Redstate

Today, however, some are saying that the Dems may indeed want to get something passed. As I said, the situation is very fluid, and the Dems are scrambling to think through the consequences of a quick legislation.

Stay tuned.

n/t

I told my wife that if something like this goes through, that I'd be strongly tempted to just stop paying our mortgage and see what the government would do for us? We're entitled, right?

I suspect that if you've only borrowed within your means that you won't be eligible for a handout. That said you will still be eligible to pick up the bill for your neighbours who remortgaged to pay for that fancy car out front.

Senator McCaskill,

I am writing to ask you to fight against the notion that Congress must bail out distressed home owners. Part of the rationale behind this push for home owner relief is the notion that "the Administration [sic] just spent $30 billion in taxpayer money to bail out Bear Stearns. We're gonna kick their butts for doing that, starting tomorrow. But now that we saved Wall Street's bacon, we have to do the same thing for homeowners." as stated by Christopher Dodd.

First, this is logically inaccurate. As you are aware, the Federal Reserve is not a member of the Administration. Second, no money was spent. That is a technical falsehood that I am not prepared to go into at great length here. Third, why should we punish the Fed for doing it's job? By many accounts, the Fed's actions in the Bear Stearns situation may have prevented a complete meltdown in our financial sector leading to a much worsening picture in our economy.

Another reason to oppose such action is that invariably political solutions do not help. The truth is that no matter how the relief is structured, it will not help. Homeowners that cannot afford their homes still won't be able to afford their homes. They will instead be reliant on the federal government to keep them in their homes. The market will have learned that if they get into trouble, Uncle Sam will be their to fix their mistakes. The other half of this situation is that a bailout will ultimately help the wrong people. As it stands, yes, many Americans will lose their houses as their ARMs reset. In these cases, many of the homeowners will lose little more than the excess that they had been paying for a mortgage over what they would have paid in rent (as they were first time buyers and purchased more house than they really could afford). Others will have lost more, but by their own faults. They had chosen to use the equity in their homes to do a myriad of things: vacations with the family, adding on to the house, etc. Some of them used it for emergency medical bills. It seems utterly distasteful that we would ask the taxpayers to ultimately pay for someone's vacation.

The group that stands to gain the most out of a bail out is the banking industry. Banks, at the urging of Congress, relaxed its lending standards, so that more people could own a home. The banks stand to lose millions upon millions of dollars if the loans are allowed to go into default. This is a good thing. The lenders have to learn that sticking to proper risk analysis is the correct way to view a loan, not the request of Congress.

Francis Cianfrocca (a contributor to the popular blog Redstate) put it best:
"But even worse, the bailout benefits the lender, who escapes the financial responsibility for having made a loan that shouldn't have happened in the first place. And why should we give a huge lollipop to people that are usually described as predatory? These people are professionals. Bailing them out for their mistakes only ensures that they'll try to do the same thing again, some other day."

Indeed, the lenders will not learn to avoid the same thing again. That is ultimately our goal when we exit a bubble burst such as the one we are experiencing now. We must learn what happened and how not to let this same bubble repeat itself. If we bail out the banks they will not learn and this bubble will repeat.

Again, I urge you to fight the urge to feel like you've done something when nothing is exactly what Congress should do.

Sincerely,
Brian Simpson

If so their case is against the mortgage broker/advisor/seller.

Here in the UK there was a situation a while back where a lot of people had been advised to take out personal pensions when they were not suitable for their financial circumstances. The regulator ordered that they review all sales made in the period and compensation was paid.

I'm not sure of the legal situation in the USA and what duty of care the brokers may have under US law. It may depend on how the sale was made and what intermediaries were used.

Under common law I think if someone acts as your agent they have a duty of care to you even if they are actually getting their comission from another party. However I am getting out of my depth here and perhaps someone else can jump in.........

In many cases though, the individual will merely lose their license. The company will face the financial loses because they should have provided proper training against such practices.

is involved.

You're right, it's still not known what the Fed's new LLC bought from Bear Stearns. There's a good possibility that it's the lower-quality, higher-yielding tranches of some of the MBS
s they packaged up.

If so, you can be sure that the Fed applied a large haircut, implicitly marking them to market.

Until this information comes out (if it ever does), we won't be able to definitively answer the question.

I do give the New York Fed credit for being very canny traders. It would surprise me tremendously if they overpaid for this deal, and as I've said elsewhere, I expect that they'll end up making a profit instead.

