Bailout

by hilzoy

From the NYT:

"Senior officials from the Bush administration and the Federal Reserve on Friday informed top executives of Fannie Mae and Freddie Mac, the mortgage finance giants, that the government was preparing to seize the two companies and place them in a conservatorship, officials and company executives briefed on the discussions said.

The plan, effectively a government bailout, was outlined in separate meetings that the chief executives were summoned to attend on Friday at the office of the companies’ new regulator. The executives were told that, under the plan, they and their boards would be replaced, shareholders would be virtually wiped out, but the companies would be able to continue functioning with the government generally standing behind their debt, people briefed on the discussions said.

It is not possible to calculate the cost of any government bailout, but the huge potential liabilities of the companies could cost taxpayers tens of billions of dollars and make any rescue among the largest in the nation’s history."

Yikes.

Comments

[MeDrewNotYou]

Yikes is right. But was there ever really a choice? I'm not the best with economics, so what would letting them fail do to the economy?

[Doctor Science]

I am mean & vindictive: I think it would be only appropriate if the boards & top 3 executives per company lost all their real estate holdings, including (especially) their personal homes.

[Bernard Yomtov]

I think it would be nice if some of the geniuses running the companies over the past five or six years had to pay back a big part of their compensation.

It's not like they did a really good job, I'd say.

[Walker]

The key issue is what happens to Fannie and Freddie shares. If the shareholders get anything (as opposed to letting the shares go to zero), then Paulson should be flayed alive.

[Walker]

In fact:

Under the plan, the federal government would place the firms in a legal state known as conservatorship, the sources said. The value of the company's common stock would be diluted but not wiped out while the holdings of other securities, including company debt and preferred shares, would be protected by the government.

Understand what this means. Your tax money is not (entirely) being used to protect the economy. Your tax money is being used to protect individual shareholders from losing their investment.

[Curt Adams]

The biggest issue is the debt. If the debt is now fully guaranteed by the US government without some kind of haircut, holders have made literally hundreds of billions because their default risk is gone. Could be a truly massive subsidy to China - and to many politically connected hedge funds, no doubt.

[Anthony Damiani]

It would be ironic if the legacy of the Republican era of control in Washington were to be be the greatest nationalization of private industry in our history...

[Mike Schilling]

If it stops at tens of billions, I'll be relieved.

And why the animus against the shareholders? An awful lot of them are held by pension funds and individual retirement accounts (who are already hurting), not Montgomery Burns.

[freelunch]

The FDIC doesn't waste time with discussions with the participants. They just come in, take over and sell the bank or create a new one as the successor. Silver State Bank is the most recent to go down and they all go down over the weekend.

The semi-banks aren't as well regulated, nor are their regulators as experienced in dealing with it. The takeover really needs to happen this weekend if we aren't to have even more problems than this is already causing.

There is actually a very good chance that the takeover would allow the government not to have to pay any money as they work out the problems of the companies. There are serious risks in the market that Fannie and Freddie had lent into, but having the government directly backing these bonds will remove the secondary risk that is causing Fannie and Freddie's problems to be exacerbated. The shareholders will get a pittance. I'm quite willing to let them have my nickel.

[Doctor Science]

Walker:

The key issue is what happens to Fannie and Freddie shares.

I actually disagree. I think it's more important to find some way to actually bring real, bad consequences down on the individuals who made bad decisions. The more diffuse the bad consequences, the less likely anyone is to learn anything.

As long as the boards and CxOs are personally enriched, they will not change their behavior. I don't think there's good evidence that they will be motivated by institutional loyalty, the good of the group, etc. They are capitalists, and they believe only in personal responsibility -- and personal gain. So they have to experience personal loss to have an incentive to change.

[ericblair]

Welcome to the results of privatization above all. A too-big-to-fail Government Sponsored Enterprise is the very definition of moral hazard: take a pile of risk, if it works out the management makes a mint, if not, stick it with Uncle Sucker your business partner. You get all the overhead and risk of private enterprise plus the expense of taxpayer bailouts like this.

Get rid of these things. If it's that critical to the country and can't fail, nationalize it. If it's just too big to fail, break it into pieces until they're not.

[Bernard Yomtov]

The shareholders have already taken a major bath - down 90-95% over the past year. That's a loss of about $90 billion. I don't think there's any reason to be particularly solicitous, but neither is it going to matter much if they get a few pennies if needed to make the deal go quickly.

