It seems that Congress, the House and the Senate, has finally reached agreement on the disbursal of $700 billion by Hankie Paulson to rescue banks, firms, and companys who hung ten of the CDS surf board. We all should all be happy and Nancy the cougar of The House is extolling the virtues of the bipartisan agreement reached today. www.msnbc.msn.com/id/21134540/­vp/26931644#26931644 "Party Is Over" I am glad she is happy because I am not and the $700 billion I just spent for her joy was done on a drunken binge with low lights.

Oh by the way, all of you home owners who have been screwed on your mortgages, tough luck. Both The House and The Senate felt a judge was not responsible enough to alter the terms of a mortgage and grant relief; although the 2005 Bankruptcy and Consumer Protection Act forces them into being the bill collectors for banks besides allowing them to murder you by giving the death sentence. Mortgage terms are more important!

Golden Parachutes for Executives are a drop in the ocean. We do not want a stake in investment firms as much as we want an end to the lack of fiscal responsibility in an unregulated part of the economy. Many companies may not take the buyout as it would require write downs of assets. Let bankruptcy judges decide what is fair in mortgage terms as they are independent of lobbyists.

The $700 billion is only a band-aid on a larger, more serious, and today a continuing problem . . . CDS. Been dogging this topic for a while and there is more to the story. Under a CDS, a bank may originate a $10 million loan to a company. The originating bank may not want to cover the risk so it may, for a small premium, sell the credit risk to another bank to cover the loan if the company defaults. The CDS may be sold to insurnace companies, overseas banks who can not make loans in the US, etc. (brings the global picture into focus and corporate America). Initially, the CDS was sold as a hedge against default and a transferr of risk from the originator to a second party. If sold "only once" to a credible bank or financial firm, it is a hedge against the risk of making the loan.

It didn't quite stay sold to just one other company. The traders wanting more volume in house went out and sold it to some other reputable banks and insurance companies, some brokers, and hedge funds. What was once a single transactional loan of $10 million and a small premium and a credit risk of $10 million blossomed into 10, or how many transactions, and a credit risk of a $160 million to $200 million expoentially. The only risk to the originator is in the profits as long as those are not hedged also. Some of the risks may offset each other; however if the company that took the loan goes bust the loss is some multiple of the original $10 million. <link> "Credit Default Swaps" On a $5 trillion commercial loan market in 2007, there was ~$50 trillion CDS outstanding. The House of Cards and the market for CDS has grown to ~$62 trillion.

The $700 billion band-aide that Paulson and Benanke asked for will not work as it is a band-aide on an Eboli sore or wound. With each passing day multiples of CDS are transacted for the same loan, Since none of this is carried on the books, it can not be regulated by the Fed, FDIC, Office of Thrift Supervison, etc. The transactions are not transparent and no one knows the extent of the CDS risk throughout the system and no reserve for the risk has been set aside. As long as the value of the assets loaned against retain value, there is no problem. As long as the person who receives the loan makes the payments, there is no problem

Some thoughts on solutions for the long term and the short term:

• As I stated, there is no, or little, requirements for reserves for CDS. It would be good practice for banks, insurance firms, brokers, and hedge funds to be accountable for a reserve to cover in case of default. We can then see how deep the rabbit hole really is in the future.
• CDS transactions are not funded. Maybe it is time that they are funded regardless of whether the purchaser of the CDS will accept your credit risk.
• End the practice of multiple CDS transactions for one loan without funding and transparency.
• Bring CDS under regulatory control.

The $700 billion is just a band-aid to solve the short term crisis. Without regulation by someone who gives a rat's-ass and could care less about laissez faire market places (no Mr. Greenspin you are not qualified), the problem will persist and pop up again in the near future. It is time to close the door on the barn and keep the remaining horses in it.

<link> House of Cards

What would have happened in our immediate short term if nothing had been done?

Bush suggested our entire economy would collapse. Did he play us and congress for fools?

there was a run on commercial money and money market funds a week ago Thursday. The fear was that we would lose those two markets; killing new commercial growth. But there's no proof that it has to return and the Treasury injected 100 billion into the market that day... so it wasn't anything more than a psychological play on Paulson's part to calm the markets. It sounds good, "we are going to bail out banks of their distressed holdings" ... but in practice there is no way to bail out 600 trillion derivatives with 600 billion dollars. If they were only looking to buy mortgages, which is what they first said, then it was a plan... a stupid plan, but still they could do it. But it quickly morphed into "mortgage backed securities" ... what the hell is that? Now you are just tossing $700 billion at Wall Street... really pointless.

