a prolonged foreclosure crisis, with Wells Fargo watching helplessly as the condition and value of some houses depreciate for years to come

TO BE NOTED: From the NY Times:

"High & Low Finance
A Bank Is Survived by Its Loans

By FLOYD NORRIS

In a mortgage market gone crazy with generous loans, no one was more generous than World Savings.

Lots of banks offered mortgages that allowed borrowers to pay less than the amount of interest being charged, but World was virtually alone in making loans that let the borrower continue to make small payments for a decade, rather than two or three years.

Most banks forced the borrower to start making much larger monthly payments if the amount owed — an amount that could rise each month if the borrower made the minimum payment — rose to 110 percent of the appraised value of the home when the loan was made. World saw that as stingy. It did not force the payments up until the amount owed was 25 percent greater than the original value.

You can’t get loans like that any more, of course. But World’s old mortgage loans live on. Other banks, where escalating monthly payments are either here or on the immediate horizon, are facing the need to foreclose or renegotiate many loans. Within a year or so, most of those loans will have vanished, for better or worse for the homeowners and for the neighborhoods those homes are in.

Few of the World borrowers face such imminent disaster, however. And that is why it is fascinating to follow the progress of World’s mortgage portfolio.

Some of those homeowners may end up all right, being able to wait out the depressed housing market.

And if the local housing market fails to recover? Homeowners there may still be able to wait out the process, making monthly payments that could well be less than the cost of a comparable rental. If such an “owner” thinks prices are unlikely to ever come back, he or she could rationally decide to stay in the home while doing little to maintain it.

That would make the house even less valuable for the bank when it finally did foreclose, and it could also damage the value of nearby properties. No one expects renters to do major maintenance work, but in this case there is no landlord who sees the necessity of such spending. Would you like to buy the house next door?

None of that will matter to World Savings. Golden West Financial, the owner of World, was bought by Wachovia in 2006, at the height of the mortgage boom.

Not realizing it might be acquiring a time bomb, Wachovia made things worse. World had demanded minimum annual payments of 1.95 to 2.85 percent of the loan balance, but that fell to 1.5 percent soon after the merger was announced. After the deal closed, Wachovia cut the minimum payment to 1 percent, thus offering the most generous terms at the time housing prices were most inflated.

It was not until mid-2008, long after the housing market began to crumble, that Wachovia stopped making such loans.

Wachovia is also gone, sold to Wells Fargo at the end of last year.

The new Wells Fargo quarterly report paints a sad picture of the portfolio of “pick-a-pay” loans that World and Wachovia originated.

The amount owed on such loans at the end of March was $115 billion, which Wells estimates is 107 percent of the current value of the properties underlying the mortgages. Just over half the owners are paying the minimum allowed, causing their debt to rise each month.

A loan-to-value ratio of 107 percent is bad enough, but it is an average and many loans are in much worse shape. For loans in California, the average is now 120 percent, and the figure is no doubt much higher in such troubled areas as the Central Valley and the so-called Inland Empire, where nearly a third of the California loans were made. Wachovia estimated that last September the loan-to-value ratio in the Central Valley was 132 percent. Since then, the median sales price of homes in that area has fallen another 20 percent.

In all, more than 70 percent of the pick-a-pay loans are in California, Arizona or Florida, three states where prices rose the fastest during the boom and have since fallen the most. Wells says it thinks 61 percent of the loans in those three states will not be paid as required by the mortgage, in contrast to 36 percent of the loans in other states.

One sad aspect of all this is that World Savings said it tried to be more responsible than many lenders during the craze. It did not sell its loans into securitizations, so it knew it stood to lose if a loan went bad. Virtually all of the pick-a-pay loans were for less than 80 percent of the appraised value of the home, and the average was just 71 percent. World said it made loans only to those who could afford the stepped-up monthly payment after the reset, and said it did not lend to subprime borrowers.

For many years, the strategy appeared to work brilliantly. World had virtually no foreclosures, as you would expect in a world where the lender had a large equity cushion at the beginning of the loan and home prices went up year after year.

But this is a different world.

Herbert and Marion Sandler, who controlled World and served as its co-chief executives, were among those who deplored the excesses of their competitors. Their loans, they said, called for minimum payments to rise by just 7.5 percent a year, so people would not face a sudden payment increase that could throw them out of their homes if the mortgage could not be refinanced.

All that was true. But since the loans had no provision to stop the amount borrowed from continuing to rise even after the value of the home fell sharply, the loans allowed for the possibility — now all too real — of creating a class of zombie homeowners with no real stake in the homes they occupy. Only $325 million of the loans — less than a third of 1 percent — will reset by the end of 2012.

