A Question For Secretary Geithner

Yesterday on MEET THE PRESS, Secretary Geithner was asked about securitization. In fact, the moderator David Gregory asked Secretary Geithner the same question about securitization twice. Neither time did Secretary Geithner answer his question about securitization. Why? I can not believe that Timothy Geithner does not know what securitization means, after all he was the head of the New York Federal Reserve Bank before coming to the Treasury Department. So, what is going on here?

Just for review, securitization is the bundling of home mortgages, car loans or even credit card receivables, and then made into debt instruments known as bonds. These bonds differ from corporate or municipal bonds that pay interest every six months and their principal at maturity. Mortgage bonds pay interest periodically and return principal periodically as mortgages are paid down and paid off.

It was the triple-A ratings on many of these structured asset bonds that lead to the bond market meltdown for these bonds, and these same bonds have been known in the press and TV as toxic bonds or toxic assets. Unfortunately for every one the rating went on before the quality went in. Many of these bonds that were made up of sub prime mortgages had no business receiving a triple-A rating.

To compound the mistake, insurance companies, like AIG, issued insurance policies, called credit default swaps, to protect bondholders against default of the triple-A rated bonds, made up of the sub prime mortgages and other loans that were bundled (securitization). A bit of irony is that the same investment bankers that did the underwriting of the sub prime mortgages, and shopped the credit rating agencies for the triple-A rating, were the same people to be paid off when AIG received the government bailout to make good on the credit default swap contracts that they so greedily underwrote.

That is why some people are upset that the companies that received full payment from AIG on those credit default swap contracts that AIG sold, were none other than the same investment banks that were receiving government bailouts too. Yes, Head I win, tails you lose!

Securitization is a financial tool. Used properly, correctly and with meaningful credit ratings that are not shopped by the underwriters, securitization can be a very useful financial tool in growing our economy. The fact that Secretary Geithner did not answer David Gregory’s question is puzzling nevertheless. Perhaps, Secretary Geithner knew if he answered the question about securitization that the next question to follow would not be so tame.

Stay tuned.

Saturday is For Art

The art show is now at the end of the month. It was a lot of fun and I sold one painting.

Securitization Did Not Fail

This morning my brother sent me the Op-Ed piece from the New York Times by Paul Krugman titled THE MARKET MYSTIQUE. I read the piece and I disagree with his conclusion. I do not know if I am allowed to disagree with an economist that won the Nobel Prize in Economics; however, since I do not know how to contact the Nobel Foundation for permission, I will proceed with my post anyway.

Professor Krugman makes the statement that “securitization failed.” Securitization did not fail. What failed was the credit ratings agencies. Remove the responsibility of rating the structured debt obligations from the private sector and put it will the Federal Government and that would go a long way to give the securitization of mortgages, car loans, etc. the kind of independent bond ratings that would make the process of securitization work. Securitization failed because the underwriters were able to shop the credit rating agencies for ratings.

In previous postings, I described in detail how the credit rating agencies permitted the bubble to grow and grow. In previous postings, I described in detail how the triple-A rated collaterized mortgage obligations found a market throughout the world. The gate keepers to this whole process of securitization were the credit rating agencies, but the men running the three largest credit rating agencies caved to the pressure from the investment bankers and instructed their people to pass out the triple-A credit rating like candy on Halloween. The CRAs were only looking out for their bottom line and felt no responsibility to the investors that used their credit ratings for guidance.

The mathematical models that were available to the credit rating agencies were not used. That does not mean that securitization failed, what failed was the Federal Government’s responsibility to give oversight to the Federally regulated credit rating agencies. Ask Senator Chuck Schumer about what hand he played in weakening their responsibilities to the investment community. That information was printed in the Sunday New York Times on December 14, 2008, yet not a word of that article was picked up and discussed on any of the news shows that week. Why?

Securitization did not fail. What failed was a financial system that regarded investors as fish to be shot in a barrel. Securitization is a financial tool, used properly it can be an important part of the of the capital markets.

Stay tuned.

How I Feel About It

Today Secretary Geithner goes before the House Committee on Financial Services to talk about the new regulations that the Federal Government will want to bring to the financial markets. In the little reading that I have done on this subject, I have yet to see any mention of the reforms that are planned for the Credit Rating Agencies (CRAs). There is talk about hedge funds and credit default swaps, but not a word about these agencies that place a credit rating on the bonds that credit default swaps are created to insure. To insure against those very bonds failing is the purpose of a credit default swap.

In that my blog, if I am lucky, is read by a dozen people a day, I still feel that I should try and bring some light to the subject of credit ratings. The whole purpose for structured debt is to expand credit for our economy. These instruments exist because of the demand for credit, and because on the other side of the transaction there are investors looking for a place to put their money to work. Pension funds, endowments, foundations and mutual funds are the buyers of structured debt obligations. And, these institutions use the credit rating system as a guide to determine the mix of risk they wish to put in their fixed income, also known as their bond portfolio. Without confidence in the credit rating system, credit ratings such as a triple-A rating is meaningless. If the highest rating, the AAA rating, is meaningless, what does that say about the ratings below AAA?

Whatever regulation the Congress decides on, I sincerely hope that they fund the new regulations with the necessary people and tools to do the job right. But, who is going to watch that Congress does not sell us out again? To me a good statement of Congress’ sincerity would be to hang a few past members on the steps of the Capitol. Those that worked to destroy the regulatory framework that protected us all for the many years since the Great Depression need to be punished. Let that serve as a warning to all members of Congress that those that sell out the American people for a few pieces of silver will pay a price. That is how I feel about it.

