Jacobs poses this question. The U.S. government has a far uglier budget than any U.S. bank, with a deficit expected to more than double to $407 billion this year from last year’s $161 billion. It also is the home of $640 toilet seats and $1 trillion in missing transactions. No bank in the U.S. has been as irresponsible as that. So who is in a better position to push the banks into more responsible performance–the government or the markets and shareholders?

via Deal Journal – WSJ.com : Banks to Treasury: Keep Your Bailout. We’ll Keep Our Bonuses.

From the NYTimes:

In 1929, Meyer Mishkin owned a shop in New York that sold silk shirts to workingmen. When the stock market crashed that October, he turned to his son, then a student at City College, and offered a version of this sentiment: It serves those rich scoundrels right.

A year later, as Wall Street’s problems were starting to spill into the broader economy, Mr. Mishkin’s store went out of business. He no longer had enough customers. His son had to go to work to support the family, and Mr. Mishkin never held a steady job again.

Frederic Mishkin — Meyer’s grandson and, until he stepped down a month ago, an ally of Ben Bernanke’s on the Federal Reserve Board — told me this story the other day, and its moral is obvious enough. Many people in Washington fear that the country is starting to spiral into a terrible downturn. And to their horror, they see the public, and many members of Congress, turning into modern-day Meyer Mishkins, more interested in punishing Wall Street than saving the economy.

The rest of the article goes toward making a case that the bailout is needed to avoid another great depression. While I don’t beleive that, I do fear the social effects of credit tightening.

Looks like the Senate has passed the new, enhanced Christmastree Bailout Bill.

Another provision added by the Senate would require most employers and health insurers to put mental health problems on par with physical illnesses, including coverage for hospital stays and doctor visits as well as co-payments and deductibles.

Senate Expands Bailout Package – WSJ.com.

Added to the original Bailout plan is a drive to increase the FDIC limit to 250k, the above mentioned mental health care, changes in SEC accounting rules, and changes in the tax rules.

The idea is that passing this bill will push the House into accepting the proposal and passing the bill. I suspect this will work, although we’ll have to wait until Friday to find out. Fiscal Conservatives can come out of this with tax cuts, while Democrats can come out helping solve health problems.

At least something will be passed. Only time will tell if this proposal solves the liquidity crisis and helps us right our economy.

The congress is now discussing the idea of raising the limit of FDIC insurance to 250k from 100k. This is a worthwhile idea, BUT I think that the FDIC insurance limit should be removed. The FDIC should be run like any other insurance company and allow banks to choose the limits they apply to their accounts and pay the appropriate rates to the FDIC to provide that insurance.

The congress could then mandate that all demand depost accounts carry a minimum of 100k or 200k.

This would run the FDIC similar to the SIPC and allow banks to target insurance on accounts at appropriate customers. Most banks don’t pay a real return on checking these days anyway, so they should have no problem peddling small business savings accounts and checking with a million dollars of deposit insurance.

Properly run, which for the most part the FDIC is (they’re running low on funds these days), this wouldn’t cost tax payers a dime.

Well, I told you it would happen. We got the Bailout We Deserve. When the bailout was defeated by the house. Decried as a bailout for Wall Street bankers which is exactly the opposite of how it would actually work. We have already had several banks failed and been taken over by the FDIC. Starting tomorrow we might see companies unable to make payroll. Expect consumer loan & credit rates to spike over the rest of the week.

The Federal Reserve is expanding its current offerings to keep liquidity in the system.

The Fed increased its existing currency swaps with foreign central banks by $330 billion to $620 billion to make more dollars available worldwide. The Term Auction Facility, the Fed’s emergency loan program, will expand by $300 billion to $450 billion. The European Central Bank, the Bank of England and the Bank of Japan are among the participating authorities.

Bloomberg.com: News.

We’re going to have to come up with something to provide the trillions in liquidity that we’re going to need.

