I saw on CNN Headline news this week that scientists, along with lots of computers, determined that Einstein's formula for the theory of relativity is, in fact, correct. Such a seemingly simple equation could help explain something as complex as our universe. How often do we find that what seems like a very complicated situation, has a very easy solution? I think we can take this approach with the current economic crisis. We have seen bailout after bailout. We have bailout waiting in the wings for the Big Three. Make no mistake, the U.S. economy is in bad shape, and there is not easy, or quick way out of our difficulties. That said, it soes not ahve to be as complicated, or expensive, as what we have seen.
Here is how things work in the real world. If a business finds itself in financial trouble, or wants to expand, there are generally several options open to it. If the business is a good business, with a good customer base, well capitalized, and needs some money to achieve its goals, it will go to the bank for a loan, issue stock, or sell bonds, and use the money for the business. This business will find that banks are more than willing to lend, and investors will giv ethe company an good price for its stock or a good interest rate on its bonds. If the business is not as sound, it will find fewer banks willing to lend, those that do will charge a higher rate and add loan covenants, require more collateral, investors will not give as much for their stock, and bind holders will require a higher rate. If a business cannot be saved, banks will not lend, they will not be able to issue new stock, and no one will buy their bonds. That business will fail.
You will notice that the Federal Government is not mentioned once in the above example. There is no need. These things happen everyday. The market decides winners and losers. Certainly, there is the need for some government involvement. The Federal Reserve and the Treasury have their roles, but picking winners and losers is not in their job description. Businesses, as well as individuals have the responsibility to act in such a way as to insure that they remain economically healthy now, and in the future. If they fail, they have the responsibility to get up and try again. This goal can be accomplished in a variety of ways, but it basically boils down to acting responsibly now, and saving for the future. That's it.
You will notice that I did not say banks, auto makers, or mortgage holders. I said businesses. I'd like to narrow it down to just those three, but, and this cannot be surprising to anyone, there is now a long list of people the government wants to give money to, and an even longer list of people with their hats out. We are now in dire economic straits. But bailouts are not the answer. In earlier editions of my blog I recommended that banks and insurance companies be allowed to fail. The government should take the same role as they did during the Savings and Loan crisis of the early and mid 1990s. They should reestablish the Resolution Trust Corp to sell the assets of the banks and insurance companies that fail. Keep in mind that this crisis is all about over-priced assets. All that is happening in the housing market and the stock market is that buyers are waiting for the bottom of the market to show its face and then they will know how to act prudently.
We have enjoyed years of sustainable and dependable economic growth. Now we are going through some bad times. While not as popular, these bad times are as important as the good times. The bad economic times, the busienss losses and failures, the foreclosures are unfortunate, but necessary because they tell us where we went wrong. In this case, they remind us that when you package loans, given to people who can never hope to pay them back, into investments, even if you call them something else, like a CDO, they are still bad investments. True, credit rating agencies like Moodies and Standard and Poors gave them investment grades, but we all knew the loans would go bad. I remember watching this activity for years and I could not believe investors actually bought these. There was no way this was going to work out anyway, but bad. It's the old silk purse from a sow's ear analogy. The loans are called sub-prime for a reason. There was an inertia (probably something from Newton) that was unexplainable, but there, nevertheless. I am not soothsayer, and I was not alone. Alan Greespan warned of a Fannie Mae and Freddie Mac crisis years ago. But people sometimes believe only what they want to, and there is a price to pay for that.
All of that being said, in addition to the resurrection of the RTC, and the just say no attitude towards all bailouts, here is what we can do to help insure we do not have a crisis like this again. First, we need to establish a FDA-type agency to "test" investment vehciles before they are allowed to go to market. Just like prescription durgs are tested, we can test investments. In the case of CDOs you simply have a very limited amount of these turned into investments and sold. Wait a few years, see how they do in good times and bad, and then you have enough data to propery structure them. There is not need to regulate the amrkets any more than they are now. What is needed is to make sure the investments are transparent and understandable. Remember, the credit rating agencies freely admitted they did not understand may of the investments they rated. The new agency gives rating agencies lots of time and data to do their jobs properly. Some may argue that this will slow the the ability of brokers to get new types of investments to the market, but one look at a Wall Street Journal will show anyone that we have plenty of investments to choose from right now. We'll make due, thanks.
