by Calculated Risk on 9/26/2008 09:38:00 PM

From Professor Nouriel Roubini: Why the Treasury TARP bailout is flawed

The Treasury plan (even in its current version agreed with Congress) is very poorly conceived and does not contain many of the key elements of a sound and efficient and fair rescue plan. ... It is a disgrace that no professional economist was consulted by Congress or invited to present his/her views at the Congressional hearings on the Treasury rescue plan.

Specifically, the Treasury plan does not formally provide senior preferred shares for the government in exchange for the government purchase of the toxic/illiquid assets of the financial institutions; so this rescue plan is a huge and massive bailout of the shareholders and the unsecured creditors of the firms; with $700 billion of taxpayer money the pockets of reckless bankers and investors have been made fatter under the fake argument that bailing out Wall Street was necessary to rescue Main Street from a severe recession. Instead, the restoration of the financial health of distressed financial firms could have been achieved with a cheaper and better use of public money.

Moreover, the plan does not address the need to recapitalize badly undercapitalized financial institutions: this could have been achieved via public injections of preferred shares into these firms; needed matching injections of Tier 1 capital by current shareholders to make sure that such shareholders take first tier loss in the presence of public recapitalization; suspension of dividends payments; conversion of some of the unsecured debt into equity (a debt for equity swap).

The plan also does not explicitly include an HOLC-style program to reduce across the board the debt burden of the distressed household sector; without such a component the debt overhang of the household sector will continue to depress consumption spending and will exacerbate the current economic recession.

Thus, the Treasury plan is a disgrace: a bailout of reckless bankers, lenders and investors that provides little direct debt relief to borrowers and financially stressed households and that will come at a very high cost to the US taxpayer. And the plan does nothing to resolve the severe stress in money markets and interbank markets that are now close to a systemic meltdown.

by Calculated Risk on 9/26/2008 06:31:00 PM

I'll post a thread on the debate tonight (starts at 9PM ET).

Here is a live feed. (hat tip AF)

Hopefully there will be some questions on the Bailout Plan. I'd like to see both Senators McCain and Obama explain the economic problem, why they see a need for the government to be involved (or not), what the purpose of the plan should be, and specifics on the plan they would propose or support.

I really don't care about lengthy discussions on how we got here and hopefully that will be avoided tonight.

Important for the comments: I encourage everyone to stay focused on economic issues only. I'll delete comments (or the entire thread) if it gets out of hand. I think this is an important issue and one of these two men will be elected President in just over one month.

My perspective: I believe there is a significant credit crisis right now. The credit markets are in severe distress and we can see evidence of this in the various credit spreads.

A number of financial institutions made bad decisions, and they now need to deleverage. For the most part these institutions can't raise private capital, and as a result they have all but stopped lending. Given a little time, this lack of lending to credit worthy borrowers will significantly impact the real economy.

In response to these problems, the government announced last week that they would present a plan to bailout the banks. Last Friday I predicted the Paulson Plan would have some of the features of the Depression era Reconstruction Finance Corporation (RFC) and make preferred stock investments in banks (with the taxpayers owning the preferred). This would help the banks recapitalize, and punish the existing shareholders by diluting their shares.

My view is that it is in the public interest to make sure the banks continue to lend to credit worthy customers. But it is not in the public interest to protect the management and shareholders of these institutions.

Over time this preferred stock would be sold on the public market. The RFC was one of most successful programs of the Depression, and has been praised by many economists including Milton Friedman.

Unfortunately that wasn't the Paulson Plan. I was very surprised. The Paulson Plan was to recapitalize the banks by paying a premium for toxic assets compared to market prices, leaving the taxpayers on the hook for any losses and rewarding the management and shareholders of the banks that made bad decisions. That is a bad idea and was immediately opposed by many economists like Paul Krugman and Nouriel Roubini who both support some sort of equity investment for taxpayers.

I would prefer that the current plan be junked, and a new RFC type plan proposed. I do feel there is a serious problem and there are reasons for some government involvement. However, at the least, I'd like to see equity investments for taxpayers.

I know that others believe any and all plans should be stopped, and there should be no government involvement. I understand that view, but I respectfully disagree.

Let's see what the candidates have to say.

Note: This week I've received hundreds of alternative proposals - many of them with very good ideas. Unfortunately I haven't had time to read them all, and I apologize for not responding to all the emails I've received. I do appreciate the input and ideas.

by Calculated Risk on 9/26/2008 05:36:00 PM

Stop me if you've heard this story before ...

From the WSJ: Wachovia Explores Sale

Wachovia Corp. has entered into preliminary discussions with a handful of potential suitors, including Banco Santander SA of Spain, Wells Fargo & Co. and Citigroup Inc., according to a person familiar with the situation.
...
Wachovia declined to comment on the discussions. Earlier Friday, a spokeswoman said the bank is "aggressively addressing our challenges" and "working to strategically strengthen and manage capital and liquidity in this challenging environment." The bank's deposit base, stretching from California to the Northeast, is "large and stable," the Wachovia spokeswoman added.

Anyone else feeling a little deja vu?

