Friday, September 26, 2008

SKINNING THE CAT

Dear Senator(s) (insert name(s) of choice),

While John McCain and certain other Republicans in Congress play games with the economic future of the average American, let's first ask a few questions, then let's lay out what the financial problem really is, what the current Paulson Plan - often dubbed the "Wall Street bailout" - is really intended to do, and finally, what the alternatives might be.

QUESTIONS

At the top level, who is truly opposed to any reasonable version of the Paulson Plan?

While the public rightly holds a negative, visceral reaction to what they perceive as a "Wall Street bailout," many of the Congressional Republican leaders that are blocking the Plan will likely not suffer all that much if the financial markets and the economy crater. They are among the wealthiest Americans that remain out of touch with you and I - the heartland. They are not concerned about their own retirement plans, let alone their checking and savings accounts, certainly let alone their jobs! Nope, sorry. No layoffs in Congress. They only have to worry about re-election. And if they continue to frame the Paulson Plan as a Wall Street bailout as opposed to a national rescue, many of them will keep their jobs come whichever election day judges their jobs.

I don't like the current circumstance any more than anyone. Your husband or wife, your neighbors could lose their jobs. You could lose your health insurance. You could be faced with frozen, inaccessible credit cards. Your investments could be flushed down the drain. And it could take years for the economy to recover from this mess.

But McCain and Republicans, and some Democrats, that seem to be leading the charge to block the Paulson Plan, even after it has been substantially amended with taxpayer safeguards, are not in financial harm's way. After all, McCain has at least seven homes and people will continue to drink Cindy's beer during a Depression.

What is the financial problem facing America (and the world)?

Everyone sees the falling stock market prices. This reflects a lack of investor confidence and expectations of a weak economy and disappointing corporate profits.

But the average American is not yet seeing how credit is freezing up for banks, small businesses and large corporations. They may, however, be seeing increasing difficulty in obtaining automobile financing or mortgages even though they believe that they have outstanding credit.

To the extent that banks are hesitant or simply unable to extend credit, in large or small amounts, business increasingly becomes unable to function on a day-to-day basis. It's simple, people. Business functions on credit, even if it's just a small business that accepts credit cards. If a small business' bank stops allowing it to accept credit cards - and they can and will - and its customers don't have the cash to pay, AND it is among the large number of small businesses that won't accept checks, well so much for their business. They will fail.

Walk into any automobile dealer in the nation. Few customers, and many or most of the remaining customers are being denied car loans, not because they are not traditionally qualified for the loans, but because a) the banks and the GMACs have severely tightened up their credit standards and b) there is far less money to loan.

Try to get a mortgage. Higher down payments, much higher credit score standards. Try to sell a home. Enough said.

Without some deal, and soon, this credit will tighten further and eventually (and that is a very soon "eventually") dry up. Let's be clear: no one is getting rich by NOT lending money as usual. It is in everyone's interest for credit markets to return to some normalcy.

Speaking of GMAC, they may be on the brink of failure. Failing auto loans, failing mortgages, and no one is buying cars. They are running low on cash, their banks have reduced their credit lines. GMAC is just a big bank, but without a deposit base. Take the deposit base out of WAMU - Washington Mutual - and you have a GMAC. And when JPMorgan Chase (JPM) took over WAMU last night after it was seized by the FDIC, the first thing they did was write down $31 billion of WAMU's mortgages - about 23 percent of WAMU's subprime and equity line loan portfolio. So GMAC is as valuable as the quality of their loan portfolio. It's highly unlikely that GMAC would have to write down 23 percent of their loans; their portfolio is generally of higher quality. But to the extent that the economy continues to sour and people walk away from their trucks and cars, well things could get very bad for GMAC. And you probably won't see many buyers for bad car loans, given the low quality of the collateral.

General Motors has drawn down essentially all of their remaining credit lines, and they are trying to sell European assets to raise cash. Chrysler, a week after its CEO, Bob Nardelli told the nation on PBS' Charlie Rose show that they had sufficient cash to get through the next two years and were very excited about their new products, laid the bombshell that they now believe they may no longer be able to produce vehicles in the U.S.

These important businesses, businesses that collectively employ hundreds of thousands of people directly, and whose ongoing activity employs millions of others through suppliers, dealers, even the local businesses like restaurants and coffee shops that reside nearby, are all in danger of substantial cutbacks if not complete failure.

That is what is at stake. It's all about credit and the availability of money.

Now many people blame Wall Street. For the most part, Republicans and others have placed the blame on Fannie Mae and Freddie Mac and Wall Street's creation of MBS' (mortgage-backed securities). The fact is that Fannie and Freddie actually played a very small role in all of this. But as home prices have cratered, mortgages in their portfolios have been failing through no fault of Fannie or Freddie.

And by the way? While JPMorgan Chase's 23 percent writedown of WAMU's subprime and equity line loan portfolio may be somewhere close to the average mark that we will see among the banks to come, Fannie Mae and Freddie Mac have been seeing bad loan rates of only about 1 percent. One percent! So let's get off the Fannie/Freddie blame game.

The Bush "Ownership Society" philosophy has deliberately encouraged the expansion of home ownership. Sounded like a good, warm and fuzzy idea. While they pushed this agenda, Bush and McCain simultaneously denied any form of regulation that would have affected the mortgage markets. Fannie, Freddie, Bear Stearns, Lehman Brothers, WAMU and all those that are in line to fail, may have been pushing the envelope. But largely they played by the rules - or lack thereof - as they were laid out by Bush, McCain, Gramm and others.

