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Obama's E Team

Posted Tuesday, November 25, 2008 - 4:53am

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It was a day of circling the economic wagons as, hot on the heels of Sunday's Citigroup rescue, President Bush announced unprecedented close cooperation with President-elect Barack Obama's transition team, and Obama unveiled a powerhouse economic team, bolstering Treasury pick Timothy F. Geithner with former Treasury Secretary Larry Summers. Obama's intent was to assure "Americans and foreign investors that he was seeking to fill any leadership vacuum" during the financial crisis, the New York Times reports. As Obama pledged a long-term economic stimulus package that includes "creating 2.5 million jobs, and spending on roads, bridges, schools and clean-energy programs," in the words of the Wall Street Journal, the Treasury Department and Federal Reserve are readying a major new consumer-loan program—pulling as much as $100 billion from the sanctioned $700 billion Troubled Asset Relief Program—that would establish a government bank to finance hundreds of billions of dollars in car loans, business leases, and student debt. With Main Street banks still unwilling to part with their cash despite the huge government bailout, Treasury Secretary Hank Paulson "is trying to find other ways to jump-start the market for lending," writes the WSJ.

The combined political action of the previous two days gave investors the jolt they'd been craving. The Dow Jones industrial average gained 397 points, or 4.9 percent, and ended the trading day having posted its biggest two-session percentage gain in 21 years, CNN Money reports. The rally continued overnight in Asia with investors sending the Nikkei soaring 5.2 percent and Hong Kong's Hang Seng up 4.3 percent on news of the U.S. government's bailout of Citigroup. The back-from-the-brink bank was a big winner yesterday: its stock price jumped 58 percent and the cost of insuring its debt fell by 50 percent, the Guardian reports. But haven't we experienced this relief before only to be smacked in the face by a new calamity? Over the longer term, "the new bailout could haunt regulators and taxpayers," writes the NYT, because it "may encourage banks to take more risks in the belief that the government will step in if they run into trouble." Already the very fact "that Citi needed a new lifebuoy from the government less than a month after getting an infusion via the TARP capital purchase program shows how the entire financial system is laboring under an unmanageable debt load," writes Fortune.

If Wall Street was happy to see Citi saved, Detroit must have been livid. The Big Three's perceived injustice in being "told to go home and write up a viable business plan" while Citi got a quick $20 billion in spending money Sunday night has everything to do the fragility of the global financial system. Simply put, "Saving a bank like Citigroup has to take precedence over the auto industry," an analyst tells CNN. And so it's a cruel irony that while GM may be on the brink of collapse, its vast pension fund is doing quite well—so well that it hasn't needed to tap the government for help. "G.M. appears to have enough money in the pension fund to pay its more than 400,000 retirees their benefits for many years—even with the markets swooning around it," writes the NYT.

Big news from Down Under this morning. Mining giant BHP Biliton has abandoned its $62 billion takeover bid for rival Rio Tinto, citing the "continued deterioration of near-term global economic conditions.” When the Aussie company launched its assault one year ago, the merger was valued at $140 billion, the Financial Times reports. One factor was the amount of debt BHP would have to assume. "Rio has $42 billion of debt as a result of its acquisition of Alcan last year, while BHP had only $US6.3 billion of debt," the Sydney Morning Herald reports. Shares in BHP jumped 12.1 percent on the news.

Finally, if you think banks not willing to lend makes for bad business, how about book publishers not willing to acquire new books? The WSJ reports that the venerable Houghton Mifflin Harcourt has put a "freeze" on new books in an "unusual move that shows how the slowdown in book sales is hurting publishing." The publisher will focus on existing inventory, though "if the next 'War and Peace' appears at Houghton's doorstep, editors may persuade their superiors to buy it," the WSJ wryly notes.

Matthew Yeomans runs Custom Communication

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Submitted by run75441 on Tue, 11/25/2008 - 11:08am.

Geithner, The Right Choice???

I had my doubts about Timothy Geithner from the initial announcement and here is why I do. Geithner is a protégé of Lawrence Summers and has worked for him at the Treasury under Clinton. If you have forgotten, Summers played a role in preventing the regulation of the Derivative Market. Expressing concerns about Brooksley Born's http://fray.slate.com/discuss/forums/thread/2011602.aspx attempts to regulate the Derivatives Market, Summers testified before Congress claiming Born's efforts to regulate the derivative market were "casting a shadow of regulatory uncertainty over an otherwise thriving market." Time and greed has proven her efforts to be on the mark and Summers testimony and beliefs to be in error billions of dollars later.

Where Daniel Gross in his column has pointed out that Geithner has many similarities to Obama in age and past actions, he fails to take up those very same similarities he has with Hank Paulson and Paul Bernanke. Geithner does have ample amounts of economic experience with Asia, Russia, and China; but, his experience is not what concerns me. Regardless of where he gets his charts, I would not call Geithner the un-Summers as he has the same relationships with the "status quo" as Summers has today and enjoyed in the past. A wolf in sheep's clothing.

