$4 Trillion and Nothing to Show for It.

Congress, without debate or investigation of any sort, blindly approved bailout after bailout.  $4 Trillion dollars of your hard earned dollars have gone to the financial rescue of banksters.  Now, after committing to spend all that money, your non-representative representatives heard a report from an oversight panel that told Congress the bailout plan was ill conceived and isn't working. 

The Congressional Oversight Panel, approved after Congress voted without little debate on allowing Treasury to have $700 billion of TARP fund.  The panel is chaired by Elizabeth Warren, a Harvard Law School professor.  The findings (Executive Summary found here) point out that there are three general approaches to crises: 1) liquidation of troubled institutions (as was done in the 1980's S&L crisis); 2) reorganization of the institutions using conservatorships (as was done with Continental Illinois and Sweden in the 1990's); or 3) Subsidization (as was done with Japan during its lost decade).  The report noted that the total spent on subsidization to date exceeds $4 Trillion Dollars.

The liquidation option, while the best choice is politically difficult, but provides certainty to the markets, prevents unending subsidies, and results in a quicker resolution to the crisis.  Our elected officials chose not to liquidate the insolvent banks.  It worked during the S&L crisis.  Reorganization involves replacing management and selling off bad assets, but it taxes government resources and results in politicization of the business.  Our non-representative representatives chose not to reorganize and replace management.  It sort of worked with Continental Illinois.  Subsidization involves endless commitment of taxpayer resources, hides true value and delays economic recovery.  It didn't work with Japan, but this is how our government chose to spend our money - without debate or fact finding.  

We know the path our elected officials chose - a path doomed to failure from the beginning.  The only way subsidization could work is if the crisis was short and shallow.  In other words, if the crisis was limited to just a temporary dip in housing prices that caused a short term liquidity issue, subsidization might have worked.  We all know from history that real estate crises are never short term.  Despite receiving calls and letter at the rate of 300 against the bailout to every one in favor, and despite having a cadre of economists telling Congress that the bailout was a bad idea, Congress went ahead with its plan.  Now we know it won't work. 

What are you going to do about it?  It is never to late to exercise your constitutional right to let your elected officials know how you feel.  Send the tea bags.  Write the letters.  Go onto the websites and send email messages.  There are plenty of ways to express yourself.  Remember - if you don't tell your representative, who will?

Below is a video introduction to the oversight panel's report.  Enjoy,

SOTUS

More on Bank Bailouts at Taxpayer Expense

Over the past several weeks many commentators and blogists have discussed how the Treasury's plan is nothing more than additional taxpayer bailouts of big banks. The public private partnership proposed by the Government is complex, but if you want to understand the fraud involved in the plan, watch the 12 minute video from Financial Ninja, below. It is explained clearly. More government efforts to bail out banks at taxpayer expense. More business losses shoveled on us.

Remember to send your tea bags to your elected officials.

Sotus

(Steve of the United States)

AIG Bonus Firestorm Misdirects Attention Away From CDS Payments

An incredible amount of outrage has been written and expressed about the $165 Million in bonuses paid by taxpayer owned AIG, and rightfully so, but the AIG bonus issue is simply a misdirection of the real outrage - the payment of $60 Billion in credit default swap bets with taxpayer bailout money. The fact remains that pouring money into AIG is pouring money into a black hole.

The outcry is building about the AIG bonuses.  President Obama knew about the payments by at least last Thursday, and his administration knew before then. The Treasury is now making noise about either recouping the funds paid on bonuses, or reducing the next tranche of bailout funds.  Provisions are being floated around Congress to tax the bonuses at varying levels.  Frankly, while I am loathe to suggest that Congress use tax policy to penalize anyone, in this instance it could be a winner.  Tax the bonus recipients at the 75-90% level (states will follow suit as well), make the excessive payments non-deductible by AIG.  Taxpayers will recover the bonus payment and AIG will still be responsible for paying back the money borrowed (which will never happen). 

Whatever solution is proposed, however, only focuses on the bonuses.  The real outrage is the payout of billions to CDS counterparties.  Last week, AIG disclosed that it used the bailout funds to bailout its credit default swap counterparties at the same time Treasury learned of the bonuses.  Payments went to Germany's Deutsche Bank, France's Societe Generale, England's Barclay's, Spain's Banco Santander, and many others, including Goldman Sachs, Merrill Lynch, UBS, Royal Bank of Scotland, Bank of America, and Bank of Montreal.  Follow the money - this is nothing more than backdoor bailouts.  Taxpayer funds went to AIG, and AIG in turn distributed the money not only to US institutions, but international financial entities.  That means that we, the taxpayer, are not only bailing out AIG from its bad business decisions, but we are bailing out foreign counterparties that took a risk that AIG would pay off its bets.  

