Blind Man’s Bluff
Most of us have played Blind Man’s Bluff as children. It’s such a popular game among kids that several versions now exist. In case you don’t remember, here’s the original version. A person is blindfolded and referred to as “it.” Everyone runs around trying to avoid being touched (tagged) by this person (it). If they are tagged they lose the game and become spectators. The game continues until “it” has tagged everyone. In another version, “it” attempts to identify the person tagged by feeling their face. If the person is correctly identified by “it” that person is eliminated from the game.
The bailout plan has a striking resemblance to Blind Man’s Bluff, except the game will take a very long time to end while registering an uncertain cost because the Treasury will be running around blind, not knowing what kind of debt they are buying, how to manage it, or how much this junk is worth. Paulson and company has no way to identify the true nature of the banks’ debt. Therefore, they won’t be able to fully assess or manage risk. The banks aren’t even able to do this, yet the Treasury will succeed?
Most likely the next Treasury Secretary will be running around for many years blindly throwing taxpayer money at the financial system. And as they dig themselves deeper and deeper into this black hole, they will use more scare tactics to secure even more money from taxpayers. The only winners will be the banks, those who buy bank debt from the Treasury and big investors who invest in banks that have been revitalized by taxpayer money, like Bill Gross and Warren Buffett.
Big Bailout, Big Problems
It would not only be highly irresponsible to pass such a plan, but also potentially disastrous. We are talking about a plan less than 3 pages in length. Something of this magnitude should be at least 500 pages for a basic description alone (see update at the end). All we really know is how the auction would proceed. Under the proposed plan, a Dutch auction would take place whereby the buyer (the U.S. Treasury) would lay out guidelines of debt securities it wanted to purchase in terms of the type, amounts, etc. The sellers would be the banks who would each offer a price. All prices would be filled until the amount asked for was filled – theoretically.
This process assumes the Treasury would be able to properly value the debt – something that in many cases would be impossible to determine. And if the Treasury does not offer a price the banks feel is fair, they may decide not to sell much of this debt. This could force the Treasury to pay very high prices for these junk bonds, ensuring massive losses to taxpayers. Also consider that banks will sell off only their worst junk bonds – bonds that have the highest chance of losing it all.
I will guarantee you most if not all of the debt purchased by the Treasury will need to be marked down many times over. That means they will have to apply a huge discount to this junk yard of debt securities. And banks might not agree to such discounts. But there would be no bluffing game because the banks know the Treasury’s main purpose is to clean up their balance sheets to unlock the credit markets. In the end, the banks will get a good price for their junk at the expense of taxpayers.
And when the Treasury goes to sell off some of this debt, investors like Bill Gross, Warren Buffett and others won’t be willing to pay what the banks sold it for. Otherwise, they’d have gone directly to the banks and bought it in the first place! Duh. So what will end up happening is that the Treasury will have to sell off the debt at a much lower price than it paid. The end result will be that taxpayers will get stiffed on both ends of the transaction while the banks and big investors benefit from taxpayer dollars. What a scam.
After trying to figure out what they have and how much it’s worth now for over a year, even the banks don’t have a clue. Are we to believe Paulson does? His approach would value these securities on a future value basis. Future value? The real future value could end up being very low.
Anyone who thinks this bailout will be limited to $700 billion or any figure Washington decides on is naïve. In my view it will cost taxpayers at minimum $3 trillion to $5 trillion and possibly much more depending on many variables. As well, it’s likely Paulson will be replaced by the new president. Although if McCain wins there is a fairly good chance he will keep him as someone to blame him when the catastrophe unfolds. Let’s say Paulson is replaced.
We will then have a new Treasury Secretary who has no experience in this crisis with a blank check. Either way you spin it, the bailout plan is likely to end up being a blowout for banks and a blowup for the already struggling budget. Even the director of the Congressional Budget Office states that the bailout could actually worsen the current financial crisis.
Perhaps the most laughable part of the plan is its two-year limit. Once again, thoughts of the invasion of Iraq come to mind. The RTC spawned from the S&L Crisis took six years and grew from an initial $50 billion to over $150 billion by the time it was finished. The Reconstruction Finance Corporation born during the Great Depression lasted for two decades. Yet this, the biggest banking crisis in history will be fixed with $700 billion in two years? What a snow job.
