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How To Buy Gold For $3 An Ounce

When Will the FBI Open an Investigation into Geithner's Racketeering Plan?

Politics / Credit Crisis Bailouts Mar 31, 2009 - 02:56 PM GMT

By: Andrew_Butter

Politics Best Financial Markets Analysis ArticleThe best thing about the Geithner Plan is it probably won't happen. Yes all the talk will buy time and allow a period of "forebearance", which is what saved the banks (that were left standing) in the Great Depression, and the financial system after the South American fiasco the S&L and the Asian Crisis.


What it won't do is re-start the wholesale credit markets, that is not a stated objective and it was never designed for that. To do that will require another plan, and until that happens the amount of debt that can written will be severely constrained, because until a loan can be "liquified" which is what happens when you create an ABS, capital is limiting.

My concern is that you only have to look at the "chosen-few" as they line-up on Prime Time to endorse the PLAN, to see what might happen, if it goes ahead.

I never saw such eager anticipation on the face of any living thing since my daughter's sweet "Poggi" went on heat and five neighborhood strays camped outside. One fateful afternoon when we were out they chewed a hole in the gate and a few months later, much to the delight of my daughter, darling Poggi was blessed with "mixed" bag litter, one black-one, one white-one...etc. And a bit later, I got the job of drowning them.

One thing is for sure; if the PLAN goes ahead somebody is going to get Gang Banged; and that someone is the US Taxpayer. The only thing that's not worked out is who will get the job of drowning the progeny.

This is how THE PLAN is supposed to work, and why?

PIMROCK will bid for a pool of toxic assets, where they are chipping-in 7% of the price that will be paid and the US taxpayer is finding the remaining 93% (debt or equity who cares, it's all coming from the same place).

The eventual profit or loss is will be shared according to a complicated formula that I can't be bothered to understand since I wasn't invited to the party, although after a cursory glace it appears that the guy who put in 7% has a much better upside than the guy who put in 93%, yet the downside is more or less in line with the relative contribution.

That sounds almost exactly like the deal that all those rocket scientists cut with the (now bankrupt) investment banks, so that they got a nice fat share of the upside, but if they slipped-up and lost, well they just lost their bonus (and if they lost over $1 billion or so, perhaps they lost their jobs (sometimes)). But the investors who had bankrolled them lost everything.

I may be missing a trick or two here, but wasn't it that sort of PLAN that helped create this mess in the first place? More on that later, but there is a lot going on here that is "accidentally on purpose".

Why does the US Government need a "go-between'" (because that's what PIMROCK are), to help them buy toxic assets?

That's simple, neither the government nor its erudite bunch of advisors; mainly academic economists, have got a clue how to value them. The "assumption" is that "the market" knows how to value them (that's PIMROCK in this case).

What the government probably doesn't know is that although PIMROCK, might have some sort of a clue, they won't value those assets properly (and if the government is aware of that then the PLAN is no longer simply asinine, it's nothing less than racketeering).

Oh sure, PIMROCK will say "we have been in this business for a 100 years, we know the value of a toxic asset from the stench, and apart from that we have got floors and floors of shiny offices full of computers and rocket scientists that sleep under their desks and eat pizza" (they probably will omit to let on that a lot of those offices are in places like Bangalore).

"So don't worry Tim-Boy", (puts arm around shoulder in fatherly embrace), "we know what we are doing, we won't let you down". And Tim-Boy is happy, all he needs is to be able to shift the blame of bad valuations to someone else.

So why won't PIMROCK value them (properly)?

Three reasons, first it's too darned hard, second it will take too long, third who cares? Remember, in the days before anyone opened those "tins of sardines" the idea was that MBS all were pretty much the same.

So for example all Fannie Mae 5-1/2% MBS backed by FRM30's (i.e. 30 year, fixed -rate mortgage loans) were treated as interchangeable. Most trades were done on a "TBA" or "to be announced" basis, and the seller had a broad flexibility in what he handed over to settle the trade, the buyer didn't even know what he was going to get, just that the Bond Market Association had established "good delivery guidelines" to govern what the seller could deliver to settle the trade (you paid more to know what you were getting, not many people took that option).

And the "exchange" well that was nothing more than a showroom that was locked during office hours, window shopping only, designed simply to get around the loophole that you needed to be "listed" to be able to write up your toxic assets as "liquid" for the sake of calculating your capital adequacy.

As far as valuation was concerned, the main focus of the market-participants was to model interest rates and bizarrely (given recent events), the borrower's propensity to pay off their loans early and re-finance (which paradoxically reduces the value of the MBS, but is probably the least of anyone's worries these days). And paradoxically also, in the credit business people who pay back early used to be called "deadbeats" because you made less money out of them. How thing change, now they use the word for people who don't pay back ever!

Insofar as default was concerned, all of that was out-sourced to the rating agencies, so if you had a AAA you expected a certain default ratio, and that was priced in, easy. More on that later.

There were two ways to do the analysis (a) Static Analysis which was simple, plug in a number for the prepayments, run out the cash flows, discount and compare to other types of security, i.e. Treasuries, and (b) Dynamic Analysis which used two computer models, one addressed the behavior of interest rates, and the other the propensity of "deadbeats" to pay back under different interest rate scenarios, and then compared the answer against various benchmarks in an iterative process to arrive at the price.

Get the picture - don't worry if you don't, suffice to say that it could be either complicated, or VERY complicated. But there were computer models, well-established benchmarks, and plenty of people that knew how to do that type of analysis.

The "problem" now is that it is THREE times MORE complicated.

On top of all that, which is pretty standard, there is a whole new ball game (or can of worms) opened up. And apart from anything else, there are not a lot of people who KNOW how to do this analysis, and there are no standard benchmarks or references. 