Wells Fargo has written the value of the pick-a-pay portfolio down by about 20 percent, and is offering to restructure some of the loans. But many of the owners may have no reason to seek such a restructuring. It would take a big concession to lower their monthly payments, and an even larger one to get the principal value of the loan down to the current value of the house.

The result may be perverse: a prolonged foreclosure crisis, with Wells Fargo watching helplessly as the condition and value of some houses depreciate for years to come.

E-mail: norris@nytimes.com"

Wells Fargo trumped that bid four days later with a higher offer for all of Wachovia, and which did not require FDIC support.

TO BE NOTED: From Reuters:

"Citigroup-Wells Fargo case moves to NY state court

Tue Mar 24, 2009 12:32pm EDT

NEW YORK (Reuters) - A federal judge has transferred Citigroup Inc's (C.N: Quote, Profile, Research, Stock Buzz) $60 billion lawsuit against Wells Fargo & Co (WFC.N: Quote, Profile, Research, Stock Buzz) over the acquisition of Wachovia Corp back to the New York state court where it began, citing a lack of jurisdiction.

In a March 20 ruling, U.S. District Judge Shira Scheindlin agreed with Citigroup that the lawsuit does not raise a federal claim.

She rejected Wells Fargo's argument that the case turns in part on Citigroup's right to relief under a provision governing acquisitions in last year's federal Emergency Economic Stabilization Act. That act authorized the $700 billion bank bailout known as the Troubled Asset Relief Program, or TARP.

Citigroup last September 29 agreed to buy much of Wachovia for $2.16 billion, with the Federal Deposit Insurance Corp sharing in losses on a pool of Wachovia loans.

Wells Fargo trumped that bid four days later with a higher offer for all of Wachovia, and which did not require FDIC support. Citigroup sued to block that merger, but later backed down.

Wells Fargo on December 31 completed the Wachovia acquisition, which was eventually valued at about $12.5 billion.

The case is Citigroup Inc v. Wachovia Corp, U.S. District Court for the Southern District of New York (Manhattan), No. 08-8668. The original case was Citigroup Inc v. Wachovia Corp, New York State Supreme Court (Manhattan), No. 602872/08.

(Reporting by Jonathan Stempel; Editing by Derek Caney)"

Below we highlight current credit default swap prices for 24 financial firms across the globe.

From Bespoke:

"Financial Company Default Risk

While default risk has dropped dramatically( GOOD NEWS ) for the financial companies listed below, it's still interesting to see how the firms compare with each other on the CDS front. Below we highlight current credit default swap prices for 24 financial firms across the globe. These prices represent the cost per year to insure $10,000 worth of debt for 5 years. As shown, default risk is the highest for Morgan Stanley, followed by Goldman Sachs, American Express, UBS, and Citigroup. The premium against default for JP Morgan is the lowest among US financial firms, with Wachovia, Wells Fargo, and Bank of America not far behind. BNP Paribas and Credit Agricole have the lowest default risk of the 24 financial firms shown.

"Wells’ acquisition of Wachovia in late September fended off an earlier government-assisted bid from Citigroup"

From the FT, some deals are finalizing:

"Shareholders are on Tuesday expected to vote in favour of two bank deals forged at the height of the financial crisis, helping to mark the end of a transformative year for the US banking industry.

The fire sales of Wachovia and National City took place under regulatory pressure to stabilise the banks’ deposit bases after heavy mortgage-related losses led to concerns over capital. For the buyers – Wells Fargo( VIA TARP ) and PNC Financial respectively – the deals are strategic victories, emblematic of how stronger players have used the crisis to expand.

Wells’ acquisition of Wachovia in late September fended off an earlier government-assisted bid ( FROM THE FDIC )from Citigroup, winning regulatory support both by giving Wachovia’s shareholders a better price and getting the Federal Deposit Insurance Corporation off the hook for Wachovia’s losses( WHICH IS WHY THEY SOUGHT OUT CITIGROUP. HOWEVER, ONE WONDERS IF THE FDIC WILL HAVE CREDIBILITY IN DOING THIS GOING FORWARD, OR INVESTORS WILL DOUBT THEIR ABILITY TO SEAL THE DEAL ).

The deal will create a national retail banking powerhouse( TOO BIG TOO FAIL ), greatly expanding Well’s West Coast franchise east of the Mississippi river and creating a coast-to-coast network of 12,200 branches – larger than those of Bank of America and JPMorgan Chase.

