William Greider: Here is the ugly truth - the pinnacle of the US financial system is broke

[marmar]

from The Nation:



Time for a Bank Holiday
Comment
By William Greider

November 19, 2008



Henry Paulson's $700 billion plan to save the world is dead or dying, but the bailout was not killed by his arrogance or his grossly misleading claims about what the public's money would buy. The plan collapsed because it didn't work. The Treasury secretary has launched a PR offensive to revive his falling influence. Too late. The Democrats should be equally embarrassed. In September their leaders in Congress rushed to embrace the Paulson solution, no hard questions asked. They now claim they were duped.

Paulson's squad at Treasury pumped $250 billion into the largest banks, buying their stock at inflated prices on the assumption it would persuade investors to step forward with their capital too. Instead, savvy financial players realized Paulson was spitting into a high wind, trying to save a system with stout talk.

Here is the ugly, unofficial truth that neither Wall Street nor the government will acknowledge: the pinnacle of the US financial system is broke--with perhaps $2 trillion in rotten financial assets on the books. Nobody knows, exactly. The bankers won't say, and regulators won't ask, or at least don't dare tell the public. Official silence naturally feeds the conviction that banking's problems are far worse than we've been told. The Levy Economics Institute of Bard College puts it plainly: "It is probable that many and perhaps most financial institutions are insolvent today--with a black hole of negative net worth that would swallow Paulson's entire $700 billion in one gulp."

The scale of this disaster explains why the Treasury secretary had to abandon his original plan to buy up failed mortgages and other bad assets from the banks. If government paid the true value for these nearly worthless assets, the banks would have to write down huge losses or, as Levy economists put it, "announce to the world that they are insolvent." On the other hand, if Paulson pumps the purchase price high enough to protect the banks from losses, $700 billion "will buy only a tiny fraction of the 'troubled' assets." ......(more)

The complete piece is: http://www.thenation.com/doc/20081208/greider

[dkf]

1. Why do we say these assets are worthless?

Houses will always have value. They are only "worthless" now because everyone is too scared to buy anything.

[burythehatchet]

3. Its not the houses, it the multiple bets that were made on the same house (mortgage)

[JackRiddler]

6. You beat me to it by 1 minute, see post #4 and be well!

[JackRiddler]

4. "These assets" are not houses...

They are derivative bets -- phantom values -- made on the interest from mortgages on the houses, exceeding the value of that interest by a huge multiple. At this point defaults on mortgages could stop and it would not change a thing, the debt system would still crash because the face value of the fradulent derivatives issued on both sides of that value (bets that the interest income would go up or down) exceeds that value -- in fact, it exceeds the value of the entire real economy by countless trillions. The total of the debt must be written down, which no one in power is yet allowing to be said, or else monetized through money creation (hyperinflation), or else be destroyed through default (economic crash and depression), or some combination of these options.

[Cassandra]

13. Actually, it exceeds the value...

of the global economy by multiple trillions. Iceland was our problem in miniature; bets made well beyond the deposits of under 400,000 people to sustain.

[DireStrike]

22. Really? Do you have articles that point to that estimate or something?

I guess you have the right name for that sort of claim, lol.

How are you getting that sort of estimate? I had no idea it was so high.

[Cassandra]

25. There was a link a while back...

that said that the estimates of the derivatives and swaps were higher than global GDP. Sorry I can't remember where it was, although it was quoted on DU and I remember the source seemed credible.

[Lochloosa]

26. Here you go. 62.2 TRILLION DOLLARS Wrap your brain around that one.

http://www.wikinvest.com/wiki/Credit_Default_Swap_(CDS)

[DireStrike]

35. Oh jeez.

So there are tens of trillions of dollars of garbage running through the books somewhere.

Huh. This IS going to be a nightmare, isn't it? I can't even understand what this is going to mean.

That needs some time to sink in. Not like there's anything else I can do about it but look over the edge and wait to "enjoy" the ride, anyway.

[SoCalDem]

36. and the REAL "next shoe" to drop is the 2 trillion or so owed to credit cards

by consumers who haven't had their incomes keep pace, so they used house "phantom equity" to pay real dollars to credit card companies, so they could keep charging their own amercian dream..

the only ones who "made out" were the lucky(smart?) ones who bought a house for $80K in 1984, never borrowed against it, and then sold it for $500k in 2004..and put the money into a paid-for-in-cash smaller house & banked the rest of the money..

the people who "paid" (borrowed) the $500k are now stuck with a debt of $500K, on a house worth maybe $125K...and no one can even buy it from them for any price, if THEY cannot get a loan..

