Fed Creates $1 Trillion 'Out of Thin Air"

[TraneWreck]

This is why bankrupcy and foreclosure mechanisms are good, they allow for corrections when needed. Say that a company will not part with A B C for offered prices, but cannot maintain with existing cash flow. It files bankrupcy, and the court commences operating the company for the benefit of the creditors. A B C are sold. There is discretion not to, such as if the creditors vote to wait until they are priced adequately.
the payment (due to not being able to stomach the loss on liquida
It doesn't matter what the company owning A B C thinks or wants.

This is usually true, but right now that doesn't work. Banks and other financial institutions have leveraged the value of those mortgages so many times that foreclusure essentially makes 95% of the wealth surrounding a mortgage instantly disapear.

When $30 million of borrowed and leveraged money are based on a $300,000 house, forclosure doesn't really help.

 

[mhaze]

This is usually true, but right now that doesn't work. Banks and other financial institutions have leveraged the value of those mortgages so many times that foreclusure essentially makes 95% of the wealth surrounding a mortgage instantly disapear.

When $30 million of borrowed and leveraged money are based on a $300,000 house, forclosure doesn't really help.

I'm afraid that you have just proved me right. When by legal or illegal means, $30M is supported solely by a $300K morgage (I don't know this is an accurate ratio but nothing would surprise me) then more than every you need the clarity of opening the books up in a legal process and selling the assets at market value to the market. The resulting money is real, and is divided up between the creditors. This is the process of "liquidation". You agree the $30M cannot be propped up, that is irrational.

As Martha Stewart before her jail cell: "It's a good thing".

 

[TraneWreck]

I'm afraid that you have just proved me right. When by legal or illegal means, $30M is supported solely by a $300K morgage (I don't know this is an accurate ratio but nothing would surprise me) then more than every you need the clarity of opening the books up in a legal process and selling the assets at market value to the market. The resulting money is real, and is divided up between the creditors. This is the process of "liquidation". You agree the $30M cannot be propped up, that is irrational.

As Martha Stewart before her jail cell: "It's a good thing".

I absolutely agree with this. I was advancing two points: first, an explanation of the government's position, that we have to bailout without condition, and second, I argued that when you do what you suggest above, the government has to temporarily provide those lost services.

I think we're basically in agreement save for the immediate need of government money in the economy.

My only point was that if you go through a bankrupcy preceeding, the companies really will go under. There's no way to even remotely cover that debt in a more standard manner.

 

[mhaze]

I absolutely agree with this. I was advancing two points: first, an explanation of the government's position, that we have to bailout without condition, and second, I argued that when you do what you suggest above, the government has to temporarily provide those lost services.

I think we're basically in agreement save for the immediate need of government money in the economy.

My only point was that if you go through a bankrupcy preceeding, the companies really will go under. There's no way to even remotely cover that debt in a more standard manner.

You said,

When $30 million of borrowed and leveraged money are based on a $300,000 house, forclosure doesn't really help

If so, how could fraud-illegalities-NOT be involved?

So are we bailing fraudsters?

 

[TraneWreck]

You said,

When $30 million of borrowed and leveraged money are based on a $300,000 house, forclosure doesn't really help

If so, how could fraud-illegalities-NOT be involved?

So are we bailing fraudsters?

I'm not sure what else to say.

We can allow bankruptcies to go forward and foreclosures to happen and provide no government funds to pick up the functions of the failed businesses. Every economist I've been able to find views this as a terrible idea.

Option two, government funds are used to help us through the crisis.

Now within option two we can either bailout the fraudsters you mentioned above, or those funds can go to banks without toxic assests, we can temporarily nationalize failed institutions, or the government can step in and provide those services themselves.

I think all the fraud should be punished. It turns out that's not what Geitner and Obama are going to do, I think they're making a mistake.

But it would also be a mistake to assume foreclosure and bankruptcy would take care of the credit market freezes and other issues.

 

[MattC]

You said,

When $30 million of borrowed and leveraged money are based on a $300,000 house, forclosure doesn't really help

If so, how could fraud-illegalities-NOT be involved?

So are we bailing fraudsters?

Have you some speedy way of weeding out the fraudulent transactions and the persons behind them from the vast web of misery the financial system has become? Bear well in mind that people suffer the longer you take to do this.

~ Matt

 

[mhaze]

Have you some speedy way of weeding out the fraudulent transactions and the persons behind them from the vast web of misery the financial system has become? Bear well in mind that people suffer the longer you take to do this.

~ Matt

That's a broad question. I understand the difficulty of it, but it is also of concern that attribution of cause may be misdirected, for various reasons, say some fraulent, some political.

