Roundup: A Two-Sided Scandal

Don't forget how this started; Times, Journal, others, on pricing the waste; Frank, Will, etc.

One thing forgotten by the business press in the debate over the $700 billion bailout, I think, is that this is not the first but the second blow dealt ordinary Americans in the credit scandal.

Forcing taxpayers—who had nothing to do with any of this—to buy the world’s most mysterious securities, that’s only the van backing up over the body.

The first blow was already delivered in the form of wildly unsuitable—indeed, trick—mortgages sold as the lending industry, starting around 2004, descended into what can only be described as breathtaking corruption to meet Wall Street’s rising demand for mortgages. If that sounds strong, I’d submit it’s only because the business press has done a poor job assembling what is in fact a very rich record, indeed. This initial accident is the one the Justice Department and FBI are investigating, and the one that California, Illinois and other states are suing about. Read all about it in CJR’s print edition (subscribe, for Pete’s sake, or okay, read it for free here).

The first blow is in fact far more damaging to the millions of those involved since it involves an equity loss and wealth transfer from homebuyers—non-combatants in the financial-services marketplace, and a particularly vulnerable group at that—to the professional classes of mortgage brokers, lenders, bond salesmen, etc.

The third blow is yet to come as the economy slows, and may trough for years, as a result of a crisis purely, solely, of the financial-services industry’s making.

As I’ve said, I really don’t think it’s possible to understand the credit crisis and bailout without fully appreciating the extravagant crookedness that underlies it. My former colleagues in the financial press, I think, are getting there. The political press is just getting started and, at this rate, may never make it.

In other news:

David Leonhardt of The New York Times asks the right question: how much is the U.S. going to pay for these securities, the value of which is utterly unknown? He says the value ranges from 25 cents to 75 cents on the dollar.

I say, Merrill Lynch sold its junk to a private equity firm back in July for 22 cents, and gave such generous terms that the real number is actually lower.

Leonhardt is wrong that it’s the only question people should focus on in this rush to passage. Still, it’s a good question, also asked in this Wall Street Journal Op-Ed:

First, there is the central issue of how to price the assets. When the subprime crisis hit in the summer of 2007, the Treasury’s first response was to encourage the private sector to create a fund — the so-called “Super SIV” (structured investment vehicle) — to buy mortgage-related assets. This proposal foundered due to the difficulty of setting a price for these assets which come in complex and incomparable varieties.

And in this Journal editorial:

Private capital is vital but won’t be forthcoming as long as no one knows what those assets are worth and which firms might fail.

And by Bill Gross, the king of bonds, who seems to be offering the rosiest scenario of all time:

I estimate the average price of distressed mortgages that pass from “troubled financial institutions” to the Treasury at auction will be 65 cents on the dollar, representing a loss of one-third of the original purchase price to the seller, and a prospective yield of 10 to 15 percent to the Treasury. Financed at 3 to 4 percent via the sale of Treasury bonds, the Treasury will therefore be in a position to earn a positive carry or yield spread of at least 7 to 8 percent.

Easy for him to say. If it’s such a great deal, why doesn’t he take it?

This Journal news story tries to explain the mechanics of how the government would hold some sort of auction to determine values. It is not very comforting:

One concern raised by members of Congress and others is the potential conflicts of interest among the asset managers who would be hired to run the program. Some critics worry that the program would create incentives for asset managers — or a future Treasury secretary — to benefit institutions with which they have financial or personal ties.

I’m sure that will never happen. This is Wall Street we’re talking about. But even assuming good faith how are our buyers going to know the value and overcome the advantages the sellers have in all of this? Unknown.

Other recommendations:

Liberal opinionist Tom Frank in the Journal:

The philosophy of government that has dominated Washington for almost three decades is now in ruins, and it is up to Mr. McCain to find out exactly why we believed it in the first place. Why did government stand back and permit all the misconduct that generated all this bad debt? What particular ideas led us to believe that government should just keep its hands off and let markets run their course?

(On a related topic, check out this brilliant piece by The Audit’s Elinore Longobardi on the press and Phil Gramm.)

Harold Meyerson in the Post calling for taxpayers to get an equity stake for its riskiest ever investment:

And having endorsed the Street’s version of socialism — the American public picks up the tab for the financial sector’s mistakes, no questions asked — Paulson and the administration and the Republicans remain opposed to the more democratically socialist, or democratically capitalist, proposition that the public should get something for its investment. China, Singapore and the oil emirates cut a deal for their people. Why won’t Hank Paulson cut one for his?

And George Will:

The essence of this crisis is lack of knowledge, including the inability to know who owes what to whom, and where risk resides. In such a moment, government’s speed should not vary inversely with its information.

That’s not the essence, but it’s a good point.

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Dean Starkman Dean Starkman runs The Audit, CJR's business section, and is the author of The Watchdog That Didn't Bark: The Financial Crisis and the Disappearance of Investigative Journalism (Columbia University Press, January 2014). Follow Dean on Twitter: @deanstarkman.