Tag Archives: bailouts

A Novel Criticism of “Mark-to-Market” Accounting Rules

One of the many ways hat Obama is artificially inflating the value of bank stocks is by allowing “mark to market” accounting rules.

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Bankers often complain about mark-to-market accounting rules these days. To see what they wish for, and how they would have to value their assets in order to operate like other actors in the global marketplace, consider the following thought-experiment.

Say you have $6. You spend $5 of that monie on a can of coca-cola, because you are foolish and easily tricked. You now want to go into the insurance business, but because this means that the quality of life of many people you do not even know would be in your hands, the government has regulations to make sure no fly-by-night insurance companies run by foolish and easily tricked CEO get off the ground.

“You can be in the insurance business,” the government official says, “as long as you prove to me you have at least $3. This way, we know you aren’t a complete fraud or loon.

“No problem!” you say. “I have $6! $1 in cash, and $5 worth of one can of coca-cola!”

At this point, the government regulator gets a headache from your attempt to make him as recklessly optimistic about pop can futures as you were, and points you to a sign. “Mark-to-market accounting rules only.” “I’m sorry,” says the regulator,” but unless you can prove that someone, somewhere, is selling the can of pop for $5, you can’t say it’s worth $5 to me. That means, you can’t go into the insurance business!”

This is what bankers are complaining about. Why aren’t the assets they bought for a price accounted for according to that price? Why can’t their wishes become your reality?

But, in this thought experiment, you go outside, and check all the stores, gas stations, and pop machines for their prices. Walmart is selling pop for a quarter. The machine at Target is going for 50 cents, and the machine at your kid’s school is at 60 cents. In the mall a can costs $1, and at the airport across town is a machine selling a can of coca-cola for $2.

Eureka! You found it! You can go into the insurance business! And if a plane crashes, a trail derails, or a comet strikes, you’re covered! You can just sell your cans of cola for $2!

Now for several years these are going well. Of course, you complain that the government is only allowing you to “mark-to-market.” Go to the movie theatre (it’s closer than the walmart, and you need them now!), buy a can that cost about 12 cents to distribute, and is for sell elsewhere for 50 cents, for $5 (as I said, your foolish and easily tricked). Account for it as $2 (because that’s what their charging for it at the airport), and sell insurance policies. You’ll need to borrow money for this, but you secrelt know (somehow) that the real value of the pop can is at least $5. For every $2 in policies you sell, you “cover” it with $2 worth of a pop can you paid $5 for, but expect to get rich from in the future! What a profit! life is good!

But then tragedy strikes. A plane crashes, a trail derails, and a comet strikes. Many houses burn down. People look to you for money. You don’t have it. Cash if fact, capital is theory, and you are sort of funds and way long on pop cans.

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So what do you do? Declare pop cans to be “toxic assets,” go on the Treasury Department, and demand a bail-out. Blame mark-to-market accounting while you’re at it, because the market price for pop cans (a measily $2, according to your accounting) is artifiicial low! You paid $5 for them!

Fortunately, in this thought experiment you have made the right friends, and your pals in the White House and Congress give you billions to cover the cost of insurance policies you sold, but could never cover in the first place. At first the government says you need to pay them back (the government takes preferred shares in exchange for the money), and then when you complain loudly enough, the government clarifies that you only will need to pay some fraction of the profit you make when pop cans magically cost more than $5 (by converting the preferred shares into common shares).

So what do you do? Go on CNBC, and complain about mark-to-market accounting rules! They are making you account for your wealth at only $2 a can, instead of $5, even when there are “no buyers.” (By this, you mean that only people nearly as optimistic and risk-taking as you will pay $2).

This is how mark-to-market accounting rules work. Mark to market accounting rules work as a bailout to banks, buy allowing them to list assets at prices too high to sustain regular market operations. The price of the marked-to-market assets only appears to be as high as it is because the banks aren’t selling the assets they do have. The price required to find many buyers is much lower than the price to find just a few buyers. In the same way, you can probably find someone willing to pay $2 for a can of coca-cola. If you want to sell a million cans, however, you’re looking at something closer to 50 cents.

