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  • September 22, 2008 09:50 AM EDT by Elizabeth MacDonald

    Where Do We Go From Here?

    "Is there any reason why the American people should be taxed to guarantee the debts of banks, any more than they should be taxed to guarantee the debts of other institutions, including merchants, industries and mills of the country?" -- Senator Carter Glass, author of the Banking Act of 1933

    With that act, US Senator Carter Glass put his imprimatur on one of the most important pieces of financial legislation, the Glass-Steagall Act of 1933, a bill that was knocked to smithereens and destroyed in 1999 by Republicans and Democrats alike.

    The bill was crafted to put a firewall between staid deposit-taking banks and more dicey Wall Street activities such as selling stocks, bonds and later speculative derivatives that has all of Wall Street, and now the US government, staring morosely at this moldering pile of decaying tissue paper.

    A pile that the US taxpayer now owns via the US government's bailout of Fannie Mae, Freddie Mac, American International Group, and the $700 bn rescue of Wall Street's mortgage-backed securities.

    It's a mountain of dust that still threatens to smother Citigroup (C), JPMorgan Chase (JPM) and Bank of America (BAC), which has bought Merrill Lynch (MER), the recipient and repackager of all things Countrywide. Derivatives that proved the downfall of Bear Stearns and Lehman Brothers.

    Derivatives that proved not just Wall Street, but Congress, with its terrible lack of regulatory oversight on the part of Democrats and Republicans alike, have no more sense than a flock of pheasants.

    And it's a pile that now threatens to swamp the US budget with record deficits never before seen in the history of this country and slam the already ailing US dollar.

    We must put up the guardrails once and for all.

    I urge you to read through to the bottom to see what is at stake and what must be done now to protect the financial system--and U.S. taxpayers.

    The Country's Mega-Dumpster

    Now we have the $700 bn bailout, the mega-bailout creating the mega-dumpster of all to buy that rotting paper that was crafted by habitually self-deceiving, hubristic hustlers on Wall Street, who, unburdened by conscience, felt entitled to follow their own codes of conduct as they went berserk enriching themselves.

    Readers, who I so appreciate, know I've been saying since last fall that the free market has turned into a free-for-all, that in the process Wall Streeters have now sewaraged the once white-shoe reputation of finance with a kind of thinking that exists only on the margins of the Bell Curve.

    It is their unfathomable stupidity, and the fact that these exotic derivatives that so enriched Wall Street but now have the same rights to the US Treasury as plain vanilla Treasurys, that is already engendering a voter outrage hot enough to melt platinum.

    And now we have come full circle, as with a great thundering thump, the Federal Reserve took the unthinkable step of converting the last two major investment banks standing, Morgan Stanley (MS) and Goldman Sachs (GS), into traditional bank holding companies.

    It's the end of Wall Street as we've known it.

    Are you being protected now?

    The clear as rain answer is no. There are positives and negatives though. "Nobody wants to swallow a bitter pill, especially a $700 bn one," says Jill Schlesinger, president of Strategic Point Advisors. "But we know for certain that doing nothing will result in financial calamity."

    Schlesinger adds: "In other words a fence at the top of a cliff is better than an ambulance at the bottom."

    *Government's coolants will start to take effect on the market. The insurer of last resort, the backstop of last resort, the US government, one of the last triple-A rated borrowers left standing, as well the temporary ban on short sales, will calm the markets starting this week. Watch out when the 10-day ban on short sales is lifted, as volatility will come storming back;

    *Don't expect interest rate cuts for now. The central banks' coordinated massive liquidity injection will cause interbank, overnight rates to drop, helping ease lending. The Federal Reserve may have temporarily lost control of the Federal Funds rate, which has risen above and below its set rate for some time now since last August when the central banks first intervened mightily with huge liquidity injections. Inflation will remain an enduring problem.;

    But Where Do We Go From Here?

    The US taxpayer will now buy distressed mortgage-backed securities not at fair market value but at the value hashed out after much arm-twisting between the Treasury and Wall Street, who wants to sell at above market prices. The brief two-pager on the plan purposely doesn't say that the government will buy this junk at distressed, fair market values.

    What Should We Do Now?

    *Keep Mark to Market Accounting. If market watchers who know anything about accounting thought this through, they'd know to stop pressuring the accounting rule makers to suspend fair value accounting because the taxpayer is now on the hook for these assets.

    Fair value accounting, called mark to market accounting, says companies must book values on their financial statements for their assets as if they were going to sell them today in the market place. Since hundreds of billions of dollars of mortgage-backed securities, $500 bn on Wall Street alone, can't be sold because no one wants to buy them, that means Wall Street must record these assets at lower and lower values, triggering record writedowns and losses, $514 bn and counting.