On Friday of last week, the FDIC closed and sold two California banks (Downey Savings and Loan & PFF Bank and Trust) with the assets being passed to US Banks. This is good news for the depositors and bad news for investors and creditors who are wiped out. "Reasonable people can argue whether this is the right call. But when we see the equity and debt holders of DSL, Washington Mutual or Lehman Brothers taking a total loss, we have to ask a basic question: "why is it that the debt holders of Bear Stearns and AIG (NYSE:AIG) are granted salvation by the Federal Reserve Board and the US Treasury, but other investors are not?"

If the rule is to drive weak banks to stronger banks, then one has to wonder why the rule is not applied 100% of the time or with Bear Stearns and AIG. "If you look at how the Fed and Treasury have handled the bailouts of Bear Stearns and AIG, a reasonable conclusion might be that the Paulson/Geithner model of political economy is rule by plutocrat." In effect, the Treasury is bailing out the speculative parts of the larger dealers and leaving the WaMu, Downeys, PFFs, and Lehmans to bankruptcy in the real world. The shareholders and creditors of the later are wiped out while AIG and Bear Stearns are saved. There are ties between Hank Paulson, Goldman Sachs, and AIG.

Hundreds of billions of dollars have been pumped into AIG by the NY Fed and the Treasury in an attempt to deal with a potential default with creditors. The effort is an attempt to 100% fund the CDS portion with hope that all will work out well in the end and greater liquidity of the market. The Paulson and Geithner model in attempting to fully fund the CDS portion of AIG, etc. provide liquidity may not be reasonable or even doable after considering the numbers/dollars of CDS outstanding.

If there are $50 trillion of CDS in existence and 40% go into default that leaves $20 trillion to be reconciled. Assuming a 25% recovery, $15 trillion will have to be paid out by the Fed and the Treasury if 100% funded. In comparison the $15 trillion represents one year of the economy if we were able to pledge such an amount of money toward liquidity and bailout. The position of a 100% has been taken by Paulson and implemented by Geithner and Bernanke with out regard for what CDS positions are speculative and which ones are really hedging to exposure.

Perhaps AIG should go into bankruptcy, the insurance go into receivership with the states, and the CDS portfolio into bankruptcy court with the likelihood of the speculators receiving pennies on the dollar. The valuable insurance segments can be sold off to other companies and the CDS crisis deflated. Alternately, we could continue onward with the Paulson/Geithner methodology for years without seeing an end of the CDS crisis and let the burden of such a commitment slow the economic growth or we can bring this to an end and set aside the speculative part of the Derivatives market. In a similar fashion, Lehman Bros has petitioned the court to set aside the CDS and speculative parts of the Derivatives which will leave the CDS portion of the portfolio facing bankruptcy.

That Geithner embraces Paulson’s position can be a serious future impediment to what Obama hopes to accomplish with the economy and his economic programs. The stance taken by Paulson and implemented by Geithner is a bailout of the more speculative CDS which represent a “ponzi” scheme in that their payout is 10, 20 and 30 times of the basis. In the end the Paulson/Geithner plan has a greater chance of failure due to the size of the CDS market, it could drag out for years and slow the economy down similar to what was experienced in Japan, or it may not even solve the issue of the CDS as the plan is not fixing the problem (see my link above to Born and Gramm). I had hoped Obama would have sent Summers out to golf and would chose a fresh and unencumbered candidate, without ties to Wall Street or its ideology, for the Treasury and also Economic Councils as both Summers and Geithner (I believe) present dilemmas/issues for Obama in the future. Hey, the CDS dealers are happy with today's arrangement. When and if all of this crashes, Obama will take the blame for Geithners and Paulson's actions.

As an addition view of how deep the rabbit hole is with CDS? Most of the bonds written for the big three were not prime over the last 4 years which puts them in the same position as those CDO that are tranched and insured by CDS in order to sell them on the market as being safe. Just letting GM go bankrupt would entail the gov to pickup ~$1.2 trillion in debt as insured by CDS. More:

"And many of these CDS contracts were written two, three and four years ago, at annual spreads and upfront fees far smaller than the 90 plus percent payouts that will likely be required upon a GM default. That’s the dirty little secret we peripherally discussed in our interview last week with Bill Janeway, namely that most of these CDS contracts were never priced correctly to reflect the true probability of default. In a true insurance market with capital and reserve requirements, the spreads on CDS would be multiples of those demanded today for such highly correlated risks. Or to put it in fair value accounting terms, pricing CDS vs. the current yield on the underlying basis is a fool’s game. Truth is not beauty, price is not value.

If you assume a recovery value of say 20% against all of the CDS tied to the auto industry, directly and indirectly, that is a really big number. The spreads on GM today suggest recovery rates in single digits, making the potential cash payout on the CDS even larger.
As Bloomberg News reported in August: 'A default by one of the automakers would trigger write downs and losses in the $1.2 trillion market for collateralized debt obligations that pool derivatives linked to corporate debt… Credit-default swaps on GM and Ford were included in more than 80 percent of CDOs created before they lost their investment-grade debt rankings in 2005, according to data compiled by Standard & Poor’s.'”

Still want to throw GM/Ford/Chrsyler to the wolves?

As taken from: http://www.ritholtz.com/blog/2008/11/what-obama-geithner-aig-fiasco/ "What Barack Obama Needs to Know About Tim Geithner, the AIG Fiasco, and Citigroup”