Congress and Paulson are NOT proposing a "Wall Street" bailout. They are actually proposing a failed Bush/Republican policy bailout and, more critically, an American public bailout.


WHAT DOES THE PAULSON PLAN DO?

Banks - your bank - and investment firms and mutual funds and individual investors and insurance companies hold trillions of dollars of these mortgage-backed securities, securities that bundle individual mortgages into packages that could be sold to investors, providing yet more money to fuel the home ownership market. These securities are generally deemed safe because people usually pay their mortgages. What changed? Lack of regulation that enabled people with marginal credit to buy homes they could not afford over the long-term.

ALSO, and this is very important. The Bush/Republican bankruptcy reform that made it more difficult to wipe out credit card debt put consumers in a position where it was far easier to walk away from houses than credit cards. The banks lobbied heavily for that reform, supposedly sticking it to consumers that needed to walk away from too much credit card debt and requiring them to pay at least some portion of it over years.

So what has happened? As I said, forget the house and try to milk the credit cards since bankruptcy became less of an option for real people in restructuring their finances.

Now some people say that bankruptcy is just a bad bad thing. But people get into financial trouble for many reasons. Millions, each year, have been forced into bankruptcy because of health problems and ridiculous medical bills. People are forced into bankruptcy and financial difficulties when a spouse in the National Guard or Reserves see their incomes decline precipitously as a result of going from a good-paying job to military pay. The list goes on, but hopefully you get it.

So what does the "Paulson Plan" do? It calls for INVESTMENT in mortgage-backed securities where the true values are in question because of some percent of non-performing loans. Treasury proposes to buy these from banks and other institutions, via a reverse auction process (whereby the LOWEST bid wins, not the highest). Taking them off the banks' books will help to free up the flow of credit and enable the banks to raise capital through private markets. All of that is good.

As the Treasury manages these loan portfolios, they will find that some are better than others. They will repackage them and resell them to willing market buyers. Clearly, there will be some percentage of the loans that will be worthless or close to it. They will be written off. But to the extent that the Treasury can repackage the good loans, which will represent a high percentage of purchased loans, the Treasury stand to make a profit by selling them at a higher price. This will likely not happen overnight. But neither did the Resolution Trust (RTC) fix in the 1990s for the S&Ls. True, RTC lost money. But given how much they were managing, they didn't lose all that much at the end of the day. It was a success.

So when it comes down to the $700 billion "bailout" concept, it is really an investment. At the end of the day, the actual cost to taxpayers will be significantly less, perhaps in real terms, not that much more than the cost of RTC.

Significant revisions to the original Paulson Plan have been proposed and substantially agreed upon by the Treasury.

They include:

* limits on compensation for senior officers of any failing institutions that participate in the Plan;

* equity participation by the government, be it in the form of warrants or preferred stock (these terms need to be worked out in the final legislation);

* independent oversight of Treasury's activities in managing the Plan - a huge concession by Paulson;

* authorizing the $700 billion in portions, something like $250 billion at a time.


No legislation is perfect. There will still need to be follow-up legislation to reform bankruptcy laws, allowing changes in mortgage terms that would permit people to retain their homes when reasonable. There most certainly needs to be a complete revamp of financial markets regulatory agencies. The current system has been outmoded for at least twenty years. Many financial instruments, as already touched upon in this blog, are simply unregulated thanks to Republican efforts to keep them so.

There needs to be some form of fiscal stimulus, be it in the form of a second round of direct payments to taxpayers or new investments in the economy, such as infrastructure programs.

WHAT ARE THE OPTIONS?

1. Do nothing and allow the so-called free markets to sort everything out - conservative Republican philosophy that got us here;

2. Allow banks and financial institutions to fail and rescue them one by one. That is what we are now doing and it is not working. There is no certainty for the markets in this strategy and markets like certainty and stability;

3. Have banks and other institutions keep the illiquid mortgage assets on their balance sheets and have the Treasury use the $700 billion to take equity interests in these private businesses, bolstering their capital and liquidity. On the surface, this sounds plausible. However, the free market would not accept this; it's socialism in its purest form;

4. Increase FDIC insurance limits for depositors. Good for protecting depositors. But it does nothing to bolster the financial system's liquidity and capital.

5. If you have other ideas, let me know. Better yet, let your Senators know.

Thursday, September 25, 2008

WE DON'T NEED NO STINKIN' DEBATES

Debates? We don't need no stinkin' debates! to paraphrase Goldhat from the 1948 classic, The Treasure of Sierra Madre.

John McCain, who never saw a piece of deregulation legislation that he didn't love, especially since his entwinement in the Keating Five S&L disaster, is now billing himself as the maverick riding his white steed to the rescue in Washington, D.C.

Dear John, if you actually think that you can do a better job in solving the economic emergency brought on by your own actions and inactions, even after you watched the S&L meltdown mano e mano, have at it. Show your fellow Republican and Democratic Senators, especially those that are actually on the Senate Banking Committee - you know, the ones that have been doing all the work since last week - that you know better.

Of course, John, you had better keep to the one consistent theme in your campaign: that you don't have to disclose any plans or details or any of that nasty solutions stuff until AFTER you are elected President of the United States.

