Wednesday, October 8, 2008

Republicans and the Bailout

Pity the poor Republican House members last Friday. Many had to vote to approve the bailout. It’s a turkey and they know it; so do most Americans, but the consequences of rejecting it would send the Republicans back to a half century of wandering the political wilderness. They’ve already been tagged with Hoover and The Great Depression. Bush and the second depression might be too much for the GOP to overcome.

The overwhelming Senate approval with its modifications gave the House no choice. The Senate’s response was great; it attached $120 billion in Christmas ornaments to the rejected $700 billion House bill and called it a substantial improvement. Even by Washington standards, that’s quite a rate of inflation.

The original proposal was three, I repeat three, pages long. The bill that left the Senate is 460 pages, nearing the size of the Manhattan phone book. Who says the Senate can’t get things done?

Whether or not the bailout will work remains to be seen, but any adverse economic consequences from not approving it would have attached to the Republicans. The Democrats control the House and Senate. Had the Democrats enforced party loyalty, no Republican votes would have been necessary, but 80 Democrats voted against it on Monday, joining the 2/3 of the Republicans who rejected it. A majority of both the Black and Hispanic caucuses voted it down. The Republicans got the onus.

The People’s House spoke; the plan was a loser, at least politically.

It does nothing directly for Main Street, forestalls no mortgage foreclosures, doesn’t loosen tight credit, and will give $700 billion to the fools who got us into this mess.

$700 billion, $810 billion – who knows? It may cost more; it might conceivably cost less.

It will not, cannot, cost the taxpayers less than $700 billion because it’s all front loaded. In theory the cost will be reduced, perhaps even show a profit over the long term as the debts are repaid.

The reality is that Congress just appropriated itself a blank check of at least $700 billion to spend as it sees fit in future years. The reason is simple. As loans are repaid, the proceeds are recorded as revenues by the Treasury, thereby providing Congress a windfall, the real windfall, to spend.

It also semi-nationalizes the financial and insurance industries – the antithesis of capitalism. Of course, conservative supporters of the free market are outraged.

They are further outraged that Senator Dodd and Congressman Frank, the Congressional protectors of Fannie Mae and Freddie Mac, and the recipients of hundreds of thousands in campaign contributions from the two, led the Congressional efforts for the bailout.

The time for the blame game is almost here. The odds are that the Democrats are not going to investigate themselves. Blame will be laid upon the greed of Wall Street and obscene compensation packages, calling for regulation of the capital industry and bankers, while simultaneously whitewashing the heavy, almost incestuous, Democratic entanglements in the debacle. Lehman Brothers and AIG are already receiving the full Congressional treatment, as Congress diverts attention to others.

Al Gore once lectured us about lock boxes; i.e. the proceeds will be locked into a closed box untouchable by the big spenders in Congress, in essence a trust. Saturday Night Live had as much fun with this patent absurdity as Tina Fay currently does portraying Governor Sarah Palin. Gore’s real inconvenient truth was the untrustworthiness of the assertion as we continue to search for a lock box in Washington. Not even an electron microscope can find one. No politician since Gore has talked of lock boxes.

No, this proposal had to pass. It was the only one on the table that had a chance of passage. Failure to act may have doomed Main Street and the economy. The plan is not to save Wall Street, but Main Street and Market Street for we are all at risk.

The financial turmoil of the past few weeks is a global financial tsunami unprecedented since Black Thursday and the Great Depression almost 7 decades ago.

Secretary of the Treasury Henry Paulson and Federal Reserve Chairman Ben Bernancke witnessed the near collapse of our banking system on Thursday, September 17, heralding perhaps a veritable global financial apocalypse. As I post this entry, an economic pandemic is sweeping the globe.

When the nation’s largest mortgage lender, Countrywide, and largest S&L, WaMu fail, and the 6th largest bank, Wachovia, essentially collapsed, that is not Wall Street. That is Main Street. When three of the five largest investment banking firms disappear, that’s not just Wall Street, that’s a hit on Main Street. The collapse of Fannie Mae and Freddy Mac could have destroyed what’s left of the mortgage industry in the country.

The Administration had to act rapidly to restore confidence to the market. If Wall Street collapses, then Main Street will not be far behind. No time for dithering; action had to be taken. Their responses included the bailout to restore confidence and trust in the financial system. Right now the Treasury is contemplating the purchase of unsecured, short term commercial paper.

The newly inaugurated President Roosevelt declared a banking holiday, shutting down all the nation’s banks. Many never reopened. A bank closure would be one step short of Armageddon today.

The failure of Bear Stearns six months ago was a harbinger of worse to come. Bear Stearns, Lehman Brothers, IndyMac Bank and WaMu all failed because of classic runs on the bank not witnessed since 1929. WaMu lost $16.7 billion in deposits in just 9 days, essentially emptying the till. Lehman Brothers had a day of cash on hand when it failed.

One of the ornaments is to increase FDIC insurance to $250,000 from the present $100,000, the effect of which hopefully is to reduce the chances of future runs on banks. The risk is now created, as with the S & L’s of 1990, that the cost to the taxpayers could well exceed the current bailout costs at a future date.

AIG is much more than the nation’s largest insurance company; its financial tentacles spread throughout America: Wall Street and Main Street; large cities and small towns, corporate and small business. It issued insurance on $441 billion in collateralized debt obligations, including$58 billion from Merrill Lynch. AIG couldn’t pay up as mortgages defaulted.

Our country, our economy, our local, state and federal governments run on credit, often financed by the trust and confidence of foreign investors. People mortgage homes, finance cars, borrow student loans for college, and owe thousands in credit card debt. Banks finance accounts receivable, inventories, and capital improvements. Small businesses finance their operations and large enterprises use commercial credit and letters of credit. Banks finance inventories, construction, and accounts receivable.

All is threatening to come to a dead stop as cash becomes king. I remember buying a house during Jimmy Carter’s Presidency. Mortgage rates hit 15 ½% with 4 points.

Credit markets dried up almost overnight a short two weeks ago. Banks wouldn’t loan to fellow banks, much less to customers. Money was being pulled out of uninsured money market accounts. The commercial paper market dried up. That’s what happens when billions in Lehman Brothers commercial paper is uncollectible. Dealerships and purchasers can not obtain financing for car purchases. Student loans are tight.

Any doubts about the need for action should be resolved by looking at the recent actions of General Electric. GE is among the bluest of the Blue Chips. It is also one of the nation’s largest providers of consumer credit. GE just turned to Warren Buffet for an expensive $3 billion handout and is seeking to raise additional capital by selling $12 billion in stock to investors at a discounted price.

All this is also happening in the global marketplace. Several major banks and mortgage lenders in England collapsed, including Northern Rock – the largest, HBOS, and Bradford & Bingley. Fortis, the Belgium-Dutch financial jugglenut, similar to AIG in the United States, collapsed last week. The Swiss giant, UBS, acquirer of Paine Webber and Dillon Read in the U.S., is choking on bad mortgage investments in the U.S.

Passage of the plan means we will probably only have a recession, although quite likely a severe recession. Failure probably meant a depression. More banks will fail. Will it work? Check your 401K not tomorrow, but in six months.

We still have to worry about a total implosion of the credit default swap market, of which AIG’s collapse is a warning, and perhaps even with Sallie Mae and student loans.

In addition, a concern is that with the lost of confidence and trust in the US banking system, foreign banks and other financial institutions might start withdrawing hundreds of billions from US banks.

One final conclusion: SarBox is a financial and regulatory nightmare for business, but did nothing to prevent this financial disaster. Part of the aftermath should be to repeal it.

No comments: