Friday, September 26, 2008

How do we fix this?

Instead of trying to be right, as I am just as wanting to be right as any of you guys, we need to get involved in how to come in with some kind of fix that could change the picture. I don't think the country gets off without some kind of deep recession, but to continue the policy of feeding Wall Street fat pitches so they can bilk America out of its economic base along with the rest of the world isn't going to do anything. The rich need to recapitalize the banks, not the customers who got stuck with the deposits created out of this mess or the guy on the bottom who is beyond even having a dog in this fight. I read something where the top 400 richest people in the US gained $600+ billion in net worth over the past 8 years, just enough to restore this lost capital. You can bet 95% of this increase was traced to banking transactions of some sort. The bailout cements this amount into permanent debt that will burden the country and all that don't hold the debt. We are looking at a swap of treasuries for debt the holders don't even dare mark down to its true value. I would exclude all Wall Street firms including GS, JPM, MS, MER, Citi and others up there from receiving a dime, as they were the group that facilitated the creation of this mess and bankrolled many a hedge fund which leveraged this stuff into trillions for themselves. The entities that need to be restored are those that can show that they were bilked by this group into buying this crap. This doesn't include FNM or FRE, who for all practical purposes, should only be indemnified to the extent that their holdings were encouraged by Congress. If any of these firms do participate, their loans should be limited to 80% of face of what is bought and to what can be determined to be FMV of these products deducted from this amount and the balance loaned to them as preferred stock at rates around the rate charged by Warren Buffett, with a 20% call premium. This way, we don't see wholesale dumping of crap that the holder doesn't need to get off their books merely to restore them to par. I am sure most of us would like the value of our SUV's and pickups restored to pre high gas price times that were in essense created out of this mess as well, but none of us outside of the lenders are going to get a dime.
I heard Mish Shedlock on the Overnight radio show just long enough to hear he had some stuff on his website about this. I think we should take action here and follow his lead in sending crap to Congress. My mother wants me to send an email to McCain to the extent that anything derived out of this mess is used to pay down the debt, not to be put into the general fund to be thrown around as if it was a windfall. That is a good concern to be addressed. My concern is that these are generally companies that in the broadest sense serve and are held by multi-hundred millionaires and up and these guys should bail out their own firms. I would rather the government have to bail out the depositors than to allow these outfits to sit back and wait a few years then fleece the country one more time. They need to pay the fiddler. Also, if short selling can be outlawed, intercompany stock transactions, like buybacks and to some extent sizable bonuses and dividends need to be limited and in the case of stock buybacks, done away with entirely for a period of 5 years. The banks need to lend around their capital, not pay screw the shareholder, smoke up the scene of performance with borrowed funds to buy back stock and pay out valuable capital in the form of dividends. The stock needs to reveal reality and not some wishful thinking of some welfare queen. All these firms are trading well above zero, some having 12 figure cap values, despite the term beaten down being used on CNBC over and over again and most of them need a capital infusion. Now how can an outfit need a capital infusion and be trading at such huge cap values?
Here are the links from Shedlocks website; We should all either back up what we can agree with on this site or offer our own opinions.] Mish Shedlocks home page Representative Sanders petition against Paulson
Fate may rest with Shelby Take back America
Protest letter by economists
John Hussman letter to congress

I think many of us realize that we have reached a point in history where it might better to lose all and go through a depression than to bow one more time to international entities in need of a bailout so they can continue to hold and increase bondage over us. I propose that this is nothing more than a treasury swap, where instead of these guys owing us, we are going to owe them. The FDR gold seizure was a similar transaction where all is now owed back to the Federal reserve and the Federal reserve owes you nothing for your paper except debt that is held against all Americans. I hate to get regional, but this is one more NY swindle of Americans, that has been going on since this Republic was founded. The Texas banks were wiped out in the 1980's along with the S&L's. The shareholders weren't bailed out and the local banks were given to east coast concerns. Except for a few freewheeling S&L guys, none of the employees were enriched in the manner that those working for these NY concerns were. We are now beginning to see that emperor Paulson has no clothes, though he was compensated at Goldman as if he were royalty. His salary is equivalent to paying Mario Mendoza Arod money in baseball (for those that don't know, 200 batting average is kindly referred to as the Mendoza line). There are some things about Paulson and his efforts I appreciate, but this is one more attempt to remove his pals from reality and to attempt to allow the American public to not face what is really going on. We can't afford another bailout of these guys and I don't believe we can afford to see another Fed chairman in the vein of bernanke or Greenspan nor can we afford another Goldman Sachs Secretary of the Treasury in the vein of Paulson or Rubin, who did more his share of veiled Wall Street bailouts.