Here is where I've got a problem - Bush paid 325B in July 2008 to correct the subprime problem, essentially making subprime AAA+. That should have trickled through all the tranches and derivatives based on morgages and stabilized their values. But in fact the various institutions began to fail in October and have continued to topple like dominos since. This tells me that the financial instruments which have questionable value are not based on subprime morgages. In turn the continued attribution of cause to subprime is in error (not necessarily fraudsters, could be just stupidity).

Granted there may have been new waves of morgages souring. But all jumbo morgages were protected from default by "PMI" in any case. Did all PMI suppliers fall? I've heard no word of that, and everyone I know is still paying a PMI premium...

So looking strictly at the issue Trane brought up, $30M in bank equity being propped up by a $300K morgage, I think that we could say that if this was actually occurring and given the facts as I laid them out, yes, you could go in and show fraud.

Tranches made up allegedly 30M in value cannot be based on 300K morgage unless there is fraud. A simple example is the same morgage being listed 100 times, when it should be listed only once.

Again, you've posed a broad question, and we more or less agree on that. But a solution method out of the mess which leaves the stones unturned is unsatisfactory, and that's what we have currently.

 

[oggiesnr]

Tranches made up allegedly 30M in value cannot be based on 300K morgage unless there is fraud. A simple example is the same morgage being listed 100 times, when it should be listed only once.

Not quite. I use the security of that mortgage to take out another loan and in turn the lender uses my loan as security for another one and there's no problem as the original loan is now part of a package of AAA loans and so the merry-go-round continues until someone defaults and people start looking at the asset value that it's all based on. At that point lots of loans get called in and mayhem ensues as the insurer hasn't made provision for this happening but just taken the premium.

Steve

 

[mhaze]

Not quite. I use the security of that mortgage to take out another loan and in turn the lender uses my loan as security for another one and there's no problem as the original loan is now part of a package of AAA loans and so the merry-go-round continues until someone defaults and people start looking at the asset value that it's all based on. At that point lots of loans get called in and mayhem ensues as the insurer hasn't made provision for this happening but just taken the premium.

Steve

Okay, how is there not fraud?

300k morgage at 8% (M) sold from A to B, A gets say 270k and does whatever with it - not relevent, that's fractional reserve.

B, morgage processor, folds M in tranche Z1, says z1 pays 8% and M is only equity.

C buys Z1 for $3M.

B is guilty of fraud. Z1 paid 0.8% at 3M valuation.

No? Yes? What did I miss?

Where is a house of cards without liars?

 

[Piggy]

What did I miss?

That it's all legal. If there's no law against it, well, there you go.

 

[mhaze]

Show the method of constructing the afore mentioned scam by which it falls outside the law.

 

[Piggy]

Show the method of constructing the afore mentioned scam by which it falls outside the law.

Well, since I'm claiming it doesn't fall outside the law, you're asking the wrong person.

 

[mhaze]

Well, since I'm claiming it doesn't fall outside the law, you're asking the wrong person.

Ok, but I meant falling outside of fraud law, etc. Sorry I was confusing.

So show how these activities are legal, then. Where is the loophole?

 

[Piggy]

Ok, but I meant falling outside of fraud law, etc. Sorry I was confusing.

So show how these activities are legal, then. Where is the loophole?

Loophole in what?

Which law do you think has been violated and by whom?

I mean, there may be some illegal activity in there somewhere, but in the grand scheme of things, considering 35-to-1 leverage was legal, even more leverage was legal if you got insurance, the insurance companies were allowed to leverage out the wazoo, exotic financial instruments were legal, the CDO market was largely unregulated, the CDS market was pretty much entirely unregulated... I just don't see what the criminal activity was that you're implying.

Maybe I'm missing something.

 

[oggiesnr]

The only possibly questionable parts of the whole deal is whether the credit agencies should have looked harder at the colateral before they rated the packages AAA but as they were all insured it fell within their guidelines so could rubber stamp them so to speak and whether the insurance companies should have looked harder and ensured they had the assets to cover their liabilities. Not so much illegal as stupid.

Steve

 

[Puppycow]

But isn't part of our problem that we have a tremendous inventory overhang from when the housing market collapsed?

And is there another way to create new money, other than "out of thin air"? I don't want to sound like a Paultard here, but the financial system really is bubble all the way down. It's the ability of the financial system to maintain momentum that keeps the whole thing afloat, and right now nothing's moving.

/gross oversimplification

Sorry I didn't notice this when you posted it.

Um, for the first question, yes. This is why the price of housing has collapsed. Too many houses on the market, so more sellers than buyers. Although houses are excluded from consumer inflation, they are nonetheless a good subject to inflation and deflation like any other good and are a part of whole picture of the real economy. So when house prices fall, it acts like deflation.

As to the second, question, I suppose we could go back to gold, but I don't think that's a good idea. Better to have the Fed target the ideal inflation range of about 2-3%. Add money (by lowering interest rates) if it falls below 2% and take money out (by raising interest rates) if it rises above 3% (simplification). This is an extraordinary situation because even with interest rates at 0%, there is still deflation. So the next step is quant easing.

