Alright, I promise some really special and original pie recipes for everyone who's had to put up with this. Heck, I think I have few enough readers I can send you all baked goods if you ask (radio stations bribe their audience, why can't I?).
So, in narrative form, how the banking crisis happened, and how the MOAB just might fix it:
Step 1)
Anytown USA, late 2006:
Bob and Sally move into Anytown USA and buy a house in a new subdivision on 10th Street. Everyone is happy, because they used their $70k combined income at Pie Widget Maker to get a mortgage for $250k on a house that the previous owner bought 5yrs ago for $200k. Anytown Bank, which originated their loan, also issued a couple dozen other loans, effectively depleting the $10m it was allowed to make based on its $1m in deposits and capital. However, Anytown is growing like a weed, and needs someone to offer more loans so that people can buy the new houses being built on 11th Street. So Anytown Bank (AB) offers Wall Street Bank (WSB) the income from $500k these loans if WSB will just give AB the cash value of the loans plus a small fee, with a promise that AB will make WSB whole if the mortgages foreclose and the value of the homes goes down. AB can't find well qualified buyers for the houses on 11th street, but decides to offer "sub-prime" mortgages, fully expecting them to refinance into standard mortgages or sell before anything goes wrong.
Step 2)
Anytown USA, late 2007/early 2008:
Something went wrong. The people who bought up the properties on 11th street were not able to turn their widget-sales jobs into something that would justify owning $250k homes. Also, the market was finally saturated, and no one wanted to move to 11th ST because housing and gasoline had become too expensive to justify the long commute to Main Street. In the meantime, Pie Widget Maker, a small company on Main Street that employs Bob and Sally, begins developing the SuperCrust Widget.
Step 3)
Anytown USA, Sept/Oct 2008:
The subprime security issued by AB and held by WSB blew up in both of their faces. WSB had taken it and sold shares in that income to many customers, along with insurance policies in case the subprime holders or AB defaulted, only to discover that the insurance company didn't have enough assets (this is what brought down Fannie/Freddie and AIG). AB was forced to bring all of it's mortgage backed securities "on balance sheet", meaning that instead of having a fresh $10m to loan, it has to hope that the securities it issued haven't lost more than $1m, or the bank becomes insolvent (kickin' it WaMu-style, in other words). The SuperCrust Widget, incidentally, was a big hit at the Pie Convention, and Main Street's biggest employer needs $300k for the machine and materials to make enough to satisfy its customers. Sadly, AB can't issue any loans because its capital, which should have been freed up by securitization, is instead being held hostage by the threat of defaulting on its obligations.
So, what are the subprime houses on 11th St worth? How about the houses on 10th St, where Sally and Bob are working hard to pay their mortgage? Because of new accounting rules, AB is required to "mark to market", express how much capital is has relative to obligations, which means AB's accountants need to pick a number. If they pick one that's too high, they will be accused of fraud. To low, and the bank goes WaMu.
Everyone knows that the $250k houses on 10th St are beyond the means of all but the president of Pie Widget Maker, who sensibly lives on 1st St in a small house. If AB was able to sell half of the foreclosed homes for $100k, does that mean all of its securities are worth 40% of their original value? If the median income of Widget Stampers is $35k, then a pair of them ought to be able to afford $210K, implying that the homes are worth 84%.
The answer to that question, then, really lies with Pie Widget Maker. If they can get their new machine up and going, they can hire, say, six more Widget Stampers. If they can't get the loan for the new machine, then they will only be able to pay their existing Widget Stampers like Bob and Sally for as long as the current product lines and production facilities last, in which case any property in Anytown is basically worthless in the long run.
So, if the Treasury Department steps in and buys up the securities issued by AB at a price that leaves them alive and able to lend a little, this story has a happy ending. The new Widget Stampers move into homes on 11th ST, and in turn justify opening a 24hr Pie House there, which employs a couple more people, and so on. Housing prices stabilize after falling a bit more, and the Treasury Dept. can sell the securities on once someone is willing pay a good price for them. By taking an equity stake in AB, they heartily discourage risk, and make sure the next shareholder's meeting includes plans to avoid exposing the bank to that kind of risk again. In the end, the equity (stock) in AB and mortgage-backed securities will be sold by the Treasury, in this case at a tidy little profit.