Thursday, September 25, 2008

No helicopter drops?

What the government did in the spring was a clear and simple helicopeter drop. Bernanke sat in front of congress and told them about $160 billion should do the trick. It went right into a black hole, as it bulled Walmart stock a little and was gone in a few weeks. This move isn't a helicopter drop and if they go through with it, most likely it will prevent the stimulus helicopter drops needed to get the economy going, the way it has been done in the past, because this bailout weakens the US financial position. To go further and roll out more spending or as far as that goes, more tax cuts would likely be counter productive, as over consumption got us here in the first place and it can be directly traced to government and Wall Street financing.

This, on the other hand is a swap. If the Congress holds the banks feet to the fire, we are actually talking about a program to reduce bank capital or thin it out, not replace it. The plan Bernanke and Paulson put out was a flat gift, which is probably what is needed for the short term as much as I hate to say it. What I would like is that the bad banks just went broke and the government then acquired the assets and liquidated them over time. Something tells me there are too many default swaps out there to let the group go insolvent and shit would fly around the world until everything was brown. Thus, attempting to maintain the status quo with some strings attached was probably a good idea, even though it was also borderline criminal.

The reason I don't believe this does much over the short term is the economy is 2 or 3 steps slow now in credit creation. I won't go into details here, except to say that the system has failed to create enough credit to keep the ball rolling and the system has had too many losses to start the pump again very quickly. Thus we are looking at a swap here, much like the RTC did in 1990. Does anyone recall an inflationary spiral in 1990 besides one in the stock market and one associated with the Gulf War? There was actually a downtick in inflation that followed this mess, to the shock of everyone.

There are a couple of things different now than in 1990. For one, we didn't have the next step in credit creation to take, which was all this crap that they are now stuck with from the CDO's to FNM/FRE. I don't think the financial postion of the US was in better shape in 1990 from a government standpoint either. But, they had an interest rate spead in 1990 that could be lowered and widened on the assets provided. Where do you go from a 2% short term/ 3.8% 10 year spread? Not too far, especially if they have to support the dollar next. I think the t-bill is sending a signal that we are going back to 1% soon and the dollar will be supported short term because the rest of the world is about to join us there.

First of all, we are looking at one of the great farces in history, a blackmail that we are going to be forced to swallow. As much as most of us bears would like to see these bull bastards get zero for their stock, the problem is the problem is so big that the Fed is out of funds and the whole system probably fails, not only in the US, but around the world. It is almost like playing Russian roulette where if the gun doesn't fire, the house is going to fall in on you. The vast marjority of us don't want to lose our money and I wouldn't snicker if you are a gold bug either because police with no paychecks in chaos don't show up for work as we saw in New Orleans, but instead join the looters.

There is absolutely no way out of this. If we prop the banks, this solves the immediate problem, ala putting our finger in the dike. The system is still going to have to deleverage. If there was sufficient capital, sufficient good credit, this mess wouldn't have happened in the first place and it is clear that the higher income people in the US are going to pay for this mess longer term. We are going to see a restriction in credit, which is going to really piss a lot of people off, but what else can come out of this? There cannot be a return to subprime, blindfolded lending and I find it highly doubtful that there is much toxic junk marketed for a long time to come under the guise of top rated credit. This means lower demand from all circles.

What is a depression? I think it is a collapse in capital goods demand. What do we have here? Clearly a capital shortage. You can devalue the dollar, up value the dollar or whatever, but it won't increase the flow to the US from China to fill up Walmarts. The most visible capital spending crazes are going on in China and much of Asia and I would venture that most of their massive growth has been coming from their capital spending craze, not their other output. The whole thing has been fed by a speculative inflow of hot money chasing return, as was demonstrated by their stock market boom and following bust, not exports as supposed. They are buying oil just like we are, iron ore, coking coal, copper, you name it. Then there is the boom in Arabia, where a major world skyline has appeared overnight. I doubt this stuff goes on, as the fuel for it all has been exported American credit. They could replace the dollar, but what would continue the flow of credit? I say all this goes into the box and the price of commodities that go into capital expansion go into the crapper.

