The High Cost of Bailouts Lies Ahead

Fortune Magazine says rather than government intervention, the financial industry needs consolidation:

Henry Paulson and Ben Bernanke have saved us, for now, from a market meltdown — but at the cost of allowing the folks who caused the current crisis to keep ducking reality. ...

The Treasury secretary and Federal Reserve chairman have spent September dashing off blank check after blank check in a bid to quell turbulent markets. ...

Ultimately, what could prove to be the most expensive aspect of the bailout spree is the message the government is sending to firms in which the market has lost confidence. Prudent management, it seems, will be punished, while the status quo — however unhealthy — must be maintained at all costs.

The strong stock-market rally of the past two days aside, intervention that fails to foster a shakeout of weaker firms will only delay the reckoning that must occur before a sustainable economic recovery can take shape.

"We continue to believe that the financial sector is in need of massive consolidation because the sector simply has too much lending capacity left over from the credit bubble," Merrill Lynch investment strategist Rich Bernstein writes Friday. "History shows well that consolidation is the primary driver of post-bubble economies." ...

Though the free fall in financial shares over recent weeks wasn't pretty to watch, it had the sanguine effect of forcing businesses with questionable fundamentals to confront an uncertain future. ...

But for the rest of us, the feds' rush to defend teetering financial firms only defers the tough decisions that will need to be made before this crisis subsides — at the expense, perhaps, of repeating Japan's so-called lost decade of economic stagnance after its property bubble collapsed around 1990.

History shows that setting up bad banks without forcing financial firms' managers to confront their problems won't solve anything.

"This seems to us," Bernstein writes, "to be a very Japanese approach to solving a credit crisis."

Fortune Magazine obviously disagrees with The Wall Street Journal about whether we're repeating Japan's mistakes. We don't need to keep guessing who is right. In time, we'll all know the answer.

Do You Support Henry Paulson?

Do you support what Treasury Secretary Henry Paulson has done so far? Why?

Against The Large Mortgage Bailout

Enough is enough! When will these bailouts end? The AP Reports:

The Bush administration asked Congress on Saturday for the power to buy $700 billion in toxic assets clogging the financial system and threatening the economy as negotiations began on the largest bailout since the Great Depression.

The rescue plan would give Washington broad authority to purchase bad mortgage-related assets from U.S. financial institutions for the next two years. It does not specify which institutions qualify or what, if anything, the government would get in return for the unprecedented infusion.

The proposal would raise the statutory limit on the national debt from $10.6 trillion to $11.3 trillion to make room for the massive rescue.

The current proposal performs more of the following: Socialize the losses, privatize the profits. Hell No! Why should the taxpayers spend hundreds of billions of dollars more to bail out irresponsible corporations on Wall Street?

I know some of the proponents believe that do nothing is worse then the bailout as it could lead to a depression. But bailing out these reckless risk takers just encourages this type of risky behaviour in the future.

Southern California Home Prices Plummet

From CNN Money:

The median home price in Southern California fell 34% in August from last year, a research firm said Wednesday.

The cost of new and resale homes and condos dropped to $330,000 last month in a six-county region.

It was down from $500,000 in August 2007 and down 5.2% from $348,000 in July, MDA DataQuick said. ...

MDA DataQuick president John Walsh said much of the sales activity has been logged in lower-priced inland areas where the market has been driven by foreclosures. ...

Foreclosures accounted for almost 46% of all resold properties last month, up from 10% in August 2007 and almost 44% in July.

This decline seems to be exaggerated due to a shift in the mix of houses being sold. One should not assume that individual homes have declined in price by 34%.

Stiglitz: How to Prevent a Repeat of this Financial Crisis

Nobel Laureate Joseph Stiglitz gives his prescription for preventing this type of crisis from happening again:

This is not the first crisis in our financial system, not the first time that those who believe in free and unregulated markets have come running to the government for bail-outs. There is a pattern here, one that suggests deep systemic problems — and a variety of solutions:

1. We need first to correct incentives for executives, reducing the scope for conflicts of interest and improving shareholder information about dilution in share value as a result of stock options. We should mitigate the incentives for excessive risk-taking and the short-term focus that has so long prevailed, for instance, by requiring bonuses to be paid on the basis of, say, five-year returns, rather than annual returns.

