The Reality Check That Bounced « Emac's Stock Watch

What Congress Must Ask the Federal Clean-Up Crew »

March 28, 2008 04:28 PM EDT by Elizabeth MacDonald

The Reality Check That Bounced

Oliver Stone is doing a movie about George W. Bush.

That bit of news was a fitting end to last week's kaleidescopic developments, straight off the fiction shelves.

Before I get to the week that was, I want to thank all of you who weighed in about my blog about listening to presidential candidate and Congressman Ron Paul. I am so deeply appreciative and grateful for all of your comments, I read them all and I am impressed with and admire your knowledge and passion.

I came here to Fox Business, the sister network to Fox News, just last October, and Fox Business gave me the honor of starting this blog this year. One thing rings through all of your responses--you deeply love this country and you are deeply worried. I hear you. Again, I thank you.

Please be aware that I am a flawed individual who is aware of my many limitations (on an hourly basis), please tell me when I am off the rails. I will do my level best. Know that I listen to everybody. I try to think things through, as I get an allergic skin reaction to knee-jerk, autopilot thinking.

I would like to see Dr. Paul debate all of the presidential candidates, not just John McCain (should Dr. Paul run as a third party candidate?). Though I may not agree with everything he says, I also don't agree with what the other candidates say as well. Dr. Paul deserves a fair hearing, this country ought to hear what he has to say, especially about monetary and fiscal policy.

Here's a recap of the week's headspinning highlights: the Treasury Department plans to propose Monday that the Federal Reserve should get more oversight authority of all of the players in the financial markets, letting the central bank examine the books of any financial institution, not just banks; planned Congressional hearings into the Federal Reserve's historic rescue of Bear Stearns and its handouts to investment banks, which it doesn't regulate; the overleveraged, underwater Fannie Mae and Freddie Mac now needing to raise a total of $20b more via dilutive stock offerings, a whopping two-thirds of their market caps; scary talk about more bank write-downs; the weakening dollar; and oil veering toward $120.

But just as thinking that Oliver Stone's movies are historically accurate is like thinking that the movie "Gone With the Wind" is a documentary, it is just as precarious to believe the fiction that the Bear Stearns-JP Morgan deal midwifed by the Fed signals the bottom of the market, as some media pundits wildly suggest.

It's also just as cavalier to believe the analysts' estimates of the writedowns in the financial sector stemming from the housing and credit crisis are etched in stone. They are all over the map, with stocks in Citigroup (C), Merrill Lynch (MER), Lehman Bros (LEH), Goldman Sachs (GS), JP Morgan Chase (JPM) and UBS (UBS) getting whipsawed (to get a handle on it, see my prior blog, "The Answer to Who's Next on Wall Street").

The writedowns will be sizable, to be sure, but the question is this: Might some of the writedowns be overstated, given cash flows are still coming in from loans backing these securities, securities the firms are being forced to write down because widespread panic has frozen the market for them?

And the broader policy issue: Will the Treasury secretary's plan really put more guardrails on a free market that's turned into a free-for-all? When will Congress stop its neat after-the-fact refereeing exhibited now in dealing with Wall Street's very expensive, very messy, and personally enriching experiment at satisfying the government's 100% homeownership dream? Will the Fed's costly moves to revivify the financial's balance sheets deadened by Frankenstein securities they created really work?

*THE REGULATORY FREIGHT TRAIN: Congress is hopping on it now, with the Treasury planning more oversight powers at the Federal Reserve of all financial institutions, not just banks. The Fed may become the sole regulator for both commercial and investment banks, following the collapse of Bear Stearns. For now the proposals are taking the shape of letting the central bank scrutinize the books at all institutions--no sign yet of tough proposals, like whether credit derivatives would have to be listed on, say, the Commodities Futures Exchange, engendering more oversight.

Also hearings on Capitol Hill that may take a closer look at the Federal Reserve's actions on Wall Street, including the forced nuptials between Bear Stearns (BSC) and JP Morgan Chase (JPM). No surprise that Jamie Dimon, who runs JP Morgan, is on the board of the New York Federal Reserve, which provided a $29b non-recourse backstop to the most illiquid parts of Bear's balance sheets, now only protected by a $1bn cushion of first loss collateral from JPMorgan. Non-recourse, meaning, the Fed can't hit up JP Morgan for this money, it has to auction those securities off and take a gain or a loss on them, not JP Morgan.

Tighter capital requirements for investment banks may also be in store--argument being if they can have access to the discount window, then they ought to face the same capital reserve requirements regular banks must meet. If the Fed is going to run with the wolves on Wall Street, then Wall Street needs to be tamed.