Second we need to rescind government promises to bailout institutions and let the free market take over. Let's keep in mind that all of the doomsday scenarios presented assume that once an insitution fails, every business will just sit back and let the economy spiral out of control. Here is what will happen. CitiGroup fails. Another bank, or a company like American Express who is trying to become a bank, will buy the assets cheap. They won't buy them now because they do not need to. All they ahave to do is wait fo rthe price to drop and they will buy. They will not let the price drop too much for fear that someone else will buy what they covet. This will happen with other failed institutions, including AIG. There is no such thing as "too big to fail." The market will just hold a going out of business sale. It will take a while for all of this to happen, but we will get through it easier and cheaper than the way we are currently going through this crisis.
Third, Sarbanes-Oxley-like legislation must be enacted for credit rating agencies and other market players to punish fraud. Punishment should include significant Federal Prison sentences and fines.
Overall, the philosphy of the federal government should be to properly test new investments, regulate the the market players, and let the chips fall where they may. If the amrket goes up and investors make millions, that's great. If the markets go down and investors lose millions, that's the way it goes. No bailouts. Let the free market decide winners and losers.
We are beginning to see the alternative. People and companies who made bad decisions are being bailed out, and those citizens who acted prudently are paying for it.
Thursday, November 27, 2008
Saturday, November 15, 2008
Take a number, please
This Wednesday, November 19, the Senate is expected to vote on a bailout for the U.S. auto industry. The cost is expected to be $25 billion. At the moment there are not enough votes to pass a bill, but proponents are hopeful that they can secure the necessary votes to pass.
The big three have had problems since the 1970s. This crisis is different, though. Ford, GM, and Chrysler are having problems getting funding from banks. GM and Chrysler discussed merging, but apparently that is not going to work out.
They want the bailout to update their factories to make more fuel efficent cars and hybrids to compete with the folks from Japan. The hearings this week produced two questions that shold be answered, though. First, lawmakers want to know what will be different now? Management is not going to leave, so what is the guarantee they will change? For years Detroit has relied on the larger profit margins of the likes of Tahoes, Silverados and Durangoes, shunning the fuel efficient market. Year after year, though they lost market share to their Japanese competitors, who concentrated on the fuel efficient market. Second, when pressed by lawmakers to prove they only needed $25 billion they could not. None of the company presidents could tell Congress just how much money they would need. Lawmakers suspect they will need more. They just got finished giving AIG more. They are now up to $150 billion. Up from $85 billion.
While this credit crisis is hitting the entire automobile industry, including Toyota, Honda, and Nissan, it is the U.S. auto makers that need the bailout. Companies have the responsibility to plan for the future. While, ultimately no one can forsee the future, the Big Three guessed wrong, and now should pay the piper. There are two problems with government bialouts. First, it prevents bad behavior from being punished. Everyone likes profits, but losses are just as important. Losses tell management that there is something in their business model that needs correcting. For years, Detroit has lost market share and money and continued to ignore the signs that it needed to change. It made unreasonable promises to its workers and retirees, and now there is a very good chance that taxpayers will have to foot those bills, in addition to providing short term cash for long term problems. Second, bailouts give other industries an excuse to come to Congress and ask for money. One of the arguments GM, Ford, and Chrysler have made the last couple weeks is that if Congress can give banks $700 billion, surely they can spare $25 billion for them.
Remember this all started with Bear Sterns in the Spring. So many companies have been deemed too big to fail. (e.g. Bear Sterns and AIG) So many investments have been deemed too complicated to let unravel. (e.g. CDOs) These contentions may be true. But, all of the doomsday scenarios assume that no one will do anything while the economy implodes. As I discussed in previous blogs, this crisis is being caused by over valued assets, primarily real-estate related. In such situations, investors holding these assets sell them, and others, wait for the price to get to a palatable level, and then buy them. We have seen the selling. The buying, however, has been sporadic, though. Some investors are scooping up foreclosures, but, for the most part, investors are waiting for the housing market to get closer to the bottom, which it cannot do unless the government puts away its wallet and allows prices to stabilize.
