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I ask this in all seriousness - how does a 20% drop in M3, which is what we're seeing, decrease the value of the dollar? At the risk of sounding like Ron Paul, a goldbug or, God forbid, a monetarist, shouldn't less dollars make the remaining dollars more valuable.


You're the best at explaining things in simple terms. I've been frustrated trying to educate myself on what exactly is going on and what the remedy should be. Could you elaborate on this post about an asset swap and the dollars' devaluation?

Damn. The timing of this really sucks. If it were up to me I'd postpone the election until this settles down. Too much political posturing going on. I'm very discouraged.

I am with you Steve, it is not a "bailout". The Treasury is doing a swap. One must first ask where do treasury securities come from. The Treasury typically issues them to cover deficit spending; if the treasury spends more than it receives in tax revenue it issues a treasury security to cover the difference. In other words they are made up out of thin air without affecting the taxpayers (an example is usually required to make this point. If the govt needs to spend $200 but only gets $100 in tax revenue, it sells a $100 security to the public. The public has given the govt $200 which it gets back when the govt spends the money. So the public has its original $200 but it also has a $100 treasury security - made up out of thin air!). We do have to pay interest on those $700 billion in Treasury Securities. Two points, the 3 month bill is currently yielding near 0%. Not much interest payment there. And the public in the aggregate is paying and receiving the interest so it is just a redistribution within the private sector. We could argue about the tax code being fair so that those receiving most of the interest pay the tax to cover the interest, but the tax code is an argument for another day.


I started the week right where you are, and then I watched as Democrats starting piling pork on top of the asset swap. I'm scared to death that government largess is going to overwhelm a decent idea and create another total Chicago-style mess.

I'd highly recommend a deep breath, $100 Billion instead of $700 Billion, letting some companies go bancrupt, removing "mark to market", and some balance to the immense power that the Treas Sec would get under the current proposal.

I don't care about CEO pay, that's the shareholders' problem, and they tend to be too lazy to step up when they have the chance to get new board members.

The WaMu FDIC to Chase Bank late last night proves there are other solutions besides government cash

Tom: The value of the dollar is driven by public opinion -- WORLD public opinion -- and the public votes every day and every week as to the dollar's value, in the forex markets and in the market for US Treasury securities. Those opinions (i.e., money demand) determine the inflation rate and the real interest rate on long-term Treasuries, not the money supply. When the buyers' consensus is that the dollar and our economy have a solid future, it amounts to a priceless intangible asset on our balance sheet; if the consensus turns sour, that intangible asset vanishes. Both of those are possible at any given level of "money supply." Lastly, although I haven't been watching the components of M3, a drop in the money supply of 20% can be driven by a credit freeze: maturing loans get paid back, but not rolled over into new loans. That's definitely NOT good news; it's an indicator that firms and individuals are unwilling to do business with each other. (See my next note to Bob.)

Bob: The "asset swap" is a trade of liquid money for illiquid financial securities (essentially, bonds of unknown value). The government will become the owner of those securities, straighten out their true value, then sell them back to private sector investors. In effect, the government creates temporary new money, trades it for those securities, straightens out the value of those securities, then recaptures that "new" money by selling the securities back. The temporary new money is necessary for unfreezing the credit markets.

Why are the credit markets frozen? Let's say we have a bustling financial sector dealing in nothing but billions of chocolate chip cookies and billions of dollars. I'm a bank, and I have a balance sheet consisting of a million dollars cash plus a million dollars worth of cookies, and that mix churns every day: some days the cookie/dollar ratio is 75/25, some days it's 25/75. Same thing is happening at all the other firms I do business with.

All along, I've simply been taking the quality of chocolate chip cookies for granted as I've scurried about managing my business. Then: somebody who knows how to judge the quality of chocolate chip cookies better than I do announces that, guess what, a small but nontrivial portion of the cookies were mistakenly made using pieces of dog crap instead of chocolate chips. Word spreads quickly. Guess what happens to my willingness to increase my ratio of cookies to dollars. Same thing happens to all the other firms: nobody wants to buy cookies from anyone else, and everybody wants to sell them -- even though only a small portion of the cookies have the problem. The movement of money and cookies stops. The velocity of money drops to zero. That's a credit freeze. If it's not unfrozen, the problem spreads: working capital dollars stop flowing to businesses, who then cannot pay some short term obligations such as wages and salaries, who then have to cut back their operations, which causes those laid off to cut back on their purchases, which further decreases the velocity of money. That's the beginning of a recession at best, a deflationary depression at worst.

