Dumbest Label Ever for a Financial Rescue Plan: "Bailing out Wall Street"
I don't know how this meme has become the dominant way of understanding this crisis or the proposed legislation to create liquidity in the banking system. I especially don't know how the proponents of the bailout have allowed their proposals to be framed this way without trying to break out of the frame.
Does everyone realize that the financial institutions that created the bad mortgage backed securities are not the same institutions that bought them?
Wall street companies purchased mortgages from mortgage originators, put them in trusts, issued mortgage backed securities against those mortgages and sold the securities on to smaller financial institutions.
It is true that some Wall Street firms retained large portfolios of the stuff they had created. But it is also true that Paulson has allowed those firms -- Bear Stearns, Lehman, Merrill -- to fail or to be swallowed up. Any program that allows the feds to have discretion about whom to purchase bad mortgage backed securities from would allow the feds to decide to not purchase them from culpable Wall Street firms.
Generally, Wall Street was a conveyor belt for the creation and sale onward of mortgage backed securities.
I realize that looking at financial statements is not very much fun -- especially if you'd rather just not think about the reality of the situation and "let it collapse" -- but I would urge you to try to look through these aggregate financial statements for the "thrift industry."
Just to backtrack, though with a little background -- the banking sector can be (or "used to could be") divided roughly into three parts:
The investment banks primarily help corporations issue stocks and bonds (including mbs) and they also sell and trade those bonds. Traditionally, these companies were referred to as "Wall Street" banks, because they were overwhelmingly concentrated in and around Wall Street in lower Manhattan. But in most ways they were not what we think of as banks at all because they did not take deposits.
Commercial banks were spread throughout the country. They provided loans to businesses and took deposits from businesses and consumers. Originally only commercial banks could provide checking accounts. These banks including the giants like Chase, Citibank and Bank of America. The Glass-Steagall Act allowed investment banks and commercial banks to acquire each other and blurred the distinction between Wall Street investment banks and the commercial banks. The recent financial crisis has seen the final swallowing up of the last independent investment banks by the commercial banks.
Thrifts were the third sector. Thrifts were divided into "savings banks" and "savings and loan associations." These banks were originally founded to help poor and middle class people save through "thrift." Many of these banks were originally non-profit savings banks or depositor-owned cooperatives (savings and loan "associations"). The conflict between a savings and loan and a local commercial bank, was one of the central plot points of the movie, "It's a Wonderful Life." That movie also showed that the main lending side business of thrifts was lending to consumers so they could purchase homes, thereby moving from Mr. Potter’s rundown tenements into Bailey Park and receiving a housewarming gift of bread, salt and wine from George Baily and his lovely wife Mary.
Depository Institutions Deregulation and Monetary Control Act passed in 1980 and the Garn-St. Germaine Act of 1982 deregulated thrifts, making them much more like commercial banks, oftlineending the George Baily era of local community thrift banking. Further deregulation under Reagan and George the First caused massive, irresponsible lending by inexperienced local George Baily's leading to the "savings and loan crisis" and bailout of the late 1980s.
But thrifts continued to specialize in taking consumer deposits from consumers and making loans to homeowners. Because thrifts were required to hold homeowner loans as their main assets, after mbs began to be widely available about 30 years ago (yes, they've been around that long), the thrifts bought them to diversify their asset portfolios so they wouldn't be as susceptible to local down turns in the economy and real estate market.
These financials are aggregate financials of the thrifts:
http://www.iii.org/financial2/banking/thriftinstitutions /
Please scroll down to the third chart: "BALANCE SHEET OF THE FEDERALLY INSURED THRIFT INDUSTRY, 2003-2007", and check out the 2007 column. There you will see that the assets of the thrifts related to mortgages consisted of $840 billion in residential mortgages and $264 billion in mortgage backed securities -- that's about 30% of their assets in mbs. Cash and other securities total $186 billion. Almost all the other assets are loans and real estate, none of which is liquid (ie instantly saleable).
When these thrift institutions bought these mortgage backed securities they were given a document called a "prospectus" by the investment banks. The prospectus is supposed to explain all the risks and safe guards involved in buying these securities. They were also told in most cases by well respected ratings agencies that these mortgage backed securities were triple A rated, investment grade securities -- almost as safe as US treasury bills. It turns out that these prospectuses did not accurately predict the risks involved in the securities and that the rating agencies did not accurately rate these bonds.
Another way to look at it is that a year or so ago, this sector had $450 billion ($264 billion in mbs and $186 billion cash and other securities = $450 billion) in instantly liquid assets for paying out money to depositors, meeting inter bank lending debts, and so on.
