A Second Hand Conjecture

A Daring Trade Has Wall Street Seething from the Wall Street Journal. Amherst, a small Austin firm found a small loophole in the system. To use a crude metaphor, they sold the big banks hurrican insurance and then made sure the hurrican never came.

The burned banks include J.P. Morgan Chase & Co., Royal Bank of Scotland Group PLC and Bank of America Corp. Some banks have reached out to two industry trade groups about Amherst’s actions, and the groups are reviewing the transaction, according to people familiar with their thinking. “It’s all-out warfare” between the banks and Amherst, said a senior banker at one firm that lost money.

Really though, I imagine the big banks are mad that they didn’t think of it first.

Economics of Contempt has much more (and better) analysis here.

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20 Chrysler lenders or about 30% of the debt Chrysler owes lending institutions are objecting to getting fleeced in the governments planned “surgical bankruptcy” plan. In a normal bankruptcy the senior secured creditors (the lenders) are first in line, while unsecured lenders (UAW) and equity holders are last. This is the basis for the lenders’ complaint:

Creditors object to the way the restructuring benefits the United Auto Workers union, which is an unsecured creditor, for the $10.6bn Chrysler owes to its retiree healthcare fund.

“What’s happening is the senior secured creditors are going to get 29 cents on the dollar and the unsecured creditors are going to get $10bn,” said Mr Lauria.

Now I think the obvious unasked question is, if the lenders are getting such a raw deal, why are only these institution objecting? what about the other lenders making up 70% of the loans? Your indirect answer is present toward the last half of the article.

Chrysler’s four main banks – JPMorgan Chase, Goldman Sachs, Morgan Stanley and Citigroup – had received about $90bn in government bail-out [TARP] cash.

Now we see why these banks are going along with losing all this money. They are scared of the government’s wraith. After Congress almost retroactively changed their contracts with AIG, and Attorney Generals outright threatened AIG executives physical well being, these TARP banks realize that the government is NOT bound by following the rules of law and can punish them for not acting in the government’s best political interest, namely, making sure the UAW is placated.

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That’s what’s claimed in this article in the IBD. This becomes pretty thuggish when you add to the fact that these banks were (allegedly) outright threatened to take the TARP funds in the first place. The reason for all of this is to make the process as opaque as possible. The political establishment’s efforts at transparency thus far have been just a show to get elected and/or score political points. It’s obvious neither Obama nor Bush believed in it, so why should we expect it with the TARP funds?

The idea as I understand it is to make sure no one knows which banks needed the money so as to not cause a run on that bank. But that means the market doesn’t know which banks are good either and so rather than reward good banks it just waits the whole thing out. Now of course the gov’t can’t accept repayments because that would make it obvious that those banks that can’t pay back the money aren’t doing as well as those that can. This is a pretty clear refusal to let the market work ostensibly because it’s “broken”.

Now all this wouldn’t be as bad if it wasn’t the gov’t involved. Why? Because the gov’t interests are politics. You have people involved and now running things that aren’t looking out for the best of the company, nor the market, but for their best interests which are being popular. Combine that with the ignorance of the system or market and you get stuff like Maxine Walters’ crazy and conspiratorial questions. Combine that with grift and you get Chris Dodd and Barney Frank. So now with the gov’t involved we start seeing wild political demands on these banks with the full force of a hypocritically righteous rage. Limits on wage rates, specially targeted, punitive 90% taxes that go back on contracts, outright extralegal public threats to intimidate.

This is why it’s dangerous to deal with the government because the government has captured that industry and won’t give it back while it can still play with it (i.e. ruin it).

(edit to fix some atrocious spelling)

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Over at Instapundit, Glenn has been keeping an eye on both the Tax Day Tea Party and the New Way Forward demonstrations.

Reading about what the left is doing, I have to think, that if the left thinks banks that are “to big to fail” should be broken up, then what about government programs like social security, medicare, and medicaid?

Surely, these are just as big, and they are to important to fail. Shouldn’t these also be broken up??

And once they’re done with the banks, and the auto industry, what are they going to find “to big to fail” then???

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The winners of the global financial turmoil look to be three American ’superbanks’: JP Morgan Chase, Bank of America and Wells Fargo. The institutions have all grown to occupy such a predominant position in the marketplace, that all three recently surpassed the Federal cap intended to prevent any one institution from controlling more than 10% of domestic deposits. A staggering realization of their scale.

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Yves Smith hits a theme I have been harping on, the Federal Reserve, and central banks in general, are making things worse in may ways by destroying the incentive for banks to lend or borrow from one another. She quotes James Bianco of Arbor Research:

The Fed’s massive and numerous liquidity facilities are making things worse. The problem is more than banks unwilling to lend to each other, they are also unwilling to borrow from each other. Banks can get all the funding they need (and then some) from their central bank so they do not need to seek a loan from another bank. I believe it has gotten so bad that they don’t even bother to make a decent market for inter-bank loans anymore. No reason to, they don’t need them anymore as central banks have replaced them.

I would suggest more subtle factors should also be emphasized besides how this distorts rates on loans. If banks do not need each other then they don’t communicate. Thus the hard work of investigating what counterparties real credit risk is goes undone. The market is shunting that off to governments. Furthermore, banks have no incentive to arrive at a believable accounting of their assets, they can wait and hope for a bailout rather than find a way or terms that other banks will accept.

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Tyler Cowen states his basic views on the crisis. My response in italics:
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I do believe we should be doing something as a nation, through our government, to avoid the not insignificant chance of a total financial meltdown. I have seen several things proposed that I find interesting, and I will get into them and other longer term issues in coming days. I had hoped to address this all comprehensively, but time just isn’t allowing that, so let us do so piecemeal.

Today I would like to endorse one proposal that aligns exactly with my thoughts on this, which is we need to recapitalize banks in a more effective, less arbitrary manner while protecting taxpayers and homeowners as well.
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Continuing the discussion on tonight’s podcast, one of the recurring themes of much of the commentary on our current financial crisis is that the cause is too much deregulation. Possibly there is some truth to this, though the evidence is rather vague. The most disturbing figure in all this is Barney Frank.

“We need stricter standards on loans.”

Except, the problem here wasn’t lack of regulation, but that the regulations were not enforced, or fraud, by lenders, brokers and their clients. More laws doesn’t help. This was also a failure of long standing, not new. I would suggest simplifying and increased enforcement would be a better option.
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Cross posted at Risk and Return

You may remember the website we discussed back in January. Dale Franks just discovered their program, because they now are on Television. He asks the obvious question:

So, should the mortgage companies get off scott-free from facing the results of their poor business decisions when it comes to the loans—loans they shouldn’t have made in the first place?

From my comment there:

No, they shouldn’t. I don’t endorse walking away, but when you take out a loan, and offer collateral, it is assumed that one possible recourse is to give back the collateral. Since lenders don’t want that to happen, they are supposed to examine the worth of that collateral pretty carefully, and get some money down. That way it isn’t in the interest of the homeowner to “walk away” even if they don’t mind the damage to their credit.

The lenders didn’t do either, now people are returning the house when it is in their best interest. I don’t count on the benevolence of my bankers, I suggest they shouldn’t have counted on consumers to take it on the chin for their sake either. Nor do I want our government, or the Fed, to keep bailing them out, either directly or indirectly by helping people keep houses they cannot afford. Neither is likely to work anyway.

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