Short term help:

Expand the FDIC for corporate checking/savings account (demand deposit) to an unlimited amount. This will require higher fees to cover the potential defaults. It will give companies a SAFE place to put payroll money prior to make distributions.

Pay interest on Federal deposits. We require banks to hold capital at the Federal Reserve but do not pay any interest on it, creating a disincentive to hold extra capital there. Additionally, paying interest makes it much easier to maintain the target Fed Funds rate.

DO NOT USE Federal Reserve emergency funds to insure Money Market funds. These have been sold as an investment, not a Federally Guaranteed fund, they should be subject to market forces. There are plenty of MM funds that are run well, let the ones that are not have their capital flee.

An example of what I have been saying all along: the special status of Rating Agencies was pivotal in the excesses of the credit boom.

That day, a member of an S&P executive committee ordered him, the company’s top mortgage official, to grade a real estate investment he’d never reviewed.

The Big Picture | Bloomberg: Blame the Ratings Agencies (Part I).

Liquidity Risk is another term that has been circulating around this financial crisis. The problem is that some asset that you want to buy or sell is thinly traded so you either cannot purchase, borrow, or sell as expected. Such thinly traded markets may at times require you to pay a hefty premium to participate.

This is the current situation with Mortgage Backed Securities. There is not a liquid market for these instruments, so banks cannot sell them without taking a huge cut in price from what they believe they are valued at. Remember, while markets help discover the appropriate prices for securities, these prices are also affected by supply and demand. The fact that a dollar is worth, well, a dollar, doesn’t matter if there is no one to trade with. You might have to take 90 cents in order to find someone willing to make the trade, even if fair value says a dollar is a dollar. In highly liquid markets arbitragers exist to, in effect, provide liquidity and profit from even the tiniest mispricings. Those willing to take a position in illiquid markets usually gain a premium compared to liquid analogs, such as off-the-run and on-the-run treasury bills.

So, is this new? Has Wall Street never seen such illiquid markets? Hardly. Richard Bookstaber’s wonderful Book, A Demon of our Own Design, details several situations where this has happened before and why it might happen again. I’ll use one of these as an example, Long Term Capital Management. Bear Stearns and Lehman Bros were both victims of an inability to find funding or dispose of assets due to illiquid markets in the exact same way as Long Term Capital Management was. As Demon describes, LTCM basically built its business on being short illiquid and long liquid trades. Since illiquid positions are harder to open there is a premium to be had for companies willing to be illiquid. Since these securities can, in some cases, be hedged with highly liquid positions it was in theory a free way to make money.

Eventually, these markets can turn against you, even against all logic about fair value, and force you out of your position.Again, Lehman & Bear were both in the same situation. They needed to sell assets but buyers knew they were trying to liquidate and withdrew their orders. They would only buy assets on these markets (highly illiquid, they knew who they were trading with) at very steep discounts, knowing that either they bought them at discount now, or during the bankruptcy hearing. Only through the JP purchase could Bear Stearns hope to keep itself halfway alive.

I’d recommend checking out  A Demon of our Own Design if you’re interested in understanding Liquidity Risk and how it affects large institutional investors, investment banks, and hedge funds. It is an engaging read and not as techinical as it might appear at first blush.

Capitalism has failed us. At least that is what I’ve heard on TV, Radio, and on the web. Our banks have failed us, deregulation has failed us, free market capitalism has failed us. We need the government to step in and help us out.

Deregulation, free market Banks are failing or about to fail. This will impact huge swaths of the economy. All because these banks made bad home loans to people who couldn’t afford them. Sure, the government encouraged them to make these loans. Hell, the government created two trillion dollar entities to help make loans affordable. And then law suits and threats were brought against banks who wouldn’t make loans to low income minorities calling this racist business practices.

Regulation has covered what kind of assets banks must hold, elevating rating agencies to lofty positions in deciding which securities were bankable and which were not. Driving these organizations to take obviously risky mortgage backed securities, created out of Frannie and Freddie mortgages, on to their books to boost returns. Free market drove consumers to these banks with their higher returns, leaving more responsible companies with no choice but to join in.