 

[charles brough]

Not quite. I use the security of that mortgage to take out another loan and in turn the lender uses my loan as security for another one and there's no problem as the original loan is now part of a package of AAA loans and so the merry-go-round continues until someone defaults and people start looking at the asset value that it's all based on. At that point lots of loans get called in and mayhem ensues as the insurer hasn't made provision for this happening but just taken the premium.Steve

A good description. It is legal unless the government passes liegislation that will prevent it.

It has happened often in history . . .nothing new. In the Dutch Tulip craze, the price of tulips, of all things, skyrocketed and became an immense speculative competition. Finally, the bubble burst and prices of them collapsed, throwing the whole economy into turmoil.

In the Johan Law Inflation, paper money was tied in value to the price of land. Land prices rose, so the government printed more money because the increased value of the land warrented it. So, land prices rose further, thus justifiying even more printing of money. Prices flew through the roof and then collapsed, leaving a depression.

In the South sea Bubble, the bubble burst when the immense promise of wealth from the South Sea empire disappeared.

 

[mhaze]

Loophole in what?

Which law do you think has been violated and by whom?

I mean, there may be some illegal activity in there somewhere, but in the grand scheme of things, considering 35-to-1 leverage was legal, even more leverage was legal if you got insurance, the insurance companies were allowed to leverage out the wazoo, exotic financial instruments were legal, the CDO market was largely unregulated, the CDS market was pretty much entirely unregulated... I just don't see what the criminal activity was that you're implying.

Maybe I'm missing something.

In either the assertions of income from the instrument or it's asset basis.

Example. $3M Derivative is sold based on 300K morgage (10-1 leverage). Morgage is based on 30K down payment (10-1 leverage, 8% return).

Return is 0.08 x 30K = about 24,000 interest per year.

$3M derivitive will not sell if it is advertized that it only yields 24,000 per year. The $3M investment needs to show a likely profit of $240,000.

How could such a yield have been asserted without lying? Now back up to the $3M valuation. The valuation must be based, as in bonds, based on the discounted present value of the future income stream at the required current yield. Thus we know that the $3M "investment" was in fact said to yield $240,000. Which is a lie. Now suppose that it was asserted the derivative had shown a historical income stream of $240,000, so you have a "safe investment". In our hypothetical here we show that the income is only $24,000. So anybody who asserted $240,000 was pulling cash from new equity to keep the ball rolling - that's called a ponzi scheme. Again illegal.

Overstating the asset base behind the 3M, lying about the income stream, faking the income stream - all illegal...

Maybe this is clearer.

 

[oggiesnr]

How could such a yield have been asserted without lying? Now back up to the $3M valuation. The valuation must be based, as in bonds, based on the discounted present value of the future income stream at the required current yield. Thus we know that the $3M "investment" was in fact said to yield $240,000. Which is a lie. Now suppose that it was asserted the derivative had shown a historical income stream of $240,000, so you have a "safe investment". In our hypothetical here we show that the income is only $24,000. So anybody who asserted $240,000 was pulling cash from new equity to keep the ball rolling - that's called a ponzi scheme. Again illegal.

Overstating the asset base behind the 3M, lying about the income stream, faking the income stream - all illegal...

The point is it didn't go from $300,000 to $30m in one jump. It did it in a series of small steps each of which appeared to make sense when you looked at the step immediately behind it. Problem is that when a step near the bottom fails all those above it are in danger of failing as well. When the bottom step was a sub-prime mortgage then there is nothing there.

But it is not a case of one entity inflating the value, the whole lot churned through the system and through many hands each banking on getting their 10%+ return. There was no new equity or investors as in the classic Ponzi scam, these were big players churning the same basic debt through the system in more and more obtuse ways.

In effect all that money was airware, it existed only on balance sheets and inside computers. The catch is that we, the taxpayer, are now turning that airware into real cash for them.

Steve

 

[mhaze]

The point is it didn't go from $300,000 to $30m in one jump. It did it in a series of small steps each of which appeared to make sense when you looked at the step immediately behind it. Problem is that when a step near the bottom fails all those above it are in danger of failing as well. When the bottom step was a sub-prime mortgage then there is nothing there. .....

Wrong. Subprimes were fully fixed 7-08 by Bush with over 300B. I used an example of jacking value from 300K to 3M to show the problem.

Now I understand what you've said is the common perception, but I believe that when you follow the money, you have to encounter one or more of the three types of illegal behavior I laid out.

Or the classic 4th case: Listing the same asset down more than once.


I'm not saying you are not right - I just haven't seem this argument laid out clearly to show that it doesn't contain fundamentally illegal activity, and I'm having difficulty contriving a way to run the scam without such. Put yourself in the shoes of the scammer, and tell me how you do it without breaking laws.