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Wed. Sep 24, 2008

Bailout Blather

I do not pretend to be an expert in high finance. If the total has six zeroes or more, I have zero experience … it’s purely theory for me (heck, if the number has more than 8 zeroes, my calculator won’t even work).

I also do not pretend that anything I might say here will have any impact at all on what happens. But there are some very basic principles in work here that have nothing to do with the big totals, and I’ve done a lot of reading that’s generated a lot of thoughts over the past several days.

It’s an amazingly complex tangle, the details of which are likely way over the head of most of us (myself included). But I found this a fairly succinct summary:

Treasury Secretary Henry Paulson offered a plan on Saturday to authorize the government to use taxpayer funds to buy up billions of dollars in bad mortgage-backed securities that were created by investment banks during the home price bubble.

Now that the bubble has popped, many U.S. homeowners saddled with mortgages they cannot afford are defaulting. As a result, securitized debt instruments that depended on those homeowners being able to repay their loans are now broken.

Banks and other institutions have recorded massive losses from their bad bets on these instruments, many of which are so complex that the banks themselves and the capital markets are unable to estimate accurately the potential for more losses.

Fear and confusion has spread through world capital markets, making banks unwilling to make new loans and threatening the stability of a global financial system that relies heavily on unprecedented amounts of leverage.

Senate attack on bailout lacks explicit threat – Yahoo! News

Note, it’s not the actual defaulted mortgages that are the catalyst for calamity, it is the “bad mortgage-backed securities that were created by investment banks during the home price bubble” and the fact they are so complex the experts can’t even figure out what they are worth anymore.

Then there’s that last part, the “unprecedented amounts of leverage.”

Here’s the best simplified description I’ve heard of leverage. Suppose there is a $100 investment you want to make. You do, and it grows in worth to $110. You gained 10%, yay for you! However, what if you’d made that same $100 investment, and only put in $10 of your own money, while borrowing the other $90. Suddenly when the value grows to $110, your personal investment of $10 has doubled! Which is way better than a measly 10% from investing your own $100. How can this go wrong?

I’ll tell you. What if your $100 investment takes a 20% hit in value, like, oh, say, the housing market. Suddenly, not only is your personal investment of $10 wiped out, you also own an asset worth less ($80) than you owe on it ($90 plus interest). You’re underwater. And if everyone else made the same kind of leveraged investments, they have no cash flow to extend you credit, as they are in the same boat.

Now, multiply this simple exercise by about 7,000,000,000, and you have a small idea of where we are today.

To Congress: Get To Work, Damn It!

The idea that our Congress is trying to still leave DC for their break on Friday is beyond ludicrous. I work in an industry with deadlines. And when one is missed, the economy does not disintegrate (except for maybe mine), but By Gum, we stay and finish the job anyway. No matter how long it takes.

If Congress thinks it is more important to leave for the “election break” (as they call it) than to stay and work on the biggest financial crisis this country has faced in 80 years, well, you know everything you need to know about their priorities, don’t you?

Getting re-elected is Job One. You, and your problems, are Job Three or Job Four (fundraising is Job Two).

And I swear, if I was a Senator running for President, and I wanted to show my leadership capabilities, the last damn place I’d be today is on the campaign trail. I’d be inside the Capitol, using my position to try and move the process forward.

If this problem is so grave, then act like it. Don’t go about your business as usual. You’re putting taxpayers on the hook for somewhere in the neighborhood of $1.8 trillion. Put in some overtime. Pretend that maybe, just maybe, this global financial crisis is more important than your personal re-election.

I can assure you, it is to me.

Don’t Play Politics

I know, what a ridiculous request two days before the first debate. But when I hear Harry Reid whining about the fact John McCain hasn’t stated his position on the bill, and that Democrats aren’t going to support this bill if McCain doesn’t, I just want to scream.

FOR ONCE IN YOUR LIVES, can you Congresspeople just do what is best for the country, regardless of the personal political cost? Take a frakkin’ stand based on principle and reality, without concern about how you are positioned against “The Enemy.”

If there was ever a time that Americans would respond to clear and strong non-partisan leadership, this is it. Anybody got any?

[silence abounds]

Deregulation & Straying From Your Core

Lehman’s core business, being a brokerage firm that advised clients and took fees for executing transactions for them, was profitable. AIG’s core insurance business was profitable. Many of these troubled firms have a profitable core business. But with the wave of deregulation that culminated in the The Gramm-Leach-Bliley Financial Modernization Act of 1999, the firewalls between the banking, insurance, and brokerage industries were effectively taken down. It was no longer enough to be successful in your core business. They delved into everything, in the name of getting bigger.

And in a mere nine years, these Free Market Masters managed to completely destroy their business model.

The Scarlet B

If the government is going to buy paper from companies at a rate higher than the companies can now sell it on the open market, that has to come at a price. Perhaps not quite a scarlet “B” branded on the forehead, but if a company’s alternative is either eventual bankruptcy or immediate bailout, you are not in a position to dictate terms. Or even whine. You’ll give up 5%, 10%, 15% in equity for what is essentially a cash infusion. And you’ll be subject to some new regulations regarding compensation and capitalization. Your tradeout for survival is that you will be smaller and take less risk.

Oh, and apparently some of you will be getting an FBI cavity search. But have no doubt, there needs to be severe accountability, absolutely naked transparency, and an actual feeling of “pain” from taking this bailout. It’s got to truly feel like a very uncomfortable last resort to those taking the bailout.