Conclusion:
We will not avoid a couple years of hard times. No matter what, some businesses and banks will fail. My favorite thing about the Paulson plan is that its relatively small magnitude will most heavily favor smaller banks with fewer shareholders (and thus less resistance to dilution of shares) that can turn around and make small business loans. We need this to happen, and we need to do things to encourage production rather than consumption. Markets, like people, can be irrational, and the most rational thing to do now is help everyone settle down. Pain will come, but it need not be a collapse.
Saturday, September 27, 2008
Friday, September 26, 2008
My flip-flop: Go Hank Go!
As mentioned below, I think that it's important to be willing to change one's mind as evidence emerges about what shapes one's opinions. In my case, I can now offer tentative support to the Bernanke/Paulson plan. A few key points:
(1) Mortgages have had the implicit backing of the government since the 1930's. Specifically, the mortgage-interest tax credit substantially reduced the cost of borrowing, and so there was huge incentive in the tax code to move unsecured debt into the mortgage market. Thus, the US voters helped caused the problem, and profited via much the same mechanism of leverage as the Wall Street banks.
(2) The $700billion will not all be spent at once, and as long as the Treasury takes an equity stake, it will not cost $700billion in the long term. The equity stake rule will keep some banks away, but after WaMu's failure, shareholders faced with insolvency or dilution will probably choose dilution. For banks that don't, the vulture capital is more likely to clean up the mess if they know other members of the sector are stable.
(3) The Great Depression did not turn around until the gov't bought bad loans from banks and helped convince people to start investing in small endeavors again (this is very pro-pie).
(4) This effort will not be able to restore 2005, and as long as the money is doled out slowly shouldn't have too much effect on inflation. Especially since there will be a general recession over the next year or so as our credit-fueled retail economy winds down and housing returns to price levels that the median wage earner can afford.
The Republican Caucus should be allocated enough money to build themselves a woodshed to take each other out behind. Their "insurance plan" basically tries to get the US governement involved in the industry that brought down AIG and which Berkshire Hathaway won't touch. If we knew what these were worth, then maybe, but the problem is that we don't. The "insurance plan" is exactly the transfer of wealth from taxpayers to Wall Street that the Hank Plan looked like at first.
Incidentally, the Democrats should use the woodshed until they learn not to pass their highly inflationary "stimulus" legislation. We need public works in this country, not an unemployment dole.
(1) Mortgages have had the implicit backing of the government since the 1930's. Specifically, the mortgage-interest tax credit substantially reduced the cost of borrowing, and so there was huge incentive in the tax code to move unsecured debt into the mortgage market. Thus, the US voters helped caused the problem, and profited via much the same mechanism of leverage as the Wall Street banks.
(2) The $700billion will not all be spent at once, and as long as the Treasury takes an equity stake, it will not cost $700billion in the long term. The equity stake rule will keep some banks away, but after WaMu's failure, shareholders faced with insolvency or dilution will probably choose dilution. For banks that don't, the vulture capital is more likely to clean up the mess if they know other members of the sector are stable.
(3) The Great Depression did not turn around until the gov't bought bad loans from banks and helped convince people to start investing in small endeavors again (this is very pro-pie).
(4) This effort will not be able to restore 2005, and as long as the money is doled out slowly shouldn't have too much effect on inflation. Especially since there will be a general recession over the next year or so as our credit-fueled retail economy winds down and housing returns to price levels that the median wage earner can afford.
The Republican Caucus should be allocated enough money to build themselves a woodshed to take each other out behind. Their "insurance plan" basically tries to get the US governement involved in the industry that brought down AIG and which Berkshire Hathaway won't touch. If we knew what these were worth, then maybe, but the problem is that we don't. The "insurance plan" is exactly the transfer of wealth from taxpayers to Wall Street that the Hank Plan looked like at first.
Incidentally, the Democrats should use the woodshed until they learn not to pass their highly inflationary "stimulus" legislation. We need public works in this country, not an unemployment dole.
Thursday, September 25, 2008
MOAB Haiku
The Mother Of All Bailouts (MOAB, an acronym more commonly used for large fuel-air bombs) inspires me to write poetry:
Please take equity
if toxic paper you buy
forget exec pay
Please take equity
if toxic paper you buy
forget exec pay
Wednesday, September 24, 2008
Calculating PMCIN
While Pie Making Capacity In Nation (PMCIN) is an interesting idea, it's still half-baked. Statistics can tell you anything if you torture them enough, and we could easily manipulate this measure to be essentially another version of gross domestic product (GDP) or to promote outright communism.
