I think that this is a misdiagnosis:
How come nobody connects the following dots:
1. Massive bank problems precipitate a $700 billion federal bailout.
2. Meanwhile, private companies (including automakers) find it difficult to get banks to loan them money.
3. So those private companies go to the feds for bailouts of their own.
4. Nobody says: “The federal government won’t bail out companies that can’t get private loans. That’s why we gave the money to the banks, so the banks could make private loans. Loan money is what banks do. If you need money, go see a banker. We gave them lots of money they can loan out. Maybe they’ll loan some to you.”Am I missing something?
An excellent point. So I put it to some auto supplier and finance sources, and this is what they say we’re missing: The federal credit bailout ain’t working.
Credit is still frozen. No banks are willing to lend. And the auto companies are still in free fall.
I don’t think that’s the problem at all. I don’t know whether credit is still “frozen” or not (there seem to be a lot of mortgage loans happening), but even if it were melted and boiling, I don’t think you’d find a sane banker who would lend these companies money, even at junk-bond rates, given the nature of their business plans and prospects. That’s why they have to go to Congress…
I don’t know whether credit is still “frozen” or not
Therre is a simple way to get enlightened on that point, namely to look at the interest yield on 3-month Treasury bills. As of today the interest rate is 0.005%, annualized. One two-hundredth of a percent. In other words, if you bought $10,000 in 3-month T-bills, then three months later you would get a whopping 12.5 cents in interest.
Meanwhile the LIBOR 3-month rate for private credit is 2.21%, or $55.25 for the same $10,000 investment.
That shows you how much more the market trusts the Fed than it trusts private credit market.
http://markets.on.nytimes.com/research/markets/bonds/bonds.asp
http://www.bankrate.com/brm/ratewatch/other-indices.asp
YES…These bozos knew they were playing with fire when they were bundling securities, but they were doing the math, and they knew they could make money as long as the housing market didn’t tank. Here they can see the math is bad to begin with and the money they are hoarding for good creditors, when they come, is their insurance policy. They have no intention in investing their money in another dog.
I’ve been suspicious of the whole use of the terms ‘no credit’ or ‘frozen credit’, wondering if that’s actually ‘no credit at an interest rate people are willing to pay.’ The difference is subtle, but important in my mind: between a truly ‘stuck’ economy or a group of borrowers spoiled due to historically-low interest rates.
The difference is subtle, but important in my mind: between a truly ’stuck’ economy or a group of borrowers spoiled due to historically-low interest rates.
The issue is corporate credit. Of course it’s not true that no one is willing to lend at any price. What is true is that there is a stampede of erstwhile lenders who are putting money under their mattresses on a short-term basis — or the modern equivalent, which is to buy 3-month T-bills that pay twelve cents in interest on $10,000. They are doing this because they don’t want to lend money to the next Iceland or the next Lehman Brothers.
The effect is a massive contraction of the money supply, and consequently a sizable contraction of the economy. Read the headlines today: US economy loses a half-million jobs in November.
This is not about not being able to get a credit card, which you can still do if you have a job. It’s about losing your job because the financial system is shrinking back.
Jim, you claim that it’s ‘losing your job because the financial system is shrinking back’. How do we know this is cause and effect? Especially since the credit crisis was supposedly in Sept or earlier, but the jobs weren’t lost then.
Another very anti-business event happened in November – the Democrats took control of the federal government. Surely it’s not unreasonable to suppose that the people talking about stopping hiring and pulling in their horns if Obama was elected were telling the truth?
I’ve been suspicious of the whole use of the terms ‘no credit’ or ‘frozen credit’, wondering if that’s actually ‘no credit at an interest rate people are willing to pay.’
Tom, that would be a fair question if it were the borrowers that were the problem. But they’re not; it’s the creditors (the banks) that are the problem. They have no money to lend.
Reserve banking is a shell game. Even the “healthy” banks would be bankrupt if everyone called in their debts (aka, a “bank run”). But they’re expected to be “reasonable” about how far into the shell game they go. Canadian banks are doing well because they’re required to have a debt:asset ratio no worse than 13:1, and the were actually holding the line at 10:1 voluntarily. The American investment ranks were running debt:asset ratios of 40:1.
