Page 1 of 2 Back to the woodshed By Julian Delasantellis
Many explanations were proffered for the 1980 electoral victory of Ronald
Reagan that marked the commencement of the conservative era in the United
States. My favorite was not from some American political strategist or pundit
but from a writer for Pravda, what was then the official house organ of the
Communist Party of the Soviet Union.
This person was certainly not going to attribute the cause to US concern for
the world situation following the previous year's Soviet invasion of
Afghanistan; for at that time the party line was that the invasion was a
glorious triumph for the whole world, delivering to a primitive nation the
blessings of modernity. Also, the explanation was not going to be the national
humiliation of the Iranian hostage
crisis, whose travails the Soviets viewed with, at the very least, sublime
serendipity.
The Soviet observer was certainly not going to attribute conservatism's triumph
to America's then ongoing economic troubles; at that time, the USSR was, as
signified by the nation's block-long queues for everything from bread to toilet
tissue, beset by its own unfortunate experience with late-stage state
socialism, troubles that would cause the country to collapse a decade later.
No, it was a reaction against the supposed leniency and licentiousness of the
previous era that the Soviet observer said led to the rise of Reagan. This was
an explanation acceptable to the enfeebled old apparatchiks then wheezing their
way towards extinction in the Kremlin, for the dangers of an overly permissive
society, of the young having a lot more fun than the old, was something on
which both old Russian Bolsheviks and old American conservatives could fully
agree.
Out would be the so-called "Dr Spock" philosophy of leniency and progressivism
- this is reference to American pediatrician Dr Benjamin Spock, whose popular
1946 book on child raising, Baby and Child Care, supposedly so poisoned
the minds of America's 60 million "baby boomers" that, when they grew to
adolescence in the 1960s, they objected to throwing their lives away in
Vietnam.
There was to be a new societal emphasis on responsibility, rules and order. The
Soviet observer took particular emphasis on the shocking rise in promiscuity by
America's teenage females. This, of course, was once a particular point of
outrage among old male conservatives of all nationalities, right up until the
introduction of Viagra that at last allowed all the old geezers an invitation
to the orgy as well.
Ironic, then, that, as the conservative era ended in the US in 2008, it
culminated with an explosion of permissiveness and irresponsibility that made
the free-love hippies of the 1960s look like Southern Baptist preachers. After
all, the hippies never cost the American nation over one trillion dollars.
Karl Marx once said that history is first experienced as tragedy and then
repeated as farce, but if the first experience was a farce, then it must follow
that the repeat will be tragedy. So it seems that is the case with the global
financial crisis, with yet another government attempt, this time by the new
Barack Obama administration, to pull the US and world economy out of the now
almost two-year pandemonium.
Last March 6, celebrating the first anniversary of my original article for this
site on what we then called the subprime mortgage crisis (see
And the band played on, Asia Times Online, March 6, 2008) , I wrote
that the crisis would come to an end only when the mortgage-backed securities
that originated out of the subprime mortgages were once and for all excised
from out of the portfolios of the banks that owned them, so that their declines
in value would no longer cause falls in bank capital that were, and thus
continue to, inhibit new lending.
As governments are always wont to do, good, necessary advice, by me and others
on how to deal with a crisis, was ignored in favor of denying the very
existence of the crisis; Republican presidential candidate John McCain's denial
that there was anything wrong with the economy went a long way towards costing
him the election.
But all the sunny bromides rang hollow and hilarious after Lehman Brothers was
allowed to fail on September 15 last year. In the three-and-a-half days from
that fateful Monday in September to the middle of trading on Thursday,
September 18, the US Dow Jones Industrial Average lost over a thousand points,
about 9% of its then value.
It was during the middle of that Thursday, September 18, that reports filtered
into the press of what we came to know as the Troubled Assets Relief Program,
or TARP, a US$700 billion initiative to buy up the said same illiquid "toxic"
mortgage security instruments that, in the final analysis, were being crushed
in value as US real estate prices accelerated their fall.
As I wrote at this site throughout the autumn, the markets loved the TARP, (the
Dow Jones Industrial Average rallied over 500 points in the first few minutes
after it became public) but the American public hated it; both the political
right and left eschewed any complex analysis of the program and the situation
that caused it, in favor of tired populist shibboleths about "bankers" getting
bailed out while the working class were being thrown out of their houses and
starved.
With then-US Treasury secretary Henry Paulson claiming that the entire world
financial system was perhaps just moments away from total collapse without
TARP, and then with him falling onto a bended knee before US House speaker
Nancy Pelosi to further beg for it, Congress passed TARP on the second attempt,
on October 3.
Then, amazingly enough for government at any level, TARP did not get spent; not
one penny came out of it to buy the private-sector mortgage securities it was
supposedly intended for. At first Paulson, to general acclaim, changed his mind
and said that instead he was going first to use TARP to replenish banks'
capital through government purchases of preferred stock; a few weeks later, he
announced he was indefinitely (or at least until election day, the only time
frame that all the George W Bush appointees were really concerned about)
suspending the mortgage security purchase emphasis of TARP before it ever
really started.
Still, the problem continued, and even accelerated, through the holiday season
and into the New Year. With US real estate prices accelerating their declines
into the end of the year, the mortgage-backed securities and derivative
asset-based securities based on the value of mortgage-backed securities' also
declined in value, which caused the financial plague called deleveraging, as
banks restricting lending initiated a vicious circle through the entire
economy, to continue and intensify.
As Obama walked down Pennsylvania Avenue on Inauguration Day, at the terminus
of his stroll was the bloody wide-open maw of the deleveraging monster, ready
to swallow up his presidency in the same way it did his predecessor.