In a post script, Congress has asked the Detroit automakers to come back with a plan. They anticipate this to occur in a couple weeks, at which time they will again consider giving the Big Three a bailout. But, nothing will change. What needs to happen is the automobile industry, as well as the financial service industry, consumers, and anyone else that has or will get a piece of the bailout pie, needs to be left to fend for themselves. Doomsday will not happen. What will happen, if we allow it, is that other, stronger companies will buy the sick firms, and pick up the market share they deserve. In addition to getting us out of this financial mess quicker, it will show companies that they cannot count on the taxpayer to bail them out of the difficulties they got themselves into.
The big three have had problems since the 1970s. This crisis is different, though. Ford, GM, and Chrysler are having problems getting funding from banks. GM and Chrysler discussed merging, but apparently that is not going to work out.
They want the bailout to update their factories to make more fuel efficent cars and hybrids to compete with the folks from Japan. The hearings this week produced two questions that shold be answered, though. First, lawmakers want to know what will be different now? Management is not going to leave, so what is the guarantee they will change? For years Detroit has relied on the larger profit margins of the likes of Tahoes, Silverados and Durangoes, shunning the fuel efficient market. Year after year, though they lost market share to their Japanese competitors, who concentrated on the fuel efficient market. Second, when pressed by lawmakers to prove they only needed $25 billion they could not. None of the company presidents could tell Congress just how much money they would need. Lawmakers suspect they will need more. They just got finished giving AIG more. They are now up to $150 billion. Up from $85 billion.
While this credit crisis is hitting the entire automobile industry, including Toyota, Honda, and Nissan, it is the U.S. auto makers that need the bailout. Companies have the responsibility to plan for the future. While, ultimately no one can forsee the future, the Big Three guessed wrong, and now should pay the piper. There are two problems with government bialouts. First, it prevents bad behavior from being punished. Everyone likes profits, but losses are just as important. Losses tell management that there is something in their business model that needs correcting. For years, Detroit has lost market share and money and continued to ignore the signs that it needed to change. It made unreasonable promises to its workers and retirees, and now there is a very good chance that taxpayers will have to foot those bills, in addition to providing short term cash for long term problems. Second, bailouts give other industries an excuse to come to Congress and ask for money. One of the arguments GM, Ford, and Chrysler have made the last couple weeks is that if Congress can give banks $700 billion, surely they can spare $25 billion for them.
Remember this all started with Bear Sterns in the Spring. So many companies have been deemed too big to fail. (e.g. Bear Sterns and AIG) So many investments have been deemed too complicated to let unravel. (e.g. CDOs) These contentions may be true. But, all of the doomsday scenarios assume that no one will do anything while the economy implodes. As I discussed in previous blogs, this crisis is being caused by over valued assets, primarily real-estate related. In such situations, investors holding these assets sell them, and others, wait for the price to get to a palatable level, and then buy them. We have seen the selling. The buying, however, has been sporadic, though. Some investors are scooping up foreclosures, but, for the most part, investors are waiting for the housing market to get closer to the bottom, which it cannot do unless the government puts away its wallet and allows prices to stabilize.
In a post script, Congress has asked the Detroit automakers to come back with a plan. They anticipate this to occur in a couple weeks, at which time they will again consider giving the Big Three a bailout. But, nothing will change. What needs to happen is the automobile industry, as well as the financial service industry, consumers, and anyone else that has or will get a piece of the bailout pie, needs to be left to fend for themselves. Doomsday will not happen. What will happen, if we allow it, is that other, stronger companies will buy the sick firms, and pick up the market share they deserve. In addition to getting us out of this financial mess quicker, it will show companies that they cannot count on the taxpayer to bail them out of the difficulties they got themselves into.
Monday, November 10, 2008
U.S. Auto Makers - Turn out the lights. The party's over.
We certainly have had our share of bailouts this year. Now momentum has gathered to add the U.S. auto industry to the list. For 2008 sales of new automobiles are down 14.6%. Adjusted for population growth, levels of new car sales have not been this low since just after WW II. GM and Chrylser employ about 145,000 people and 600,000 retirees depend on them for pensions and health care. The auto makers cannot get credit from banks, they cannot raise the money from stocks, and their bonds are trading at between 20 cents and forty cents on the dollar. But the question we must ask ourselves is what exactly do we want from another government bailout? Do we want to save the U.S. automobile industry? I’ll go out on a limb and say the answer is yes. The next question is, in order to insure that we do this correctly, how much of a bailout is needed. The answer is zero. Nada. Not a dime.
