Is the Apocalypse apon us ?

[cjolley]

@Umfriend Send it my way too if you would.

This was an interesting read:

http://www.slate.com/id/2201428/

How the financial markets fell for a 400-year-old sucker bet.

By Jordan Ellenberg
Posted Thursday, Oct. 2, 2008, at 1:20 PM ET

Here's how to make money flipping a coin. Bet 100 bucks on heads. If you win, you walk away $100 richer. If you lose, no problem; on the next flip, bet $200 on heads, and if you win this time, take your $100 profit and quit. If you lose, you're down $300 on the day; so you double down again and bet $400. The coin can't come up tails forever! Eventually, you've got to win your $100 back.

This doubling game, sometimes called "the martingale," offers something for nothing—certain profits, with no risk. You can see why it's so appealing to gamblers. But five more minutes of thought reveals that the martingale can lead to disaster. The coin will come up heads eventually—but "eventually" might be too late. Most of the time, one of the first few flips will land heads and you'll come out on top. But suppose you get 10 tails in a row. Just like that, you're out $204,700. The next step is to bet $204,800—if you've got it. If you're out of cash, the game is over, and you're going home 200 grand lighter.

But wait a minute, maybe somebody will loan you the $200,000 you need to stay in the game. After all, you've got a great track record; up until this moment, you've always ended up ahead! If people keep staking you money, you can just keep betting until, eventually, you win big time.

See where I'm going with this?
...

Be sure to read on. It's a long story...

[lowlifecat]

[Umfriend]

@Umfriend Send it my way too if you would.

This was an interesting read:

http://www.slate.com/id/2201428/

Be sure to read on. It's a long story...

Ah well, WxDude did not find it controversial at all, I'll post it here.

Nice article on the martingales though somewhat misleading. The financial industry has not been betting on a zero sum game. It has been investing, i.e., putting money where the expectation is one of a potive return. That there was a risk for a catastrophic event is true, as we've seen.

Indivuduals and individual companies can't be expected to take those into account because they can't cause it nor control it by themselves. [Here we may get political?] It's one of these situations where the market is more than the sum of the individual participants. That is where regulation comes in.

Anyway, the PM to WxDude

Hi WxDude,

The first issue with you idea you identified yourself already. There is about 10 trillion in mortgage debt outstanding. 700bn is a mere 7% of that.

One important statistic in mortgage lending is the Loan-to-Value ratio. If you have a loan of 100k for a property with a value of 150k, that ration is then 66.6%.

You could lower the LTV by 7%. With the houseprices falling far more than that, it'd be of little help.

The problem is, it is not effective, as you'd be lowering LTVs for all mortgage loans that are doing fine as well => waste.

Then, this money would actually be spent: it'd be gone. The current bailout purchases mortgage loans (I think mostly bundled in securities, RMBS/HELOCs etc) and not at par. It is not money spent but invested. May turn out to become a bad one of course, but that is not the issue here.

So if the is a bundle of mortgage loans with 100k in balance but because of the expected performance has a value of, say, 40K, then that is the price at which it would be purchased from a bank.

This is far more effective as the Treasury would primarily purchase mortgage loans that are in trouble; banks would retain the debt that is expected to do well.

Banks would not profit from this bailout (or at least not that much) but it would help in a different way.

Banks need to be recapitalised; they need to find investors who are willing to put in equity. But investors are currently unable to asses the value of the banks because they hold to much debt that is hard to value at present. By taking this debt off their balance sheet, leaving reasonable assets, investors may be easier to establish their though on the value of a bank without the perception that they may miss the mark completely.

And this gets at the core of the issue: noone knows what the current situation of a bank is. Banks may be weak but that would not make it impossible to find new capital. It is the uncertainty about how weak they actually are that makes it hard.

This is also why credit markets stop functioning. Banks take deposits and lend the money. But there is hardly any bank that lends as much as it borrows (takes in in deposits). This problem is resolved by banks lending to/borrowing from other banks to deal with surplusses and deficits.
Now that banks can't value each other, they can't assess the likelihood of non-repayment. It is far easier for banks to deal with weak banks if they feel they know how weak they actually are than not at all.

There may be healthy banks that would be willing to extend loans to small local businesses but need funding from other banks that have excess deposits. So you can see that although all could be allright, one of the actual functions of the financial system (transformation of location of funds) does not work. This is where the financial crisis starts to reflect in the actual economy.

Moreover, WxDude, your solution actually does reward both ledners and borrowers for taking to much risk. Who would receive the money? Right, the lenders who would now have lower LTV loans on their balance sheet. But those are not the ones you'd like to reward.

The idea (introduced by the Dems I think) to not evict borrowers under mortgage loans taken over by the bailout comes closer to your intentions I think. In fact, your solution affected all borrowers (and their lenders) but starting off with purchasing these loans gives a far better pointer to the problematic borrowers where one could try to mitigate something.

I hope I'm reasonable clear.

Kind rgds,
Umf

[cjolley]

Very well said Umf.
If the administration had gone to Congress and handed them your outline, which I think reflects what they want to do, and asked for legislation to that effect then Congress might have obliged fairly quickly.
Instead they ran over acting like their hair was on fire and basically said "Quick! Give us 700B to fix this. Trust us. We'll tell you the details after we finish."
That failed rather predictably.
I understand their panic. The week they came up with this there was a 2 hour period one day where NO commercial paper was created in the US. Nothing like that has ever happened before here. It was like the economy's heart had stopped beating. It picked back up again on it's own, but it sent them into a panic.
And panic is not conducive to good judgment.

[Evildead666]

From over here it looks like its not gonna be enough cash to solve the problem, just postpone it a while...

They should have gone by the rule where you ask for 25-50% more than you need in reality...
Then you can say you cut short...

[Umfriend]

It remains to be seen, of course, whether the 700bn will be enough or effective in any case.

Had the Treasurer asked and gotten 700bn to directly recapitalise banks (in effect nationalising some/many of them, at least for a while), that would have been, I think, far more effective and efficient.

Just goes against the free-market ideal to much to be acceptible in the US I guess. It's quite a feat that they got this 700bn package through.

We can only hope I guess. Hope that the banks can use this to clean up their balance sheet fast so that the 3Q figures show the last losses/write-down/provisions and all can rely the numbers are interpretable again as of then.

[Gurm]

I'm convinced that they asked for 700B because any larger number would have caused people to use the term "trillion". 750B is "three quarters of a trillion", 800B+ is "nearly a trillion".

And that would have made people even MORE upset.

[Jammrock]

A lot of the big banks here in teh US are gobbling up the debt of some many of the banks that are failing because of the bad sub-prime investments. They will still get some aide from the bailout, but it will hopefully lessen the impact by the industry absorbing the greed and stupidity of others.