I have had several questions in the last few days about why Congress is even considering a bailout package for the failing U.S. financial industry. Many will mention to me that this is nothing but regular taxpayers like you and I, paying for the mistakes of some wealthy Wall Street executives. Some will remark that if we save them now, then how will they learn not to repeat this mistake again. Others believe that it just isn’t fair.

If you are one of those struggling to make your mortgage payments, paying for college for your kids, or coping with the rising cost of health care, then you are probably not all that excited about saving some millionaire from New York. The truth is neither am I; however, I believe I have a relatively clear understanding of what is likely to happen if our government just leaves us twisting in the wind.

The risks of not doing anything certainly outweighs the satisfaction of allowing those to inherit the fate which they deserve. Washington policy makers, and Wall Street Executives have gotten us to where we are, we can either address the problem today, or let them pull us all down tomorrow.

Our main challenge is not volatile stock markets, it is credit. If the federal government does not do something here, we risk a freezing of the global credit markets. Overnight lending rates from bank to bank are higher than ever, this can only mean higher interest rates for small business owners and individuals. If credit markets freeze, businesses won’t be able to meet their obligations due to their lines of credit being pulled, people will have a difficult time finding a lender to buy a new home, and in the worst case you may not even be able to use your credit card.

I don’t like the idea of bailing out Wall Street, but I am not a fan of playing Russian Roulette with the future of my business. Our representatives in Washington got us in to the mess, I don’t remember them being so reticent to usher in the regulations which allowed this to happen. These same representatives need to do what is right for everyone, as opposed to what is convenient to their short term political future. They need to get a package passed that will save Main Street, while they bailout Wall Street.

In what is likely to be proven a colossally idiotic move, the U.S. House of Representatives failed to pass the proposed federal bailout today.  Although I suspect (hope) they will vote again sometime in the near future, I am sure the impact over the next day or two will be painful.  I think this is a perfect example of our representatives in Congress being too chicken to act!  I don’t like teeing up $700 billion of taxpayer dollars to bailout Wall Street banks, but I am a practical person; hence, I don’t believe it is in our best interest to just let this play out in the markets.  That has been tried in the past, and it was not overly successful.

Without some sort of intervention, banks will stop loaning to each other, and they will make borrowing very difficult for businesses and individuals.  The government got us into this mess by creating and supporting an environment that allowed banks and investors to take huge risk believing there was no downside.  Now the folks who created the mess don’t have the guts to solve the problem.  Depending on how long this drags out, I would expect to see a couple of regional banks that are already teetering to go over the cliff in the next 24-48 hours.       

It must be Monday, because another large American Financial Institution is no longer independent.  Last week it was Washington Mutual being acquired by JP Morgan Chase in what was described as the biggest bank failure in U.S. history.  Today Wachovia is being acquired by Citigroup, although this is not being described as a bank failure, it sure as heck isn’t a huge success.  When all is said and done, 30 percent of deposits in the U.S. will be controlled by three banks, Chase, Citi, and Bank of America.  This will likely put pressure on some larger regional banks like Fifth Third and National City, to find a suitor or face an extremely difficult future!

This comes on the heels of this weekend’s announcement that policy makers in Washington have come to an agreement on a financial bailout package.  It appears that nobody is all too enthusiastic about the bailout package, although many in DC feel it is necessary to keep the credit markets moving.  Politically the biggest loser here, other than the American People, is the GOP.  I get the sense that the public is not happy about the bailout (count me in that category), and they will be looking for someone to blame.  Since the GOP currently holds the keys to 1600 Pennsylvania Ave. I imagine they will take the brunt of the electorate’s anger. 

The bottom line, it looks to me like this will be another wild and woolly week on Wall Street, and we will all be left scratching our heads wondering what shoe will be dropping next!   

I am watching President Bush give a quick lesson on the meltdown of the U.S. financial markets. More than a year ago I posted an article about the subprime problem, and the potential ripple effects. Although I am firmly in the camp that we need to do something, and that something probably needs to include an effort to keep credit markets moving, and helping those homeowners who have found themselves on the brink, I also am very disappointed in how our leaders have handled this issue.

