May 18, 2022

$700 Billion Debated – $5 Trillion Ignored

When the original $700 billion TARP bailout program was proposed by Treasury Secretary Paulson and Federal Reserve Chairman Bernanke, the American public was shocked.  The size of the bailout request was colossal, representing almost 10% of the country’s entire yearly economic output.  The country’s financial meltdown hit the front pages and caused public outrage.  Realization set in that the Government had been blindsided by the crisis and that interest rate cuts alone would not solve this problem.

Opposition to the bill’s passage was intense and the initial bill was defeated.   The Treasury and Federal Reserve insisted that the money was needed to prevent a collapse of the banking system.  Scare tactics were employed to sway voters minds.   President Bush informed us that the bill was necessary to protect America’s retirement plans and financial future.

TARP was passed and $350 billion quickly dissipated with little to show for it.  Secretary Paulson is now requesting the remaining $350 which will quickly disappear as well, with little assurance of ending the financial crisis.

Meanwhile, with virtually no public debate, the Federal Reserve has put the US taxpayers at risk for over $5 trillion dollars and counting.   This $5 trillion includes direct loans (such as to AIG),  debt guarantees and asset purchases from troubled institutions.

Bernanke, the non elected head of a central bank gone wild is committing vast sums of taxpayer money with no assurance of a positive outcome.  Are we to put our trust in a man who did not see this crisis coming, predicted that it would be contained and is now in charge of solving the problem?    Is Bernanke the savior or the guide on the road to financial Armageddon?

Mr. Bernanke’s predecessor at the Federal Reserve allowed the explosive credit growth and easy lending that fueled financial bubbles.  These bubbles are now bursting and collapsing the world economy.  We now have the lunacy of the Federal Reserve trying to convince us that easy money, which caused the problem, is now also the solution.  Easy money and low interest rates are the only answer the Fed has and so far all it has caused is financial insolvency on a worldwide scale..

The fact of the matter is, the Federal Reserve is not bigger than the US economy.   The power of the Fed is derived from the US free enterprise system.   The Fed cannot change the primary trend of market forces nor can it bailout an entire nation.  All they can do is slow it down and drag it out, as happened in Japan.  The end result of the Fed’s “rescue” is likely  to be an impoverished future caused by unmanageable debt burdens.

The line at the Treasury grows longer

It is no secret that the budget deficits of state and local governments have been growing this year and are likely to accelerate sharply as this recession deepens.  Tax revenues for most states in the previous two months have shown no growth and this situation will only darken with each passing month as job losses accelerate.  Alaska, the only state with a healthy surplus due to higher oil prices is also likely to see their fiscal fortunes darken as the price of oil collapses due to a weak global economy.

Question: given the seeming inability at any level of government to cut spending or increase taxes (see IOU’s Pile Up – Taxpayers Refuse to Pay), what outcome can we expect?

Answer:  based on the numerous recent bailout precedents by the US Government,  the state governments, one after another will line up outside the Treasury for bailouts or government guarantees of their debt issues.  Result:more bailouts until we reach the point where serious minds will have to ask “who is going to bailout the US Treasury?

This week California was the latest supplicant to the US Treasury, asking for $7 billion to tide them over until tax receipts come in.   State officials also blamed the frozen credit markets for preventing them from tapping the credit markets.   I have news for the State of California -you can’t run up never ending debts without limit; it is not “frozen credit” markets causing the problem – it is the fact that poor credit quality borrowers cannot now expect to borrow unlimited sums at low rates.  After his election, Governor Schwarzenegger attempted to cut the State’s budget by reducing the bloated state bureaucracy; after massive political protests he gave up and here we are.

If the Treasury bails out California, there will be 49 states in line right behind them also asking for loans and guarantees.  After spending  $800 billion bailing out Wall Street and providing tax breaks to special interests, it will be politically impossible for Washington to say no to California.   Is Washington going to do what President Gerald Ford did in 1975  when New York City was on the verge of bankruptcy -“Ford to New York City – Drop Dead”?   Different time and different place -California will get their loans and guarantees and continue to spend until there is no one left  foolish enough to lend them money.

Here’s a solution for Governor Schwarzenegger – fight against the financial insanity of open ended deficits; lose  the next election if necessary for the greater good of the State.  Insist on budget cuts – increasing taxes will only make things worse; take on the unions that are bankrupting the future of unborn; get your financial house in order by reducing debt, sell State assets – there is an ocean of cash waiting for the right time and price point to invest; be candid with your citizens and tell them that we cannot borrow our way to “prosperity” anymore, there will be pain but you we will be building a future based on economic growth and real prosperity instead of the false prosperity built upon leverage and debt; tell your citizens that times have changed  and we all need to spend less, expect less and save more until we can correct the insane excesses of the past; if necessary go the route of The City of Vallejo, California which filed for Chapter 9 in order to break the fiscal stranglehold of sky high municipal salaries and benefits.

Sarah Palin touched on the need to save and only buy what we can afford to during her last debate but I am convinced that there are few politicians out there who have the courage or verbal skills to give the voters this type of message.

Unfortunately, the local, state and federal governments face tough choices on the road to financial health since they will need to reduce the multi trillion dollar benefits promised but now impossible to pay.   An age of hard times is upon us and those who chose to believe that their “entitlements” are due no matter what are in for a rude awakening since the future has already been spent.

Say no to California for  a bailout – they need to figure things out for themselves.

Next Bailout – Insurance Industry?