2. Secondly, we need to create a financial product safety commission, to make sure that products bought and sold by banks, pension funds, etc. are safe for "human consumption." Consenting adults should be given great freedom to do whatever they want, but that does not mean they should gamble with other people's money. Some may worry that this may stifle innovation. But that may be a good thing considering the kind of innovation we had — attempting to subvert accounting and regulations. What we need is more innovation addressing the needs of ordinary Americans, so they can stay in their homes when economic conditions change.

3. We need to create a financial systems stability commission to take an overview of the entire financial system, recognizing the interrelations among the various parts, and to prevent the excessive systemic leveraging that we have just experienced.

4. We need to impose other regulations to improve the safety and soundness of our financial system, such as "speed bumps" to limit borrowing. Historically, rapid expansion of lending has been responsible for a large fraction of crises and this crisis is no exception.

5. We need better consumer protection laws, including laws that prevent predatory lending.

6. We need better competition laws. The financial institutions have been able to prey on consumers through credit cards partly because of the absence of competition. But even more importantly, we should not be in situations where a firm is "too big to fail." If it is that big, it should be broken up.

These reforms will not guarantee that we will not have another crisis. The ingenuity of those in the financial markets is impressive. Eventually, they will figure out how to circumvent whatever regulations are imposed. But these reforms will make another crisis of this kind less likely, and, should it occur, make it less severe than it otherwise would be.

Another Bank Failure! Whoo-Hoo!

From CNBC:

Regulators closed on Friday Ameribank, which became the 12th bank failure this year as the struggling economy and falling home prices take their toll on financial institutions.

The Federal Deposit Insurance Corp said the Northfork, West Virginia-based bank had $115 million in assets and $102 million in deposits as of June 30. The failure is expected to cost the U.S. bank deposit insurance fund about $42 million.

Foreclosures Hit a New Record High

From CNN:

Foreclosures hit another record high in August: 304,000 homes were in default and 91,000 families lost their houses.

More than 770,000 homes have been repossessed by lenders since August 2007, when the credit crunch took hold.

The report from RealtyTrac, an online marketer of foreclosures properties, is the latest in string of bad news for housing.

Foreclosure filings of all kinds, including notices of defaults, notices of auctions and bank repossessions, grew 12% in August over July, and 27% compared with August 2007.

The 27% jump over last August represents a more modest year-over-year increase than in previous months, but that's only because the housing crisis was already underway in August 2007, which saw a big spike in foreclosures.

"In August 2008 the total number of U.S. properties that received foreclosure filings, as well as the national foreclosure rate, were both the highest we've seen in any month since we began issuing our report in January 2005," RealtyTrac CEO James Saccacio said in a statement.

The Trillion Dollar Bailout... And Counting

CNBC says the bailouts have cost over $900 billion, so far:

The U.S. Federal Reserve stepped in to rescue insurance giant American International Group from bankruptcy with an $85 billion loan on Tuesday, the latest in a series of bailouts and loans for the financial and housing sectors.

The action brings the total tab for government rescues and special loan facilities this year to more than $900 billion.

• $200 billion for Fannie Mae and Freddie Mac...
• $300 billion for the Federal Housing Administration to refinance failing mortgage[s]...
• $4 billion in grants to local communities to help them buy and repair homes...
• $85 billion loan for AIG...
• At least $87 billion in repayments to JPMorgan Chase for providing financing to underpin trades with units of bankrupt investment bank Lehman Brothers...
• $29 billion in financing for JPMorgan Chase's government-brokered buyout of Bear Stearns...
• At least $200 billion of currently outstanding loans to banks issued through the Fed's Term Auction Facility...

The new bailout plan announced yesterday may cost another half trillion:

Treasury Secretary Hank Paulson briefed Congressional leaders on plans to address the "illiquid assets" on U.S. financial institutions' balance sheets, possibly including the creation of a government facility to take on financial firms' bad debts.

