flwyd: (mathnet - to cogitate and to solve)
[personal profile] flwyd
[livejournal.com profile] mackys asks
What is a reasonable estimate for the ACTUAL value of the mortgage-backed "junk" securities that $810 billion of my tax dollars bought?
The answer to that question has fluctuated every few days recently, so note that everything I say could be wrong soon.

First, a timeline.
  1. US Financial System: OMG! We paid way too much for all these mortgages and nobody wants to buy them from us! O noes!
  2. US Treasury Secretary: You guys are too big to fail. I'll save you!
  3. Lehman Brothers: Save us, Henry!
  4. US Treasury Secretary: Wait, not you, Lehman.
  5. Lehman Brothers: <is dead>
  6. US Financial System: OMG! Did you see what just happened to Lehman, guys?!? I'm not going to give you any of the money I don't have in case you're the next Lehman.
  7. US Treasury Secretary: Ruh roh.
  8. US Treasury Secretary: I has a 3-page plan; let me show you it! Let me offer you a $700 billion "bailout" by buying all your "toxic waste." No oversight, no accountability. Sounds great, huh fellas?
  9. US Taxpayers: WTF?!? You're bailing out a bunch of bankers by buying toxic waste?
  10. Karl Rove: What happened to the Bush administrations public relations team after I left? That's the worst sales job ever.
  11. Senate Banking Chairman: Hey, I've got an 8-page better idea. The government should buy shares in banks. They'll get a liquidity injection and the government will make money when the banks do.
  12. US Financial System: <flail wildly>
  13. John McCain: In my many years in Warshington, I've fought wasteful government spending. And as president... Wait. For the next two days, I don't want to be president. I need to rush off to help the government hastily approve $700 billion in spending.
  14. Political Pundits: You're not a maverick. You're a loony.
  15. US President, US Treasury Secretary, Federal Reserve Chairman, Speaker of the House, Committee Heads, Attention Whores Presidential Candidates: Buying $700 billion of toxic assets sounds great. Here's a 100-page proposal.
  16. House Representatives in Tight Races: O noes! Our constituents found our phone numbers! Halp! I want to get reelected, screw this bailout.
  17. US Financial System: Well shiiiiiit.
  18. Emergency Conference Meeting: You know what people think is tasty? Bacon. Let's add 350 pages of pork.
  19. Somebody In The Meeting: *psst* Let's slip the stock purchase option back in there.
  20. US Senate: Tastes great, we're willing!
  21. US House of Representatives: Okay, I guess...
  22. Financial Commentators: So... the government is going to invent a price for a bunch of stuff which has no market value because nobody wants to buy it.
  23. Economists (some): Something must be done. This is something, therefore, it must be done.
  24. Economists (others): This is a terrible idea.
  25. Economists (still others): This might work, but I've got a better idea.
  26. US Financial System: I'm going to drink heavily for a week and then turn on MTV and the radio at the same time.
  27. US Treasury Secretary: I know I said there might not be an economy by Monday, but I'll need five weeks and some Wall Street executives on staff before I can do anything.
  28. Germany: Scheise! Now our banks are in trouble. Immediate action! Your money is safe in German banks!
  29. Europeans: Hey, now we have to guarantee our banks!
  30. Economists: Hey... that sock purchase plan is in the bailout plan. Let's try that.
  31. United Kingdom: Bollocks! Now our banks are in trouble. Immediate action! We'll take major shares in you chaps. kthxbai.
  32. World Financial System: Whoa... I think I'm still drunk.
  33. World's Major Central Banks: All together now: lower interest rates! That usually works!
  34. World Financial System: Crap! I mean Great! I mean... maybe?
  35. Iceland: We're melting! And not just because of global warming.
  36. US Treasury Secretary: World leader huddle!
  37. World Financial Leaders: Okay... we're not making progress running straight into the line. Let's run the option.
  38. US Treasury Secretary: But I hate the option. My fans always boo.
  39. World Financial Leaders: Henry... you can run the option or you can lose the game.
  40. US Treasury Secretary: Fine! I'll run the stupid option.
  41. World Financial Leaders: Okay, everybody. I know we've all trumpeted the wonders of the free market system for years. But the free market is having trouble, so we need to save it. Our plan is often called "nationalization." We're going to become part owners of major banks so they'll have money they can use to lube the wheels of the economy.
  42. Financial Commentators: Wow. The best option is socialism.
  43. John McCain: I'm gonna go ahead and NOT mention that in my campaign.
  44. US Financial System: Well... okay... I guess. But I won't move until everybody else moves too.
  45. US Treasury Secretary: Dear diary... the last month has sucked ass. But I think we're going somewhere.
So... what's the value of what taxpayers are buying? Like most questions in finance, the answer is "That depends on the future market." What are the pieces?