There are simply too many unanswered questions and enormous risks with no assurances whatsoever. We’ve learned some valuable lessons from Iraq. Without adequate preparation and a defined strategy, America will most certainly be worse off entering the financial black hole with essentially one person having a blank check but with no clear plan. If the bailout is passed in its current form, it’s likely to create more problems than it solves.
On the other hand, if the plan is rejected or modified in a way that comes up short of Washington’s requirements, you better believe the next administration will blame the inevitable meltdown on those who didn’t support passage of what is currently a reckless plan.
Big Investors Already Drooling
“Warren Buffett called the $700 billion U.S. bailout plan ‘absolutely necessary’ to help pull the financial system out of an "economic Pearl Harbor." Easy for him to say.
The plan has not even been passed and Buffett has already taken a stake in Goldman Sachs. What kind of investor would give the green light to an administration that was in the dark and had no idea what was going on? What kind of investor would endorse a 2-page plan that ensures an ultimate cost of trillions, with no details, no rules or guidelines? Answer: an opportunistic investor who stands to gain through buying assets directly from the U.S. Treasury and investing in banks with cleaned up balance sheets.
It’s a great investment opportunity for the guys with big money. Taxpayers will clean up the banking mess. Then big investors will pour in huge amounts of investment capital and reap big returns. Make no mistake; this is a bailout not only for the banks but for all who will buy the debt from the Treasury and take ownership stakes in them. It will be taxpayer-funded support for private investments such as those run by Warren Buffett, Bill Gross and others.
Even corporations are calling for the bailout to be passed because they stand to gain. The latest plea has come from Steve Balmer, CEO of Microsoft. Sure he wants it passed, as do many other CEOs. Jack Welsh is also behind it. Of course he is. General Electric is in deep trouble. With over 40% of its revenues coming from its financial units, GE is trending water waiting for a rescue.
Hey Steve…sit down and get back to work. For you to voice your opinion on this matter is similar to Britney Spears using her Hollywood clout to influence the presidential election. Steve, you have plenty of problems at Microsoft, so I suggest you focus on them. If these CEOs want the bailout to pass, Microsoft and other companies can pay for it. As for Jack Welch, if he was even remotely as good as he claims to be, he would have never transformed GE into a bank.
Is there a free market solution? Definitely. Would it require some form of government assistance? Without a doubt. But to hand a man a who refuses to outline any real details a blank check; a man who has preached no bailouts over and over, only to change his mind; a man who obviously has does not understand what is going on any better than the clueless bank CEOs; a man who is likely to favor his Wall Street friends – this is a very dangerous proposition.
Free market economics works great. The only problem is that America hasn’t operated in a true free market system for many years. This is unlikely to change without a radical restructuring of economic, trade and tax policies. We must also have real oversight from the SEC and much more banking regulation. Finally, those who engage in fraud or criminal neglect must face dire consequences.
Are the bank CEOs a part of the free market solution? Only if they are cornered and provided with a clear incentive so they will actually add value for a change. The fact that they were guaranteed huge compensation packages even after destroying companies is one of the many reasons for this crisis. What if we give them a chance – fix this crisis and do it with minimum taxpayer money, legally, and without fraud – or send them to prison for a very long time. I’ll guarantee you they would find a way.
Instead of using taxpayer money to buy worthless junk, the Treasury should recapitalize distressed banks in exchange for preferred stock so taxpayers can benefit from any possible upside. And a good chunk of the money for the bailout should come from the $75 billion in bonuses Wall Street executives received in 2006 and 2007. This method is much more effective and is the route that’s been taken by Europe.
Better yet, assemble a team of business and finance leaders with proven track records (and no ties to the capital markets) to fix this mess. Replace Paulson with Lawrence Summers or Nouriel Roubini - two of the rare economists who “get it.” Or what about or John Snow? Replace Bernanke with Paul Volcker and SEC Chairman Cox with Andrew Cuomo or Elliot Spitzer.
Yea, I remember Spitzer liked hookers but so what. I’m not concerned what he does in his personal life. I’m only concerned what he does as an official. And he has shown the willingness and success in going after criminals. There are many others who should be leading this nation – Paul O’ Neill, Colin Powell, and many others. America has some truly skillful, honest and great leaders. But they have been shut out by the Washington mafia.
Make no mistake, this bailout will only feed the fire and will in no way address the nation’s fundamental problems. I can think of a much better way to spend $700 billion and it would provide guaranteed results. The money could go to public works projects to repair the nations decaying infrastructure. This would create jobs while taking care of something that will ultimately need to be addressed anyway.
