"The problem with financial institution balance sheets is that on the left hand side nothing is right and on the right hand side nothing is left."
It's pretty obvious that financial institutions are struggling. We've had 16 banks taken over by the FDIC in the past two years, 13 so far this year. Other failing banks have been taken over or merged, lest they too have the FDIC take them over. 286 mortgage lenders have imploded in the past two years.
News like that is why Congress went along with Bailout 2.0
Since August 2007, the Fed has developed programs to increase emergency lending. One part of the strategy involves accepting securities of questionable value, as collateral for loans. In the past two weeks, the Federal Reserve System has handed out something like $370 billion. Most of this is very short-term lending. But it is happening so much that the total lending by the Fed has expanded greatly. All this Fed lending is what constitutes Bailout 1.0.
Bailout 1.0 may have seemed like a good idea. Good or not, it did't work.
Now, some are speculating that the Federal Reserve System is at risk of
running out of liquid capital. See London Banker:
http://londonbanker.blogspot.com/2008/09/brad-setser-extraordinary-times.html
That is why Congress has passed Bailout 2.0...
The announcement was made at about 12:30 AM, and the WaPo article went up at 12:47 AM. So I can forgive them for being imprecise. However, readers would be well advised to notice that the $700 billion figure is NOT what Congress agreed to spend. What they agreed, is that the total balance in the program won't exceed $700 billion at any one time.
Think of Bailout 2.0 as a great big washing machine. It holds $700 billion. The Treasury takes lousy securities is exchange for cash or a cash equivalent. The bad securities go into the washing machine. If the Treasury is able to take some out and hang them to dry, they can buy more, and put those in the washing machine.
It is, in fact, a giant money-laundering scheme, if you accept the notion that the lousy securities were based upon loans that were made fraudulently.
The really cute thing about it is this: once the machine starts going, then the corporations that borrowed from the Fed will be able to pay back those loans. The Fed's balance sheet will look better. So Bailout 1.0 can keep running, right alongside Bailout 2.0.
This will all work out just fine, if the lousy securities ever regain their value. That will happen as soon as housing prices go back up. Housing prices will go back up once wages go up to a level that will support the house payments.
So everyone should join a Union right now. Bargain for higher wages. The corporations, flush with cash from Bailout 2.0, will gladly pay. If they run short of cash from time to time, they can fall back on Bailout 1.0.
The workers will take the higher wages, buy bigger houses, the lousy securities won't be lousy anymore, and we can all have a beer and a Happy Meal.
Or, wages will remain stagnant, housing prices will continue to fall, as price inflation eats away at those stagnant wages, property taxes go up, and the cost of heating and cooling homes increases.
Wages have to support the total cost of homeownership. The price of the house is only part of that. If wages are constant, and the other components of the total cost of ownership go up, then the price of the house has to come down.
If that is the way it goes, it will end badly. Our economy will be a scrap heap. Then the only thing that Bailout 2.0 will have accomplished, is that it will have given the Government the power to decide who gets the best scraps.
http://londonbanker.blogspot.com/2008/09/brad-setser-extraordinary-times.html
For a graphical representation, see the (PDF) at Cumberland
Advisors:
http://www.cumber.com/home/Factors.pdf
That is why Congress has passed Bailout 2.0...
Congressional Leaders Announce Breakthrough in Bailout Bill Negotiations
By Lori Montgomery and Paul Kane
Washington Post Staff Writers
Sunday, September 28, 2008; 12:47 AM
Congressional leaders and the Bush administration last night struck a historic accord to insert the government deeply into the nation's financial markets, agreeing to spend up to $700 billion to relieve Wall Street of troubled assets backed by faltering home mortgages.
Negotiators emerged from a marathon session in the Capitol about 12:30 a.m. to announce that they had reached agreement on a proposal to give Treasury Secretary Henry M. Paulson Jr. broad authority to organize one of the biggest government interventions in the private sector since the Great Depression...
The announcement was made at about 12:30 AM, and the WaPo article went up at 12:47 AM. So I can forgive them for being imprecise. However, readers would be well advised to notice that the $700 billion figure is NOT what Congress agreed to spend. What they agreed, is that the total balance in the program won't exceed $700 billion at any one time.
Think of Bailout 2.0 as a great big washing machine. It holds $700 billion. The Treasury takes lousy securities is exchange for cash or a cash equivalent. The bad securities go into the washing machine. If the Treasury is able to take some out and hang them to dry, they can buy more, and put those in the washing machine.
