I told you that a vacation would do me a world of good. The result is two blogs in three days. But all of the credit cannot be given to rest - let's thank Treasury Secretary Paulson and Fed Chairman Bernake too. After all, it's not everyday the two get together on CNBC and talk to members of congress asking for quick passage of $700 Billion.
And at the risk of being labeled conservative in my common-sense approach to this whole thing, I would ask each of you to consider the following before giving Paulson carte blanche authority to buy these mortgages at "a deep discount."
If the assets can be purchased at such a deep discount, why isn't anyone else rushing into the market to scoop these up? Additionally, consider the fact that Bernake and Paulson are suggesting that they will pay a fair market value for these assets. Huh? If they pay fair value for these assets, or in some instances, above fair value, isn't that the same as creating profits for Wall Street?
The next point to consider is that Paulson used to work for Goldman Sachs. Before the White House tapped him to be Treasury Secretary, Paulson ran Goldman Sachs and made about $50 million per year. I can only speculate that he still has shares in GS today. By the way, Sachs is no longer an investment bank and will likely survive this implosion. The cynic in me is guessing that they will be the first in line when it comes time to dump these valuable mortgage assets, too.
Here is the point that drives it home, however. I know that we all hate history, but I'm going to ask you to go back to your eighth grade civics class and revisit the New Deal in 1933.
That year, the New Deal disallowed investment banks from also acting like commercial banks. Five years later, the New Deal created Fannie Mae to increase liquidity in the mortgage market. This allowed lower down payments and easier terms to obtain home loan financing. Freddie Maca was created in 1970.
Skip ahead to 1989 and the Savings & Loan debacle. The government stepped in when the S&L's were writing bad loans before it was en vogue and had a TON of bad loans on the books. This action changed everything - setting precedent to banks and other investment firms that if you make bad loans, the government had yoru back and would bail you out.
In 1995, Congress re-established the CRA (Community Reinvestment Act) that emphasized lending to low-moderate income borrowers in less affluent communities. If a bank was going to buy another bank or merge with another entity, it had better adhere to CRA standards in order to get its plan approved. Homeownership skyrockets to over 65% of all Americans that could be homeowners becoming homeowners.
Flash forward to 9/11. Rather than allowing the market to shoulder the burden for bad loans that occurred as a result of the business slowdown due to the terrorist acts of that day, the Feds decide to continually lower interest rates; from 6.5% to 1%. This allowed an artificial "inflation" in the market for loans and created a new demand.
Now, we find ourselves in the same predicament and we are following the same exact path! It has to stop.
Worse yet, we are allowing Paulson the ability to do whatever he wants, whenever he wants, with our money. No checks or balances here, sir.
There is an alternative and it's a simple thing to enact. Sadly for congress, it doesn't come with pomp and circumstance or a $700 Billion price tag. It's changing an accounting rule that currently requires banks to list loans as assets and value them at their current price. In case you haven't followed the mortgage market, you probably would have more luck selling sand in the desert right now than selling a mortgage on Wall Street. This is why the market liquidity crunch has hit. Not because of foreclosures, which are bad, and not because of subprime lending, which is also part of the problem.
Think about it this way. If you absolutely HAD to sell your house today. Not tomorrow, not next week, but today, would you get top dollar for it? NO WAY JOSE (my five year old daughter's favorite quote.) THAT'S what is going on in the mortgage/banking market right now.
These investment banks don't have to sell their mortgage loans today, but they have to value them on their books based upon today's demand... go figure.
The real culprit is a little accounting requirement. Sorry it's not sexier, but that's too hard to explain I guess.
Please, I am asking you as someone that really doesn't want his children to pay for this horrible plan to spend two minutes and contact Congressman Altmire and Senators Casey and Specter and ask them to please NOT sign this horrible piece of legislation.
Send me your comments and don't worry, there will be another post Monday.
