Thursday, January 24, 2008

And Who Will Bail Out The Other Guys?

The NY State insurance regulators are trying to put together a bank scheme to recapitalize the monoline credit insurers, so that AAA ratings can be salvaged. Banks are obviously concerned because of the higher capital adequacy ratios and haircuts required for non-AAA holdings.

  1. Where are they going to get the equity money ($15-30 billion, depending on who you ask) considering they are still raising money for themselves from abroad?
  2. How will the banks' new foreign investors (Kuwaitis, Koreans, Singaporeans, Chinese..) react to having their money even partially siphoned from "their" banks to the insurers?
  3. Why throw good money away, when the new kid on the block is ready to steal the business with a sparkling new AAA rating? I'm referring to Mr. Buffett's new credit insurance company, which has stated it will only insure muni bonds. In other words, it will skim the cream and leave the sludge - structured finance - to the old monolines.
The scheme is being considered to "protect" the AAA ratings on the existing sludge, something that banks and many others who bought it (pension funds, bond mutual funds, trusts) are very concerned about. The usual smoke and mirrors is not going to work in this case, because the rating agencies are unlikely to play ball. Their reputation has already been badly tarnished, and as the recession sets in every pol inside the Beltway will be looking for scapegoats. And it's an election year...

But the more serious question is this: The monolines have underwritten insurance on $2.4 trillion worth of bonds and are regulated... what about all the CDS sellers who are not tightly regulated? Hedge funds, for example...

Who will bail them out, if need be? The CDX investment grade index is shown below.


P.S. SocGen announced a huge $7.1 billion loss from a single rogue trader. They are calling it "fraud", but of course it is plain old failure to supervise. The scheme was apparently the regular "hide and roll", common in all such trader hanky-panky. But the loss size is astonishing, particularly coming from a low-level 100k/yr equity trader. Something smells fishy here - for example, how could a lowly employee put on such big positions? His book must have been in the high tens of billions and that's not easy to do, or hide, no matter how well he knew "the system". Sophisticated risk and compliance systems have multiple layers and cannot be "gamed" by a single person. Hmmmm...

But if the loss was the responsibility of just one tiny trader, then SocGen's risk management system is worse than swiss cheese: high in fat and full of holes. Incroyable!


  1. The whole scheme seems patently absurd to me. Another sign of desperation. But the markets seem to be running with it. Apparently.

    I am starting to wonder if a taxpayer bailout of the bond insurers ('monolines') will be the ultimate outcome of any "stimulus" package. I think it was Fitch's downgrade of Ambac last Friday that caused the selloff in Asia on Monday. I think there is no way to find enough capital for ABK to meet its insurance obligations; the talk of having their own counterparties -- e.g. banks whose bonds ABK (supposedly) insures -- provide this money is just crazy nonsense. And it is clear that writedowns and losses triggered by more downgrades -- and worse a failure -- of bond insurers would be catastrophic. At the least this eventuality is greatly feared. So the only thing that makes sense is for taxpayers to assume those obligations. As unthinkable as that would be in normal times, the magnitude of this problem dwarfs the S&L crisis, and it will be clearly seen as the lesser of two evils.

    If that happens, we have most likely seen the bottom.

  2. I seriously doubt the govt. will bail out the monolines. The muni business is pretty sound stuff and can be moved over to Berkshire. This leaves the structured bonds and I can't think of any way that the govt. can sell their bailout to the public. Particularly in an election year.

    Don't forget, even the govt. has to borrow money - and eventually raise it through taxes.

  3. I still don't think you get it Hellasious. Bush, Norquist, Cheyney, et al hate government and by extension hate the people that make the democracy. What more proof do you need. Job number one is to destroy the federal budget so we have to do away with all of those ideologically offensive (evil) social programs.

    All they have to do is transfer the liability to the banks, its already too confusing for the average rube to understand (present company not excluded).

    Next, talk about how they got to "protect" the mercan people from economic holocaust, you know economic "terrism". Then, bail out the banks. Socialism for corporations and hard-nose capitalism for the peons.

    Fear rules all in the new world order.

  4. Don't forget, even the govt. has to borrow money - and eventually raise it through taxes.

    Reagan proved deficits don't matter.