That Magic Number, $700 Billion

It’s way oversimplified, but my mind keeps going back to the numbers. What is the root cause of all these troubles? People defaulting on mortgages that they probably should not have been given. Now, $700 billion divided by 300 million Americans is about $2,333.00 per living breathing individual, from newborn infant to deathbed patient.

That means if you are an average American family of 3, the government is putting out about $7,000 on your behalf. Now, how many families do you think are having mortgage trouble? Let’s be overgenerous and assume it is 20%. Which means you could give each troubled homeowner about $35,000 each (probably a lot more, because I don’t think the number is anywhere near 20%). That would fix a lot of troubled mortgage owners, or at least buy them many months of time to figure out a solution.

But that would be a “bottom up” solution, in which people got to keep their homes, all that bad paper was made better, and thus no corporation needed a bailout.

This is either too simple or too complex a solution to even be considered. Apparently.

However, it is also apparently quite easy to quickly fix a specific number on this problem, $700 billion. I would not be inclined to write a blank check for that amount, I’d rather see us write three checks for $233 billion, and pass them out only if they are needed, after additional review … and Big Time oversight.

The View From On Top

Though Sec. Paulson has now backtracked off of the odious Section 8 provision in his original proposal, that’s still of great concern to me. There’s simply no way they can say this deal is not subject to review or oversight by any judicial or legislative body, and you won’t see the first report for 90 days.

Huh? You need the money by the end of the week, and then will take three months to tell us what you did with it? I … don’t … think … so! I want both Congressional oversight, and independent oversight. Weekly, starting now. I want anyone who abuses the process to face immediate judicial action.

Parachutes, Bonuses & Leverage

Lots of folks are upset about executive compensation, particularly at companies that went under (Lehman) or came under government control (AIG). Others note that when you’re talking about a bailout of hundreds of billions, a few tens of millions in executive compensation is a fraction of a percent of the problem (it should also be noted the outgoing CEO of AIG declined to collect the $22 million “parachute payment” his contract called for).

I’m personally troubled with the idea of the government stepping in to void a contract between two private parties that was entirely legal when it was created. However, I’m absolutely pumped about the idea of a new tax law that states any bonus or parting payment that exceeds 150% of annual salary is payroll taxed (as in, withheld) at a 95% rate.

I’m not going to bother to track it down right now, but I read an article that reviewed the top five firms on Wall Street, and their employee bonuses. These five firms paid out $39 billion in bonuses in 2007. A per employee average of over $201,000.

The fact is that a bonus-driven company is going to engage in higher levels of risk, as each individual within that company scrapes for their own bigger bonus … to the overall detriment of the firm. IMHO, as long as Wall Street firms operate on a bonus-driven economy, recovery will be slow.

The best way to mitigate that is to force higher levels of capitalization in all their dealings. It is said that Fannie Mae and Freddie Mac may have been leveraged by a ratio of 60-1. It’s hard to say, because we’re also pretty sure they were shifting the debt around on the books to make it look better than it was.

A couple of weeks ago, AIG had a market valuation of about $10 billion, yet required an $85 billion bailout. That’s leverage.

But a lot of these companies have struggled to get back to 30-1 or even 40-1 … and think they’re OK now. I’d make them conform to at least 20-1 if they want government money.

I think it also needs to be said loudly and clearly, the reason these firms call this “bad paper” and “sludge” is because they cannot move it … in the short term. As in, within the creative machinations of their daily rollovers for profit. The reason the government is buying this paper is because they are apparently the only entity able to take a longer view. They will buy this “bad paper” and wait until the housing market recovers, making it no longer “bad,” and therefore sellable.

You know, sort of like you are having wait until the housing market rebounds to recover any loss in the current value in your home.

Too Big To Fail … Can Haz List?

We now know that Lehman was not too big to fail. We know that AIG was. Between those “benchmarks,” and the re-shuffling and consolidation of the remaining players, it ought to be fairly easy to come up with a list of entities that are considered too big to be allowed to fail.

At this point, shouldn’t that be a public “known.” In particular, I’d like for the companies not on the list to understand, with certainty, they’d better figure it out and run their ship tighter, as there will be no special bailing for them.

Go Make Something

One of the reasons much of this financial mess is so hard to comprehend is because none of these companies create a tangible product. They move paper, in increasing obtuse ways, to generate profit. They gambled, in ever riskier ways, with ever more worthless paper. And when the numbers on the paper changed, or became sufficiently vague, it all came crumbling down.

They are a part of our now nearly entirely service-based economy. My wife has been on a “buy American” kick of late, and while I support her in theory, I’ve also told her she will have to give up her TV and walk around largely naked. Because clothes and TV’s (and hundreds of other things) are no longer “made in America.”

Go ahead, name me a widely held consumer product (other than a car) that is predominantly made in America. Hell, name me an industry where the American-made product is the sales leader. Soft drinks? Fast food?

We no longer make anything the world wants. Even our dollars our beginning to look tainted. But as I’ve said before…

And here is a glorious opportunity to change that. Not just for our benefit, but for the entire world’s. We should be throwing ourselves feet first into the deep end of the energy industry. We should be fomenting an Energy Revolution.

The thing is, if we don’t, someone else will. And our descent into an energy starved second rate economy will be set in concrete.

You may not see it happening now, and you may not live to ever see it. But your children surely will.

I wrote that back in July, and now I wonder how wrong I was with that last line.

This needs to be more than a bailout, even though that is all that is going to happen in the next seven days. This needs to bring about a re-investment in our manufacturing economy, so that we’re not so reliant on houses of cards made of bad paper.