Also, as it stands now, the capital reserve levels the investment banks face from the Securities & Exchange Commission are roughly a third of what the Fed requires. Remember, banks in Japan dropped into a black hole in the '90s because they didn't have to set aside a sufficient amount in capital reserves to back their lending. The collapse of the banking sector in Japan led to that country's lost decade of the '90s, which it only surfaced from several years ago.

And despite what you hear that the Fed is only charged with printing money and that this backstop doesn't hurt taxpayers, it does. The Fed gets to print money, with the US taxpayer paying the interest on the treasury bonds that the governement gives the Fed in exchange for printing a similar amount of dollar bills. The Fed also turns over to government coffers what it earns on the investments it holds in its portfolio. Taking a hit from Frankenstein securities means less money coming in those coffers from the Fed.

And printing more money to make up the difference--which taxpayers pay for in the form of inflation. Watch this quote: In 2002, then Fed board member Ben Bernanke, now the Fed chairman, said in a speech, "the U.S. government has a technology called a printing press...that allows it to produce as many U.S. dollars as it wishes at essentially no cost."

*BEHIND THE BANK WRITE-DOWNS: The market is volatile because the accounting rules the financials use to book these write-downs for their securities backed by mortgages and other credit act more like a weathervane, auditors and accounting pros say (for the heated debate about what's driving the record write-downs, see my prior blogs on the controversial accounting rules to book them, the fair market rules, "The Answer to Who's Next on Wall Street," "What's Really Rocking the Stock Market," and "In the Weeds").

You'd have to have the training of a tornado forecaster at the National Weather Center to say with any certainty what the write-downs are going to look like, and some of these estimates already have been dreadfully wrong.

That was certainly true for the recent, way off-the-mark write-downs expected at Goldman Sachs and Lehman Bros., which came in lower than estimated. There will be losses, we just don't know the size. No one does--hence the record volatility. Transparency works--so long as it's accompanied by common sense.

Fights are breaking out between the companies and auditors, because the accounting rules say the companies have to get a price-tag for these securities that are backed by loans based on what the market says they are worth. That's called 'marking to market.'

Sounding like an Abbott and Costello routine, you can't mark something to market when there is no market to market these securities in. "Everyone seems to be clueless when it comes to projecting how much still needs to be written off and how much longer this [market distress] will continue," says economist Ed Yardeni. One thing you can bet on: More write-downs--again no one knows the dollar amounts--and thus more shotgun weddings between damaged financials.

*INFLATION: New numbers purport to show that inflation is not a problem. Not. Talk to any middle class family struggling with health care costs and tuition expenses, and they'll tell you it is. Why is inflation a problem? Too many dollars, rising demand for commodities, plus, again, zero oversight, no where, none, for things like health care and tuition costs.

*GDP: GDP growth came in at a low six-tenths of a percent. Don't know if that'll get revised downward--if it does it'll mean the tip of a recession. I saw a great study that says GDP should be considered on a per capita basis, to show how truly productive a country's workers really are and to get a better window on how much an economy is growing.

In Japan, GDP per head increased at annual rate of 2.1% in the past five years to ‘07, a bit better than the US's 1.9% and a lot better than Germany's 1.4%, the study says. And despite all the talk about Brazil and Russia being on fire, check this out. On this basis, Brazil increased 2.3% per capita per year since '03, a touch faster than Japan. Russia comes in at 7.4% per capita, but that's because its petrodollars are pouring in while its population has been on the decline.

*THE DEMOCRATS AND TAX CUTS: In his speech on the economy last week, to punish what he thinks is "the investor class" on Wall Street, Democratic presidential hopeful and Senator Barack Obama says he wants to raise taxes on dividends and capital gains; so does Democratic presidential hopeful Senator Hillary Clinton. The presumptive Republican nominee, John McCain, still backs the Bush tax cuts.

Set aside for now the fact that the Bush tax cuts on capital gains and the death tax alone raised more revenue than President Bill Clinton's tax hike on the upper bracket, analysts note.

For some time now, the Democrats have had no more sense than a flock of geese. That's because hiking these taxes hurts Main Street, the most important investor class of all. Many senior citizens live entirely on dividend income alone; the middle class desperately needs its 401K and IRA money like never before because Social Security is in a ditch (thanks to the Democrats changing the law in the ‘60s so it could, for the first time, get its mitts on Social Security funds to spend on pork and to buy votes).

