The Fed and US Treasury
announced today a further plan to buy up to $800 billion of mortgage backed
securities. This is in addition to the $700 billion financial bail-out
package announced in September. In just past 3 months, over $1.5 trillion has
been committed to help home owners and solve financial crisis.
Let's get this right:
Countrywide (now Bank of America) lent Bob $1 million for a home that's worth
$200,000. The genius AIG comes in and insures this mortgage and collects a
premium from Countrywide.
Now that Bob can't make the
credit card and house payment, troubled American Express gets a $20 billion
help out, AIG gets a $150 billion bailout from the insurance obligation, and
Countrywide gets to sell Bob's non-paying mortgage to the Fed?
So what does Bob get from this
rescue? Nothing.
Don't be fooled by Mr.
Paulson. The case above is not an over simplification; it is exactly what is
happening.
If you were to ask a
libertarian like Ron Paul about who the government should rescue, he will
say, "No one". In normal circumstance I would agree, however, we
are living in unusual times. We had over 25 years of massive credit expansion
so the current debt implosion, with no intervention, will cause a spiral of
asset price deflation, social chaos, and leave several tens of millions of
Americans on the street.
If Mr. Bush really wants to
help, the government is much better off giving money directly to the homeowners
in trouble. And it can be done: Of the total $10 trillion US residential
mortgages, upwards of $3 trillion are non-performing. It will cost a mere
$150 billion to pay the interests of those $3 trillion mortgages for one
entire year at 5%. This will immediately alleviate foreclosures, and
temporarily stop the bleeding in the values of mortgage securities. To those
who faithfully make payments, they can deduct 200% of the interest payments
from tax returns. This "tax cut" will likely cost another $200 billion.
For the savers who are mortgage free, waiving capital gains tax will generate
interests in investments. The plan will also have the pleasant side effect of
generating housing demands by folks taking advantage of interest tax write
off and zero capital gains tax. The total cost of such a proposal will still
be well below that of Mr. Paulson.
I can't find any rationale to
bail out toxic mortgage investors. I am still waiting for a bailout from last
night's black jack losses.
What about the ailing banks?
Banks are like airlines, however badly managed, they must exist for the
economy to function. However, I would not rescue Citi, which benefits solely
Citi's shareholders such as the Saudi Prince and the Singaporean government.
Instead the US government should only buy viable assets from Citi and other
failing banks. These assets include buildings, machines, and banking
networks. Next the government should institute a new federal bank with a
clean slate to resume residential and commercial lending. The new bank would
have oversight by independent audit firms and a reasonable salary scale.
After the crisis subdues, the new bank can then seek IPO and replenish the US
treasury with the proceeds.
The idea of nationalizing
banks may sound anti capitalistic, but it is exactly what we are doing right
now. In fact, we are doing worse as we leave the good assets to the bankers
and bank shareholders and buy the worst toxic waste from them. This makes no
sense at all.
While we are debating where
the government should spend its bailout money, the funny thing is, the
government doesn't have the money! The 2008 federal deficit is over $500
billion, and if the bail out programs comes into effect, the federal deficit
could easily top $1 trillion or even $2 trillion in 2009.
Where does the money come from
you asked? Stay tuned for part II, where we discuss the current investment
climate and how to protect and profit from this mess.
