Thursday, October 02, 2008

Rolling the Dice?

This past week, as it became increasingly clear that an infusion of $700 billion in taxpayer capital might be necessary to stave off national economic "calamity", a number of Americans expressed increased feelings of doubt, confusion and frustration.

In fact, according to a "Bloomberg/Los Angeles Times" Sept 19-22 poll, by a margin of 55 to 31 percent, "Americans say it's not the government's responsibility to bail out private companies with taxpayer dollars, even if their collapse could damage the economy."

Even in New York City, the home Wall Street of Wall Street Giants, talk on the streets, bars and boutiques beyond the cavernous streets downtown is mixed with worry and anger.

"I do not believe the American taxpayer should have to bail out another business like Bear Stearns" said Scott Woodward, CEO of Sewbranded, a marketing and branding firm in New York.

"My inclination is to let it play itself out naturally, and maybe the goings on of Wall Street as we knew it, will halt the greed and corruption of how CEO's run firms for short term personal gain will subside," said Woodward.

In his initial appearance before lawmakers in Washington, Secretary of the Treasury Henry Paulson urged that the bailout plan, as it's commonly called, be passed "quickly and clearly" and that inaction could lead to a "recession."

President Bush used similar language during a number of television appearances.

Despite acknowledging the use of shrill language, a number of experts appear to believe that the doing nothing is simply not an option.

"The use of recession sounds to me like a scare tactic," said David Backus, Heinz Riehl Professor of International Economics and Finance at New York University's (NYU) Stern School of Business.

But Backus says that a "reasonably rapid response to problems in the financial sector are important."

"Japan is the obvious case of the opposite (inaction),"said Professor Backus.

From 1986 to 1990, Japan experienced what many call an asset price bubble where real estate and stock prices. When the bubble collapsed, gradually, the next 10 years became known in economic circles as the "lost decade."

"The government there ignored the onset of serious problems, and the economy stopped growing," Backus said.

"That's not a recession, it's much worse, that is ten to fifteen years of slow growth," he said.

According to, a nation's economic growth rate is measured by economic growth during a given interval. Gross National Product and Gross Domestic Product are the fundaments used to measure those growth rates.

Still, understanding the evolution of, and accepting the severity of what a slowdown could mean, has at best, proven to be challenging.

The bailout plan would allow the Treasury Department to buy bad mortgages from banks, and if and when the market improves, then sell them, in the best case scenario, at a profit.

But, ultimately, the Government would pump billions of dollars into the economy by buying up bad debt and restoring credibility to firms like AIG, Freddie Mac and Fannie, providing clean balance sheets, so banks can start lending to one another again.

In a recent broadcast of the PBS program "Newshour'" Paul Solmon explained that in this most recent and current era of "credit," the collapse of firms like Lehman Brothers was not a net loss of faith in stocks, but in bonds, basically, the debts of firms like Lehman, Fannie , Freddie and AIG.

Bonds are like official IOUs isued by governments and corporations.

Newshour's Solmon points out that credit is the most important ingredient in an economy. Futher, he says in the report that 'firms, from railways to high tech, pay for their equipment , offices, and workers as they try to grow or expand, on credit.

The availability of fast and easy credit via credit cards, loans, and mortgages has enabled American consumers to buy cars, homes, television sets and vacations basically with a bet that future income from work will allow them to cover debt, or at least allow them to keep up with monthly payments .

Still, many wonder why taxpayers should bail out an industry they view as profiteers of misfortune or bad financial decisions of average citizens...especially during the era of the perjorative term, predatory lender.

Of course, it isn't just sub-prime mortgage lenders who have the appearance of predators who capitalize off the inability of countless individuals who fail to to pay in full or on time.

Just look at the commercial banking industry's biggest arm of profit.

Back in 2004, the PBS documentary series Frontline in collaboration with the "New York Times" produced its "Secret History of the Credit Card" that revealed over 145 million Americans carried charge cards. Of those individuals, 55 million paid their full payments monthly. 90 million of them carried balances while 35 million paid only the minimum required amounts.

FRONTLINE pointed out that the average credit card amount owed by consumers was $8,000.

The documentary meticulously reported how around 25 years ago, 'the banking industry successfully eliminated a critical restriction: the limit on the interest rate a lender can charge a borrower' setting in motion what has proven to be one of the most profitable profit streams for the banking industry.

As most consumers know, a credit card might be issued at a low interest rate of perhaps, 6 percent. But, if the consumer misses or is late on a payment, hidden within the fine print of most charge card agreements are stipulations that allow the bank to raise the rate to as much as 29 or more percent.

According to the FRONTLINE report by Lowell Bergman, the industry's most profitable customers, the ones being sought by creative marketing tactics, are the "revolvers:" the estimated 115 million Americans who carry monthly credit card debt.
To the extent the current the current 'crisis' would affect credit card lending is not yet known.

But as Jocelyn Slovak, a former New York City Public School Teacher, said last week, she's worried that if some sort of plan doesn't save the sector, it's pretty clear that a good bit of the financial freedom that credit provides might be be taken away.

"We've always had the luxury to take risks, through credit and other means, and it looks like that's going to change rather quickly," said Slovak.

So how did America arrive at a place where luxury and now it appears, big houses on credit became the norm?

In a June, 2006 "New York Times Magazine" article titled "The American Way of Debt" Jackson Lears, editor of Raritan: A Quarterly Review wrote During the 1980's, while real income continued to stagnate for most Americans, the ascendancy of Ronald Reagan gave government sanction to unprecedented consumer spending. Reagan's rhetorical refusal of limits combined with the deregulation of the lending industry to detach dreams of luxury from previous constraints.