Where Obama’s mortgage bailout will go

Instapundit links to this interesting article:

THE FORECLOSURE FIVE – New York Post
The beneficiaries of taxpayer charity will be highly concentrated in just five states – California, Nevada, Arizona, Florida and Michigan. That is not because the subsidized homeowners are poor Californians with $700,000 mortgages are not poor, but because they took on too much debt, often by refinancing in risky ways to “cash out” thousands more than the original loan. Nearly all subprime loans were for refinancing, not buying a home.

It turns out that the five states with by far the highest foreclosure rates have some things in common with each other, but very little in common with most other states.

I studied the latest available figures for state foreclosure rates, changes in home prices over one and five years, existing home sales, the percentage of mortgages that are underwater, and unemployment. Then I compared figures for the five most foreclosure-prone states with New York and also with the 25th-ranking median state.

One out of 76 homes in Nevada went into foreclosure in January, for example, compared with one out of 173 in California, with Arizona and Florida close behind. In New York, by contrast, only 1 out of 2,271 homes went into foreclosure.

Of course, real estate speculators existed in every state. Some of them doubtless did not realize that leveraging up to buy a house that one does not plan to live in for many years is about as wise as leveraging up to buy stock that one does not plan to live in for many years.

Certainly, those home-owners are just as sympathetic and deserving of a bailout as all those who borrowed tens or hundreds of thousands of dollars to buy stock.

Only fools bought houses they could afford

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(Based on the Detroit Bailout, using a photo from Wikimedia Commons)

A nice follow out to only fools pay their mortgages

By David Leonhardt (corutesy Calculated Risk):

Now, not all economists buy this argument. They say that the psychology of the current bust is different from what it was in Boston in the early 1990s. In a handful of metropolitan areas, including Phoenix, prices have fallen almost 50 percent from their 2006 peak.

Homeowners in such places may wonder if their houses will ever be worth more than their mortgages. So fairly small changes in their lives — like a reduction in work hours or the breakdown of a car — may lead them to walk away from their homes.

“I would not minimize that risk at all,” said Frederic Mishkin, a member of the Fed’s board of governors until last year.

If even 10 percent of the underwater homeowners walked away, Mishkin notes, foreclosures would soar, exacerbating the economy’s many problems.

Other economists who share his view are calling for across-the-board programs that would reduce interest rates or otherwise juice the housing market. They are worried that without bolder government actions, the housing market will continue to spiral downward.

In the end, the choice between the two approaches becomes a matter of cost-benefit analysis. The more aggressive approach would almost certainly do more to reduce foreclosures. But it would also be enormously more expensive.

If the economists from the Boston Fed are right — or even close to right — then the aggressive approach may cost something like $500 billion to prevent 500,000 foreclosures.

That’s $1 million per prevented foreclosure. Is that really worth it? Or could the money be better spent in other ways? (There is also the small matter of whether Congress would be willing to spend another $500 billion anytime soon.)

An example of the sort of house that you may soon be paying for are these McMansiosn in California, which have lost a million dollars worth of value.

Bailout Logic

Two very good pieces, from Calculated Risk

Less funny are the Britain dedicating 60% of its GDP to bailout, and our 2nd UAW Bailout of 2009. Citi is begging for a bailout

Now, stimulus spending is not necessarily bad. There are a lot of layoffs these days,

Still, our habit of bailing out banks and companies in a way that rewards shareholders is disturbing. We should be taking something between 51% and 99% of company’s equity in preferred shares when we bail out a company, to wipe out the shareholders who allowed this mess to develop.

In the long term, we need to reform corporate democracy, so that shareholders are able to keep a better eye on their Board of Directors – and the Board of Directors are able to keep an eye on their executive management.

Bush Bails out the UAW

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I don’t doubt that the UAW bailout is good party politics; it forces then-President Obama (a Democrat) to decide between continuing yet another unpopular Bush policy or throwing yet more loyal supporters under the bus. It’s just bad for America.

Auto Makers to Get $17.4 Billion – WSJ.com
The White House announced a $17.4 billion rescue package for the troubled Detroit auto makers that allows them to avoid bankruptcy and leaves many of the big decisions for the incoming Obama administration.