If you want to truly save the U.S. automobile industry, you must let the free market do it. If we briefly look at the other bailouts we will find that, left alone, the markets will adjust to whatever challenges are presented. Regarding mortgages, Bank of America, JP Morgan, Wachovia, IndyMac, and others have all begun to renegotiate with mortgage holders to allow them to navigate their way through these tough times. These actions were easy to predict. Banks do not want your house. They want the loan payments. In addition, before FDIC limits were increased, consumers were shifting their money from troubled institutions to healthy banks. Again, this behavior was easy to predict. Given the opportunity, consumers will act in their best interests to safeguard their savings.
Getting back to the U.S. automobile industry, their problems go back to the 1970s when they did not shift to making smaller, fuel efficient cars, like the Japanese. Now, even in the most ideal conditions, it will be difficult for them to compete because of their unsustainable commitments to their retirees. If we look at other industries, historically, when companies go bankrupt, former rivals buy the assets at drastically reduced prices, hire some of the workers back, and fill in the vacuum left in the market place. Simply put, if the U.S. auto makers go under, all that will happen is that Honda, Volkswagon, or another automotive company will buy their plants and equipment to produce cars in the U.S., save themselves the shipping and handling, and build some of their cars here. Toyota builds many of its cars in the U.S. Many will still lose their jobs, but, even if GM and Chrysler would merge, it is estimated that 40,000 employees would lose their jobs. There is no easy fix. By contrast, a bailout only means prolonging the inevitable. These problems have been building for decades, and no amount of hope or money will solve them.
If you want to truly save the U.S. automobile industry, you must let the free market do it. If we briefly look at the other bailouts we will find that, left alone, the markets will adjust to whatever challenges are presented. Regarding mortgages, Bank of America, JP Morgan, Wachovia, IndyMac, and others have all begun to renegotiate with mortgage holders to allow them to navigate their way through these tough times. These actions were easy to predict. Banks do not want your house. They want the loan payments. In addition, before FDIC limits were increased, consumers were shifting their money from troubled institutions to healthy banks. Again, this behavior was easy to predict. Given the opportunity, consumers will act in their best interests to safeguard their savings.
Getting back to the U.S. automobile industry, their problems go back to the 1970s when they did not shift to making smaller, fuel efficient cars, like the Japanese. Now, even in the most ideal conditions, it will be difficult for them to compete because of their unsustainable commitments to their retirees. If we look at other industries, historically, when companies go bankrupt, former rivals buy the assets at drastically reduced prices, hire some of the workers back, and fill in the vacuum left in the market place. Simply put, if the U.S. auto makers go under, all that will happen is that Honda, Volkswagon, or another automotive company will buy their plants and equipment to produce cars in the U.S., save themselves the shipping and handling, and build some of their cars here. Toyota builds many of its cars in the U.S. Many will still lose their jobs, but, even if GM and Chrysler would merge, it is estimated that 40,000 employees would lose their jobs. There is no easy fix. By contrast, a bailout only means prolonging the inevitable. These problems have been building for decades, and no amount of hope or money will solve them.
You can't get there from here, part two
As I write this the U.S auto makers are asking for a piece of the bailout pie, so I have to type fast to catchup. I'm behind in my blogging. But, I'm only one person. I can only handle one bailout at a time. So, let's pick up where we left off. The $700 billion bailout has been passed. It's stated goal was to inject fresh capital into banks struggling because of bad mortgages on their books. It's been too early to determine whether the program has been a success, so it would not be fair to judge it. However, we can take a look at the underlying issues and see if it has a chance to work. History can tell us if we are right, later.
Anyone who has spent any significant time with me since the Bear Sterns bailout knows that I have disagreed with almost everything that has been done, thus far. I am not one to disagree and then not offer a solution, however. Essentially, I believe that the free market can and will take care of the financial crisis, in its own time. It's a lot like having the flu. You cannot do anything about it, you just have to ride it out. Like the flu, though, we can do some common sense things to make the recovery easier.