1: Different toxic assets have slightly different legal structures, often depending on the laws in the place where the original mortgages were written. Before that wasn't an issue, now it is.

2: The risk of default is not homogeneous, that is now KNOWN, so the bonds cannot be treated as interchangeable.

Based on some of the statements that are circulating, I wonder how much the people who designed this system actually know how it all worked; for example Lucian Bebchuck of Harvard University who is credited with providing much of the theory explained "if the underlying market failure is at least partly one of liquidity...then" (I paraphrase) "this is the solution" (http://www.rgemonitor.com/economonitor-monitor/256162/the_public-private_partnership_investment_program_ppip__will_it_work).

Well that sounds typical of most economists who these days seem to start every sentence with the words "if we assume" followed by a stream of economic consciousness on Prime Time. Which brings me back to that famous line in Under Siege 2 "assumptions are the mother of all F@@K up's" So much for John Maynard Keynes' idea that economics should become a "trade" like plumbing.

Much more likely is that the way the market worked in the past was explicitly designed for trading things that were (believed to be) homogeneous, so it's not liquidity that stalled the market, it's that the market was not designed to trade "goods" that are not homogeneous. So market when participants found out that the "goods" were not interchangeable (like some "pools" of AAA had a 0.26% default rate and some "identical" pools has a 26% default rate), they stopped trading.

Pump all the liquidity you like into the system, it won't solve that problem.

3: Then there are the ratings. The only thing that anyone needs to know about how the rating agencies calculated the risk of default is that it proved to be extraordinarily unreliable. Rating agencies have been calculating the risk of default the way they did it in the old days, for years, so that should be easy, the problem is that now everyone KNOWS that the way they did it for years was wrong - evidently!

But we won't talk about that! Sure so this time they will try harder! That's good to know, because I was beginning to suspect that they were going to deploy the same people using the same models that delivered such spectacularly wrong answers as what happened last time. And Yup, that's exactly the plan, just this time they will REALLY try harder!!

The reason they don't know any better and they don't have resources that know any better is because they never did the job that's required now. To do a proper valuation it will be necessary to gather market-derived data to make reliable and defensible estimates (defensible in Court), that neither PIMROCK nor the rating agencies have ever done in their lives.

Which is as a minimum to build algorithms from market derived data to explain foreclosures as a function, of (a) how much the borrower is under-water (b) the current sales comparison in the location (c) the economic activity in the location (d) the legal environment (changes from place to place), AND then use that market derived data to build a model that explains observed foreclosure and THEN project those variables into the future.

It's not actually hard to do all that if you know how (complicated but not hard) but neither PIMROCK nor the ratings agencies ever did it before, all their people know is how to run models that were proven conclusively to give the wrong answer, they don't have the experience, capability or track-record to make reliable market based predictions.

So the outcome is a foregone conclusion?

That's exactly what it is, although The PLAN is worse than doing nothing (a) because it will not fix the problem of trading non-homogeneous bonds (so it won't re-start the market) (b) because there is no incentive for PIMROCK to do a proper valuation, so their bids will be too low. In which case the banks won't sell.

UNLESS

Two things can break that deadlock; first the government can twist the arm of the banks to sell at a price significantly below the price they want to sell at. But it won't really be "arm-twisting" it will be bribing, and the government will have to give something in return. And in that case it is highly likely that the value of the "something" will be more than the concession (and who will pay for that? Err...the taxpayer).

The other thing is if it happens that neither the government nor PIMROCK care what price is paid, so long as there can be an appearance of proprietary, and so long as the price makes the banks look solvent. Who cares if the government loses on the deal, it's used to that and in any case it's not their money (it's the taxpayers), but how come PIMROCK would be relaxed about losing (a little) on the deal?

A good explanation for that was provided by Steve Waldman (http://interfluidity.powerblogs.com/posts/1237877649.shtml) who pointed out PIMROCK will be happy to lose all of that 7% if they get to be made whole without "haircuts" on the $100 billion of J.P. Citi and BOA bonds the hold, by "shaking hands with the government".

Talk about a conflict of interest, and this is not racketeering? Isn't the FBI or the Department of Homeland Security supposed to protect American people from this sort of thing?

And as was explained in (http://www.marketoracle.co.uk/Article9743.html), by Mike Shedlock, who pointed out that all this is about is "to make it appear as if there is a fair bidding process so that a "fair market value" can be determined". That seems "fair-enough", to everyone involved, except of course, Err...the US Taxpayer.

So what if they do nothing?

The best part of the Paulson plan was the part that didn't happen, buying toxic assets.

Instead he declared that he "might" which created a semblance of calm. Although this had the unwanted side effect of totally stalling the market because anyone with one of those assets who might have a buyer, held out for the day that the government would pay too much - and that day is arriving.

But there is no reason why the government can't go on doing nothing; (whilst promising to do something if they like). That's how you effectively suspend the mark-to-market scam that created this mess (by allowing assets to be valued for more than they were really worth so more and more credit could be written), and instead implement an ad hoc variant of International Valuation Standards and other-than-market-value.

And just forget about solvency or capital adequacy so long as the books square if valued under IVS; after all you are guaranteeing against runs anyway, and whatever happens the government will have to pay if it wants the US banking system to recover; the issue is now simply "How much".

And how much of what they pay out gets stolen?

OPEN LETTER TO THE SECRETARY OF THE TREASURY :

Dear Secretary Geithner,

You got into trouble before, not complying with the letter of the Law and signing documents as true when you didn't understand the details.

A piece of advice young man, don't let it happen again.

Yours Sincerely,

Andrew Butter

By Andrew Butter

Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2009 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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