Where is the outrage?  The amount spent on these bailouts far exceeds the bonus payments, yet despite knowing last Thursday about the bonuses, President Obama timed his expression of outrage to coincide with AIG's disclosure of payments to counterparties.  While it isn't a cover-up, it certainly looks like our attention is being misdirected away from a major problem to focus on a relatively small problem.  It is unlikely that the taxpayers will ever see the $170 Billion of bailout funds repaid - and certainly any payment will not be made with equivalent dollars (but that is another topic), and it is likely that unless something is done, the taxpayers will continue to fund the losing propositions made by AIG and the other banks.  We are, however, not helpless while waiting (futilely) for the government to do something.  We can take matters into our own hands and stop doing business with AIG.  It is very simple.  Look at all your insurance policies and find out if any of the issuers are subsidiaries of AIG.  If so, cancel the policy and replace it with a policy from another, more solvent insurer.  

FDIC Chair Advocates Bail Out to Save Insolvent Banks' Bondholders

In yet another act showing complete disregard for market discipline, fiscal restraint or prudence with taxpayer funds, FDIC Chair Sheila Blair is advocating for the taxpayers to spend more money to buy bad assets from insolvent banks. Blair claims the Bad Asset Plan will jumpstart the economy.  

FDIC chairman Sheila Bair told the newspaper that the cost might exceed the $700 billion Congress approved to bailout the U.S. financial system and that the greatest challenge is persuading banks and taxpayers to accept the necessity of the costly program.

"This takes courage to do, but if we don't do it, history shows that this kind of mechanism -- recognize the losses, get at the root of it and move on -- this is how you jump-start the economy," she said in a discussion with Washington Post reporters and editors. "The other option, just to park those assets on the balance sheet, I don't think that gets us very far."

In other words, instead of letting the insolvent banks and shareholders take the losses, the FDIC is suggesting to let the taxpayer take the losses.  The Calculated Risk Blog posted an excerpt from a 60 minutes article showing the FDIC seizing a bank.  In the excerpt, Blair admits that the government seizes and closes down small banks, but is ill equiped to close larger banks.  

So instead of liquidating the larger banks, we keep funneling more and more taxpayer dollars to support these insolvent institutions.  Buying "troubled assets" - which are nothing more than bad loans and bad investments - is subsidizing the loss. We tried before to purchase the loans and realized there was a disagreement as to value.  Bernanke wanted to buy the assets at a premium over current value in order to induce the banks to sell.  Blair is proposing more of the same.  

Make no mistake about it, capital infusions into these financial institutions as well as premium purchases of bad loans is the use of taxpayer funds to bail out bondholders and stockholders.  It is not making sure innocent depositors are made whole.  The ramifications to the financial system are not devistating.  Certainly, no one is advocating a disorganized, free-for-all liquidation of the banks, but if we are using government resources at all, it should be to facilitate an orderly break-up of the companies,  sell off the assets, and let the bondholders and stockholders take the losses.  Not the taxpayer.  

Why Not Let Insolvent Banks Fail?

Over the weekend, Senators Richard Shelby and John McCain finally floated the idea of letting big banks fail.  After spending billions of taxpayer dollars trying to prop up large but insolvent financial institutions, 2 of 100 Senators are finally realizing the black hole they have created.

The debate is now turning to nationalization.  Let's get some terminology straight - nationalization in this context does not mean having the government run the banks indefinitely. It is a temporary solution to provide an orderly liqidation of the banks.  We do it all the time with smaller banks that become insolvent.  That is the role of the FDIC.  The problem is that the FDIC is ill equiped to handle an insolvency of the size of Citigroup, Bank of America, or even non-bank groups like AIG.  

The solution is to let the banks fail under government control.  Government liquidation oversight will allow time for a replacement banking system to become established.  As part of the process, the governement could even create a new banking system now.  In fact, we already have a banking system in place - local community banks!

The real debate is the difference between Wall Street and Main Street.  Wall Street is dominated by a few very large institutions seeking the largest deals at the upper echelon of finance.  Without doubt some portion of our economy is dependent upon the financing brought by some of these large institutions.  On the other hand, we are told all the time that small business is the engine of the economy.  Small business creates jobs.  It is also true that small business does not do business with Wall Street.

Who finances small business?  The thousands of smaller regional and local banks!  That is right, our economy is not solely dependent upon Wall Street.  It is dependent upon Main Street.  The FDIC does not hesitate to pull the plug on Main Street banks, so why are we hesitating to pull the plug on Wall Street banks?  There is no reason to do so.  Lending will still occur, commerce will continue.  We will be healthier if we stop the bleeding.

Congress needs to understand that we cannot keep using taxpayer funds to replace business losses incurred by large Wall Street financial institutions.  Whether you take our money by taxation or by devaluing currency by printing more, or increase costs by borrowing more, the result is the same:  Main Street bears the brunt of the government action.  There is no just reason for shifting the burden of bad business decisions to the general public.  The failure to allow banks to fail is the failure to govern.  Stop the bleeding now.

