Explosive Expressions

So it looks like I'm not the only one who thinks the bailout should be dropped...

I had been taking some time to pour through the version of the bailout bill that the House voted on, but the Senate threw a wrench in that by releasing another version. This new one is 450+ pages! I just don't have the time to read something THAT large...

As I mentioned the other day, the bill the House voted on grew by a few pages. My first perusal was a quick one, intended to figure out what the deal was rather than digging into the nitty gritty. Now, however, I want to understand it a bit more. So, here are my current thoughts.

First and foremost, all the brouhaha about executive pay, I would like to go on the record by saying that this is nothing more than a big fat RED HERRING! Look, executives get paid a lot. They get all sorts of bonuses and end up getting massive payouts, even when companies fail. The current wording in the bailout bill (in the senate version too) really doesn't block anything.

But, let's look at it another way. First off, you need to understand what a golden parachute is. Simply put, it's a guaranteed payout that top executives get IF the company fails or is taken over. In short, unless that executive loses their job, there is no payout. The purpose of the bailout plan is to prevent companies from failing, which means that executives wouldn't be able to take advantage of the golden parachute anyway. Also realize that the provisions in the bailout bill are only in effect for companies that are assisted, and only for as long as they are assisted. Sure, there's a chance that some companies will still fail, but even if 10 failed, and the average parachute was $10 million, that's only $100 million. That's a drop in the bucket compared to how much this bill is going to lay on the line... So let's stop pretending that executive pay is the only issue here.

This bill also gives the Secretary of the Treasury an unprecedented amount of power. There are so-called checks and balances in the form of justifications, but if he wanted, he could easily sink a company, purely by stating that they were a risky investment, as if any of them aren't... That is a fairly large amount of power to put in the hands of someone who used to run one of those companies. As I mentioned before, he may be a stand up guy, and he may have the best of intentions, but the temptation is definitely there.

The rest of it is pretty much everything that has been in the news. Insurance, paid by the bailed-out institutions, public reporting, oversight, etc. One important note is the modification of existing mortgages. The only mortgages that can be modified are ones from companies that get bailed out. If your bank doesn't take part, you are out of luck.

The new bailout bill, per the senate, has some additional "stuff" in it.. Let's see... Tax breaks for motorsport facilities, a bunch of energy stuff, disaster aid, etc. The list just goes on and on... So much for bailout, this thing is loaded with crap. I've heard estimates of $150 billion or more in extra junk. It's unreal how large these bills can get in just a day or two...

Well, we'll find out what happens next.. The bailout just passed. 263 to 171.

Shit.

Current score? 205 Yea to 228 Nay. Of course, both sides are blaming each other, as expected. They're like a bunch of unruly children... "It's not my fault, it's their fault.. We did our job..." Bunch of whiners...

Regardless, I, myself, view this as a win. Maybe those fat cats on Wall Street can get off their asses now and work towards a solution. They won't, though, because the government keeps telling everyone that they WILL pass something. What a great excuse to fall back on... "Sorry the bank failed, but the government said they would help and they haven't..."

The latest version of the bill can be found here. An additional 3 pages, based on page count alone. I haven't had a chance to digest it yet, though...

Meanwhile, golden parachutes are floating from the sky...

Seriously.. Are we kidding here? This chick wants to run the country?

It's out. Read it here. It's early enough that we don't have a full handle on everything in it yet. What is know is the following:

• Insurance covering any assets purchased by the government



• Oversight by the government via the Financial Stability Oversight Board (members of which are not to be additionally compensated)



• Money will be dispersed in stages, starting with a $250 billion disbursement



• The Secretary of the Treasury gets to sell off these assets when and however he wants...



• Provisions to help homeowners (including owners of rental properties) keep or refinance their mortgages (Apparently the HOPE for Homeowners program is highlighted)



• Wording to prevent golden parachutes, but it looks like there are likely ways around this. So this seems to be working just to make certain partied happy as opposed to a definite prohibition. (Warning! This looks like a red herring!)



• All information related to assets purchased by the government will be made public within 2 days of the transaction



• A report on the current state of regulatory reform has to be submitted by January 20, 2009.... This is a report to congress, however, and will not necessarily become public.



• It appears that in 5 years, upon the expiration of this bill, if there's a shortfall, that shortfall can be recouped from the companies benefiting from the act.



• Financial experts and consultants can be brought in for advice (presumably in paid positions)



• The treasury can, optionally, take an ownership in any company participating in this bailout.

