If J.P. Morgan came down from heaven this evening, with a $700 billion check to buy mortgage securities, conservatives like Jim Bunning would be shouting hallelujah and liberals like Chris Dodd (right) would be muttering about a "single individual taking over the economy."
Well, as I explained yesterday you and I are J.P. Morgan. We are the only folks who can play the part. So the roles are reversed. Conservatives are calling this "socialism," and liberals like Dodd are reluctantly going along.
There is no doubt among market makers that, without new investment, the "big shitpile" will kill the economic patient. In this case the name is apt. The market is constipated. The money is a laxative.
What does the shitpile consist of? Mortgages, and complex instruments based on mortgages. Some of these are bad mortgages, or mortgages that are going bad. Many are not, although if jobs are lost or prices keep falling they might become bad. But because of how these securities were constructed, and what traders were then allowed to do with them, they are all currently worth zero dollars.
What is needed to find a price? Liquidity and time. A buyer willing to step up sets a price for these securities, injecting money into the accounts of the sellers. The buyer can then look at the securities and see what is what, where the real value lies and, following this audit, take losses on the bad parts and sell off the good parts. The person who got the money is not going to stuff it under a mattress. They are going to reinvest it in something. Maybe new mortgages. Maybe the new securities created by the people they sold the initial securities to. Maybe in windmills.
Without this buyer emerging the securities remain worthless. You may continue to make your mortgage payments but the holder may still call the mortgage, trying to get some cash. Even if your home is worth more than the mortgage principal (and given the present state of the market, with all those foreclosures and all, that’s unlikely) you then have to enter a non-liquid market and find a new loan, or you lose the house.
This is what Democrats fear, and this is why most Democrats are stepping up to the plate. (There are exceptions among Netroots Democrats who fear this is all a big scam on the part of the Bush people to take their last dimes and run off to Dubai with them.)
This is what many Republicans are conveniently ignoring. This is something investors need to remember on November 4.
Is there risk? Yes. Whoever is in charge of the money pile may make a
pricing mistake. We may lose some money. And it is likely that initial
purchases will be at a price above what the market should really bear.
It’s what William Seidman (left), who started the unwinding of the last such fiasco, called "chum."
Fishermen know what this means. You throw some fish guts into the water
to attract a school of fish. Then you put your poles in and start
catching fish. The chum in this case represents the initial purchases,
at prices the market has confidence in. Then you can start pulling in
fish for the cost of bait.
Sellers right now are as scared as a school of fish. This is an
enormous opportunity. Why isn’t a private party then pulling them into
the boat? Because no private party has enough free capital to do it.
Even Warren Buffett doesn’t have enough free capital to do it.
Only you do.
Now there is a second, larger, more systemic risk in all this. That is,
it may be these are all worthless securities, enough to break every bank that has touched them. If that’s the
case the $700 billion would be gone in a week, there would never be a
return, and we all go over the falls.
If that’s the case, we’re going over the falls anyway. The $700 billion
means nothing. All dollars are worthless. We never had a chance. Leave
the keys in the door, go back to a barter system, and whoever has the
most guns makes the new law.
In other words, if the situation is as bad as the worst pessimists fear
then it doesn’t matter what we do. The long run has come, we’re all
dead. Kiss your ass goodbye.
But in that case trying this "experiment" is still worthwhile. You want to die now or you want to try
something first? Because those are your economic choices.
Jim Bunning wants you to die for his principles. Chris Dodd wants to try something which many smart people think will get you back your principal.