Henry Paulson (Secretary of the Treasury) wanted to solve the problem by spending $700 billion to buy mortgage-backed assets. (Essentially, that's a bunch of assets tossed in a pile. Except then somebody pulled pieces out of each mortgage and stuck them into other piles. It's like everybody in a neighborhood having spaghetti, but each noodle is really long and is on everybody's plate.) What would the value of these assets be? In some approaches to value, something is worth exactly what someone else is willing to pay. So in a sense, we'd be buying $700 billion of mortgage assets because we're willing to pay $700 billion. But then they'd be immediately worth much less because nobody else wants to pay $700 billion for them. In fact, nobody wants to pay much of anything for them. Part of the problem is that, under mark-to-market accounting rules, if nobody wants to buy a bank's piles of mortgages, banks can't pretend they have a bunch of money instead. And if they can't pretend they have a bunch of money, they have problems doing their normal bank activities like borrowing and lending money.

Under other approaches to value, the piles of mortgages are worth significantly more than nothing. Some percentage of the people who mortgaged their homes are making monthly payments, so the piles of mortgages are earning income. But investors don't think they can make a good guess about how many people will keep paying their mortgages, so they aren't willing to gamble on invest in them. If the U.S. government owned them, they wouldn't have to worry as much about accounting rules. The government would get the money that homeowners pay each month, meaning they'd have some real value. After a few years, once the economy settled down and investors felt like buying stuff again, the government would sell the piles of mortgages back and recover some of the taxpayer's money. In the mean time, the federal government would be the country's biggest landlord and end up owning a bunch of houses. I'll come back into that in a bit.

The main problem with the Paulson plan (aside from the world's worst marketing job) is that it put the government in the role of a really dumb investor. One of the main goals of the "OMG, save the banking system!" plans is to inject liquidity (i.e., money that's easy to spend) into financial system. If the government drove a hard bargain (what a private investor would do), they'd get a bunch of really cheap mortgages (great for the budget when the market improves later!), but banks wouldn't get much money they could spend. If they paid enough to get the money flowing (what a government would do), they'd probably end up losing a bunch of money in the end. The government has some smart people working out some rules for a reverse auction The federal government is good at losing money (call it an Investment Portfolio to Nowhere), but a lot of economists looked into the proposal and thought it wasn't very good.

Finally, Paulson bit the bullet and followed the European lead to the government buying major shares in banks. Some key things to note:
  • The government gets "preferred stock." That means that the government gets company profits (from dividends or sale of assets in case of a collapse) before normal shareholders.
  • The Treasury has said, on their honor, that they won't use the shares to influence the decisions of the bank.
  • This provides an immediate infusion of liquid cash (technically it's electronic, which is kind of like liquid... there's electrons flowing through wire instead of water flowing through pipes...)
  • Nobody has to make up a price for the piles of mortgages. The government's buying shares which currently have a market value.
  • If the banks get better, the government makes money when they sell the shares.
  • If the banks fail, the government gets a chunk of their assets.
  • This guy thinks there are some devilish details the banks can twist to connive with the sudden infusion of taxpayer money. (He lists "rotisserie baseball" as an interest. I hope that doesn't involve hitting a chicken with a stick.) Listen to the Planet Money podcast for his points. (As usual, Adam Davidson does a better job than I do at explaining this stuff.)
  • I think Treasury is still planning to buy "toxic assets," but their total available cash for toxic waste and bank stock is around $350 billion and the latter will take about $200 billion.
So what's the real value of the mortgage-backed securities taxpayers are buying? Hard to say. But we aren't spending $700 billion on them. What's the value of the bank stock we're spending $200 billion on? Hard to say, but if things get better the value should be more than $200 billion. The bankers don't really like the stock plan, but their collective overvaluing of the market got us into this mess, so tough cookies.

