post “rescue” punish the poorly run institutions and not punish the well run companies.
5. A significant and immediate tax credit for purchasing homes would be a far less expensive and more effective cure for the mortgage market and financial system than the proposed “rescue” plan.
6. This is a housing value crisis. It does not make economic sense to purchase credit card loans, automobile loans, etc. The government should directly purchase housing assets, not real estate bonds. This would include lots and houses under construction.
7. The guaranty of money funds by the U.S. Treasury creates enormous risk for the banking industry. Banks have been paying into the FDIC insurance fund since 1933. The fund has a limit of $100,000 per client. An arbitrary, “out of the blue” guarantee of money funds creates risk for the taxpayers and significantly distorts financial markets.
8. Protecting the banking system, which is fundamentally controlled by the Federal Reserve, is an established government function. It is completely unclear why the government needs to or should bailout insurance companies, investment banks, hedge funds and foreign companies.
9. It is extremely unclear how the government will price the problem real estate assets. Priced too low, the real estate markets will be worse off than if the bail out did not exist. Priced too high, the taxpayers will take huge losses. Without a market price, how can you rationally determine value?
10. The proposed bankruptcy “cram down” will severely negatively impact mortgage markets and will damage well run institutions. This will provide an incentive for homeowners who are able to pay their mortgages, but have a loss in their house, to take bankruptcy and force losses on banks. (Banks would not have received the gains had the houses appreciated.) This will substantially increase the risk in mortgage lending and make mortgage pricing much higher in the future.
11. Fair Value accounting should be changed immediately. It does not work when there are no market prices. If we had Fair Value accounting, as interpreted today, in the early 1990’s the United States financial system would have crashed. Accounting should not drive economic activity, it should reflect it.
12. The proposed new merger accounting rules should be deferred for at least five years. The new merger accounting rules are creating uncertainty for high quality companies who might potentially purchase weaker companies.
13. The primary beneficiaries of the proposed rescue are Goldman Sachs and Morgan Stanley. The Treasury has a number of smart individuals, including Hank Paulson. However, Treasury is totally dominated by Wall Street investment bankers. They do not have knowledge of the commercial banking industry. Therefore, they can not be relied on to objectively assess all the implications of government policy on all financial intermediaries. The decision to protect the money funds is a clear example of a material lack of insight into the risk to the total financial system.
14. Arbitrary limits on executive compensation will be self defeating. With these limits, only the failing financial institutions will participate in the “rescue,” effectively making this plan a massive subsidy for incompetence. Also, how will companies attract the leadership talent to manage their business effectively with irrational compensation limits?

Friday Fun Vid

Tired of every youtube link turning out to be something about the campaign or the financial crisis?  Me too.  Here's something new from the crazies at Eepybird, who brought you the original Coke & Mentos meltdown.  Via Vanderleun. Enjoy!

I Oppose The Bailout; Use A Collar Instead

After several days of watching the Fed, the White House, candidates for same, and the congress critters mix it up re the proposed $700b bailout of the financial sector and dealers in sub-prime mortgages, I've reached my own conclusion: Don't do it.

Something needs to be done, but putting $700b in actual funds into the hands of the Federal government to dole out is not the right answer. Given the horrible track record of log rolling, pork barreling and earmarking of the legislative branch - and I'm talking both parties here - that's likely to lead to myriad opportunities for graft, with too little accountability to make sure we aren't creating more opportunities for moral hazard and regulatory capture.

Just as one example, if this report is true, the current proposal on the table directs several billion dollars to the leftist organization ACORN, well know for electoral fraud and the kind of CRA shakedowns that were one factor in precipitating the current crisis. (The linked articles predate the crisis and the current campaign.) Update: confirmed and it's actually worse, follow the link.

This is supposed to reassure the markets? And if there's something like that visible now, imagine what's hiding below the waterline of this Federal balance sheet busting iceberg. There's no way the current government should be trusted to handle that amount of funds reputably - the record shows that it can't.

Then what? We are indeed at risk of both a liquidity crisis, and a deflationary environment. And those 'progressives' chortling over the carcasses of defunct financial institutions had better think twice and read their history. Cross of Gold anyone? A deflationary environment is not one favorable to debtors.

It strikes me, first, that the proper role of government is to help markets function by defining their parameters, not by direct participation (which the Paulson bailout represents). Second, that one of the core issues of both the current debt and derivative markets, and the bailout purchase, is the inability to determine a likely return and therefore fair market price. (The rating agencies having blown all credibility in this matter.) What's need is in effect a sort of collar on the returns of the debt and derivatives. If this report by Michael Barone is true, then the House Republicans are effectively proposing the downside half of a collar structure. With their desire for an equity participation in return for any bailout, the Democrats have effectively put forth the upside of a collar structure, albeit in different terms. Update: More via Jeff Nolan on the House GOP framework.

There's no insurance company standing that could rationally or credibly be the counter-party to such a structure. The Feds could. It would expose the government to the risk of coverage payments in the future, but also the opportunity on the upside. It would keep $700b out of the hands of those who helped create the problems, and make sure that any future payments happened in a well-structured and transparent fashion. It would allow the offering of a variety of upside/downside structures, letting any institutions participating decide themselves how they would like to position, and creating the possibility that private counter-parties might eventually reenter the market.

Of course, the institutions should paying for this accommodation, in cash or a portion of their holdings or perhaps equity. And here I'd add one additional tweak (which I know I picked up from a blog comment somewhere, but have lost the link): Put the premiums into a real Social Security fund and out of reach of future collusive deals for their disposal. Such a fund might turn out to be worth nothing, and we're no worse off. If there's substantial value in the long run, it's a down payment on reforming the SS Ponzi scheme.

That's my story, and I'm sticking to it for at least 24 hours.

