Umm, What's The Next Bailout Plan?

Two months ago, when The Great Wall Street Bailout Plan I was being hashed out, a number of very able economists, including the fairly clairvoyant Nouriel Roubini, argued that that buying up all the banks' bad loans would cost the government a fortune without solving the credit problem. Agreeing that guaranteeing bad loans wasn't enough, Paulson & Co. reversed course and more or less adopted the alternate plan of pumping capital into the banks.

Now we've injected some $350 billion of new capital into the banking system, and it seems to have failed so far to reopen the credit markets and disappeared into a giant sinkhole. (And don't believe for a second that the government is going to earn some kind of great windfall on it preferred stock deal. As Zubin Jelveh at Portfolio.com has pointed out, other countries have been down this road before.) So, will $350 billion more do the trick? Or is there another idea?

Madoff's Victim, And His Enablers

Last week in The Big Money I wrote about why, given the precedent set by the last big hedge fund fraud, investors who noticed that something seemed suspicious about Madoff and reported it would have been likely to be rewarded by losing their shirts . One reader, Debbie Reches, took me to task for justifying a corrupt, look out for yourself mentality of Wall Street. She wrote me an email:

In the regular world, if someone is aware of a crime or fraud being committed it is expected that they will report it. Yet in the case of these investors, the question becomes, "How can anybody be expected to report on an illegal activity, inknowing it might cost them money?" Better to just ignore the whole thing and hope it goes away. Really? I don't think so. saying that people who suspect something have no choice but to keep quiet shows an entitlement mentality that needs to go.

The last thing I wanted to do, however, was to justify the action of funds like Tremont and Fairfield that seem to have done their level best not to find anything wrong. I have a ton of sympathy for ordinary investors--including very rich ones--who lost money with Madoff, but those guys may well turn out to be little better than silent co-conspirators. However, regardless of what kind of investor we're talking about, I think that you have to separate the ethical question of when a fraud should be reported from the practical question of how to maximize the chances that frauds actually will be reported.

If investors who pull their money out of a scheme like Madoff's and then report it to the SEC wind up being told that they then have to give back what they recovered and share it with other people who were ripped off, the reality is that they simply will not go to the SEC. That just doesn't work. There's no easy solution here, but my impulse is to err on the side of a system that encourages rather than penalizes reporting, while still keeping lucky early investors in a Ponzi scheme get windfall profits.

That said, the theorizing here may turn out to be moot. The question right now is just how entangled Tremont and Fairfield, which essentially marketed Madoff's services, will turn out to be in all this. I'm with Donald Trump on this one: you don't pull off a fraud like this alone. (And I second Trump's suspicions that the sons weren't as clueless as they claim. The Donald's a blowhard, but I imagine that decades in New York and Atlantic City real estate make you pretty good at recognizing the smell of bullshit.)

Just How Many Billions Did Madoff Lose?

Yeah, no matter how you count it, it's arguably the biggest investment fraud in history. But I'm still wondering about the $50 billion number that's getting attached to the Madoff Ponzi scheme. "$50 billion" seems to come from ... well, Madoff himself. It's what in his come-to-Jesus moment of breakdown he told his sons he'd lost. But the sons seemed to think the money that had disappeared added up to about $17 billion. Which number will turn out to be right? The only possible answer right now is "Who knows?" But given the list of losses out there so far, I'm leaning toward the lower, $17 billion figure. The structure of the thing's complicated, and I suspect that some of the individual investor losses (those country club friends) were actually held in funds like Tremont and Fairfield and may be double counted. I could be wrong. But $50 billion sounds really high--that would mean that Madoff was managing, or mismanaging more money than anybody in the hedge fund world.

Alert: There Is Justice In The World

The Journal reports that Credit Suisse will pay $5 billion of its senior staff bonuses in it's own "illiquid" (ie. quite possibly worthless) assets such as mortgage backed securities. No further comment seems necessary. If only someone had thought of this three years ago...

I'm Not Exactly Taking Blago's Side ...

... but maybe I am the only one in the world with some measure of sympathy for the predicament of someone like Rod Blagojevich, who sees his peers raking in cash while he's wondering how to stay "politically viable" while keeping himself more or less solvent. The Blago complaint is one of the best pictures of the sound of financial desperation. I don't see Blago as a fiendish, bribe maximizing wheeler-dealer.

I’ve got this thing and it’s fucking golden, and, uh, uh, I’m just not giving it up for fuckin’ nothing. I’m not gonna do it.

To me this is the sound of a guy who's cornered and sees that the windfall he's been betting on is slipping away. It's William H. Macy kicking at his car in the endless expanse of white snow in Fargo.