Mike is probably correct that there are some pension funds and so on that hold the shares, but I doubt even a wipeout will have a huge effect. Most of the horses are long gone. I suspect many shares are now held speculatively by investors who were looking for a recovery that didn't happen. No way to know of course.

In normal FDIC bank closings, as I understand it, the govt can take action against board members for negligence. I have no idea if there is a way to do this here. The very fact that the govt guarantee was implicit might raise problems. Maybe others are more familiar with the legalities.

I do think whatever can be done about that should be done. I also eagerly await explanations as to why the executives really deserved those paychecks, and it was just the market, etc.

[von]

Understand what this means. Your tax money is not (entirely) being used to protect the economy. Your tax money is being used to protect individual shareholders from losing their investment.

I'm a little confused regarding how you can neatly differentiate the "[free market] economy" from individual shareholders. They are linked, you know.

In any event, this form of bailout is probably inevitable. It's in part a result of the run-up in home prices and in part a result of structural defects that have long been remarked on at the FMs. They should have been truly privatized long ago, or they should have been made part of the government: their hybrid status created huge expectation problems.

A lesson for the future.

[Blackburn]

I actually disagree. I think it's more important to find some way to actually bring real, bad consequences down on the individuals who made bad decisions. The more diffuse the bad consequences, the less likely anyone is to learn anything.

But some of those "individuals" are financially stressed regional banks holding preferred shares, others include other countries, including our largest creditors, holding bonds. How much punishment would you mete out? Would you be prepared to suffer the possible economic consequences?

[David]

If anyone wants to track FM and FC and the general hollowing-out of the US and global economies, day by day, your best site for one-stop shopping is The Automatic Earth.

You get a daily compendium of stories from around the world, and some pithy commentary from the site's hosts, Ilargi and Stoneleigh. Speaking as someone who considers ObWi to be the best all-round one-stop shop for commentary on the US political scene (great hosts, wonderful commentators), I think the folks at TAE are doing something similar for financial news: burrowing through the endless complexity and BS of business and economic coverage in the mainstream media, and making it digestible to those of us who blanked out in Econ 101.

[Doctor Science]

Blackburn:
But some of those "individuals" are financially stressed regional banks holding preferred shares, others include other countries, including our largest creditors, holding bonds.

No, those are not individuals, they are (as you say) "individuals". When I say individuals I mean actual, single, identifiable *human* persons.

[Bernard Yomtov]

Blackburn,

I understand Dr. Science to be referring to the executives and boards of the mortgage companies, not necessarily the holders of the preferred securities or bonds.

[cw]

Discosure - last time I looked, I owned some bonds from one or the other of the FM's.

The only way someone can make a big profit on a bond is to have the price of that bond go way down from its face value, due to i.e. interest or risk factors, and then have the bond rescued by reverses in same. I don't think anyone made major profits on FM bonds, as the prices have generally had the government bailout factored in.

[dmbeaster]

Yikes is right. But was there ever really a choice?

No, but the choice is in how the "bailout" is done. The question is why the government is giving a free ride to the preferred and bondholders. There are plenty of good reasons, such as the fact that most of those people are institutional investors, as well as US and foreign banks, and not doing the bailout leads to other real costs. For example, allow the complete failure but trigger bank failures that kill off the FDIC.

Sadly, the same corrupt people who have been running the executive branch of the government are going to be in charge of this one. They are going to shape the plan, and probably not with the same idea of "public interest" that you or I have. In fact, I would love to hear a believable explanantion of what Republicans believe is the "public interest" in such situations, and how that differs from favoring business interests that most strongly support it.

[Blackburn]

Dr. Science, Bernard Yomtov: Apologies for the belated post, but I just wanted to acknowledge my misunderstanding of the Dr.'s meaning. I agree with that sentiment, though I'm not holding my breath waiting for those responsible for this mess to be held to account.

As an aside, developments over the weekend have been interesting to say the least.

[Blackburn]

cw: You're looking at this from a small investor's viewpoint; the entities parking billions of dollars (e.g. China) into agency bonds are counting on the extra earnings from the spread between those instruments and Treasury bonds.