FED STILL REFUSES TO IDENTIFY RECIPIENTS OF OUR MONEY

Bloomberg is reporting that the Fed Refuses to Release Bank Lending Data, Insists on Secrecy.    

The Fed refused yesterday to disclose the names of the borrowers and the loans, alleging that it would cast “a stigma” on recipients of more than $1.9 trillion of emergency credit from U.S. taxpayers and the assets the central bank is accepting as collateral.

Transparency is exactly what is needed to get us out of this mess, yet the government continues to obfuscate the data and hide the private parties that are benefiting from taxpayer dollars.  In January 1932, a couple years into the Great Depression, Herbert Hoover asked Congress to create the Reconstruction Finance Corporation - an entity that lent money to banks and private businesses in order to prop them up during the ordeal.  Like the Fed now, the RFC refused to disclose the identities of the recipients of the taxpayers' money.  It took an act of Congress in July of 1932 to force the RFC to disclose the parties that benefited from the fund.  What was discovered was that the government was playing favorites - picking and choosing the winners and losers.  

The administration claims now that disclosure will undermine confidence in the parties that receive the funds.  What will undermine confidence in the system is the failure of transparency.  If it turns out that the government has been playing favorites, then confidence will be lost in those institutions as well as in government itself.  The only way to restore confidence is full disclosure.  Government is about rules and the equal application of those rules to the people.  Hiding the truth leads to fear and suspicion that the administration of justice and government aid is unequal and unfair.  Hiding the truth undermines our very system of government.

I suspect that most people believe there has been some degree of favoritism already in the administration of the bailout funds, but if we are serious about restoring confidence in the markets, it is imperative that we have faith in our government. That faith can only come about with full disclosure.  

Las Vegas Now Wants Taxpayer Subsidies!

Las Vegas Sands owner, Sheldon Adelson, is criticizing President Obama for railing on bankers for holding meeting in Las Vegas.  Adelson, who not too long ago was once one of the wealthiest Americans, at least while his Las Vegas Sands enterprise was enjoying a sky high ride on the stock market.  Adelson's fortune is tied to the Las Vegas roller coaster.  The company's stock sold at one point for about $140 per share.  Today it is going for about $2.30 per share.  

Las Vegas is one of the most popular destinations for conventions and meetings.  Adelson played no small part in transforming the town from a mob-run laundering operation into the premier destination for meetings and conferences.  In fact, in terms of meeting space, Vegas can't be topped.  Only Orlando gives it a run for the meeting money.   When the economy causes businesses to tighten their belts it is understandable why attendance at meetings, conferences and conventions are cut back.  Las Vegas, like Orlando, is suffering from the poor economy.

The real question is whether taxpayers should subsidize lavish meetings and conferences.  Obama, understandably, does not want bankers who receive taxpayer funds to pay for lavish conferences and meetings.  We expect government funded groups to behave responsibly.  Adelson needs to understand that the taxpayers can't subsidize Las Vegas.  On the other hand, the government should not be in the business of playing favorites and moving meetings from Las Vegas to Obama's hometown of Chicago for example.  

The bottom line is that bonuses and conventions are not the type of spending that taxpayer subsidies should be used for.  If these bankers can afford a conference or bonus, they shouldn't be receiving our money.

AUTOS CONTINUE TO RUST IN PORTS

US Automobile sales are expected to continue to decline about 42% from last year at this time, Reuters reports..  That is only 685,000 cars and light trucks were sold in February, although that number should be up slightly  from January sales.  Annually, that projects to 9.5 million cars and trucks - that is the same sales level as in 1982.  Yikes.  

The decline, however, should not have been unexpected from the auto industry.  Over the past five years, the industry ramped up production and sold cars on credit to borrowers with lower risk profiles than normal.  The availability of credit and low interest rates artificially accelerated demand by a couple years.  The decline in auto sales is heading towards the mean, although as can be expected, the sales decline will need to overshoot the mean before coming back.  

This is not the first time in history that we have experienced such a cycle in manufacturing and in the auto industry in particular.  Granted, this occurs at the same time a global financial crises occurs (due in part to the auto makers' foray into the credit industry), but it is hard to have any sympathy for an industry who's business practices caused sales demand to increase beyond what was sustainable.  Instead of taking the profits and putting them to use restructuring the company and preparing for the inevitable decline in demand, the auto makers squandered the resources and find themselves begging Washington for more bailouts.  

Bailouts are not the solution to poor business practices.  Forced restructuring is the solution.  Chop the companies up into bits and sell off the parts to the highest bidder.  The industry won't go away, and will be much stronger  as a result.  Manufacturing can be profitable, and America can sell price competitive products once the legacy systems burdening the industry are put to rest.  

