The Everyman Economist

The Everyman is angry. He wants to know why the government is asking Everytaxpayer to bail out Wall St when it was the government and Wall St that got us into this mess. A fair question to be sure, but there’s no simple answer. Truth be told, George Bush couldn’t satisfy the Everyman with any answer right now, even if he was able to articulate it with 100% accuracy. In the mind of the Everyman the President has lost his credibility and he’s like the boy who cried wolf, only worse. He’s used fear in the past to get his way and the Everyman thinks he’s doing it again. Unfortunately, the wrong guy is trying to send the right message, but nobody believes him. And that’s why we are On The Brink…

The President offered a plan that was crafted primarily by the heads of the Treasury and Federal Reserve to stave off a financial meltdown. What they are seeing developing is REAL and it will impact the Everyman in a very REAL way. Banks and financial institutions have been unable to obtain the necessary funding that keeps their doors open Everyday. It’s only a series of temporary emergency measures taken by the Fed that has prevented this problem from mushrooming already. Some companies and banks have failed, even with the emergency measures, and it will get much worse if something isn’t done VERY SOON. Case in point, WAMU -the nation’s largest Savings and Loan failed overnight. The Everyman’s deposits are safe because JP Morgan Chase acquired the assets of the bank and is now holding all of the accounts. But what if the WAMU situation were to be multiplied tenfold, or fiftyfold? Is Chase or Citi or Bank of America or all of them together big enough to take on all of those failed institutions? Absolutely NOT! And that’s where we are right now…On The Brink…

We need to put anger aside. We need to put politics aside. We need to suspend the disbelief and we need to trust that the situation is as bad as Warren Buffet put it - “we are facing financial Pearl Harbor.” And if this all begins to unravel, it will unravel very quickly. The list of failures will grow and the impact will be seen in the Everyman’s savings account, checking account and IRA & 401k accounts. This is not just a Wall St problem, it is now Everyman’s problem and we are perilously close to it becoming a reality. If Congress does not take action on a plan TODAY, FRIDAY 9/26/08, the global markets will begin to take action and we will no longer be On The Brink…                

Let’s use some plain Everyman English to try to understand what’s going on right now. What’s The Real Deal?

The Problem: Last week the financial and banking system, which is the place where money is borrowed and lent every day, was coming to a screeching hault. Too many institutions had too many securities on their books that were impossible to value. These securities were backed by mortgages on homes that were declining in price and nobody knew exactly how to value these securities in light of rising foreclosures and forced real estate liquidations. As a result, many institutions were holding losses on their books and it was impossible to determine how bad these losses were. This caused institutions to stop lending money to each other and many companies to stop functioning. As the lack of available credit spread, it began to trickle down to every corner of America and there was a very sudden and real threat to the Everyman’s savings, investment and retirement accounts. Without some immediate action, we could soon find ourselves on the verge of a major Depression.

The Plan: Since the immediate cause of the problem was the bad paper (better known as securities) that was on the books of so many institutions, it was clear that the time had come to find a way to remove those securities from the books of as many companies as possible and go back to a healthier environment. And that’s now the basic plan awaiting approval by Congress and it is estimated that the Treasury will need $700 billion to accomplish this task. There is no question that Congress will approve the plan this week, although there may be some wrangling over what else to include in the plan to try to help the current housing conditions. After all, that’s still what’s behind this entire mess, so we need to ease the pressures and slow down the crisis. When all is said and done, the Everyman can be sure that a bi-partisan agreement will be reached.

The Result: Our financial system will begin to operate more normally very quickly and money will flow more easily. Without the bad paper to worry about, many institutions will focus on helping the Everyman ease his housing burdens and we will begin to see a slowing in foreclosures and property liquidations over the next 12 months. In 2009 we will see a significant rise in the nation’s budget deficit, but it will not be the same type of “structural deficit” that’s caused by overspending. Instead, you can think of the government’s current bailout plan as more of an “investment strategy” which we can reasonably expect to pay off over time. As Uncle Sam sells or matures the paper, he will receive money back, which will bring the deficit back down to earth.

The Danger: There are numerous dangers that could make things problematic along the way. The #1 danger is that Congress fails to act quickly and do what’s necessary now. This is very unlikely, as the results would be pretty catastrophic and Congress knows it. The second danger has to do with how the bad paper leaves the books of financial institutions and moves to the books of the US government. The paper will have to be priced and you can be sure that the prices will create even more losses for many of these troubled companies. This could have another negative impact on the economy and drag out a much needed turnaround. The third danger is the impact of historic deficit spending on the value of the US Dollar and inflation. The government is going to have to raise a lot of money next year to pay for its plan and that could be hazardous to our currency and to inflation. But with all these dangers in mind, we still have to get this mess under control and live with some additional pain if we can expect to end the turmoil once and for all.  

Treasury and Federal Reserve officials announced that a plan is in the works to create a facility that would rid bank balance sheets of the toxic illiquid assets that plague the nation’s  banking system. In short, the facility would be a sort of “bad bank” that will hold these assets, probably until they mature, and free financial institutions of the #1 problem that is wreaking havoc. Is the plan costly? Of course! Will the improved “good banks” pay a steep price for their poor judgement? Of course! Will the taxpayers carry the bulk of the burden? Of course! But when all is said and done, we believe that this is the beginning of the end of the worst financial crisis since the Great Depression. There are still more details to work out and Congress needs to pass some emergency legislation to push the plan along, but as long as it happens the patient will begin to recover. It is no wonder that markets across the globe are reacting favorably.