[David]

To my elected representative,

Please STOP the lunacy that is the proposed $700 billion bailout of the financial industry. Make no mistake, this is not a bailout of the citizens you were elected to represent. This is a bailout of the corporations from whom you've accepted money and other support, using money you are taking from the citizens you were elected to represent...and from their children...and from their children.

The citizens you were elected to represent are substantially protected from major changes in the financial industry via FDIC, SIPC, and excess SIPC insurance on their bank and brokerage accounts. Only those citizens who freely chose to invest in financial companies will suffer investment losses, just as those did who freely chose to invest in technology companies before the dot com bust. That's the way it should be.

The financial companies in trouble are the ones who freely chose to make bad decisions about what they invested in, and about how they managed risk and cash flows. They deserve to fail so that a new generation of financial companies which are better managed can flourish, making it much less likely that the current situation will ever repeat. The financial companies in trouble do not deserve to be gifted, or even "loaned," taxpayer money so that they can continue their past mistakes. If they are able to avoid failing by changing quickly into a next-generation financial company WITHOUT a taxpayer-funded bailout, then they have proven they deserve to survive. Whether new or re-born, we need better managed next-generation financial companies in our economy.

You are free to use the arguments made here to publicly justify your vote against the proposed $700 billion bailout.

I am asking you to vote AGAINST the proposed $700 billion bailout, in any form. I will record which of my representatives vote FOR the bailout, and will vote AGAINST them and their parties in the November election. I am also urging my friends, colleagues, and community to do the same.

Warm regards,
David

[Carl]

The Republican party pushes its agenda by scaring the American public into supporting legislation in a mode of panic. This has been the method for "selling" us on the Iraq war (remember WMDs?), "persuasive interrogation" A.K.A. torture (it's OK, they're all terrorists!), invasion of citizens' privacy (sleeper cells!), and now this $700 billion bailout of the financial markets (looming financial disaster!).

I made a little character I call "Chickenhawk Little", a humorous mashup of the right-wing war mongers and the classic childrens' character, Chicken Little. Take a look at my blog to see it. http://chickenhawklittle.blogspot.com/

[Chris]

Lets get reasonable for a second and look at what happened to get into this cluster before we start throwing a bunch of economic jargon around so we can see what the actual cause of this was. In other words, Who's To Blame!?

Plausible deniability? by Dr. John Lott 9/22/08
http://www.foxnews.com/story/0,2933,425924,00.html


FOX Video Clips
http://www.youtube.com/watch?v=3QBRIsCkGQ0


Whose Policies Led To The Credit Crisis? by Ed Morrissey
http://hotair.com/archives/2008/09/16/whose-policies-led-to-the-credit-crisis/?print=1

FOX Video Clips
http://www.youtube.com/watch?v=RYz1rbB5V1s&feature=related

[Chris]

Hey Chickenlittle Carl,

When your aspersions get thrown back in your face you could always try to learn what you're talking about.

[hilzoy]

Chris: the posting rules require civility. Please respect them.

[David]

An open letter from America Is Our Creation! at http://AmericaIs.OurCreation.info .

To my U.S. Government representative:

Please DECLARE VICTORY with your Save America Plan for the American economy! Please STOP the lunacy that is the proposed $700 billion Paulnankebush Bailout of Global Financial Investors and Employees!

You have a choice.

You had the foresight to insure the stability of the U.S. financial system, and to insure the safety of deposit and investment accounts in banks, savings and loans, credit unions, and brokerages up to reasonable levels by establishing the FDIC (Federal Deposit Insurance Corporation), NCUA (National Credit Union Administration), and SIPC (Securities Investor Protection Corporation). You gave the FDIC and NCUA the power to use the full faith and credit of the U.S. Government to do this for banks, savings and loans, and credit unions.

You also have allowed the Federal Reserve to grease the wheels of the credit markets by accepting high risk debt as collateral for short term loans.

Please declare victory via your Save America Plan and focus your efforts on enabling the FDIC, NCUA, SIPC, and Federal Reserve to do what they do even better, instead of focusing your efforts on the duplicative, excessive, and THIEVING Paulnankebush (Paulson/Bernanke/Bush) Global Financial Investors and Employees Bailout.