This is a problem we could have limited. Avoiding it may have been nearly impossible, but limiting the fallout was certainly within our grasp. Last year at this time people who pointed out some of the major challenges we were facing were considered alarmist. Our political leaders worked to convince us that the economy was fundamentally sound, many pundits and analysts indicated that this was a media driven problem, and perhaps we are just a “nation of whiners.” It was not as if people did not point out the problem, but there was a massive PR campaign put forth to convince the American public that everything was just fine. I would have to admit that watching this play out has shifted my perception of our current government, and their ability to effectively govern!

So now when the impact of our inaction is upon us, we are told that this really is an emergency. This was an emergency twelve months ago, and many in Washington refused to admit it. I would like to say better late than never, but even a minor league analyst like myself could see the storm clouds on the horizon last year. Now the president is on TV telling us we have a problem, one of our presidential candidates is parachuting into DC to save the day, and those of us down here on the bottom are scratching our heads asking what the hell just happened.

This is a perfect example of a government so slow to move that it has once again failed to act when needed. Over the last several years we have numerous examples of the failings of our government. Whether it was missing the advance of global terrorism, miscalculating the potential cost of the War in Iraq, reacting slowly to a drowning city , or ignoring troubling economic signs, our government is proving itself to be completely ineffective at preventing issues before they happen. They have reverted to a fire-fighting style of management, and it is just not working! I am not sure our business, the American Enterprise, can take much more of this.

With the projected cost of the proposed Wall Street bailout program being proposed by U.S. Treasury Secretary reaching $1.8 trillion, the question that is now being debated by policy makers in Washington is who we should include in the bailout program. Some say the Fed should stick to only throwing a lifeline to the investment banks and lending institutions that are at risk. Others believe we need to extend that lifeline to the homeowners that find themselves on the brink of being tossed out on the street by those same banks being saved by the Feds.

This program will be big and expensive, of that there is no doubt. The Fed and policy makers in Washington need to do something to keep the credit wheels greased. Hopefully this bailout program will do just that, if banks stop lending to each other that will make it difficult for everyone to find credit. Whether someone wants to buy a car, a house, or a business they will find it challenging to raise the cash they need for big transactions. In that regard the bailout program makes sense, it helps ease some fears about the value of assets on some of the troubled institution’s balance sheets, and makes banks less wary of lending to other banks.

The program falls short though, when it does nothing for the individual homeowners that are at the root cause of this problem. This whole problem was caused by rising default rates on risky loans made by mortgage lenders. The U.S. Government created and supported an environment where lenders were encouraged to write the risky loans, and borrowers were encouraged to apply for them. How many loan officers told the prospective homeowner to take advantage of that low entry rate on an ARM loan, and buy as much house as they could? As these loans began to reset, and defaults started to rise, inventories of unsold homes increased, which started to drive prices down. This is the real core of the problem, and unless we address it we will be facing a prolonged depression in the housing market.

Next year more loans will reset to higher rates than in 2007, the year after even more loans will reset. This could lead to a whole new round of loan defaults, and bad credit conditions. The government’s responsibility does not stop at Wall Street. What does it say about a society that believes bailing out billion dollar financial institutions is a necessity, but allows individuals to fall through the cracks? If we are going to spend trillions of dollars to fix this problem, let’s fix the entire problem. Our government has decided that it is our responsibility to save U.S. financial markets, we should not allow that same government to turn a blind eye to its citizens that may need its help!

U.S. Treasury Secretary, Hank Paulson, and U.S. Federal Reserve Chairman, Ben Bernanke announced today a proposal to move illiquid assets from the troubled balance sheets of U.S. financial institutions to an entity owned by the U.S. government. Translated, instead of bailing out these large institutions like Fannie, Freddie, and AIG one at a time, now they are creating an entity that will bail everybody out at once. The cost of this bailout program could be as much as $1,000,000,000,000 (that is a lot of zeroes)!

