It's everybody's problem, not just Wall Street's

30 Sep, 2008

Lawmakers in Washington have been scrambling over the last few days to build enough consensus to pass legislation approving a $700 billion package to help the ailing financial industry. Despite the fact that the present Republican President, the Federal Reserve, the US Treasury and ironically the Democrats, who presently control Congress, all agree on the importance and timely approval of this package, the American people have yet to hear of a final decision.
The wall facing US Treasury Secretary Paulson, who was the primary architect of this bailout proposal, is comprised of the House Republicans. There are two basic reasons why this proposal is being debated so acrimoniously and dragged out in front of international and national media. The main reason is that America is set to vote for its next leader in a matter of just six weeks.
What this implies for this process is that the political forces will try to get maximum mileage out of this event by playing to their audience rather than buckling down and passing a bill which may avert complete financial ruin. The other reason is that for some reason, perhaps for the very reason mentioned in the earlier sentence, this financial package is being sold in the media as a bailout for Wall Street.
This is creating a lot of ill will in the minds of the taxpayers since Wall Street is synonymous with big bonuses, private jets and every other excess that may come to mind. What the Treasury, Fed and those lawmakers who favour the deal, are failing to explain is the link between this bailout package and Main Street.
The $700 billion in taxpayer money will not just go towards funding the investment banks and the bonuses for their CEOs and protection for their large wealthy individual and institutional clients.
It is a comprehensive proposal which aims at reducing the risk which currently is tainting the balance sheet of every major financial institution in the US and many around the globe. This risk of course is comprised of the billions of dollars of securities they own which are backed by bad mortgages, which was a result of the housing crisis, which started this domino effect.
The investment banks may have built these securities. They may have marketed these securities, but everyone bought these securities. Everyone includes the 8,400 banks operating in America.
Everyone also includes the 117 "troubled" institutions, so termed by the Federal Deposit Insurance Corporation ("FDIC"). Why is this important? Because the FDIC is not concerned with investment banks. This is the institution which insures, up to $100,000 each, practically every bank deposit in the US. The reason they are watching Washington so closely is that the success of this package means a significant reduction in the possibility and number of failed banks. Which would not be a bad thing if one looks at the numbers.
After suffering a loss of about $9 billion from the collapse of IndyMac Bank, the FDIC is sitting on about $45.2 billion. The most recent bank failure was Washington Mutual ("WaMu") which was seized by the federal regulators this week and sold to J P Morgan Chase for $1.9 billion. Had this deal not gone through, the closure of WaMu would have cost the FDIC more than $30 billion, which would have been a crushing blow.
This federal agency was created in 1933 after the US had undergone the Great Depression which was caused by the stock market crash of October 1929. Thousands of banks failed during the depression and millions of Americans lost all or some of the money they had deposited in these banks. Since the start of FDIC insurance, no one has lost a cent of insured money because of a bank failure.
Sure the American taxpayer should be concerned, or even upset at the government using $700 billion to bailout the banks. But if these banks collapse, or if the potential threat of collapse leads to a run on the banks, which will undoubtedly lead to their collapse, the American taxpayer could stand to lose even more.
The good news is that by Sunday the negotiations were over and the resultant 110-page bill was expected to be presented to Congress on Monday. All sides included in the process had to make concessions to get this far. The current administration had to accept limits on executive pay as well as tougher oversight, Democrats had to give up on the proposal allowing bankruptcy judges to re-write mortgages, and the House Republicans fell short of trying to have the government insure the bad debt as opposed to buying it.
More importantly for the American taxpayer, who is ultimately going to foot this bill, certain new amendments have been put in place to secure their investment, so to speak. First off the Treasury will acquire those assets which it feels have the potential to increase in value over time thus creating a situation where they might turn a profit on that investment. More importantly if this program to resell assets has posted a loss in five years time, the President must submit a plan to Congress to recover those losses from the financial industry.
These provisions and others, like limiting the ability of participating firms to offer golden handshakes, are expected to help get support of the American public. While the lawmakers seem convinced for now, that they must act, they fear the fall-out they may face in their home-town, some even expect to lose re-election bids over this. But there is little doubt that Congress has any other option, if its wants to prevent a financial catastrophe. The package, once approved, should not be expected to recall the bulls to the stock market. We are not going to see a rapid turnaround and the return of market rallies like in 1999.
In fact things may still get worse. Over the weekend we saw the latest victims of this crisis, Dutch-Belgium bank Fortis NV, and UK's largest buy-to-let mortgage lender Bradford & Bingley, both to be rescued by their respective governments. There is speculation that Germany, France and Japan have not come clean yet and will follow in the same direction.
So this package may never get the credit it deserves. Things will not improve immediately, but they may not get as bad as they could. The "Oracle of Omaha", Warren Buffet, who is considered to be one of the savviest investors in the world, warned Saturday night that if this package is not approved, we may be looking at "the biggest financial meltdown in American history". He also warned that the financial crisis is "everybody's problem", not just Wall Street's. I agree with Mr Buffet, I hope the American people do as well.

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