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Dawn:

I do not need lap-dances from Nancy the same as I do not need BJs from Larry. I (we) do need both of them to fix the problem before them instead of pandering to the populace with supposition, conjecture, and lies. The problem is not fixed and Nancy the same as Congress fiddles while the country burns.

Just totally unacceptable. Read the post Dawn, Nancy is pandering.

Very good post, Run, and I agree with your assessments. The more than $1 trillion already spent on the mortgage crisis plus the additional $700 Billion to be spent is insufficient. The banks just have royally screwed the economy. The only consolation is that the amendments insisted upon by the Democrats (limiting executive compensation, giving only $350 Billion at first with some congressional oversight, getting partial ownership of the banks in exchange for the bailout) sweeten the pill a little bit. But they'll be back for more because housing prices still need to drop another 20%.

when they were to be had.

Thank you for a well researched and well written analysis that answers many questions that I did not know how to formulate just yet. I believe that the 700B, although it sounds ominous and huge, is really just as you said...a small fix for a much bigger problem that will only be fixed with a financial crash of unlimited proportions. Scary...but sometimes the truth is scary.

Thanks again

jo

Nick:

If you read the part about AIG, it is essentially true. AIG was not bankrupt, it could not raise the capital to collaterize the write-downs it took. Everone was betting through their CDS by bidding them up, that AIG would go bankrupt and the bankers said no. Who knows how many times a CDS was sold for the same loans. Given the extent of the numbers of CDS in the market place, a default by AIG could have serious ramifications.

Whether the US would collapse, I do not know because no one knows the true extent of the CDS. Commercial Loans made up ~$5 trillion in the 2007 economy with $50 trillion in CDS (not counting miscellanious riffraff being sold today) against them. Who has them and on what loan, no one knows. It is all off books like the off-budget war in Iraq. It is the "wild-west" of Wall Street, a laissez faire market place Greenspin endorsed and always wanted. Bush and the rest may be right. The present solution does nothing to prevent future problems

Time to get a new sheriff in town and get the drunks off the street, close down the saloons, and bring some law and orderliness to the CDS transactional process. Companies have to account for the CDS on their books and reserves for them established.

if you must pursue that metaphor, at least "pander" is somewhat sex-neutral. Your subject-line ("lap-dance" !!??), on the other hand, is blatantly, gratuitously sexist. Ideally, women of action and influence can be described figuratively without resort to the madonna/prostitute template.

"Read the post, Dawn" is irrelevant to the above, and condescending besides, even reminiscient of McCain's "Senator Obama just doesn't understand" refrain. Remember, Run, you've fallen all over yourself in the past praising Dawn, and supporting the use of her acute sexism-antenna. Sincere praise and respect should include the occasions on which yourself may have offended, and this one's not even a close call.

... allow banks to maintain zero reserves?

The Fed will pay interest on any reserve the bank does decide to hold.

Now if I understand the purpose of the reserve, it is to buffer the volitility in the system, to be a sort of insurance that protects the institution from finding itself swamped by external market forces.

So why are we still listening to folks like Greg Ip formerly with the WSJ;

"But since required reserves earn no interest, they are a tax, and like all taxes, create distortions."

It seems these guys call every cost of doing business a TAX, and of course all TAXES must be brought to zero.

Am I wrong?

Is there no end to the list of costs that these guys will try to explain as 'distortions'?

Isn't there a value to clearly understanding what is and what is not a tax?

I'd like to see some indication that the folks who are asking us for our help, will agree to accept the definitions of terms that the rest of us use in everyday reality.

and I never praised Dawn in the past for anything. But you are right, this one's not even a close call.

What's a CDS?

Forgive my ignorance but how does repeated passing off of an insurance obligation create a ten or hundred fold multiplication of the basic obligation?

Their flipping compensation is a distortion of reality but they don't want to talk about that either. In the USA Today there was a partial list of annual compensation for financial CEOs. No one is worth what these people are given unless they have done something like Bill Gates or Thomas Edison. these people are thieves.

However, we need to know that when we have to spend 100 dollars to fill our tanks that our credit cards will work. The day that stops we are in a depression from hell and given that these same people have sold out our infrastrucure and our industrial base it will be harder to recover than it was during the thirties.

Its sad to see how the GOP who lead the rally call that caused this mess now try to blame the Democrats who are stuck with trying to clean the GOPs disaster.

For example, in insurance there is a process called reinsurance in which one company agrees to pick up part of the risk of an initial insurer and there can be many layers of reinsurance in which the basic risk never changes although portions of the underlying risk may be wide spread. Why is it so bizarrely different with swaps?