    Yes, governments affected by the Latin American debt crisis temporarily suspended mark-to-market accounting, where companies price-tagged their assets based on prevailing market prices (meaning these things were bottoming fast because no one wanted them). At that time, they let companies under their purview use historic pricing.

    Marking to Taxpayers

    Suspending it temporarily over the past year prior to government intervention might have made sense.

    But now that the government has stepped in with massive bailout money, marking this Kryptonite to market now is the right thing for taxpayers as it will keep costs down. Wall Street and banks who will take the profit hits can access the expanded Fed discount window--or merge. Enough is enough.

    Doing otherwise, letting Treasury buy at any price, should make foreign funding sources look askance at the country's balance sheet--and think twice about buying our Treasurys, (what analyst Brad Setser rightfully calls "the quiet bailout"), a shunning which is already happening by China.

    The valuation swings between these assets at companies are huge. In the most recent quarter, for example, A.I.G. had $20 bn of subprime mortgages marked at 69 cents on the dollar and $24 bn in Alt-A securities valued at 67 cents on the dollar.

    But Lehman officials on one of its last conference calls with investors said it was valuing similar subprime mortgage securities to those held by A.I.G. at 34 cents on the dollar; its mark on the Alt-A holdings was 39 cents.

    Why should you care about this? Again keeping mark-to-market accounting will save taxpayers money as housing continues to bottom.

    Meredith Whitney, a top Oppenheimer bank analyst, has already reported that major banks are understating the severity of the house price declines in their assumptions, which means they could be overstating the value of their mortgage-backed securities (see blog "Top Analyst Warns Banks Too Optimistic About Housing").

    Futures markets have priced a peak-to-trough decline of 33%.  We are now about 20 percentage points off the peak of July 2006. I say 35% to 40% is more reasonable. We have a long way to go.

    Bank of America (BAC) and JPMorgan Chase (JPM), through 2008, are using 25% to 30% and 24% peak-to-trough declines, respectively. Citigroup is using just a 23% peak-to-trough assumption.

    Will the Treasury Do the Right Thing?

    Watch out.

    The new bailout provision says explicitly that: "Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency."

    This puts the Treasury's actions beyond the rule of law, which means the Treasury can at will buy this Kryptonite at any price it deems fit with no accountability.

    All Treasury has to do is make a report to Congress twice a year on its progress. I can see the conflicts of interest looming from lobbyists who want their consultants to get a piece of this action.

    So....

    *Protect the Fire Sale. There will be political pressure from financial companies on the new government mega-dumpster, a bum's rush, "me first" arm wringing. The Democrats are right to call on the Office of the Comptroller of the Currency to conduct oversight and to keep the bankers' mitts off the new entity. It happened during Sweden's credit crisis in the ‘90s--the Swedish government shelled out 4% of GDP to recast problem credits.

    But politicians in Sweden mucked it up, delaying the end game. That 4% by the way in our case would equate to a $552 bn burden to taxpayers, but it ended up being much less eventually in Sweden because the government sold off assets at a profit--once meddling politicians got out of the way.

    Also, just by way of comparison, the Resolution Trust Corp. in the early '90s restructured 750 insolvent thrifts, took on about $225 bn in bad S&L assets and sold them for $140 bn.

    *Dial down Freddie and Fannie. Now. The new law forces the two behemoths, which taxpayers now own, to start winding down their book of business starting in 2010. But they only have to do so after they, by a new law, get to ratchet up their book of businesses to a total of $1.7 tn to help with the housing crisis.

    The new law says they must dial back, starting in 2010, by 10% a year until they hit $250 bn each, down from $850 bn each.

    Do you think future Congresses will have the intestinal fortitude to see this through?

    *Do More Bank Mergers. Now. Pre-emptive, bazookanomics policy is the order of the day. Why not with bank mergers? Some 1,187 banks and S&Ls went under in the ‘90s thrift crisis, equal to more than $454 bn in assets. So far there have been 11 failures this year equal to about $40 bn. There are now 117 banks on the FDIC's problem watch list, up fm 90 in the prior quarter and 60 a year earlier. Washington Mutual's (WM) $170 bn in deposits would give a shock to the FDIC claimant pool of about $43 bn or so (much of those deposits have been lent out in the form of loans).

    *Force Wall Street to Ante Up. Force a new FDIC style insurance premium pool that investment banks must pay in to back their businesses. Taxpayers, who have bailed it out, deserve no less.