The problem with the government bailing out Bear Sterns, AIG, Fannie Mae, and Freddie Mac, as well as propping up failing banks with fresh funds is that the markets cannot tell what investments are worth. By markets, I do not just mean the stock market. I mean all types of financial markets including real estate, investments, banks, etc. The problem is not a lack of money for banks to lend each other, it is that the banks do not know which banks are healthy and which ones are not. No one is going to lend if they are not assured of getting their money back, with interest. Recently the government has expressed disdain for the banks for not lending, claiming it is there job to lend. That is only partially correct. A bank's job is to lend to an acceptable risk, and pricing for whatever the risk is. If the risk is higher than normal, the loan must be structures accordingly, i.e. higher interest rate, more stringent collateral requirements, personal sureties. Lending otherwise, is what got us here in the first place. The banks are lending. Most are also going back to the basics, rather than taking on unacceptable risks.
Most economists agree that home values have to find a floor before we can even think about a recovery. That will be difficult with this bailout. Not allowing problem banks to fail or homes to be foreclosed artificially inflates home values. Keep in mind that 98 percent of banks are properly capitalized, and it is estimated that only 117 of the over 8500 banks are actually in danger of failing. If banks are forced to deal with their bad home loans one of two things will happen. First, the bank could try to renegotiate the loan with the borrower. Banks do not want to foreclose. They want their loans paid back, with interest. If this could not be accomplished, the loan would be written off, and then the home would be foreclosed upon, and sold on the open market. Granted, the home would be sold for less than the bank would like, but it would be sold and a value (albeit a low value) would be established. This is the beginning of the process of reestablishing home values. I did not say it wold be easy, and you certainly cannot put a time limit on it, but it is the only way to truely establish a value. The markets must be allowed to function properly.
This idea is not mine. The government proved this would work when it established the Resolution Trust Corp to handle the orderly dismantling of the Savings and Loan industry in the early to mid 1990s. Not only did the RTC do it's job, the taxpayers did not lose a dime.
Another idea that is being tried is to increase FDIC coverage for deposits at all banks, healthy or otherwise. The FDIC has temporarily increased coverage from $100,000 to $250,000 until Dec. 31, 2009. In addition, non-interest bearing transaction accounts (i.e. a checking account) are insured for any amount. The idea was a noble one: help the depositors feel good about their deposits. But, like the help with the bad loans, this distorts the market. Keep in mind that 98 percent of the banks are just fine. (that number has not change since the last paragraph) Depositors were certainly upset, and many of them panicky, but reports show that, during the third quarter of the year, before the increase in FDIC limits, money was not withdrawn and shoved in mattresses, rather it flowed from unhealthy banks to healthy banks. Consumers made rational choices. Rather than follow the high rates, they went for safer options. They trusted the banking system, in spite of their worries. They just did not want to go through the worry of an FDIC takeover of their bank. In addition, ther are so may ways to structure an account that it is easy to increase a person's FDIC coverage, without leaving a bank. Corporations do not have as many options, but they can get coverage in non-interst bearing transaction accounts.
The point is that the market, i.e. consumers will make the choices for the government. When the dust settles, the government can buy the assets of the failed banks, like the RTC did, package them, and sell them. There is always a buyer if the price is right.
Don't get me wrong. Markets can never be completely free. This crisis proved that. Where money is involved, greed generally rears its ugly head. As we have seen in the last year, it does not take many to bring down everyone. This can be remidied through proper regulatroy legislation, including criminal penalties for those responsible for fraud and other acts against the interests of investors. Investors can and will lose money, but perpetuating the frauds that went on in the investment banking and mortgage industries must be punished, and punished severely.
Thanks for taking the time to read this. I'll talk to you soon.
Anyone who has spent any significant time with me since the Bear Sterns bailout knows that I have disagreed with almost everything that has been done, thus far. I am not one to disagree and then not offer a solution, however. Essentially, I believe that the free market can and will take care of the financial crisis, in its own time. It's a lot like having the flu. You cannot do anything about it, you just have to ride it out. Like the flu, though, we can do some common sense things to make the recovery easier.