Unfreezing the credit markets quickly is absolutely necessary. The Fed and Treasury need the authority to buy up all the chocolate chip cookies, sort out the perfectly good ones from the tainted ones, then sell the cleansed assets back to the private sector. If a few of our politicians are ignorant of what that process is all about, a baseball bat to the side of the head is in order, this morning.

I've heard that 99+% of the public is "against" the "bailout" -- and I suspect that might be why a contingent of House Republicans is holding out. If that is the case (as opposed to ignorance), a baseball bat is still in order. The two parties' politicians need to unite, do the right thing today in spite of public opinion, then explain it to the public later. We are out of time, folks. Leadership, not political game-playing, is what we need.

Last note, for what it's worth... If McCain had anything to do with encouraging the faction that's holding out, it's over: my vote will go to Obama.

It is beyond me why so many who should know that apparently don't know that.


Hand me the baseball bat, please.

Your post was the bright spot in a very gloomy morning, Steve. I was beginning to think the entire world was insane.

According to this account, McCain did not encourage the hold out.


He only acknowledged their concerns and urged all sides to come together.

Funny, despite their public comments, I thought Bernanke and Paulson have been doing their best to devalue the dollar over the past 2 years.

I guess I'm confused about the "asset swap" thing. If you swap cash for something that, almost by definition, has no credible value, is that really an asset swap. I seem to remember that the feds told us the RTC would end up turning a profit for the taxpayers. Last I checked, not so much.

Excellent explanation. Can someone please email this column to John Boehner.

The emotional view by Joe Sixpack comes from the terminology "bailout of Wall Street."

That is unfortunate, but expected. The majority of the populace function entirely from their lizard brains.

Steve, It sounded to me like the "holdouts" were pushing for insurance as opposed to buying the bad loans. I heard Newt talking about a "workout" instead of a "bailout". How are we worse off with the insurance concept?

Thanks as always for your insights.


I agree w/ Cassandra - your explanation has helped me pull back on the throttle. I had a gut feeling that when the stinking media continually uses the term "bailout" over and over and over that they are up to something. I now better understand this is a debt swap.

Found this today...it also allowed me to relax a bit more:


Lastly, we're screw either way IMHO. But, if I am going to get my pocket picked - and that is for certain - I'd prefer to have it done by a socialist than a warmonger neocon wannabe. Plus, by choosing Palin McCain lost all credibility with me.

Check that..."asset swap" not "debt swap". My bad.


I love the blog and I've been waiting for your comments on the asset swap aka bailout.

My question is I'm not sure how this additional money is actually put into the economy. Is it by the usual method that the Fed does when it drops interest rates? (Which I understand is through the auctioning of treasury securities until they get to the target rate thus providing banks with additional monies at the new interest rate? To me that sounds like business as usual. However, when the government takes title to this "bad" paper (mortgage backed securities?) who is actually going to manage the sale of the assets such as real estate? FHA and HUD? Freddie and Fannie? A new government agency? These are not rhetorical questions. Who will do this?

I also think that politics cannot help to become involved in this. Whatever the final compromise is, the next presidential administration will have to deal with it and do most of the implementation. And they will get credit and/or blame.

Rich: There are two ways the government can get the money to buy up the chocolate chip cookies (and the second way is the one they'll use for this): (1) The Fed "prints" new money, and uses it to buy the cookies; or (2) the Treasury prints new T-bonds, sells them to the public, then uses the proceeds to buy the cookies.

Note that it is not taxpayers, but willing buyers of Treasury securities who initially provide the necessary funds.