As a result of the market for mortgage backed securities essentially coming to a standstill because no one knows what they are worth and no one will "make a market" in them, the thrifts have seen their liquidity reduced by 58%.
Remember, they have to keep the cash and "other securities" liquid for depositors -- especially now that so many depositors want to rush out and withdraw money from their local savings banks.
Other big purchasers of mbs -- all pursuant to reading prospectuses and getting triple A ratings -- were pension funds, and 401K fixed income funds.
Now, can anyone explain to me why a program to purchase mortgage backed securities from, for example, thrifts is "bailing out Wall Street"?
Can someone explain why purchasing mortgage backed securities from thrift institutions is somehow "bailing out the people who created this mess"?
I’m not saying that only the thrifts will get bailed out. There's no question that the commercial banks' mbs will also be bought, as they are the biggest sector, and therefore, they will proportionally sell the most to whatever federal entity is doing the buying.
My main point is that there is no necessary correlation between those who created this stuff and those who bought it. Those who created it were mostly investment banks (including to be fair some investment banks owned by commercial banks).
I just want us to examine the misleading meme that it is exclusively the people who created this stuff (Wall Street) who are getting bailed out. That's not true.
The big question is what policy will drive what gets bought and from whom. The idea is not to buy all of it; the idea is to buy enough of it so that there is liquidity in the system again. That's why Schumer's contribution to the plan was so astute. Start small, ratchet it up and see when the liquidity starts to flow again. But there is nothing in the plan that says the worst offenders in creating this stuff are the ones who are going to have their mbs replaced with t-bills.
In fact, I could imagine all sorts of Congressional preferences determining what gets bought and from whom. One possibility is that if the feds decide their main goal is to call whole series of particular issuers (to facilitate repackaging the stuff), then who gets to sell at any time will be pretty random. Another possibility is to focus on those sectors where credit is most frozen and liquidity is most desperately needed (possibly commercial and international banking). Another is to focus on uninsured money market funds. Another could be to get the housing market moving again and prevent a further collapse of housing prices (thrifts would benefit).
The idea, though, that it will exclusively be a buyout of investment banks is pretty preposterous.
But the real question is: how did the financial press start calling this a bailout of Wall Street? And why did Nancy Pelosi, Barney Frank and others acquiesce in this nonsense and even repeat it?
Why didn’t they just call their proposal the "Let’s give $700 billion of your hard earned tax dollars to the richest, greediest guys on the planet who almost caused the next Great Depression Act"?
It would have had about as much chance of passing.
Does everyone realize that the financial institutions that created the bad mortgage backed securities are not the same institutions that bought them?
Wall street companies purchased mortgages from mortgage originators, put them in trusts, issued mortgage backed securities against those mortgages and sold the securities on to smaller financial institutions.
It is true that some Wall Street firms retained large portfolios of the stuff they had created. But it is also true that Paulson has allowed those firms -- Bear Stearns, Lehman, Merrill -- to fail or to be swallowed up. Any program that allows the feds to have discretion about whom to purchase bad mortgage backed securities from would allow the feds to decide to not purchase them from culpable Wall Street firms.
Generally, Wall Street was a conveyor belt for the creation and sale onward of mortgage backed securities.
I realize that looking at financial statements is not very much fun -- especially if you'd rather just not think about the reality of the situation and "let it collapse" -- but I would urge you to try to look through these aggregate financial statements for the "thrift industry."
Just to backtrack, though with a little background -- the banking sector can be (or "used to could be") divided roughly into three parts:
The investment banks primarily help corporations issue stocks and bonds (including mbs) and they also sell and trade those bonds. Traditionally, these companies were referred to as "Wall Street" banks, because they were overwhelmingly concentrated in and around Wall Street in lower Manhattan. But in most ways they were not what we think of as banks at all because they did not take deposits.
Commercial banks were spread throughout the country. They provided loans to businesses and took deposits from businesses and consumers. Originally only commercial banks could provide checking accounts. These banks including the giants like Chase, Citibank and Bank of America. The Glass-Steagall Act allowed investment banks and commercial banks to acquire each other and blurred the distinction between Wall Street investment banks and the commercial banks. The recent financial crisis has seen the final swallowing up of the last independent investment banks by the commercial banks.
Thrifts were the third sector. Thrifts were divided into "savings banks" and "savings and loan associations." These banks were originally founded to help poor and middle class people save through "thrift." Many of these banks were originally non-profit savings banks or depositor-owned cooperatives (savings and loan "associations"). The conflict between a savings and loan and a local commercial bank, was one of the central plot points of the movie, "It's a Wonderful Life." That movie also showed that the main lending side business of thrifts was lending to consumers so they could purchase homes, thereby moving from Mr. Potter’s rundown tenements into Bailey Park and receiving a housewarming gift of bread, salt and wine from George Baily and his lovely wife Mary.