It is, in fact, a giant money-laundering scheme, if you accept the notion that the lousy securities were based upon loans that were made fraudulently.
The really cute thing about it is this: once the machine starts going, then the corporations that borrowed from the Fed will be able to pay back those loans. The Fed's balance sheet will look better. So Bailout 1.0 can keep running, right alongside Bailout 2.0.
This will all work out just fine, if the lousy securities ever regain their value. That will happen as soon as housing prices go back up. Housing prices will go back up once wages go up to a level that will support the house payments.
So everyone should join a Union right now. Bargain for higher wages. The corporations, flush with cash from Bailout 2.0, will gladly pay. If they run short of cash from time to time, they can fall back on Bailout 1.0.
The workers will take the higher wages, buy bigger houses, the lousy securities won't be lousy anymore, and we can all have a beer and a Happy Meal.
Or, wages will remain stagnant, housing prices will continue to fall, as price inflation eats away at those stagnant wages, property taxes go up, and the cost of heating and cooling homes increases.
Wages have to support the total cost of homeownership. The price of the house is only part of that. If wages are constant, and the other components of the total cost of ownership go up, then the price of the house has to come down.
If that is the way it goes, it will end badly. Our economy will be a scrap heap. Then the only thing that Bailout 2.0 will have accomplished, is that it will have given the Government the power to decide who gets the best scraps.
Politics
Comments
Here's a nice little chart showing borrowing from the Fed:
http://2.bp.blogspot.com/_ON7RAMsBrik/SNtO4Omo_SI/AAAAAAAACS8/hcPIWtcplCY/s1600-h/BORROW_Max_630_378.png
Posted by: OmegaMom | September 28, 2008 3:43 PM
Food for thought. Lets take all this bail out money, pay off all of the American Consumers debt. What happens then? We free up all the money earned or in possesion of the American Consumer so we can start spending again which will influx real money into the economy. The worst that can happen is that it will take 80 to 100 years before we are back in the same boat again rather then the six months it will take for this joke of a bail out to fail. We are being screwed again by the con men of Washington.
Posted by: Steve Consorti | September 28, 2008 4:55 PM
all bank owners should surrender 1/2 of there assetts, and all bank officers with any level of responsibility should surrender all bonus's and comissions for the last 2 years, to lighten the burden they put on the tax payers that are bailing them out of this mess they created.
Posted by: craig coleman | September 28, 2008 5:33 PM
Omegamom, that's a nice little chart, because it is so clear, easy to understand. The Cumberland Advisors' chart tells you more, but it's a bear to figure out what it means.
Steve C., as attractive as it seems to pay off all consumer debt, right now there is about $2.58 trillion in consumer debt in the US. It would give the economy an enormous boost to get rid of it all, but it also would cause problems. Plus, the government simply does not have the that much money.
Craig C., banks are overleveraged as it is. If they had to surrender that much of their assets, they would have to go out and raise an enormous amount of capital. They've been trying to do that already, with very limited success. So that plan would simply force them all into bankruptcy. There is a certain appear to that, but I think the idea is to have the weaker ones fail one by one. Of course that means more of the wealth migrates to the top.
For what it's worth, by main objection to the bailout is that I have not seen Congress make any moves to impose structural and regulatory changes that are needed to promote a sustainable economy:
See Karl Denninger for proposals:
http://market-ticker.denninger.net/archives/593-CONGRESS-STOP-AND-THINK!.html
———
1. Force all off-balance sheet “assets” back onto the balance sheet, and force the valuation models and identification of individual assets out of Level 3 and into 10Qs and 10Ks. Do it now.
2. Force all OTC derivatives onto a regulated exchange similar to that used by listed options in the equity markets. This permanently defuses the derivatives time bomb. Give market participants 90 days; any that are not listed in 90 days are declared void; let the participants sue each other if they can’t prove capital adequacy.
3. Force leverage by all institutions to no more than 12:1. The SEC intentionally dropped broker/dealer leverage limits in 2004; prior to that date 12:1 was the limit. Every firm that has failed had double or more the leverage of that former 12:1 limit. Enact this with a six month time limit and require 1/6th of the excess taken down monthly.
Posted by: j7uy5 | September 28, 2008 7:51 PM
Food for thought. Lets take all this bail out money, pay off all of the American Consumers debt. What happens then? We free up all the money earned or in possesion of the American Consumer so we can start spending again which will influx real money into the economy. The worst that can happen is that it will take 80 to 100 years before we are back in the same boat again rather then the six months it will take for this joke of a bail out to fail. We are being screwed again by the con men of Washington.
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