I know a guy that I talk about this stuff to quite often. He has a brother that is a street guy in California. His brother got a credit card for $3000, maxed it out and now don't know what to do. The guy lives in a homeless shelter and got a credit card with a pretty nice line of credit. This is what built Asia and broke the banks. The recent string of Presidents, Congressmen and others hasn't been too anxious to end this as it kept the game going.

When I grew up , we had recessions every 3 to 4 years and they were planned and usually not so bad. Then LBJ launched the Great society, fought the Viet Nam war and flooded the world with credit. Inside of 9 years, the dollar was pushed off the gold standard and the business cycle was in ruins. Devalued dollar meant leverage was less forceful in doing anything and the recessions got to be something to be avoided at all costs, as President after President went to slaughter in the 1970's. There were 2 problems that were fixed by Reagan(I know I am going to be debated here), spiraling government spending and tax bracket creep. If Reagan had dropped the tax brackets 10% instead of 20%, maybe capped unearned income at 60% instead of 50% and indexed for inflation, his plan might have worked perfectly or at least much better, but I think he also knew the tax bracket creep game had been allowed to run too long. Politics is beside the point, as what Reagan did worked to the point that it created an expansion that lasted most of his term, most likely becaused he wiped out the shot of speed the Congress typically gave the economy and replaced it with requests for spending cuts and a military expansion. The fact that the trend for interest rates turned down was another factor and maybe a bigger factor than anything else but it too was traced to the political scene. That and the creation of a market for some new financial products, derivatives.

Bush I lost in 1992 because he was probably 6 months early in his term, meaning he was 6 months early in running for election. Had the election been in May 1993 instead of November 1992, I doubt the economy stupid would have played. Bush I had to fade the first deflation game and part of it was probably taking a tax increase. Clinton walked into a new game, new derivatives, cleaned out banking system, the GSE's deciding they could write all the mortgages in the world and a Treasury secretary who could sell anything, fresh from sucking all the money out of Mexico for Goldman Sachs. Rubin knew the prosperity game came out of leverage and I believe his aim was to create a bubble and a favorable view of Wall Street (by the end if the 1990's, everyone loved Wall Street in politics). If you read Greenies book, you realize that Rubin convinced Greenie, who always worked on the fringe of Wall Street that there were no such things as bubbles. I believe Greenie wanted to prove the central bank could fix anything and went along(had he not tried, some idiot would think for the rest of time this could be done). Because the credit machine was so big, the distribution of money(balances belonged to one group to the extreme, debts to another group) in the bank so poor, the game ran on. When it bursted, Greenie came with a new money game called the carry trade and Bush with tax cuts and a war. Anything but to come face to face with the dreaded recession(probably depression by 2001) word. Things weren't getting better for the guys on the bottom, but they did have a job and credit cards came in the mail.

So here we are, at the end of a long economic cycle. There has been almost 30 years since we have had a recession worse than the previous one. Some say 1990 to 1992 was the worst economy since the depression, but I think credit was just tougher, not the real economy worse. The rebound was weak, but the depth of that recession was much less than the 1980 recession that they called a double dip (that was a political lie made up over years, as that one started in 1979) which was worse than the 1975, which was worse than the 1971 or whatever year it was. The 2000 one wasn't as bad as the 1990 one and this one is going to be worse.

One has to look at the string of artificial demand that has circled the world to realize that to deleverage means a collapse in that demand. The 1930's was a capital goods collapse. People can drive the cars on the street in the US for another 20 years before they had to have a new car and maybe car sales go to 12 or 13 million instead of the bubble level. That is 4 or 5 million cars less in capital goods needed. China's exports drop, the financial burden of a bubble economy hits and their building boom stops or slows. That is a massive decline in capital spending. The capital spending to do capital spending also declines, whether it be mine production or machine tools to make machine tools. Who needs the latest PC to run their business? Best guess is very few can't go another year or 2 without one.