The Democratic candidates, in their blinkered concretism, stubbornly refuse to acknowledge human behavior. Investors sit on assets, including stocks, rather than sell and pay the capital gains tax, because capital gains taxes are voluntary. You don't have to pay until you sell. Higher capital gains taxes keep frozen all sorts of economic activity. Hike taxes, you also get tax avoidance schemes going viral too--and massive loopholes written into the colossally inefficient tax code, a big tangled pile of barbed wire as it is. But we'd rather be a nation of tax lawyers and accountants. Both Obama and Clinton want to make it even more confusing with gimmicky credits that won't buy you a bag of groceries for a month.

Obama and Clinton want to hurt Main Street with more taxes. "Why is Barack Obama so hell-bent on pursuing policies that would wreck America's retirement savings?" asks Ryan Ellis, tax policy director at Americans for Tax Reform. "Because, by and large, he doesn't have any skin in the game."

How so? Obama is not part of the investor class because he's reported no dividend income on his tax returns from 2001 to 2004, and just $2,754 in dividend income on his 2005 tax return and $1,188 on his 2006 return (Clinton has yet to release her returns).

Where are the John F. Kennedy tax-cutting Democrats? Lower taxes help the economy. Even the former Soviet satellite states like Estonia and Lithuania have enacted flat taxes. Lowering rates in our anti-growth, anti-entrepreneur tax code is the best non-inflationary liquidity in the galaxy. But as the Heritage Foundation notes, though we won the Cold war, Russia has a flat tax while we're still stuck with America's museum of mass confusion, the IRS.

*SILVER LINING: Weekly initial unemployment claims. In previous deep recessions, they tended to rise rapidly, over 400,000 toward 500,000, notes Yardeni. In the 1990-1991 recession, jobless claims hit 496,000 on a four-week moving average basis; in 2001-2001, it hit 489,000. The latest four-week average was only 358,000. Sigh of relief. For now.

23 Comments

tj

You do understand that is exactly Dr. Pauls message. It is so great to here someone tellthe truth. I am going to show you the dedication of his supporters. I am going right now to inform them of today blog. Even if this is just a ploy to get people to come here, it is working great, great business practice.

March 28, 2008 at 4:57 pm

Peggy Beach

Ms. MacDonald, thanks so much for your informative article. I wish the rest of the media would wake up and follow your advice about whom this country needs to hear. The good Dr. Paul has been laughed at and vilified for the last year when speaking on the coming economic crisies. Now it turns out he was very knowledgeable and correct, and the nation needs to hear him out and weigh whether or not he has the necessary ideas to fix our problems. The MSM needs to put him up front more and let the people decide.

March 28, 2008 at 5:02 pm

Joe_From_PA

The whole country would benefit from a 4 way debate. Why don't you talk to the powers at Fox and see if you can make it happen.

March 28, 2008 at 5:14 pm

Alexia

I wish you would answer a question for me, and maybe point out what could be a real story. As one of those folks who deeply respect the country - how is the Fed allowed to spend a thin dime of our money bailing out banks and brokerages when the Constitution clearly requires all spending to originate in the House? When we bailed out Chevrolet, Congress voted on it.

March 28, 2008 at 5:18 pm

Vinnie

Thanks again for your insight and praise for Dr. Paul. You are correct, we love our country and can't stand what is taking place. Please use what pull you have to try and setup a debate on monetary and foreign policy. I am definitely a fan of yours!

March 28, 2008 at 5:26 pm

Paul F.

Thank you Ms. McDonald. I've never been much with math but you make it all very easy to understand. Excellant observations and summary. If I can understand it, you would assume our Congress could. I'm middle class and I I am worried. I can only imagine what fixed income or handicapped people must feel.

March 28, 2008 at 5:56 pm

Rick Litten

Yes indeed, Ms MacDonald, we love our country and are worried. We generally have a clear understanding of the issues. For these reasons, we support Dr. Paul. A four way debate between Senators Clinton, Obama, McCain and Congressman Paul would be stellar (not to mention probably a high ratings achiever). It could really get down to the proverbial "Brass tacks" without the silliness and bickering which ensued with 6 or more from the same party on the stage. Thank you again for not marginalizing Ron Paul, and congratulations on your perception that he speaks the truth.

March 28, 2008 at 6:10 pm

Terri K

Elizabeth, I nearly cried tears of joy reading your statement about those of us who commented on your blog about listening to Ron Paul. You hit the nail on the head; you have described the "Ron Paul People" precisely as I see it. Especially the part about our deep love of our country, no matter how many people accuse us of being "America haters". Perhaps you're one of us?? You DO understand Ron Paul's economic policy! I too would like to see Ron Paul debate all the candidates, on the economy most especially. If you haven't seen them, check out the youtubes where Paul schools Bernanke. If people actually took the time to read Paul's positions, they would know that he knows the remedy for this broken economy and further, his policies would help the middle class and the poor tremendously, without putting any [more] of us on the public dole. Oh to live in freedom, peace and prosperity and to return these United States to the shining beacon of liberty it once was! A BIG THANK YOU, Elizabeth! Keep writing, we'll keep reading and commenting.