    And the Federal Reserve should force publicly traded investment banks and force their parents too, to have capital cushions at these units equal to 15% of net assets, with no debt nonsense in it or junk like credit defaults swaps or preferred shares in Freddie Mac or Fannie Mae. I mean true, liquid assets.

    It is nonsense of the highest order to let these teenagers gear themselves up 40 to 1, for example, (Merrill Lynch) with no adult supervision from the Securities and Exchange Commission.

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chuck

Yhe question now that congress has gotten itself into with thier economic stabelize act: is this how far down the rabbt hole now have the politicians have traveled? Now their the ones at risk when the actions of unattended consequences play itself out. But what finacial intrustement would the gov't use for these toxic subprime loans? Has anyone examined it?

September 28, 2008 at 7:55 pm

Neil, Daytona Beach Fl

How can congress even claim their paychecks after what they are putting us through...its shameful

September 28, 2008 at 7:46 am

Dana Swan

The total cash reserves that the Federal Reserve keeps on hand is about 900 billion USD. Look it up.... If you are keeping track of the bailouts so far, the total with this new one is about 1.6 triion USD. That means that THEY DON'T HAVE THE MONEY TO TO ALL THE BAILL OUTS!!!! However the bailouts are necessary to to keep the banking system and the economy from falling into a Deflationary Contraction (ECONOMIC DEPRESSION) But, The Goverment is going to create an inflationary disater by doing so...... However, that is preferable to a depression....

September 28, 2008 at 1:11 am

Scott

Madam Speaker, It is with respect that I as an American citizen request that you respectfully recognize that you have single handedly wrecked this economy and resign your position as Speaker of the House. Since you have been Speaker of the House the American Dollar has declined against the Euro and all other world currencies which has caused prices to go up and economy to go down. Your lack of leadership has drawn our nation to the brink of disaster, and I don't think you really recognize your errors or care about our country. Scott

September 26, 2008 at 11:05 pm

Felix

As a financially ignorant resident of Main Street I have yet to hear a good explanation for the the bailout. First, the Financial Institution buys a packaged instrument for a certain price and expects a certain ROI. Certainly there must be an income coming in on that instrument.Does this not give some measure of value to the package ? Why must I bail out someone who has acquired more than they can hold on to for a long period of time. If I make a bad investment and have to hold it for better times why are the Financial Institutions any different ? Small businesses fail every day for a variety of reasons and no one is there to help them. Let the free market system prevail and there will always be another to take their place.

September 25, 2008 at 8:37 am

Stanley Hirtle

Who we need to bail out are all the homeowners who were talked and tricked into making bad loans by the sophisticated, unregulated and commission driven mortgage industry. America's homeowners are as important to the success of America and America's economy as all these market players. And what good comes from foreclosing on millions of homes and destroying the lives of millions of families? Legislatures and regulators must be criticized for waiting too long to act and for being too protective of the secondary market, which too many saw as a goose laying golden eggs. Instead it was a way for mortgage originators to take their money off the top and sell the loans downstream, profit without accountability. Most of the loot was gotten away with by mortgage salespeople and secondary market securitizers, who took advantage of borrowers and investors alike. If someone can sue or prosecute them, great. But to restore confidence in the economy, the government should buy the loans at a deep discount and then modify them (at least for owner occupants rather than speculators) to get rid of “toxic” features. They need to eliminate all the upward rate adjustments from the initial “teaser rates” reduce loan principals to the real appraised value rather than the bogus appraisals the originators purchased and eliminate other predatory features. This needs to be done on a mass basis as neither borrowers industry nor government can handle intense case by case examinations. Congress needs to fund the staffing of loan modifications and provide counselors and lawyers for homeowners assistance. Once the loans are sound they can be sold on the marketplace.

September 23, 2008 at 10:37 am

Carla, Ballwin, MO

Since reading your blog, I feel less shocked by all the dismal news of late. You really have kept us informed before the fall.

September 23, 2008 at 8:09 am

B Scott

If I were a homeless person,I would go occupy an empty foreclosed house,after all, as a US taxpayer,I kinda own it now.