Here is the question. I think the economy moves to survival mode, which means that gasoline and food take over the concern of most people, followed by a roof over their head with the desire to get the latest TV or cellphone and service moving to the rear. This crisis has probably thrown the election to Obama, who will attempt helicopter drops at the expense of the rich then have to address the other problem, which is the deficit. The government is going to have to prepare for war, which means that the stream of money paid out for goodies is going to decline. My guess is the near term goal is that something be done to weaken the economies of our likely foes and piling up payments to give them leverage over us isn't going to solve the problem. We have been leveraging up for 70 years or more and the leveraging game is over.

Maybe the gold bugs are correct and this results in hyperinflation, but I think we are going to see a deep recession worldwide that is going to reveal a massive liquidity squeeze due to the fact the punchbowl has been drained. It hasn't been taken away, the host is just flat out of punch. In that vein, I think we deflate and the world joins us.

Saturday, September 20, 2008

What the real problem is

I need to write something where I am not responding to questions or debating, so I am here. To spend an hour writing something for the PB board as to have it gone in a matter of minutes under the senseless stuff that is quite often posted there is a waste of time for any well thought out post, correct or in error. I know my writing always contains some erroneous conclusion, but amidst the errors is a basic point that is true to the point you can write it in stone.

The first point is that there is nothing new under the sun. FDR started this emergency procedure and it has never stopped since March 4, 1933. The day it stops will be the day that the phrase, "this note is legal tender for all debts, pubic and private", quits showing up on our money. I am not going to write 12USC95a and 12USC95b on this page, as it only consumes time, but I would get a copy of it and read it every time something like this happens. Rubin used it to send $40 billion to Mexico. Not one peep out of Congress. The Fed posted what it was going to do in assisting money market funds and banks in keeping that system liquid, saying there was no debate and they were going to start immediately. What was posted on PB was the press release, but somewhere there was an actual order issued by the Secretary or the President that quoted 48 stat 1 as its authority or 12USC95a and 95b. This is war ladies and gentleman.

I will start out by saying that the net result of what the government is doing in the money markets and capital markets will add up to about nothing. For the most part, what they are doing is assisting in liquidation. This is pretty much all the government does other than finance hot checks and put the balances in some of our accounts. The money market emergency allows the movement of deposits from money market accounts to other accounts by providing temporary liquidity. It allows for banks to deal with their off balance sheet subsidiaries that violate rule 23A or 23B, which deal in size in relation to capital reserves. We are looking at another SIV model in the money market accounts, something that seems to elude a lot of people and little if any insurance, only commercial paper, which is generally very high quality.

FNM, FRE and AIG were taken over in order to keep assets and liabilities that permeate the entire world financial system from collapsing. It appears that they either should have done nothing and let the chips fall or they should have taken in LEH as well. I am not going to get into any of this other than to say that the system is already illiquid and that for the short term, the mistake would be to allow any of these operations with assets and liabilities this large to cease to function. The mistakes made in taking them in can be rectified, as the businesses can be operated and liquidated in some kind of orderly fashion instead of falling into chaos, as is the case for Lehman. We will never know if such action would stop a depression until we do it, but to let them fail in a world system that has so much debt would be certain deflation and depression. If this doesn't work, which I don't expect it to work to the point that it is declared an immediate success, then we will find out about it and speculation that it should be done might end. If it does work, it adds an important tool. On an individual basis, this might be a moral hazard, but company wide, it is definitely a total loss for most involved in ownership of these companies. In the case of FRE, FNM and AIG, the shareholders are left with a maximum of 20% of what comes out of this mess, which probably isn't going to be much. The government stands to lose big or profit big, but the losses that hit the system had these operations failed would have made the government losses that much bigger. They were all headed for bankruptcy by the end of September and the GSE's would have probably been operated at that time under a rule of emergency, as the entire financial system would have seized up.