The problem with the government bailing out Bear Sterns, AIG, Fannie Mae, and Freddie Mac, as well as propping up failing banks with fresh funds is that the markets cannot tell what investments are worth. By markets, I do not just mean the stock market. I mean all types of financial markets including real estate, investments, banks, etc. The problem is not a lack of money for banks to lend each other, it is that the banks do not know which banks are healthy and which ones are not. No one is going to lend if they are not assured of getting their money back, with interest. Recently the government has expressed disdain for the banks for not lending, claiming it is there job to lend. That is only partially correct. A bank's job is to lend to an acceptable risk, and pricing for whatever the risk is. If the risk is higher than normal, the loan must be structures accordingly, i.e. higher interest rate, more stringent collateral requirements, personal sureties. Lending otherwise, is what got us here in the first place. The banks are lending. Most are also going back to the basics, rather than taking on unacceptable risks.
Most economists agree that home values have to find a floor before we can even think about a recovery. That will be difficult with this bailout. Not allowing problem banks to fail or homes to be foreclosed artificially inflates home values. Keep in mind that 98 percent of banks are properly capitalized, and it is estimated that only 117 of the over 8500 banks are actually in danger of failing. If banks are forced to deal with their bad home loans one of two things will happen. First, the bank could try to renegotiate the loan with the borrower. Banks do not want to foreclose. They want their loans paid back, with interest. If this could not be accomplished, the loan would be written off, and then the home would be foreclosed upon, and sold on the open market. Granted, the home would be sold for less than the bank would like, but it would be sold and a value (albeit a low value) would be established. This is the beginning of the process of reestablishing home values. I did not say it wold be easy, and you certainly cannot put a time limit on it, but it is the only way to truely establish a value. The markets must be allowed to function properly.
This idea is not mine. The government proved this would work when it established the Resolution Trust Corp to handle the orderly dismantling of the Savings and Loan industry in the early to mid 1990s. Not only did the RTC do it's job, the taxpayers did not lose a dime.
Another idea that is being tried is to increase FDIC coverage for deposits at all banks, healthy or otherwise. The FDIC has temporarily increased coverage from $100,000 to $250,000 until Dec. 31, 2009. In addition, non-interest bearing transaction accounts (i.e. a checking account) are insured for any amount. The idea was a noble one: help the depositors feel good about their deposits. But, like the help with the bad loans, this distorts the market. Keep in mind that 98 percent of the banks are just fine. (that number has not change since the last paragraph) Depositors were certainly upset, and many of them panicky, but reports show that, during the third quarter of the year, before the increase in FDIC limits, money was not withdrawn and shoved in mattresses, rather it flowed from unhealthy banks to healthy banks. Consumers made rational choices. Rather than follow the high rates, they went for safer options. They trusted the banking system, in spite of their worries. They just did not want to go through the worry of an FDIC takeover of their bank. In addition, ther are so may ways to structure an account that it is easy to increase a person's FDIC coverage, without leaving a bank. Corporations do not have as many options, but they can get coverage in non-interst bearing transaction accounts.
The point is that the market, i.e. consumers will make the choices for the government. When the dust settles, the government can buy the assets of the failed banks, like the RTC did, package them, and sell them. There is always a buyer if the price is right.
Don't get me wrong. Markets can never be completely free. This crisis proved that. Where money is involved, greed generally rears its ugly head. As we have seen in the last year, it does not take many to bring down everyone. This can be remidied through proper regulatroy legislation, including criminal penalties for those responsible for fraud and other acts against the interests of investors. Investors can and will lose money, but perpetuating the frauds that went on in the investment banking and mortgage industries must be punished, and punished severely.
Thanks for taking the time to read this. I'll talk to you soon.
Saturday, November 1, 2008
You Can't Get There From Here
Two weeks ago, when faced with the decision regarding whether or not to rescue the financial services industry, Congress, after some pressure by the President and the Treasury Secretary, chose "whether," and passed the $700 billion dollar bailout legislation. The hope was, and is, that injecting fresh capital into the banking system will cause banks to start lending again, which will then reverse the downward trend in the economy, and begin the recovery. This week that capital began flowing as the Treasury gave $125 billion to nine large banks, including Bank of America and Citigroup. These banks really did not want the money, but the Treasury made them an offer they couldn't refuse. Another $125 billion will be given to other banks, although what the banks do with it, may not directly involve lending. PNC Financial Services Group, Inc., for instance, received $7.7 billion from the Treasury and purchased National City Corp. Government officials encouraged this deal. It follows Banco Santander SA, of Spain buying Sovereign Bancorp, Inc., Wells Fargo buying Wachovia, as well as purchases by Bank of America and JP Morgan Chase.