September 22, 2008 at 9:37 pm

Robert Coutinho

Matt and David Harrell: Both of you have spoken facts that need to be realized by readers of this article. To David: the logical way to limit CEO pay is to do so by tying it to pay of other employees at the corporation. 40:1 in the late 70's became >400:1 now. Cap the pay of others at 10:1 other than stock options that 1) Can not be redeemed earlier than 3 years from issuance. 2) Must be offered at the price of the stock at the time or when the person came into the job--whichever is HIGHER. THAT is how you make sure that CEO's look towards the future; that is how you ensure that worthless paper is not gobbled up. If the stock price is the sole (or nearly so) source of wealth for top officers in industry, you can bet that they won't gamble it on the roll of a die. As for those who wish to blame congress: look at who has been heading the regulatory agencies and setting the tone for them. Those are the people who could have stopped all this nonsense. The problem is that Republicans have never met a regulation on businesses that they didn't want to repeal and the Democrats never met a business that they didn't want more regulation on. Never the less, the Republican Party has been seeking deregulation ever since they controlled congress in 1994. The Democrats have held control in congress for less than two years since and could not have passed or reinstituted new regulations due to President Bush's veto. Congress could NOT have stopped this in the past two years--they could never have gotten the administration to sign the laws.

September 22, 2008 at 5:54 pm

David

Where do we go from here? Into a depression! What will the government do? Take over EVERYTHING!

September 22, 2008 at 4:04 pm

David Harrell

I have had a change of heart....PLEASE save Wall Street! Who else is there to gamble with America's wealth? Leverage a million-to-one, and roll them dice. For God's sake! Get it OVER with!!! Close all banks, garnish all wages 100%, do it now! do IT! DO IT!!!! ARRGHH!!!

September 22, 2008 at 3:30 pm

Mike Stephenson

Let me see if I got this straight Banks or lending instituitons as well as investors over inflated the housing market, thus driving up the price of homes and land . Lending instituions then gave out mortages on over priced real-estate to people who could not afford the home in which they bought to begin with. And now the US goverment is going to "bail-out" these instituitons for such practices. That is like giving a "Crack Addict" a loan for $100. Are we to believe as tax payers that this just happened over night? Looks like "Another Pirate Politican Raid. Vote them all out and do so now. PS With an over inflated real-estate market those who owned homes had thier property tax raised and now that things have taken a turn will towns across the US re-assess at a lower tax rate, Of course not. Thanks for sticking it to us again.

September 22, 2008 at 3:13 pm

ken Kesler

Please, let us put the blame squarely where it belongs------ON THE US CONGRESS. They were the ones who accepted bribes to gut Glass-Steagal. They were the ones who were bribed to allow F&F to take on questionable mortgages. They were the ones who were bribed to allow banks to make the "don't ask" mortgages. They were the ones bribed to allow unregulated energy trading. The list of bribes will go on until we understand fully what the congress has done and NEVER vote for an incumbent politician again. Ken Kesler

September 22, 2008 at 2:42 pm

Sinomania!

Wow, welcome to the People's Republic of America! As recently as 2006 I sat in a private equity investment conference and heard Merrill Lynch and Morgan Stanley economists and bankers deride China's financial system and the huge 'problem' of non-performing loans and how wrong it was that Beijing owned a controlling share in important conglomerates. But China's central government rarely owns more than 60% of so-called "state owned enterprises". Now Uncle Sam owns just under 80% of AIG and all of Fannie/Freddie. What does this make our system? Thanks Dan for parroting the new Republican talking point about CRA. Sure, Wall Street failed because they had to make poor people (read = blacks and hispanics) buy half million dollar mcmansions. Right.

September 22, 2008 at 2:14 pm

Steve

Liz, Beauty and brains in the same package. The bailout is a crock and let the system (capitalism) determine the winners and losers not Paulson and his cronies.

September 22, 2008 at 1:50 pm

Kevin

I couldn't understand what was written here but I would say that this article reflects our system. "Make it complicated enough that no one can truly understand it and hide it like the nut shell game". Greed, selfishness and the lack of integrity and honesty in our system dwarfs and has caused the instability and monetary results we have been experiencing for years.

September 22, 2008 at 1:46 pm

John

Elizabeth, Fox should produce the list of all the companies that are on the give-me list and their last year profits. Also a list (before the elections) of all those (on Wall St and political) that requested and/or supported this insane idea of overlooking credit ratings and income when issueing mortgages. Perhaps a URL to the lists from this site would be good.

September 22, 2008 at 1:45 pm

BILL MILLER

Naked short sellers have NO interest in a company therefor their market should be seperate from the actual buy/sell equity market for a company. When the short seller sells 1000 shares he doesn't own or control, his sail should NOT be thrown in the hopper with the true equity buy/sell to determine price. Make it like a futures market; let them sell an emaginary number of stocks as against a buyer of emaginary number of stocks and let them feed off each other. I get tired of the short sellers selling more stock than the float! It's not fair and it disrupts the true market.

