The Binary Circumstance

Today the House approved the massive $700 billion bailout (I’m sure that’s just the beginning) that was approved by the Senate a couple of days ago.

The stock market as measured by the DJIA had been up over 300 points in anticipation of the positive vote in the House. But it dropped 470 points off it’s high for the day to close down 157 points for the day, and down over 800 points for the week.

In addition, the credit markets remained frozen after the bailout was approved.

My own personal view is that the market is trying to form a bottom and it would do that without the bailout. (See some of the evidence here.) The pressure to get the bailout passed was more about getting the taxpayers to pick up the bill for the bad decisions of banks. It would be much harder to sell that politically if the markets had already started to recover on their own.

Today’s purchase of Wachovia Bank by Well’s Fargo without any help from the government, along with Warren Buffet’s multi-billion dollar investments in Goldman Sachs and GE show that big investors are finding great long-term value in the stock market at these levels.

Continued efforts by the government to artificially prop up markets with bailouts and restrictions on short sales will only further erode confidence I believe. Artificially propping up housing prices didn’t work in recent years did it? That’s what got us into this mess. But at along as the public views government intervention in the markets are their salvation, we’ll get more of the same. I fear this could drag on for a long time.

Markets, in order to function properly must be free and honest. The government has a nasty habit frustrating those ideals making it impossible to know what the true value of anything is.

President Bush along with others in his administration have told us repeatedly as the housing bubble burst and the credit crisis swept around the globe that the American economy was sound. Now he’s singing a different tune and the name of that tune is “700 Billion Dollar Bailout.”

Now Bush says the U.S. is in the midst of a serious financial crisis.

In his speech last night he said very little about the causes of the current credit problems which are largely due to government monetary policy and their cozy relationship with Wall Street. Bush did mention Fannie Mae and Freddie Mac but made them sound as if they were the victims of the mortgage meltdown rather than one of the main causes.

Bush said:

See, in today’s mortgage industry, home loans are often packaged together, and converted into financial products called “mortgage-backed securities.” These securities were sold to investors around the world. Many investors assumed these securities were trustworthy, and asked few questions about their actual value. Two of the leading purchasers of mortgage-backed securities were Fannie Mae and Freddie Mac. Because these companies were chartered by Congress, many believed they were guaranteed by the federal government. This allowed them to borrow enormous sums of money, fuel the market for questionable investments, and put our financial system at risk.

While he acknowledged that they helped fuel the market for questionable investments, he inaccurately described their role. They are the creators of mortgage-based securities, not the buyers. They buy loans and package them into securities that are sold all around the world and they guarantee the loans and the principle. When borrowers began to default, Fannie and Freddie had huge liabilities which is why the government took them over to keep them from failing.

The government takeover of both companies put the taxpayers on the hook for the loan guarantees.

Wikipedia describes their role:

Fannie Mae (and Freddie Mac) buy loans from mortgage originators, such as banks and non-bank mortgage firms. It repackages the loans, as mortgage backed securities, and sells them on the secondary mortgage market, with a guarantee that the interest and principal will be paid, whether or not the original borrower pays. Also, Fannie Mae may hold the purchased mortgages for its own portfolio. By purchasing the mortgages, Fannie Mae and Freddie Mac provide banks and other financial institutions with fresh money to make new loans. This gives the United States housing and credit markets flexibility and liquidity.[6]

If he doesn’t understand the cause of the problem, can Bush and Co. be trusted to fix it?

We must not forget how we got conned into the war in Iraq with a lot of fear-mongering. Remember how little it was supposed to cost and quickly that problem was supposed to be fixed?

Ron Paul is the only person who seems to understand that we can’t escape our current financial problems by borrowing and printing more money. That’s what created the problem in the first place.

The latest proposed bailout, which politicians are trying to scare us into accepting just like they did with the Iraq war, is like giving more credit cards to a person who has already maxed out all the cards he currently has even though he can’t afford the payments. And since he’s not making enough money to pay off his debts, let’s also give him a printing press so he can print all the money he wants as well.

As expected the Feds moved in to seize Fannie Mae and Freddie Mac to prevent collapse.

Under the plan, the Treasury will receive $1 billion of senior preferred stock in coming days, with warrants representing ownership stakes of 79.9 percent of Fannie and Freddie. The government will receive annual interest of 10 percent on its stake.

As a condition for the assistance, Fannie and Freddie eventually will have to reduce their holdings of mortgages and securities backed by home loans.

The portfolios “shall not exceed $850 billion as of Dec. 31, 2009, and shall decline by 10 percent per year until it reaches $250 billion,” the Treasury said. Fannie’s portfolio was $758 billion at the end of July, and Freddie’s was $798 billion.

Officials are aiming “to prevent the mortgage market from falling apart,” said former Federal Reserve Bank of St. Louis President William Poole. The Treasury’s funds “will be flowing in for quite a long time,” Poole, a Bloomberg contributor, said on Bloomberg Radio.
[…]
Banks and insurance companies have typically purchased the two companies’ preferred shares. The Federal Reserve and three other bank regulators said that they will work to “develop capital restoration plans” with the “limited number” of smaller institutions that hold Fannie and Freddie stock as a significant portion of their capital.

There is not enough detail on what they plan to do with shareholders. Typically they come last in line when it comes to getting money back.

This and other articles seem to imply that the government is going to treat institutional shareholders differently than individual shareholders. Reportedly the Fed, FDIC and others are going to help smaller banks with significant stock holdings in the two seized GSE’s to keep them from failing.

Paulson urged banks to contact their primary federal regulator if they believe losses on holdings of common or preferred shares in Fannie Mae or Freddie Mac will cause them to fall below the government’s benchmark for “well-capitalized” institutions.

Besides the Fed and FDIC, the Office of the Comptroller of the Currency and the Office of Thrift Supervision also signed onto today’s release.

That would just be another transfer of wealth to the rich and powerful at the expense of average citizens. It keeps the shareholders in those banks afloat at the expense of the taxpayers, even when the FDIC is supposed to be adequate protection for the depositors.

The good news is that they are both required to become a lot smaller.

William Poole former president of the Federal Reserve Bank in St. Louis says that taxpayers may pay $300 billion for this bailout.

Given that the government has consistently understated the magnitude of the mortgage/banking crisis, I suspect that is a very conservative estimate.