The lack of constraint and de-regulation apparently created an industry that led to the current bubble linked to credit, a bubble that now appears to be popping most loudly on Wall Street.

Back on street level in New York, Scott Woodward said while he worries that the pain of not bailing out Wall Street will be immediate and extreme, his adverse opinions to this plan's particulars were only strengthened when he heard Secretary Henry Paulson first detail and defend the initial bailout terms with "no attached conditions", conditions that Woodward and plenty of others saw as a gift to CEO's and other players.

"I'd love to know the headhunter that was able to devise the notion of million dollar severances for executives that get fired for running their firms into the ground and not performing," he said.

Headhunters aside, it's understandable why Woodward would blast one of the more high profile companies that will be receiving Washington, ahem, taxpayer money, the nation's largest insurer or AIG. (American International Group Inc.)

For consideration, AIG, whose $85 billion dollar bailout is in addition to the $700 billion figure being crafted in Washington, has what some would might call a less than stellar record in some of its past corporate dealings.

For example, according to Austin based non profit organization Texans for Public Justice, after the 9/11 attacks in New York and Washington, AIG's former chair and CEO, Maurice "Hank" Greenberg, led "a lobbying blitz to get taxpayers to bail out terrorism-related insurance losses.

TPJ also reported in a series called Bush donor profiles, that AIG had helped the now infamous Enron Corporation "cook its books" by investing in its LJM2 partnership along with Merril Lynch.

In 2003, AIG paid $10 million to settle Securities and Exchange Commission fraud charges that it helped a struggling mobile phone company pad its earnings by selling it a phony, back-dated insurance policy. Further still, AIG paid $126 million in 2004 to settle criminal and civil charges that it similarly helped PNC Financial Services hid $762 million in poorly performing loans in 2001.

According to TPJ, former AIG CEO Greenberg, while sitting on the New York Stock Exchange , helped approve what became a publicly condemned $187 million retirement package leading to the ouster of NYSE Chairman Dick Grasso.

TPJ goes on to say that "around that time, Greenberg got Grasso to pressure NYSE buyers to prop up AIG's stock price.

And while such alleged mischief leaves a bad taste in the mouths of countless taxpayers, experts caution that AIG's assets must go someplace and the bailout of AIG and others is probably necessary.

"It's entirely legitimate for people to ask questions about why we're doing this and who benefits as long as this isn't used as an excuse to delay action," said New York University's David Backus.

"To the extent we might want to blame somone, there's more than enough evidence of bad judgement by both parties with Fannie and Freddie being the most obvious examples," he said.

But, there are some holdouts.

As Ari J. Officer and Lawrence J. Officer opined on September 29 in TIME Magazine, 'the $700 billion (ultimately $1 trillion or more) bailout is not predominantly for mortgages and homeowners. Instead, the bailout is for mortgage-backed securities. In fact, some versions of these instruments are imaginary derivatives. These claims overlap on the same types of mortgages.

The Time article said that many financial institutions wrote claims over the same mortgages, and these are the majority of claims that have "gone bad."

One solution that might provide some level of palatability to taxpayers who others who view the bailout as extreme is an "institutional risk insurance premium."

The idea was touted in a September 17, "New York Times" Op-Ed by Jonathan G S Koppell, Director of the Millstein Center for Corporate Governance and Performance at Yale.

Koppell asked "why not make investment banks and other companies pay premiums for this catastrophic insurance." He argues further that the "goal should be to limit the contagion of failure rather than prevent the failure itself."
Later, in an email message, Professor Koppell wrote that the idea of 'failure tax' "could be used to emphasize that the public should not be providing insurance to these companies gratis."

"The American people don't get the profits so why should they be stuck with the losses," he said.

Such input from experts and others has only fueled the ongoing informal conversations, questions and nighttime arguments over who, what and how this will all play out in the end for those beyond the busy trading floors in the financial district and the halls of Government in Washington.

"In a nutshell, we are an over-inflated economy that has placed to much trust in synthetic trades," according to one New York stock analyst who asked to remain anonymous while sipping drinks with a friend who works for a major New York City bank.

The annonymous analyst said that Wall Street is all about leverage. He went on to say that leverage is like odds, you bet one, but if you lose, you lose a thousand.

During that same conversation at a downtown bar, the analyst said that Wall Streets assets are based on synthetic value, mere blips on a screen.

Whatever that means, it seems clear, that Wall Street has been and will continue to capitalize off of every day American's debt, and that debt, has allowed Americans to operate, often beyond their means.

Still, as the anaylist in New York pointed out, ordinary Americans don't really have a say here.

"Whether you think it's good, bad or you're indifferent, you have no control," he said to his banker friend.

He went on to say that taxpayers will be rolling the dice with the $700 billion dollar bailout. First, there is no way of knowing whether or not the market will buy back the distressed debt at any point in the future and whether or not, this will put the country back on the path to greater growth.

According to an August 2008 report from the Office of Macroeconomic Analysis, the United States economy has "remained on a path of slower growth since late 2007.

To this, many Americans are asking whether or not this plan that allegedly provides a shot in the arm of the market abyss will impact their own income streams.

"There is absolutely no guaruntee this $700 billion will do anything to stave off a catastrophe in the longterm," the anonymous analyst said wearily over a Grey Goose martini with olives.

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