I have a friend who recently lost her house.. she put down $27K on it 15 years ago ...paid $99K for it.. then she hooked up with a con-artist "boyfriend".. last moneth when she finally left him and the house, they owed $335K on that stupid house..and it appraised at $175K..and there are millions just like her...

[Warren Stupidity]

5. The houses back the mortgages that failed

and the value of those houses, right now, are less than the principle advanced by various institutions to buy or build those houses. Worse, the mortgages are in default, so all the investment 'vehicles' based on the profit being made from those mortgages are also upside down.

The houses of course have *some* value, but when that values is estimated, along with the value of any new mortgages that might be issued to those who could buy these houses, it leaves our leading financial institutions bankrupt. It appears that the upside-down quality of this problem can be pegged at some astounding numbers - as in trillions not billions.

[dkf]

30. Yes, but mortgages have value because houses have value and they are the collateral.

Just because a person can't pay their mortgage doesn't mean their house isn't worth anything. It is worth something to someone.

They just aren't the right owners for the house because they can't afford it.

[kentuck]

31. But if that house is sold ten times to a different buyer..?

How does each of them collect on the value of that home? I think that was the idea behind the CDS's?

[dkf]

32. Yes but not everyone collected the premium 30 times on that mortgage.

The Government needs to figure out who is viable. Then they need to regulate and keep track of all derivatives so they can be aware of systemic failure.

It also makes me wonder how a mortgage backed security can default when not everyone in that pool will do so. What will trigger the need to buy back the MBS?

In a way it makes me wonder if there is too much money in deliberately bringing down financial institutions so people can collect on CDSs. Could that be why our banks are being brought down one by one? Its like a swarm that goes from institution to institution bringing them down systematically. I am suspicious.

[Warren Stupidity]

34. This is not that complicated.

Bank A pays builder B 500,000 for a house now 'owned' by citizen C, who has a mortgage for 500,000. C can't make his payments, the house goes into foreclosure, but is only worth 300,000. Bank A is now upside down 200,000 on the house. Meanwhile Wall Street Shark S has financial instruments I who's value is based on citizen C actually making his mortgage payments, along with citzen C1, C2, ... CN, and some huge number of them are also in foreclosure, so I is now upside down too, and all the jerks who bought shares of I are busy dumping them as fast as they can. That of course starts wrecking the capital reserve positions of huge investment firms that are holding these instruments as part of their portfolio. They start collapsing... and here we are.

Yes somebody new can step in and buy the original house for 300,000 - that is why the bank isn't out the whole 500,000. However as this crap multiplies through the economy lenders become adverse to issuing mortgages even to the credit worthy so a lot of 'valued at' 300,000 foreclosed houses are just sitting there with a theoretical value that can't be realized. Plus the glut of houses is killing the businesses based on building new houses, so those businesses are defaulting on their operating capital loans - they are going bankrupt too, and the mess starts eating away at everything connected to it.

[quaker bill]

7. because the assets

are not houses. Many of them are insurance policies taken out on a bet that you and others will pay their mortgages.

[Nay]

8. Because the assets aren't the houses. The "assets" are the 30 or 40

bets made on each house that the mortgagee would, or would not, welsh on the loan. Then there are the "assets" from AIG, which are insurance papers insuring those 30 or 40 bets on each house.

Do you see what they've done? They have made a huge edifice of nothing but Las Vegas-type bets. This they consider "assets"! But they aren't assets -- they are just computer bets. And because dozens, and perhaps hundreds, of these bets have been done on each mortgage/credit card/loan, and because they are not really attached to any one mortgage/credit card/loan (remember, the loans have been "bundled" into packs of thousands of loans), they are based on nothing but the perceived ability of most ppl to keep on paying.

But those who made the loans made those loans to ppl who, in any real-world situation, wouldn't have been given a loan for a pack of cigarettes. Why? Because the more loans they made and bundled, the more money and fees they made on those bets. And because no bank holds any individual mortgages (they're all bundled, remember?), when an individual loan goes bad, no one bank can take the hit. That made the banks and financial institutions very careless in their lending, because it would never come back to haunt them -- the loans were sold off in bundles, and the bets laid on each bundle are 50 or 100 times the worth of the actual mortgages involved.

Once the con is uncovered, it all falls down.