The key is the assumptions about what constitutes pie making capacity. Here, I will assume the maximum personal input estimate (PIE) is 1 per adult per week. Thus, the maximum PMCIN/wk, the default estimate, will be the population of the country.
The following is intended to be the minimum requirements for good pies. I know there's a technically savvy reader who's just itching to write scripts to grab these numbers and compute PMCIN on a daily basis.
Inedible contributions:
An oven and a counter top
Price: Average rent / 2 (assume 2 adults per household)
There's many sources for this, I'd like to average the first page of Craig's List "appartments/homes for rent" since that is the most open and accurate measurement tool.
(although gov't cost of living data is acceptable. Given that rent reflects actual cost of housing and mortgages are a mess, we'll only use rental prices for this statistic.)
Cooking implements:
Price: determined from an average of the 10 highest product rating results on Google Shopping, divided by 52, implying annual replacement
9" glass pie pan, 9 1/2" pie pan, 18" rolling pin, 1 set glass mixing bowls, 1 set measuring cups, 1 2cup glass measuring cup, 1 large cookie sheet, 1 set measuring spoons, pie bird,
Consumables:
Pie and Policy believes in seasonally appropriate cooking, and so will use a "basket" of three pies to determine the cost of a pie with seasonally appropriate filling. This also allows us to use in-season farmer's market costs, thus increasing PMCIN.
However, I will only use a basic crust, since the ingredients reflect the costs of making other types of crusts, and these don't tend to change with seasons. I'll also assume a double crust.
3 cups flour (.3lb, so 1/15th of a five lb bag)
1/2 cup unsalted butter (1 stick, divide package cost by 4)
1t salt (call it 1/60th of a 26oz package)
1T sugar (call it 1/100th of a 5lb package)
The rest, as I said, depends on the season and the farmer's market. I will start keeping a record of the cost of my fillings, and then annualize them. A good starting assumption, though, is roughly $6.oo/pie. That's at the high end, and I'll give more accurate numbers with future recipes.
The key is the assumptions about what constitutes pie making capacity. Here, I will assume the maximum personal input estimate (PIE) is 1 per adult per week. Thus, the maximum PMCIN/wk, the default estimate, will be the population of the country.
The following is intended to be the minimum requirements for good pies. I know there's a technically savvy reader who's just itching to write scripts to grab these numbers and compute PMCIN on a daily basis.
Inedible contributions:
An oven and a counter top
Price: Average rent / 2 (assume 2 adults per household)
There's many sources for this, I'd like to average the first page of Craig's List "appartments/homes for rent" since that is the most open and accurate measurement tool.
(although gov't cost of living data is acceptable. Given that rent reflects actual cost of housing and mortgages are a mess, we'll only use rental prices for this statistic.)
Cooking implements:
Price: determined from an average of the 10 highest product rating results on Google Shopping, divided by 52, implying annual replacement
9" glass pie pan, 9 1/2" pie pan, 18" rolling pin, 1 set glass mixing bowls, 1 set measuring cups, 1 2cup glass measuring cup, 1 large cookie sheet, 1 set measuring spoons, pie bird,
Consumables:
Pie and Policy believes in seasonally appropriate cooking, and so will use a "basket" of three pies to determine the cost of a pie with seasonally appropriate filling. This also allows us to use in-season farmer's market costs, thus increasing PMCIN.
However, I will only use a basic crust, since the ingredients reflect the costs of making other types of crusts, and these don't tend to change with seasons. I'll also assume a double crust.
3 cups flour (.3lb, so 1/15th of a five lb bag)
1/2 cup unsalted butter (1 stick, divide package cost by 4)
1t salt (call it 1/60th of a 26oz package)
1T sugar (call it 1/100th of a 5lb package)
The rest, as I said, depends on the season and the farmer's market. I will start keeping a record of the cost of my fillings, and then annualize them. A good starting assumption, though, is roughly $6.oo/pie. That's at the high end, and I'll give more accurate numbers with future recipes.
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