Depository Institutions Deregulation and Monetary Control Act passed in 1980 and the Garn-St. Germaine Act of 1982 deregulated thrifts, making them much more like commercial banks, oftlineending the George Baily era of local community thrift banking. Further deregulation under Reagan and George the First caused massive, irresponsible lending by inexperienced local George Baily's leading to the "savings and loan crisis" and bailout of the late 1980s.
But thrifts continued to specialize in taking consumer deposits from consumers and making loans to homeowners. Because thrifts were required to hold homeowner loans as their main assets, after mbs began to be widely available about 30 years ago (yes, they've been around that long), the thrifts bought them to diversify their asset portfolios so they wouldn't be as susceptible to local down turns in the economy and real estate market.
These financials are aggregate financials of the thrifts:
http://www.iii.org/financial2/banking/thriftinstitutions /
Please scroll down to the third chart: "BALANCE SHEET OF THE FEDERALLY INSURED THRIFT INDUSTRY, 2003-2007", and check out the 2007 column. There you will see that the assets of the thrifts related to mortgages consisted of $840 billion in residential mortgages and $264 billion in mortgage backed securities -- that's about 30% of their assets in mbs. Cash and other securities total $186 billion. Almost all the other assets are loans and real estate, none of which is liquid (ie instantly saleable).
When these thrift institutions bought these mortgage backed securities they were given a document called a "prospectus" by the investment banks. The prospectus is supposed to explain all the risks and safe guards involved in buying these securities. They were also told in most cases by well respected ratings agencies that these mortgage backed securities were triple A rated, investment grade securities -- almost as safe as US treasury bills. It turns out that these prospectuses did not accurately predict the risks involved in the securities and that the rating agencies did not accurately rate these bonds.
Another way to look at it is that a year or so ago, this sector had $450 billion ($264 billion in mbs and $186 billion cash and other securities = $450 billion) in instantly liquid assets for paying out money to depositors, meeting inter bank lending debts, and so on.
As a result of the market for mortgage backed securities essentially coming to a standstill because no one knows what they are worth and no one will "make a market" in them, the thrifts have seen their liquidity reduced by 58%.
Remember, they have to keep the cash and "other securities" liquid for depositors -- especially now that so many depositors want to rush out and withdraw money from their local savings banks.
Other big purchasers of mbs -- all pursuant to reading prospectuses and getting triple A ratings -- were pension funds, and 401K fixed income funds.
Now, can anyone explain to me why a program to purchase mortgage backed securities from, for example, thrifts is "bailing out Wall Street"?
Can someone explain why purchasing mortgage backed securities from thrift institutions is somehow "bailing out the people who created this mess"?
I’m not saying that only the thrifts will get bailed out. There's no question that the commercial banks' mbs will also be bought, as they are the biggest sector, and therefore, they will proportionally sell the most to whatever federal entity is doing the buying.
My main point is that there is no necessary correlation between those who created this stuff and those who bought it. Those who created it were mostly investment banks (including to be fair some investment banks owned by commercial banks).
I just want us to examine the misleading meme that it is exclusively the people who created this stuff (Wall Street) who are getting bailed out. That's not true.
The big question is what policy will drive what gets bought and from whom. The idea is not to buy all of it; the idea is to buy enough of it so that there is liquidity in the system again. That's why Schumer's contribution to the plan was so astute. Start small, ratchet it up and see when the liquidity starts to flow again. But there is nothing in the plan that says the worst offenders in creating this stuff are the ones who are going to have their mbs replaced with t-bills.
In fact, I could imagine all sorts of Congressional preferences determining what gets bought and from whom. One possibility is that if the feds decide their main goal is to call whole series of particular issuers (to facilitate repackaging the stuff), then who gets to sell at any time will be pretty random. Another possibility is to focus on those sectors where credit is most frozen and liquidity is most desperately needed (possibly commercial and international banking). Another is to focus on uninsured money market funds. Another could be to get the housing market moving again and prevent a further collapse of housing prices (thrifts would benefit).
The idea, though, that it will exclusively be a buyout of investment banks is pretty preposterous.
But the real question is: how did the financial press start calling this a bailout of Wall Street? And why did Nancy Pelosi, Barney Frank and others acquiesce in this nonsense and even repeat it?
Why didn’t they just call their proposal the "Let’s give $700 billion of your hard earned tax dollars to the richest, greediest guys on the planet who almost caused the next Great Depression Act"?
It would have had about as much chance of passing.
Labels: economic crisis
posted by HamdenRice at
9:07 AM
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