Your Save America Plan is a much better solution than the proposed Paulnankebush Bailout of Global Financial Investors and Employees because:
* Your Save America Plan injects cash into the financial system through multiple vehicles, reestablishing the flow of credit.
* Your Save America Plan insures the market value of deposit and investment accounts up to reasonable levels.
* Your Save America Plan takes MUCH less money from American taxpayers than the thieving Paulnankebush Bailout of Global Financial Investors and Employees.
* Your Save America Plan keeps inflation manageable. You would create runaway inflation if you support the excessive Paulnankebush Bailout of Global Financial Investors and Employees, making Americans poorer on Day 1 as the prices skyrocket for gas, food, and all goods and services that are imported, have any imported component, or use oil and gas in their creation or distribution.
* Your Save America Plan GUARANTEES repayment of deposit account insurance claims to American taxpayers whereas the thieving Paulnankebush Bailout of Global Financial Investors and Employees does not. Financial institutions will repay FDIC/NCUA insurance claims through increased risk-based insurance premiums, whereas your support for the Paulnankebush Bailout of Global Financial Investors and Employees would be a gamble on a new U.S. government agency buying low and selling high. If (more likely when) when you lose that gamble, you will force the American taxpayers to foot the cost of the Paulnankebush Bailout of Global Financial Investors and Employees forever.
* Your Save America Plan moves deposit and investment accounts to financial institutions whose management teams are so STRONG that they didn't cause themselves to fail by taking too much risk. We desperately need these kinds of better managed next-generation financial companies in the American economy. If you support the Paulnankebush Bailout of Global Financial Investors and Employees, you will leave deposit and investment accounts in financial institutions whose management teams are so WEAK that they caused themselves to fail by taking too much risk.
* Your Save America Plan prices and disposes of the toxic wastes that are the bad loans/debt and their derivatives. The FDIC/NCUA/SIPC have been successfully selling bad loans/debt and their derivatives for years, whereas you would entrust a new and inexperienced (at least in working together) team to do this with the Paulnankebush Bailout of Global Financial Investors and Employees.
* Your Save America Plan enables housing prices to fall to sustainable levels. Homeowners in trouble can sign their house over to the mortgage holder, rent for a while, and then buy a new home when housing prices fall to sustainable levels. Yes, they lost their current gamble on owning a home that they FREELY CHOSE to buy and often refinance at inflated prices via mortgage and home equity loans/lines, but they are much more likely to be in a winning gamble when they buy a new home at a much lower price. Your support for the Paulnankebush Bailout of Global Financial Investors and Employees would just make homeowners wait longer for housing prices to fall to the same sustainable level, at which point they could buy a new home.
* Your Save America Plan puts the losses where they belong...with the people, funds, and companies -- U.S. and FOREIGN -- that FREELY CHOSE to invest in, and/or work for, financial companies. The same thing happened with the dot com bust and other burst bubbles where nobody bailed out the investors and employees. This is the way it should be. The investors and employees made the gamble in anticipation of making huge profits and/or enormous wages; they deserve to take the profit when the gamble succeeds…and the loss when the gamble fails. On the contrary, the losers in the Paulnankebush Bailout of Global Financial Investors and Employees are the American taxpayers who you -- acting as THIEVES -- would force to transfer their wealth to the people, funds, and companies -- U.S. and foreign -- that FREELY CHOSE to invest in, and/or work for, financial companies.
* Your Save America plan keeps the responsibility and accountability where it has a successful track record, with the FDIC, NCUA, SIPC, and Federal Reserve. Your support for the Paulnankebush Bailout of Global Financial Investors and Employees would place the blame on your shoulders, and unchecked power in the hands of a Treasury with strong ties to Wall Street and much less experience resolving such a crisis.