March 28, 2008 at 6:13 pm

Eric

Apparently the rule is that it's OK to mention Ron Paul in blogs - just not over the airwaves. Your network did more than any other in marginalizing Ron Paul - shamefully so - and now we're all supposed to go, "hey, FOX is fair and balanced". After being a HUGE fan of FOX, I haven't tuned in in months and never will again. Saying now that Ron Paul was right all along is nothing more than FOX trying to eat the cake and have it to. Cest la vie FOX.

March 28, 2008 at 6:16 pm

Ronald Schoedel III

A monetary and fiscal policy debate. Now THAT would be a real barn-burner. I'd pay to see that, with all four remaining candidates. If FOX Business could host such a debate, it would be the eye-openingest, truth-tellingest debate ever aired on TV. No silly questions about old newsletters or Obama's pastor. No debating technicalities of how to run the war in Iraq. Just an honest-to-goodness roundtable discussion about monetary policy. The public would receive, from two hours of Ron Paul debating these three, the best education on money and the Fed that their worthless dollars could buy. I bet you McCain, Obama, and Hillary would learn more from Ron Paul in those two or so hours than they previously ever thought they knew about monetary policy. Ron Paul has forgotten more monetary policy than those three combined have ever known. Thanks, E., for your great blog. I came here to see what you had to say about Ron Paul, and now I've added you to my Favorites and check back for each new posting. Your commentary is wonderful.

March 28, 2008 at 6:17 pm

JP

Elizabeth... We are grateful that you are acknowledging Ron Paul.... He is a very courageous, educated and honest man...truly the first honest-with-the-people candidate to run for president in my lifetime, and I have the utmost respect for him.... (words I have never imagined publicly proclaiming about a political figure, until now!).... YES, please do encourage a 4-way debate with Ron Paul!!!!! Our country deserves to hear his message and then make a truly educated decision. Again, thank you for giving us hope and bringing awareness to Ron Paul's message.....

March 28, 2008 at 6:20 pm

Mark

Great to here someone talking about The only Candidate that understands monetary policy and true Free Markets Economics. The Law of Supply and Demand is a natural a law as is The Law of Gravity, yet so many seem to think it can be manipulated. Yet it cannot. Taxes can only be raised so high. A graduated Income Tax was one of Marx's Ten Plancks. Something that should not even be considered in Our Country. Yet due to a fiat based money system is necessary. Competing currencies worked for years in this country and helped to make it what it is today. Yet why have we drifted so far from what made this country great?

March 28, 2008 at 6:27 pm

Edward Lunny

An interesting and inciteful article, keep them coming. On the topic of Dr. Paul, he did debate, well , actually he whined. He has exposed himself as a raving, racist, anti-semite, isolationist. None of those positions are solutions, not one. His other favorite is the gold standard, good lord, when is he going to join the 21st century ? A commodity based currency and monetary policy is a cave looking for enough darkness. He needs to join the real world in the light of day.

March 28, 2008 at 6:28 pm

Jenny Granados

Thanks again for having Dr. Ron Paul on your show. It was great hearing him and seeing someone at Fox share some of his same beliefs on the economy. The best part was having someone at Fox treat him with some respect and dignity. You are awesome!!!

March 28, 2008 at 6:46 pm

Too Little too Late

It should also be pointed out that the Federal Reserve Bank in reality actually *is* the investment banks themselves. Have a look at the the Board membership for the Federal Reserve Bank(s). Is it not an incredibly egregious conflict of interest for the CEO of JP Morgan Chase to be a Board member of the most powerful Fed bank (the NY Fed) even as the Fed itself hands a taxpayer backed gift to his company? The financial system of this country (namely the Federal Reserve Bank operation, to discuss the core of the problem) is rigged to private gains and to socialize losses. No one in power cares about the average American on the street, despite all of their hollow lip service (most of which is provided free of charge by the major news networks). It is a scam visited upon the American people, and the only one who tells the truth about it is Ron Paul. The wars are a very similar situation, wherefrom the defense contracting industry reaps incredible profits in relation to our country's interventionist foreign policy. You know I read earlier today that something like 83% of ALL domestic manufacturing is directly related to government 'defense' purchasing (as, making war)... Thanks for your open-mindedness and your thoughtful perspectives. They really are a breath of fresh air. I strongly suggest, though, that you are only allowed to express yourself in such a manner because this blog represents no threat to the entrenched crooks in power. You'd never be allowed to express such views on FoxNews channel and may yet get yourself in trouble if your blog gets too popular. Those in power in this country, (including in control of the major media) fully recognize how angry the average American will be if the 'average Joe' were allowed to be provided real information on the nature of our corrupt elitist society.