Or how about this alternative. With about 10% of current homeowners mortgage value (of the $11.5 trillion outstanding) in default or in foreclosure, Washington could create an agency to service the loans and dump $1.4 trillion of taxpayer funds into it along with the $75 billion in Wall Street bonuses. This would be enough to pay off 100% of the outstanding loans with no further funds needed, unlike the current plan which is only the very beginning of what will amount to trillions of taxpayer dollars.
Under this plan, taxpayers would receive a modest return. But the real benefit would be the stabilization of home prices which would benefit all homeowners, the real estate industry and ultimately the economy. For those who could not make payments, the properties would be owned by the taxpayers and sold at a special financing rate to certain groups if they signed employment contracts, such as teachers, scientists, etc. – you know, the part of the U.S. workforce that is underpaid and overworked; the part of the U.S. workforce that is declining in talent.
While this $1.4 trillion figure is twice that of the $700 billion mark proposed by Paulson, keep in mind his numbers do not include the previous bailouts for Bear Stearns, Fannie, Freddie, or AIG. They also do not include what would definitely be additional amounts that I have previously estimated to be $3 trillion at minimum, but most likely $5 trillion by the time it’s all done.
Make no mistake. I do not want a bailout for anyone….not banks and not homeowners. It’s about responsibility and accountability; something America has abandoned over the years. But if I had to choose over the current bailout black hole and the one proposed here, I’ll take the later, but only if it is fair for everyone.
The Bush administration has bled Americans dry for 8 years. Now Americans are expected to bail out the same companies that screwed them? The American people need a host of real options instead of some bogus bailout plan marketed by scare tactics. Ultimately, the people have decided on this matter and they are strongly against this bailout. Americans are sick and tired of having their money stolen from those who least need it.
Ultimately, there needs to be an international financial regulatory agency because we are now dealing with a global financial network. And we must ensure that no single financial institution becomes so large and influential that it needs a bailout. The “Too big to fail” excuse simply won’t work next time. This proposed global agency would imply more strict anti-monopoly laws and enforcement.
Coming Up Short
At the best of scenarios, this bailout will only address short-term liquidity. It offers no real solutions. In fact, it will weaken the dollar further, driving up inflation and oil prices. It will also cause foreigners to question the credit risk of U.S. Treasury securities more than they already have. The bailout plan won’t even offer solutions for the real estate market unless it provides some type of assistance to those facing foreclosure.
But it would be impossible to help taxpayers in an equitable manner. In the best of scenarios, millions will be left out and become very angry. Who could blame them? What about those who already lost their home? What about those who struggled any way they could by taking another job, tapping into their 401(k)s, borrowing from relatives, selling assets, and other ways? These are the people who tried to pull through. These are the people who will pay the price for being responsible.
Even assistance to homeowners via low mortgages will cost a lot of taxpayer dollars, but who is to say they will be able to pay off their mortgage? The economy is weak now and was weak prior to 2007. And it’s going to get weaker. The only way to improve the economy on a short- or intermediate-term basis is to keep printing money and borrowing from foreigners. But that will create the illusion of a recovery, while positioning the U.S. for an even bigger collapse down the road.
With little doubt, a bailout will be passed. And I will guarantee you it’s going to cost an enormous amount of money with no real help to consumers. And you had better believe it is only going to make things much worse down the road. But politicians do not care about tomorrow. They only care about securing the next term. That is precisely why America cannot escape what will be remembered as a decade-long depressive period.
The best way to help Americans keep their homes is to create real jobs and increase wages. America needs a permanent economic solution. That means it needs a viable energy strategy, a restructuring of free trade and the free market system, and universal healthcare. Without these things, the bailout funds (that will have to be borrowed from foreigners) will just add more pain to the debt with false hopes and more profiteering by insiders. It’s a theme that will continue to repeat over and over until Washington is forced to start serving the people, as mandated by the United States Constitution.
Update since first published
Sure, over the past week the TARP has been made into a 500-page document with added tax breaks and raised the limit on federal deposit insurance from $100,000 to $250,000. The Senate subsequently passed this version of the plan. Then the House passed it. The final plan can be found here
When you see tax breaks for makers of wooden arrows for children, fishermen, casino operators and other BS, it really confirms what kind of idiots are in Washington. Here’s the deal. Politicians added these provisions so when reelection time comes they will tell you that they made sure to help their local voters with one or more of these useless cuts. Don’t let them get away with it. Vote them all out of office.
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