The Financial Times columnist Munchau is right when he says, “I am sceptical of the Fed’s new policy of quantitative easing. We do not have a liquidity crisis, but a solvency crisis….” There have been a lot of complaints from bankers about the “mark to market” requirement, which means they should carry assets on their books at the price at which they could be sold in the market. The problem is that their assets are junk, similar to but much worse than Michael Milken’s “junk bonds.”
What we have is a bunch of huge banks who went out to talk to the day laborers in front of Home Depot and said, “How would you like to buy a 5,000 square foot house? We’ll give you a mortgage at 1% or even a negative percent, if you can’t afford 1%.” So, a lot of the day laborers and their friends took the banks up on their offer. They could buy a 5,000 sq. ft. house cheaper than they could rent a 1,000 sq. ft. apartment on a monthly basis. In theory they signed away their lives when then completed all the mortgage paperwork at the mortgage broker’s office, but in fact because they put nothing down on the house and were not held to any standard of honesty for the background information on income, etc., that they gave; they incurred no obligation when they signed the documents. In essence what the banks got in return for lending trillions of dollars in such transactions were bunches of worthless IOUs for which there was no enforceability other than possibly getting the house back some day. The banks want these IOUs to be carried on the books at face value, but it fact they are worth only a few cents on the dollar. Because they are not negotiable in normal, open markets, nobody really knows exactly how much they are worth. Why are they not negotiable? Because they are a bunch of almost worthless IOUs with little legal enforceability. So, when the bank threatens to foreclose and take back the house, the day laborer says, “Fine, take it; I didn’t like the color of the media room anyway.”
But Washington is all upset that their goal of getting everyone living in America, citizen or not, into a new, expensive house is threatened by the foreclosures. So, Ben Bernanke at the Fed says, “What do I have to do to get you back into this luxurious house? I’ll push mortgage interest rates to zero. I’ll forgive any negative equity that you have; we’ll reduce your mortgage to whatever value an honest appraiser (who was missing in the original transaction) says it’s worth, and we’ll reimburse the banks for any loss they incur as a result.”
So, Munchau is right when he says the problem is not liquidity (banks’ unwillingness to lend) but insolvency (banks’ lacking money to lend). Their assets are worth far less than the loans that they already are committed to; the banks have no assets to draw on to make additional loans. The Fed says, “No problem, we’ll buy the worthless assets from Fannie Mae and Freddy Mac, so that they have real, Fed supplied assets to make new loans from.” This is in essence what Hank Paulson originally proposed to use his $700 billion for. But then he followed Britain’s example of just giving the money to the banks to shore up their balance sheets, leaving them their unmarketable toxic assets plus whatever additional capital the government gave them to make new loans from.
It’s a house of cards, but Bernanke and Paulson are running around trying to close all the doors and windows to keep drafts from blowing all the cards down. I wish them luck, but why did the future of the United States come to depend on a house of cards? In the old days, they used to talk about investment bankers being the “smartest guys in the room.” Now they look like the dumbest. On the other hand, they all became millionaires; they just did it by sucking the blood out of hard-working, ordinary Americans. Wall Street is the vampire capital of the world. Maybe that’s why vampires are so trendy now.