How the Obama/Geithner Scam Works

http://www.counterpunch.org/hudson03272009.html

The Free Market, Financial Style
How the Scam Works
By MICHAEL HUDSON

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Why are the very worst offenders – Bank of America (now owner of the Countrywide crooks) and Citibank the largest buyers? As the worst abusers and packagers of CDOs, shouldn’t they be in the best position to see how worthless their junk mortgages are?

That turns out to be the key! Obviously, the government has failed to protect itself – deliberately, intentionally failed to do so – in order to let the banks pull off the following scam.

Suppose a bank is sitting on a $10 million package of collateralized debt obligations (CDOs) that was put together by, say, Countrywide out of junk mortgages. Given the high proportion of fraud (and a recent Fitch study found that every package it examined was rife with financial fraud), this package may be worth at most only $2 million as defaults loom on Alt-A “liars’ loan” mortgages and subprime mortgages where the mortgage brokers also have lied in filling out the forms for hapless borrowers or witting operators taking out mortgages at far more than properties were worth and pocketing the excess.

The bank now offers $3 million to buy back this mortgage. What the hell, the more they bid, the more they get from the government. So why not bid $5 million. (In practice, friendly banks may bid for each other’s junk CDOs.) The government – that is, the hapless FDIC – puts up 85 per cent of $5 million to buy this – namely, $4,250,000. The bank only needs to put up 15 per cent – namely, $750,000.

Here’s the rip-off as I see it. For an outlay of $750,000, the bank rids its books of a mortgage worth $2 million, for which it receives $4,250,000. It gets twice as much as the junk is worth.

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It's one thing to be able to stand outside "the Beltway" and put forth what you think should be done, a la Krugman and Hudson, it's another thing to be able to present these ideas in a form that is politically and materially viable.

Krugman came the closest to admitting that he knew what he was proposing could not be done politically, especially with the Republicans already advocating armed revolution as a "solution."

I would have more respect for these economists if they would also work out how the president could sell their ideas in the current political environment; otherwise, it's just pie-in-the-sky with no practical value.

When you have voices as diverse as Greenspan, Stiglitz (the most well-respected economist around) and Lindsay Graham agreeing that pre-privatization is the best option, Obama plenty of political cover. The problem now appears to be that the administration is too beholden to Wall Street.

and the first rule is don't bite the hand that feeds you.

And while Stiglitz has made important contributions to economic theory, it is bizarre to paint him as an expert on financial institutions.

Writing off the losses would instantly collapse the world's largest banks.

The ramifications of that are far-reaching and frankly, scary as hell: massive layoffs, shortages of goods, social breakdown, etc. WE would take it in the shorts in the most painful way, to be sure.

If there were some way to stage a controlled deconstruction of the worst offenders that would temper the fallout to some degree, that would be preferable, imo.

I am in agreement that the currently proposed solution is basically a bloodless coup.

... of printing 2 trillion dollars are not any better, in fact they are worse.

b) you didn't even understand the most basic point: that a form of robbery is being done against the taxpayers.

So start by not robbing the taxpayers. As for Hudson's alternatives: read about them yourself. He's got like 50 articles published on that same site.

you said the bank only needs to put up 15%

but I read that even that 15% is not required

the gov't pays part of that 15% also, from some other fund

and how suddenly only they know what's right and because some blog lets them post on it suddenly they are experts.

long before the current financial crisis. That's not what I would call suddenly crawling out the woodwork.

And Counterpunch is not a blog.

surely in the past 6 years you've been reading him on Counterpunch he raised many warning bells about this current crisis since he knows what's best?

On Counterpunch, Mike Whitney is the one who I remember ringing the warning bells.

I don't recall Hudson doing so.

But my point is that these guys didn't just pop up out of nowhere. But nobody listens to economists writing for leftist newsletters much.

I'm surprised this thread hasn't been pulled yet...

When my mom and her husband were buying their nice brand new house... Their Realtor told them that in a few years a lot of the homes in their area were going to become HUD homes because of the bullshit banking practices and the interest only loans...

They got a 15 year 5% fixed rate.

And now quite a few of the homes in their sub are for sale because the people could afford them. They bought their house for $260K, two years ago it was worth $320K, now it's worth $190K.

If their Realtor saw it coming... I'm sure MANY others did too.

doesn't take an economist to see that, just open your eyes

the US government. If WaMu had failed the FDIC would not have had enough
money to cover the WaMu customers deposits, and the FDIC would have, in
theory, gone bankrupt.
WaMu was largest bank failure at the time.

Now JPM Chase bought WaMu at 10 cent on the dollar. In other words,
JPM Chase only paid 10% of what WaMu was worth. JPM Chase agreed to
the purchase as long as they didn't have to buy the bad loans. So, JPM
Chase bought my mortgage for 10% of it's worth.

The day that sale was announced, I went into my WaMu bank and asked
the loan officer, why I was not offered to purchase my mortgage at 10%?
I would have offered 15%. I could have offered as much as 25%.