[Pharaoh]

23. Capitalism is a big scam

A mother fucking huge pyramid scheme. Unregulated capitalism is a total disaster.

A system of highly regulated capitalism along with a system of socialism for the basic needs of human beings, Food, shelter, health care, should be looked at to replace this failed corrupt system.

[JackRiddler]

10. Wow, did you get your answer yet?

Talk about rapid reaction force!

[dkf]

11. Not every institution is screwed up with Credit Default Swaps.

Frankly I think they should have let AIG fail, then CDSs would only be as good as the Company you bought them from.

I think the Govt should require that in order to collect on a CDS, you have to own the underlying bond. Then you can't have 30x exposure and anyone owning the CDS without the bond would find them worthless. The agreement on a CDS is you are supposed to exchange them anyway...the person who got the premium turns over the cash in exchange for the mortgages.

[JackRiddler]

19. Okay. They should have.

But they didn't. And they won't.

Since there won't be a revolution against the bankers' coup prior to the dominoes falling, the crash is going all the way, with the Treasury and Fed (that would be the taxpayers' money) riding it down like Slim Pickens atop The Bomb from Dr. Strangelove.

[dkf]

29. They don't even know what the exposures are.

This needs to be transparent.

This really is Phil Gramm's fault. All financial instruments should have been regulated. Stupidest idea ever.

[sendero]

33. LOL

.... my sentiments exactly.

[Sophree]

14. Yes, at least I did

After reading this thread alone, I feel like I understand the whole thing a bit better.

Derivatives- isn't this what brought Enron down?

[Two Americas]

24. not just fear

People can't afford to live. They are afraid of poverty and destitution, not that their investment portfolio is declining. Their fears are well founded. That is because of declining wages, the result of the indulging all out war on the working people.

The idea that things are only worth what people are willing to pay, and that we have a choice between fear and greed, only serves a small percentage of the population and destroys the lives of most of the people to one degree or another.

You cannot run an economy for long as a gigantic fire sale, an orgy of speculating and investing and profiteering on the backs of the working people. Wealth is produced by the working people, and if you destroy them - which is what is happening - there is no more economy.

The 90% of us working and producing should not be forced to cater to, serve and support the 10% in the investing class. The point of finance and banking, sales and investing and speculating is to serve the producers, not the other way around. The economy should serve the people, the people should not be seen as cogs in the machinery or as commodities on the market.

The vast majority of people in the country value family, friends and community over profits, desire to contribute to the well being of others rather than to climb to the top of the heap, seek meaningful and satisfying work rather than an enhanced portfolio, see their dwelling as a home rather than as an investment.

[Barack_America]

2. Fuckwads.

I can't even believe what these assholes have done to our country. And yet they are thrown money and their transgressions allowed to remain in the shadows.

[JackRiddler]

9. Why is Greider ignoring the Federal Reserve role?

The scale of this disaster explains why the Treasury secretary had to abandon his original plan to buy up failed mortgages and other bad assets from the banks. If government paid the true value for these nearly worthless assets, the banks would have to write down huge losses or, as Levy economists put it, "announce to the world that they are insolvent." On the other hand, if Paulson pumps the purchase price high enough to protect the banks from losses, $700 billion "will buy only a tiny fraction of the 'troubled' assets."

Paulson did not abandon that plan, unfortunately. Because the $700 billion was a joke compared to the failed assets, he is merely giving it away to his friends and fellow class members. Meanwhile, the Federal Reserve has been trying to implement the original Paulson plan, so far lending a sum on the order of $2 trillion or more to the banks and accepting the toxic assets as collateral in return. Even this is a "tiny fraction" and will never cover the losses, but it is done anyway to maintain the system as long as they can (or to allow the Ponzi scheme inventors to make off with as much as possible before it collapses anyway - regardless, a matter of months at most) and getting us collectively further in the hole.

[slipslidingaway]

16. Great question - Bloomberg Sues The Fed; Transparency At The FED

http://www.youtube.com/watch?v=jlcvsuqAVVE

[GoesTo11]

12. But aren't there two sides to every one of those bets?

If there are derivatives where someone has something worthless, there's another side that can write off it's bad debt. It's like this.

Let's say you and I are taking a walk. I say "I'll bet you a trillion dollars that our friend Iggy makes his home payments." You say "I'll bet you a trillion dollars that our friend Ziggy makes his home payments too."