PNC, based in Pittsburgh, will become the 8th-largest US depository institution( TOO BIG TO FAIL. BOTH HAVE JUST PURCHASED GOVERNMENT INSURANCE ).

The deals were the first to take advantage of a tax ruling that allows acquirers to use the built-in losses of target banks to reduce their own taxable income, a factor that helped clinch the Wells-Wachovia transaction in ­particular( TARP. PAULSON'S CHANGES ).

PNC’s acquisition of National City for $5.58bn in cash and stock was also facilitated by a $7.7bn capital commitment from the US Treasury under its capital purchase programme( DO TELL ). PNC, which had shied away from doing a deal without government assistance( AND YOU STILL BELIEVE THAT THESE PEOPLE DESPISE GOVERNMENT? ), said this allowed it to acquire National City using “attractively priced” government money to help cope with the potential effects on its balance sheet.

Wells Fargo received $25bn under the Treasury’s programme( GOVERNMENT AID. AGAIN ), but said it still intended to raise $20bn of new capital to help fund its acquisition. Wells raised a total of $12.6bn, at a heavy discount, in November.

Yet, while the deals are blockbusters for Wells and PNC, neither is without risks. In both cases, the greatest of these lies with managing the targets’ troubled mortgage portfolios.

Wells is set to take on Wachovia’s $312bn portfolio of residential and commercial mortgage debt, on which Wells expects to take a $40bn writedown when the deal closes and a total of $60bn worth of losses over the life of the portfolio. PNC expects National City’s portfolio to experience $20bn of losses.

Wells’ integration with Wachovia will also proceed in the shadow of continued legal costs from its skirmish with Citigroup. Citi has vowed to pursue its claim for up to $60bn in damages “vigorously”( DUE TO THE FDIC VS TARP DEVELOPMENT ).

● The US Federal Reserve Board on Monday approved commercial finance firm CIT Group’s bid to become a bank holding company( JOIN THE CLUB ), clearing the way for it to access up to $2.5bn in capital from a financial rescue programme, Reuters reports from Washington."

"I'm betting the theory of regulatory competition is going to go on holiday for a few years"

Justin Fox with a post about what I call Rationalization:

"The top West Coast regulator of the Office of Thrift Supervision has been removed from his jobwhile the Treasury Department's inspector general looks into some weirdness surrounding backdated capital infusions into since-failed thrift IndyMac( I POSTED ABOUT THIS STORY ). Add that to the demise of the biggest savings institution regulated by OTS, Washington Mutual, the loan troubles inherited from OTS-regulated Golden West Financial that forced Wachovia into a merger with Wells Fargo, and the various shenanigans associated with OTS-regulated Countrywide Financial, and things really aren't looking good for the agency. Oh, and don't forget AIG, which due to a quirk in our country's deeply quirky regulatory setup was also overseen at the holding company level by OTS( PLEASE. NO MORE ).

The OTS was created as a semi-autonomous division of the Treasury Department 1989, to take over the regulatory duties of the Federal Home Loan Bank Board, which was seen as identifying too closely with the savings and loan industry to do a good job of supervising it( YOU CAN'T BE SERIOUS ). I was the OTS beat writer for American Banker in the mid-1990s, and in those days the agency was trying hard to be professional and just as tough as the other banking regulators. But there was still lots of talk of looking out for the interests of the thrift industry, and ensuring the attractiveness of the federal savings bank charter that OTS oversaw( HOW CHUMMY ).

That's just the natural tendency of any specialized industry regulator, and I'm certainly not going to blame OTS for our current troubles ( I WILL GIVE THEM A TINY PORTION OF BLAME, IN THAT THEY ALLOWED REGULATORY SHOPPING ). The craziest of crazy mortgage lending was done by mortgage brokers selling to Wall Street. The OTS-regulated thrifts mostly just followed( THAT'S ENOUGH FOR BLAME ) in their lead. But OTS didn't stop them, I imagine, because people there were worried about thrifts losing market share( YES ). That, and they had been drinking the same home-prices-never-go-down Koolaid ( I DON'T BUY THIS KOOLAID ) as everyone else in real estate. The regulators were of the industry, not above it( NICE ).

This country's Balkanized financial regulatory structure (just for banks and savings institutions there's the OTS, the OCC, the FDIC, the Federal Reserve, and all the state banking commissioners) is mostly the product of history and bureaucratic turf wars. But for the past few decades there's also been a theory—regulatory competition, it's called—to back it up.