So John, I understand why you want to delay or even just cancel debates that plain old Americans - you know, those of us that only have one house or no house - probably really really want. Maybe it's not that you want to keep all these solutions to all of our problems secret until after November 4. Perhaps it's just that you really don't have ANY solutions.

One last thing: You really instilled me with confidence in your secret solutions by surrounding yourself with a blue chip panel of economic and business experts like Carly Fiorina and Mitt Romney, true captains of industry who made their fortunes largely by firing tens of thousands of employees from their respective companies, shipping production offshore and otherwise discrediting themselves with us small folks.

THE ELEPHANT IN THE ROOM

While we debate the merits, or lack thereof, of the proposed $700 Billion economic bailout package, I am reminded of Harry Potter novels in which there is a character who is referred to as "He who shall not be named." No, I won't mention his name even though I know it. He shall not be named, remember?

I am talking about "credit default swaps," which I'll refer to as CDSs.

Quickly, CDSs are contracts between two financial parties where the CDS buyer is essentially taking out a completely unregulated form of insurance contract, either with the expectation that the CDS seller is guaranteeing - for a stream of payments - against the default of an issuer of debt/bonds, etc. In the case of default, the seller of the CDS is expected top pay the seller a predetermined amount. This could be the entire principle value that is subject to the CDS. It could be some percentage.

In some cases, in the event of a default by a credit instrument issuer, the buyer of the CDS must deliver the defaulted instrument to the CDS seller. But since this market is NOT regulated, there is no obligation for the CDS buyer to actually own the defaulted security. The result is that this is a casino market. It has become filled both with honest people and institutions that legitimately want to hedge their investments in debt instruments. This facilitates the liquidity of debt markets.

On the other hand, there is an unknown element of this huge market - I'll get to that momentarily - that is simply filled with speculators that are betting on creditor defaults. In the event of a default, they actually hold none of the securities. If you are familiar with the stock options markets, it is somewhat like that. You don't own the stock; you own the right to buy the stock. But even worse, in the case of CDSs, you don't even have a right to buy anything that you can deliver to the seller of the CDS. That is why they are often structured so that the seller would pay the buyer the difference between the par value and the market price of a specified debt obligation.

In other words, the market is filled with pure speculators. And, let me reiterate, this market is unregulated. There are no rules, there is no central clearing house or any agency that provides any degree of oversight.


HOW BIG IS THIS ELEPHANT?

According to the Bank For International Settlements, at December 2007, there were $55.9 TRILLION of credit default swaps outstanding*. According to the International Swaps and Derivatives Association, the market is currently $54.6 TRILLION, having fallen from a peak of $62 TRILLION in the first half of 2008**.

Put those numbers in perspective.

*see Table 19 of http://www.bis.org/statistics/derstats.htm

**http://www.bloomberg.com/apps/news?pid=20601087&sid=af4NNOO9P7iU&refer=home

Financial institutions worldwide own these instruments. Mutual funds, investment banks, banks, insurance companies, industrial companies, hedge funds, individual investors, etc.

So where lies the problem other than the fact that this worldwide market is unregulated - in no small thanks to the efforts of John McCain, Phil Gramm and company? Earlier this year, Lehman Brothers Holdings Inc. estimated that there was only about $43 trillion of debt outstanding. Now we can take that amount with some grain of salt if you like. But if you place any credibility in it, that indicates that somewhere between $12- and $19 Trillion of credit default swaps were/are simply casino bets. Gambles. No underlying securities to deliver in the case of issuer defaults.

This number could be somewhat smaller or larger. But this much needs to be made clear to both the public and members of Congress: We are having trouble crafting and passing a $700 Billion economic rescue plan thanks to a cratering housing market, foreclosure flood, and abuse-filled mortgage market.

In no way do I expect or propose that the Treasury bail out CDS market participants should they run into calamitous difficulties. But we do need a regulated market, at least in the United States if not worldwide. Should economies weaken drastically, even if we are talking protracted or deep recession as opposed to Depression, it is more than possible that losses in the CDS market will swamp and exacerbate any traditional economic damage.


SOLUTIONS

Do I have solutions? Nope. Can I easily point fingers of blame? Don't get me started. I don't have the time right now.

Do we need solutions? You bet.

It is hard to challenge elephants. S.E.C. Chairman Christopher Cox, Federal Reserve Chairman Ben Bernanke, and Goldman Sachs alumnus and Treasury Secretary Hank Paulson have done nothing to prevent absolute global disaster should this deliberately unregulated market implode.

These 'Three Stooges' have been sitting on their hands since assuming their respective offices. The original Stooges were famous for their film serials, all of which had comedic ends. Sadly, these new Stooges are not so fortunate. Their continued negligence, perhaps criminal negligence, will impact the future of every American - perhaps other than the top 1 percent of earners - for decades to come.

Wednesday, September 24, 2008

OBAMA...MCCAIN...WHO'S ON FIRST?

This afternoon, John McCain announced that he was suspending his campaign and would seek a delay in Friday's presidential debate. McCain stated that he wanted to return to Washington to assist in finding a solution to the nation's financial crisis.


“I am calling on the President to convene a meeting with the leadership from both houses of Congress, including Senator Obama and myself,” he said in New York Wednesday afternoon. “It is time for both parties to come together to solve this problem.”

But who said what first, who called for what first? Details are still emerging.


Shortly after McCain's announcement, the Obama campaign issued a statement that Obama had contacted McCain by telephone about six hours earlier about issuing a statement on the financial crisis, but did not address canceling the debate.