The question leading up to the bailout vote was how to best help the banking system get out of the mess it made. When deciding the bailout qeustion, the misperception that proponents of the bill focused on, was that the choice was to passs the legislation or do nothing. Choices in life are rarely all or nothing. After the vote failed initially in the House a representative from New Jersey, who voted against the plan, was interviewed and said that the reason the plan did not pass was that representatives on both sides of the aisle just did not think the plan would work. he said that as soon as the plan was voted down, Republicans and Democrats began to work on alternatives. He recalled asking Treasury Secretary Paulson whether he thought the plan would work, and Mr. Paulson admitted he did not know. That's fair. No one has a crystal ball. Alternative plans were available, though, including reviving the Resolution Trust Corporation, or RTC. The RTC was the vehicle that the government used to sell off the assets of the Savings and Loan industry when it collapsed in the early 1990s. In fact, weeks before the vote, a Congressman from New York proposed reviving the RTC, and an article appeared in the Wall Street Journal, penned by three notable economists, including former Fed Chariman, Paul Volker, detailing how the RTC would bring back stability and liquidity to the markets, while costing the taxpayers little or nothing. Just for the record, the RTC made money in the 1990s.
The way it works is that banks would have to write down their bad loans. No ifs, ands, or buts. Some would survive, and some would fail. Those that failed would have their assets bought by the RTC, bundled, and sold. One of the fallacies that is currently being perpetuated is that there is no market for the bad loans. The proper way to phrase this is that the market does not value homes as high as banks and homeowners would like. There is a market for almost everything. By propping up home values instead of forcing their write-downs, though, the bailout legislation is not allowing the market to correct itself, which it would do, given enough time. How much time? Who knows? But the market can, and must, figure it out on its own, without interference from the Treasury, Congress and the President, if we are to begin to truely recover.
Think about it for a minute. Let's say that you are in the market for a house. You know that it is a buyers market, meaning that those trying to sell their house, are having a difficult time doing so. You have your eye on a particular house, and want to make an offer. You feel you can negotiate the price down, but the homeowner is not going to give the home away. So, somewhere between zero and the price the homeowner is asking, is a price you can each agree on. Since this is a buyers market, that price is lower, probably much lower, than normal. So, while the seller may not get nearly the price he wants, he will sell eventually. You just have to find the right price. The banks are in the same boat. They have bad loans on their books. If they have to write them off, they may go bankrupt. So they are claiming that they cannot value these assets (loans are assets to a bank), since there is not a market. For my money, if there is not market, the value is zero. That is absurd, though, so banks must write down the loans. The free market will sort out the winners and losers. That is what banks are waiting for.
Banks are nervous because these bad loans are on the books. You do not lend to a company if you do not know if they can pay you back, and a bank cannot know if another bank will pay them back if they cannot be sure about the assets backing up the loan. Write down the loans, and the uncertainty goes away. That is what the RTC would do. Then the recovery could truely begin. Recovery would not happen over night. Many would certainly lose their jobs in the recession, and possibly their homes to foreclosure. But, the pain will be less, overall, than if the government trys to bailout those who are struggling. (more on that in a future blog)
What do we do, though? The bailout was passed and the money has started to flow from the Treasury to the banks. Well, while I admit that I disagreed with the bailout, I am glad that the Treasury is encouraging deals like the PNC/National City deal. When a strong bank buys a weak bank, that takes the pressure almost completely off of the taxpayer. True, the taxpayer is potentially on the hook if the deal goes sour, but the chances of that are much lower. Banks, like PNC, that have come through this crisis healthy enough to purchase another bank should be OK. The taxpayers should make some money on these deals also, since the money is lent at 5 percent for five years. So, some of the money is being put to good use. We'll have to wait and see what the rest is used for.