It is apparent that Paulson and Bernanke were in a position that they felt as though they had no choice. Handling these issues as they came up was creating significant turmoil in the financial markets. The real fear is that credit would eventually completely lock-up, and it would all grind to a halt, forcing a massive sell-off of hedge funds causing markets globally to go into a free fall in the flight to safety. This is a massive government bailout to keep the financial markets moving.There is no doubt that this is not business as usual. When the government is proposing to create new entities that will cost the taxpayers trillions of dollars, I would guess they are not doing so without good reason. They are doing whatever they can to hold off a financial and economic disaster. Some have said recently that our economy is fundamentally strong. I would say that actions like this are not the actions people take in a fundamentally strong economy. These are frantic moves that are being taken to keep the ship from going down!

I do not disagree with any of the steps Mr. Paulson or Mr. Bernanke have taken in recent days to stave off financial disaster. I think they are using the tools they have to prevent the worst. I do find it interesting though. Our government cannot seem to create a program that helps small businesses and individuals get affordable and reasonable health care. Our leaders have never seemed overly concerned about trying to stem the tide of American manufacturing jobs moving overseas. When an entrepreneur decides to take a risk, and start a new business, if he fails he fails. None of the policy makers in Washington are overly concerned about keeping the guy on main street humming. The case could be made that if Wall Street goes down, then we all go down, but when the government essentially nationalizes $1 trillion in assets, they are not exactly adhering to the real tenets of capitalism!

The biggest irony I see here is that all these folks, whether in the current administration, or a large majority in the financial community, will always complain about government social programs, national health care proposals, or a tax code that they believe redistributes wealth from the rich to the poor. I am sure these folks won’t be complaining now, even though the U.S. government is proposing the creation of a massive welfare program for Wall Street, and the redistribution of debt from financial firms (and their highly paid executives) that took bad risk, to all of us “Regular Joes” that work and pay our taxes! This is the redistribution of wealth in reverse, they are redistributing the bad debt of people who made poor decisions to everybody else. I am not sure how well this will work out in the long-run, but my suspicion is that it cannot be good. I also wonder, of this does not work, where could we possibly go from here!

The U.S. Government announced last night that they had come to an agreement with AIG, the nation’s largest insurer, to provide AIG with a bridge loan of $85 billion to prevent the business from declaring bankruptcy.  Many felt the bailout was necessary because AIG touches many aspects of the financial markets.  A failure of AIG could have resulted in a massive hedge fund sell-off pushing major markets much lower, lowering asset values, and raising the cost to borrow money. All things which could have pushed a teetering economy over the edge.

The Fed’s Board of Governors met yesterday, and decided to keep interest rates steady despite evidence that the economy is continuing to deteriorate. The Fed indicated they still have some concerns about inflation. I agree with both actions by the government yesterday. AIG had to be bailed out, a failure would have been cataclysmic. Holding rates steady makes sense primarily because there are only so many bullets left in the Fed’s rate cut gun. They may want to save those for sometime in the future when they may need the ammo.

There is a bit of irony to the idea that many of our most ardent capitalist who believe we should allow free markets and competition to prevail, are now the ones scrambling with taxpayer dollars to stave off disaster. Despite all the challenges we still have some who believe that the fundamentals are still strong, and we just need to work through the problem. Over the last two weeks those “strong” fundamentals have resulted in the government’s takeover of Fannie and Freddie, the acquisition of Merrill Lynch, the bankruptcy of Lehman Brothers, and the takeover of AIG. My guess is, before we start slapping each other on the back for a job well done, we need to be prepared for what is next. We have a long way to go before this one is cracked! 

What are the fundamentals?  Since so many are trying to tell us lately that the fundamentals are sound, it raises the question about what those fundamentals are.  I would go to the basics, employment, inflation, consumers, business investment, manufacturing strength, etc.  The stock markets can be a leading indicator of the economy’s health, although I always suggest looking at the bigger picture.  So when folks stand in front of the microphone and insist the fundamentals are sound, I wonder what fundamentals they are talking about.