AIG BLACK HOLE - US CONTINUES TO POUR MONEY INTO SAVING THE INSURER

AIG the insurance giant "partially" taken over by the US Government (under the Bush administration) is getting another $30 billion of your tax dollars.  The Federal Reserve announced this morning that the terms of the bailout have been adjusted.

The company continues to face significant challenges, driven by the rapid deterioration in certain financial markets in the last two months of the year and continued turbulence in the markets generally. The additional resources will help stabilize the company, and in doing so help to stabilize the financial system. 

The New York Times stated that AIG plans to announce a $62 Billion loss last quarter.  Continuing to use taxpayer dollars to bailout AIG is simply throwing good money after bad.  AIG got into this mess because of its unfunded credit default swaps backed by no reserves.  The unregulated CDS market was (and still is) nothing more than a casino style sports book where the events being bet upon were the health and stability of the banking world.  Casinos stay in business because they balance their books with offsetting bets and make money on the vig.  A well run CDS game should have been done the same way.  Unfortuantely, AIG did not have a balanced book, thus with every bank failure and with every corporate failure that it bet against, AIG will have to shell out more and more money to pay off its losing bets.  The notional value of AIG's book is $300 Billion.  The losses could actually be much higher.

Ultimately, AIG will fail - there is no way we can continue to sustain these losses on taxpayer dollars.  While the government is trying to buy time in the hopes that the economy will turn around in time to minimize AIG's losses, our taxpayer dollars are being used to payoff bets AIG made on the health of the financial system.  The wisdom of the continued bailout is being questioned.  Peter Morici told Reuters that "[t]here's no amount of money that you can give (AIG), there are $2 trillion in losses out there."  Karl Denninger, who recently won an award for truth in journalism, even questioned the lawfulness of the Fed's investment.  His analysis is on target.  The gist of the argument is that the Fed is not empowered to make investments, but only to lend money on the best collateral.  What the Fed did with AIG is make an investment first into preferred stock and then converted that into common stock with additional cash.  The Fed isn't making a loan at all, but is shelling out taxpayer money to support an institution that is bound to fail.

The Bush administration made the argument that a takeover of AIG was necessary to prevent a siezure in the insurance industry - so that businesses on Main Street could maintain insurance.  Of course, that was pure rubbish, as all traditional lines of insurance are regulated by the states and require reserves to fund probable liabilities.  The CDS market was not regulated, required no reserves, and is irrelevant to Main Street businesses.  It was a corporate bet that made money for AIG's executives for years, and it is now loosing money for the taxpayer.  This silliness needs to stop.  The only reason to take over AIG in the first place is to assist an orderly liquidation so as not to shock the market.  I accept that as a legitimate function of government.  

Using taxpayer funds to prop up institutions is not a legitimate function of government, and will lead to disasterous consequences down the road.   We rightfully expect our government to be fair and impartial in its dealings with its citizens (including corporate citizens), and we have a right to expect prudence with our money.  The governement cannot bail out all entities.  By picking and choosing which ones to save and which ones it should let perish, the administration is playing favorites.  Playing favorites undermines confidence in government.  Just as Bush and his cronies were roundly unpopular because they blatantly used government power to favor a few at the expense of others, President Obama is heading down that same path.  It makes no difference that the Democratic favorites are different than the Republican favorites.  It is still choosing winners and losers and it is not being neutral.  Faith in government will continue to erode until the nonsense stops.  AIG will fail eventually despite the governments best efforts.  The question is, will the United States go down with AIG?

THE ORACLE OF OMAHA SPEAKS

Berkshire Hathaway, the company chaired by Warren Buffet, released its annual report today.  Mr. Buffet's annual letter to stockholders is always a good read, if not prescient.  Because the letter is dense and has many topics, this post will be longer than usual, but it is worth it.  

Buffet noted that the US economy is in shambles:

"We're certain, for example, that the economy will remain in shambles throughout 2009 - and for that matter, probably well beyond - but that conclusion does not tell us whether the stock market will rise or fall."

And we are not out of the woods.  Whether the market will yield investable opportunities or not is unknown, even in a downward spiraling economy; however, Buffet offered these words of wisdom:  "When investing, pessimism is your friend, euphoria the enemy."

The government is taking acts to give the appearance that it is taking acts to help the economy, but no one really knows if these actions will work.  We do know that they didn't work during the great depression and they didn't work in Japan.  Nevertheless, we do know that the  government solutions will have unwelcome aftereffects.  Buffet said:

"The U.S. – and much of the world – became trapped in a vicious negative-feedback cycle. Fear led to business contraction, and that in turn led to even greater fear. This debilitating spiral has spurred our government to take massive action. In poker terms, the Treasury and the Fed have gone “all in.” Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation."

Aside from inflation, the government spending is making private industries, and municipalities dependent upon government aid.