Having different state and federal entities compete for the privilege to regulate a particular company results in more market-friendly regulations, the thinking( THAT'S WHAT IT IS UNTIL THE REAL WORLD COMPLIES ) goes. That may be true, but more market-friendly regulations are also generally weaker regulations( TRUE ), and in the financial sector weak regulations can eventually end up destroying the very markets they're being friendly to. As we've seen lately( I AGREE. SOMETIMES, POORLY ENFORCED REGULATIONS ARE WORSE THAN BOTH ZERO REGULATIONS AND TOUGHER REGULATIONS ).

I'm betting the theory of regulatory competition is going to go on holiday for a few years, maybe decades. The OTS will be among the first victims of the new intellectual climate—Hank Paulson already proposed getting rid of it last spring. Any guesses as to who's next after that?"

I've already said that the whole system needs to be Rationalized. In other words, streamlined.

"That helped ignite the current panic, which was exacerbated by a drumbeat of bleak economic news."

From the WSJ story about the Citi deal:

"Citigroup has tried repeatedly to rid itself of its exposure to those assets -- and nearly hammered out a similar arrangement with the government nearly two months ago.

In late September, the company reached an agreement for a government-financed acquisition of Wachovia Corp. Under that planned deal, Citigroup and the government were going to divvy up the losses on $312 billion of assets, with Citigroup absorbing the first $30 billion in losses and the government shouldering the remainder.

Citigroup described that arrangement as intended to insulate it from Wachovia's risky mortgage assets. But Citigroup also would have been able to unload some of its own assets, according to people familiar with the matter.

That deal unraveled in less than a week, after Wells Fargo & Co. emerged with a higher bid that didn't require direct government backing. That deprived Citigroup not only of a way to dump its risky assets but also of a deep pool of deposits, which would have substantially strengthened its access to stable low-cost funding.

Shortly after the Wachovia deal fell apart, Citigroup pitched the idea to the government of it helping to protect the company against some of its losses. Citigroup executives argued that the government should help the company after Wachovia slipped away, according to a person familiar with the matter. But federal officials balked at the idea."

That's how the Wachovia deal impacted the current Citi problems.

"As recently as one month ago, Citigroup had hoped to be able to unload some of those assets to the U.S. government through its Troubled Asset Relief Program, according to people familiar with the bank's plans. But when Treasury Secretary Paulson earlier this month shelved plans to use TARP to purchase banks' bad assets, that option vanished."

This is interesting. TARP pulled the rug out from under Citi with the Wachovia deal, and TARP not buying toxic assets calcified the toxic assets market so Citi could get rid of some of its toxic assets. Maybe Paulson felt that he owed Citi.

"Last Monday, Mr. Pandit said in a meeting with employees that Citigroup was scrapping plans to try to sell about $80 billion in risky assets. Investors and analysts interpreted the move as a sign that Citigroup either was unable to sell the assets, or would have had to incur hefty losses in the process.

Two days later, Citigroup announced it was buying $17.4 billion in assets from its structured-investment vehicles -- complex entities whose holdings included risky mortgage-linked securities -- and faced a $1.1 billion loss due to their diminished values.

The back-to-back moves, coupled with existing fears about Citigroup's massive off-balance-sheet holdings, stoked investor fears that Citigroup could be swamped by toxic assets flooding back onto its books. That helped ignite the current panic, which was exacerbated by a drumbeat of bleak economic news."

I'm on record saying that this was a panic reaction, and not sensible, so I'm still not sure that this was necessary. I didn't doubt that the government would step in if it had to, but I'm not sure, absent panic, we'd have been in this position.

"Government officials could face requests from other banks for similar help shoring up their balance sheets. Banks, hedge funds, and private equity firms have urged Capitol Hill and government officials to restart the asset-purchase program in recent weeks.

"The problem is that other banks would want to get in line" for such government support, says Thomas B. Michaud, a vice chairman of investment bank Keefe, Bruyette & Woods Inc. "Is there enough money to do that?"

I think that we can guarantee this.

"A senior Republican senator is seeking an investigation into potential conflicts of interest "

Let's see if we can understand this story from the FT. First, here's my post about the problems with TARP:

"Saturday, October 4, 2008

Problems With The Bailout

From the NY Times article "For Treasury Dept., Now Comes Hard Part of Bailout", I see the following problems with the plan as envisaged:

1) Possible conflicts of interest with the administrators of the plan.

2) Overpaying for assets.

3) Doesn't do enough to ease credit markets or makes it worse.

4) When the assets are eventually sold, there is a huge and unanticipated loss.

5) Lobbying by hedge funds, etc.