“At 8:30 this morning, Senator Obama called Senator McCain to ask him if he would join in issuing a joint statement outlining their shared principles and conditions for the Treasury proposal and urging Congress and the White House to act in a bipartisan manner to pass such a proposal,” said Bill Burton, the spokesman for the Obama campaign.

“At 2:30 this afternoon,” he added, “Senator McCain returned Senator Obama’s call and agreed to join him in issuing such a statement. The two campaigns are currently working together on the details.”

Mr McCain said that “it has become clear that no consensus has developed to support the Administration’s proposal. I do not believe that the plan on the table will pass as it currently stands, and we are running out of time.”

So does anyone gain higher ground as a result? Hard to say as yet. It feels like a game of chicken, doesn't it?

While on one hand, it sounds prudent to suspend partisan campaign activities and have both party leaders take active roles in crafting critical legislation to rescue the U.S. economy from a potential abyss, is it a good decision to delay the presidential debate? Is it perhaps a better decision for the debate sponsors to change the debate subject matter to domestic policy rather than the planned foreign policy discussion?

Voters - all Americans - need to know exactly where the candidates stand on the now critical economic and domestic issues. They need to have crystallized for them exactly who supported deregulation of the financial system in the first place, who continued to support it, and in which political party those folks reside and lead.

It is curious that at the same time (of day) that McCain is alleging a lack of consensus-building on the rescue plan, well, consensus IS developing - by the minute and by the hour. Is this yet another sign that McCain is out of phase with current events? Or is it a sincere "Country First" strategy? If it is the latter, it might be the first time McCain has actually placed "Country First" since his Vietnam War service.

We'd like to believe that everyone is truly sincere. But given the fact that John McCain holds dear to the anti-regulatory economic policies of Phil Gramm, and that he holds high the record of his other economic adviser, Carly Fiorina, perhaps it's prudent to view McCain's actions as insincere and simply an attempt to game the system of politics, trying to stall Barack Obama's momentum in the polls.

Barack Obama first approached John McCain about issuing a joint statement, expressing a nonpartisan position on the economic emergency and the need for both parties to come together as Americans.

Before receiving a definitive answer, here we find John McCain jumping up and telling us that he is suspending his campaign activities and also wants to postpone Friday's debate.

In a press conference later in the day, Obama outlined his conversation with McCain. he also, however, expressed his position that particularly at this critical time, it was important to get the campaigns' positions out to the American people and that he would prefer that the debate go forward.

So what is McCain's game? And how will he play his cards during the next 48 hours?



McCAIN'S ECONOMIC, REFORMIST EXPERTISE (OR LACK THEREOF)

McCAIN: Carly Fiorina McCain is “a role model to millions of young Americans.

“I think she did a good job as CEO in many respects. I don’t know the details of her compensation package but she is one of many advisers that I have. I do not know the details of what happened. I know that she was a very successful businesswoman. She started out as a part-time secretary and made her way to the top of the corporate ladder as one of the biggest CEOs of corporate America."

Sounds "sweet," doesn't it? For the record: During Ms. Fiorina's stint as CEO of Hewlett-Packard, its stock price declined by 50 percent. In 2003, she fired nearly 18,000 employees. The company lost nearly $1 billion.

Carly was soon thereafter quoted as follows: "There is no job that is America's God-given right anymore. We have to compete for jobs."

A Business Week post-mortem noted,

"Management experts say Fiorina, through the Compaq acquisition, created a good executive team with a can-do attitude. That helped a rank-and-file, engineering-focused organization consider how to market products instead of simply making them. But the charismatic leader refused to delegate operations to top lieutenants managing HP's far-flung divisions. What's more, she had a tough time getting them to work together....

As a result, many of the execs who came to HP through Compaq have jumped ship since the merger. That left Fiorina with much the same slate of HP'ers who were in key positions before the blockbuster deal."

Larry Magin, technology analyst for CBS News, observed,

"There is plenty to criticize about Fiorina's tenure at HP. At this point, the changes that Fiorina made didn't turn out so well for the thousands of Hewlett-Packard and Compaq employees that were laid off and the millions of HP stockholders who lost equity since she took over. HP stock is worth less today than it was in 1999. Dell and IBM stock has increased in value."

But Fiorina did fine for herself. She departed the company with a $21 million severance package. "I doubt very much that she's worried about making ends meet," Magin cracked.


BANANA PEEL POLITICS?

After announcing to the nation on '60 Minutes' last Sunday that his campaign manager, Rick Davis, had had no involvement with now taxpayer-controlled Fannie Mae for the last several years, the New York Times revealed yesterday that Davis had been receiving monthly payments from Freddie until...this month when it was seized by the government.

To quote from The New York Times story:

"Mr. Davis’s firm received the payments from the company, Freddie Mac, until it was taken over by the government this month along with Fannie Mae, the other big mortgage lender whose deteriorating finances helped precipitate the cascading problems on Wall Street, the two people said.

"They said they did not recall Mr. Davis’s doing much substantive work for the company in return for the money, other than to speak to a political action committee of high-ranking employees in October 2006 on the approaching midterm Congressional elections. They said Mr. Davis’s firm, Davis Manafort, had been kept on the payroll because of his close ties to Mr. McCain, the Republican presidential nominee, who by 2006 was widely expected to run again for the White House.