How the asset sales will be managed is still to be worked out. The CNBC show Fast Money (Dylan Radigan's show) has proposed a transparent auction market to several politicians (...a bunch of savvy traders came up with the idea, and he passed it along to every politician he interviewed); the politicians appeared to be listening, too, although I can't assess how much actually sunk in. Bottom line is, nobody knows all the details yet, but the cookie buy-up half of the plan is slightly more urgent at this point.


I am with you a huge percentage of the time. However, I do have serious concerns about this ‘asset swap’. I’ll use your analogy of turds in the chips…

Let us postulate that the government funds the purchase of the cookies with Treasuries. If our brilliant government asset managers (maybe borrow some expertise from Fannie Mae or Freddy Mac) can melt, mash, and refine the assets - separating the turds from the chocolate - than you have at least two piles of assets. The pile over here is comprised of quite tasty chocolate chip cookies. Yummy. I think I saw Barney Frank romping and chomping on that pile. But, over here, a nauseating fecal smell permeates the atmosphere. The dogs come by, sniff, and walk away. Children run gagging from that pile of ‘assets’.

However, we know the truth, eh… Nobody will be able to refine these assets into their elemental parts. How are you going to know if grandma Boomer One bought a small, almost imperceptible, turd in her cookie while grandma Boomer Two owns an untainted treat. Anyone think any politician will have the heart tell Grandma One to give her cookie back – tell her she is gobbling on a turd. Upper lip quivering and feeling her pain or something. We all know everything will be dumped at fire sale prices because the government will not be able to sniff out the turds from the chips. Our government won’t even want to get on their knees and initiate the sniff test.

Regardless, assuming our vaunted government sniffers are up to the task, now what do we do?

1. Mix it all back together to hide the power of the stench and mark it down with a known turd to chip ratio. What happens to the Turd Tainted Treasuries? This is the most likely ‘solution’. Yippie, this asset lump has a turd to chip ratio of 5%. We can make a plan or something. However, Grandpa and the Chinese and the Saudi Sheiks will want a bit more of a return to cover their potential medical bills. But, at least they know they have a 5% chance of catching cholera.

2. Keep them separate. Wait till the good assets grow in value enough to cover the cost of the turds under the tarp. All the while paying the rent on the gym where the two piles are stored (the cost of borrowing required to purchase the original pile of tainted assets). Might be a while. Then hire someone to start shoveling the turds into the toilet bowl. Don’t want this to be a SuperDome thang, eh…

Here, however is my solution!

Since the brilliant government flaks are obviously in charge – and worthy of managing a trillion dollars – they obviously have some handle on what they are buying. That is, they must have some idea of how big the pile under the tarp is in relation to the one Barney Frank has been traipsing in. Have confidence. Now, in my opinion the government should fund the ORIGINAL purchase of the asset mix via two different instruments. Something like a Ginnie Mae for the yummy cookies. And, a brand new ‘Treasury for Turds’ bond for the not so good cookies. If someone buys the ‘Treasury for Turds’ bond he/she is speculating that there will still be some chips in the mess. Probably a good bet, eh. Then get to the refining.

Here, Steve, is my offer:

I’ll buy the second ‘Treasury for Turds’ bond.

Steve, you buy the first.

Hopefully, the bond will have a cute design like a Disney stock certificate. Maybe a collector’s item.

Hi Steve,

You're my final reference for stuff like this, but from what I've seen - which admittedly isn't everything since, after all, I have a job outside the financial world and only have a limited amount of time to devote to education on this - you may be misreading the Republicans' resistance to the plan(s) proposed so far.

My take is that the Treasury / Bush originally proposed a plan designed to keep the strong economy (yes, I've agreed with you that it is strong) strong. This involves preventing a stock meltdown by purchasing as much toxic debt as the government can hold so that the value of the companies currently holding those debts don't plummet and take the rest of the market, and then the economy, down with them like 2000/01.

The problem was in Paulson's hysterical rhetoric (justified or not) and in his demand to prevent any oversight. Paulson didn't see this coming. Neither did Bernanke. Neither did Bush. Bush has given warnings and joined with Greeenspan twice to try to increase oversight of GSE's like Fannie and Freddie, but he (and the Treasury) were obviously not aware of the magnitude of the imminent threat to the economy that so suddenly emerged.