This is a lot here. The plan has expanded a tad from a mere 3 page proposal to a 106 page draft. I'm still skeptical of this entire process, I'm of the opinion that the market will right itself given time, but as far as a bill goes, it doesn't seem too bad ... Though I am not a lawyer and I don't completely understand everything in the draft.

One thing I would like to point out is that this bill gives an insane amount of power to the Secretary of the Treasury. At the moment, that is Henry Paulson, the former CEO of Goldman Sachs. I don't know much about this guy, but regardless, this feels like an awful lot of power for someone with such ties to the financial community. I could, of course, be wrong, and this may be the perfect person to handle this. But there are a number of provisions within the draft to prevent the limitation of the power of the Secretary... I'm not sure that's such a wise decision.

Regardless, there it is. I'm sure there will be a lot of talk over the next few hours, possibly days. And I'll bet that the wording will change, probably significantly, prior to it being accepted... And, unfortunately, as much as I'd like to see it fall flat and not get passed, I can almost guarantee that it will pass.

In just a few short weeks, the most powerful financial cornerstones in the world have been reduced to rubble. But has the carnage ended? Or is there more on the horizon? And dammit, how did we get here?

Lets get one thing straight, first. This is my take on what's going on based on information gathered from news outlets on the web. I am not a financial guru, economist, or really anyone who should be trusted with investing money at all. I'm writing this because I can, and I'm trying to make sure it's as accurate as I can. I will come back and edit if need be. That said, lets move on.

Since about 2000, the housing market has been booming. Prices have been rising steadily, reaching all-time highs. Mortgage lenders offered subprime mortgages, a truly stupid way to make a quick buck. Subprime mortgages worked something like this :

Joe wants to buy a house, but Joe doesn't have very good credit. This could be because Joe is new to the financial world, or because Joe made some bad choices in his past. Either way, he doesn't fit the criteria to be offered a standard loan. But, not wanting to turn a potential customer away, the bank decides to offer Joe a subprime loan. Subprime loans are great, says the bank, because they allow you to buy a house today and help fix your credit over the short term. Then, in a few years when your credit is better, you can re-apply for a normal loan!

So, Joe opts in for the subprime loan. The bank will give him a loan for his new home, and all he has to do is pay interest payments for the next 5-10 years. Of course, since the bank is doing him this huge favor, at great risk to themselves, there are some conditions. If Joe is late on a payment, he'll pay a pretty hefty fee. And in 5-10 years, the subprime interest rate he's enjoying today will be switched to an adjustable rate. But that's 5-10 years in the future, plenty of time to deal with that later.

Ok, so what's the problem here? Joe will surely fix his credit and be able to get a better loan in 5 years, right? Well.. maybe. 5 years go by and Joe is still having some financial trouble. Nothing huge, his mortgage payment is always on time, but those damn credit cards are killing him. Oh well, no way to get a better rate and re-finance his mortgage. And suddenly, Joe's mortgage payment jumps up by a pretty hefty sum. Why? Because he's past the interest-only payments, and needs to pay on the actual mortgage balance now.

Now we have a problem. Joe can't afford all of this, so he delays paying the mortgage until he has the full amount. Of course, this makes the payment late, which then adds a late fee. More money that Joe doesn't have. This starts a rather vicious cycle which typically ends in Joe's credit being completely destroyed, the mortgage defaulting, and the house being foreclosed upon.

This started to happen quite a lot in about 2007 causing the mortgage industry to start a slow collapse. First to go was New Century Financial which filed for Chapter 11 bankruptcy in April, 2007. In the months following the initial collapse of the subprime market, the heavy hitters of Wall Street, who dealt in mortgage-backed securities, started trying to sell off their subprime mortgage assets. Of course, noone wanted them because they were now worthless, a horrible investment guaranteed to lose money. CNN has a great definition of a mortgage-backed security:

Banks lend money to homeowners through home mortgages; these loans are then bought from the banks and sliced up and repackaged into securities that investors buy and sell just like stocks. Those investors make money off the homeowners’ monthly interest payments. The nation’s housing crisis has forced many Americans to skip payments, or worse, foreclose on their homes, so investors don’t get the interest payments. That’s why the securities become toxic assets to have on a company’s balance sheet: nobody wants to buy them, and there’s no market for them. Thus, all those institutions that hold these mortgage-backed securities — and they’ve got a lot of them! — are in big trouble.

