Monday, December 29, 2008

Somebody always makes money

The New York Times reports that a lot of old hands who were in the thick of the late 80s/early 90s bailout of a passel of failed and failing savings and loans, the Resolution Trust Corporation, are now homing in on the bucks to be gotten in our current mess. Says the Times:
What is obvious to former R.T.C. officials is that, like the last go around, a great deal of money will be made by a select group of investors and business operators, particularly those with government contacts. The former government officials said in interviews that much of what is motivating them is a desire to help the nation recover from this latest stumble. But they acknowledge they intend to be among the winners who emerge.
That $700 billion in TARP money is getting spread around. Deals are getting done. And, most importantly, commissions are being charged.

One interesting outfit emerging from all this is SecondMarket, which bills itself as "the marketplace for illiquid assets." This is curious largely because "illiquid" means there is no market for the asset. Illiquid assets are items of dubious value which are REALLY hard to sell. Say, for example, you own a basket of debt paper issued by a company like Lehman Brothers. What can you do? The debt issuer is bankrupt. If you're the guy charged with telling regulators and shareholders what your assets are worth, you need to find out what an illiquid asset like a bond issued by a bankrupt bank can be sold for. Nobody wants it, true. But there is still something of value left in the corpse of Lehman. Some spare change under the couch cushions, maybe. And your bond gives you claim to a portion of the remaining money pie along with all the other creditors in line for a slice.

The fine folks over at SecondMarket have a plan for you: they work to make markets for junk like that. Even if it's only a few pennies on the dollar, they can find somebody who'll buy your paper. The trick is arriving at the right price.

Currently SecondMarket deals in auction rate securities, bankruptcy claims, restricted securities, and limited partnership interests.

Auction rate securities were once touted as safe as cash. They're bonds with long maturity periods, but which are auctioned monthly or even weekly, so their value fluctuates according to what the market will bear at any given time. It's a long-term debt that behaves like something with a much shorter half life. But about 11 months ago the auctions began to fail. Nobody wanted to buy them because of their risk of default. They once were liquid. They became illiquid.

Restricted securities are financial instruments which are bought from companies under certain circumstances which are not registered with the SEC. They are part of the so-called shadow financial system. Since they may not be sold in the regulated market for financial instruments, they are also illiquid.

Limited partnership interests are basically hedge funds. Here's a telling quote from the SecondMarket Web site:
Limited partnership (LP) interests are ownership rights in investment entities
such as private equity funds, hedge funds, and funds of funds (also known as
alternative investment managers or AIMs). Over the past several years the
secondary market for limited partnership interests, which are typically longer
term investments, has grown tremendously.

The market is expected to continue to grow at a rapid pace as many limited
partners seek to reduce their alternative investment exposure. Many are
requesting redemptions or simply seeking to get out of their positions largely due
to poor fund performance, a need for capital or a desire to rebalance their
portfolios. To fund these redemption requests, many AIMs are selling their
positions at sub‐optimal levels, artificially decreasing capital availability and asset
prices as well as increasing market volatility.
The secondary market is comprised of folks trying to dump shit before the stink gets too strong for their noses or stomachs. And the dumping has pushed the price of their shit pretty far down. It'll go down more, but someday the price will rise. So the plan is to make markets for these items with people positioned to buy them at fire sale prices, people expecting an economic turnaround in a reasonable time.

The management team at SecondMarket includes a "Senior Advisor" by the name of Bill Seidman, a CNBC talking head, a former FDIC chairman, and the fist chairman of the Resolution Trust Corporation. Says Mr. Seidman in the Times:
“It is an enormous market,” said Mr. Seidman, who has already joined two such potential money-making efforts and is evaluating proposals to participate in a third. “I am enjoying this.”
Well there's big money to be gotten. Why not?

Here's why not: We have a system of finance designed to cheat us. Its job is to make industry and services possible. Its effect is to generate imaginary wealth.

Somebody wants to open a cafe? He gets a loan and works his ass off to pay the loan back. A school district wants to build a new computer lab? They float a bond and the honest citizens of the district pay taxes to make the debt right. Somebody wants to open a tech business? He borrows to make it happen and then works to make it happen and repay his debt along the way.

But the financial markets have gotten butt-ugly distorted. They've fallen down the rabbit hole and begun to hallucinate wealth and value when there is none. Market fundamentalists will tell us over and over and over again that they make entrepreneurship possible with their capital machinations, but I can see no proof of this supposition. They only make money for themselves. They care not for goods and services, except insofar as they can buy them with their many many dollars.

At some future date SecondMarket will begin dealing in collateralized debt obligations and mortgage backed securities and other instruments of financial innovation. And they'll make another boatload of money, as will their more savvy investors. When this happens, there will be no increase in entrepreneurship. There will be no new ideas about dinners out or digital widgets or instructional technology in public schools. There will be only dollars.

Can you see what is wrong with this picture?

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