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All The King’s Horses and All The King’s Men . . .

Posted by Larry Doyle on May 6, 2009 11:37 AM |

Can Barack Obama’s horses and men in the persons of Ben Bernanke, Tim Geithner, Larry Summers, Paul Volcker, Rham Emanuel, Sheila Bair, and their minions put Wall Street together again? The glue and putty in the form of trillions of dollars of taxpayer funds and commitments is still wet. Mr. “Humpty Dumpty” Wall Street is still on the ground.

Humpty’s most severe injury is the breakdown of the securitization process in which Wall Street promoted a pure “originate to distribute” model. Obama himself offered in the May 3rd Sunday New York Times Magazine:

. . . we’re going to have to figure out what we do with the nonbanking sector that was providing almost half of our credit out there. And we’re going to have to determine whether or not as a consequence of some of the steps that the Fed has been taking, the Treasury has been taking, that we see the market for securitized products restored.

I’m optimistic that ultimately we’re going to be able to get that part of the financial sector going again, but it could take some time to regain confidence and trust.

Time for the cement to harden and for Humpty to get back on his feet. Why will it take so much time? Very simply, Humpty was not an honest broker in the process of originating, securitizing, and distributing poorly written – if not fraudulently written – loans over the last 5 to 7 years. The Financial Times highlights this fact this morning in Securitization Is Crucial for Revitalizing Lending.” The FT reports:

Securitisation is a way to raise money by repackaging securities based upon underlying assets such as mortgages.

The US government is seeking to restart this market with up to $1,000bn of funding for purchases of securitised debt. But the complexity and risks involved mean it remains difficult to replicate the scale of the market that collapsed under the weight of losses and the departure of leveraged investors.

Meredith Whitney, of Meredith Whitney Advisory Group, says about $2,200bn less in funds has been raised by means of the US capital markets since the start of the credit crunch in July 2007, with $2,700bn less money raised globally.

She said: “With debt issuance to date seeing year-on-year gains, it is suggestive to say that things aren’t getting much worse. They just aren’t getting any better.”

The US government’s programme to revive securitisation – the Term asset-backed securities loan facility (Talf) – has made some funds available and it has also led spreads on some asset classes to narrow, reducing the potential funding costs. The programme works by lending money to hedge funds, which can increase the returns on triple A rated securities by means of the cheap loans.

In a sign of a big pick-up in demand, the Federal Reserve said late yesterday that investors requested $10.6bn worth of loans in its most recent round of the programme. This included $2.2bn worth of requests for auto loan bonds and $5.5bn for bonds backed by credit card loans.

If we review those statistics, the government’s TALF (Term Asset-Backed Lending Facility) has facilitated $18.5 billion in sales since its launch in March. While the Fed views the demand as picking up, be mindful that the $18.5 billion figure represents approximately .008 of the total credit that has evaporated from the economy via the shadow banking system. In layman’s terms, we just gave Humpty a swab with a warm cloth while his limb is holding on by a thread.

My concern with the TALF is that the buyers will cherry pick bank assets and simply purchase those which have the most rigorous underwriting. The dregs will be left for the banks and taxpayers to absorb.

If Uncle Sam does get Humpty somewhat propped back up against the wall (note that I’m not even hinting at Humpty getting “on the wall”), how do we make sure Humpty does not once again fall down and take us all with him?

We need to make sure Humpty plays by strict rules and regulations, both in terms of underwriting and business engagement. The FT addresses proposed underwriting rules in “Watchdog Proposes Strict Rules.”  The FT reports,

Yesterday’s Iosco (International Organization of Securities Commissions) report called for minimum levels of due diligence by the originators and suggested mandating far greater disclosure to investors of what checks had been carried out. It also called for ongoing disclosure to investors of the performance of the underlying assets and for originators to be forced to hold on to some tranches of each deal.

Other proposals included imposing standards forcing originators to check that products were suitable for each investor and looking into developing alternative measures of assessing risk other than the credit ratings agencies that were relied on by investors previously.

Wow, you mean Humpty actually has to display a measure of integrity in his operations?  What a novel idea!  Who may be keeping an eye on Humpty to make sure he plays by the rules going forward? The SEC and FINRA (Financial Industry Regulatory Authority).

Hey, wait a second. When Humpty fell off the wall, we have very credible evidence that FINRA was actually one of his playmates. None other than Harry Markopolos said that FINRA was on the wall (“in bed”) with Humpty. I have highlighted issues within FINRA that still need to be addressed: FINRA Is Supposed To Police The Market.

President Obama, what do you prescribe for Humpty given his relationship with FINRA? Obama told the Times,

. . . the fact that we had such poor regulation means — in some of these markets, particularly around the securitized mortgages — means that the pain has been democratized as well. And that’s a problem. But I think that overall there are ways in which people have been able to participate in our stock markets and our financial markets that are potentially healthy. Again, what you have to have, though, is an updating of the regulatory regimes comparable to what we did in the 1930s, when there were rules that were put in place that gave investors a little more assurance that they knew what they were buying.

