Bad Bank = Bad Idea

by Larry Levin

Yesterday’s late leak by the Obama administration of creating a bad bank to relieve Wall Street of its toxic debt was cheered today. The indices all posted very strong closes. If the bad bank is created, has the debt problem gone away? No! Come on folks - wake up! This is nothing but a shell game. The putrid debt of the banks and brokers will simply be moved, but the new stewards of the decomposing assets will be you, and your children, and your grandchildren…and your great grandchildren.

Have you heard what the initial cost of this will be? The first guess by the circus clowns that keep getting re-elected to Congress (aka, Representatives & Senators) is $1 TRILLION. And this is on top of the so-called “stimulus” plan of $825 billion. However, the current plan will stimulate little and come in with a total price tag of $1 TRILLION. So this week the Obama Administration is proposing to put you in debt by an additional $2 TRILLION (snap) - just like that. Why should we believe it will work this time? Remember that Congress, Treasury, and the Fed have already printed up or promised to loan more than $8.5 trillion to try and get us out of this mess.

In Washington DC if something doesn’t work, the plan isn’t killed, it’s expanded. Better intentions are all that are needed they say. “Change?” I think not.

The supporters of this idea claim to find successful precedent in the Resolution Trust Corp of 1989. Like in true politico-speak, however, only half of the story is told. When all of the data is considered, the RTC was not financially successful. It may have been successful in terms of taking the bad assets of the failed banks and eventually disposing of them, but it was done at a loss to the taxpayer. If you hear anyone on television or at a local cocktail party say that the RTC was profitable, they are at best misinformed, and at worst lying.

So if the history of past banking rescues is any guide, there’s a very high probability (I’d say 99%) that removing toxic assets from bank balance sheets will leave taxpayers with a significant tab. What’s more, many of you as well as me weren’t even at the dinner party known as Wall Street’s Easy Money Machine, or House Flipping 101 - The Guide to Easy Riches. Nope, we just get the bill.

Comparing the current situation to the RTC is about all the proponents can do, but things are far worse today. When Congress created the Resolution Trust Corp. in 1989 to clean up the mess left by the collapse of the savings and loan industry, legislators gave the RTC $50 billion to close or resolve troubled institutions. But that was just a down payment. The RTC wound up fleecing the taxpayer three additional times over six years, as regulators confronted an industry whose health was much worse than feared.

DOES THIS SOUND FAMILIAR? TODAY WE NEED JUST $1 TRILLION…TO START!

According to a study published by the FDIC in 2000, taxpayers eventually took a $124 billion beating on the RTC’s operations, losing 31 cents on each dollar of assets it handled. What’s more, since the RTC was simply disposing of the property of failed institutions, it didn’t have to pay for assets it later sold.

Today, however, the current masterminds in Washington want to PAY the banks for their $#!* assets. Hmm, so the government won’t allow these institutions to fail, the housing problem is at least 3 times greater than they think, we will be paying for worthless JUNK, and no boards of directors or executives will be fired - sounds like a great plan.

It is simply another money grab that we will pay for in perpetuity!

In the end it won’t work because this is just the beginning. What’s coming next are; a wave of Alt-A mortgage defaults, credit card defaults, auto loan defaults, State defaults, and a commercial real estate bubble that, when it bursts, will dwarf the housing bubble.

I have harped about the government and the Federal Reserve sowing moral hazard seeds throughout the economy because this is what we reap: everyone looking for a handout. Capitalism without the fear of failure (moral hazard) is like religion without the fear of hell: it just doesn’t work.

But the government isn’t stopping there - oh no! Today we learn that late Tuesday a key House of Representatives committee approved legislation that would give bankruptcy judges the authority to eliminate some mortgage debt in order to help reduce foreclosures. If this is passed into law, you can kiss the idea of a contract goodbye.

As usual, the mental midgets in Washington never consider the unintended side effect of their legislation. In my opinion, if judges can force a bank to eat a huge portion of their assets, (essentially giving the homeowner tens of thousands of dollars back) the consequence will be that private investment in single family mortgages will dry up like a desert. Who will invest if they cannot determine the risk or yield?

And if this legislation passes, how will lenders approach NEW loans? Will the fees and rates be the same? Hell no! The lenders will charge more for new loans to compensate for losses on their old modified loans. Once again, those of you who were not involved in the wild orgy of home loans from 2004 through 2007 will be paying the tab.

“Hello Mr. Ben Dover. Bend over - here come the terms.”

So what are we teaching the next generation? Apparently it is to get the biggest mortgage possible - and refi the f*&#^@g hell out of it. It will be a win-win; if the house value appreciates that’s good, if the value goes down no worries, the government will reimburse you the difference via the new power of the judge. And if you decided you don’t want the house, just walk away and rent. Seems like a low risk trade.

It’s all so ridiculous because 100% of this money is coming via the kindness of strangers: foreign investors. But the problem with this approach, like Socialism, is that eventually you run out of “other peoples” money!

Previous Day's Trading Room Results:

Trade Date: 1/27/09

E-Mini S&P Trades*
(before fees and commissions):

1) Engf buy @ 8:50am at 860.00 = -2.25 (1 lot)

2) Algorithm positions (3)…combined SofT and Algo total…+1.75

ZB (30 Year Bond) Trades*
(before fees and commissions):


1) No trades today.



Sign up as an AvidTrader Member to receive "The Technician" Value Area's each day. The market then has an 80% chance of filling the Value Area. Many traders familiar with the Value Area and the techniques that go along with it use it to help them decide what trades to do each day. Join and see how this technique can help you trade more successfully!