The Treasury Morphs Into A Hedgefund
The Mother of All Bailouts plan gives the Treasury not only authority to buy and sell Mortgage Backed Securities, but allows it to deal in any financial instruments including leveraged derivatives.
This evolved over the various versions.
The original Paulson proposal said:
Sec. 2. Purchases of Mortgage-Related Assets.
(a) Authority to Purchase.-- The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.
...
Sec. 12. Definitions.(1) Mortgage-Related Assets.--The term “mortgage-related assets” means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.
All media reports and blogs I have read about this assume that the Treasury under this plan would only buy Mortgage Backed Securities, i.e. bonds backed my mortgage payments.
But the above language also includes Credit Default Swaps. Insurance contracts or derivatives, that guarantee the recoverability of MBS and change their value in relation to an MBS' value.
The language in the Treasury Fact Sheed on the proposal is even wider:
Treasury will have authority to issue up to $700 billion of Treasury securities to finance the purchase of troubled assets. The purchases are intended to be residential and commercial mortgage-related assets, which may include mortgage-backed securities and whole loans. The Secretary will have the discretion, in consultation with the Chairman of the Federal Reserve, to purchase other assets, as deemed necessary to effectively stabilize financial markets.
It seems like the fact sheed exceeds the breadth of the released proposal.
Oh, you say, the Democrats in Congress will prevent the Treasury from morphing into a investment bank backed by $700 billion of taxpayer capital?
Here is Senator Dodd's expanded proposal of the Paulson plan. The language is even worse than in the original:
SEC. 2. AUTHORITY TO PURCHASE TROUBLED ASSETS.
(a) OFFICES; AUTHORITY.—
(1) AUTHORITY.—The Secretary is authorized to establish a program to purchase, and to make and fund commitments to purchase troubled assets from any financial institution, on such terms and conditions as are determined by the Secretary, and in accordance with policies and procedures developed by the Secretary.
...
SEC. 21. DEFINITIONS.(7) TROUBLED ASSETS.—The term ‘‘troubled assets’’ means—
(A) residential or commercial mortgages, and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case were originated or issued on or before March 14, 2008; and
(B) upon the determination of the Secretary, in consultation with the Chairman of the Board of Governors of the Federal Reserve System, any other financial instrument, as the Secretary determines necessary to promote financial market stability.
The Dodd version gets lauded by Krugman, DeLong and other 'liberal' luminaries.
This while the bailout language morphed from "mortgage related assets" to "any financial instrument."
The Dodd version added some nice little extras for a homeowners in distress and some oversight provision. But it also extended the scope of the Paulson plan far beyond housing and mortgages towards an all encompassing bailout for any financial issue.
Since 2003 Dodd collected over $4 million in contributions from Securities and Investment companies. His top five doners include Citibank, SAC Capital Partners and Royal Bank of Scotland. That may well be the reason why he does not want to keep the bill restricted to mortgage related assets but wants to include any financial instrument.
If this becomes law, Paulson and whoever replaces him in January will have the authority to buy Asset
Backed Securities from car loans and credit card loans. He will be able
to buy and sell derivatives based on ABS that have build in leverage
effects. The Treasury may even deal in synthetic Collateral Debt
Obligations and derivatives base on those. It can buy and sell shares
of public dealt companies, precious metals, future contracts on these
and it can speculate on interest moves of Russian government bonds.
Are there any big long future positions on the Canadian dollar the U.S. president does not like? Just get the Treasury buy them up. Congress is giving it the right to do so.
With a capital of $700 billion and the authority to buy and sell any highly leveraged financial instruments, the Treasury will become one gigantic hedge fund that can and may well act to move multi-trillions.
If such an entity makes one wrong move, it can bankrupt its owners within a few hours. The Treasury is too knowledgeable to make such mistakes? So were two Nobel Price winners at LTCM.
Posted by b on September 23, 2008 at 13:12 UTC | Permalink
mea culpa- that should be Mancur Olson, who pioneered much of the work on the formation of states and collective action.
Posted by: erichwwk | Sep 23 2008 14:23 utc | 2
Kabuki Theatre.
Dodd and Shelby are the Senator and Congressperson heading the Banking Committees. They are being presented as the honchos who will stop this thing, or slow it down, or put some honesty into it.
They won't.
The Democrats and Republicans in Congress have been informed of the real facts, which are that the bailouts by the Federal Reserve to date have used up $600 Billion of its $800 Billion balance sheet. That the Federal Reserve Bank is itself insolvent, incapable of sailing forward in the face of a perfect storm of bad debt and derivatives ten times the girth of the financial world.
If the Federal Reserve does not get a monster-sized blank check from someone -- anyone -- real damn soon, its operations are going to stop after the next bank it bails out, and the economy will deleverage the natural way. By fire. By burning down, and letting the law of the jungle sort it all out.
In the event of the Fed not getting its Trillion Dollar Fix, quick, the Fed will turn to the Treasury to print up a trillion dollars, which will put inflation into high gear, unemployment into the high teens or twenties, stop all business growth or investment for a decade, and make the dollar worth about a third or less of what it is right now.
There is no bright future in any event. All this bailout -- or Treasury printing party -- can possibly accomplish is to reinflate the asset bubble we once called the Housing Boom.
That horse isn't going to pull anyone's wagon any more. It is just a matter of getting a trillion dollars for horse meat.