A caricature of the Soviet economic system is that everybody gets an identical place to live (owned by the government) and gives most of their money to the State. America, these caricaturists say, is better because we let each person decide what house to buy with their own money. But in the end, everybody ended up buying a house that looked just like all the other houses in their subdivision. And under the Paulson plan, the government would've owned a bunch of them and everybody would've paid their mortgages to the State. Under socialism, government men start with a plan to exploit their fellow men. Under capitalism, it just ends up that way.

Part of me thinks it would be really interesting for the government to own a whole bunch of suburban real estate. They could embark on projects to create local centers of employment and commerce, reducing the distance people would have to drive and thereby reducing dependence on foreign oil. They could turn vacant McMansions (in Denver lingo "Prairie Palaces") into housing cooperatives. The other part of me thinks housing cooperatives and local community development must grow bottom-up to have a chance of success. The federal government is good at doing big things like running national parks. A half-dozen hippies are good at doing small things like organizing a house inhabited by a half-dozen hippies. But I think there's a chance that the anonymous sprawl suburbs will become the new ghettos while former industrial buildings (aka lofts) become the hip expensive places to live. Centennial will be a really swank ghetto, but it'll still be a ghetto. Maybe we'll be listening to rap songs entitled "Straight Outa Rancho Cucamonga."

I've come to understand some interesting things about macroeconomics in the last few years, but hard-core capitalism still bothers me. At its root, it's a bunch of people doing stuff in exchange for imaginary pieces of paper. The main advantages of money are that you can do math with it and it can be exchanged multiple times. If you give me $10, I can later give the $10 to somebody else. Or I can divide it in half and give $5 to two people. But money isn't the only thing that can be exchanged. Much of the time, it stands in for time, effort, or information. If I give you an afternoon of my time and energy moving all your stuff from one apartment to another, you can't necessarily give that afternoon to somebody else. If you and I have sex for ten minutes, it has no (necessary) impact on your ability to have sex with somebody else for ten minutes... or two other people for five minutes. If I tell you a funny story and you want to tell it to two other people, there's no need to tell each only half the story.

Money is a tool to enable zero-sum games. But a very effective path to success is for multiple individuals to team up and play a game that's not zero-sum. Maybe that's why society gets so skittish about prostitution: it tries to mix a zero-sum game (paying money) with a non-zero-sum game (two people helping each other have an orgasm).

Remember that investing is essentially gambling with two important differences: Nobody's quite sure what the odds are and the house doesn't always win in the long run. When you invest money, you might get more of it back or you might get less of it back. When you invest time (hanging out with friends, playing games, having sex, relaxing in the sun on the porch) you know that hour of time won't come back, but you also know it won't suddenly turn into just half an hour. Remember that money isn't the only thing in the world worth exchanging with another person.

So that's all the economics questions I was asked on my original post. If I didn't bore you to tears and you didn't learn what you want to know from Planet Money, ask more questions!

Date: 2008-10-16 07:33 am (UTC)
From: [identity profile] mackys.livejournal.com
Remember that money isn't the only thing in the world worth exchanging with another person.

Yeah, but as a man my bodily fluids have no intrinsic value. ;D

Thanks for a very long non-answer. ;]

Date: 2008-10-16 11:43 am (UTC)
From: [identity profile] altamira16.livejournal.com
At least a small piece of this has to be in [livejournal.com profile] metaquotes.

Date: 2008-10-16 01:28 pm (UTC)
From: [identity profile] dr-tectonic.livejournal.com
The other thing to remember is that arguably, that $8.1e+11 purchased not just a bunch of weird pieces of paper with indeterminate resale value, but a sizeable chunk of Continued Functioning of Civilization. How big a chunk is hard to say, but in my book, Civilization is worth a lot, so I'm okay with it if it turns out we don't get all our money back from reselling the abstractions later on...