Are there others? "

See Problem 1:

Also, read my post here about William Gross, who's my guy, and I still thought there could be problems.

Now, from the FT:

"A senior Republican senator is seeking an investigation into potential conflicts of interest among former Goldman Sachs executives serving at the US Treasury and whether any officials exceeded their authority by implementing a controversial tax change without the approval of Congress.

Chuck Grassley, the most senior Republican on the Senate finance committee, asked Eric Thorson, inspector-general of the Treasury, to investigate the "independence" of several Treasury officials who formerly worked at Goldman Sachs and serve as advisers to Treasury secretary Hank Paulson, the former chief executive of the Wall Street bank.

Mr Grassley said in a letter to Mr Thorson that there was reason to be concerned that “relationships” between the officials and board members at two merging banks, Wells Fargo and Wachovia, gave the “appearance of preferential treatment”.

Good work Sen. Grassley. You're right on the ball.

"Mr Grassley singled out Robert Steel, a former Goldman official who worked under Mr Paulson at the Treasury before he became chief executive of Wachovia.

Mr Grassley is specifically concerned with a change in the tax code the Treasury initiated in late September that saved some institutions tens of billions of dollars and paved the way for Wells Fargo's acquisition of Wachovia.

Citigroup was at the time also bidding for Wachovia, but was ultimately trumped by Wells Fargo, in part because it would not have received any benefit from the tax change because of its losses.

The September 30 “notice” by the tax authorities, which fall under Treasury's jurisdiction, altered a section of the tax code that had previously prevented tax-motivated acquisitions of loss-making corporations. In effect, the notice eradicated a limit on the amount of taxable income an acquiring bank could deduct after a takeover.

It has been estimated that the change could save Wells Fargo nearly $20bn (€15.9bn, £13.6bn)."

If you want to understand this, read my recent post here.

Back to the FT:

"Mr Grassley, who has a reputation for aggressively uncovering and pursuing tax evasion, has a previous working relationship with Mr Thorson, who served as chief investigator for the Senate finance committee and whom Mr Grassley once praised for having “integrity and courage”.

Last week, Mr Paulson defended the code change and said it had been done through an “administrative process” that was “quite legal”. The Treasury secretary said that the previous tax policy was “impractical and unworkable” in the current economic environment.

The Treasury said on Sunday it was reviewing the letter. Wachovia said “to the best of our knowledge” the company was not involved in the tax change. It added that Mr Steel did not have a severance agreement."

Okay. Good for Grassley. But please, nobody tell me this wasn't expected. The problem with TARP was that you had to hire people from some of the firms involved in the crisis, and the plan, the way it was constructed, as a hybrid plan, looked arbitrary, and reeked of cronyism. Calling Charles Krauthammer in my recent posts about his article on the Auto Bailout. TARP was pushing consolidation, meaning that it had to look like it was favoring some banks over others. That was one of the problems about letting insolvent banks fail, as Anna Schwartz wanted. It could look like some banks were being saved while others cut loose, and the solvency of the bank could meld into an issue of preferential treatment. Were they really solvent/insolvent?

This was a huge negative with the plan from the beginning, as was the problem of lobbying, which has also been serious.

"Paulson did it quietly and in the background": Then How Did I Know It?

I wonder how many times that I have to read this. From 124 Monkeys:

"I had completely missed this story by Amit Paley until Michael Scherer put up a blog post about it. Basically, the Treasury Department completely bypassed Congress and the Constitution* to revise Section 382 of the U.S. Tax Code. The why of it is pretty obvious on its face. Paulson believes that we’re on the verge of another Great Depression and he intends to not make the mistakes of letting banks fail and contracting the money supply that caused the first one.

*you know, that pesky document that spells out and specifically states that Congress and only Congress shall have the power to tax the people and pass laws about taxation

Paulson’s original plan was to buy up the bad securities and encourage the credit markets to start trading and lending again. Part of that scenario would definitely involve banks buying up other banks that had tons and tons of losses and bad assets on their books. In order to encourage such behavior, Paulson ordered a roll back of Section 382 to make buying companies with lots of losses - either on their books or waiting to be declared - more attractive.

Paulson did it quietly and in the background because he knew the top down nature of his plan, which essentially was “save Wall Street, let the solvent banks carry the overall economy through the crisis, screw the little guys” would go over very, very badly with Congress who would need votes from all those little guys to get re-elected in a month.

What I don’t understand is why this roll back wasn’t rolled back when the TARP plan changed to bank nationalization. Plus, its like totally unconstitutional and stuff."

