When Wall Street died...
“Within a week, Wall Street as it was known — loosely regulated, daringly risky and lavishly rewarded — was dead.”
Today’s must read MSM article is a front page WSJ piece, titled, The Weekend That Wall Street Died. Since we have been tossing around blame for various parties in the entire credit/hosuing/securitization debacle, its refreshing to see a major paper actually place blame where it (in large part) belongs: Wall Street bosses:
Why Bailouts Attract Handout Seekers
“The biggest surprise was how quickly it went from ‘I don’t need this,’ to ‘How do I get in?
-Michele A. Davis, Treasury Department, head of public affairs
A truisim of all bailouts: Enormous amounts of taxpayer cash attracts all manner of unsavory, undeserving characters. What was supposed to be a narrow and limited attempt to reduce the systemic risk of a financial collapse has become a taxpayer funded free-for-all.
Like hyenas trying to steal the kill from a lion, the mere scent of this enormous pile of loot starts attracts the scavengers. They cannot help themselves, for it is their essence, and who they are.
Like the dreaded 17 year locust, Lobbyists too, are swarming the capital, consuming everything in their path. Never before has a trillion dollars been authorized so quickly. Never before has so much money been spent with so little oversight, controls, or transparency. Now, on top of the negligent manner in which this money has been thrown about, we have the latest jackals attracted by the scent.
AIG's New Plan: Restructuring is now $125 Billion
The original $85 billion dollar package is now 70% higher, at $125 billion. Bloomberg reports it could easily scale up to $150 billion.
The U.S. will cut the original $85 billion loan that saved the New York-based insurer in September to $60 billion, buy $40 billion of preferred shares, and purchase $52.5 billion of mortgage securities owned or backed by AIG.
Yves Smith does a full blown analysis in the cafe.
AIG: We Need More Money
And so, more errors of these emergency bailouts begins: Once committed to the initial $85 billion dollars, what choice does nation have but to throw good money after bad.
Down the rathole:
AIG is asking the US government for a new bail-out less than two months after the Federal Reserve came to the rescue of the stricken insurer with an $85bn loan, according to people close to the situation.
AIG’s executives were on Friday night locked in negotiations with the authorities over a plan that could involve a debt-for-equity swap and the government’s purchase of troubled mortgage-backed securities from the insurer.
People close to the talks said the discussions were on-going and might still collapse, but added that AIG was pressing for a decision before it reports third-quarter results on Monday.
AIG’s board is due to meet on Sunday to approve the results and discuss any new government plan, they added.
The moves come amid growing fears AIG might soon use up the $85bn cash infusion it received from the Fed in September, as well as an additional $37.5bn loan aimed at stemming a cash drain from the insurer’s securities lending unit.
AIG has drawn down more than $81bn of the combined $122.5bn facility. The company’s efforts to begin repaying it before the 2010 deadline have been hampered by its difficulties in selling assets amid the global financial turmoil.
Un-frickin-believable . . .
AIG in talks with Fed over new bail-out
FT, November 8 2008 00:36
The Thundering Herd . . . "Were Pigs"
“The mortgage business at Merrill Lynch was an afterthought — they didn’t really have a strategy. They had found this huge profit potential, and everybody wanted a piece of it. But they were pigs about it.”
-- William Dallas, founder of Ownit Mortgage Solutions, a lending business in which Merrill bought a stake a few years ago.
There is a monster Gretchen Morgenson piece in the Sunday Times, titled, How the Thundering Herd Faltered and Fell. Its about the rise and ignomius fall of Mother Merrill.
How did it happen? Bad mortgages.
TYPICAL of those who dealt in Wall Street’s dizzying and opaque financial arrangements, Merrill ended up getting burned, former executives say, by inadequately assessing the risks it took with newfangled financial products — an error compounded when it held on to the products far too long.
The fire that Merrill was playing with was an arcane instrument known as a synthetic collateralized debt obligation. The product was an amalgam of collateralized debt obligations (the pools of loans that it bundled for investors) and credit-default swaps (which essentially are insurance that bondholders buy to protect themselves against possible defaults).
Synthetic C.D.O.’s, in other words, are exemplars of a type of modern financial engineering known as derivatives. Essentially, derivatives are financial instruments that can be used to limit risk; their value is “derived” from underlying assets like mortgages, stocks, bonds or commodities. Stock futures, for example, are a common and relatively simple derivative.
Among the more complex derivatives, however, are the mortgage-related variety. They involve a cornucopia of exotic, jumbo-size contracts ultimately linked to real-world loans and debts. So as the housing market went sour, and borrowers defaulted on their mortgages, these contracts collapsed, too, amplifying the meltdown.
The synthetic C.D.O. grew out of a structure that an elite team of J. P. Morgan bankers invented in 1997. Their goal was to reduce the risk that Morgan would lose money when it made loans to top-tier corporate borrowers like I.B.M., General Electric and Procter & Gamble.