"[M]ajor industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political challenge. They won’t leave willingly."

In other words, be prepared for continuing this extreme level of wealth redistribution far into the future.  Just think how long it has taken us to dismantle the temporary solutions put in place by FDR to get us through the depths of the great depression. (Hint: Those Programs Still Exist.)

What is worse, the government is playing favorites.  After years of trying to level the playing field among various financial institutions (on the theory that competition helps consumers and the economy), the administration's bailout is playing favorites by giving  insolvent banks money at lower cost than banks that didn't act irresponsibly.

"Funders that have access to any sort of government guarantee – banks with FDIC-insured deposits, large entities with commercial paper now backed by the Federal Reserve, and others who are using imaginative methods (or lobbying skills) to come under the government’s umbrella – have money costs that are minimal. Conversely, highly-rated companies, such as Berkshire, are experiencing borrowing costs that, in relation to Treasury rates, are at record levels. Moreover, funds are abundant for the government-guaranteed borrower but often scarce for others, no matter how creditworthy they may be. This unprecedented “spread” in the cost of money makes it unprofitable for any lender who doesn’t enjoy government-guaranteed funds to go up against those with a favored status. Government is determining the “haves” and “have-nots.” "

In other words, our government is rewarding bad economic policy.  It is the same  wrong headed message we send when we tell people that if they borrowed money to buy a house, the government will step in to pay the mortgage when the borrower can't pay.  Here we are telling banks that if they make bad loans and become insolvent, instead of letting the banks fail, we will give them a competitive advantage over other banks and lenders by giving them money below market cost.   

Berkshire Hathaway also has a division that is involved in housing, mainly through manufactured homes.  While not immune from credit risk, Buffet's company is in a far better position to weather the storm because of sensible lending practices. 

Here is what Buffet had to say:

Commentary about the current housing crisis often ignores the crucial fact that most foreclosures do not occur because a house is worth less than its mortgage (so-called “upside-down” loans). Rather, foreclosures take place because borrowers can’t pay the monthly payment that they agreed to pay. Homeowners who have made a meaningful down-payment – derived from savings and not from other borrowing – seldom walk away from a primary residence simply because its value today is less than the mortgage. Instead, they walk when they can’t make the monthly payments. 

*  *  * 

The present housing debacle should teach home buyers, lenders, brokers and government some simple lessons that will ensure stability in the future. Home purchases should involve an honest-to-God down payment of at least 10% and monthly payments that can be comfortably handled by the borrower’s income. That income should be carefully verified. Putting people into homes, though a desirable goal, shouldn't be our country’s primary objective. Keeping them in their homes should be the ambition.

There are many more tidbits in the annual report, but this post is lengthy enough so I will move on.  Please go to the Berkshire Hathaway site to read the entire annual report.  Enjoy the read.

Obama Delivers Message of Hope

His oratory is phenomenal.  The President's speech, about an hour long, highlighted not only what needs to be done immediately to keep credit flowing and assist the ailing auto industry, but also showcased his budget priorities.  Those priorities are renewable energy, health care reform, and education.  At the same time he told Congress to reduce the deficit.  Obama talked about elimination of waste in government and reform of antiquated programs.  Follow this link for the full text of President Obama's address.  The showcase line delivered by the President was:

"But while our economy may be weakened and our confidence shaken; though we are living through difficult and uncertain times, tonight I want every American to know this: We will rebuild, we will recover, and the United States of America will emerge stronger than before."

The budget and priorities will be debated, and hopefully legislation will be enacted quickly to advance renewable energy, reform health care delivery and improve education.  With that said, however, there is still serious disagreement as to the short term tactics to handle the economic crisis.  The issue is not the flow of credit to individuals and small businesses, but whether we have the capacity to borrow more without repaying the debts we previously incurred.  When people have gorged themselves on all forms of credit available at the buffet they stop eating until they digest their food.  Restaurants do not force them to eat more than they need or before they are ready.  No matter what we do with the banking system, responsible borrowers need to clean up their balance sheet before we begin borrowing anew.  Responsible lenders will not extend credit when the risk of default is great.  Returning to the practices that got us into the problem is not the solution.  Create a new banking system that can lend to borrowers without regard to bad loans on its books.  Stop the bleeding of the insolvent banks.  That will get us out of this situation, 

 

The President's otherwise wonderful speech was unfortunately marred by a few partisan snipes aimed at the Bush administration that he could not resist delivering. While most of his comments were met with bipartisan standing ovations, only the Democrats stood and applauded his partisanship.  In addition he gave credit to America for inventing the automobile.  Hopefully our German friends wont take much umbridge at the sleight to Daimler, Maybach and Benz.  Nevertheless, his comments were well received and hopefully will set the tone for some real budget cutting and reform.