Here's my post from, read it carefully:

Saturday, October 4, 2008

Not Really Free Market After All

Paulson's stimulus plan:

"Treasury Secretary Henry Paulson’s plan, which is now law, is fiscal stimulus that will be injected directly into the banking system to supplement almost nonexistent private-sector lending with government cash and determination. Mr. Paulson may be shooting the right weapon at the right time because it will help rescue the banks while restarting corporate and consumer lending.

But Mr. Paulson’s fiscal-stimulus work didn’t end with the bailout bill.

With hardly anyone noticing, on Wednesday he pushed through very technical and obscure changes to tax regulations that provide a “tax subsidy” for acquirers of troubled banks. Just as automakers stimulate car sales through rebate checks, the Treasury is providing a form of tax rebate to acquirers of troubled banks. Everyone can thank Hank Paulson and his stealth tax-driven fiscal stimulus for the astonishing news that Wachovia was being acquired by Wells Fargo and not Citigroup. It was Mr. Paulson’s tax subsidy to Wells Fargo that provided the fiscal grease to make this deal happen. Pundits who point to the deal and proclaim that the “free markets work without government help” don’t understand the motivating effect of several billion dollars of tax benefits to Wells Fargo."

Your government's dollars at work.

And this post:

Saturday, October 4, 2008

Are Regulators Always Wise?

On the Wachovia sale:

"Lawyers not involved in the battle said that Wachovia could defend the Wells Fargo deal by arguing that it is better for its shareholders. Wachovia is likely to claim that its fiduciary obligations — its responsibility to protect the interests of its investors — required it to consider the Wells Fargo bid and, given its higher price, to accept that bid.

The litigation could put regulators in a difficult spot. The Wells Fargo deal may be better for taxpayers, but if it succeeds, in the future other financial institutions may not be willing to help the government, as Citigroup did, because of the risk that they might not reap the anticipated benefit."

You think?

And this post:

Monday, October 20, 2008

“One purpose of this plan is to drive consolidation.”

Score one for Surowiecki. From the NY Times:

"As the Treasury embarks on its unprecedented recapitalization, it is becoming clear that the government wants not only to stabilize the industry, but also to reshape it. Two senior officials said the selection criteria would include banks that need more capital to finance acquisitions.

“Treasury doesn’t want to prop up weak banks,” said an official who spoke on condition of anonymity, because of the sensitivity of the matter. “One purpose of this plan is to drive consolidation.”

I understand this as a temporary move, but don't find consolidation, or creating very large banks, a positive development in the long run.

As well, I don't think that a credit stimulus plan that doesn't stimulate lending to be very useful.


Okay. These three posts explain everything. Citigroup had a deal to buy Wachovia brokered by the government. When the TARP was passed, which included the provisions that I knew about at the time, and that people are claiming were hidden, Wells Fargo took advantage of the new law to put a better bid in to buy Wachovia. This put the government in the odd situation of brokering a deal with Citigroup, only then to pass tax subsidies that led to Wells Fargo making a better deal. A suit by Citigroup then ensued.

Also, the TARP plan was designed to acquire toxic assets from banks, not recapitalize them as happened. So, the original plan for recapitalization was to pass these tax subsidies so that banks could merge, making recapitalization easier, and, hopefully, making the banks more profitable, hence more able to pay us back and survive, since there was less competition.

Now, if you followed the Wachovia deal, or tried to understand how TARP could actually work and what it said, these provisions were obvious from the beginning. So, these stories are not news. The only news I can find is that some people claim that it's unconstitutional. But, I believe that is was in the bill that passed, so I'm missing something about this argument. It could be correct, but I need to understand it better.

But, if an amateur blogger like me knew this, how could all these experts not know it?

"Credit card companies were shut out of the market for bonds backed by customer payments"

Bloomberg on Credit Card Bonds:

"Credit Card Bond Sales at Zero, First Time Since 1993 (Update1)

By Sarah Mulholland

Nov. 5 (Bloomberg) -- Credit card companies were shut out of the market for bonds backed by customer payments in October for the first time in more than 15 years, as investors shunned the debt amid the global credit freeze.

A weakening job market and a looming recession are making it harder for consumers to make monthly payments, eroding confidence among investors about the safety of credit-card-backed bonds. It's the first month since April 1993 that there have been no sales, according to Wachovia Corp. data. Issuers sold $17.1 billion of the debt in October 2007, the data show.