Memo: (While You Were Out) Our Financial System Went Missing

Three weeks of being on the road with wretched connectivity (about which more later) forced a partial recourse to the MSM just as the mortgage mess went into hyperventilation mode. It's really hard to imagine how anyone without previous financial background or access to decent net commentary could make heads or tails of the mess reading the tripe that's passing for news out there. Now being back at home base with decent bandwidth, I've been scouting around for the most succinct summaries to recommend for those coming up to speed.

For the textual types, there's (thank heavens) still the WSJ which, after lampooning what's passing for analysis elsewhere, gives a very nice primer of the debacle, including ID on the major villains.

For the more visual, there's this Powerpoint primer, from Tom Maguire, which delivers the fundamental logic, let's say, though scuffing over the Fannie and Freddie angle. (Those who've worked with me in the past will note that it upholds my high standards for graphic content.)

Update: Here's a nice collection of more detailed links from an econ prof. Via Jeff Goldstein.

If we get nothing else from this, we're going to have several decades supply of Econ 101 and 201 cases for:

• Perverse incentives
• Moral hazard
• Regulatory capture

Since it's impossible to avoid a political angle in this season, I'll also note that John McCain seems to have racked up another "told you so" point to go with his advocacy of the surge: He was a sponsor of a measure that would have more strictly regulated Freddie and Fannie back in 2005, but was derailed by Senate Democrats.

One other angle to consider: Since extensions of credit are de facto expansions of the money supply, we need to keep in mind that deleveraging the $11 trillion or so mortgage market, not to speak of the all of the derivatives based on it, could have a notable deflationary monetary effect. Just one more thing for the Fed to think about while considering the effects of acquiring all that bad paper, and perhaps tarnishing the sovereign debt to do so.

Seven Years

We spent our day under blue skies in Vancouver, Washington.  Extreme clear, with Mt. St. Helens or Mt. Hood etched on the horizon when we topped a ridge.

Seven years ago was another extreme clear day.  Waking not to oldies, but to "Ladies and Gentlemen, the South Tower of the World Trade Center has just collapsed."  Not a joke.  Turn on the tube.  Plane into building.  Two planes.   Slo mo.  Full speed.  Towers.  People.  Falling, falling.  Over, and over, and over and over.  The skies blue, and quiet, on the SFO approach path.  We're at war. 

In seven years, they haven't touched us again.  It's not an accident.  We took the fight to Al Qaeda, closed with the enemy.  Kicked them out of Kabul, tore up their networks, sucked them in and killed them.  Whatever mistakes we made in Iraq, they made worse, and showed their murderous intent to Muslims as well as the West.

We've won in Iraq.  What did we win?  We don't know yet.  Iraqis, Arabs and Muslims will tell us, that's the only way it can be.  We do know we'll never fight such a campaign again.  The political will to fight slowly and carefully is exhausted.  And if the attempt to build a strategic backfire in the Arab and Muslim worlds fails, then come another extreme clear day, it will be war to the knife.

They are still out there.  The weakened government of Pakistan offers sanctuary to the Taliban and Al Qaeda, willingly or not.  And we're over the border after them, admitted or not.  Iran still perseveres in building a Bomb, and Russia plays with that fire thinking it can escape being burnt.  The next administration will get to figure out how to take up where Jimmy Carter left off.

The scars are deep on our own body politic.  The enemy used our own media - some willing - against our civilization.  The Fourth Estate is debauched and debilitated.  Our citizenry will now be informed through the Internet.  What will that do to the Republic?  We do not know.  We talk of some form of civil war - can the center hold?

Seven years.  Never forget.  Never forgive.

Hitting the Highway - With A Bad Taste In The Mouth

It's time for a road trip that was postponed due to my little incident in January.  We're off on a camping vacation that will take us north to the Portland area, up the Columbia, along the old Oregon Trail route to the Snake and Boise, and finally back south through the Oregon high desert (which we've never seen) and along the eastern edge of the Sierra.  Sightseeing, foodie delights, and geocaching are on the menu for nearly three weeks.  With a little luck and time, there may be some travel blogging.

Unfortunately, this comes after a most disappointing week on the Internet.  That period has witnessed some of the most foul behavior that I have seen in the blogosphere since I joined five years ago.  I'm referred to the vile smears about Sarah Palin that arose after her surprise pick as McCain's VP.  Not only were these rumors putrid, but it was obvious from the liberal dose of cross posts, drive-by trolls and Mobies that the foulness was coordinated and organized.  It would be interesting to know by whom.

What's worse is the way in which the anonymous foulness was picked up first by the electronic presences of big name media, and then by the MSM itself.  It will be a cold day in Hades before the Atlantic gets another link from here.  It's to my own discredit that I once sent a contribution to excitable Andy before it became clear what he has become, and there will be no more attention given to that piece of human filth.

I'm also disappointed that I didn't pay more attention to the Hillary supporters who decried the misogyny of the MSM.  As a long term critic of the legacy press, this is a story I should have been following.  But I didn't have a dog in that fight, and too many cries of 'victim!' over the years led to a calloused indifference.  Well, they were right.  The Hillary folks have been the frog slow-cooked over the years, while with Palin we got to see the whole act compressed into one week.  They were right, and I was wrong to be indifferent.  Apologies for sins of omission are hereby tendered (not that you'll catch me voting for Hillary).

Having worked hard to drive off any audience that is not left of center, now the MSM seem to be going into overtime to annoy a large fraction of those of the XX persuasion.  The sensation-seeking inherent in the mass media is finally coming home to roost.  The MSM (and a large chunk of the left) have become a predictable foil to McCain or anyone else able to work out their likely knee-jerk responses.  They seem utterly unable to consider the long term effects of abandoning actual reporting to spread bigotry picked up from the more putrid end of the blogosphere.