Showing posts with label bailout. Show all posts
Showing posts with label bailout. Show all posts
Tuesday, September 23, 2008
Sunday, September 14, 2008
Bailing More than Water
Well it's been one of those weeks in the economy. And while I attempt to stress the importance of everything to my students, I can't help but wonder if any of them get it.
The reality of the situation is very simple: our federal government is bailing out private enterprises faster than Homer Simpson can dunk a donut. It concerns me beyond compare.
To date, the feds have stepped in and assisted Lehman Brothers buy out Bear Stearns, and they've also taken over Fannie Mae and Freddie Mac. As of this writing, there is speculation that they might assist an entity buy out Lehman Brothers. Yes, the same Lehman Brothers that just purchased Bear Stearns about six months ago. The automakers are also asking for $50 billion in government handouts (fortunately, they will probably only get $25 billion.)
Throw in an election year with two candidates that desperately want to win, and it's evident our federal reserve system is really just an ATM (except they don't get to keep the $2.00 fee each time.)
I'm not going to argue whether or not the economy is in dire straits. It is. I don't need Ben Bernake to tell me that and my students don't need me to remind them that their dollar is worth about $.85 compared to last year. That's called inflation.
What I am going to argue, however, is this: I don't think the government should step in and bail ANYONE out - ever.
Get your pencils out for this terribly complex economic/financial formula. Risk = reward. Whew. Got it? Good. Repeat after me. Risk = reward.
So I have to ask you this. Where is the risk to start and mismanage a business if you know the government is going to come in and save the day?
And make no mistake about it. Each of the companies seeking goverment assistance has been horribly mismanaged for years, not just the last few months. Fannie Mae and Freddie Mac epitomize mismanagement, providing deep pockets for Wall Street while simultaneously spending in excess of $150 million in lobbying during the past decade. There is a reason prices of housing escalated so quickly - both agencies allowed consumers to qualify for loans they couldn't afford, with debt ratios in excess of 50% of a homebuyers GROSS income. Think about that for a moment. You make $4000 per month before taxes, utilities, groceries, car insurance, etc. and Fannie Mae tells you to go ahead and take that $2000 per month payment. Where does the rest of the money go?
Throw in the fact that you could purchase a home with $0 down payment (as in ZERO) and you have a recipe for disaster. Nevermind the fact that often the buyer had impaired credit and the seller was paying part, or all, of the closing costs associated with the transaction. Appraised values were inflated, inspections were skewed and sometimes even the real occupancy of the owner came into question. Oh, and everyone made gobs of money.
Even my first year business student recognizes the flaws in this business model. Mismanagement 101, my friend.
So I return to my basic question. Are you willing to kick in the $10-15 BILLION required to bailout Fannie Mae and Freddie Mac?
To be sure, GMAC isn't exactly the model of efficiency and Lehman has been called "greedy" from time to time. They, too, are asking for help.
For argument sake, recognize that we are spending about $10 billion per month on the war on terror in Iraq. Should we rob Peter to pay Paul? That's what we're doing.
How do you pay for these bailouts? There are two ways and neither one is a good option.
1. Alternative revenue sources (political speech for "raise taxes.")
2. Print more money since the value of Treasury Bonds will run more risk than current yields support. If this occurs, something called Hyperinflation will occur and yes, that's worse than it sounds.
There is an answer and it is a painful one.
Allow the markets to take care of themselves. Penalize Fannie, Freddie, GMAC, Lehman and any other company that fails due to mismanagement by letting them become extinct. Yes, it will hurt - bad. But investors will learn their lesson and adjust accordingly. If they don't, they will risk losing on their next investment.
The message being sent right now is "too big to fail." Tell that to Enron, MCI/Worldcom, Adelphia. On the flip side, is Microsoft too big to succeed? We try to break up successful models, calling them a monopoly. Where is the fairness? Is Wal Mart next to be broken up, or are they better of simply running themselves into the ground too?
Risk = reward. If you take big risks, you are entitled to big rewards - or big losses.
You cannot regulate risk any better than you can regulate deman; something communist countries discovered through the black market. And while I don't want to insinuate that we are heading toward communism, we are certainly further away from a free market economy today than we were a mere ten years ago.