Obama To Give Message of Hope

President Obama is expected to deliver a sorely needed message of hope to this Country in a short while.  After the President outlines the recent culture of placing short term gains ahead of long term prosperity, he will take the opportunity to pave a new beginning of responsibility.  He is expected to tell America that:

"Now is the time to act boldly and wisely – to not only revive this economy, but to build a new foundation for lasting prosperity. Now is the time to jump start job creation, re-start lending, and invest in areas like energy, health care, and education that will grow our economy, even as we make hard choices to bring our deficit down."   

We know President Obama will use all of his fabled oratory skills to convince America that it is time to start focusing on the long term, but his challenge (and our challenge) will be to convince 435 members of the House of Representatives and 100 Senators to break their culture of bickering, infighting, partisanship and pork barrel politics.  It is hard to imagine how the existing crew, with about 470 running for election every 2 years, would be willing to put the Nation's long term interests above the perceived need to get something accomplished in the short term at the expense of another party in order to get re-elected.  Let's hope Mr. Obama can deliver this type of change.

More Bailouts Are Just Wasteful

Every day we hear more and more news about companies coming back to the government for more bailout funds.  Banks, insurance companies, auto makers have all received massive amounts of our tax dollars and are now coming back for more.  The New York Times is reporting that the U.S. is Pressed to Add Billions to the Bailout .  The real question is whether any of this will help.  

The fundamental problem with the economy is that the consumer, the main engine of the economy, is tapped out.  Collectively, we are trying to get our own balance sheets in order.  Instead of buying new big screen televisions and automobiles, we are trying to pay down the debt we accumulated.  Hopefully, we are starting to live within our means.  But, that also means we need to adjust the way we do business.  The demand for goods and services will not return to the way they were anytime soon.  Take a look at this chart from Contrary Investor:

What this chart shows is that households are borrowing less and less.  It is a sign that we are starting to unwind the debt we have accumulated.  While no one can predict where this chart may lead, it is very likely in the coming months, if not years, that this chart will actually be negative - that is, that households will be reducing more debt than we collectively borrow.  

What does that say for the future of the financial industry that relies upon the collection of interest?  It means revenues are permanently down.  A smaller pool of resources.  What does it say about product companies like the automotive industry?  It means demand will be reduced.  In the end, it will be a good thing if we all live within our means.  In the short run, it means that industries will need to readjust what they are doing to meet the lower levels of demand.  

With the spectre of lower demand, how does it make any sense to continuing to finance the banks, insurance companies and auto industry when they can't make a profit?  It doesn't.  It is one thing if we are adding funds to preside over an orderly liquidation and restructuring, but it is quite another to keep funding these industries without any plan or goal in mind.

Create A New Banking System Now

The challenge we face, and the challenge the administration is grappling with, is what to do with insolvent financial institutions.  If you let them fail it will send the market into a panic.  Credit will seize up as it did when Lehman went under.  Without credit, the engines of the economy - at least the engines of large business - grind to a halt.  The fear mongers tell us that jobs will be lost and all commerce will stop.  Whether that will be the result or not is unknown, but there is no question that the catastrophic failure of banks without a replacement financial system in place would have far reaching consequences.  

Here is an idea floating around.  Instead of spending money trying to keep insolvent banks afloat while all their bad loans come home to roost, spend the money now to create a new banking system that will be in place when the insolvent banks inevitably fail.  David Warsh in his blog , Economic Principles, suggests using government money to set up half a dozen start-up wholesale banks, and once they get to borrowing and lending freely, sell them off to the public.  Once these banks take root, we can dismantle the existing Wall Street system that cannot survive.  

Common sense tells us that this can be done rather quickly - especially with full government backing.  Imagine newly chartered banks with fresh capital and no legacy obligations.  Depositor would be attracted to them for they would at the same time have a lower risk than Bank of America, Citgroup, JPMorgan or any of the other large mega banks burdened by bad loans and hard to value assets.  Whether money would be lent out is a very different question.  The fact remains that in times of uncertainty there can be little faith that sums lent will be repaid except only to the most credit worthy of all the borrowers.  Prudence should remain the backbone of lending, and the reason we are even discussing the banking crisis is because these banks made impudent loans and/or purchased assets backed by these imprudent loans.  Nevertheless, there will come a time when the risk reward ratio will make sense, and these newly created institutions would have the ability to lend.  Further, the swift privatization of these new banks will assure that taxpayer funds get repaid to the treasury.

Once the system is in place, we can cut the life support to the insolvent banks and let the shareholders and bondholders get what they deserve.   

  

CItigroup Is Near Nationalization - Updated

There is much attention this morning to reports that the US may not only convert its $45 Billion Dollar bailout of Citigroup into common stock, but that our tax dollars may go to buy up to a 40% stake in the insolvent bank.  Mike Shedlock has done an excellent analysis of the report, and Barry Ritholtz has also noted that we are proposing to throw good money after bad.  Best of all is Karl Denninger's analysisposted on his blog.  Henry Blodgett had joined the debate as well pointing out that at current valuation converting the taxpayer's $45 Billion preferred into common would result in an 80% stake not a 40% stake as the insolvent bastards propose.