"Mr. Davis took a leave from Davis Manafort for the presidential campaign, but as an equity holder continues to benefit from its income. No one at Davis Manafort other than Mr. Davis was involved in efforts on Freddie Mac’s behalf, the people familiar with the arrangement said.

"Jill Hazelbaker, a spokeswoman for the McCain campaign, did not dispute the payments to Mr. Davis’s firm. But she said that Mr. Davis had stopped taking a salary from the firm by the end of 2006 and that his work did not affect Mr. McCain.

“Senator McCain’s positions on policy matters are based upon what he believes to be in the public interest,” Ms. Hazelbaker said in a written statement."

Really????!!!!!!

Depending on whose sources you read, Davis has received as much as $2.5 million in compensation courtesy of both Fannie Mae and Freddie Mac since 2000.

Shouldn't John McCain have known ANYTHING about this? About his campaign manager? It's that old darned vetting process. He didn't deem it necessary to vet his Vice Presidential running mate, Sarah Palin. Why should he bother vetting his own campaign manager?

Tuesday, September 23, 2008

WHAT DO THEY HAVE TO HIDE?

Having spent more than four hours this morning diligently watching the Senate Banking Committee hearings with Treasury Secretary Paulson, Federal Reserve Chairman Ben Berbnanke, S.E.C. Chairman Christopher Cox, and Director of the federal Housing Finance Administration (FHFA), James Lockhart, sadly we have very few answers to the many important questions asked by the Senators - from both parties.

REPUBLICAN STRATEGY - A LOSING ONE?

As much as one would believe that the Republicans (John McCain was not part of the Senate hearings)might be in favor of bailing out Wall Street, it was clear that at least members of the Senate Banking Committee were extremely - and rightly - skeptical of the Paulson Plan to spend up to $700 billion additional taxpayer dollars with the objective/hope of saving the U.S. financial system from possible collapse.

In some cases, I am paraphrasing:

Richard Shelby (R) Alabama, the ranking Republican on the Senate Banking Committee - What about the Average American? It seems like we are only rescuing Wall Street. You (Paulson, Bernanke) have given "no credible assurances" that the Plan will work.

Chuck Hagel (R) Nebraska - He expressed concern about transparency and accountability.

James Bunning (R) Kentucky - Often what we do is "throw money at the problem." You want to "take Wall Street's pain and take it to the taxpayers." Paulson's Plan is "un-American."

Mike Crapo (R) Idaho - "We must protect the taxpayers."

Elizabeth Dole (R) North Carolina - "Not at all convinced" that the Paulson Plan will solve the crisis.

In a conversation with NPR's Melissa Block, prominent Republican conservative and former Speaker of House, Newt Gingrich says he thinks the bailout plan is "just wrong," and that "it's likely to fail, and it's likely to make the situation worse over time."

Gingrich added, "Well, I think you have a Goldman Sachs chief of staff to the president and the Goldman Sachs secretary of the Treasury. And they convinced the president that the American people ought to send $700 billion to Wall Street, which I think is a very, very bad idea, and I would argue is a very un-Republican idea. I don't understand what they think they're doing."

NPR's Block asked, "Do you feel betrayed by the Bush administration and by the president?"

Responded Gingrich, "Well, betrayed is too strong a word. I think what they're doing is just wrong. And I think that it's likely to fail, and it's likely to make the situation worse over time. And I think that [U.S. Treasury] Secretary [Henry] Paulson has shown almost no understanding of how a democracy operates. His initial draft would have given him $700 billion of your tax money with no oversight, no judicial review, no accountability. I mean, we're not a dictatorship."

Meanwhile, John McCain seems obsessing about wanting to limit the compensation of any institution that receives government aid to $400,000, President Bush's salary. He has said little about his position on the actual Plan. Surely he has given it some thought?

AND THE DEMOCRATS

Tim Johnson (D) South Dakota - "When you make mistakes (Wall Street), you should be held accountable."

Jack Reed (D) Rhode Island - Taxpayers are assuming risks. There should be a mandatory program of warrants. And we must assist homeowners.

Chuck Schumer (D) New York - "There are real dangers if we do not act...We will not 'Christmas tree' this bill" There is a "danger of choosing a bad solution. That would be an even worse outcome." Schumer also spoke about the need for taxpayer protections, priority over bondholders and shareholders, that here should be something in the Plan for homeowners/housing, and regulation.

Tom Carper (D) Delaware - "How did we get into this mess?" Sen. Carper is concerned that the Plan may be "rewarding bad behavior." Carper wants some feeling that the current circumstance doesn't occur again.

Robert Menendez (D) New Jersey - Sen. Menendez expressed his opinion that there was/is "lax regulation," that regulators were "asleep at the switch." He commented that he had raised "'tsunami' concerns in March 2007." Oh that "We must protect the taxpayers."

Sherrod Brown (D) - "Ohioans are universally negative" about the Paulson Plan.

Evan Bay (D) Indiana - It is "important to take the time to get it right." Bay also questions the issue of equity for taxpayers: "If not, why not?"

Chris Dodd (D) CT, Chairman of the committee, commented that he had received Christopher Cox's written testimony twenty-minutes before the hearing. He wasn't very happy about that. Chris Cox - take that as an admonishment.


ANSWERS FROM THE ECONOMIC CZARS?