In a statement, President George W. Bush said the administration decided against forcing a bankruptcy to compel cost-cutting, in order to avoid the risk that consumers would desert one or more of the companies and touch off an industry collapse, deepening the current economic downturn.

The economy is hurt, as unions and large companies learn if things get really bad, they can depend on the government (as long as they spend a fortune on lobbyists and unions: Enron, Arthur Anderson, Lehman Brothers, et al. were not so wise). Auto innovation is hurt, as dinosaurs continue to take funding and investment that could go to innovative start-ups instead. Our infrastructure is hurt, as we continue to pour money into the past. The American taxpayer is hurt, as some of this money will be turned around to lobby us for even more.

The $350 Billion UAW Bailout

Rumors are swirling that President Bush may use Bush-Pelosi Bailout funds to save the UAW, General Motors, and Chrysler.

But even while Detroit is lobbying against local governments buying fuel-efficient vehicles and selling biodiesel trucks that aren’t, the Detroit 3 and their monopolist union supplier may be saved by this maneuver:

Bush may give funds to the Detroit bailout on the condition that Congress not refuse $350 billion more for Wall Street.

Detroit is in trouble because of its coddling of its unions, its incompetent management, its short-sighted use of government connections, and its love of debt.

Next up: a newspaper bailout? (courtesy gmgDesign)

The Minimum Winning Coalition

In politics, victories are achieved by “minimum winning coalitions.” To the extent possible, each side does what it can to win, which involves selling the goods of victory to potential allies in exchange for their support. So grand coalitions that obtain 70% or 80% of the vote are unusual. Whatever side is losing will promise everything — up to and including kitchen sink bail-outs — in order to attract friends.

While flying cars are still off the agenda, GM, Ford, and Chrysler are beginning to hear what terms will be needed for them to form their minimum winning agenda.

The farm states sound like they can support a bail-out… in exchange for a massive increase in ethanol consumption. Others are talking about federal Volt fleets… or even a free trade agreement with Colombia.

Time is running on Detroit. The median home/condo price there is $9,250. (That is not a typo.)

The Credit Card Bailout

The Bush-Pelosi bailout has now officially jumped the shark.

Hank Paul, empowered by George Bush and Nancy Pelosi, now present: The Credit Card Bailout.

What is disturbing about our President, and our even worse Congress, is that we are throwing good money after bad in a way that is not only wasteful, but also foolish.

The purpose of the credit card bailout is obviously to increase spending. The credit card bailout does so by socializing the losses that individuals and banks have taken because people bought things they could not afford, while allowing the individuals to keep those toys and the bansk to keep collecting interest payments.

Without the credit card bailout, less bad offers would be made, and more people would forced into bankruptcy by institutions desperate to get whatver cash back is possible, as soon as possible.

However, instead of rewarding bad behavior, this money can be spent on ways that will help our country and our world.

For instance, while the government maintains a large fleet of flex-fuel vehicle, 92% of them consume pure gasoline because they are too far from E85 stations. We could spend money to subsidize nearbye stations putting in E85 pumps, which would immediately create work and then reduce the flow of capital from us to petro-states.

Instead, we do a credit card bailout.

We subsidize men like Hugo Chavez, who recently threatened to send in the tanks if a friend lost an election, in order to bailout credit cards.

The financial crisis is an opportunity: money will have to be spent to limit the pain, and this money can be invested in mediating the destructive influence of oil and natural gas. However, the same forces make alternative energy sources (ethanol, wind, etc) less attractive in the short term.

The Democrats may be ready to do their part.

Unfortunately, with Bush we get more of the same: a credit card bailout.

Update: While I was writing this, the fed announced a $500 billion plan to bailout bad mortgage-backed securities. The quicker we can get the Bush financial team out of office, the better.

How much does the $25,000,000,000 bailout of Detroit cost?

(I’m talking about the proposed second bailout. We already gave Detroit a $25 billion bailout in September.)

Over the next few years, several Plugin Hybrid Electriv Vehicles (PHEVs) will come on the market, from Toyota, Nissan, and other manufacturers.

(You’ve heard more about the Chevy Volt than any others, in a desparate attempt by GM to make up for lack of innovation with an expensive marketing push. We were making plug-ins a century ago, when they competed against flex-fuel vehicles. GM’s position on innovation is better shown by the EV-1, where GM threatened to sue Western Washington University for driving theirs)

So how much does the $25,000,000,000 bailout of Detroit cost?