Here is the problem as I see it and why it can't be solved. I asked last night where were the deposits coming out of all these socalled printing press actions? There aren't any because assets of the system are being bought to liquidate debt and accounts. The actions to support the money market accounts is nothing more than allowing for liquidation of balance sheet assets to move balances. There isn't going to be a 1 cent increase in the balances of the new accounts from the old accounts because the Fed provided the liquidity. There was a reduction of $169 billion in MM accounts last week according to statistics posted by Doug Nolands Credit bubble bulletin. There was no corresponding increase in m1 and m2 to reflect this. Maybe we are dealing with a lag. This isn't the long term problem though

Before all this mess became public, what were the big financials doing with their profits? Well, they were buying back stock and paying huge bonuses. This capital position money was pretty much being put into accounts that became liabilities of the system. To understand banking, one must realize that the balance sheets of the banks reverse mirror the balance sheets of their customers. This is why my deposit is a debit on my account and a credit on theirs. That term used to drive me crazy. Their balance sheet has all their loans on one side of the sheet, the debit side and all their liabilities and owners equity on the other side. Now they have the new games, the SIV's and MM companies that are off balance sheet and most likely have no capital requirements. But that is another matter. The problem with this layout is the net worth of the banks. As you might see, their loan balances and other assets are generally stated to be higher than their deposit liabilities. The paradox here is that the deposits are the only thing in the system as a whole that can pay the liabilities, meaning the capital account or the owners equity if you prefer is an illusion. This works well as long as money circulates in general, but once the imbalance gets large, it no longer works. This is why the rich become poor or much less rich as well in a depression, as their bank balances are required to disappear in order for the system to heal itself.

All the actions I have seen so far have done nothing to change the balance between assets and liabilities in the financial system. The new proposal is to create a super fund, now $700 billion to buy mortgages in the system. What is this going to do? My guess is the government is going to have to sell bonds, which means that all the mone spent to buy the mortgages is going to go back to the government or fed to buy the bonds. The government is going to counterbalance its costs of funds with the income off these mortgages and maybe redeem the mortgages over time. I have heard they are going to pay fair market value for them, maybe sell them off and maybe let some of them pay off on their own. If the bulls are correct, the government will make out like a bandit if they pay something close to FMV for these assets and not just set up a fund to buy bad assets. They say the problem is liquidity. I say it is capital position.

Why is it capital position? As I brought up, this time around, the banks didn't keep their earnings, but instead used them to buy back stock and pay large bonuses to their employees. What does this do? It converts capital to bank liabilities. Not bank assets, but bank liabilities. How? It converts bank capital, the earnings left after operation into money that now exists in the accounts of those that sold the stock. This served to inflate the value of the stock market temporarily as did the leveraging of the balance sheet of banks into more credit. Thus, the net worth of the banks were converted from net worth to liabilities. Pretty amazing fact. Do the transaction if you don't believe me.

Now what kind of deal did the banks make in this matter? Well, I doubt one of them can sell stock at anywhere near what they bought it back for. Also, they are now caught short capital and any capital raised now reverses the transaction I mentioned in the previous paragraph, increasing net worth and decreasing liabilities. But, it also decreases the amount of deposits in the system to pay the assets on the bank balance sheet, something that few understand. The entire cash movement in banks is a reduction or increase of liabilities and a reduction or increase in owners equity and there isn't a cash account per se on the debit side of the account other than cash held as an asset, as in Federal Reserve cash or credit balances of the Federal reserve. The exchange of check is all done on the other side of the equation and against assets,but rarely against cash to a significant degree with the public.

So here is the real problem. If we start out with a bank that has lets say $1 billion and it represents the entire game of credit. If it earns a net 3% on its business after expenses, its net worth will be $2 billion at the end of 24 years. It will owe $1 billion and have $3 billion or it will owe $2 billion and have $2 billion. Thus it will now have assets, mostly loans and cash of $4 billion and liabilities of $2 billion. This could be more extreme in that it might have assets of $10 billion and liabilities of $8 billion and owners equity of $2 billion. This works well as long as the bank is still acquiring physical assets or collateral as part of its net worth and the balances it owes to customers is circulating around the community as medium of exchange.