Regular C.D.O.’s contain hundreds or thousands of actual loans or bonds. Synthetics, on the other hand, replace those physical bonds with a computer-generated group of credit-default swaps. Synthetics could be slapped together faster, and they generated fatter fees than regular C.D.O.’s, making them especially attractive to Wall Street.
Michael A. J. Farrell is chief executive of Annaly Capital Management, a real estate investment trust that manages mortgage assets. A unit of his company has liquidated billions of dollars in collateralized debt obligations for clients, and he believes that derivatives have magnified the pain of the financial collapse.
“We have auctioned billions in credit-default swap positions in our C.D.O. liquidation business,” Mr. Farrell said, “and what we have learned is that the carnage we are witnessing now would have been much more contained, to use that overworked word, without credit-default swaps.”
The whole piece is worth a read . . .
How the Thundering Herd Faltered and Fell
NYT, November 8, 2008
Dogbert the CEO
Our Employees Are Our Greatest Assets
This cartoon comes to us via bankers in Zurich, who appreciate irony where they see it:
AIG: Derivative Danger Known in 2007
How aware was AIG that it had a major, company threatening derivative problem?
"Top officials at American International Group Inc. knew of potential problems in valuing derivative contracts long before these risky transactions caused the insurer's shareholders severe pain, according to documents released by congressional investigators.
The disclosures come as prospects dimmed this past week for AIG's efforts to quickly sell assets to repay its bulging debt to the government. The derivative-contract problems would have driven AIG into bankruptcy; in the past month, the government has made available to AIG nearly $123 billion in a rescue plan...
At congressional hearings Tuesday, a former internal AIG auditor wrote that he had early on raised concerns about being excluded from conversations about the valuation of the derivatives. The auditor, Joseph St. Denis, wrote in a letter to the House Committee on Oversight and Government Reform that in early September 2007, he learned that AIG's financial-products unit had been asked for billions of dollars in collateral related to derivatives it had sold...
[November 2007] AIG said it would discuss the financial-products business at an investor conference on Dec. 5. An official at PricewaterhouseCoopers, AIG's external auditor, said the firm told then-AIG Chief Executive Martin Sullivan and his chief financial officer, Steven Bensinger, on Nov. 29 that it "believed that AIG could have a material weakness" in its risk management, according to minutes of a January meeting of the AIG board's audit committee, also released by Congress."
Fascinating stuff . . .
Documents Show AIG Knew Of Problems With Valuations
LIAM PLEVEN and AMIR EFRATI
WSJ, OCTOBER 11, 2008
Behind Insurer’s Crisis, Blind Eye to a Web of Risk
NYT, September 27, 2008
Insurance Industry Joins Banking Giants on the Hot Seat
MARY WILLIAMS WALSH
NYT, October 9, 2008
Will the US Fashion a Smarter Bailout Plan?
So far, we in the US have had an ad hoc, half-assed, on-the-fly approach to resolving the credit and financial crisis.
The smartest bailout approach to date has been the British/Swedish/Buffett approach: Inject capital at a corporate capital structure level by buying preferred stock, rather than at the balance sheet level by buying bad assets.
Now, we read that the Treasury is considering following these other, smarter approaches:
"Having tried without success to unlock frozen credit markets, the Treasury Department is considering taking ownership stakes in many United States banks to try to restore confidence in the financial system, according to government officials.
Treasury officials say the just-passed $700 billion bailout bill gives them the authority to inject cash directly into banks that request it. Such a move would quickly strengthen banks’ balance sheets and, officials hope, persuade them to resume lending. In return, the law gives the Treasury the right to take ownership positions in banks, including healthy ones.
The Treasury plan was still preliminary and it was unclear how the process would work, but it appeared that it would be voluntary for banks.
The proposal resembles one announced on Wednesday in Britain. Under that plan, the British government would offer banks like the Royal Bank of Scotland, Barclays and HSBC Holdings up to $87 billion to shore up their capital in exchange for preference shares. It also would provide a guarantee of about $430 billion to help banks refinance debt."
Sure its a year late, and a trillion dollars short. Yes, this would have saved most of the firms that went belly up.
Better late than never . . .
UPDATE: October 9, 2008 2:18 pm
The way we have the government buys into a cop-any via prefereds is to match any private sector investment into banks on the same terms. So GE and Goldman Sachs get double the capital injection, and since Warren did it on those same terms, we know Uncle Sam isn't getting ripped off.
If you cannot raise dollar one, Uncle Sam doesn't waste any good money on you.
UPDATE 2: October 9, 2008 2:40 pm>
Greg Mankiw discusses a similar approach: How to Recapitalize the Financial System
5 Historical Economic Crises and the U.S. (February 09, 2008)
Global Financial Crises, Part II: Norway 1987 (February 10, 2008)
U.S. May Take Ownership Stake in Banks
EDMUND L. ANDREWS and MARK LANDLER
NYT, October 8, 2008
Vanishing Act Timeline
How various firms on Wall Street are disappearing:
click for ginormous
Wall Street, R.I.P.: The End of an Era, Even at Goldman
JULIE CRESWELL and BEN WHITE
NYT, September 27, 2008