The proposal to create a massive facility to buy mortgage-backed securities could cost as much as a half-trillion-dollars and would involve the purchase of both private-label and government-guaranteed mortgages, according to an administration official.

The plan would have two parts. The largest part would be the purchase of private-label (those underwritten by Wall Street) mortgages by some as-yet unnamed vehicle. Financing would occur through the sale of treasuries, the official said. That part of the plan would require congressional approval. The idea is to hold the securities to maturity. The average mortgage has a life of about 7 years.

A second part of the plan would involve the purchase by Treasury of additional government-backed (Fannie Mae and Freddie Mac) under a plan it announced several weeks ago to rescue the two government-sponsored entities. Back then, it said it would purchase $5 billion initially. The idea is to ramp up those purchases more quickly. It does not require approval by Congress. ...

CNBC first reported the creation of a Treasury plan, similar to the Resolution Trust Corp., that would take mortgage backed securities off the market. ...

A federal government plan could also involve FDIC-type protection for money market funds, according to a report in the Wall Street Journal.

SEC Bans Shorting of Financial Stocks

Within hours after U.S. presidential candidate John McCain threatened to fire SEC chairman Christopher Cox for not enforcing the rules against naked shorting, the SEC has banned all shorting of financial stocks. (Will this ban, too, go unenforced?) From CNN:

The U.S. Securities and Exchange Commission took what it called "emergency action" on Friday and temporarily banned investors from short-selling 799 financial companies.

The temporary ban, aimed at helping restore falling stock prices that have shattered confidence in the financial markets, takes effect immediately.

Short sellers borrow stock with the aim of selling it, then buy it back at a lower price, hoping to pocket the difference. The commission said short sellers add liquidity to the markets during normal conditions, but recent unbridled short selling has contributed to the recent tailspin in the stock market. ...

Cox said the action "would not be necessary in a well-functioning market," ...

Some market observers, including top bank executives, have also blamed short sellers for the punishing declines in bank stock prices over the past few days.

The shorting of stocks provides a valuable service in a market where most actors have an incentive to promote bubbles. Company managements have a vested interest in overstating the company's earnings and fund managers have a vested interest in 'talking up' the stocks they own. In such a market, short sellers often end up as the only voice of dissent. (Meredith Whitney excepted.)

The banning of shorting during a financial panic seems reasonable, but I will point out that there is no counterpart during a bubble. Too many people have an "only up" mentality, which attempts to defy the laws of mathematics.

This new outright ban on shorting financials raises the question of what will happen to mutual funds and ETFs, such as UltraShort Financials ProShares, which exist solely for the purpose of shorting financial stocks. Can they avoid the new rule by relying on options, rather than shares of stock? Are ordinary investors who own these ETFs suddenly criminals?

If the Fed had stepped in to restrain the housing bubble five years ago, none if this would have been necessary.

US Financial Leadership Cannot be Trusted

The financial leadership in the United States cannot be trusted; from the huge debts racked up by the government to the speculative investments by the big boys on Wall Street. These speculative investments lead to their demise. The WashingtonPost reports:

The traditional model of investment banking came under renewed threat Wednesday as Morgan Stanley and Goldman Sachs, the two remaining giants of this beleaguered Wall Street industry, suffered stunning losses only one day after they reported quarterly earnings that exceeded analysts' expectations.

The turmoil at the two vaunted institutions -- which only a year ago had the company of three other major investment banks -- follows an unprecedented week in American finance that has rattled investors, reshaped the landscape of the investment-banking business and raised questions about the viability of stand-alone brokerages

Here is a list of recent reckless financial events :

1) Technology bubble
2) Housing Bubble
3) Reckless Government Debt Spending
4) Oil Bubble / Commodity Bubble (some of this occured outside of this country)

Where were the voices of reason? The financial leadership in our county has shown its incompetence. It is a tragic period in our nation's financial history. It is d*mn scary.