But, what happens once the system becomes highly collateralized and the bank no longer can expand its assets and liabilities against existing assets? Well, it still might work as long as the balances are circulating, but in time something is going to happen. The bank is going to make a mistake in sector lending, thus lend too much against real estate or stocks or new business or inventory. Second is the mathematical equation that money won't circulate evenly and the liabilities of the banks will become concentrated in one group of hands and the assets will be claims against another group of people. Thus, in either case, what started out as a bank having $1 billion morphed into the bank having $2 billion and the people having a billion to pay back the banks $3 billion or whatever.

One thing is clear and that is once systematic imbalances do occur, the problem of debt increase moves from being shown in price inflation to asset inflation, as the balances that increase over time become concentrated in the hands of few who now spend their money to enhance returns rather than to buy Cadillacs. They leave these acts to the welfare queens and the general public, who continue spending and increasing their pile of cash assets. Thus the bank balance sheet becomes a picture of liabilities it owes to a group that is entirely different than the group in general that owes its assets. A prime example would be a guy that bought a nice real estate project with 20% down for $1 billion. This guy is rich, but the loan proceeds went into the accounts of a group of 25 partners who now have $40 million each to draw interest off of and bid for other assets. Most will look to buy some stock of some other rich guy who will maintain the cash in his account. The money might filter down, but it won't filter down to the guys it needs to filter down to and it probably won't make it back long term to the guy that just borrowed the $800 million. That guy is going depend on the little guys continuing to get cash to go shopping and once that don't occur, the bank is going to get the project back. The entire value of the project then becomes the availability of credit for the middle class guy to go shopping and the next rich guy to buy the project. If credit for either disappears, the bank becomes dependent on the previous sellers or their assigns to come back and buy the property, hopefully at a price of at least $800 million. In the procedure, the $200 million put up for the purchase appears to have disappeared, but in reality, it exists now as a bank liability to the previous sellers or their assigns as well. Thus we have entered a period where the assets can't support the liabilities and the liabilities can't support the assets and the net worth must be adjusted downward. (if this appears to be out of order, I added it later so the flow to the next paragraph is going to look a little jerky)

So lets see what is happening today? First of all, this thing operates in a loop. The Fed doesn't print money and give it out without acquiring interest bearing assets in return. So, the more the Fed puts out, the more it takes back in the form of interest, thus its activities are always a net drain over time. Second, the banks give up their good assets and the Fed is taking even less good assets, but lending less money against them if this is necessary. But, they aren't printing money, but temporarily liquidating the assets of the banking system to supply cash equivalents to settle the liabilities of the system. They are not making these loans to allow the banks to loan money, only to settle their balances between themselves created out of prior loan activity. An example is the money market mess that erupted this week out of the LEH bankruptcy and most likely has been brewing for 20 years. The Fed opened a special window to allow for liquidation of commercial paper to facilitate the relocation of these liabilities. Lets say the head organization is Chase. If Chase is faced with a run on its off balance sheet MM fund, it can face a liability of huge amounts that it can't liquidate in the current market. If all the money merely moved from Chase MM account to Chase bank, the bank could merely buy the assets of the MM fund with the deposits moved, a trade. But lets say that Chase MM account has $10 billion that moves to another bank. Chase has no way of moving that money save an around the block liquidation of commercial paper in an unstable market. There was $90 billion moved in one day, so you might grasp the problem. There wasn't any new money created here, only a facilitation of liquidation of high qualilty, short term paper. The balances remain the same, only the collateral rests with another bank. There is no more money to lend, as the liability exists and has not been extinguished. Only the holder of the collateral and how draws the interest on it has changed.

The FNM, FRE and AIG take overs are another game. That said, has the government done anything different than KKR did with AIG? The government has backstopped these crucial organizations, not monetized them. The corporate takeover boom of the past 5 years was much more inflationary and dangerous than these moves. Credit contraction and squeezes were the problems with these firms along with maybe insufficient capital to exist as financial intermediaries. This doesn't mean they had negative worth on the market though. In the case of AIG, it had one side that was a mess and the other side which was probably worth more than the bad side was negative. But, it had to operate as an ongoing financial entity and it wasn't going to operate as such under the current financial conditions. Thus it was not going to match its cost of doing business with its income. Neither were FNM and FRE and all of them were woven throughout the world financial system. The government didn't even write a check to buy these operations in the sense that KKR, Blackstone, Cerebus and the other raiders would have. The idea at which end the government was going to get the bill for these failures was really a choice of whether they wanted to go through the worldwide financial failure or not. I don't think there is going to be a choice, as the whole thing is going to deflate, but this buys time.