S&P acknowledged that WaMu's deposit base appears to be stable and the company has enough liquidity to meet all fixed obligations throughout 2010.
Financial Times, Sept 16, 2008

by Calculated Risk on 9/26/2008 04:20:00 PM

From the NY Times: Wachovia Begins Early Deal Talks with Citi

Wachovia has begun preliminary talks with Citigroup about a potential merger, people briefed on the matter said Friday afternoon.

Meanwhile Wachovia stock was off 27%.

National City was off 27%.

First Federal was off 45%.

Downey Savings was off 48%.

Vineyard was only off 20%.

by Calculated Risk on 9/26/2008 02:22:00 PM

The TED Spread from Bloomberg is still very high at 2.91, although down a little from yesterday.

Note: the TED spread is the difference between the three month T-bill and the LIBOR interest rate. Usually the TED spread is less than 0.5%. The higher the spread, the greater the perceived credit risks (compared to "risk free" treasuries).

This will probably be one of the first indicators to show any benefit from any plan.

by Calculated Risk on 9/26/2008 12:47:00 PM

Update from MarketWatch: Counterparty credit risk jumps on Wachovia concern

The CDR Counterparty Risk Index, which tracks credit-default swaps on leading banks and brokerage firms, surged more than 100 basis points to 430.2, close to a record. A basis point is one one-hundredth of a percentage point.
...
Credit-default swap spreads on Wachovia widened by 827.2 basis points and now trade between 28% and 33% "upfront," according to CDR.
...
"Wachovia is now trading at distressed levels, raising the specter of another major U.S. bank failure in the near future," CDR said in a statement.

National City stock is now off 50%.

Wachovia is off 30%.

Reader BR notes that investors are reacting to JPM's marks on WaMu's loan portfolio. These published marks will force the regionals to write down the value of their paper too.

As I mentioned earler, investors appear to be asking "Who is next?"

I don't think either of these banks will be seized today, but based on the pace of failures, I'd guess a bank failure is likely.

by Calculated Risk on 9/26/2008 10:44:00 AM

First, here is the investor presentation material from the JPMorgan conference call last night.

Click on chart for larger image in new window.

Here are the House Price Appreciation (HPA) numbers JPM is working with.

JPMorgan presented three scenarios: a base case (with national prices falling 25% peak to trough), a deeper recession (28% decline), and a severe recession (37% decline).

Currently the Case-Shiller futures are predicting a 33% decline peak-to-trough, Goldman is forecasting 27%, and Lehman was forecasting 32%.

Also note the unemployment numbers for each scenario (7%, 7.5%, and 8% for a severe recession), and price forecasts for California and Florida.

Earlier this month, I presented three ways to look at prices: real prices, price-to-rent, and price-to-income. I've taken the JPMorgan national prices forecasts and added them to the price-to-household income chart.

This graph shows the price-to-household income ratio and is based off the Case-Shiller index, and the Census Bureau's median income Historical Income Tables - Households.

Using national median incomes and house prices provides a gross overview of price-to-income (it would be better to do this analysis on a local area).

For this graph, I assumed that prices would fall over four more quarters for JPMorgan's base house price projection, over five more quarters for the "Deeper recession" projections, and over eight more quarters for the "Severe recession" projections.

Also, after reaching the price trough, I held house prices steady while incomes continue to rise mostly with inflation.

I'd expect this ratio to decline below 1.0 (like in the mid-90s), so I think the JPMorgan base case is too optimistic. My guess is that national house prices will decline somewhere between JPMorgan's "deeper recession" (28% peak to trough) and their "severe recession" (37% peak to trough) projections.

by Calculated Risk on 9/26/2008 09:54:00 AM

Wachovia's (WB) stock price is off 22%.

National City (NCC) is off 19%.

With WaMu seized, investors are now asking who is next ...

by Calculated Risk on 9/26/2008 09:31:00 AM

UPDATE: Bush "It's hard work"

Basically Bush said:

There is no disagreement that something must be done. We are going to get a package passed. Republicans and Democrats will come together and pass a substantial rescue plan.

That was it. Sorry for posting the link ...

President Bush will speak on the financial crisis and status of the Paulson Plan at 9:35AM ET

Here is the live feed from CNBC.

by Calculated Risk on 9/26/2008 08:31:00 AM

From the Washington Post: Away from Wall Street, Economists Question Basis of Paulson's Plan. A couple of quotes:

"There is a kind of suggestion in the Paulson proposal that if only we provide enough money to financial markets, this problem will disappear," said Joseph Stiglitz, a Nobel Prize-winning economist. "But that does nothing to address the fundamental problem of bleeding foreclosures and the holes in the balance sheets of banks."
...
"The root of the issue is recapitalizing banks," said Glenn Hubbard, dean of Columbia Business School and a former chairman of President Bush's Council of Economic Advisers. "That could be done more efficiently through the government injection of preferred equity. Then the market could figure out the prices of the assets."

Initially many of us expected a Depression era Reconstruction Finance Corporation (RFC) type preferred stock investment to recapitalize the banks. Instead, the Paulson Plan intended to recapitalize the banks by paying a premium for troubled assets. The compromise bill discussed yesterday was a step in the right direction because of the equity sharing provision (although there was no details).

Apparently there will be meetings again today starting at 11:30AM ET. (scroll down to see posts on JPM / WaMu)