Ben Bernanke, who some (including this writer over a year ago) warned of his predicted consequences: job losses, rising unemployment, more foreclosures, impacts on retirees, GDP contracting. When asked why no equity participation rights were included in Paulson's Plan, he simply evaded the question. To his credit, Bernanke reacted positively to Chuck Schumer's idea of a new insurance fund similar to the FDIC, for which financial institutions above certain size would pay fees that would help taxpayers recover some of the $700 billion.

Asked by Elizabeth Dole about the $62 billion in the totally unregulated credit-default swaps market - which played a role in the implosions of Lehman Brothers and AIG, Bernanke said that the Federal Reserve "has been very active in moving to a central clearing organization." Sarcastically, I would add that we have certainly seen lots of evidence of that over the YEARS.

Bernanke, in response to questions by Sen. Menendez, said that "risk is involved, for sure, but there will be substantial recovery (by taxpayers).

When Sherrod Brown reiterated his experience of receiving only negative phone calls and emails from fellow Ohioans, asking Bernanke if "Wall Street owe[s] "Main Street" an apology," Bernanke responded, "Wall Street, itself, is an abstraction."

Brown likened the creation of the questionable mortgages, the creation and packaging of them into high-rated securities, the subsequent sale of them to financial institutions and other trusting investors (here and overseas), and now likely being dumped into the hands of the federal government (taxpayers), as being "like musical chairs."

When Sen. Casey brought up the flood of foreclosures, which he characterized as 10,000 a day, Bernanke replied, "We should prevent preventable foreclosures." When asked by Casey about the possibility of modifying mortgages and the use of bankruptcy law, Bernanke said that he "hadn't taken a position." Nothing in the Plan addresses foreclosures.

Also telling was Richard Shelby's question to Bernanke, asking him if he knows if any foreign central banks ever bailed out foreign banks, Bernanke's answer was something like, "blah blah blah, blah blah blah." You might have expected something more specific from a Princeton world economics scholar.



Hank Paulson spent lots of valuable time reiterating time and again in his testimony and answers that he was frustrated and had hoped to never be in his current situation. Now THAT instills confidence!

In his prepared testimony, Paulson said that "we need oversight...I'm frustrated...We need reform."

When queried by Sen. Shelby, you "must have considered other possibilities, he responded, "Yes," blah blah blah, blah blah blah.

Shelby asked Paulson, "What if it doesn't work?" Paulson: no answer.

Sen. Johnson on whether there should be punitive actions to bad actors, Paulson replied, "____________________." silence.

Senator Bennett, another Republican, asked Paulson if there would be problems with paying too little or too much for the "toxic debts," he replied, "You're right."

Sen. Reed again harped on the corporate punishment theme again, and why there was no equity participation for taxpayers, Paulson said it's "not about the companies, it's about the AMERICAN PEOPLE." He never answered the question.

Paulson also said that he was "open to" Chuck Schumer's idea of a new insurance fund similar to the FDIC.

On modifying mortgages, Paulson said it "would be a mistake." He suggested that it would be a disincentive to lenders to continue lending.

Sen. Bunning, perhaps with one of the most telling and either disturbing or dishonest exchanges with Paulson, asked about Paulson's history with Goldman Sachs as CEO. Paulson stated that he was CEO from May 1999 until his appointment as Secretary of the Treasury in mid-2006 (couldn't he remember the month?). Paulson stated that he "didn't realize the maize of problems on the Hill until you [I] got there." "I was not studying..." But then he added, "I was dealing very well with the regulatory..."

When asked by Dodd about the currently infamous Section 8 of the Paulson Plan, the one that would give Paulson Czarist powers, not to be reviewed by courts or any other government body, with Dodd commenting that it was "rather sweeping...and troubling to me," Paulson responded simply, "I hear your comment."


AND JOHN MCCAIN?

McCain held a press conference, his first in months, about two hours after the hearing. He began by restating that he warned about Fannie Mae and Freddie Mack two years ago - which to his credit he did. The bill, the Federal Housing Enterprise Regulatory Reform Act of 2005, died in committee. Democrats have been blamed for its failure, but that's another piece. In any event, Fannie Mae and Freddie Mack are not the only players in the toxic mortgage marketplace.

McCain added, "We must pass legislation to address this crisis." He proposed five improvements, essentially parroting/agreeing with what Barack Obama had pretty much said in his press conference several hours earlier:

1. greater accountability, with a bi-partisan oversight committee
2. path for taxpayers to recover their money
3. complete transparency - what businesses would be helped, online access for people to monitor what was taking place
4. no Wall Street executives should be paid more than the highest paid government (president) official
5. No earmarks (of course!)

Not to criticize him too much, but it was apparent on several occasions that he was having difficulties reading his 3x5 cards.

McCain stated that the $700 billion Paulson Plan would cost each American household $10,000. A couple of comments: McCain might be assuming that the entire $700 billion will be flushed down the drain. I assume that his position is that every mortgage and mortgage-backed security that the Treasury would purchase under the plan would a) just be worthless from the start and/or b) Treasury would be unable to resell any of them - which IS Treasury's intention.

The other problem with this $10,000 per household comment is that there are about 116 million households in America. Let's see $700 billion divided by 116 million equals.....$6,034.

When asked by a reporter if he would support a Democratic economic stimulus package, he didn't answer other than to suggest that he was opposed to earmarks, of course. Point of fact: the Democrats are NOT talking about an earmark (though anti-earmark McCain HAS voted for billions of dollars of earmarks during his career, and yes, even voted for earmarks for Arizona). Oh my!