Taking another stake in the bank is a bad idea.  Throwing more money at the bank will not work.  How much more will the government commit waste of our tax dollars?  More than the whole is worth?  If you or I had an old family car in need of repair, we would look at the cost of repair in relation to its market value.  No prudent man would pay more for repair than the item is worth.  No government should spend more to fix a problem than the problem is worth.  Citigroup's current market value - the sum of the outstanding shares of the enterprise is approximately $12 Billion.  Does adding $40 Billion to the enterprise make sense?  More than 3.5 times its cost?  For an insolvent company that is ready to be taken over by the FDIC?  Where is the prudence?  See for yourself.  Here is Citigroup's chart:

Either liquidate Citigroup because it is insolvent, or nationalize it to preside over an orderly liquidation.  Just don't waste more money trying to save an insolvent bank.  We roundly criticized Japan for maintaining zombie banks during their 20 year depression.  Why should we follow in their footsteps?  There is going to be paid either way, but the question is whether the pain should be quick and deep to get it over - which will hurt most those with a financial stake in the bank (stockholders and bondholders), or should we drag the pain out slowly, every day watching another crisis, spending taxpayer dollars with another bailout and spreading the loss and pain to the entire nation over 20 years.   Neither solution is good, but my vote is to make those that took the risk and benefited from the gain to take the loss.  Not the taxpayer.  Short term nationalization of banks now is what is needed to liquidate the banks and purge the rottenness out of the system.  Only when we have rid ourselves - through bankruptcy or the equivalent - of these insolvent banks will we be able to recover the economy and start the growth cycle anew.

Oh and by the way, its time to move your money to a local community bank that you know is solvent.  The return to Main Street is underway.  Do business with people you know and trust.

The Rant Heard Around the World

Rick Santelli's now famous rant on CNBC in reaction to the President's mortgage plan has resonated with America.  Evidence of how he hit home comes from the White House response, which shamelessly attacked Rick in a most undignified manner.  Well, Rick and CNBC are not taking the attack sitting down.  Rick defended himself and once again explained how Obama's plan to use our tax dollars to pay for bad loans so banks don't have to take a loss and the borrower can keep houses they can't afford is simply bad policy and unfair to the nation.  

I encourage Rick and CNBC to tour across the country to rally the 92% of us who play by the rules to make Obama and Congress act in a fair and prudent manner, especially with our tax dollars.  If the government continues on this course, history will look back at Rick at view his rant as the shot heard around the world.  (I have never owned a pitchfork, but if Rick has a rally, I may just go buy one.)

Tax Cuts For Everyone!

Normally I am ecstatic when I hear of tax cuts.  Anything that will reduce the cost we bear to sustain our government is generally good.  On the other hand, Obama's "stimulus" tax cuts are just plain stupid.  Reuters is reporting that President Obama ordered the Treasury Department to begin implementing the tax cuts to the nation's workers by reducing the amount withheld from paychecks.  How much is less will be withheld?  About $15 per week.    

Barak Obama actually sounded proud of that!  What will $15 per week do anyway?  How many more big screen TVs will that buy?  Let's see, at $15 each week, if saved in our nations insolvent banks (with virtually no interest) after a year, each worker will have about $750.  After 2 years they might be able to buy another TV.  That is stimulus we can believe in!  

Wait - with $15 per week, I can apply for a new mortgage loan.  I will just accidentally add 2 more zeros to it and get a huge mortgage to buy a new, larger home with a third bathroom, then default on the mortgage and have the government pay for it!

The link to the Reuters story is: 

http://www.reuters.com/article/topNews/idUSTRE51G5X720090221

Great Chart from EconompicData!

The Econompic Data blog (http://econompicdata.blogspot.com/) has a great graphic on the moral hazard of Obama's mortgage bailout plan.  Very pithy, but it also points out exactly why the majority of us are so outraged by having our government steal our money to pay for property other people can't afford.  The chart is reproduced below, but you can see more at the above link.

Click on the above chart for a bigger picture

Hold Those Responsible Accountable!

Outright bank fraud and fraudulent and reckless banking practices contributed to the current economic meltdown.  Everyone involved in the process - from the borrowers to the brokers to the bankers to the underwriters and ratings agencies - should be held accountable.  How?  Existing fraud laws are sufficient, but Congress should expressly authorize private individuals to pursue these bad actors for a cut of the recovery.  Authorize the public to bring the equivalent of a qui tam  action in the name of the People of the United States against those  involved in this massive fraud and reckless conduct.  Until these individuals are pursued, the country will not be able to put the crisis behind and will not be able to have faith in the markets or banking system.   