The reality of the situation is very simple: our federal government is bailing out private enterprises faster than Homer Simpson can dunk a donut. It concerns me beyond compare.
To date, the feds have stepped in and assisted Lehman Brothers buy out Bear Stearns, and they've also taken over Fannie Mae and Freddie Mac. As of this writing, there is speculation that they might assist an entity buy out Lehman Brothers. Yes, the same Lehman Brothers that just purchased Bear Stearns about six months ago. The automakers are also asking for $50 billion in government handouts (fortunately, they will probably only get $25 billion.)
Throw in an election year with two candidates that desperately want to win, and it's evident our federal reserve system is really just an ATM (except they don't get to keep the $2.00 fee each time.)
I'm not going to argue whether or not the economy is in dire straits. It is. I don't need Ben Bernake to tell me that and my students don't need me to remind them that their dollar is worth about $.85 compared to last year. That's called inflation.
What I am going to argue, however, is this: I don't think the government should step in and bail ANYONE out - ever.
Get your pencils out for this terribly complex economic/financial formula. Risk = reward. Whew. Got it? Good. Repeat after me. Risk = reward.
So I have to ask you this. Where is the risk to start and mismanage a business if you know the government is going to come in and save the day?
And make no mistake about it. Each of the companies seeking goverment assistance has been horribly mismanaged for years, not just the last few months. Fannie Mae and Freddie Mac epitomize mismanagement, providing deep pockets for Wall Street while simultaneously spending in excess of $150 million in lobbying during the past decade. There is a reason prices of housing escalated so quickly - both agencies allowed consumers to qualify for loans they couldn't afford, with debt ratios in excess of 50% of a homebuyers GROSS income. Think about that for a moment. You make $4000 per month before taxes, utilities, groceries, car insurance, etc. and Fannie Mae tells you to go ahead and take that $2000 per month payment. Where does the rest of the money go?
Throw in the fact that you could purchase a home with $0 down payment (as in ZERO) and you have a recipe for disaster. Nevermind the fact that often the buyer had impaired credit and the seller was paying part, or all, of the closing costs associated with the transaction. Appraised values were inflated, inspections were skewed and sometimes even the real occupancy of the owner came into question. Oh, and everyone made gobs of money.
Even my first year business student recognizes the flaws in this business model. Mismanagement 101, my friend.
So I return to my basic question. Are you willing to kick in the $10-15 BILLION required to bailout Fannie Mae and Freddie Mac?
To be sure, GMAC isn't exactly the model of efficiency and Lehman has been called "greedy" from time to time. They, too, are asking for help.
For argument sake, recognize that we are spending about $10 billion per month on the war on terror in Iraq. Should we rob Peter to pay Paul? That's what we're doing.
How do you pay for these bailouts? There are two ways and neither one is a good option.
1. Alternative revenue sources (political speech for "raise taxes.")
2. Print more money since the value of Treasury Bonds will run more risk than current yields support. If this occurs, something called Hyperinflation will occur and yes, that's worse than it sounds.
There is an answer and it is a painful one.
Allow the markets to take care of themselves. Penalize Fannie, Freddie, GMAC, Lehman and any other company that fails due to mismanagement by letting them become extinct. Yes, it will hurt - bad. But investors will learn their lesson and adjust accordingly. If they don't, they will risk losing on their next investment.
The message being sent right now is "too big to fail." Tell that to Enron, MCI/Worldcom, Adelphia. On the flip side, is Microsoft too big to succeed? We try to break up successful models, calling them a monopoly. Where is the fairness? Is Wal Mart next to be broken up, or are they better of simply running themselves into the ground too?
Risk = reward. If you take big risks, you are entitled to big rewards - or big losses.
You cannot regulate risk any better than you can regulate deman; something communist countries discovered through the black market. And while I don't want to insinuate that we are heading toward communism, we are certainly further away from a free market economy today than we were a mere ten years ago.
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