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>Why Taxpayers Should Bail Out Wall Street

>One stormy morning, Obama leads by nine points in the polls. Here we are, 41 days from election and the tall guy starts sprinting down the track and opens up a 9 point lead over the short, old guy. How long can the young “empty suit” go this fast is anyone’s guess. But unless something is done–and the debates start Friday–the old, stout guy is done. That, despite predictions to the contrary by other pollsters and experts.

Unfortunately, neither the fast “empty suit” or the old, slow guy knows what to do about the proposed Wall Street bailout. The young guy can only read scripts and his handlers are puzzled. Was the old guy right, should we not bail out Wall Street? I think he will say whatever will supercharge his election campaign. We’ll see on Friday. Meanwhile, read on and you decide.
By the way, I don’t believe in polls.

I did enjoy a Washington Post story by Robert Samuelson this morning that said Paulson and Bernanke are rewriting the text books and running scared–“panic” was the operative word. “Paulson’s Panic” was the headline.

I commented that what Americans need most at this time is a better understanding of the markets. Most people think this bailout is just to help the rich guys. Actually, it is meant to protect the people more than help the once rich and fat.

Think of the stock market as a mother. Mothers have kids and they nourish them until they can eat, walk, speak, and blunder on their own. Our markets are our mothers. They are the source of capital for all business in America, so they are the mothers or the source. If we don’t help the moms out, there will be no milk or cash for the kids, the many businesses that are capitalized will fail.

To capitalized means to issue stock that is sold on Wall Street that produces the money needed to move the trucks, pay the workers, and produce the goods–it’s the money that gets main street and rural business going and makes them viable manufacturers, transporters, farmers, and everything else that qualifies for an American business.

There’s a big bully called stupidity, greed, and bad judgment stalking our moms. They will go under if we don’t help. Actually they have “Mom” in a strangle hold. She’s ready to expire. If she does, there won’t be any mother’s milk or financial support for all the kids who have these businesses. If that happens, everyone goes to bed hungry at night because jobs dry up and there aren’t paychecks or money to buy groceries; no money to buy gas or to pay for the heat and lights. That’s called DEPRESSION.

Then government must jump in and create jobs–make work projects like they had in the great depression. My dad was only 24 years old and he had one of those jobs. He made a dollar a day building “a road to nowhere” and our family of five barely survived. No one wants that, so instead of waiting for the big GONG to sound in the sky or depression to hit, we help out Wall Street now instead of bailing out the public later. “Pay me now or pay me later?”

Here’s what I wrote in the Washington Post “comment” slot today. Then I’ll follow with a smart guy’s comments. He explains stuff that may be over all our heads, except those who work in the markets. And I’m not sure how his comments help educate us to the point where we can decide if Congress should do a bailout or not. That’s for you to decide. As you may know, Congress is stymied, almost in a state of rigor mortis. It’s brain damaged and in permanent shock and awe and delay. Of course most of them were that way when they came to Washington, so what else is new? (me):For we the taxpayer, Washington should do something to educate us. Unfortunately, no one in government, the economists, or market gurus really know what’s going on in this financial crisis, much less know how to solve it. I doubt Paulson, Bernanke, or any of the economists advising Congress know what to do and this is creating delay and panic in some quarters including the halls of Congress. No one wants to make a mistake that worsens the problem.

Is it really true that delay is bad for America? Along with others including McCain, initially I argued that the government should not bail out anyone. It is basically against the free enterprise notion that companies live and fail on their own. Then comes along Bernanke and Paulson who are running scared, telling us action today or the crisis will create a depression. What are these two–some kind of socialists? What–we own all the companies in America? I don’t think so…

None of the above does the taxpayer understand, much less believe. Government should not expect support for it’s programs without first telling the public what the **$$!! are the options. We’re smart. We can figure things out. We just need some help re-explaining Free Enterprise 101 and how all this “hurry-up and bail-out ” stuff is germaine to anything.
Don White

Here’s the smart guy’s comments:

DCX2 wrote:
It all starts with bad mortgages that are pooled into Mortgage Backed Securities (MBS) and expands from there. The MBSs are used to create fake capital that can be used for a wide variety of purposes when you don’t have enough money, increasing your leverage.

The first avenue of exploit was structured finance; over-the-counter derivatives that are unregulated. MBSs are collected and sliced into different tranches as part of a Collateralized Debt Obligation (CDO). The upper tranches are low-risk low-yield (they get money back first), and the lower tranches are high-risk high-yield (they get money back last). Knowing that these subprime loans will eventually default, they rig the game so they can skim off the good money with “super senior” tranches and then sell the rest of the junk that won’t ever be paid back in junior tranches. Ta-da, they keep real money and you get imaginary money.

But they didn’t plan on recursion. Sometimes a bunch of CDO slices are combined to create a CDO squared (and, further, CDO cubed, and so on). This is how imaginary money can get a good rating and be sold to institutions who normally only buy real money.

Even further, Fannie Mae and Freddie Mac enjoyed access to a special interest rate discount window. They would take out loans from the discount window, and then buy up MBSs and CDOs that had a better rate of return, and take advantage of the interest rate gap (Alan Greenspan called it a “Big Fat Gap” of profit). Then they would use their profits to lobby Congress and ensure that the Office of Federal Housing Enterprise Oversight (OFHEO) was practically neutered, thus minimizing regulation and oversight.

Finally, we have the Credit Default Swap (CDS) market. Someone (like UBS) would buy a bunch of bad debt (like $1.3b in CDOs) and then would seek insurance from a hedge fund (like Paramax) for an annual premium (like $2m). Since the CDS market is unregulated, there are no capital requirements, so Paramax is ensuring $1.3b with $4.6m. Paramax is now ultra-leveraged and a lot of the money involved is imaginary (both Paramax’s lack of capital to insure the CDO, and the subprime borrowers’ inability to fulfill their obligation)

This gigantic web of financial foolishness created an intense hunger on Wall Street for more MBSs. In order to get more CDOs to tranche up and sell to Fannie/Freddie/UBS/Citibank/Bear Stearns/etc, they need more MBSs, so some lenders lower lending standards so they can feed Wall Street’s hunger. Lenders who don’t lower standards might get knocked off by those who do, so everyone feels compelled to be evil. And with more CDOs out there, there are more hedge funds and insurance companies who can make easy cash off of the insurance scam with nearly zero collateral.

Regulation at any point – keeping sane lending standards, regulating the maximum leverage, monitoring the real risk of CDOs, stopping Fannie/Freddie from exploiting the Big Fat Gap, regulating CDSs to at least require significant capital – could have minimized or even eliminated this problem.

And the solution, contrary to Paulson’s plan, is to make sure people keep paying their mortgages, and to try to sell the foreclosed homes. Then the money will start flowing again, CDOs won’t default, CDSs won’t need to be paid out, and life will return to normal.

9/24/2008 12:57:34 PM

Do you understand more now than you did five minutes ago about what Congress should do with the Bush-Paulson plea for $700 billion?

Read Robert Samuelson’s report in the Washington Post