335 – Oktoberfest Redux!

Continued from The Sub-Prime Market Crisis and Economic Ruin, Made Easy! Part Two

9-11, Meet 9-29

So, where were you the day that Congress approved the Emergency Economic Stabilization Act? (Also known as the swearing in of King Henry.)

You will be hearing about this for a very long time.

As we covered last week, the Big Banks lowered the bar for selling mortgages, and let in a whole bunch of people who couldn’t afford the buffet. When it came time to pay, these folks started defaulting on their loans. Because the banks had been selling, pooling, reselling and repooling these mortgages, it was totally unclear which banks were holding bad debt and which were not. As a result, the banks stopped loaning each other the money they needed for day to day operating expenses, not knowing how much bad debt anybody had, or if they would get paid back. With no operating capital, the banks stopped operating, and the world’s economy was suddenly standing on the edge of a cliff in a Roadrunner cartoon with an anvil strapped to it’s back.

I’ll Use a Lifeline, Regis

So what exactly is it that the government is trying to do to fix this? Well, we had several models of economic crisis management to look at and figure a way out of this mess. First, there was our own model from the Great Depression. Basically, the government did nothing, (until after it was far too late) trusting that market forces would act to correct the problem. The name “Great Depression” sort of gives away how effective that was.

Japan’s “Lost Decade” showed us what happens when you feed the banks just enough money to keep their noses above water, trying to be a friendly arm up. You end up drawing out the death gasps of a failing financial sector over a ten year period, and then watch everything fall apart. Again, it’s in the name.

Sweden did a pretty good job when their crunch time happened, rolling up shirtsleeves and jumping in with both feet to take over failing banks and set things aright. This is (sort of) what we have seemingly decided to do with the Emergency Economic Stabilization Act. The bill grants Secretary of Treasury Henry M. Paulson (hereafter known as King Henry) the power to spend up to $700 billion dollars, that’s $2,300 from each and every American citizen, in order to get us out from under this giant pile of crap.

(This is Sweden, and not a giant pile of crap!)

The basic idea is that King Henry will use the money to buy up the bad mortgages, so that all the banks will know there are no more bad mortgages and they can start lending to one another again. All the other junk that Republicans and Democrats spent the weekend fighting about including in the bill? Ignore it. Except for the increased oversight, it’s all meaningless. Just stuff they threw in to point to later during their next election cycle.

I’ll give you a couple of examples. First, the Dems were crazy to get restrictions on executives “golden parachutes,” or the money a company pays an exiting executive when he leaves that company’s employ. It’s really called a severance package, but you can think of it as a firing bonus. The Dems were dead set against these guys profiting from their failures. Admirable sounding enough, but it only takes place when a company takes part in the buy-out, and opponents were afraid that CEOs would allow their companies and subsequently the economy to self-destruct rather than give up the pay-off on their eleventh home. (Gee, I wonder how a person with that kind of priorities would have ended up in this type of situation?) The final wording in the bill does restrict CEO parachutes…if the company (bank, whatever) sells large chunks of it’s assets to the government, if there was no pre-existing deal already in place, and if the executive is either fired or the company goes out of business. (And if, of course, that’s what King Henry wants.)

The Republicans, on the other hand decided late in the game that they wanted to insure the banks bad debt rather than purchase it, seeing that as the cheaper (and less Socialist) alternative. As an illustration of why this is such a dumb idea, let’s look at an example of a person trying to obtain insurance for something that has already happened. Imagine this conversation if you will. You’re at the local branch office of Blue Cross/Blue Shield, looking to obtain medical insurance for yourself.

You: Excuse me, I’d like to obtain medical insurance for myself.

Blue Cross/Blue Shield: Certainly, but I need you to answer a few questions first.

You: I’d be delighted.

Blue Cross/Blue Shield: Any dependents?

You: Nope. Just me and the cat.

Blue Cross/Blue Shield: Okay, any pre-existing conditions?

You: Nope, fit as a fiddle.

Blue Cross/Blue Shield: … Are you sure?

You: Yes.

Blue Cross/Blue Shield: May I ask… um… who’s leg that is you’re carrying?

You: Oh… um… I just found this. It was in the parking lot. (Growing pale.)

Blue Cross/Blue Shield: That’s your leg, isn’t it?

You: No it isn’t. (Passing out)

Blue Cross/Blue Shield: You’re bleeding all over my desk! I… I don’t think we’re going to be able to insure you today, Dear Reader.

You: Unnnhhh……

The bill requires the formation of an insurance plan for bad mortgages, and then pointedly states that King Henry is under no obligation to make use of it. Same for the Democrats idea to have judges rewrite terms on defaulted mortgages. It’s in there, but is only to be used if it can be shown not the cost the taxpayers anything extra. Like… filing fees.

The Future

So is there an upside? Eventually, probably, yes. While this bill isn’t a cure-all, and whoever ends up in the White house (already paid for, no mortgage worries there) is going to be dealing with this for years, there is every reason to expect that the ultimate cost of all of this will be somewhere in the vicinity of zero. Or less.

The government is buying securities at hugely reduced rates, no one knows for sure yet, but I’m expecting 60-50 cents on the dollar. Returns are likely to be far greater than that. Even after the Great Depression the government ended up making money on the various buy-outs that took place, and there’s no reason to expect this to be any different. Especially if King Henry does what I think he’s planning and begins this dance by making the short-term day-to-day loans to the banks himself, and moves on to buying the bad debt as a stage two. It won’t be much, but he’d actually be making money while getting the banks moving again.

Finally, things will get worse before they get better, but god willin’ an’ the crick don’t rise, they willget better. But uh… don’t use that credit card anymore, okay?

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