So, from a taxpayer's and Republican Congress perspective, why on earth would anyone trust their judgment on how to resolve the problem?

Furthermore - as someone else noted - as soon as a bill was guaranteed passage because something MUST be done, idiots like Dodd began using it to further their own political agendas - like his desire to allow "unlucky" (??!) debtors to walk away from debt virtually scot-free (see his campaign website on bankruptcy "reform" for more info). Bush and the Treas. Dept. may want to include school and car loans in the asset swap because it will further shore up the economy (indirectly - see above), but taxpayers (and Republican Congress on their behalf) are naturally going to balk at even temporarily acting as guarantor for some surgeon's $350k in school loans or some welfare recipient's failure to pay her car loan.

So I don't think the Republicans are as stubborn as much as they're suspicious. I am too. I simply don't trust this government - which allowed us to get into the current position - to CORRECTLY perform an asset swap of the magnitude we're discussing.

I would MUCH rather see something like what was done with WaMu - auction off the assets and securities of Fannie and Freddie directly AND DISSOLVE THEM - leave the government funding OUT of it. If that requires federal involvement to broker (without actually acting as a middleman) fine.

I don't know if something like that's feasible, but I don't see how it would work out any differently - unless of course the government is going to assess the illiquid assets and guarantee a minimum value before selling them off - which leaves the taxpayer exposed. Given the "speed" at which the federal government moves, a direct auction seems like a much more expeditious solution - one which doesn't allow for the possibility of the taxpayers' holding the bag. The market is going to correct itself, most likely resulting in a recession, either way. Given that, I'd prefer to see American Enterprise ingenuity working through a resolution on this, not a bunch of worthless political hacks with agendas as long as my, uhm, arm.

President Bush almost dragged us out of annual budget deficits between 2004 and 2007. He used an incremental improvement approach. He knew he had to bribe both Democrats and Republicans to succeed in the war effort and to have any chance to improve the asset backing of Medicare and Social Security.

However, he did not act quickly enough. And, he too easily accepted the ‘requirement’ to bribe our lousy Congress (the one we elected – so don’t blame those louts alone of stupidity) to get necessary things done.

The implication is that during a time of massive Federal government revenue increases we never grabbed hold of a budget that bloated by 7% - 9% per year. Thus, we never ran a surplus. Shrinking government bloat to the inflation rate for ONE YEAR would have resulted in annual surpluses in the good times (2005 through 2007).

Had we run surpluses I would have more faith and confidence in the U.S. Government.

Not running those surpluses means that I have NO faith and confidence in the U.S. Government.

We are running a half trillion annual deficit this year.

Do we want to run a $1.2 Trillion annual deficit next year – just in time to start paying for Obama’s health care plan or McCain's military/Veterans Benefits annual 11% growth.

Boghie and goy:

I do understand the concerns. You have articulated one of them; specifically, the second of the two major problems. Here it is:

(Problem 2): The inept, corrupt government would bungle the buying and selling of the securities that were freezing up the credit system.

By the way, here is the other problem:

(Problem 1): A credit market freeze could push the economy into a deflationary death spiral.

Guess what: If Problem 1 isn't solved, then Problem 2 will not be of concern to anybody -- because it won't have a chance to happen. I personally hope we make it to the point at which we must solve Problem 2, because that would mean Problem 1 had been averted.

That said, there are plenty of ideas being floated for fixing problem 2. Transparency into all transactions is the basic idea. Outsourcing was what helped reduce the effect of government ineptness during the S&L fix; "Crowdsourcing" is what Mark Cuban and several others are now suggesting for this one (for a definition, see this article: http://tinyurl.com/6732ln ). Sunshine is the best disinfectant. CNBC was brokering such ideas with politicians every day last week. Probably next week, too.

Both problems are big ones, but problem 1 is the first in line.

When Michael Darda, usually an optimist, summarized the status of the credit markets on CNBC Friday, he said "This is really scary." Commercial paper and short term revolving lines of credit are the way businesses meet payrolls and pay their bills; they are the capillaries of the economy. They are close to drying up, as of two days ago, according to Darda and other experts.

