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Saturday, October 04, 2008

 

3 step plan to recovery

The current financial crisis will be resolved when banks and other lenders overcome their fear of counter party risk and resume lending to each other. For that to happen, there must be a belief that mortgage lenders can ride out the housing depression without more dominoes falling. Each time a big player goes down, it means more bad paper on everyone else's books.

That's why the regulators blew it when they let Lehman go down (since it was a counter party on all kinds of transactions) and why they realized just in time that they could not let AIG go down.

A big part of why companies are going down is the requirement that they mark impaired assets to market, even when there is no active market in the assets. For debt instruments, this is actually recent accounting policy, and highly questionable. Stocks were always carried at market, since there was an active market with readily available prices. This is not the case for most debt instruments, including securitizations, like asset backed mortgages. Debt instruments were traditionally carried at amortized historical cost as long as the debt was being serviced. Though accountants and certain investors object, it was very bad accounting policy to switch these to mark-to-market when they are not actually traded very often. All that does is force conservative valuations on asset holders, driving them to insolvency and the negative feedback loop of increasing collateral, ratings downgrades, and more collateral. This is what is felling the dominoes, not the foreclosures.

Foreclosures may, in fact be inevitable, but there is no incentive for the mortgage servicer to work with the debtor to avoid foreclosure if they are going to have to write down the mortgage loan anyway.

Fortunately, the bill passed Friday includes some relief from mark-to-market requirements, and the SEC provided additional help in the form of a statement last week that where markets are not ordinary (such as when there is no trading), assets do not have to be marked to market. This is coming too late to save Bear, Lehman, and others but just in time to save our financial system.

What we need are the following three steps:

Relief from mark to market (begun last week)
Passage of the bailout bill (done- needed to restore confidence and liquidity)
Reduce the Federal Funds rate AND the Discount rate to show the Fed will add liquidity to the extent required.

It may take time, but moving on these initiatives should eventually get credit flowing again.

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The Palin - Biden debate showed that both candidates are quite good at executing their game plan and driving home their talking points. Sadly, it also showed how silly campaigns have become, frankly in response to the pitiful level of knowledge most Americans have about politics, national and world affairs, and the issues overall.

The explanation that our current crisis resulted from greedy Wall St. traders and bankers exploiting Americans who could not afford the mortgages they were taking on makes a nice populist soundbite, but it ignores the role of Congress in propping up the GSE's, the Dems encouragement of subprime lending in the interest of home ownership, the popularity of no-doc loans in order to generate fees, and the role of the Fed in inflating the housing bubble by keeping interest rates so low. Also, an awful lot of foreclosures involve houses bought on speculation or for investment purposes.

Realizing that the Bush administration is extraordinarily unpopular, it is still unconscionable to state categorically, as Biden did that Mr. Cheney is the worst VP in history, etc. And where are the Republicans to defend the administration? This administration has removed one of the most notorious dictators ever, successfully prosecuted a difficult war, and avoided any terrorist attack on our soil since Sept. 11 2001, despite bureaucracies hostile to administration goals and a Congress that has sought to hamstring it at all times. Objective historians, if there will be any, will certainly give the Bush administration much higher marks than its contemporaries.
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The VP debate outscored the Presidential debate in the ratings by about a third. Much has been written by the liberal media about Sarah Palin's supposedly falling popularity, but does anyone honestly believe that all, or any of these additional viewers tuned in to see Mr. Biden?

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On Monday, I bought 500 share of Bank of Granite (GRAN) at 4.25. On Wednesday, I bought 19 shares of Transocean (RIG) at 108, a zero buy.

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