Instead of focusing your efforts on the thieving Paulnankebush Bailout of Global Financial Investors and Employees, please focus your efforts on improving your Save America Plan by taking these actions:
* Nationalize the SIPC so that like the FDIC and NCUA it's backed by the full faith and credit of the U.S. Government, with financial companies paying risk-based premiums so that it too has a net cost of $0 to American taxpayers over medium term time horizons.
* Nationalize and make permanent the one year money market insurance plan so that like the FDIC and NCUA it's backed by the full faith and credit of the U.S. Government, with financial companies paying risk-based premiums so that it too has a net cost of $0 to American taxpayers over medium term time horizons. Make it a responsibility of FDIC or NCUA, rather than creating a new government agency.
* Establish controls over the Federal Reserve so that it does not sneak the Paulnankebush Bailout of Global Financial Investors and Employees past the rest of the U.S. Government by making short term loans that are too large relative to the low value of the high risk debt it accepts as collateral.
* Ensure the FDIC, NCUA, SIPC, money market insurance plan, and Federal Reserve are able to obtain the temporary peak resources they need to handle the crisis.
* Encourage financial companies to cut their dividends to preserve capital, and raise the interest rates they offer to attract capital.
* To reduce panic, educate -- through a single unified campaign -- deposit and investment account holders about their FDIC, NCUA, SIPC, and money market insurance rights.
* To increase Americans' wealth, educate homeowners who are in trouble to 1) renegotiate their mortgages and home equity loans/lines and 2) if the mortgage holders are unwilling to renegotiate, to sign their house over to the mortgage holder, rent for a while, and then buy a new home when housing prices fall to sustainable levels.
* To increase Americans' wealth, educate investors in poorly managed financial companies to sell their holdings, take their losses, and reinvest what they have left...diversified across some combination of deposit accounts, money market funds, bonds, stocks, real estate, small businesses, etc.

You have an historic CHOICE now.
* You can SUPPORT and strengthen the Save America Plan you've already created. You'll go down in history as one of the WISE people who had the foresight mitigate a crisis nearing the scope of the Great Depression WITHOUT stealing from the American taxpayers to give to the people, funds, and companies -- U.S. and foreign -- that freely chose to invest in, and/or work for, financial companies.
* You can UNDERMINE the Save America Plan you've already created and instead support the Paulnankebush Bailout of Global Financial Investors and Employees. You'll go down in history as a THIEF made the crisis worse by stealing from the American taxpayers -- who can ill afford it -- to give to the people, funds, and companies -- U.S. and foreign -- that freely chose to invest in, and/or work for, financial companies. You'll also go down in history as one of the people who made the crisis worse by crippling American taxpayers financially at the very moment the American economy could least afford it.

I understand that I will suffer pain from this crisis, just like almost everyone else living in the U.S. It's inevitable. I freely chose to own a home via a mortgage. I freely chose to invest some money in financial companies. I freely chose to be part of the American economy. I am accountable for my decisions and their consequences.

However, I am NOT accountable for the decisions and consequences made by investors and employees of financial companies, who made their own free choices. They are!

Now, you have a choice. I will hold you accountable for your choice and its consequences. If you support the thieving Paulnankebush Bailout of Global Financial Investors and Employees, I will vote against you and your party in the November election and I will similarly work to have you fired if you are an appointed, rather than elected, official.

I am urging my family, friends, colleagues, and fellow citizens across the nation to do the same.

It's your choice.

[David]

Stop the Great Bailout!

Given the now likely passage of the Great Bailout, I'm mad as hell and I'm not going to take this anymore!

This is our last chance.

Visit http://ImMad.net to stop the passage of the Great Bailout right now!

Then spread the word to as many people as you can right away.

[Tom Abbott]

I haven't heard or seen any one mention the fact that the FED IS ILLEGAL,meaning the banking system we have,It is run by private individuals who own stock in the banks in other words,the FED is not U.S. [government]it is A private entity.The congress can skirt the FED and order interest free money printed for infrastructure.in the U.S.That my friends is the dirty little secret we are not being told.

[Tom Abbott]

I haven't heard or seen any one mention the fact that the FED IS ILLEGAL,meaning the banking system we have,It is run by private individuals who own stock in the banks in other words,the FED is not U.S. [government]it is A private entity.The congress can skirt the FED and order interest free money printed for infrastructure.in the U.S.That my friends is the dirty little secret we are not being told.

[Tom Abbott]

I haven't heard or seen any one mention the fact that the FED IS ILLEGAL,meaning the banking system we have,It is run by private individuals who own stock in the banks in other words,the FED is not U.S. [government]it is A private entity.The congress can skirt the FED and order interest free money printed for infrastructure.in the U.S.That my friends is the dirty little secret we are not being told.

[Tom Abbott]

I haven't heard or seen any one mention the fact that the FED IS ILLEGAL,meaning the banking system we have,It is run by private individuals who own stock in the banks in other words,the FED is not U.S. [government]it is A private entity.The congress can skirt the FED and order interest free money printed for infrastructure.in the U.S.That my friends is the dirty little secret we are not being told.

[Gary Farber]

Might ObWi consider a policy of regarding as s p a m any "open letters"?