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The Fed and US Treasury announced
today a further plan to buy up to $800 billion of mortgage backed
securities. This is in addition to the $700 billion financial bail-out
package announced in September. In just past 3 months, over $1.5 trillion has
been committed to help home owners and solve financial crisis.
Let's get this right: Countrywide (now
Bank of America) lent Bob $1 million for a home that's worth $200,000. The
genius AIG comes in and insures this mortgage and collects a premium from
Countrywide.
Now that Bob can't make the credit
card and house payment, troubled American Express gets a $20 billion help
out, AIG gets a $150 billion bailout from the insurance obligation, and
Countrywide gets to sell Bob's non-paying mortgage to the Fed?
So what does Bob get from this rescue?
Nothing.
Don't be fooled by Mr. Paulson. The
case above is not an over simplification; it is exactly what is happening.
If you were to ask a libertarian
like Ron Paul about who the government should rescue, he will say,
"No one". In normal circumstance I would agree, however, we are
living in unusual times. We had over 25 years of massive credit expansion so
the current debt implosion, with no intervention, will cause a spiral of
asset price deflation, social chaos, and leave several tens of
millions of Americans on the street.
If Mr. Bush really wants to help, the
government is much better off giving money directly to the homeowners in
trouble. And it can be done: Of the total $10 trillion US residential
mortgages, upwards of $3 trillion are non-performing. It will cost a
mere $150 billion to pay the interests of those $3 trillion mortgages for one
entire year at 5%. This will immediately alleviate foreclosures, and
temporarily stop the bleeding in the values of mortgage securities. To those
who faithfully make payments, they can deduct 200% of the interest payments
from tax returns. This "tax cut" will likely cost another $200
billion. For the savers who are mortgage free, waiving capital gains tax will
generate interests in investments. The plan will also have the pleasant side
effect of generating housing demands by folks taking advantage of
interest tax write off and zero capital gains tax. The total cost of such a
proposal will still be well below that of Mr. Paulson.
I can't find any rationale to bail out
toxic mortgage investors. I am still waiting for a bailout from last night's
black jack losses.
What about the ailing banks? Banks are
like airlines, however badly managed, they must exist for the economy to
function. However, I would not rescue Citi, which benefits solely Citi's
shareholders such as the Saudi Prince and the Singaporean government. Instead
the US government should only buy viable assets from Citi and other failing
banks. These assets include buildings, machines, and banking networks.
Next the government should institute a new federal bank with a clean slate to
resume residential and commercial lending. The new bank would have oversight
by independent audit firms and a reasonable salary scale. After the
crisis subdues, the new bank can then seek IPO and replenish the US treasury with the proceeds.
The idea of nationalizing banks may
sound anti capitalistic, but it is exactly what we are doing right now. In
fact, we are doing worse as we leave the good assets to the bankers and bank
shareholders and buy the worst toxic waste from them. This makes no
sense at all.
While we are debating where the
government should spend its bailout money, the funny thing is, the
government doesn't have the money! The 2008 federal deficit is over $500
billion, and if the bail out programs comes into effect, the
federal deficit could easily top $1 trillion or even $2 trillion in 2009.
Where does the money come from you
asked? Staying tuned for part II, where we discuss the current investment
climate and how to protect and profit from this mess.
John Lee, CFA
Goldmau.com
John Lee is a portfolio manager
at Mau Capital Management. He is a CFA charter holder and has degrees in
Economics and Engineering from Rice University. He previously studied under
Mr. James Turk, a renowned authority on the gold market, and is specialized
in investing in junior gold and resource companies. Mr. Lee's articles are
frequently cited at major resource websites and a esteemed speaker at several
major resource conferences.
Please visit www.GoldMau for
instant market alerts and stock updates.
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