Since You Asked … Here’s How I Would’ve Fixed the Fiasco
By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report
I was speaking to a standing-room-only crowd at a North Carolina investing conference recently when a sharply worded question soared over the group from a gentleman seated in the back row – and who was clearly agitated by my analysis of the whole bailout-plan situation.
“How would you have handled it differently, Mr. Smarty-Pants?” he asked, in a challenging voice.
What I’m about to say is academic because – when it comes to the bailout plan – “Bernanke, Paulson & Co.” has already made up its mind.
I believe Paulson actually missed a historic opportunity to remove the U.S. taxpayer from further financial troubles rather than lump more debt on them, just as I believe Bernanke missed several opportunities earlier this year.
By appointing the Federal Housing Finance Authority (FHFA) as a conservator, U.S. Treasury Secretary Henry M. “Hank” Paulson Jr. has essentially assigned the FHFA to be the legal guardian of mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE). And that’s good, since conservatorships are typically established when a company can’t take care of itself and is considered incapable of handling its own affairs.
In this instance, both Fannie and Freddie qualify as not only being incapable, but perhaps even criminal as well, after hemorrhaging capital over the past 12 months. And this situation was even more complicated than it initially appeared, since there were global implications. As
Money Morning detailed in a special report, it was pressure from foreign bondholders that finally forced the U.S. government’s hand.
Unfortunately, conservators can rarely do anything more than keep the lights on. As the term implies, they’re intended to “conserve” assets and property, until they can return the entity to solvency.
So, despite Paulson’s fancy plans and the $200 billion capital infusion he’s lined up, he may have handed hollow authority to an agency that cannot, for all intents and purposes, assign, strip, liquidate or materially alter how either Fannie or Freddie operates. Nor can conservators typically take possession of assets, which is a critically important distinction in this instance.
On the other hand, receivers are typically entrusted by the courts, or secured creditors, specifically to take possession of troubled assets and to dispose of them in a timely manner, and in such a way that they maximize returns to the secured creditors. And in the case of a public company, that duty theoretically extends to the company’s shareholders, as well.
In that sense, rather than placing an emphasis on continued operations as a conservatorship, a receivership emphasizes a return on capital and the cessation of operations.
In my opinion, that’s what’s really needed here.
Were I running the show, I would have assigned the FHFA (or brought in some true bailout specialists) to act more as receivers than as conservators. With that accomplished, I would have taken three key steps:
- First, instead of making a $200 billion down payment on the mother of all mortgages, I would have charged the receiver with immediately separating “good” debt from “bad” debt.
- Second, I would have ordered the receiver to weed out and repudiate flawed contracts.
- And, third, I would have searched for a way to sell Fannie and Freddie common and preferred shares in such a way that it would minimize taxpayer losses, rather than make them potentially unlimited as Paulson’s done.
Apparently, FHFA Director James B. Lockhart III does have the discretion to place Fannie and Freddie into receivership if he determines that’s the move that’s required, but the eventual dissolution could only take place by Congressional Act. That makes such an outcome highly unlikely, to say the least, given how much “pork barreling” has historically been linked to the two companies and to the financial industry in general. Despite the fact that liquidation – rather than keeping the lights on – is exactly what’s needed in my opinion.
I find it terribly sad that Paulson is going to throw $200 billion, or more, of taxpayer money into a black hole that’s already consumed billions. Especially when he’s publicly admitted that regulators don’t know enough about the complex financial derivatives and off-balance-sheet investment vehicles that have forced the bailouts of some of the world’s largest banks, forcing the U.S. Federal Reserve and U.S. Treasury Department to travel deep into uncharted waters.
It would seem that cutting our losses short is a far more productive option, especially when it minimizes potential taxpayer losses from the “unknown.”
It would also appear that Paulson has opted for the easy way out by socializing losses and allowing gains to remain private. Some will say that’s the way it’s always worked and that I’m naïve for thinking that it could somehow be different this time. Perhaps that’s the case. But I also believe this country’s financial situation cannot be stabilized by stopgap measures and half-baked bailout plans.
Nor do I think that running up even more debt in the face of the unknown is the direction to travel. I need only point out that the initial Office of Management and Budget estimates for the Iraqi war were a mere $50 billion.
I believe that Paulson could have been a hero by engineering a true workout that maximizes any remaining shareholder value. Instead, he’s structured $200 billion, or more, in preferred stock, and warrants that may never be paid back and that are effectively worthless unless Fannie and Freddie return to profitability.
And with the broad-based bailout he proposed a week ago – and that Congress is now sculpting into another shape – he’s effectively added another $700 billion to the U.S. bailout tab. In short, we’re talking about a flawed “fix-it” plan that’s going to cost you and I nearly $1 trillion.