At this point, my balance sheet says I have an asset with a book value of $1 trillion. You have an asset with a book value of $1 trillion. But I also have a potential liability of $1 trillion and so do you. The market value of each of these bets depends on the probability that Iggy and Ziggy will default. Since Iggy and Ziggy work the same job with the same company and always buy the same things and have the same personality, they pretty much always have the same probability of default, so my liability cancels my asset and so does yours.

What happens when Iggy and Ziggy default?

I owe you a trillion dollars but I can't pay it. You know why I can't pay it? Because you owe me a trillion dollars which you can't pay. You're in the same boat.

So now we both have to go to Paulsen and ask him to help us either pay off our bad debt or compensate us for the debt that went bad. Paulsen compromises. He pays off 17.5% of our bad debt and buys a share in each of us that's worth 17.5% of the original book value of our asset. In other words, he gave me $175 billion to buy your bad debt, and gave me $175 Billion for a (very small) share of my profits. He does the same for you. What happens now? I have $350 Billion and so do you. This is great, because when we were out walking, we each had nothing. The debts are written off. The government is out $700 Billion.

[Festivito]

17. That is fun. Very close to the mark. Just off enough to be fun.

It's such an awful mess.

[JackRiddler]

20. Thank God It Passed!

Excellent analogy. The CDS scam was predicated all along on the knowledge that the government (effectively an insurance subsidiary of the banks) would step up to monetize these phantom values at any price to the people, who are utterly worthless slaughter-units. We are all supposed to starve so gamblers can pay off bets on "values" they invented by picking a number.

It's not nationalization, as some say; it's privatization of the Treasury.

[Tierra_y_Libertad]

15. K&R

[Festivito]

18. Broke, sure, but with the rest in stasis so it can haunt Obama.

They don't want to buy up all the bad debt -- yet.

When Obama turns left, then they release a little more, ready for their pundit connections to shout: "LOOK AT WHAT HE'S DOING TO THE ECONOMY." When Obama turns right again, they hold back and wait again.

[progressoid]

21. "The Democrats should be equally embarrassed. "

Amen.

[kentuck]

27. We are being governed by "dupes"..

How encouraging!

[kentuck]

28. Here is the bottom line:

"Paulson was trapped by these circumstances (and his own mendacity). Each time he tried to change the script, market insiders became even more alarmed. Congress is trapped too. So is President-elect Obama. From the outset of the crisis, the essential fallacy shared by governing influentials has been a wishful assumption that quick interventions with tons of public money would somehow restore the system to "normal" without disturbing free-market principles. Replenished banks would start lending again and lead us to recovery. "Normal" is not going to happen. If the new president does not break free of the denial and act decisively, his administration will be dangerously compromised from the start."

[whosinpower]

37. What the 700 billion was really for

Was to protect the status quo of Wall Street banksters. It was not designed to get the economy going - nor was it designed to inject capital into the credit crisis - if that was the case, then it would of been mandatory that the banks had to loan out that money -they did not legislate that requirement. Paulson himself stated that the money was to protect the financial institutions that were deemed to big/important to fail.

He never stated it was a stimulus plan - it was protection money.

My own thoughts on this - why can't government just declare all CDO's null and void? Every single one of them. Why hasn't AIG declared who it is paying these out to? The Fed's had to give AIG several bunches of money to pay out some of these. Why are we not allowed to know that?

Now, I just heard GeorgeW Bush on the radio speaking at the APEC summit. He stated that free trade, free globalism and free people was the answer. That protectionism was what made the depression so long lasting and deep.

If I was Obama, and I am not, nor do I have the requisite degrees in economics, but if I was, I would nationalize the banks - every single one of them. I would get labour working, by increasing investment in infrastructure, renewable energies and green technologies. I would cap maximum salaries and any NAFTA type agreements would have a minimum wage requirement between those countries. Free trade can only work to the benefit of both nations when both are on an even scale of labour.

[scarletwoman]

40. I like your plan, I wish it would be Obama's plan. Fat chance, of course. (nt)

[kentuck]

38. We need to understand that it was the banks....

that put us into this mess. They are the culprit.

[Greyhound]

39. The real killer is that $700B (really way more, but let's use the number everybody knows)

put in the hands of the people that own it in the first place, would make a huge difference in the real economy.

$2K per household would immediately be pumped into the economy at the bottom where it multiplies itself several times. That would be a tremendous "jump start" that the whole cycle would benefit from.

It won't be done because the people that matter would still be left holding the bad bets they made and lost. This will not do.