Do you know why the Fed hasn't released which securities are backing the Fed loan?

...most of what they do: to avoid moving the markets.

estate.

Tulip bulbs always had some intrinsic value, despite all the speculation that surrounded them in one of history's best known bubbles.

Unlike tulip bulbs, which can be multiplied at will with some modest agricultural work, the supply of real estate is finite. They are not making any more of it (and if GW fears are true, there will be less!). As long as population and economic growth is on a long-term upwards trend, the same trend will hold for real estate.

As blackhedd notes, Bear had to bare its bosom to the knife. The Fed took is pound of flesh, and then some. It is quite possible that they will make a profit.

There are investors now, who sat out the 2005-2007 bubble, who will make a bigger profit, if their time horizon is long enough. A very, very, very big profit.

Not enough people remember that the tulip-bulb craze actually arose in trading for call options on tulip bulbs, not the bulbs themselves. (Calls and puts have been widely used for centuries. Before Black-Scholes-Merton, they were priced by dead reckoning, often at three cents on the dollar.)

And as often happens, the government (a German prince in this case) had a hand in the speculation. I'm not remembering this completely at the moment, but I think he engineered a supply squeeze that forced people who had forward-sold bulbs for the subsequent spring, to pay whatever they had to for them.

Not as irrational as it's often portrayed.

;-)

As for Bear giving its "pound of flesh," that's just hogwash. Bear shareholders received $10 per share in the sale. If the Fed had not intervened and let the market work, then Stearns would have either gone under (resulting in a value of $0 per share) a share or JP Morgan would have been unwilling to purchase Bear without offering a significantly lower price (likely resulting in something between $.01 and $2.50 per share), if they were willing to take the risk at all.

As it stands, the Fed made a loan with taxpayer money that the private sector was unwilling to make. It may turn out that the loan pays off in spades, in which case I'm still uncomfortable with the move but at least it doesn't cost us anything...this time.

On the other hand, it may turn out that the Fed takes a loss (and every day that the Fed refuses to discuss the details of the deal, it looks more likely that this is indeed what will happen). Since the Treasury has promised to bail out the Fed if necessary, that would mean that, if the Fed does take such a loss, then it has essentially given Bear shareholders an inflated price and/or JP Morgan a discount in the deal at the expense of everyone else.

...for Bear, they budgeted $6 billion for expenses related to closing the deal. Add that to $250 million ($2/share), and you get an awfully large number, one that in fact is in the neighborhood of Bear's stated book value of $80/share.

Why such a large reserve? Probably because Morgan expected litigation from the shareholders. Upping the offer from $2 to $10 after a week of due diligence on the Bear portfolio may have saved them as much as $5 billion in closing costs.

And keep in mind that all reports agree that it wasn't Morgan but rather the New York Fed that drove the embarrassingly low price, partly because they wanted to punish Bear Stearns.

(Although, as I said above, I'm still not comfortable with the Fed putting tax-payer money at risk in this manner.)

I'm not saying that $2 per share or $10 per share or any other price was appropriate. Whatever the "appropriate price" it was artificially inflated by the Fed subsidized loan. The company was worth whatever another company was willing to pay for it. Without the Fed's $29 million dollar loan, JP Morgan would have offered less, since it would have been their own money at risk. If Bear's shareholders were unwilling to sell at the price JP Morgan or any other company was willing to offer, then Bear would have gone under and the shareholders would have lost all of their money, rather than just most of it.

It's simple supply and demand. How is the sale of a large corporation an exception to the axiom that free markets work best?

You have a certain point of view on that matter, and that's perfectly fine. You're asking reasonable questions about a transaction that, under normal conditions, makes no sense whatsoever.

As it turns out, there was nothing normal about this transaction at all. It's darned lucky that Morgan happened to have a clean balance sheet and wasn't in the middle of trying to buy someone else right at that precise moment when the Fed needed a buyer.

And they had to negotiate an extremely challenging transaction under conditions no one ever wants to be in. And on top of that, they had to paper it too! All in one and a half weekend days.

I don't know your background, and I agree that to normal analysis, the acquisition is very, very fishy.

But I assume you've never or rarely been in the situation of negotiating financial terms in exchange for the life of a company (and a set of great employees who don't deserve to get hurt) under extreme time pressure, while simultaneously facing a ruinous personal outcome.

I have. That's why nothing about the Bear transaction surprised me. Except that they got $2/share. I expected zero.