Here's more, from an article in the LA Times today:
“If the Dow goes down 1,000 points, you know exactly what that means,” said Michael Darda, chief economist at the investment firm MKM Partners in Greenwich, Conn. "You’ll see it on the news and in your 401(k). It’s palpable and understandable. If the credit markets freeze, that hits the economy with a lag, but it’s just as powerful, maybe more so.”

The economy and banking system run on credit, much of it short-term in nature. Untold billions of dollars change hands each day to fund U.S. banks’ operations and the workings of companies and local governments.

If that money stops flowing, the economy loses the lubricant that keeps the gears turning.

(source: http://tinyurl.com/3tjxf7 )

Wouldn't it be nice if our politicians could solve both problems by Sunday afternoon, then have a unanimous kumbaya photo-op (prior to 8pm Eastern, when the Asian markets open for business)?

Yes, that would be nice.

But if they can only solve one of the two problems by Sunday night, guess which one it should be ... even if getting them focused on it requires the help of a baseball bat.

Steve -

Just a word: there is no Republican "holdout". The Democrats have the votes, Bush will sign.

The Democrats desperately want the House Republicans on board because that means that the Democrats won't be the only ones bearing the richly deserved condemnation for the bail-out.

The House Republicans are holding to their principles, rightly so. The Democrats need to bear the burden of this: they caused it, with their CRA and the resulting creation of subprimes.


I do not believe the house republicans know what is at stake and it is only because of the election that they are resisting this plan. You don't see this kind of uprising in the senate.

Steve, concur…

Although it might sound as if I would never accept the asset swap that is not exactly correct. When Bernanke appeared in front of the Congressional Ignoramuses (my states is responsible for Boxer and Pelosi and Waters) to present his case I knew in the end I would be chowing on some turds. You are right, cholera is treatable - death is not.

I do like the insurance option, the pork reduction, the balanced oversight, and the sunshine policies the conservatives have managed to push through. That was worth the delay. The insurance option will probably be taken by banks in reasonably good shape that got caught in this mess through little or no fault of their own. Dropping the 20% skim on profits for an ‘affordable housing’ boondoggle to activists was a big plus. And the Liberals holding firm (don’t know about the conservatives) on disallowing ‘golden parachutes’ for companies at the Federal Trough was a very good thing. I do not like much government control of corporate business structure, but these chaps are lining up to gobble MY assets – assets I did not elect to invest in their caring hands. On the other hand, I don’t think that a company that elects the insurance option should be forced into government oversight of their business operations in any way.

Another thing I think might be necessary is some means of noting those companies that can’t meet a payroll or financial obligation without borrowing money. Walmart??? Sam Walton is rolling in his grave. Banks with a capitalization rate of 3% - 4%? It can be a good thing that the credit market froze for a short time – certain ‘just in time’ business practices that work in boom times demonstrably broke in down times. Lots of financial and analytical and mathematical geniuses will be looking for new employment.

So, my best guess right now is that those assets covered by the insurance are the tasty cookies. The assets swapped to the government will be those covered by the tarp with the dogs sniffing and the children crying. And, any ‘financial institution’ crying for that last $350 Billion in the bailout will be bankrupt before the tear hits the ground. Watch out… I think the credit market will revive, but the stock market will mark down companies that can’t survive on the insurance or who come to congress hat in hand to open the gates on the last slop wagon.

Me, as a soon to be stock vulture capitalist, will be looking at the options these financial institutions accept.


I just saw Gingrich on ABC's Sunday show. He repeated his objections and concerns with the package (objections with which I tend to agree), but he admitted that we have no choice, we have to do something quickly (with which I obviously agree). He and the rest of the panel seemed to understand that it's politically imperative that both parties do it together, given such a high level of public anger about having to do something so big so quickly. Count me as one of that crowd, by the way.

So, it looks as if something, as opposed to nothing, will happen today. If it does, and it appears to be (reluctant) unanimity, we'll see how the markets react tomorrow to that news -- most importantly, the credit markets.

After that hurdle is cleared successfully, we'll all (thankfully) have plenty of time for finger pointing and hindsight told-ya-so's. (In fact, I got a head start; I already posted a told-ya-so article below this one, about corporate boards.)

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