Mark Knows It All Special: The Big Bailout
This has been an extraordinary week in American history, and me being me, I can’t let it pass without comment. The issues presented to our financial system have been complex and difficult to understand. I don’t understand it all myself, but I know enough to allow me to conclude that very few of the television commentators and anchors, and all of the political candidates from all of the political parties, probably know less than me. The country deserves better explanations about what is going on other than it is a taxpayer bailout. What the government did for Fannie Mae and Freddie Mac was a bailout. The Chase Bank takeover of Bear-Stearns was a bailout. AIG was a bailout What the government is doing today is NOT a bailout, and had it been done 6 months ago when the few voices in the wilderness were calling for it, the actual bailouts most likely would have been unnecessary.
Take away the static and noise, here is what the government is doing. For various reasons, and there is plenty of blame across both political parties and the administrations of President Bush and former President Clinton, the real estate market got overheated, and financial entities made over aggressive loans. Many of these were made in good faith and in the ordinary course of business. Many of them, including several that passed through my office, looked suspicious and smacked of fraud. We stopped assisting in these.
Notwithstanding, these mortgages were sold out of the originating institution, repackaged, and sold to investors as a collateralized mortgage instrument. When the overheated real estate market cooled down, a portion of these mortgages went bad, and due to government imposed accounting rules, the value of the collateralized instruments came into question. The holders had to value them at close to “0”, triggering a bank crisis as the bond holders, including banks and brokerage houses, could no longer use them as collateral in interbank borrowing, as well as depleting their capitalization levels causing the FDIC to force them into selling themselves, or file for bankruptcy.
Normal inter-institutional borrowing came slowly to a halt. The crisis spread this week into money market funds as interbank borrowing needed for our system to function, stopped. If any of you have a brokerage account, that is where they park your cash . This forced the government’s hand into a comprehensive solution to the problem.
Uncle Sam will form some sort of quasi-governmental vehicle which will purchase all of this “toxic” debt from the various financial institutions. This will allow the financial institutions to clean up their balance sheets, and start from scratch. It will also facilitate regular banking business, such as loaning money to you and to small businesses. The institutions will sell the toxic bonds for pennies on the dollar, and take huge write downs on their asset base.
Here is the rub. MOST OF THE BONDS AREN'T TOXIC. They are non-liquid…which means they can’t be sold right now or used as collateral between banks. But for the most part, many of the bonds will either perform fully or at least to a substantial degree; which means in the long run, they will be worth much more than the government will pay for them. Currently, the government intends to hold the bonds to maturity. This will result in mammoth profits to the government over the long run. The profit may be so high, it could be used to solve the social security deficit, perhaps? Don’t think for one minute that the government is not aware of this.
Take away the static and noise, here is what the government is doing. For various reasons, and there is plenty of blame across both political parties and the administrations of President Bush and former President Clinton, the real estate market got overheated, and financial entities made over aggressive loans. Many of these were made in good faith and in the ordinary course of business. Many of them, including several that passed through my office, looked suspicious and smacked of fraud. We stopped assisting in these.
Notwithstanding, these mortgages were sold out of the originating institution, repackaged, and sold to investors as a collateralized mortgage instrument. When the overheated real estate market cooled down, a portion of these mortgages went bad, and due to government imposed accounting rules, the value of the collateralized instruments came into question. The holders had to value them at close to “0”, triggering a bank crisis as the bond holders, including banks and brokerage houses, could no longer use them as collateral in interbank borrowing, as well as depleting their capitalization levels causing the FDIC to force them into selling themselves, or file for bankruptcy.
Normal inter-institutional borrowing came slowly to a halt. The crisis spread this week into money market funds as interbank borrowing needed for our system to function, stopped. If any of you have a brokerage account, that is where they park your cash . This forced the government’s hand into a comprehensive solution to the problem.
Uncle Sam will form some sort of quasi-governmental vehicle which will purchase all of this “toxic” debt from the various financial institutions. This will allow the financial institutions to clean up their balance sheets, and start from scratch. It will also facilitate regular banking business, such as loaning money to you and to small businesses. The institutions will sell the toxic bonds for pennies on the dollar, and take huge write downs on their asset base.
Here is the rub. MOST OF THE BONDS AREN'T TOXIC. They are non-liquid…which means they can’t be sold right now or used as collateral between banks. But for the most part, many of the bonds will either perform fully or at least to a substantial degree; which means in the long run, they will be worth much more than the government will pay for them. Currently, the government intends to hold the bonds to maturity. This will result in mammoth profits to the government over the long run. The profit may be so high, it could be used to solve the social security deficit, perhaps? Don’t think for one minute that the government is not aware of this.
In fact, this deal for the government is so good, I would not be surprised if so called sovereign funds (funds run by countries like Saudi Arabia and China) enter the market to bid for those bonds once the government establishes a base price that can be relied on. If this happens, or if the governemnt changes its intention to hold the bonds to maturity and immediately resell them at a profit, the government might not have to spend one dime. Remember, 98% of all mortgages are being paid on time. The problem mortgages are less than 1.5% of the total.
So when you hear the politicians complain about the huge government bailout, or the socialization of the financial system, or bad guys are profiting at the hands of ordinary people, think again. For the taxpayers, this is a good deal.
So when you hear the politicians complain about the huge government bailout, or the socialization of the financial system, or bad guys are profiting at the hands of ordinary people, think again. For the taxpayers, this is a good deal.
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