Putting Humpty back together is going to be very challenging. Sense on Cents will be monitoring the operation very closely.


For newer readers who may want to more fully understand how Humpty “had a great fall,” I strongly recommend The Wall Street Model Is Broken….and Won’t Soon Be Fixed.

  • oowawa

    Good morning, Larry. I left the following question on your article over at No Quarter, but the spam filter took it. Anyway, if Wall Street is Humpty, and it’s had a great fall, my question involves the possibility of propping up the stock market as a partial means of putting Humpty back together again:

    LD, I’ve asked you before about TARP funds and other taxpayer resources finding their way to prop up the stock market in blatant market manipulation. Your opinion, as I recall, is that you were doubtful such a thing is occurring. I wonder if you still hold this opinion? I read lots of comments from traders on Market Watch and other sites pertaining to this subject, and Goldman Sachs seems to be at the center of the manipulation “conspiracy” theories. This remark from “Law97” on MW is typical:

    This is not a classic suckers rally, this time it is different. The Fed is printing and the treasury is handing over trillions to GS and the like with the back room understanding that after all the bonus payouts, they must use some of the taxpayer money to prop up the stock market. The side benefit is that the SEC will continue to look the other way as the TARP recipients make insider trading profits when they put the money to work.

    Do you still think such possibilities of market manipulation are remote? I don’t have a financial dog in this fight–I’m just very curious.

  • Wow….I will say that I have been increasingly bewildered by the equity market price action. In fact, I said to somebody just the other day that I have begun to discount the price action in the equity market as not being in sync with the economy.

    In my opinion, if the equity markets are truly reflective of the health of the economy, then the bond market should be a LOT lower than it is currently even with the Fed’s purchasing program.

    One of these two markets is out of sync and potentially both.

    If the govt is using GS or anybody else to prop the market, the losses involved in foreclosures and defaults are very real and can not be avoided. That is the real economy and that has my focus.

    If the equity markets rally and I miss it, c’est la vie. I’m not playing. I’m writing and looking to help people “navigate the economic landscape.”

    One final point, as I mentioned in my post Water Finds Its Own Level, markets which are manipulated work their way lower to find their natural level over time.

    Thanks for visit/comment!!

    • oowawa

      Thanks for the response, Larry. I have very little invested in stocks, but I watch the market carefully, and the rationalizations for recent rallies have been feeble, at best. It’s perplexing, and with so much bailout money flowing through so many conduits, it’s really tempting to suspect that public money is somehow propping up the market. It makes me nervous. I really enjoy your columns!

  • bonddadddy

    C and BAC have to raise billions in new capital and both stocks up almost 20% on this ‘great’ news leaked out early of course to CNBC …………. XLF up 8% …….. financial crisis ? never existed … it was just a made up silly George Bush plot to harm America exposed and disposed of by ‘ The One ‘ …………

  • If in fact the equity markets are an indication of the health of our economy, then what are bonds doing at these levels? (is somebody driving shorts or as oowawa hints at, manipulating the mkt? perhaps)

    If bonds are accurately priced, then what are equities doing here?

    I’ll focus on the economy and know that the bill remains outstanding and Humpty is still broken.

    I enjoy your comments and trader’s mentality.

  • Petricone456

    By my math the market has it right on BAC… well, I’m being somewhat generous. Tangible book on the stock is somewhere in the mid-teens (say $15-$16) and if you assume an $11 conversion price (33% dilution) on a market cap of $70bn, an $11 price tag seems to be in the ballpark. I’m generous because the preferred issued to BAC under TARP was supposed to convert at $6.24. That said, the rules constantly seem to be changing under Big O’s administration. Recall Citi stock benefitted from a nice squeeze when arbs heard that the preferred conversion price might be changed.

  • Larry –

    Isn’t Humpty Dumpty a fundmentally flawed model and system to begin with? Isn’t the whole system that collapsed fundamentally flawed at its core? Even if they do put Humpty Dumpty back together again, aren’t they just resuscitating a fundamentally flawed system? Isn’t it inevitable that it would crash again and maybe crash even harder the second time? I know I’m probably preaching to the choir, but why can’t we allow bad companies and bad banks to fail, even if it does in fact cause systemic failure, so that we can start all over again with a new, more stable, more viable, more sustainable system?


    P.S. I don’t think Bank of America and Citigroup would still be in existence at all right now if it wasn’t for TARP money. BofA needs $34 billion in capital, but no big deal, because they’re getting $45 billion in TARP money, so they have an $11 billion surplus! Unbelievable.

    • Matt,

      The $34 billion number takes into consideration the existing TARP money. They actually need to raise new money and/or convert some preferred shares to common (very likely).

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