Sunday, September 7, 2008

Coming Home to Roost

Try as hard as it might, Bush 43 could not postpone the consequences of its actions until it January 20, 2009. Bush 41 largely escaped. Son’s administration was not so lucky.

Yes, things started unraveling early in 2007 with the subprime market leading the way. But, the economy did not ‘tank’ and many, including McCain’s friend, advisor, and one time choice for Secretary of the Treasury in a McCain administration, kept telling us that ‘things weren’t so bad’ and that some people just suffered from mental depression and were just whiners.

After the initial liquidity scare, the unwinding of financial positions has been relatively smooth. Sure, Bear Stearns was bailed out, but Citigroup and Merrill have gotten capital infusions and are still standing. The housing industry has suffered tremendously, but there have been no major wipe-outs. There now have been 11 takeovers in the banking industry, but they have been relatively small banks…in general. Retail trades have only experienced a few bankruptcies. Food chains have been suffering, but no real biggies here. Manufacturing has been on hold but most large companies seem to be holding on with a fair amount of cash on hand. (Hold your breath General Motors…)

Now, however, some of the bigger paychecks are coming due. Fannie Mae and Freddie Mac have been taken over, their top executives relieved of their positions, and the United States Treasury Department has committed the American Government to “an open-ended guarantee to provide as much capital as they (Fannie and Freddie) need to stave off insolvency.”

What might this commitment amount to?

Well, Fannie and Freddie have accumulated more than $5 trillion in assets. Five trillion dollars includes a lot of zeros. There have been estimates that this commitment could cost around $20 to $30 billion, but I quoted a figure of $200 billion in a recent post. These are big numbers so we need to be careful in trying to comprehend their size. If there were a 20% write off of asset value, this would amount to $1 trillion; a 10% write off would amount to $500 billion, a 5% write off would amount to $250 billion, and a 1% write off would amount to $50 billion.

You pick a number. What will be the amount of the write down of these assets?

The important thing is that action has finally been taken. The administration finally reached the point where a takeover could not be postponed any longer. In fact, that has been the case for the last twelve months or so. The people in authority kept postponing and postponing action until they have no further choice.

The Bernanke Fed has gotten a lot of attention and praise/blame for the dramatic reduction in the target Fed Funds rate it uses to anchor monetary policy. But, if you remember the situation in the spring of 2007, Bernanke and the Fed kept putting off and putting off any reduction in its target rate of interest because they did not comprehend the need for such action. Then, when they did move they felt the drop needed to be one of the most precipitous declines on record.

The same thing is true of many of the other responses of Bush 43 in 2007 or 2008.

This is an administration that was pro-business and hands off in terms of rules and regulations. This administration did not want any economic dislocation coming on its watch. Now, it is having to act and the question is, how much more is it going to have to do before it gives up office?

The irony of the situation reminds me of that faced by the Nixon administration back in August of 1971. I joined the Nixon administration as a Special Assistant to George Romney (HUD) on August 1. Sunday evening, August 15, President Nixon went on national television and announced the freezing of wages and prices. I was fortunate (or not, depending on your philosophical leanings) to attend meetings of the Cost of Living Council and the Committee on Interest and Dividends. It was remarkable to sit in these meetings, day-after-day, and see individuals that abhorred controls of any kind, attempt to administer wage and price controls. Many of these people were violently opposed to wage and price controls or, at least, were indifferent to their application.

I perceive that many in the current administration are going through this soul-searching at the present time. And, they are faced with the prospect of other intrusions into the economic and financial system as they wind down their terms in office. How many of them wish that they had left the administration a year or so ago?

Fred Mishkin, who resigned from the Board of Governors of the Federal Reserve System in August…how lucky you are!!!

I really believe that these people want out. And, what is one of our presidential candidates shouting? “I think that we’ve got to keep people in their homes. There’s got to be restructuring, there’s got to be reorganization, and there’s got to be some confidence that we’ve stopped this downward spiral.” Senator McCain concluded, “It’s hard, its tough, but it’s also the classic example of why we need change in Washington.”

My question here is, who is Senator McCain, if he is elected President, going to use to clean up the financial and economic mess? My take is that the current people want out…they are receiving enough of the blame for the current administration. And, who might be brought in…Phil Gramm and Jack Kemp? The Republican pool is relatively dry…it has been picked over for the last eight years. Shall McCain reach across the aisle? If he is going to bring in a bunch of Democrats to clean up the mess…isn’t this a little bizarre?

There is a lot a new administration is going to have to do when it gets in office to get the economy and the financial system working smoothly again. Yes, economic growth is going to have to be renewed, but there is also the underlying inflation that will still be worrisome. Yes, the regulatory system needs to be revisited. Yes, the dollar needs to be attended to? Yes, foreign money is buying up American assets at a record pace. Yes, we need a real energy policy. Yes, the auto industry is in the tank. Yes, home owners are losing their homes. Yes, these are just a part of the agenda that will be facing a new administration come January 20, 2009.

This agenda is why I don’t believe any new President is going to have much room to introduce new items that are on their social or economic agenda. I think the campaign message should be…I would like to do thus and so…but, because of the current mess that I will inherit, there will be very little I can do in the next two to three years. I know you would like to hear something different, but, in all honesty, that is all I can promise you at the present time.

The problems created by Bush 43 are coming home and we must face them head on. The absence of an energy policy has put the United States in an embarrassing hole that it is finding difficult to climb out of. But, we need to stop digging the hole deeper. Our policy with respect to the dollar has been abysmal and it has put many United States assets on the block for foreign interests. Our fiscal policy has been totally out-of-control and has placed a large amount of the United States government debt in foreign coffers. Our monetary and banking policies have ignored the innovation taking place in the financial sector and, as a consequence, our authorities have lost control of sub sector inflations…inflations that have resulted in credit expansions pertaining to specific asset stocks and not to their sector cash flows.

We have a long way to go before we are out of this economic and financial morass. To me, risk is still being underestimated in the markets. The Fannie and Freddie experience is only another step along the bumpy road ahead of us.

1 comment:

Anonymous said...

Hi John,

This post and your previous post are great reviews of the current bank bailouts.

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