Date: 2008-10-16 07:24 pm (UTC)
From: [identity profile] mackys.livejournal.com
I guess my major problem comes from not the intent, but the way it was done.

I think I read somewhere that $2 billion could have paid off all the mortgages currently in default, and $500 billion could pay off half the mortgages in the USA. Given this, it's hard (or not) for me to understand how our idiot government came up with the idea of giving away $810 billion.

Date: 2008-10-16 07:43 pm (UTC)
From: [identity profile] flwyd.livejournal.com
I think the price tag comes in large part from derivatives. If you have a $1,000,000 mortgage there could be tens of millions of dollars of derivatives floating around based on it. As Planet Money explained (or maybe it was This American Life a couple weeks ago), it's like everybody on your block taking out a life insurance policy against you. When economists talk about worries this could spill over into the "real economy," we can infer that it's already destroyed the imaginary economy.

The individual mortgages in default are not the main piece of the global economic crisis (though it's certainly part of personal economic crises). Assets were overvalued and so banks were undercapitalized when the bubble burst. This is the liquidity portion of the crisis. Further, investors are very leery of many of the existing assets and don't trust their lending options. This is the credit part of the crisis. So while $2 billion might stabilize a lot of mortgages, it wouldn't go very far to recapitalize the banks. (For comparison, Warren Buffet invested $5 billion in Goldman Sachs.)

Of course, the libertarian answer is "Let the banks fail. People will start new banks that are better run." But that's sort of like saying "Let the house collapse, we'll build one with a better foundation later" instead of pouring new concrete into an old slab. Except there are a whole lot of people living in the house who can't quickly move.

Date: 2008-10-16 09:32 pm (UTC)
From: [identity profile] mackys.livejournal.com
The individual mortgages in default are not the main piece of the global economic crisis (though it's certainly part of personal economic crises). Assets were overvalued and so banks were undercapitalized when the bubble burst. This is the liquidity portion of the crisis. Further, investors are very leery of many of the existing assets and don't trust their lending options. This is the credit part of the crisis. So while $2 billion might stabilize a lot of mortgages, it wouldn't go very far to recapitalize the banks. (For comparison, Warren Buffet invested $5 billion in Goldman Sachs.)

My uneducated opinion is that we should address the underlying cause (credit) and let the liquidity stuff work itself out. I haven't been a big fan of this WE MUST MAINTAIN LIQUIDITY AT ALL COST thing since way back when Bernake first started making noise about it this spring. Seems to me that we're fixing the short-term problem (stupid derivatives and bad financial instruments that have already proven themselves worse than worthless) and not addressing the cause.

I don't claim to be degreed in Econ, though. Nor even as self-educated as you are.

And yes, it's certain in my mind that we should have let some banks fail. If there was a worry about people losing their money, maybe the right thing would have been to extend FDIC deposit insurance so the little guys wouldn't get screwed.

Date: 2008-10-16 10:03 pm (UTC)
From: [identity profile] flwyd.livejournal.com
My uneducated opinion is that we should address the underlying cause (credit) and let the liquidity stuff work itself out.

It seems like liquidity would make credit a lot easier. But that sort of interplay is getting out of my realm of understanding.

Date: 2008-10-16 10:12 pm (UTC)
From: [identity profile] mackys.livejournal.com
It seems like liquidity would make credit a lot easier.

Ya think maybe we've had enough easy credit already?

Date: 2008-10-16 10:15 pm (UTC)
From: [identity profile] flwyd.livejournal.com
Sorry, I wasn't clear. I didn't mean "Easy" as in "I just got a mortgage, but I don't have a job." I meant it'll be easier for a bank to agree to lend money to qualified borrowers if they've got sensible levels of cash. Perhaps "would make it easier to provide credit."

Date: 2008-10-17 12:26 am (UTC)
From: [identity profile] grenacia.livejournal.com
Cool post. Some of the timeline made me giggle.

Date: 2008-10-18 03:39 am (UTC)
From: [identity profile] xoxeskel.livejournal.com
Entertaining. Will read in more depth later...hopefully.
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