The DOW is 4,000 points below its high of just a few months ago.  Unemployment now sits at 6.1 percent, up from 4.7 percent not that long ago.  The economy has lost more than 600,000 jobs so far this year.  The cost of capital, and the ability to borrow has gotten more difficult for consumers and investors, this has slowed consumer spending, and slowed business investment. Inflation has been all over the map due to rising energy and food cost; however, the price of oil appears to be receding, although not for reasons that would indicate a strong economy.  None of this gives me a warm and fuzzy about the fundamentals of our economy.

People need to stop trying to defend the indefensible, and face up to the challenges before us. If we continue down this path of ignoring the issues, then the failure of Lehman and AIG will be the least of our problems! I wonder what all these folks, who have worked so hard to convince everything is just fine, will tell us then.
 

The big news today is what will happen to AIG, the nation’s largest insurer. AIG sells credit insurance contracts in which an investors pays them to protect the investor from a potential default. AIG was required to post collateral to show that in the event of a default they could pay their obligations. The problem is that in our upside down credit markets the collateral posted was generally not enough to cover the potential debt. If AIG cannot raise enough capital, or sell itself to a healthier institution, then they will need to force the hedge funds which provided the collateral to pony up. Translated, this will result in a massive sell-off of mortgage backed securities pushing prices down further. I am told that these guys touch everyone, not just here at home, but abroad as well. I get the impression the markets are hoping the Feds will step in and do something to keep these guys from failing. The worry is that further declines in asset prices will hit main street pretty hard, giving consumers less spending power, small businesses less borrowing power, and forcing a global slowdown.

Last year (August 2007) I posted an article about subprime fallout and the potential impact on your business. This year I spent a great deal of time following my own advice and trimming any cost out of our business that I could. As I look back over the last thirteen months I am highly disappointed, and now skeptical, of any comments coming from our leaders in Washington. Many experts saw this coming, and yet many were told that the fundamentals are sound, and we need not worry. We were told that global growth would save us, or that the subprime meltdown would only affect the housing sector, everyone else would just float along as if nothing ever happened. When things got worse we were told by some that this was a media driven event, that things were not that bad, and we needed to stop whining. Pointing out the obvious is not whining it is common sense! Burying your head in the sand while Wall Street collapses is denial!

Today was a tough day on Wall Street as the Dow dropped 500 points on continued concerns about the turmoil hammering the U.S. financial sector.  After last minute efforts to hold off the inevitable, Lehman Brothers, the nation’s fourth largest investment firms, announced they would be declaring bankruptcy, and the nation’s largest investment firm, Merrill Lynch, was acquired by Bank of America.  On top of today’s news there are major concerns that AIG, the nation’s largest insurer by assets, is in serious need of a capital infusion. Although Rome burns, many of our leaders insist the fundamentals are fine, and there is no need to worry. If you complain, or point out the real issues, you are being a “whiner” or “not patriotic.”

So as reminder to those who think everything is just fine, the U.S. economy has lost 600,000 jobs this year, the unemployment rate has jumped to over 6 percent, gas prices have risen 36 percent, mortgage defaults are at an all time high, the government is running a $400 billion deficit, and we can’t seem to get through a day without hearing about some bank or financial institution that is in the process of a meltdown. By most accepted metrics everything is not fine, the fundamentals are not sound, and we need to face up to some major challenges.

I don’t know what the answers are, but I do know that ignoring the problems will not make them go away. We cannot turn a blind eye to these issues in hopes they will go away. The credit crisis has been on us for more than a year, job growth has been fading for almost two years, and the housing market has been fading for more than two years. Every time one of these issues rears its ugly head, our leaders do all they can to convince us there is no problem. From what I can see, the only thing they are doing is convincing themselves while the rest of us pay for their mistakes!