Tuesday, May 20, 2008


Welfare queens, homeowner queens and bailout queens

Those of you too young to remember Ronald Reagan may be unfamiliar with the concept of the "welfare queen," so let me explain. "Welfare" referred to government programs of the Sixties and Seventies that attempted to offset the inequities of capitalism and racism. Contrary to popular belief, they were reasonably successful—certainly by comparison with what came before and since. And "queen" at that historical moment was not thought of as a man in stockings but as someone, well, more like the Queen—abusing the system to maintain an exalted lifestyle.

Ronald Reagan didn't invent the concept. The Right was touting examples of fraud and abuse in the welfare system as soon as the programs began. But Reagan popularized the phrase in his failed run for the Presidency in '76, and Republicans have run their campaigns against the poor ever since. The media loved it, and the phrase remained a staple until Bill Clinton eliminated the word "welfare"—and thus the phrase—entirely from our vocabulary.

The homeowner queen

Now comes an effort in Congress to save at least some of the homeowners whose adjustable-rate mortgages (ARMs) are on the verge of adjusting them right out of their houses. Earlier this month the House approved a plan to help, and on Monday the Senate passed a similiar but more modest plan. If the House and Senate can reconcile the two versions, Bush has promised to veto it, since he hates to "burden the taxpayers."

I don't know if anything resembling either of these plans will eventually become law, but the Fox News guys and gals were all over the Senate plan this morning, fearful of the ways the system might be abused. Homeowners might deliberately miss payments to become eligibile for the program, one of them worried. Let's dub these greedy people "homeowner queens," because, as you know, if there's anything rightwingers hate, it's waste, fraud and abuse.

But before going further, we should consider the Congress' motives. Liberals may like to think the Congress has suddenly taken a renewed interest in "the people." But let me disabuse them of the notion. This is a program to protect the wealthy.

Those mortgage packages that were passed around in the financial community like Altoids derive their ultimate value from the soundness of the mortgages contained in the package. Currently, American banks that bought or traded in them are keeping their doors open only because the Federal Reserve is accepting those packages as collateral to loan the banks more money. So if these assets continue to turn rancid, the Federal Reserve—and hence the federal government—and hence the taxpayer—will be left with a stinking pile of trash. By saving the homeowner, Congress is trying to protect the mortgages that have not yet gone bad.

The banks go on welfare

To put it plainly, the banks along with some other financial institutions have suddenly found themselves quite poor and have been put on government welfare. If George Bush has any concern about the taxpayer in this matter, he forgot to mention it.

It's not just U.S. banks on welfare. The UK got the ball rolling when it nationalized the failing Northern Rock bank—a deal in which the British Treasury at least acquired buildings and land and generally demanded better terms than the Federal Reserve has demanded. The European Central Bank (ECB) is bailing out European banks in much the same fashion as the Federal Reserve.

I've never opposed letting the banks go on welfare. However repugnant the notion of bank bailouts are, governments and central banks had two options when the banks began to teeter on the brink of failure: attempt a bailout or face the horrors certain to follow. For governments it was an easy choice, though it's by no means certain that their efforts have been successful.

Bailout queens

But can you have welfare without fraud? Can you have any system without abuse? Not that I've discovered. So we shouldn't be surprised if banks, whose officers spend their days figuring out how to sucker somebody out of some money, started thinking of ways to beat the system—no matter how sincerely the poor politicians and central bankers were only trying to help them through hard times.

The first mention that I've read of this came Monday. The Financial Times ran a story with the enigmatic title "ECB concern over liquidity scheme." Since the European Central Bank has been scheming to provide liquidity, why should they be worried about a "liquidity scheme," I wondered.

The story, it turns out, is much more interesting than the title—

The European Central Bank on Thursday voiced its “high concern” at growing evidence that banks are exploiting its efforts to unblock the frozen funding markets by using its liquidity scheme to offload more risky assets than it envisaged.

Translation: European banks are filling the coffers of the ECB with more trash than the ECB had expected.

Yves Mersch, a governing council member, said the ECB was now “looking very hard at whether there is not a specific deterioration of collateral” which the central bank is accepting in return for funds.

He was speaking amid signs of some banks creating low-rated assets specifically so they can be traded for treasuries at the European Central Bank.

Deliberately creating low-rated assets? Why, that would be like homeowners missing their mortgage payments in order to get into the distressed homeowner program!

The Bank of England recently created a facility for UK banks to access funding for mortgages and the Financial Times has learnt that almost £90bn ($175bn) worth of bonds are being created to be placed there – almost twice the £50bn initially expected when the scheme was launched only three weeks ago.

We might be talking here about massive fraud and abuse! And in only three weeks! But far be it from me to cast suspicion upon British banks. Let's be fair. Maybe they've just been lying all along about just how putrid their assets really are.

The importance of central bank involvement in supporting securitisation markets has been shown again in the UK, where the Bank of England’s Special Liquidity Scheme has already attracted almost twice the level of demand originally anticipated.

According to debt market sources, the banks planning to use the scheme are the UK’s eight largest lenders.

Well, it's always good to help the poor. But let's see how things are working in Europe—

... the ECB, which is proud of having always had in place the same system to support bank liquidity, accepts a far broader range of collateral than other central banks. It now appears to have some worries about what is being used by banks.

On Thursday, ... speaking at the International Capital Market Association in Vienna, Mr Mersch said the type of collateral now being accepted was: “A matter of high concern.”

His comments come as banks, whose main centres of operations are not within the eurozone, are structuring new bonds based on assets other than mortgages in order to gain access to ECB funding.

Translation: Non-eurozone banks (such as banks in the Axis of English) are trying to lay their hands on some of the ECB's euros. Since there aren't enough bad mortgages to go around, they're creating other "products" that the ECB will accept as collateral.

Here are some details—

... this week Glitnir, the Icelandic bank, is in the process of clearing the use of a €890m ($1.37bn) collateralised loan obligation (CLO) for funding at the ECB. Similarly, Lehman Brothers recently structured a €1.1bn CLO, which it is expected to use for ECB funding.

Meanwhile, Macquarie Leasing, a unit of the Australian bank, has done a securitisation of Australian motor loans, which will have a euro-denominated slice so that the investors who buy the deal can use it at the ECB.

Now I know that sounds complicated, and it's supposed to. Why else would the public let them get away with it? But always remember the Simply Appalling Rule of Finance: If a banker can understand it, so can you.

Let's take out our Sherlock Holmes magnifier and examine the Macquarie deal. The scheme might go something like this: Macquarie collects all those auto loans it has made (some of which may go bad any day now) and puts them into a package for sale to investors—other investment banks, let's say. Now the actual loans, being Australian, are presumably being repaid in Australian dollars. But Macquarie announces that it will be happy to accept euros from anyone wanting to buy a portion of the package. A eurozone bank then takes Macquarie up on the offer. Macquarie happily accepts one of the world's strongest currencies and gets rid of the worry over those loans and the Australian dollar.

But why would the eurozone bank make such a purchase, you wonder? Elementary, my dear Watson. The bank can go to the ECB and trade in its "asset" for more cash. If the package of loans holds its value, it still belong to the bank. And if it doesn't—oh, well. That will be the ECB's problem.

“There is moral hazard . . . and we are not in the business of taking over the market,” Mr Mersch [of the ECB] said. “That means there must be an exit strategy.

That also means there isn't.

Back in the U.S.A.

Are American banks attempting similar shenanigans with the Federal Reserve? Who knows? The Fed has made it quite clear that what goes on between it and the banks is none of our business. But I would be surprised to learn that our homegrown bankers are less crafty than their European fellows.


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