Well, consider than such a plug-in electric vehicle can achieve greater than 100 miles per gallon in normal driving conditions. Swap out the standard gasoline engine with one capable of running an 15% ethanol blend (E-85), and you should get about 500 miles per gallon of gas (with the bulk of the power typically coming from either electricity or ethanol).

So how many vehicles capable of 500 miles per gallon could we subsidize with the funds needed for the $25 billion bailout? How many PHEV-E85s could we help America purchase for the money that is going to go into saving the skins of people ot put the Detroit Three in this mess?

If we make the provide a subsidy of $1500 for each plug-in ethanol-burning electric, that means we could subsidize the purchase of 1,666,667 500 mile per gallon of gas vehicles for the cost of the Detroit Bailout.

President George Bush and President-Elect Barack Obama have a choice: investing in saving GM and the UAW, or invest in freeing ourselves from foreign oil.

Bush’s job seems easier: all he needs to do is hold tough through January 20, by which time GM should declare bankruptcy.

Obama has to choose between investing in the future or investing in the latest and greatest in 1950s ideas.

I hope both of them are up to the job.

The Detroit Push-poll

Courtesy of Gas 2.0 and Hybrid Car Blog, I found the Peter D. Hart Research Associates poll on a bailout for auto-makers.

It is a push-poll.

The poll sensible begins with demographic information, and as expected with a poll of “landlines” is demographically skewed. The modal age group is 30-34 yera olds, with 35-44 year olds being dramatically underrepresented. The poll undercounts both blacks and hispanics, and has a shows more respondents as indicating being black than hispanic.

Question 4 begins the substance of the poll, and asks

How important do you feel the American automobile industry is to the American economy–extremely
important, very important, somewhat important, not important, or not at all important?

Sensible enough. However, consider the next two questions:

If the American automobile industry no longer had the resources to produce vehicles, how much harm would
it cause to [America’s manufacturing job sector / The American economy / America’s standing in the world / Consumer choice for America’s car buyers ] a great deal of harm, quite a bit of harm, just some harm, or very little harm?

And Question 6, which is the first of the serious of “do we bail out Detroit” questions:

Do you believe that the government should or should not provide loans to America’s automakers so they have the money to manufacture vehicles?

Question #5 is what we call a “Prime” It is a stimulus that changes what responses will be elicted. So for instance, if you ask a question emphasize harm to the American economy, and then ask about things that might reduce that harm, you of course get resposnes skewed to “doing something.”

In the same way, if Question #5 had been

If the American government began bailing out industries that were no longer able to pay their bills because they had made unwise business decisions, how much harm would
it cause to [America’s manufacturing job sector / The American economy / America’s standing in the world / Consumer choice ] a great deal of harm, quite a bit of harm, just some harm, or very little harm?

The answers would have been dramatically different.

There is an easy way to correct this problem: randomly vary the order in which questions are asked. Then you can examine what effect, if any, your prime has. If it has an effect, then you can be safe by reporting the unprimed result: if it does not have an effect, so much the better. However, the method section…

The accompanying poll results are from a survey conducted by the polling organization of Peter D. Hart Research Associates for General Motors on November 11 and 12, 2008. The survey was conducted by telephone among a cross section of 804 American adults.
The national sample for this poll was drawn in the following manner: 350 geographic points were randomly selected proportionate to the population of each region and, within each region, by size of place. Individuals were selected in accordance with a probability sample design that gives all landline telephone numbers (both listed and unlisted) an equal chance to be included. One adult, 18 years old or over, from each household was included, selected by a systematic procedure to provide a balance of respondents by sex.
The data’s margin of error is ±3.5 percentage points for 804 adults at the 95% confidence level. Sample tolerances for subgroups are larger.

… provides no indication that this was done.

The poll, titled “Study #8877: Auto Industry Survey” displays results in percentages, but does not appear to indicate how many participants kept answering questions. It people surveyed were against the bailout and recognized the biased nature of the questions, they may have ceased responding, causing the sample to skew to those who are in favor of a bailout anyway.