Please forgive me in advance if I come across as parochial or pedantic, that’s not my intention.
My belief is that we currently have a solvency problem, not a liquidity problem.
first examine the definition of those two words, solvency and
liquidity. Solvency is defined as the ability to pay one’s debts.
Liquidity is more difficult. The dictionary says that liquidity is a
"high volume of activity in a market." When people say that a stock,
option, bond, or other instrument isn’t liquid what they’re really
saying is, "I’m already in this turkey and I don’t like the price being
offered to exit." Nobody complains about liquidity on the way up —
only on the way down. They’ll get in at any price, but damn them if
they’ll take that "illiquid market bid." In current times, greed is a
stronger emotion than fear. This has not always been the case.
If the problem were truly liquidity, credit markets would have
returned to normal after at least one of the central banks’ plans.
Remember the "Super SIV" that was proposed back in August? The big
banks would throw in some money (and the governments too), the Super
SIV would carry a lot of this distressed debt on its books, and all
would be happy. Well that was the plan at least. Nobody would touch
this thing. Zero interest in it. Why? Because investors had zero faith
in the plan about ever seeing that money again. Why throw good money
after bad? (Especially when they all knew their balance sheets were
about to blow up.) The investors had no confidence that the money would
ever be repaid. That’s the definition of insolvency.
So next the Fed decides to lower both the Fed funds rate and
the discount rate by 25 bps. Additionally, the Fed lowers its
collateral requirements and will accept mortgage backed securities for
these short-term loans. This is what you do when you have a liquidity
problem. Markets are locked up and everyone’s sitting on their hands?
Induce them to lend by making it cheaper and government (quasi) backed.
A few institutions did use the discount window a little. They borrowed
from the Fed to shore up balance sheets in a vain attempt to pawn off
the toxic mortgage debt to some poor bagholder. None of them could, and
they had to repay at the discount window. Problem still exists. Nobody
wanted the debt b/c nobody believed it was worth anything. Also, they
took this action in an unscheduled announcement only 3 days after the
regular meeting where they did nothing (ergo: they’re panicking).
Next meeting a month later, Fed does the same thing as above,
but with 50 basis points. The stock market guys rejoice as it goes up.
Credit markets are still locked up. A temporary reprieve as assets used
to maintain LTV (loan to value) leverage increases. A few sighs of
relief even though there’s a world of hurt still out there.
Over the course of October and November, equity markets swoon
and bond markets rally as institution after institution writes down
huge chunks of debt. Countrywide’s CEO heads to the press and
repeatedly states that everything is fine, the dividend is safe,
they’re not going to declare bankruptcy. This outright, boldfaced lie
should be followed up with a prison sentence. Instead, he’ll get a
golden parachute. The Fed cuts 25 bps in October and December still
thinking that there’s a liquidity problem. Everyone else is starting to
realize that it’s a solvency problem. These assets just aren’t worth
what they were sold for. Writedowns loom on the horizon.
January comes. Holidays were crappy. No one bought anything —
people don’t have any money. This is a solvency problem. Equity markets
resume selling off. This forces financial institutions to unwind trades
as they no longer have the capital requirements to maintain current
leverage levels. Selling begets selling until the balance sheets are
shored up. Again, a financial institution solvency issue that has
nothing to do with credit markets. During all of this, some dumbass
French trader is buying into all of the dips. He lies about the losses.
He covers them up. Finally, the compliance department catches one of
his trades when he goes over the house limit. Societe General is over
$7 billion in the hole by the time they figure out what’s going on.
This was last Friday. Rather than ask for a bailout, they do the right
thing. They have a fire-sale and liquidate everything in sight to meet
capital requirements — fixing their solvency problem. Before doing so,
they hedge themselves to a degree by selling short futures around the
world. This is why the Dow was down 500 points Monday while markets
were closed. SG was hedging themselves against losses as they crushed
bid after bid with heavy selling. Markets do not crash from overbought
levels. They crash from oversold levels. The Fed knows this, panics
again, and cuts rates 75 basis points. Societe General did not tell the
Fed what they were doing. They didn’t tell the ECB. They did not have a
liquidity problem, yet the Fed continued to treat it as one. The US
market rallied hard on short covering in battered sectors such as
homebuilders, financials, and retail. The tech leaders sat out the
rally and ended way down. Today, the news about SG comes out. Everyone
realizes that the Fed is inept. We still have a solvency problem, yet
the Fed keeps pulling the liquidity lever. The Fed should be dispensing
justice. It should be tightening requirements and policing them
vigorously. Instead the Fed is throwing cheap money at a problem that
requires hard assets, not fiat money.
Interestingly, the ECB barely budged on rates during this
whole process. I don’t have the hard facts off-hand, but I think they
might have provided some overnight capital once or twice. They didn’t
cut nearly as much as the Fed. They knew they had a solvency problem on
their hands, not a liquidity problem.
What is the solution to a solvency problem? Assets that are
properly valued. In August, nobody wanted to buy that $550k mortgage on
a 3BR/2BA in Modesto, CA. Why not? They bought them earlier, why change
their minds now? Well, we were in a bubble before. We’re not now. The
greater fool theory applied then. If you’re stuck with that mortgage
now, you’re the greatest fool. Well what’s a brother with an overvalued
mortgage (or basket of them like Wall Street) supposed to do? Easy,
sell. Get out of that depreciating asset and start over. Nobody ever
said you were entitled to live beyond your means. It’s time to start
living in them. Nobody said you could live your life without
consequence. The cures for the current ills are a) time — inflate your
way out b) a reversion to the mean — housing prices correct and fall
for several years.
It’s time the American public drank their castor oil instead
of begging mommy to let them take it tomorrow night (and twice as
much). If this FHA limit is approved, enjoy your $600 tax rebate. We’ll
all be paying thousands for another bailout in a few years. If we do
raise these limits, we’re giving Wall Street and other financial firms
a free pass. Take all that toxic debt and punt it to the Feds. For
them, it’s a new lease on life. Do they deserve it? No. Will they
change their ways? No. Will we be back in this mess again? You can
count on it.
Over my years on this planet, I’ve been accused of being a
cynical bastard. I’d disagree with that and as jba put it, describe
myself as pragmatic. When I see a bill proposed that smacks of bailout
and cronyism, I look to see who the biggest backers and beneficiaries
are. Who’s behind the FHA increase? The National Association of Home
Builders and the Housing
Policy Council — two parties that have a vested interest in seeing the
housing bubble prolonged.
Keeping people in mortgages for a house valued twice as much as its
current value is not the solution. Saving a few rich people in SF and
NYC a couple of points on their mortgage is not the solution. Yes "Bob", you directly might benefit from this in the short term. But by
your own admission you take on financial risk and deal with the
consequences (re: stock options). You are a rare bird. However, the vast
majority of Americans do not want to deal with the consequences.
From the over-extended sub-prime borrowers who bought too
expensive of a house only to watch it halve in value, to the 9-figure
salaried CEOs of Wall Street, America is in desperate need of a kick in
the nuts, a punch to the face, followed by a dousing of acid. Housing
must be left to its own devices and correct either by price or time.
Americans must learn to stop such rapacious consuming and save.
Politicians must spend more time on the budget and think of the greater
good rather than their constituents. Wall Street must stop treating our
economy and savings like a dice game.
If there’s any saving grace, the Treasury is against the
move. They have a veto (of sorts) in the matter, and I pray they use it.