So the investment bankers start feeling the heat and are unable to get rid of these so-called "toxic" assets. The value of these assets begins to plummet causing the value of some investment banking companies, who had a large stake in the subprime market, to drop. Bear Stearns, one of the largest, was particularly hard hit and had to apply for an emergency loan in March of 2008 in order to stay afloat. Later that month, they agreed to merge with JP Morgan Chase, effectively ending the existence of Bear Stearns.

Fannie Mae and Freddie Mac, both government sponsored enterprises, controlled upwards of 50% of the mortgage market at the beginning of 2008. When the floor fell out from under the subprime market, these companies found themselves unable to cover the resulting losses. Both Fannie Mae and Freddie Mac began to fail and were quickly placed into conservatorship by the federal government. The government will allow both entities to continue to guarantee all loans, as well as grow their loan portfolio in the coming months.

Following this, additional companies began to fall. Lehman Brothers, a financial services company, suffered greatly from the subprime collapse and filed for bankrupcy on September 15th. The next day, Barclays plc, another financial services company, agreed to purchase what was left of Lehman Brothers. Following this, the American International Group (AIG), an insurance company, began to collapse. Investors noted that both AIG and Lehman Brothers had similar mortgage portfolios, but that AIG had them valued much higher. As a result, investors began selling off AIG stock in an effort to distance themselves from the company. On September 16th, the Federal Reserve bank agreed to loan the company up to $85 billion to bail the company out. In return, AIG agreed to give the Federal Reserve a 79.9% stake in AIG.

On September 19th, the Federal Government announced a plan to avert the financial crisis. The government would make available a minimum of $700 billion to cover the purchase of mortgage-backed securities from failing companies. The government would purchase these assets, effectively saving the companies involved from any losses, and sell them at a later date. The intention is to save the market and make the money back later when the assets are sold.

But, the carnage doesn't end there. The last two Investment banks, Morgan Stanley and Goldman Sachs, both saw their stock prices plummet. On September 22nd, they both agreed to convert from investment banks to traditional bank holding companies. By becoming traditional bank holding companies, they have easier access to credit, including the government-sponsored bailout, thereby increasing their chances of making it through the current financial turmoil.

And that is about where we stand today. Congress is currently debating the bailout proposal, weighing the options and determining a course of action. President Bush addressed the nation last night, explaining his position and the intended bailout. All said and done, this bailout may cost upwards of $1.8 trillion, which includes money already spent on bailing out companies like Fannie Mae, Freddie Mac, and AIG.

But is this the correct course of action? Should the Federal Government provide an out for these companies? Companies, I might add, that manipulated the system just to make a quick buck? Many economists disagree with the current proposal. Some of the reasons cited include a lack of oversight on the use of the bailout money, displeasure at the amount of control the government is asking for, and a belief that the government sale of the assets will be unable to cover the cost of buying them.

From my own view, I don't see this as the domain of the government. These are private companies that made bad mistakes. The fault of these mistakes lies both on the companies as well as the investor. Simply put, if you cannot afford a mortgage, you have no business getting one. Owning a house is great, but do you want the own a house at the risk of complete financial ruin? While there's always a risk, minimizing that risk is the job of the risk taker.

The banks offering these types of loans should bear a good bit of the blame as well. In some cases, loans were pushed on unsuspecting consumers without fully explaining the risks. Regardless, I still don't see how a bank can justify offering a loan to a high-risk borrower. I understand the frustration of the high-risk borrower, having been one myself at one time, but blindly offering loans to anyone asking for one can only end in catastrophe, as we are seeing today.

So what can be done to fix this? Well, I definitely don't believe the government should be bailing these companies out. If I understand the proposal, the companies that caused all of this will, in the end, take almost no loss and suffer no consequences. On the other side, the government assumes the burden of dealing with those bad loans, and the cost associated will eventually be put on the taxpayer. In the end, the responsible taxpayer suffers because the big financial players got greedy.

Personally, I say we let them suffer. Let them figure out how to fix the system. It's often amazing to see what solutions will pop up when the pressure is great enough. They'll likely lose a great deal of money, and much of the financial sector will feel the crunch, but those of us who are responsible will likely be ok. Sure, my 401K will take a hit, probably more than it has already, but in the end, I'm willing to bet it will balance itself out.

So let this be a lesson to you.. Making stupid decisions can lead to disastrous results...