Getting back to the free market, though, we would get out of this mess much quicker and be better off in the long run if the market sorted all of this out itself. That topic will be continued in the next few blogs, in which I will deal with free market solutions that are occurring now, and the possible foreclosure bailout plan that is being proposed.
Thanks for your time. Talk to you soon
The question leading up to the bailout vote was how to best help the banking system get out of the mess it made. When deciding the bailout qeustion, the misperception that proponents of the bill focused on, was that the choice was to passs the legislation or do nothing. Choices in life are rarely all or nothing. After the vote failed initially in the House a representative from New Jersey, who voted against the plan, was interviewed and said that the reason the plan did not pass was that representatives on both sides of the aisle just did not think the plan would work. he said that as soon as the plan was voted down, Republicans and Democrats began to work on alternatives. He recalled asking Treasury Secretary Paulson whether he thought the plan would work, and Mr. Paulson admitted he did not know. That's fair. No one has a crystal ball. Alternative plans were available, though, including reviving the Resolution Trust Corporation, or RTC. The RTC was the vehicle that the government used to sell off the assets of the Savings and Loan industry when it collapsed in the early 1990s. In fact, weeks before the vote, a Congressman from New York proposed reviving the RTC, and an article appeared in the Wall Street Journal, penned by three notable economists, including former Fed Chariman, Paul Volker, detailing how the RTC would bring back stability and liquidity to the markets, while costing the taxpayers little or nothing. Just for the record, the RTC made money in the 1990s.
The way it works is that banks would have to write down their bad loans. No ifs, ands, or buts. Some would survive, and some would fail. Those that failed would have their assets bought by the RTC, bundled, and sold. One of the fallacies that is currently being perpetuated is that there is no market for the bad loans. The proper way to phrase this is that the market does not value homes as high as banks and homeowners would like. There is a market for almost everything. By propping up home values instead of forcing their write-downs, though, the bailout legislation is not allowing the market to correct itself, which it would do, given enough time. How much time? Who knows? But the market can, and must, figure it out on its own, without interference from the Treasury, Congress and the President, if we are to begin to truely recover.
Think about it for a minute. Let's say that you are in the market for a house. You know that it is a buyers market, meaning that those trying to sell their house, are having a difficult time doing so. You have your eye on a particular house, and want to make an offer. You feel you can negotiate the price down, but the homeowner is not going to give the home away. So, somewhere between zero and the price the homeowner is asking, is a price you can each agree on. Since this is a buyers market, that price is lower, probably much lower, than normal. So, while the seller may not get nearly the price he wants, he will sell eventually. You just have to find the right price. The banks are in the same boat. They have bad loans on their books. If they have to write them off, they may go bankrupt. So they are claiming that they cannot value these assets (loans are assets to a bank), since there is not a market. For my money, if there is not market, the value is zero. That is absurd, though, so banks must write down the loans. The free market will sort out the winners and losers. That is what banks are waiting for.
Banks are nervous because these bad loans are on the books. You do not lend to a company if you do not know if they can pay you back, and a bank cannot know if another bank will pay them back if they cannot be sure about the assets backing up the loan. Write down the loans, and the uncertainty goes away. That is what the RTC would do. Then the recovery could truely begin. Recovery would not happen over night. Many would certainly lose their jobs in the recession, and possibly their homes to foreclosure. But, the pain will be less, overall, than if the government trys to bailout those who are struggling. (more on that in a future blog)
What do we do, though? The bailout was passed and the money has started to flow from the Treasury to the banks. Well, while I admit that I disagreed with the bailout, I am glad that the Treasury is encouraging deals like the PNC/National City deal. When a strong bank buys a weak bank, that takes the pressure almost completely off of the taxpayer. True, the taxpayer is potentially on the hook if the deal goes sour, but the chances of that are much lower. Banks, like PNC, that have come through this crisis healthy enough to purchase another bank should be OK. The taxpayers should make some money on these deals also, since the money is lent at 5 percent for five years. So, some of the money is being put to good use. We'll have to wait and see what the rest is used for.
Getting back to the free market, though, we would get out of this mess much quicker and be better off in the long run if the market sorted all of this out itself. That topic will be continued in the next few blogs, in which I will deal with free market solutions that are occurring now, and the possible foreclosure bailout plan that is being proposed.
Thanks for your time. Talk to you soon
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