The government took bold steps to turn the market around this week but have been very quiet about where all this money is going to come from.
Did the government really do enough to save us or is this just like throwing a few more sandbags in front of the levee during Katrina? There are two very different schools of thought and both have their points but most people focus too much on the US economy which, although about 23% of the global economy, will not be able to rise on it's own. We still have the power to take the world down with us if we slip into the abyss but we're not likely to turn things around if the other 77% of the world is already sliding down anyway.
On the other hand, the new rules imposed on the markets and the $500Bn injected by the Fed and Treasury last week would be a 100% boost to the entire GDP of all but 17 of the World's nations so if you've even glanced at the markets in Pakistan ($144Bn GDP) or Vietnam ($70Bn) or the UAE ($192Bn), Hong Kong ($206Bn), Saudi Arabia ($376Bn) or worried about Nigeria ($166Bn) then you can understand how MASSIVE this action is.
Last year, the GDP of the United States was just under $14,000Bn. The government already collects $2.5Tn of that (18%) but spends about $2.8Tn that they admit to and another $500Bn they don't on wars and bailouts. Clearly some belt tightening will be in order but it stands to reason that if the government were to control spending and RAISE taxes to collect say $4Tn a year (28%) then we would have an extra $1,000,000,000,000 to pay off those debts (which are costing us $250Bn a year in interest) and probably enough left over to bail out the GSEs and everyone else with room to spare.
The problem seems massive – it is massive, but so is our economy and, if given time, it can get back on its feet but it's time that is the question. BSC, LEH, AIG, FRE, FNM, MER ran out of time – hopefully this very late action is going to buy enough for everyone else but we need to follow it up with responsible action from our leaders and that means telling people they are going to have to take their medicine and those people cannot be the bottom 80% of the earners, who make less than 20% of the money – it's not possible, nor is it right to try to fix things that way.
Even Ronald Reagan, when faced with a similar deficit crisis, in 1982 passed the Tax Equity and Fiscal Responsibility Act (TEFRA) along with the Highway Revenue Act, which raised fuel taxes. Overall, this the two taxes accounted for 1% of the GDP ($140Bn a year in today's numbers). In 1983 Reagan raised Social Security taxes and in 1984 he signed the Deficit Reduction Act followed by the Consolidated Omnibus Budget Reconciliation Act of 1985, the Tax Reform Act of 1986 (which was a nice way of saying increase), and the Omnibus Budget Reconciliation Act of 1987. Overall, the largest tax increases in US history came under the Reagan Presidency.
While Reagan was anti-taxes and anti-big government, he wasn't so unrealistic that he didn't think we needed to balance our budget at some point. To me, the scariest thing about what the government is doing is that they have made no mention of how it's going to be paid for. I don't see that we can afford to sweep this under the rug. If we lose the faith of the other 77% of the global economy they may be forced to take the very painful step of cutting us off, the same way Paulson decided to let LEH die.
The price tag on the next phase of the government bailout has been set at $700Bn today in a proposal sent to Congress this morning. Included in the proposal is legislation that will raise our nation's debt limt from $10.6Bn to $11.3Bn. The Treasury plans to hire asset managers to purchase the assets through so-called reverse auctions, seeking the lowest prices, a person briefed on the proposal said yesterday. The proposal specifies that only assets from U.S.-based financial institutions issued or originated on or before Sept. 17 can be purchased but some see this as nothing more than economic extortion on the part of Paulson and Co., timed to jam this "rescue" down Congresses' throat just ahead of the recess or else they will be branded as the villains as they head home to campaign for re-election.
Bush today said he's unconcerned that the price tag on the package may seem high. “I'm sure there are some of my friends out there that are saying, I thought this guy was a market guy, what happened to him,'' the President said. “My first instinct was to let the market work, until I realized, while being briefed by the experts, how significant this problem became.''
Thanks Mr. President. The headline in the LA Times is "Europeans on Left and Right Ridicule US Money Meltdown" and some of the quotes are just too depressing to even post so I warn you before reading it. The NYTimes accurately calls the whole package a "Hail Mary Pass" by the government and there will, in fact, be no time left in the game if this one doesn't connect for a touchdown.
Mish points out the the actual text of the bailout plan says: "The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time." Indicating that this is not a one-time $700Bn but more of a revolving debt that allows the government to be a dumping ground for $700Bn in assets and then another $700Bn as soon as they unload the first batch. "At taxpayer expense," Mish says, "Bernanke and Paulson are willing to bail out their banking buddies at enormous expense to the average taxpayer of this country. Bernanke and Paulson should both should be fired. Instead Congressional sheep will baa yes to this bailout and Bush will baa yes when he signs it. It is a sickeningly sad that day for America that Congress will go along with this proposal that makes the US Taxpayer A Giant Dumpster For Illiquid Assets."
Time magazine has an alarming article called "Why China Won't Come to the Rescue" noting that China's sovereign wealth fund already did come to the rescue when they took a 9.9% stake in MS ($5Bn) and a $3Bn stake in BX on their IPO (now down almost 50% from the open at $34). According to Time, the SWF has "been the subject of withering public scorn in China and has drawn pointed private criticism from the highest levels of the Communist Party."
In order to entice Sovereign Wealth funds, foreign governments and foreign capital of all stripes to back this plan, we are going to have to have a real fire sale, structuring deals like the one MER made with Temasek (Singapore SWF) last December, which had onerous terms that allowed Temasek to dump shares at 1/2 price and still end up about even.
It will be very important to look at the terms of the deals being signed, not just the dollars involved as there is going to be little point in being a future investor if 90% of the value of the company is already held by preferred investors who can dump shares with impunity. As Paulson and Co rush to raise the auction hammer on the United States, Forbes asks 10 pertinent questions:
- Who gets to participate?
- How much will individual companies be allowed to dump?
- How will the assets be priced?
- How open will the books be?
- Who will run it?
- How long will this thing be around?
- How much will the new agency cost taxpayers?
- Doesn't this make it harder to say no to other bailouts?
- What happens next week in Congress (they are supposed to adjourn).
- Will this end the credit crisis?
How did this happen to us? Well Time has a very good, very long article on that as well but be warned – not on a full stomach! Great opening line: "Every day brings another financial horror show, as if Stephen King were channeling Alan Greenspan to produce scary stories full of negative numbers."