March 28, 2008 at 6:54 pm

Jen

The Comments scrip is so small, I can not read them.

March 28, 2008 at 7:12 pm

Carla, Ballwin,MO

Moderate and Conservative Dems for Hill! There are smart,hardworking,solid citizens out there for Hillary! In my small circle - a teacher, police officer, artist, technical writer, and accountant - they are all strong Hillary supporters. Hillary and Evan Bayh in 2008! Thank you, Carla Baynes

March 28, 2008 at 8:05 pm

Kevin A. McCauley

Elizabeth, I am so happy I found your blog. I find great information and I am also in complete agreement with your assessment of things finacial and political. I don't have anything of revelation to share with you except this little tidbit- I now have a better handle on the entitlement mentality that is so prevalent in our beloved country. I am the general manager of a retail store. I had to terminate someone the other day due to numerous infractions of company rules. I have since heard that that person refers to me as "that no-good rich bastard". I make $36,000.00 a year plus bonuses. Pretty funny, nes pas? Thanks for listening. Kevin

March 28, 2008 at 8:10 pm

Joe in Los Angeles

Thank you for your article. Ron Paul has proven to be be the only honest and responsible candidate in this election cycle. He has spoken truth to this nation in a way I've never seen before. He is the only one who has addressed the true implications of this financial crisis. I wonder what the majority of Americans will think when their entire 401k is worthless. I suspect those who caused this situation will leave the continent and settle in Dubai. Come November, I will vote for Ron Paul for President, even if I have to write in his name. I think many more will join me once they realize this is not about party affiliation at all. It's about our future as a nation and economy. Unfortunately, most have ignored him up to this point, but as they say... money talk and b.s. walks.

March 28, 2008 at 8:32 pm

JP

I appreciated your article and your response to the people that posted. There is a feeling of deception here though. Fox has been dead against everything Ron Paul to this point. It is also well known that many people have left Fox solely because of their Top down requirements for the broadcasters. Allowing you to go totally against the grain of Fox's past year of total effort to marginalize and make Ron Paul out to be a kook smells like a rat. What happened? Did Murdoch and the rest of the group figure out that their plan is out-of-control and they can't handle it so now they're trying to look like the Good guys to the people? Be careful Elizabeth MacDonald! You may be playing into a serious wolves den. These people are ruthless. They have all the money they would ever need but they have orgasms over Power. Pure evil. We've watched it for many years especially the last.

March 28, 2008 at 9:03 pm

Dwight

Thank you again for your comments on Dr. Ron Paul. You stated that you appreciatiate the passion we have for Dr. Ron Paul. The supporters of Dr. Ron Paul only wanted our leader to have equal time for his message to be heard by the American People. Would you like to know who I fear more than Al Quida? I fear more the People/Group that control the flow of information, the Main Stream Media. The majority of America depends on the Main Stream media to shape thier opinions. When Americans are misinformed and cant think for themselves thats when we lose our democracy. That is something Al Quida will never be able to do. (Take our Democracy away) Being a Veteran of The U.S. Navy, I just have one request. Please remind the American People in anyway possible that in the 5+ year war we have been fighting. Our Active/Retired Military Members have finacially donated more to Dr. Ron Paul's Campaign more than all the other Candidates COMBINED. They have made it very lear who they want as thier Commander in Chief. People always proudly say "SUPPORT THE TROOPS" Lets be thier voice who they want as Commander in Chief. Dr. Ron Paul "REAL HOPE FOR AMERICA"

March 28, 2008 at 9:08 pm

sherrie

i just recieved the times alert stating that bush plans to propose a broad new authority for the federal reserve to oversee market stability possibly exposing wall street firms to greater scrutiny, but avoiding a call for tighter regulation. there is no trusting this administration.

March 28, 2008 at 9:26 pm

Jimmie

YOU GO GIRL !!!!!! Tell it like it is...........

March 28, 2008 at 9:28 pm

about this blog

Elizabeth MacDonald is the stocks editor for Fox Business Network. She is recognized as one of the top prize-winning business journalists in the country, and has received 14 awards, including the top prize in business journalism, the Gerald Loeb Award for Distinguished Business Journalism, and the Newswomen's Club of New York Front Page Award for Excellence in Investigative Journalism.

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The Reality Check That Bounced