Now these banks are looking for the government to step in a buy these securities. Why? Because the free market won’t at the prices the banks are asking. Free marketers say no, leave them to dry. What will happen? Banks will stop lending to poor creditors, highly tightening their lending standards. Some small banks will fail. Small businesses will fail to make payroll. Some decent people will get turned down for home and auto loans.

Wait, we say. We don’t want that. We don’t want the turmoil of the free market. We also don’t want a bailout. We just want affordable housing, easy credit, and no bailouts. So, here we are. Decrying a bailout. We say that Capitalism failed us when we never really had a free market in housing or capital structure. Surely the solution to this is not a bail out, but more regulation on capital and government intervention in housing and credit.

Capitalism did not fail us, we failed capitalism by doing our damnest to undermine it. Turmoil is part of capitalism. Difficulty obtaining loans by poor creditors is part of capitalism. The failure of banks is part of capitalism. We don’t want the downsides of capitalism, just the economic boost. If we truely want to come out of this, we need to stomach our way through this mess and let Capitalism work its invisible hand.

Else, we need to stomach the massive costs to dig ourselves out of the mess we created. Yes, all of us. From Bankers down to personal mortgages we’re all responsible for this mess. We cheered the housing subsidies, tax breaks, and GSEs. We lauded the fair lending and capital regulations which distorted market incentives for banking. We rejoiced at limitations of bank ownership by private companies. And here we are, complaining that for all our meddling something still went wrong. If we can’t stomach the pain then we have to take the bailout pill.

Ultimately, Capitalism has not Failed. It worked exactly as many experts have been saying all along.

All the discussion has been about the Bailout being targeted at big wall street bankers. Implying that the government is going to spend 700 billion on helping those poor bastards with their yaht and third home payments. Luckily our Congress is fighting back against these big wigs and they’ve attached enough strings on the bailout package that there is now a chance that nothing will get done. Down with the Wall Street bailout, up with the Main Street bailout.

The problem is that this IS a Main Street bailout. The idea is to provide liquidity by purchasing toxic assets off of banking balance sheets. Yes, these are the same toxic assets that poor risk management has caused billions in losses at banking institutions. This will provide enough liquidity for normal business and interbank lending. Additional, this will (hopefully) send Banks back to making mortgage loans to people without enough to money to make down payments, credit cards for people with more debt than they make in a year already, and student loans to C students to get full rides at State Colleges. Guess what, big bankers, CEOs, and Wall Street titans are going to do pretty well of off this.

Cancel the bailout, it won’t hit the Wall Street titans or the big banks. They’ll just cut down on low probability lending and ride this one out. It’ll be a rough couple of quarters but they’ll come out ok. And they’ll still make more a small fortune. However, the small businesses that need to make payroll are going to have to cut back. Maybe delay a payment or two. Small banks that need to borrow money from larger ones to shore up their balance sheets are going to be left in the wind. Walmat will have no problem accessing temporary funding for their operations, but Ted’s Hardware probably will.

Other plans, such as mortgage restructuring plans are going to benefit those Wall Street big wigs too.

Now, I think there are plenty of things that can and should be changed in this bailout bill. However, with the popular rhetoric about “Bailout for Wall Street” I suspect we’re not going to get the bailout we need. We will however, get the Bailout we Deserve.

Great Opinion article at the WSJ

Blame Fannie Mae and Congress For the Credit Mess – WSJ.com.

If the Democrats had let the 2005 legislation come to a vote, the huge growth in the subprime and Alt-A loan portfolios of Fannie and Freddie could not have occurred, and the scale of the financial meltdown would have been substantially less. The same politicians who today decry the lack of intervention to stop excess risk taking in 2005-2006 were the ones who blocked the only legislative effort that could have stopped it.