Rather, the Democrats are talking about assembling a separate economic stimulus package.



SOMETHING has to be done. The Paulson Plan may not be perfect; economics is not a perfect science. But the Plan is the best proposal out there. My personal preference is to do something different. But no one is asking me.

Congress needs to get to work finalizing negotiations with Treasury, and quickly. Putting a portion of the $700 Billion at risk is - a risk. But it will tell the financial markets and other nations that we mean business.

New regulations, let alone regulations, period, of credit-default swaps, need to be enacted. But they need to be enacted as separate legislation.

Congress, GET BUSY!

Monday, September 22, 2008

ECONOMIC DEBACLE - OUTDOING HOOVER

Not to slam everyone that has earned an MBA from the Harvard Business School, let alone those that belong to the same overly paid MBA club of anointed leaders from, oh, Universities of Michigan, Chicago, Pennsylvania, Stanford University, etc., Henry "Hank" Paulson has been transmuted from Secretary of the Treasury to Czar Henry, self-proclaimed and "club"-proclaimed savior of the U.S. and world economic order.

As we slog through events and the recent so-called federal/taxpayer bail-out of the economy, let us keep in mind that events and "solutions" have again accelerated just over the weekend as the venerable "old boys" Goldman Sachs/Morgan Stanley empires stood at the precipice of financial failure.

After receiving his "passport to the uppercrust class" - his MBA from Harvard B School - in 1970, Paulson landed where? In the Nixon administration as, of course, Staff Assistant to the Assistant Secretary of Defense. I can, of course, understand how receiving a shiny new Harvard MBA qualifies you for a high position in the Department of Defense, can't you? Let alone in Richard Nixon's kingdom?

Paulson began a long career at Goldman Sachs in 1974, rising to CEO in 1999 after taking the investment bank public. I'll get back to that later.

In June 2006, the U.S. Senate confirmed Paulson as Secretary of the Treasury, succeeding another "rocket scientist," John Snow, under whose watch we experienced the beginnings of the so-called subprime crisis and deep mismanagement of America's finances.

Until September 2008, Paulson and friends watched as economic problems festered, essentially taking a hands-off policy, as unemployment rose, as mortgage foreclosures increased to post-Depression records, as free trade policies continued to encourage the growth of our greatest export next to guns, jet fighters, and missiles - good-paying American jobs.

SO HERE WE ARE

Paulson's U.S. Treasury worked through the weekend with Congress to draft a plan to spend somewhere between $700 billion and $1.8 Trillion of OUR money to bail out banks, investment firms, and insurance companies under the guise of saving the economy, saving our retirement plans and ATMs.

What began as a plan to buy up to $700 billion in mortgage instruments has now become a proposal to buy not only mortgage instruments - mortgages and Wall Street mortgage derivatives - but banks' and Wall Street's credit card, auto loan and student loan debts. Pretty much anything that "friends o'Paulson and company" no longer want to own because they are now sorry they ever created them in the first place. Well, let me take that back. For years they made billions of these financial instruments. Now time will tell if they'll break even on the deal.

This is what we have so far, and we are still counting:

* $85 billion Federal Reserve rescue of the failing American International Group (AIG) via a loan in exchange for a 79.9 percent interest in the insurance giant.

* Some $6 Trillion of mortgages via the Treasury's takeover of housing finance firms Fannie Mae (FNM) and Freddie Mac (FRE).

* Up to $700 billion to buy assets from struggling institutions. Commercial and residential mortgages, student loan portfolios, credit card debt and auto loan debt.

* Up to $50 billion from the Great Depression-era Exchange Stabilization Fund to guarantee principal in money market mutual funds to provide the same confidence that consumers have in federally insured bank deposits.

* The Fed committed to make unspecified discount window loans to financial institutions to finance the purchase of assets from money market funds to aid redemptions.

* At least $10 billion in Treasury direct purchases of mortgage-backed securities in September, likely increasing those purchases in forthcoming months.

* Up to $144 billion in additional mortgage-backed securities (MBS) purchases by Fannie Mae and Freddie Mac.

* $200 billion for Fannie Mae and Freddie Mac. The Treasury will inject up to $100 billion into each institution by purchasing preferred stock to shore up their capital as needed. The deal puts the two housing finance firms under government control.

* $29 billion in financing for JPMorgan Chase's government-brokered buyout of Bear Stearns in March. The Fed agreed to take $30 billion in questionable Bear Stearns assets as collateral, making JPMorgan liable for the first $1 billion in losses, while agreeing to shoulder any further losses.

* At least $87 billion in repayments to JPMorgan Chase (JPM) for providing financing to underpin trades with units of bankrupt investment bank Lehman Brothers (LEH).

* $300 billion for the Federal Housing Administration to refinance failing mortgages into new, reduced-principal loans with a federal guarantee, passed as part of a broad housing rescue bill.

* $4 billion in grants to local communities to help them buy and repair homes abandoned due to mortgage foreclosures.

* At least $200 billion of currently outstanding loans to banks issued through the Fed's Term Auction Facility, which was recently expanded to allow for longer loans of 84 days alongside the previous 28-day credits.

