No Treasury Bailout ... For Good?

The US House of Representatives today defeated the Paulson Bailout Bill.  Leaving the politics of this aside, what are the real economic and financial consequences?  Are we really now doomed to Great Depression 2.0?  Or is this the beginning of the healing process?

Some things to consider:

• Free market fundamentalism is likely to fail as bad as, or worse than, wreckless interventionism.  Hopefully we learned those lessons in the Great Depression 1.0.  Laissez-faire economic policy is arguably just as bad as command socialistic economic policy.
• Failure of this plan alone is not sufficient to ensure a Great Depression 2.0.
• The DOW is not the economy.  I, for one, am tired of the media running around acting like the DOW is a proxy for the health of the economy.
• Calling the bailout plan a "rescue plan" won't change anything other than what the talking heads on television spew.  They've lost that battle anyway, my 70 year old mom in Ohio calls it a "bailout".  Therefore, it is a "bailout" to Main Street.  Get over it, media and Wall Street apologists.
• And most of all -- for anyone in the real estate industry:  look out below!  You thought home prices were coming down before?  You ain' seen nothing yet.  (By the way, I just saw a new construction home we looked at earlier this year, which had then been marked down from $1.55mm to $1.395mm, and was advertising $1.098mm a couple months ago...$699K.  And it's _still_ overpriced.  If you're the guy next door who paid $1.6mm for your nearly identical unit in 2007, what do you do now?  That home won't retrace that price in your lifetime.)

Comments

[randolfe]

By the way, this is the old Shiller graph that I did a curve-fit to a regression to mean based on the most recent two previous downturns, scaled to the size of this bubble.

I'm a little scared about how accurate this turns out to be looking:

Link

[astrid]

I don't think this bailout is dead quite yet. The House Republicans are calling for a re-vote of the current bill - some of them might have their arms twisted into a Yea vote. Some Nay Democrats also indicated that they're willing to vote yes if they get the CEO pay cap.

[randolfe]

Oh, I think the possibility of passing this bill just went way down. The politics just got much more complicated. There's now cover for lots of dissenters.

[astrid]

Well, it'll be interesting. If the bailout fails, I'll be fervently hoping that Randy and Brand are right.

[Brand]

Can anyone else get onto the Congressional voting record site? Everything on www.house.gov seems completely overwhelmed right now. Apparently America is very interested.

As said on the previous thread, I don't think this is the end. Paulson, Bernanke and Bush got kicked squarely in the teeth for all their fearmongering. America acually called bullsh--. Just because we're in trouble, doesn't mean we need to approve their crazy proposal.

I seriously feel like flying a flag right now.

Cut the golden parachute strings, and take preferred equity positions in all rescued firms. And no more "At the discretion of the Treasury Secretary..." clauses.

[randolfe]

CNBC is about to make me puke. Maria's lovefest for Wall Street elitists is palpable. It is disgusting.

If you ask me everyone on there needs to STFU and listen to Rick, who not coincidentally is the only guy not on Wall Street but is in Chicago, ie. Main Street.

[randolfe]

Ok. I got that off my chest. Now I can be productive the remainder of the day.

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[astrid]

BTW, thanks for the datapoint on Bay Area real estate prices. Is that a short sale or a foreclosure, or just a very desperate seller?

My parents' old home in Leesburg, VA (a DC exurb) is my reference point. Zillow has it priced at approximately $400,000. They had sold it in 2005 for $600,000.

[Brand]

astrid, it seems like a lot of real estate in northern Colorado has siezed up. I bet if the banks don't get fast liquidity, a lot of pending deals will fall through due to broken financing.

[astrid]

@ Brand:

http://www.nytimes.com/ref/washington/ROLLCALL.html?currentChamber=house&currentSession=2&currentCongress=110&currentRoll=674

[Joseney21]

is it safe to make the assumption that without the bailout prices will fall back within fundamentally supported numbers sooner?? Randy, how long do you think the downturn will be with/without a bailout??

