Sep. 24th, 2008

peterbirks: (Default)
It says a lot for the faith which the markets have in governments when it comes to economics that, when Alistair Darling says that an institution is sound, its share price drops, but when Warren Buffett says that it is sound, the price goes up. I'm not sure on how many sides of how many faces Buffett is laughing, but I think that we can set the lower level at "at least one". Here he is, getting hold of a nice chunk of Goldman Sachs, one of the creators of those financial WMDs about which Buffett warned us seven or so years ago, for $5bn, with options to buy more if things go well.

Meanwhile, Capitol Hill does its best to make itself look stupid. Paulson and Bernanke ask for a blank cheque. Capitol Hill rightly protests (saying that it would like a little bit of oversight please on where the money is going), but then decides that staving off the end of capitalism isn't sufficient; it wants to throw in some social policy too. Then Bush, bless him, threatens to veto a bill that isn't completely to his liking.

"You mean that this will not only save the world's financial system, but will also subsidize single mothers in Wichita? Hell no! We won't go! Veto veto veto."

Or something like that.

Well, the FMs have been nationalized, the country's largest insurer has been nationalized, and there are 900 US stocks that you can't sell short. Meanwhile, the US also plans to create the ultimate "Bad Bank". All well and good, but one does wonder what the US government or, indeed, any government, can do if the markets go into another tailspin. Somehow I don't think that a half-point cut in interest rates will cut it.

The most concerning point is the, possibly valid, argument, that $700m won't be enough. You may remember that I sort of tried to cobble together some numbers on how much cash had really "disappeared" (i.e., turned from cash into liens on a load of houses that no-one at the moment wants to buy) and I came up with about $300bn, which could eventually turn into a loss of only $100bn, in the long run. (Of course, in the long run we are all dead....)

That would seem to indicate that $700m would be plenty enough to solve the "real" problem.

But the problem is, er, so to speak, that the real problem isn't the only problem in town. We also have the derivatives problem.

That $300bn that has gone missing is probably represented in the derivatives economy by at least $900bn and possibly as much as $3trn, because no-one knows how much the debts have been sliced and diced. So, if one company is sitting on 10% of the original problem ($30bn), but has sliced and diced it off to another company, which has in turn resliced and diced it to a third company, then already you have some $90bn in toxic sludge. To this extent it is a liquidity and a confidence problem. The "real" loss on many of these instruments might well be as little as 1% (or a third of 1% after the property market debts unwind), but at the moment no-one wants to touch any of the whole debt. A small amount of toxicity poisons the whole product.

That, at least, is the nub of the pessimists' argument, and it's not a bad argument. The $300bn of crap causes many trillions of dollars of dislocation. The problem then for Tarp is to decide which stuff to buy and which stuff not to buy.

The optimists might argue that the very existence of Tarp will ease the situation and that this will cause institutions to hang on to a lot of stuff in the belief that it will be worth more tomorrow than it can get from Tarp today. We shall see.


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