The plan will not immediately end the housing problems in America and save us from some additional economic weakness. Foreclosures will continue and home prices will be under continued pressure. However, the plan will now allow the banking system to focus on more positive ways to help the Everyman which will shorten the duration of the downturn. There is now light at the end of the tunnel and it’s no longer an oncoming train.       

“Is My Money Safe?” This is the #1 question the Everyman is now asking Everyone and if he’s not asking yet, he should be. Normally the answer would be a simple YES, but these are not normal times and the Everyman needs to be serious and prudent about the current financial landscape. In the old days, the Everyman’s money was tucked away in a small local bank, blanketed by FDIC insurance and under no real threat from changes in the economy. But times have changed and local banks have been replaced by global financial institutions offering a myriad of investments and accounts that confound the Everyman in these trouble times. And now we have some of the most prominent financial companies going from boom to bust in a matter of weeks, or even days. It’s no wonder the Everyman has no idea where his money may be going with the next news story. So take heed and look at your accounts NOW! You must be comfortable with the institutions that hold your money, and if you’re not, make some changes. In most cases you have no obligation to maintain an account with a specific company, so moving elsewhere is just a matter of painful paperwork. But better to be pained by paperwork, than to see the fruits of your labor go down the drain. So where should you go for safety and security? The best suggestion right now is to keep your money at a large money center commercial bank and deposit no more than $100,000 in any single account. You can either accept the savings rate, as low as it is, or buy US Treasury securities for additional safety. Most importantly, don’t look to salespeople for advice. Now is not the time to have someone sell you a product or investment that is out of the mainstream. Now is the time for “capital preservation” and the time to let the dominoes fall where they may, just so long as they don’t fall on you.  

Itching to prove that Uncle Sam WILL NOT open the bailout spigot for everyone, the US government WILL allow Lehman Brothers, America’s 4th largest securities company, to fail. Only moments ago, the company announced that it will file for Chapter 11 bankruptcy protection and end its 158 year history. Lehman’s imminent failure sent shock waves across the globe, with stock markets reeling from Europe to Asia and pre-market futures trading indicating a decline of several hundred points in the United States.

As a single event, Lehman’s failure will not bring down the financial system. But within the context of staggering losses across the broad financial spectrum and the ongoing deterioration of confidence in the financial industry, the system seems perilously close to a financial meltdown. So with this in mind, all eyes and attention will immediately focus on providing stability throughout the day on Monday, 9/15. Adding  to the equation, the last few hours included the following developments: (1) the Bank of America will launch a $50 billion takeover of Merrill Lynch (2) AIG (American International Group), the world’s largest insurance group, is reported to be announcing a major restructuring of its business (3) a group of 10 global banks has established a $70 billion pool of funds to lend to troubled financial institutions (4) the US Federal Reserve has broadened its emergency lending program for commercial and investment banks.

There is no doubt that the banking system will survive, but the future will look much different than the past as consolidation and “the survival of the fittest” unfolds. The Everyman can expect to see more failures and mergers among banks and financial services companies, and it remains to be seen how this will impact the Everyman’s life. These are certainly trying times for the Everyman and for America, but this too shall pass and we will all get through it together.    

They may not be as famous as Felix and Oscar or Lucy and Ricky, but Fannie and Freddie are the most important twosome in the Everday life of today’s Everyman. Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) are the 2 biggest mortgage lenders in the United States, accounting for more than half the total of outstanding mortgage debt, or about $5 trillion. The possibility of these 2 “private” institutions facing an unprecedented demise was a catastrophic event that the US government just couldn’t afford to let happen. So in the most recent mode of Bear Stearns type bailouts, the US federal government is now the proud owner of these 2 mortgage giants, along with all of their good and bad debt and their new nationalized responsibilities to the health of our ailing housing and mortgage markets. All in all it’s not just a good thing, it’s the ONLY thing the Bush administration could do under some very precarious circumstances, because as goes Fannie and Freddie, so goes the potential stability of the US financial system.

So with this newfound stability in place, where do we go from here? As always, there’s good news and bad news, but most of it is good this time around. The mortgage markets will regain some much needed credibility as the US government’s backing of Fannie and Freddie will bring back willing buyers of their securities. In turn, this will help lower mortgage rates from their current lofty levels, perhaps by as much as 1%. Now that’s very good news for the Everyman! In addition, now that Uncle Sam is the nation’s largest mortage lender, it has much greater flexibility in helping the Everyman buy or sell a home in today’s difficult housing environment. That should all help stabilize the freefall and at least create a floor that we can all stand on and begin to look up from. After all, it’s been pretty hard for the Everyman to look up while he felt like he was falling off a steep cliff.

Okay, so now the bad news. This will not be a free ride of course. The intitial cost will be at least $100 billion, but that could very well soar to $500 billion or more over the next couple of years. The hope is that the market will stabilize and begin to reverse itself so the US government will be able to sell off its holdings over time and recoup its investment. Let’s keep our fingers crossed. In the meantime, however, the housing issues that face us immediately, like foreclosures and a glut of outstanding inventory are not going away soon. We are still going to feel some pain over the next year, but the Everyman now has a floor to stand on and a blue sky overhead that’s not always falling.