Other than my required econ classes and my Roth IRA, I haven't and don't typically deal in economic type stuff, so your posts and others who know more about this than me are always very information.

My problem is more one of principle. I hear all the time that allowing people to suffer the consequences their foolish mistakes prevents others from making similar mistakes in the future, in addition to providing an opportunity for those who were more prudent to reap benefits from those mistakes. I agree with this general principle, so I oppose federal subsidies and bailouts of imprudent risk.

What I don't understand, though, is how Bear Stearns is an exception. If the company failed to prudently manage itself, then it should have paid the natural consequences of its imprudence. If the economy would have been unable to handle to imminent collapse of BSC and the government was forced to step in, the appropriate price for such gross negligence is $0 per share. Anything more, to my mind, is a bailout, and if the shareholders wanted more, they should be forced to sell at the price that the market demands.

In regard to the adverse effects on the employees, that's why I support expansion of government unemployment benefits, job retraining programs, and healthcare. Employees lose their jobs all the time due to no fault of their own; why should some unfortunate folks be propped up just because their company happens to be one of the largest financial firms in the country?

My perception of the amount BSC shareholders recieved (whether its $10 or $2- although I like $2 a lot more than $10) was simply a nuisance value amount to give them some basis to sign up the deal quickly.

To get things done quickly and in an orderly manner unfortunately did require BSC's constructive involvement. In a perfect world BSC would have been cooperative in signing over their no-longer-managemable business for $0, but this isn't a perfect world, and I can live with a 10% or less nuisance payment (relative to what the share price was 2 weeks earlier, if I've followed things correctly) if it meant the avoidance of the collapse of our financial system.

But I will say one other thing- the "bailout" aspect of the BSC thing that I am still scratching my head about is not regarding the BSC equity holders- who got chump change relative to their original investments, but the BSC debt holders who are getting out whole, where as they may have had greately discounted recoveries in a bankruptcy scenario. Those are the folks I am concerned may have unjustly received a bailout here.

the highly beloved progressive tax rates pushed by some people. Look at this as a TAX imposed indirectly by the Fed on the BSC shareholders and you will feel better!

I have a little more knowledge than I would like to have about stocks in bankruptcy. There are many trading opportunities there. (Although ultimately most existing equity is wiped out.) It is possible that the BSC shareholders could have done better than $2-$10, at least some of them. But the Fed, quite properly, thought that ensuring liquidity in the midst of such a bankruptcy was too risky, and they went for the "rescue tax" on BSC's senior management, directors and large shareholders, who truly failed at corporate governance.

The value of insolvent Bear Stearns is, naturally, considerably less. That value is precisely equal to what someone else would have been willing to pay for it. We'll never know what that value would have been, but the fact the Fed stepped in and subsidized the deal artificially inflated the price, as does every other subsidy.

However, there is a big difference between bankruptcy and liquidation.

I will defer to blackhedd on the ultimate interpretation of the BSC transaction. However, a market price depends on an arms' length transaction between a knowledgeable buyer and seller, with reasonably good information and freedom of action.

None of these circumstances was present. The Fed had extraordinary power as the lender of last resort to dictate the terms of the transaction. BSC had no bargaining power because of its short term liquidity crisis, although its long term prospects might have improved with a more benign lender. The Fed was determined to PUNISH BSC, and that's exactly what they did. Also, the dealer broker business is an oligopoly with 5 big players, four of whom hated BSC. So the dynamics of the transaction are that of an extremely imperfect market, with lots of secret information and secret motivations.

BTW, I concur witht the general principle that government subsidies inflate prices. I will hold you to that one! Are you already writing in protest to oppose the Dems' efforts to bail out mortageholders? :>)

as I oppose the "refunds" that go out later this spring.
(NB: Both are in my personal financial best interest, since foreclosures would drive down my home's value and money in the mail in money in the mail). I do, however, support the government providing essential services (although my definition of "essential" is likely broader than that of most Redstaters).

I don't find the "short-term liquidity crisis" argument relevant. If I buy a house, lose my job, am unable to make my mortgage payment, and forced to sell my house quickly to avoid foreclosure, then naturally my "crisis" (i.e. my desperation to sell quickly) will drive down the price which I will receive for the house. Should the government step in and subsidize the sale so that I get a more "fair" price?

(The BSC shareholders got a NEGATIVE subsidy- at least the argument could be made. And the shareholders were willing to sue, which was instrumental in getting the price from $2 to $10.)