From the United States Congress.
Yeah, that could work.
Posted by: Antifa | Sep 23 2008 14:33 utc | 3
The bailout plan from the Treasury looks like it is something well researched ( from a point of view of bailing out wall street), me thinks this plan has been in existence since 2006 when the derivatives beast first began to show signs of trouble? What do you'll think
Posted by: swindler | Sep 23 2008 14:45 utc | 4
this meltdown does not come as a surprise, hence i agree w/ swindler.
Re Antifa. there is only ONE source of rectifying the credit imbalance w/o creating a massive inflation and that is restructuring the current debt holdings- we simply cannot allow the gains from the phony debt creation to stand!
Current USA GDP growth reminds me of the scam the USFS used to increase current logging in the 1980's, based on the sustained yield principle. The Forest Service would spray a given management unit w/ herbicides, asserting (without supporting evidence) that this practice would result in increased future yields, hence more could be harvested NOW, as it was alleged the current harvest was being replaced by FUTURE increase in inventory. (it wasn't).
This is essentially what happened w/ growth built on inflating current assets. Nothing changed except your house or financial asset was purported to be worth more, creating the illusion of greater wealth, justifying spending more out of current income. Eventually, of course, reality rears its head, exposing the illusion of "greater wealth", as nothing really changed but the paper accounting, pretending to measure wealth.
Let me speak the obvious by saying that our military might isn't worth a damn if our economy is on the brink of collapse. And no matter how hard some want to believe otherwise, no amount of military might can do a damn thing to stop our economy from collapsing. So I'd like to think that this financial crisis plaguing Wall Street is something of a blessing in disguise in that it should serve as a potent antidote to all of our poisonous military adventures, here and abroad.
Posted by: Cynthia | Sep 23 2008 15:47 utc | 7
>me thinks this plan has been in existence since 2006 when the derivatives beast first began to show signs of trouble?
My even more pissed-off take is that the many smart (if immoral) people on Wall Street realized almost 10 years ago that the whole thing was a Ponzi scheme, and the only way to keep it going was to find more suckers to fill out the bottom of the pyramid.
Hence the entire bullshit-filled egg about Social Security needing to be privatized was hatched. They didn't believe all the crap they were spouting any more than the people here, you don't need to work through Dean Baker's math to grok that (paraphrasing) "If the economy is OK, SS will be fine, if it isn't, the stock market certainly won't be either".
They just wanted that 15% of payroll to be driven into their pyramid. As soon as possible - why else was there such an "emergency" to fix something that was based on hazy projections of 50 years in the future?
Now in 2006 the SS thing not only failed, it was followed up by a Democratic Party landslide victory. So much for that revenue stream.
Now, without that and the Cheney regime coming to an end, they have thrown a Hail Mary pass - a blatant application of the Shock Doctrine.
Shorter different chris: they fully expected the derivative beast to eventually act up, what they didn't expect was their abject failure in getting their hands in the SS till.
Posted by: a different chris | Sep 23 2008 16:54 utc | 8
"By April 1995 I had become, in my judgment, the most cynical person on Earth. I now believed everything was a fraud, and I had a well-founded basis for my beliefs. Derivatives were a fraud, investment banking was a fraud,
What lessons did I draw from my experience selling derivatives? I believe derivatives are the most recent example of a basic theme in the history of finance: Wall Street bilks Main Street. Since the introduction of money thousands of years ago, financial intermediaries with more information have been taking advantage of lenders and borrowers with less."
~ Confessions of a Former Derivatives Trader ~
Ron Paul's warnings have come to pass, the Fed played fast and loose and lost big. The time has come to close down the Federal Reserve/IRS and return monetary control to the U.S Dept of Treasury. Federal Reserve Notes need to be called in and replaced by new currency called U.S. Treasury Notes which will be backed by hard assets. The entire National Dept as well as the Trade Deficit will be wiped out in one fell swoop as a 10% exchange tax is placed on each and every Federal Reserve Note Dollar exchanged and that is for private U.S. Citizens, the Federal Government, Corporations and all money parked offshore (stolen taxes and black market money) will pay 25% and State/Local governments will exchange for free. The massive surplus instantly produced will be used for infrastructure revitilization and wiping out private debts, then a TRF Tax Retirement Fund will be set-up for every U.S Citizen with a birth certificate and the Social Security System will then be eliminated.
Posted by: John | Sep 24 2008 8:27 utc | 10
Chris Dodd's version.
search Section eight (no review).
Posted by: yallaer dawg | Sep 24 2008 19:50 utc | 11
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Very nice!
You seem to see these bailouts as I do- as a last ditch effort for those that created money via leveraged creditswaps to gain immunity for their theft. Not only are the victims to be blamed, but our government is now acting as a "roving bandit", more interested in cleaning out the till, rather than as a "stationary bandit", one who takes into account the impact of current theft on future theft opportunities. (Terms from Mancur Olsen)
Also kudos for recognizing that Dodd is part of the problem, not part of the solution.
There is no LR hope w/o an effort to return the stolen monies to their rightful owner. Merely adopting a policy that purports to disallow FUTURE theft is not enough.
To repossess houses from the public, and then to propose taxing those (or their children) to make good the half of the transaction that transfers wealth to the very richest is brazen beyond belief.
Posted by: erichwwk | Sep 23 2008 14:21 utc | 1