In the wee hours of the Obama presidency, reports leaked out of a new
initiative being considered to battle the financial crisis, one that involved
the creation of something called "The Aggregator".
In the January 21 Lex column in the Financial Times, The Aggregator was
cleverly compared to its somewhat like-sounding possible inspiration from 1984, The
Terminator, and found sorely lacking.
"In the Year of Darkness, 2009, the rulers of this planet devised the ultimate
plan. They would reshape the future by changing the past ... They created The
Aggregator. Drawing inspiration from the Terminator, which felt no pity, no
pain and no fear, may be no bad thing for the imperiled financial system.
Unfortunately, an aggregator bank - a suggested vehicle to buy troubled
real-estate assets from ailing banks - would lack the cyborg's unstoppable
might."
As usual in government, The Aggregator is nothing new, it was just the where to
the TARP's what. Another attempt would be made to buy up the TARP's bad
mortgage and securities, once that was done, they would go on to reside in The
Aggregator, a government-run bank, where they might or might not recover in
value - that's not really important. What would be of critical importance would
be the fact that, at last, the securities would no longer be like termites
chomping away at the frame of a wooden house, eating away at the banks' and
financial system's capital base from the inside.
So why would The Aggregator triumph when the TARP failed?
Good question, for without a radically new approach to this problem it will
fail for exactly the same reasons as did its predecessor.
The original TARP emphasis, buying up mortgage-backed securities, is easy to
understand until you really try to understand it. It's that simple three-letter
verb, "buy", in the previous sentence that is proving so problematical. Buy
implies a purchase, and a purchase implies a purchase price. How do you agree
on a purchase price?
Of course, in any commercial transaction, the buyers want to pay as little, and
the sellers want to charge as much as possible. This dilemma is usually solved
by a market that establishes a price which moves the sellers' inventory to the
buyers while still providing a profit to the seller. But special situations
rule the items being placed into the marketplace here, mortgage-backed
securities (MBSs).
At their very core, MBSs are collections of home and commercial real-estate
mortgages bundled into interest-paying securities that trade and act like
commercial or government bonds. Ignoring for the moment the issue of how
interest rate changes affect MBS values, the pricing of MBSs can be simplicity
itself. If every single one of the underlying component mortgages in any MBS is
being fully paid back on time, its value should be 100, or par. If all the
underlying mortgages are being defaulted on, the MBS will be worth only what
the properties are expected to fetch in the subsequent foreclosure auctions,
which will be a lot less than par.
During the decade's real-estate boom that ended in 2006, there was a deep,
active and vigorously traded secondary market in MBSs. Why shouldn't there have
been? MBSs were selling like hotcakes in the bond market. They paid higher
coupon interest rates than US Treasuries and/or corporates, and they were also
considered very safe. With real-estate prices rising as quickly as they were,
20% or more of yearly appreciation in some of the hot markets such as Nevada or
South Florida, who was going to default on a mortgage, lose their home, and in
doing so, forfeit their ticket to the great sweepstakes?
Things sure are different now. The secondary market for MBSs has all but
collapsed; they are subsequently said to be illiquid, and thus hard, or in some
cases impossible, to price accurately.
Your dentist may take a break from boring through your bicuspids so that he can
check his computer to see how richer the stocks he owns have made him since you
sat in the chair, but for banks, knowing how much the assets they have are
worth is a much more serious business. The amount of loans they can make, in
essence how much business they can do and profit they can earn, is wholly
dependent on how much capital reserve they have. If they are carrying MBSs as
an asset, and the value of that asset declines, they have to subsequently and
concomitantly pull back on new lending.
Now you understand what deleveraging is.
But why aren't the MBSs selling? In contemporaneous America there's a healthy
secondary market for everything from Star Trek phasers (178 currently listed on
eBay) to gently used meditation mantras (21 of those). Why has the market
failed here?
If you were an American adolescent male in October, 1973, your first
introduction to economics might have been the "gas crisis" that hit the country
following the Arab oil boycott in the 1973 Yom Kippur war. There you were, with
a freshly minted driver's license, which, of course, you wanted to use to pick
up girls. That was accomplished by driving to some hotspot where the girls were
hanging with their friends, catching one's eye, then driving around the block
maybe 20 or so times to see if any eye contact the two of you had established
was going anywhere.
But that was much harder to do during the gas crisis. Fuel supplies during that
time were extremely limited, so you might have been only able to purchase 30
liters at a time, maybe every other day - that wouldn't get you that many spins
around the block. Also, you might have had to wait up to five hours at a time
just to get that wholly inadequate fillup.
That was just the first experience of Americans having to realize that
plentiful and cheap oil supplies were not a right granted to the country on the
Pilgrim's landing at Plymouth Rock. There would be many other "gas crises" to
come - in 1979, following the Iranian Revolution; 1990, following Saddam
Hussein's invasion of Kuwait; in 2005, following Hurricane Katrina's
devastation of the Gulf of Mexico offshore oil production infrastructure; and
last summer, as the great commodity price bubble of the new millennium finally
stretched, strained and blew.
But, even though all those events produced very significant hikes in gas
prices, none of them produced the gas lines of 1973. The markets were then able
to "clear", albeit at much higher prices.
But in 1973, the gasoline markets did not clear. They were still operating
under the last vestiges of the wage-price freeze regime instituted by president
Richard Nixon in 1971. That limited what could be charged for gas at the retail
level, and with America scouring the world for the oil that the Arab oil
producers were denying it, and then only finding it at much higher prices, it
was costing more to produce the gas than it could be sold for, so the market,
much like that currently of the MBSs, froze; it became illiquid.
Could the same thing be happening here with MBSs? Is the illiquid market that
bedevils the banks' balance sheets real, or artificial?
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