One individual does not get attention. But if the pols suspect that there are millions of them, they are willing to subsidize in return for that greatest gift- elective office. Many are willing to serve even without the hookers.

After all, there are lots of folks who will be helped, and I'm sure that they'll return the favor in the form of votes.

My principles are flexible enought to envision some help for mortgageholders who LIVE in a normal middle class home who may be overextended and facing a rate increase, depending on what that help might be.

As for investors with inventories of homes bought on spec in hopes of quick flipping, tough cookies. They have to downsize and take the hit. Ditto for affluent people who bought supersized homes that they couldn't afford except under the most prolonged of optimistic economic scenarios.

But I would prefer that, if the government is to take action, the action be in the form of a permanent program (in the vein of creating a federal mortgage insurance program that would provide temporary support for those who temporarily lose their means of income and allows them to get back on their feet), not one-time reactionary measures (like sending out free money in the mail in time of crisis).

The former simply changes the rules of the game; the latter breaks them.

Dodd and Shelby? Do you have a link to a published report?

I heard something very similar from a reliable but non-public source.

"Reid agreed not to bring up a Democratic plan containing a controversial provision -- strongly opposed by Republicans and President Bush -- to give bankruptcy judges power to cut interest rates and principal on troubled mortgages. That plan stalled a month ago.

Instead, Senate Banking Committee Chairman Christopher Dodd, D-Conn., and the panel's top Republican, Richard Shelby of Alabama, were instructed to forge a compromise by Wednesday afternoon."

http://www.suntimes.com/business/873183,foreclose040208.article

Here's the lunacy that Durbin is pushing-

Republicans generally oppose a provision offered by Sen. Richard Durbin, an Illinois Democrat, that in limited cases would allow judges to revise the terms of a mortgage on a primary residence for a homeowner in Chapter 11 bankruptcy.

This is now prohibited, although a bankruptcy court judge may now revise the terms of a loan for a vacation home, a farm, a ranch, a boat or other debts in Chapter 11 cases.

Durbin's provision would allow mortgage changes only for a primary residence and only for borrowers who pass a means test showing they cannot afford their current mortgage.

http://www.cnbc.com/id/23912176

Let me reiterate that last part- allow mortgage changes only for a primary residence and only for borrowers WHO PASS A MEANS TEST SHOWING THEY CAN NOT AFFORD THEIR CURRENT MORTGAGE.

So- on Planet Durbin- if you were "smart" you would have bought a house with a mortage you couldn't afford, then gone to bankruptcy court and have the judge take care of it for you.

Beyond embarrassing that idiot is my Senator.

40 year mortgages have been floating around the US for a few years as well. I'm not sure how popular they are. I think they generally get lumped into the "creative financing" category.

A few years back, I was working at a large Manhattan bank, and France had just issued a 100-year government bond.

And we had to compute the Macaulay duration of these critters. To my complete surprise, they turned out to be just a few years (like five or so) longer than a 30-year bond with the same coupon rate.

So this was an issue that actually made total sense as a tool for someone constructing a pension fund or similar thing.

If inflation expectations start getting a lot higher (which I'm not necessarily predicting), we might start seeing more of those crazy things.

In the late 19th century, 100-year bonds issued by American railroads were commonplace.

And of course, don't forget the perpetual bonds issued by the Bank of England back in the 18th century. They're called "consols," which is short for something I don't remember. And they of course still exist, and are still paying coupons. They have no maturity date, so they never repay their principal.

You can buy consols today for about 250 basis points. When they were issued back in the 1700s, the coupon rate was something like 5%.

the princely income cited in Jane Austen's famous novel, would qualify as poverty level income in today's Britain.

Consols feature prominently in discussions re money in the classic English novels.

Please, everybody, don't tell Ron Paul about the destitution of these heroes and heroines thanks to fiat money!

I wasn't against the Bear Stearns acquisition. In fact, I was biting my nails practically the whole weekend until they announced it.

It was a politically-challenging thing to do, and the Democrats are astutely playing this as you say, that's true enough.

But if the Fed had let Bear collapse messily instead of neatly, by now you'd be wondering just exactly why people thought the 1929 crash was so bad.

I got the impression that the BS management was trying to deny that their marriage was falling apart even while being served divorce papers by their spouse.

It is quite amazing that an 85 year old firm could go up in smoke in the course of about a week.