At about $171,000, the salary of the governor of Illinois is easily within the realm of what the vast majority of his constituents would (very reasonably) consider comfortable. But still, a useful data point to underline is that it's just about in the range of what the average Illinois district school superintendent gets, and only about half the salary of the highest paid local school chief. I don't think anybody in the country wants to make public service a sure path to riches--and there will never be a salary so high that it eliminates the temptations of getting more. But ever tightening ethics rules create a de facto property requirement for office holders. Self financed--in other words, really rich candidates--have in recent years very effectively plugged into an unspoken but pervasive acceptance of the idea that someone who comes into office without a fortune of his own will be corrupted. New Jersey governor Jon Corzine, who made his money at Goldman Sachs, was a pioneer in this and made the theme pretty much explicit with his slogan of "unbossed and unbought."

This is an age old problem, and I won't pretend to offer any solutions. It's worth noting, though, that some regimes have seen the problem of office holders profiting from their government work as so fiendishly intractable that they have simply chosen to institutionalize corruption--for instance, pre-Revolutionary France, where public office was a profit making venture and official positions could be bought and sold.

The Foreclosure Auction Mudpit

So how much more is there left to be uncovered in the muck of the mortgage crisis? A lot. A little while ago I wrote about the LA Times's efforts to get into the foreclosure auction business to replace all its lost real estate advertising. I meant to follow up on that with a few words about the auction business itself. I mentioned in the story that two big players, REDC and Hudson & Marshall, have essentially locked up the business of auctioning off the houses that mortgage issuers are foreclosing on.

The question is how these two players have managed to split the market so efficiently. One thing to look at is their relationships with the banks that serve as preferred lenders for their auctions. These lenders seem to be largely the very same ones that financed the houses that are now being foreclosed on in the first place (I wrote about Countrywide's relationship with REDC earlier this year in Slate). It's a relationship rife with the possibility of conflicts of interest. If a mortgage company actually owns the underlying mortgage, it has a great deal of incentive to finance a buyer that will get it out of foreclosure, even if the loan is likely to go bad later. If, one the other hand, it's the servicer for a mortgage that's been packaged into a bond and sold to investors, the big incentive for the company auctioning off the house isn't to get maximum value, but to make sure it gets to finance it (hey, there's not much mortgage business these days). It's a small corner of the real estate market, but it's one that's worth looking into. Though the whole mortgage crisis is feeling a little like yesterday's news with everything else going on, isn't it?

Aw, Forget The Headline, GM Can't Afford It

So Congress has for the moment told the auto companies to drop dead--and that's after Nancy Pelosi's half hearted claim that bankruptcy wasn't an option. A few days ago in this story for The Big Money I wrote about how the crisis in Detroit gave ideologues on both sides--right wingers who hate unions and left wingers who hate big cars--a chance to remake the auto industry in their preferred image. I'm not sure there's much to add now: is it any wonder that the deal fell apart when it goes straight to the most fiercely held fixed ideas on both sides? You can't really split this baby in half.

There is one thing that both sides have right: the "other guy's plan" sucks because both plans suck. Yes, we can let them rot and go bankrupt. But then who's going to figure out what to do with their laid off workers and busted pension plans? Or, yes, we can mandate that they limit their production to compact hybrids. With gas back down below two dollars a gallon, there's no need to worry: if Ford stops building F150s, Toyota can pick up the slack with the Tundra. I said a few weeks ago that with the auto industry in the shape it was in, the federal government couldn't ignore the "battleground state" of Michigan once the election was over. I was wrong.

Countrywide May Die, But Fine Print Lives Forever

I've pointed out before, in stories and in this blog, that modifying the terms of mortgages that have been packaged into bonds and sold to investors is not as easily done as people think. Specifically, I'd pointed out that the terms of the mortgage bonds that Countrywide issued required it to buy back any mortgages for which it modified terms. That "buy back your own dogshit" rule is the reason that Countrywide spent a good year making sure it didn't do that.

Well, now that Bank of America has bought Countrywide, they've gone ahead and started modifying loan terms--at this point far less an expression of generosity from the bank than of sanity, since the alternative to modifying loans is to foreclose and get stuck with yet more houses the bank can't sell. But guess what? The bondholders have sued , and are demanding Bank of America now buy back $8.4 billion of loans. This may seem crazy to you--the bondholders are not likely to be better served by foreclosure (though there could be exception, the terms are complicated and not all bond holders have the same interests). But the plain language of the terms is clear, so I'm genuinely wondering if the people who keep track of ... oh, you know, potential 11 figure liabilities ... for Bank of America's Ken Lewis told him this before he decided to plunk down a bunch of stock to buy The Most Evil Company In History.