ADDING THINGS UP

$1.8 TRILLION in commitments, and pretty darned soon, in taxpayer dollars. Oh I forgot. Thanks to Bush administration fiscal policies, we are running enormous annual federal deficits. In the soon-to-be-completed fiscal year, the deficit will be something north of $400 billion, NOT including the costs of the Wars in Iraq and Afghanistan. So this $1.8 TRILLION - oh, we are borrowing it, I forgot. BECAUSE WE DO NOT HAVE IT! Hello China? Hello OPEC? Hello Japan? Hello Russia? Hello children, grandchildren and great-grandchildren? Can we get a little help here?

BACK TO PAULSON AND GOLDMAN SACHS

During the weekend television "talking head" circuit, Czar Hank was quite skillful in avoiding straight answers to straight questions. Clearly that is something he picked up during his years at Harvard B School. I am so glad that his gold-plated education served him well in some area.

The failure of Lehman Brothers was a wake-up call for Paulson and his club. Keep these numbers in mind:

When Lehman failed, it's debt-to-equity ratio was 30:1. In layman terms, that's like you or I having $100,000 in equity in our home, investments and bank accounts while we try to support $3 million in credit card debt. Now even if we had great, storied family names, would our creditors permit that situation to even develop? I think not. But you what they say. If your debts are truly big enough, you are likely to get assistance. But you and I, Mr. and Ms. typical American citizen? Forget it.

Back to Paulson and Goldman. When Merrill Lynch was forced to sell itself to Bank of America - after having had credit facilities frozen by - Bank of America - their debt-to-equity ratio was about 28:1.

According to reports in The New York Times, that ratio had climbed to 30:1 at Morgan Stanley and 22:1 at Goldman Sachs.

In other words, Paulson's fraternity was on the brink of catastrophe. The frat house could no longer afford its own mortgage. No more keggers, boys.

So along comes Czar Paulson, backed by the full faith and credit of the United States of America - you and I (even though "you and I" had no voice in it). Suddenly, literally overnight, Morgan Stanley and Goldman Sachs are converting to bank holding companies. The days of over-leveraged investment houses appear over - for now of course.

Bank holding companies can establish traditional commercial banks, taking in deposits from you and I, from businesses, offering checking accounts, CDs, consumer loans, etc. Oh yes, and they can also invest those funds in - mortgages and business/consumer loans that they deem risk-worthy.

WHERE SHOULD WE REALLY GO?

So as much as things will change, they are also inclined to remain the same. Without substantial modernization of our economic and financial markets regulatory systems as part of a "fix," pumping trillions into our banking system will not solve our crisis.

At the same time, "Main Street" needs help and lots of it. Senator Clinton and some others are beginning to raise their voices on this critical issue.

Senator McCain would have us believe that people that took at adjustable rate mortgages, for instance, are very bad, stupid people. They borrowed more than they could afford, encouraged by those villains on Wall Street, of course, that McCain suddenly believes are so evil.

The foreclosure flood needs to be halted. True, there are people that that were able to take out unaffordable mortgages. Maybe they lied on their applications. Maybe they were assisted in lying. Perhaps they were simply anticipating a meaningful raise at year-end, or just having a spouse keep their job and not having it shipped to China or India. Maybe they did not anticipate their health insurance continuing to increase by double-digits annually. Regardless, I favor what is so beautifully called "cram downs." The federal government needs to require that banks adjust the terms of mortgages - for people that are otherwise credit-worthy - so that the foreclosure flood returns to a relative trickle.

Banks have choices. They can sell mortgages to the Treasury for perhaps 10- to 30-cents on the dollar, or they can reduce the interest rates they are charging customers, and/or they can take "haircuts" on the principal values of mortgages to better reflect the declines in home values the market has realized. Perhaps that strategy might reduce earnings on mortgage portfolios by 10 to 30 percent. Keep in mind that the vast majority of mortgages are sound. We are only talking about a minority that is creating such havoc.

In any case, what confounds me is that banks and investment firms will take substantial losses, whether they sell their portfolios to the Treasury for cents on the dollar or they choose to work with their customers to restructure these debts. Either path will lead to the need for them to raise hundreds of billions of dollars of new capital in order to maintain "normal" lending practices.

Of course...there is something that has been little discussed as yet. Czar Paulson will be reaching out to that very same financial community that worked so hard these past eight years to create this fiasco to help manage whatever paper assets Treasury will be buying with your billion or so dollars. Gee...might these very same shaky loans essentially be "laundered" and repackaged, sold off by the billions after taxpayers lose hundreds of billions of dollars on these purchases?

President Bush and others would have us believe that "eventually" these mortgages and other instrument will realize their values. But that is simply not true; it's not the game that is about to be played.

CONCLUSIONS...FOR THE MOMENT

It is the withdrawal of regulatory oversight of our financial institutions, led by the likes of Presidents Reagan (R) and Bush (R), Senators like Phil Gramm (R) and John McCain (R) and Republican-led Congresses that allowed the "Ownership Society" to become the "Buried in Debt Society." Oh we hear the voices that point out that important deregulation took place during President Clinton's watch. But they fail to admit that during that decisive Clinton period, Republicans controlled Congress and the agenda.

Will Paulson's plan save us all from potential ruin? I pray that it will, at least for the time being. But I have little faith that it will as currently proposed. Yes, time is of the essence to a certain degree. But bipartisan agreement must push through a fast-track path to regulatory reform. And it must include substantial relief for homeowners and other Americans that haven't had the privilege of membership in the "Old Boys Club," be it based on college pedigree or simply who you know or what you inherited from folks that maybe worked harder than you to accumulate wealth.