Adding insult to injury, the relatively few individuals who engineered this whole mess with implicit government support are apparently going to be allowed to ride into the sunset with their saddlebags packed full of taxpayer money. Or at least with the millions of dollars they reap from their “golden parachute” corporate-severance packages. Either way, they’re not going to suffer like the U.S. taxpayer will. And that suffering will last for a long, long time.
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News and Related Story Links:
- Money Morning:
Dear Ben: To Save the U.S. Economy, Here Are the Moves You Need to Make Now. - U.S. Department of the Treasury Press Release:
Statement by Secretary Henry M. Paulson, Jr. on Treasury and Federal Housing Finance Agency Action to Protect Financial Markets and Taxpayers. - Money Morning Special Investment Research Report:
Foreign Bondholders – and not the U.S. Mortgage Market – Drove the Fannie/Freddie Bailout. - Wikipedia:
Henry M. Paulson Jr. - Wikipedia:
Office of Management and Budget. - Money Morning Special Report:
Dear Hank: Here’s How to End the Credit Crisis at No Cost to Taxpayers.
Comment by Lucie on 27 September 2008:
It is my opinion that to restore faith in our free market and help tax-payer/Home-owners defaulting on their sub-prime loans and not so sub-prime loans, we need to infuse these mortgages with new creatively designed but effective long term affordable fixed rate loans with needed funds. We would thereby also infuse confidence into the mortgage backed securities that have lost value. This move would help reduce if not eridicate the mortgage defaults, help families keep their homes, rekindle the housing market… and restore some confidence in and on Wall Street.
And last but not least… the American Taxpayers WOULD support this bail-out because it helps the middle class and real estate is the best investment for our hard earned cash… still!!
Lucie
Comment by mahmoud on 27 September 2008:
plz im to now not undrstand thanx
Comment by john trapalis on 28 September 2008:
“On the Bailout”
I e-mailed the following to all Senators on the Senate Banking Committee,and the two major Presidentioal candidates. To date I have 4 replys, none addressing the letter. There have been no replys from the presidential candidates. Possibly most Senators and the presiential candidates are overworked and we should reduce their work load on election day.
Dear Senator;
I have been following the monitory crisis and our Country’s attempts to find a solution to it with deep concern. I must say that I find congresses attempt to find a fair and equitable solution to these crises hopeful. It appears as if our Country is on the brink of an unpresenteted tragedy, and while the single unsolicited voice of a 70 year old retiree may be out of order; I never the less would like to offer what I hope to be food for thought as to our way out of this dilemma.
Let’s begin with the basics. It has been reported that our financial crisis is too complicated to allow the market to solve it on its own. We are told that Federal intervention is necessary. It may be too complicated to understand, but I do know that the only way to eat an elephant is one bite at a time.
I also know that every non performing real estate asset has or had a mortgage and a note attached to it, and that someone has to keep track of the borrowers payments or lack there of. Also, accompanying every mortgage is an amortization schedule whereby the first 5 years of the mortgage is primarily interest. Very little is paid toward principal. The last 5 years of the loan payment is mainly principal, very little goes towards interest.
Therefore, if we tax payers must get involved in this bail out I would suggest that rather than purchase non performing real estate loans outright from whomever, we conditionally make payments on these loans over a guaranteed 5 year period of time.
I am in hopes that this approach, using the original loan amortization schedule for the properties in question and making payments on them over a select 5 year period of the loan, just as the borrowers would have, will take less of our National treasure, provide liquidity to the markets, and give us additional time in order to work our way through this mess. After all if the borrowers of these foreclosed properties were able to make their payments faithfully and on time we would not be in this dilemma.
Secondarily vacant real estate, aside from being a hazard to neighbors and the neighborhood, is a burden to everyone concerned. Therefor if the mortgagors who have not yet lost their property to foreclosure can pay anything at all, I would make every attempt to keep them in the property. I would attempt to work out incentives whereby they could maintain ownership or some form of financial interest in the property during and after the 5 year period, provided they maintain the property and make their’ work out payments faithfully.
While the lenders should not profit from any workout, it is not beneficial to cut them off at the knees either. Their profit and executive salaries can be contingent on their ability, willingness and help in turning around these non performing assets over the 5 year period. By using the current amortization schedule for each property, interest can be adjusted, deferred, or partially waived, in order to affect a work out. Whatever works! In closing, I know you have a tough job ahead and my prayers are with you.
Regards,
John Trapalis
Comment by Intp Deaf on 3 October 2008:
Please clarify what you are suggesting…
You want us to invest in the environmental clean up of China’s polluted waters. Does this entail giving any money to China (Proud sponsor of GENOCIDE.)?? Would we be taking money from China through investments in American Companies?
I detest China’s funding the Genocide in Darfur. I do not purchase ANYTHING mfg. in China nor do I support any environmental or other charitable organizations or financial institutions which deal in goods &/or services that financially benefit China.
Please respond in clear, concise manner. Thanking you in advance for your answer.
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