[randolfe]

Joseney21, click the link I put in the first comment. I don't read tea leaves, but if I fit the curves of the two most recent downturns to this one, at scale, then it looks like either:

Very fast = 2009-2010 prices near mean growth. But the problem here is there will almost certainly be a significant overshoot because for prices to fall that quickly there will be a lot of economic turmoil. I have no idea when prices actually bottom and start recovering, which would be marked by faster-than-normal price increases as prices climb back to fundamental support.

Slower with a bounce = 2010 is a false bottom, with prices then going back up for 2-4 years, then another sharp decline to mean. Probably less overshoot, but no way to tell. It could be 2015 or later until a real bottom is put in on this curve.

*NOTE: these are simply curve fits of the last to cycles. Nothing says this cycle won't take on unique attributes due to its immense scale. In fact, I think government intervention will be extreme in this cycle, one way or another, and it will serve to distort the recovery. It could make it slower or faster, depending.

Personally, we plan to start looking for desperation sales in 2009, assuming steady jobs. By 2010 we'll probably buy something, but again, only if prices are coming down fast. We're also continuously looking for foreclosures and shorts.

[randolfe]

Interestingly, I started looking back over my blog articles from 2006 on real estate. It is very funny to read some of the comments from people arguing with those of us who thought there was a bubble.

There was one guy on the Shiller graphs who argued all of his analysis was meaningless because Shiller's data series starts in 1890. No one could disavow him of his ignorance. I finally had to close the comments because he just kept spamming with the same inane argument.

[Brand]

The expected bounce this morning. What are the odds that yesterday's plunge was some kind of electronic event triggered by covering leveraged long positions?

[randolfe]

I've been curious about that too. I'm not a market technician by any measure, but the imbalances at close yesterday were unprecedented. Something happened in the last few minutes of the market. Electronic event or perhaps just one of the leading hedge funds making a massive movement, which would then be followed by hundreds of smaller funds which mirror the big guys as read by their models.

[Brand]

Things got to 10.6 pretty fast, with some whipsaws. Then there were two huge spikes and troughs below 10.6 yesterday afternoon, both significantly after the bill was defeated. In fact, the Dow carved off another 150-200 points in the last five minutes of trading.

Today, we're back around 10.5-10.6, and if you look at the graphs, it's almost continuous from the initial fall level reached right after the bill was tossed. I'm not a market technician either, but I'm an engineer, and that just looks way too artificial, especially if it happened on no new information.

[randolfe]

There is so much "artificial" going on right now I suspect finding genuine, free market pricing is the exception. For example, all this chatter about changing the accounting rules to allow banks to value assets differently.

Two things about that:

1. Japan tried that. Didn't work out so well for them. Are we seriously going to step in every single footprint left from their lost decade? Really? Keiretsu and all?

2. There *is* a market for those assets. The banks just don't like that market. I know it's a crappy market. I know it's a reflective market (ie, the more bad assets they dispose of, the worse it prices their remaining garbage). But tough. That's the market. That's the way a market works. That's one of the many risks associated with a market. Tough sheisse. If the market is telling you ten cents on the dollar, then it's worth ten cents on the dollar regardless of whether you hold it for 30 more years or for 30 more seconds.

There is absolutely no difference between banks with crappy debts they want magical accounting to value at some fictional face value for their balance sheets and homeowners with bubble-priced houses they want to forever assume are equal or greater value than those Tulip Market prices.

[JimSulli]

Many analogies come to mind to describe this. Ripping off a bandaid in order to minimize time of pain, but to get it over with? That describes it for me.

But the best is right infront of us. It's called a "bail out", which essentially does what it says. Bail is set at $700bn, but it only buys us a small amount of freedom until we get the final verdict...Guilty. Guilty of false riches, and not enough capital to support it. Let's leave the $700bn as unprinted paper (save a few trees), and consider this as part of time served...and for goodness sake, rip off the bandaid.