As we well know by now, borrowers falsified mortgage applications to get loans they could not repay in order to buy houses they could not afford.  Mortgage brokers assisted and guided these borrowers into lying in order to get qualified so the mortgage broker could get a commission from the banks.  The banks, in turn, knew and understood that they were approving loans with less security and lower ratios than they usually required, and they knew that noone to that point had verified the information on the mortgage applications.   Knowing these loans were substandard, the banks packaged the mortgages for sale and colluded with the ratings agencies to give the collective pool of loans a higher rating than the individual loans in that pool deserved.  That was only the start of the chain, but that chain is oozing with culpability.

Instead of bailing out the banks that were at the very least collusive with the reckless conduct and/or using my tax dollars to pay my neighbor's mortgage, spend the tax dollars to pursue and hold accountable those truly responsible or authorize the private sector to do so.  Create an army of private attorneys general to pursue those who participated in this fraud.  Start with the borrowers who lied on thier applications.  Not all borrowers lied on thier applications and not all borrowed beyond their means.  Recover what you can from the ones that are culpable and leave the rest alone.  Some estimates are that these liars are less than 8% of the mortgage borrowers.  Hold these thieves accountable!

After ferreting out the dishonest borrowers, use discovery or whatever practical leverage can be applied to encourage the lying borrowers to identify the mortgage broker involved and the process used.  Then pursue the mortgage brokers.  With a vengence.  Like borrowers, not all mortgage brokers are evil.  Many were actually doing a great job placing legitimate credit with lenders.  As an aside, it is a shame that the governments are moving to over regulate the mortgage brokerage industry based on the fruadulent actions of a relatively small minority.  Focus on the small minority of mortgage brokers.  Discover how the brokers encouraged (or misled) borrowers into misstating accurate information on their application.  (Did you ever use a mortgage broker - you filled out forms by hand and they input the numbers into the computer on their forms - - the trouble is the broker never put the same numbers onto the form - - but I digress.)  These brokers were instrumental in perpetrating the fraud.  Either they failed to input the correct information in order to fudge the numbers, and/or they encouraged the borrower to misstate their financial information and/or they turned a blind eye to obviously false information.  Ferret these brokers out and recover from them the money defrauded out of the system by these loans.  Hold these thieves accountable!

 Don't stop at the mortgage brokers.  The fraud gets worse and the pool of wrongdoings is not empty.  Go after the executives and everyone in the chain at the banks who recklessly or intentionally encouraged the mortgage brokers to lie.  There is a now famous "Cheats and Tips" memo from Chase that circulated instructing its brokers how to lie on loan applications.  (Isn't that bank fraud?)   Many more examples will surface if we stop protecting those responsible and hold them accountable.  Hold these thieves accountable!

There is further to go too!  We have the ratings agencies that packaged and sold these junk bond grade assets as the highest grade assets.  That is fraud too.  It isn't just an errant opinion on value, it is systemic fraud.  Hold these thieves accountable!

Authorizing private actions and an army of private attorneys general will remove the burden of prosecution from the government and remove the recovery from the spectre of government corruption.   Part of the problem with arresting the downward slide of the economy is that noone has any faith in the system - with good reason.  It was a rigged game.  Until the government is willing to prosecute the people that raped our banking system with fraudulent and reckless practices to line their own pockets, no faith will ever be restored in the system.  (With all this fraud out their, maybe we should just forget about authorizing private actions and use the stimulus money to hire every attorney out there to purse the perpetrators - nah  - we need the private attorneys general. ) 

Does Anyone Really Know The True Cost of the Mortgage Bailout?

How much is Obama's mortgage bailout plan anyway?  The New York Times and Wall Street Journal report the plan costs $275 billion; the Washington Post claims just $75 billion (links to articles below).  That is a huge spread people!  Does anyone really know the true cost?  If they do, are they telling us?  

What do we get for that money anyway?  Our tax dollars are being used to let people keep property they bought when they borrowed money they couldn't repay.  Instead letting these borrowers work themselves out of their own debt (like selling property they can't afford or filing for bankruptcy), the government is appropriating OUR money to keep these people in the life style they can't afford.  

Obama claims the program will  support real estate prices.  Haven't we learned that government interference with the free market doesn't work.  Real estate prices were unrealistically high (caused by an increase in the monetary supply through credit expansion) and now must fall to true pricing levels.  Prices are determined by supply and effective demand.  The market is bigger than the government.  Supporting artificially high prices does what exactly?  It may postpone the inevitable fall in prices, but it will not stop the decline.  Does anyone know what they are doing?

http://www.nytimes.com/2009/02/19/business/19housing.html?hp

http://online.wsj.com/article/SB123496582087411241.html

http://www.washingtonpost.com/wp-dyn/content/article/2009/02/18/AR2009021801081.html?hpid%3Dtopnews⊂=new