I was told that JPM Chase also bought the bad loans, but every report I read
mentioned that JPM Chase would not have purchased WaMu if they had to
buy the bad loans.

These are the bad loans that the government now wants to unload.

I just think he's wrong. Sincerely wrong, but wrong just the same.

Stuff with this sort of tone is a complete turn off to me. In fact I didn't even finish it. I can find excellent critique from sources that aren't busy trying to guess people's motives and assume the worst in everyone.

As nervous and as worried as I am, I still believe Obama's team knows more than the average layman knows about the economy. I till trust and believe our president, which is something I could not say for for 8 years.

I am so sick and tired of the know-alls, of the negativity and of the drama.

Imo, we should all just try to relax and give the man a chance. He did not create this mess, he did not ask for it but I do believe he is trying his best to get us out of it.

Especially when a lot of the 'data' is going to be corrupted, missing, outdated or simple fraudulent.

Oye!

We are told what to suppose. The author then builds on that supposition with a series of hypothetical actions. In that the reader is not an economist (I know I'm not) the reader has no basis to judge whether those actions or even the base supposition are valid. The author does a very good job of attacking the structure that he put together (what's called a "straw man") but without any knowledge of how valid a structure it is, I'm certainly not going to go "torches & pitchforks" at Obama on the basis of this author's fantasy.

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Besides, I don't know the OP well enough to "expect" anything.

I think your initial response to Hudson is pretty reasonable. The outcome he describes is so bizarre, it's hard to believe that's really how the Obama/Geithner scam is structured. Unfortunately, Hudson's analysis appears correct, assuming, that is, Sachs is correct in his description. I'd be more than happy if someone could show these economists are wrong and this kind of unconscionable wealth transfer isn't going to take place.

http://www.huffingtonpost.com/jeffrey-sachs/will-geithner-and-summers_b_177982.html

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A major part of the plan works as follows. One or more giant investment funds will be created to buy up toxic assets from the commercial banks. The investment funds will have the following balance sheet. For every $1 of toxic assets that they buy from the banks, the FDIC will lend up to 85.7 cents (six-sevenths of $1), and the Treasury and private investors will each put in 7.15 cents in equity to cover the remaining balance. The Federal Deposit Insurance Corporation (FDIC) loans will be non-recourse, meaning that if the toxic assets purchased by private investors fall in value below the amount of the FDIC loans, the investment funds will default on the loans, and the FDIC will end up holding the toxic assets.

To understand the essence of the giveaway to bank shareholders, it's useful to use a numerical illustration. Consider a portfolio of toxic assets with a face value of $1 trillion. Assume that these assets have a 20 percent chance of paying out their full face value ($1 trillion) and an 80 percent chance of paying out only $200 billion. The market value of these assets is given by their expected payout, which is 20 percent of $1 trillion plus 80 percent of $200 billion, which sums to $360 billion. The assets therefore currently trade at 36 percent of face value.

Investment funds will bid for these assets. It might seem at first that the investment funds would bid $360 billion for these toxic assets, but this is not correct. The investors will bid substantially more than $360 billion because of the massive subsidy implicit in the FDIC loan. The FDIC is giving a "heads you win, tails the taxpayer loses" offer to the private investors.

Specifically, the FDIC is lending money at a low interest rate and on a non-recourse basis even though the FDIC is likely to experience a massive default on its loans to the investment funds. The FDIC subsidy shows up as a bid price for the toxic assets that is far above $360 billion. In essence, the FDIC is transferring hundreds of billions of dollars of taxpayer wealth to the banks.

With a little arithmetic, we can calculate the size of that transfer. In this scenario, the private investors (who manage the investment fund) will actually be willing to bid $636 billion for the $360 billion of real market value of the toxic assets, in effect transferring excess $276 billion from the FDIC (taxpayers) to the bank shareholders! Here's why.

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I dont buy that for a second. They are not going to overbid themselves into losers on purpose. This is an oportunity for them to make huge profits with little investment. This dooms day scenario seems to base itself on the idea that these guys are alll going to go out and make incredibly bad decisions on purpose.

nt

...most all of their drivel is based on making some gigantic leaps of faith (i.e., their "assumptions"). I don't take one word written there seriously.

What is your plan anyway? Give the money to you, or let them fail?

I've been looking all over the place for it

Cough it up please

http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=389x5351541

the government has failed to protect itself – deliberately, intentionally failed to do so – in order to let the banks pull off the following scam.

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YES! It's the Guild of Calamitous Intent's decade long plot to "Suppose a bank is sitting on a $10 million package of collateralized debt obligations (CDOs) that was put together by, say, Countrywide out of junk mortgages." That's it! MWHAHAHA! They planned it since the 90's! The Phantom Limb is obviously behind it. Obama is his pawn!

Or suppose they just systematically deregulated the industry to make wads of cash and the ethics and future of it all be damned. Now they're tap dancing a hard as they can....and improvising.

What am I missing here?