``Nobody is eager to put money to work given the uncertainty in the market,'' said James Grady, a managing director at Deutsche Bank AG's asset management unit. ``When you think it can't get worse, it continues to get worse. There is not a demand'' for these bonds.

Top-rated credit card-backed securities maturing in three years traded at a gap, or spread, of 475 basis points over the London interbank offered rate, or Libor, during the week ended Oct. 30, JPMorgan Chase & Co. data show, 25 basis points higher than the previous week. The debt was trading at 50 basis points more than Libor in January.

The higher cost to sell the bonds makes it more expensive for banks and credit card companies to fund loans to customers. New York-based American Express Co. paid 160 basis points more than Libor at a Sept. 11 sale of the securities compared with 30 basis points over the benchmark at a similar sale in October 2007, Bloomberg data show."

This interests me. I'd like to know what investors are afraid of. Credit Card companies defaulting? In America? Wow. That would be revolutionary. Maybe Yves Smith was correct.

Regulations And Regulators

Terrific post on the NY Times by Gretchen Morgenson.

Point 1) The problem of regulators:

"And that has created the biggest problem for regulators right now: at precisely the moment they are entrusted with breathtaking powers, investors’ and taxpayers’ trust in them is at a nadir."

Of course, the SEC story earlier and handling of the Wachovia deal weren't great shakes for regulators either.

Point 2) The implicit government guarantee:

"There are a few straight talkers in the regulatory regime, of course. One is Gary H. Stern, president of the Federal Reserve Bank of Minneapolis and co-author of “Too Big to Fail: The Hazards of Bank Bailouts.” In a speech last Thursday, Mr. Stern expressed deep unease over the consequences of using taxpayer money to rescue big and reckless financial institutions.

“The too-big-to-fail problem, with which I have long been concerned, has been exacerbated by actions taken over the past year to bolster financial stability,” he said, according to his prepared remarks. While conceding that the recent lifelines were appropriate, given the circumstances, he said that “it is critical that we address ‘too big to fail’ because, if left unchecked, it could well be a major source of future instability.”

It seems to me that this problem has already led to instability.

Point 3) Regulations going forward:

"Mr. Stern’s solution is an approach he calls “systemic focused supervision.” It involves “early identification, enhanced prompt corrective action and stability-related communication.”

First, regulators would identify what Mr. Stern described as “material exposures between large financial institutions and between these institutions and capital markets.”

Read on.

In other words:

A. Identify problem bank.

B. Close It.

C. Tell the public why.

Of course, this solution relates to Point 1, since this system will necessarily rely on regulators. However, it's better to have Point 1 be a problem, from my point of view, than Point 2. It seems to me that it would be cheaper, and hinder the free market less than the consequences of implicit government guarantees, i.e., to big to fail.

On Government Intervention And Complexity

Great article by Steven M. Davidoff in the NY Times on the Wachovia deal:

"The Law of Unintended Consequences Rules the Day

The slew of legislation, regulation and government intervention is going to engender a cascade of unintended consequences. We saw the first signs of this in the Wachovia deal. The Tuesday after it was announced, the Internal Revenue Service announced that banks would be permitted to deduct on an accelerated basis losses on loans or bad debt acquired in any bank acquisition. This rule will allow Wells Fargo to take substantial tax deductions -– Wells Fargo conservatively predicts a $74 billion loss on Wachovia’s $498 billion loan portfolio. That is a big tax deduction, and no doubt this made Wells Fargo’s decision to bid easier. Incidentally, this means the Wells Fargo bid may ultimately cost the government more money than the Citi transaction, because of the lower taxes that Wells Fargo would pay.

In addition, the parties are battling over the meaning of 126(c) of the TARP bill, for Troubled Assets Relief Program, that Congress passed last week. Each side contends that this provision nullifies the other’s agreement with Wachovia. But at this point, no one definitively knows what the provision means."

My problem with this statement is the problem I had with Bob Barr calling this a non-government solution. Excuse me, but tax policies are government interventions.

Here's another quote:

"Complexity Is Death in Today’s Market

Citi went with a letter of intent because it was arranging an asset purchase. Carving out these depository institutions from Wachovia and negotiating the arrangements could not be done overnight. Hence the use of a term sheet, and perhaps in this haste the reason for the failure to put in a break-up fee. But the need to negotiate these complex documents allowed Wells Fargo to slip in and make a higher bid on a 27-page merger agreement that needed little negotiation. Speed is everything in this market and complexity unduly delays things."

I agree with this, which is why I favored the Swedish Plan and not TARP.