  5. What we have now and have had for some time is a Federal Reserve and various corporations that are allowed by proxy of government to tax the U.S. populace to engage in activities outrageously profitable to themselves (CEO compensation, $500.00 military contract toilet seats) while obscuring with the smoke and mirrors of job creation. The “people” will not pay the debt for much longer. The U.S. will become insolvent or create a hyperinflation that will result in holders of U.S. debt instruments holding nothing but worthless paper.

    I would not be surprised if U.S. taxpayers are somehow underwriting the migration of capital and jobs to China and repatriation of profits to the U.S. thereby financing the construction of our own gallows and paying the hangman’s salary. Is it any wonder the “terrorists” of the Middle East try to defend themselves from these beasts?

    It seems that “red in tooth and claw” operates beneath the thin façade of merry make-believe of democracy and egalitarianism. “Red in tooth and claw” will soon be breaking through the façade more frequently and more often, but why worry, according to the chuckle heads on the MSM its not really real, whatever that means.

  6. Seems all the more obvious as time goes on that there is a coordinated attempt at crisis management. Should these efforts to 'save' us from the crisis lead to more empty promises (e.g. SIV bailout), at what point does it become all the more apparent that not much can be done by our great leaders in DC. Once that well runs dry, then things might get real serious.

    Note: Over at Big Picture, this take on the global stock market sell off Monday and the futures pointing the expected decline in US stock markets Tuesday that precipitated the Fed emergency cut:

    SG's $7.1Billion dollar unwinding led to panicked futures selling on Monday and Tuesday.

  7. I think people might have a clearer perception of the situation if we replace the emotionally-laden term "home" with say...tulip.

    Tulip's price was so high people needed mortgages to buy them, but it was within reason enough for the gov to insure these mortgages through GSEs. The prices appreciated even further so people took out crazy neg am tulip mortgages not backed by the gov, but deemed AAA by a reputable monoline. Pension funds bought it all.

    People then woke up and, though they still liked tulips, they did not like them enough to live in debt-slavery. So the tulip price crashed.

    And now the government doesn't know what to do so they're trying to reinflate the tulip prices. Shouldn't we just let the prices fall back into reason even if it means some financial pain for some fools who had tulipmania?

  8. Excellent Blog, always look forward to your comments.

  9. Thanks for your time and energy you have dedicated to your blog.

    I have what may be a couple of dumb question.

    1 Every quarter The Fed publishes the "call report" which has a category, "Derivatives and off-balance sheet items." Is there enough data in the call report to identify banks over-exposed to CDS? If not identify, then at least quantify the issue?

    Wikipedia reference:

    Fed's site for call reports:

    2. The short term goal is to use the data to protect what value my portfolio has, and possibly work this to my gain. Does anyone have any ideas how I would reallocate to benefit from CDS fallout?

  10. Dick Cheney said, "
    Reagan proved deficits don't matter."

    Reagan didn't "prove" anything. There were willing lenders for Reagan's schemes. Claiming anything else is arguing lies, damn lies and statistics.

    You have probably conveniently forgotten all of the banking debacles his deregulation efforts have cost the taxpayers over the ensuing decades.

  11. As long as Halliburton makes a profit and I get richer, why do I care?

  12. I can't help thinking of that old saying, "The best laid plans of mice and men..."

    I'm not exactly sure where this whole 'experience' is heading but I have a feeling it won't work out quite the way TPTB envision. If it's not been planned out by TPTB and is some sort of fly-by-night cluster-*^&$ then, GOD HELP US ALL.

    I think the real 'entertainment' starts when over 50% of the US population is destitute. That'll make for some very interesting times indeed. Gonna be real hard for those still working to get to work (or even concentrate on what they are doing) when rocks are flying through windshields, burning cars litter the streets and law enforcement is over-whelmed and under compensated. Are you even going to leave your house to go to work under those conditions?

    Don't think that can happen? Try living outside, eating from a dumpster, and drinking water out of the oily puddles left after it rains for a day or two. Not hard to imagine a lot of anger being mis-directed at the most readily available target(s).

    In the old days before property taxes as long as you could keep the place livable you were doing well. I can't see how this is going to end well if people start getting thrown into the street in meaningful numbers approaching 50% of the population. I guess when we start hearing about property taxes being 'repealed' we'll know we are in a real 'recession'.