Maybe the rant doesn't make sense in writing, but it sure makes sense in my head...scary huh?

[astrid]

What do you think of the bailout plan floated by the French and the plan just executed by the Icelandic government? I think some sort of government cash injection is inevitable. It's a good opportunity for some updated regulation for the fiscal WMD industry...though knowing the clowns/appeasers in power, they'll f___ it up somehow.

[randolfe]

I think the French plan is a disaster ... from an American (read Anglo-Western economy) perspective. For the French, it's probably fine. Though I don't think their plan is any more certain than ours. They don't seem to know if they even have a plan or not at the moment. They're also burdened with the added complications caused by EU fiscal wrangling and unified monetary policy.

I don't know anything about Iceland's plan. Iceland is in the same boat as New Zealand, South Africa, Australia, and Canada, in that order of peril -- they will/are taking the brunt of the carry-trade unwinding. Iceland really has a problem in that their interest rate lever is very ineffective, and they are rate takers from the US & Japan. That makes fiscal injections risky because they could end up simply printing money and throwing it away on foreign capital flows if currency rates move against them. I feel for these countries because they are the ones which have no choice in helping the US to carry our ZIRP policy.

[JimSulli]

Randy, did you read Dave Ramsey's Common Sense Fix proposal?

Here's the link:

http://a1611.g.akamai.net/f/1611/26335/9h/dramsey.download.akamai.com/23572/dr/media/pdf/the_common_sense_fix.pdf

[randolfe]

I disagree with most of his proposal.

1. I don't want the government making rules about compensation limits, benefits limits or other incentive packages. A simpler solution is to enact uniform minimum shareholder rights laws. The shareholders are the sole stakeholder of interest when it comes to these issues.

2. Suspension of mark-to-market is a terrible idea, no matter how limited to this or that asset class. As it stands now, the entity is forced to mark when 2% of the asset in question becomes impaired. So saying that mark-to-market forces an "artificial" pricing is nonsense. No, it forces a market pricing. It's just that no one likes the market.

To go further on this point, the notion that one can simply hold to maturity the asset, and therefore it is worth more falls apart on these assets because they are so heavily levered and they are currently impaired. In other words, the market is valuing the deleveraged intrinsic value of these assets, with a more rational risk assessment. I know that is a hard pill to swallow, but that's the way leverage works. How many times have we argued with real estate "professionals" who used to wax poetic about the "magic of leverage" as if it only works one direction.

No, mark-to-market is essential and serves as intended.

3. While I'm obviously in favor of permanently eliminating the capital gains tax (I'm in favor of eliminating all non-consumption/value taxes except property taxes), it is not feasible so it's a waste of time to propose it. Realpolitik will not allow that to happen, especially during a period where fairness itself is at the root of voter psychology.

[JimSulli]

I agree with your assessment of the "Golden Parachutes". Your simpler solution..."A simpler solution is to enact uniform minimum shareholder rights laws. The shareholders are the sole stakeholder of interest when it comes to these issues."...make a lot more sense. But how can it be governed, and what stop gap measures would you set in place for such laws?

I understand what you are saying with the "mark to market", however, it IS the subprime that is most clogging the flow of capital, is it not? A 2 year suspension on mark to market accounting rules, on a short leash with regulation MAY have some value. (Not a guarantee, just a thought)

This is where I disagreed with him. Getting rid of capital gains does not necessarily "flood the investors". I think that may be hopeful thinking.

[randolfe]

The problem is that, intentionally keeping non performing assets on the balance sheets of banks at artificially overstate prices is **exactly** what Japan did. We know how that plays out. It sounds good to say it's a "stop gap" or "temporary" measure. But that is bull. It becomes an escalating cycle of commitment. Once you start it, the costs to dispose/write-down those assets later becomes higher and higher, and so the political viability of doing so becomes less and less.

Eventually it breaks and everyone is hurt much worse.

See: Japan's Lost Decade.

[JimSulli]

Ah the Slippery Slope theory.