Arnold Kling  

Two Thoughts

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What if it's a Wealth Shock?... I'm a Media Star...

1. I read in the paper that Nancy Pelosi said they were going to post the legislation on the Web 24 hours before they voted on it. That means it should be up by now, right? Anyone know where to find it? I went to house.gov and to Pelosi's main page, and as of now I don't see it. There is a bullet-point summary at the Washington Post web site, but it's pretty high-level.

(UPDATE: CNN has a draft. The official version is on the financial services committee web site, or so I'm told. Anyway, I am not going to comment. I know as much about marking up legislation as the principals involved know about valuing mortgage securities.)

One idea I have is that Congress could come back after the election and hold hearings on the legislation. This would allow differing points of view to be aired. You're probably thinking, If they didn't hold hearings before they passed the legislation, why would they want to hold them afterward? You're probably thinking that I must be on crack.

What I want to know about the legislation is whether it includes any restrictions on leverage for the Treasury. Lots of clueless pundits are saying that it's wrong to think of $700 billion as the cost of the bailout. They write that it has to cost much less. It probably will cost less, but with leverage and bad luck, it actually could cost more than $700 billion. A lot of the instruments that might be eligible for purchase have leverage built into them--it's not like Treasury has to buy on margin to wind up with a levered portfolio.

2. This gets back to Robert Merton's other point, about financial engineering, and how few of the executives and regulators (what I refer to as "suits") understand it. And journalists especially. I have not seen a single news analysis or op-ed piece on the bailout that is informed by an understanding of modern financial engineering.

Honestly, I'm writing like I'm such a maven, but I'm out of date myself by more than 10 important years. I have only the sketchiest understanding of CDS's and CDO's. I'm like someone whose computer programming knowledge stoped with BASIC, when the modern tool is Java.

But the journalists and all the suits don't have clue one. They keep talking about "yield to maturity" as if they were buying bonds. That would be like a technology journalist or CEO not understanding the difference between a laptop and a typewriter.

The bottom line is this: the mess we're in is due in large part to the ignorance of modern finance on the part of high-level executives, regulators, and of course Congress. And those are the people designing the bailout.

Have a nice day.


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COMMENTS (3 to date)
Guan Yang writes:

It seems that CNN has a copy:
http://money.cnn.com/2008/09/28/news/pdf/firstdraft.pdf
http://money.cnn.com/2008/09/28/news/pdf/index.htm

parviziyi writes:

Here's a notable example of the "lots of clueless pundits" problem.

Bruce Bartlett, deputy assistant secretary for economic policy at the Treasury Department for the four years of the Bush 41 administration, says in support of the Paulson plan: "When one bank starts unloading [mortgage assets] at fire-sale prices, this drives down the market price - imposing losses on everyone holding such assets. Under mark-to-market accounting rules, banks must recognize these losses immediately - even when their intention is to hold a bond or mortgage to maturity and (likely) be paid the full face value of the asset."

If a security is held to maturity (HTM), it does not need to be marked-to-market. This is the very reason why banks have been choosing to take OTTI (Other than Temporary Impairment) charges to avoid this volatility. Also, under the regulations, "fire-sale" prices are not applicable to other banks' accounting; in other words, if the sale is deemed distressed other banks will not be forced to mark like securities to those levels.

My source for the above is the mighty New York Post:
http://www.nypost.com/seven/09272008/postopinion/opedcolumnists/why_the_bailout__130927.htm

kingstu writes:
If a security is held to maturity (HTM), it does not need to be marked-to-market. This is the very reason why banks have been choosing to take OTTI (Other than Temporary Impairment) charges to avoid this volatility. Also, under the regulations, "fire-sale" prices are not applicable to other banks' accounting; in other words, if the sale is deemed distressed other banks will not be forced to mark like securities to those levels.

This is only true with debt securities (i.e. securities with definitive maturities like bonds). MBS aren't equities or debt securities...they have characteristics of both.

They DO have to be marked to market and since the market is illiquid the value is based on management estimate (as are so many things in accounting). If I hold the top tranche in an MBS (meaning I am ahead of 90% of the bottom tranches in the event of defaults)...is there any way that 90% of those mortgages are going to default leaving the value of my MBS impaired?

Home loans aren't like other investments...if the value of a person's home declines implying an LTV above 100%...people still continue to pay the payments and keep the home. IMHO, writing down an MBS simply because home prices decline...vastly overstates the amount of the write down.

Are MBS impaired? Certainly. Has the true value fallen by 70% in some cases? I don't think so unless we are talking about the tranches at the bottom of the waterfall...

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