Insurance company stocks continued their brutal decline today as questions continued over capital adequacy, credit downgrades, uncertainty on future portfolio write-downs, potential cash calls on CDS obligations and investor disbelief over company statements that all is well.   As noted yesterday, HIG’s stock imploded along with the rest of the industry and I stated that they should come out with very decisive action to stop the vicious downward cycle of stock declines; which is exactly what GE did today by raising cash that they said they really didn’t need.

HIG issued a relatively neutral statement saying that all was well and it’s stock continued to decline.  I don’t think investors will be putting much credence in company statements of assurance after the AIG meltdown where everything was fine until one day it wasn’t and they needed $85 billion and lights out.   With a crisis of confidence, any company that has generated questions on its financial soundness needs to respond immediately before the market makes its own harsh decision.

The insurance industry is in many ways more important to our economy than the banking system; they should take immediate action to  strengthen their balance sheets to ride out this financial crisis.

STOCK CLOSED CHANGE %CHANGE
MET 48.15 10/1/2008 -7.85 -14.00
GNW 7.36 10/1/2008 -1.25 -14.50
ALL 44.00 10/1/2008 -2.12 -4.60
CB 51.55 10/1/2008 -3.35 -6.10
PRU 64.80 10/1/2008 -7.20 -10.00
HIG 38.11 10/1/2008 -2.88 -7.00

IOU’S Pile Up – Taxpayers Refuse to Pay

Forbes Magazine had a great article by William Baldwin explaining the addiction to debt by everyone from the Federal Government on down to Joe Sixpack. Politicians get elected by handing out entitlements that the “future generation” has to pay for, therefore, no new taxes need be imposed and the voters are kept happy; Joe Sixpack can buy his house with no money down and instead of saving for a downpayment can buy the new plasma TV and jet off to Cancun for the weekend; the ultra rich hedge fund operators and bankers can leverage up 40 to 1 and exponentially increase their net worth. Up until now this has worked like magic and no one, except for a few fiscal conservatives, worried about the mountains of debt building up at every level of society. As is the case with most trends that go to unimaginable extremes, all of a sudden it does matter in a very big way. Properly enough, the ones who incurred the most debt are now suddenly suffering the most from hedge fund managers facing liquidations requests and job loss to Joe Sixpack receiving his default notice to towns, cities and states suddenly facing massive deficits as the great credit machine implodes.

Debt to GDP

Here’s where it gets really interesting as the bills come due and the debts can’t be rolled over. Governments cannot cut back due to the nature of democracy; no will vote for someone who tells us what we need to hear – that the bills are due and we now have two options – drastically cut government services or dramatically raise taxes to pay for our past purchases. The option previously used on every occasion was to simply borrow more to pay the bills but, as we saw today, when you can’t borrow more it gets very ugly, very quickly.

Ironically, a few pages after the article by William Baldwin on out of control debt levels, we have the “Taxed to the Max” comment about a ballot initiative that will be voted on in Massachusetts which would eliminate the state income, wage and capital gain taxes which currently brings in the State of Mass over $12 billion a year. After a decade of stagnant wages, increased cost of living and maxed out credit cards it is going to be political suicide to convince the taxpayer that he needs to start paying on the mountains of debt that have piled up. How this problem is ultimately resolved will profoundly affect all of us for many years and there is no easy way out. How many people will accept a much lower standard of living and higher taxes to bring our debts in line with our ability to repay? I fear that as usual, the politicians will take the easy way out and try to continue to borrow until they can’t. The real big question is, short of simply printing the money, do we still have the ability to borrow and roll over our debts?

Taxed to the Max
Massachusetts is often referred to as “Taxachusetts” because the state’s taxes are so high. Now the Committee for Small Government wants to change that image by pushing legislation called the Small Government Act, which Bay Staters will vote on in November. The legislation repeals the state income, wage and capital gains taxes. That’s a $12.5 billion state revenue cut–with no other revenue to replace it. That reduction would force state legislators to seriously rethink their financial priorities. But it would also leave that money in the hands of families, where it will surely be better spent. Bostonians were once brave enough to tell England–and the world–that taxes were too high. Now let’s see if they have the courage to tell their own legislators.
–Merrill Matthews, Institute for Policy Innovation

What Does This Man Do All Day???

What's an economy?

The Wall Street Journal reports today that the President expressed surprise that the bailout bill did not pass. Earlier in the day, White House spokesman Tony Fratto had predicted that the vote would pass. One has to wonder what kind of indifferent involvement there was by the White House if they had no idea how many members of their own party were not going to go along with the President’s plea to pass the bail out bill.

Someone not familiar with the structure of our government and reading the financial press for the past year, could easily be pardoned for assuming that our country was being ruled by Ben Bernanke and Henry Paulson, whose decision making powers seem to be unlimited yet still have had no ability to forestall the deepening loss of confidence and the rapidly escalating meltdown of the world financial system. Is it possible that the President did not want to get engaged, believing that his Treasury Secretary and the Federal Reserve would solve all our financial problems in short time? I think the more likely answer is that President Bush never had and still has no comprehension of the magnitude and dangers of the financial crisis that has been unfolding in ever more frightening ways over the past two years. Apparently aroused from his slumber a week ago by dire forecasts of an imminent meltdown, he gave a national speech that was so dumbed down and ineffective, you have to wonder what audience he thought he was speaking to. Obviously, the President wasn’t even able to convince members of his own party, that the bailout made sense and could never overcome the popular notion that the bailout was simply another handout to Wall Street.

My own perception is that even if the bailout is passed, it will not accomplish what the powers to be were expecting. Confidence worldwide has been shattered by huge losses on virtually every asset class. The perception that loss avoidance is better than taking any risk for a gain will remain with us for some time, especially with the daily collapse of large institutions. Few saw this collapse coming and none know how it will ultimately end.