    If TPTB let this situation get out of hand, IMHO, it is going to get very difficult to find enough qualified technical people who are functioning to keep this incredibly complex system running.

  13. excuse the off-topic.

    Hell, you think the 625-conforming loan mod is a quid pro quo to BAC for taking on CFC? Seems to me like a way for them to make almost all of the CFC junk conforming and pass it on to a GSE.

    Curious on your take.

  14. dopamine said:

    I would not be surprised if U.S. taxpayers are somehow underwriting the migration of capital and jobs to China and repatriation of profits to the U.S. thereby financing the construction of our own gallows and paying the hangman’s salary.

    You can bank on it, but I frame the problem as one in which different political jurisdictions compete for jobs and do so through bidding wars, with each jurisdiction seeking to better the others in supplying corps with direct and indirect subsidies. corp welfare that, in a system dominated by transnational firms, can 'end up' anywhere in the world just as China's cheap labor subsidy to capital arrives here in the form of products.

    ...the mayor has sought to revive—expensively—the antiquated but historic Philadelphia Naval Yard. He and Governor Tom Ridge have given the Anglo-Norwegian firm Kvaerner over $400 million in subsidies, for which Kvaerner was obligated to create between 700 and 1,000 jobs—a $400,000 subsidy per job, at best. Worse still, Kvaerner, faced with low-cost competition from other countries, has now withdrawn from the shipbuilding business, as if to mock the city's superannuated approach to job creation. So that $400 million—which, notes David Thornburgh of the Pennsylvania Economy League, could have begun buying down the wage tax that is chasing off more innovative businesses—bought virtually nothing.
    [(Philadelphia) City Journal, Autumn 1999]

    'A special report by St. Petersburg Times staff writers Sydney P. Freedberg and Connie Humburg concluded the state could pay more than $900-million in 2004-05 on economic development.
    The true benefits of such tax breaks are questionable. It is hard to fathom that Wal-Mart or Home Depot would not bring more jobs to the fourth-largest state if they did not receive tax incentives.
    The state cannot guarantee that companies receiving tax incentives won't downsize, merge or move jobs overseas.'
    (St. Petersburg Times, April 17, 2005)

    This process operates from the international to local levels and is one in which governments effectively become labor contractors with taxpayers purchasing jobs from very large enterprises.

    Total corporate welfare cannot be precisely determined but a decade ago:

    The Federal Government alone shells out $125 billion a year in corporate welfare, this in the midst of one of the more robust economic periods in the nation's history. ...

    That makes the Federal Government America's biggest sugar daddy, dispensing a range of giveaways from tax abatements to price supports for sugar itself. Companies get government money to advertise their products; to help build new plants, offices and stores; and to train their workers. They sell their goods to foreign buyers that make the acquisitions with tax dollars supplied by the U.S. government; engage in foreign transactions that are insured by the government; and are excused from paying a portion of their income tax if they sell products overseas. They pocket lucrative government contracts to carry out ordinary business operations, and government grants to conduct research that will improve their profit margins. They are extended partial tax immunity if they locate in certain geographical areas, and they may write off as business expenses some of the perks enjoyed by their top executives.

    The justification for much of this welfare is that the U.S. government is creating jobs. Over the past six years, Congress appropriated $5 billion to run the Export-Import Bank of the United States, which subsidizes companies that sell goods abroad. James A. Harmon, president and chairman, puts it this way: "American workers...have higher-quality, better-paying jobs, thanks to Eximbank's financing." But the numbers at the bank's five biggest beneficiaries--AT&T, Bechtel, Boeing, General Electric and McDonnell Douglas (now a part of Boeing)--tell another story. At these companies, which have accounted for about 40% of all loans, grants and long-term guarantees in this decade, overall employment has fallen 38%, as more than a third of a million jobs have disappeared.

    The picture is much the same at the state and local level, where a different kind of feeding frenzy is taking place. ...

  15. Hey Hell, and anyone else, how about today's action in the Bond Pits? A big fat FU (in the form of a massive spike) to CONgress and the monetary authorities that the only thing that will be stimulated by the "stimulus" package will be interest rates.

  16. Re: $625.000 conforming loans

    I don't know if the hike is specifically targeted to BofA/CFC but CA is probably the largest market for jumbo loans, so I would guess it helps them more than anyone else.