Then the housing market collapsed, sending d/a ratios to 80:1 as the bank’s asset base collapsed by 50%. Then Bear Stearns and Lehman went bankrupt and solvent creditors to the banks (aka, “savers”), like Toyota, Apple, Microsoft and old fashioned insurance companies, pulled their cash out of savings and bought Federal Treasuries with it in brokerage accounts. This sent the T-bill into the negatives and sent the banks’ d/a ratios to infinity:1.
So the banks that were stupid during the housing boom really have no money to lend. It’s not a question of price, but existence.
David,
When you knock a domino over they don’t all collapse simultaneously. They fall in sequence, over time. This particular set of dominoes were tipped last August (2007) (I know this because I was there) and only made the headlines this August (2008). It’s been in the cards for two years now.
“…given the nature of their business plans…”
They have a plan? Who knew!!?
Thanks guys. Good info to think about.
Brock, are you refering to this as the trigger event in August 2007?
Karl, that was one of the Fed’s first attempts to fix this problem. The trigger was the loss of confidence in the system that slowly dawned on enough people to reach a tipping point in July/August 2007. Given that the whole thing was a house of cards a loss in confidence was warranted.
Rand noted:
“I don’t think you’d find a sane banker who would lend these companies money, even at junk-bond rates”
Depends, what kind of collateral do you have?
There are a lot of inter-twined problems here, but the liquidity crunch is largely a function of folks trying to net out and unwind CDSes, now that it’s becoming evident just how malignant they are. The increasing numbers of corporate bankruptcies aren’t going to help either. If a company with a $100Mn bond issue goes into BK, a hedged transaction would involve the payment of $100Mn from the seller of the hedge to the owners of the bonds who had purchased protection for their principal. When every Tom, Dick and Harry gets to buy a CDS ‘hedge’, then the BK triggers cash payments from ALL of the sellers of the protection to all the buyers of the protection, and so may involve multi-billions in cash flows (or more), versus $0.1Bn.
That’s what everyone needs cash for, and that’s why all the equities were sold into the market – to raise cash for these settlements. I don’t think that part’s over yet.
Another twisted facet of the equation is anything collateralized. More people are awaking to the fact that a lot of the collateral underlying bonds were valued using ‘As-If’ appraisals (versus ‘As-Is’), and the ‘If’ part never materialized because, at least in the leveraged buyouts, all of the money from the syndicated bank loans (the leverage in the leveraged buyouts) was dividended up to the new owners to guarantee their future profits (and thereby fixing the Enron error), and so wasn’t available to the now private (and therefore not reporting financials to the SEC) companies to chance the ‘If’ to ‘Is’.
Anyone that has done their due diligence and analysis has looked at the documentation for the loans and bonds, understands the underlying collateral and its secondary markets, and therefore knows what the price is for those loans/bonds. If a $100Mn loan is secured by assets worth $40Mn, then the price for the bonds is somewhere south of 40¢ on the $.
The problem here is that the holders of the debt aren’t willing to sell at that price, because the realized loss goes to the P&L. Diligent bankers and investors aren’t going to pay the stupid prices that the sellers want.
Result: Frozen markets
Now, they are starting to unfreeze in quiet ways, because everyone is now looking at that 12/31 date when they close the books for the year. Buyers and sellers are actively talking to each other, even if they are often insulted by the price quotes on both sides. Stuff is starting to move, but there is a serious risk of the process becoming frenzied, which would leave a lot of carnage in its wake, and a ton of work for lawyers in the new year. That’s why they want the other half of the TARP – to assure markets that there is going to be ample cash for everyone.
Looking longer term, the difficult challenge is to figure out what the inflation is going to be once the market gets back near equilibrium and folks get a better sense of the value of things compared with the enormous piles of dollar bills that are floating around. There’s opportunity in preparing for that, but the challenge is in finding it.