September 22, 2008 at 1:21 pm

David Harrell

If AIG is "too big to fail", it is a defacto monopoly. Divest it into pieces that small, honest, well-run banks can take over, and let the giant die. Properly raze any "financial institution" over two stories tall in the same way. You get my drift. Banks may only leverage one-to-one again, like in days of yore....w-a-a-a-y yore. Speculators must take physically, and keep, what they buy. Legitimate ones can simply build a few warehouses. Make lobbying of any kind a serious crime. Let legitimate special interests use petitions or PUBLIC advertising to make known their wants/needs. Give Big Oil fair market value for their rigs and refineries and send them to Saudi Arabia. Release the 65 million acres of possible oil/ natural gas lands to small wildcatters. They will uncap the wells, drill quickly, pay royalties to local governments, and get oil flowing for the short term in 6 months, easy. Make Bush give us the Justice Dept. back and prosecute all the "players-cum-gamblers" from S&L up to and including CDS's, going back a quarter century of malfeasance and corrupt greed. Top salary for ANYONE in the U.S.of A.: $250,000...hah. Replace accountants with engineers again, give hardhats to the cubicle, keyboard-pounding economists/analysts and let's BUILD things again. The country wasn't built on money, it was and is built on sweat. No countries' economy, other than the devious Swiss, can exist through financial "markets", as we now see. Actual goods and food must be produced. Fair trade, not "free" trade: You tarriff, we tarriff; you dump, we dump; you subsidize, we subsidize; you use slave labor, w/o health, etc. benefits, we boycott. Paulson and his ilk gamble our money and use fear tactics to keep their house of cards, stacking the deck, and playing on a crooked table. If credit/investment is temporarily on the fritz, so be it. Americans and honest banks can take it, and recover much faster than the fearmongers would like you to think. anyway, that's my 2 cents worth, and I feel better, thanks, lol. Let's get real in this country and get back to some common sense.

September 22, 2008 at 1:08 pm

Bob

Wall St is problem, but not the only one. AS reported elsewhere on Fox, this at least as far back as the Clinton Administration and pushing Freddie and Fannie to overlook credit ratings and income when issueing mortgages. The Politicians are as guilty as Wall St. Stricter regulations are not the answer. Good goverance is. The government has a role, and it shouldn't be to promote imprudence, regardless of the social value. The companies have a role to ake a profit, but not bet the company. There are many guilty hands in this, ansd it looks like the tax payers will foot the bill. Heads should role, starting with the politicians.

September 22, 2008 at 12:55 pm

Mike R.

This is no time for us who have hoped our stock investments would supplement our retirement to take chance. I'd rather stop my losses now....hold on to what's left and wait to see how things shake out. The unfortunate effect of this is that this "will" get partisan which will cause a loss of focus on the crisis at hand. I have no faith in our politicians to come together to do what's best in this cirucmstance for "all" Americans.

September 22, 2008 at 12:47 pm

chuck

Where do we go from here: Call into the line the Democrats that cause the havoc and choas in financial sector in the first place. Rush Limbaugh is now naming names. Especially democrats related to Frannie and Freddie. By the Speaker Nancy Pelosi lost her investments in AIG. So did Senator Kerry. Time to call in those respobisble including former preident Jimmy Carter. Here it can show failure of the democratic liberals with there arrogance and class warfare cliches. Obama too accauntable becouse of the KICKBACKS which Freddie and Fannie Mae. It's time to point the finger at the left wingers socialist of the Democratic partie and embarrass them for what they did. See where the wall street campaign contributions went to in Congress. As Rush is saying on his show this morning "all roads lead to Freddie and Fannie Mas." Time roll the dice and embarras some key Democrats and thier failed finicial polocies for the sake of the marketplace.

September 22, 2008 at 12:39 pm

PHIL

Great article !!!

September 22, 2008 at 12:01 pm

TNgal

Still waiting for someone to talk about the real picture. We are bailing out banks and investment houses because they did not live up to their fiduciary responsibilities. Packaged loans were sold by greedy correspondents (what they are called) employees of the banks and investment houses to investors all over the world. When the loan paper becomes worthless on our homes countries all over the world suffer because they hold worthless investments. This government intervention is not just to keep AIG's Wachovia from folding but banks in this country and in other countries. Look at Venezuela who holds millions in our home mortgage. Because of what our lending industry did we could throw the world into choas.

September 22, 2008 at 11:58 am

Hillbilly #4

from article: "Protect the fire sale" could be Words such as "Keep an eye on the burn pile" come to mind too. or "Watch that lawn fire Leeeeeeroy don't git outta hand, you member lassss time !"

September 22, 2008 at 11:58 am

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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