Stay tuned.

Down That Rabbit Hole

Perhaps this is as good of time as any to take a few steps back from the economic scene in the United States and take a look at what we have. Did you watch the President's press conference last night?

First, it is quite evident to me that we have a President that has a highly developed brain. This is a real plus as the job he found waiting for him when he entered The White House was already complicated by the fact that our domestic economy was in the toilet. But, as we all know, the economy is more precisely the political-economy and that means that simple economic problems can not be taken care of by simple economic policy adjustments. Washington, D.C. is our own rabbit hole where things that appear to us outside the Beltway have a way of appearing to those inside the Beltway inverted. Remember the inverted relationship that bond prices have to bond yields? Remember, as price goes up yields come down, and as prices of bonds come down their yield goes up. Well, there are other inverted relationships that I have observed over many years. Some are quite funny, like the more a tie costs the stronger the food magnet in the tie. Cheap ties never attract any food, only an expensive tie will find food the very first time you wear it. Doing the right thing for the majority of the American people is another of those inverse relationships. If you help your constituents when they are down, will they remember you when times are good? Some people remember those that helped them when they needed help and some do not.

It appears that new regulations for the banking and securities industry are on the way. It will be interesting to see what we wind up with. When you make your living shooting fish in a barrel, the idea that you would be made to actually learn how to fish is a pretty frightening prospect. No more financial muggings? Well, I am waiting to see what they will unveil. My pet project, the credit rating agencies, CRAs, is what I am most interested in seeing what they do. Will they eliminate the conflict of interest between the CRAs and the underwriting bankers? Unless they solve this problem, I do not see how bond credit ratings for structured debt financing will have the confidence of the investing community around the world.

I enjoy watching this President work. It is refreshing to see someone who has the capacity to do the job right. His job is not an easy one as he is working against the rabbit hole and the people that live down that rabbit hole. But, if enough of us outside the Beltway support his efforts on our behalf, I think he can make our economy better and prepare the way for our country to lead in the 21st century.

Stay tuned.

Let The Games Begin

The Government’s plan to auction off the so called toxic assets needs to be given a chance. To have the banks sit with mortgage-backed bonds in their portfolios and wait for them to work their way out of the system will take years and will delay the economic recovery.

The sad truth is that we, our country, needs some of these players that helped to get us in this financial mess in the first place. While analogies are never quite perfect, this is like needing the bomb maker to now take apart the bomb.

Portfolio managers and traders that maintain a position using their own capital, their company’s capital or a combination of the two, put their abilities on the line each second of the day that the markets are open for trading. That is why they are paid the big bucks. Trading investment securities is nothing more than a high stakes poker game.

Getting these mortgage-backed bonds to start trading again will be no easy trick. However, if I was Paul Krugman or anyone else with little actual experience as a bond trader in New York or any other large capital market, I would keep quiet on this point. You do not know what is possible when it comes to bond traders and the bond market. Having been involved at one time, and knowing the kind of people that take those jobs, I would not bet against them.

Nothing is perfect when it comes to working the country out of a mess that our Congress had a hand in creating. Let us not worry about who is going to make money. Let us keep our eyes and our minds on our own resources and continue to manage them as best we can. If the toxic asset program is successful, it will be good for the nation as a whole. Yes, some people will make money, but no one takes risk without the possibility of making money. That is just how markets work. Stepping on the gas pedal may in itself be fun, but unless the car moves forward as a result of pushing on the pedal, the novelty would quickly wear off.

I think that there is a good chance this toxic asset program that the Treasury has put forth has a good chance for success. The alternative to it is to do nothing and that would certainly cost us another ten years or more of no growth in our economy. The risk is worth the rewards. Let the games begin.

Stay tuned.

My Idea For Today

Everyone has their opinion about the Stimulus Plan, and I am no exception. Here is a simple idea that will put more money into the hands of hard working people and families.

As you may or may not know, people that own a home and have equity in their home can get a Home Equity Loan from a bank. Home Equity Loans permit homeowners to borrow money, but more importantly, they permit homeowners to deduct their interest expense on the Home Equity Loan from their taxes. Just as mortgage interest is tax deductible, so too is the interest on a Home Equity Loan.

People that have Home Equity Loans do not have to carry a balance on their credit cards and pay a higher interest rate that is also not deductible from their Federal Income Tax. My proposal would be to permit the interest rate expense on credit cards to be deductible the same way that the interest rate charges on a mortgage or Home Equity Loan are deductible for homeowners.

There must be millions of people, young and old, that rent and do not have this option because they do not own property on which to get a Home Equity Loan. But, by giving anyone and everyone that pays interest on a credit card balance the opportunity to deduct their interest expense on their Federal Income Tax filing, would put money back in the hands of people that are almost certainly struggling to keep their heads above water. I have no exact number as to how much money this would put back in the hands of working families, but I would be willing to bet that conservatively speaking, it could amount to several billion dollars.

I think this would level the tax playing field a bit. As so many people are losing their homes and even more are on the edge of losing their homes, giving people the opportunity to deduct their interest expense on all their credit cards at the end of the year could amount to a big enough number that would certainly permit more money to get back in the hands of people and families that need it.

That is my idea for today. Simple. To the point. I think this idea is a good idea and would make for a better Stimulus Plan. What do you think?

Stay tuned.