Barr Misses Tax Rebate

Bob Barr says the following on Huffington:

"Even more dramatically, a bidding war has broken out between Citigroup, which had been tapped by the Federal Reserve to save troubled Wachovia bank, and Wells Fargo, which jumped in with an unexpected $15 billion purchase offer. The two are now battling in court over the right to buy a bank seen as financial road kill only last week."

However, he missed this:

"But Mr. Paulson’s fiscal-stimulus work didn’t end with the bailout bill.

With hardly anyone noticing, on Wednesday he pushed through very technical and obscure changes to tax regulations that provide a “tax subsidy” for acquirers of troubled banks. Just as automakers stimulate car sales through rebate checks, the Treasury is providing a form of tax rebate to acquirers of troubled banks. Everyone can thank Hank Paulson and his stealth tax-driven fiscal stimulus for the astonishing news that Wachovia was being acquired by Wells Fargo and not Citigroup. It was Mr. Paulson’s tax subsidy to Wells Fargo that provided the fiscal grease to make this deal happen. Pundits who point to the deal and proclaim that the “free markets work without government help” don’t understand the motivating effect of several billion dollars of tax benefits to Wells Fargo."

Not exactly free market, but close enough for some.

Not Really Free Market After All

Paulson's stimulus plan:

"Treasury Secretary Henry Paulson’s plan, which is now law, is fiscal stimulus that will be injected directly into the banking system to supplement almost nonexistent private-sector lending with government cash and determination. Mr. Paulson may be shooting the right weapon at the right time because it will help rescue the banks while restarting corporate and consumer lending.

But Mr. Paulson’s fiscal-stimulus work didn’t end with the bailout bill.

With hardly anyone noticing, on Wednesday he pushed through very technical and obscure changes to tax regulations that provide a “tax subsidy” for acquirers of troubled banks. Just as automakers stimulate car sales through rebate checks, the Treasury is providing a form of tax rebate to acquirers of troubled banks. Everyone can thank Hank Paulson and his stealth tax-driven fiscal stimulus for the astonishing news that Wachovia was being acquired by Wells Fargo and not Citigroup. It was Mr. Paulson’s tax subsidy to Wells Fargo that provided the fiscal grease to make this deal happen. Pundits who point to the deal and proclaim that the “free markets work without government help” don’t understand the motivating effect of several billion dollars of tax benefits to Wells Fargo."

Your government's dollars at work.

Are Regulators Always Wise?

On the Wachovia sale:

"Lawyers not involved in the battle said that Wachovia could defend the Wells Fargo deal by arguing that it is better for its shareholders. Wachovia is likely to claim that its fiduciary obligations — its responsibility to protect the interests of its investors — required it to consider the Wells Fargo bid and, given its higher price, to accept that bid.

The litigation could put regulators in a difficult spot. The Wells Fargo deal may be better for taxpayers, but if it succeeds, in the future other financial institutions may not be willing to help the government, as Citigroup did, because of the risk that they might not reap the anticipated benefit."

You think?

Markets Were Counting On The Government Acting

Henry Blodget says the following on Huffington:

"And, as Paul Krugman notes, in part McCain's nosedive is the result of a critical decision by Bush Treasury Secretary Hank Paulson earlier this month: to let Lehman Brothers fail.

Two weeks ago, on September 14th, Paulson let Lehman croak--and the credit markets went haywire. In short order, this led to the failure of AIG, WaMu, Wachovia, and the chaos of the emergency Wall Street Bailout."

As Krugman says:

"But I found myself thinking about that sign when reading this terrific WSJ article about how the fall of Lehman triggered global panic. One lesson of the article is that Paulson messed up very badly by letting Lehman fail."

Here's from the WSJ:

"In hindsight, some critics say the systemic crisis that has emerged since the Lehman collapse could have been avoided if the government had stepped in. Before Lehman, federal officials had dealt with a series of financial brushfires in a way designed to keep troubled institutions such as Fannie Mae, Freddie Mac and Bear Stearns Cos. in business. Judging them as too big to fail, officials committed billions of taxpayer dollars to prop them up. Not so Lehman.

"I don't understand why they didn't understand that the markets would be completely spooked by this failure," says Richard Portes, professor of economics at London Business School and president of the Centre for Economic Policy Research. Rather than showing the government's resolve, he says, letting Lehman fail only exacerbated the central problem that has afflicted markets since the financial crisis began more than a year ago: Nobody knows which financial firms will be able to make good on their debts."

Doesn't this tell us that the credit markets going haywire and being spooked was because they were counting on government stepping in? I'm just asking.

So much for free markets, since the people playing the game don't even believe in it.