For the inflationists, where is the capital? The financial system needs capital, not Fed funds injections to expand. They need fed funds injections to meet the liabilities and imbalances in the system, not to make new loans. What about the GSE's and AIG? AIG sold for roughly $100 a share in 2000. That means their top worth was well in excess of $200 billion. FRE sold for roughly $70 per share in December of 2004. This talllies to $45 billion. FNM brought $86.75 in January of 2001. With roughly 1 billion shares, that is $86 billion. So conservatively we are talking about 3 institutions that had a worth of well over $330 at their combined peaks and now the private side of these 3 are worth less than $12 billion, over $10 billion still accorded to AIG. I highly doubt that at this fire sale time that the enterprise liquidation value of AIG is going to come anywhere near $50 billion, which is what it would have to bring in order for the current price to hold true. Chances are that by the time it pays the government its financing fees, buys its way out of its derivative positions that the whole thing might produce $5 billion. AIG stock is a dead short, which is why shorting has been banned.

The brokers are another animal. The Government didn't take over any brokers because the brokers depend on keeping their large customers. What customers would stay with a broker should the company be taken over by the government? Well, I think we all know the answer to that, which means that there wouldn't be a enterprise value at all for these guys because their business was gone the day the government would have stepped in. AIG and the GSE's have a potential enterprise value and I suspect that the GSE's might be significantly undervalued in the current environment, but then again might not be worth anything. But, it appears that the government is going to have to cut these guys into what they sell the next time around the block, regardless of how much money they have to put in. I don't believe this is true of AIG, which is being propped by a loan in exchange for high interest and 80% of the equity. The LIBOR plus 8% is going to force time to be of essense in this matter and the assets will probably be moved at less than attractive to AIG prices. The good side of AIG is a Cadillac in a stable of Fords, while the bad side is the sludge at the bottom of the feedlot pit.

No one has explained to me where the capital is coming from? All these transactions involve giving up good assets for liquidity that is already owed. The best the Fed can do is keep the price of assets up by preventing the system from freezing up. The now $700 billion bailout involves selling mortgages that to this point are illiquid. If they are bad paper, they won't bring much, so the entity selling them is going to have to take a writedown. Maybe this will allow some writing up of assets as some of the poor value has to do more with the fact that there isn't a market for them, but it won't make the assets good nor will it allow for capital appreciation. This is basically allowing companies to move their assets to liquidate their liabilities. It will speed deflation rather than prevent it.

Lets say that they do put up $700 billion? How are they going to finance this? My guess is a swap of treasuries for the mortgages. That was how the RTC was handled, but this has a problem attached to it. The government is limited in how much they can pay for this crap and if it is indeed toxic waste, this will be very little. In fact, there is a lot of level 3 assets that I suspect fit this category that have been marked to some kind of fiction that may be bought here. If the market price is what many of us expect, there will no longer be a mark to model or some other kind of fiction to support the fiction on the balance sheet of GS, MS, BAC, MER and others. The problem for all these assets holders is the fiction will no longer be the fact. There will be more hell raised than can be spoken generally over the next century in the next year if they end up paying a massive subsidy to the failed financial system. So, the best the system can do is sell these assets in return for treasuries. This won't be rolled off the press cash and the treasury and these sellers now exposes themselves to an interest rate risk and to a need to move interest rates on the short term higher to protect the dollar.

My points are that buying the assets of the banking system don't do anything to remove the liabilities of the banking system. They can support the liabilities of the banking system, but they can't make the assets good because the assets are owed by an entirely different group of people. They can tax away the liabilies and give the money to the other side of the equation if they close Walmart and do away with the game over a period of years, but they can't make the assets good or keep the liabilities intact over time. The problem is that credit has expanded to maximum potential and now has to implode. Banning short selling, the government purchasing assets at FMV, the government buying treasuries, etc., none of this extinguishes the liabilities in the system or creates a dime of capital. The losses or the bill is now coming due.