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$700 Billion Bailout Wastes $7,000
for Each American Family
by Chet Billingsley
PART I – HOMES:
Starting in 1995, rules were changed and federal agencies were
encouraged to loan to not only the rich, and financially qualified,
but also to everyone else. Since not much economic support was
required for a loan, LTV ratios for many borrowers were allowed to
climb to 98% or even 105% The easy credit resulted in grand homes
with equity tapped for cars, toys and a nice lifestyle for many.
recent downward shift in the perceived value we place on having a
big home relative to gas, bread and savings caused the price we
assigned a typical house, that had bubbled up 100%, to now lose 20%
of its inflated value. The unqualified and over-leveraged slipped
To alleviate the tax pain felt by the those who got themselves in
over their head, a well intentioned Congress eliminated the tax on
the gain that people used to have to recognize when they walked away
from a loan. Just as the government made it easy to run up a big
loan, they now made it easy to step away from that loan. As a
result, 6.5% of home loans are now in default.
At the housing level, what then happens is a transfer of wealth.
Frugal renters will become happy future buyers, and historically
imprudent and aggressive buyers will become future renters. It is a
zero-sum game, with the bad for some being good for others. In the
end, home prices will have trended down to the new reality, and a
greater percentage of the owners of our homes will be those who have
been more responsible with their housing investments.
The government bailout upsets this natural balance of reward and
punishment in the market. $700 Billion could cover 80% of all
defaults and allow the imprudent to stay in their homes (and will
make money for us when pigs fly). But, the $700 Billion would have
to come from the frugal, who, on average, would be forced by tax to
pay $7,000 per family to the wasteful. This reward of waste is not
what a great economy is made of. The nation will be better off if
the frugal are allowed to keep their $7,000 and use it to buy into
their own homes.
PART II – BANKS & WALL STREET:
Since the market seems to be working through the foreclosures, why
then are we still considering a $700 Billion bailout? The answer
here has to do with the influence and size of the big institutions
that received these 98% loans and took on additional risks with
them. The many imprudent borrowers got their loans from larger
imprudent banks, who passed them through Wall Street, and on to rich
investors and institutions in America and abroad. Executives and
advisors at these banks, investment banks and institutions knew they
were taking risk and went for it. “Go big, or go home,” was the
motto and much money was made on the way up. 80% or more of
investment bank revenue goes right into lavish salaries.
To make even more profit (and salary) these firms, like their
imprudent homebuyers, took on 96% to 98% debt to fund their business
dealings. This was allowed in our system, because the rules had been
relaxed to promote fairness in lending to the less qualified. When
the market turned, some institutions lost tremendous sums on their
previously winning bets.
Having bet the firm and lost everything, these Wall Street
institutions do not want to leave the privileged trough where they
have enjoyed such great paydays. They argue that they are unique and
too big to fail. In their self-importance, they actually believe
that only they can provide the financial services they have
provided. Their messenger is Treasury Secretary Henry Paulson, the
former head and 30 year veteran of Goldman Sachs, who now argues for
his former investment banking fellows.
In an act of monumental hubris, Paulson asks for Caesar-like power
to dole out the $700 Billion to his friends unfettered by courts,
laws or review. Perhaps they each should pull their hand out of a
bucket of water and contemplate the hole they leave behind.
In reality, better-financed companies with better executive
management, will step forward to fill the gap left by the departing
investment banks and related firms. Not all firms took great risk.
The US Bank president was roundly criticized for not going into
sub-prime loans, but his bank is now solid. Sam Zell sold out of his
multi-billion dollar REITs at the peak. Berkshire Hathaway has ample
cash and now can invest $5 Billion into Goldman Sachs. Leaving the
$7,000 per household in the economy for individuals to spend or
invest, sometimes in new mortgages, into these replacement firms or
other growing companies is substantially better than throwing good
money after bad.
Letting losing financial firms be sold off is part of the creative
destruction that strengthens our economy. The winners grow and the
losers fade away. $700 Billion in funds should not be pulled from
the economy and handed to failed firms to prop up risk taking
companies and executives at a cost to every other firm and us all
PART III – THE END OF THE WORLD:
Because the reverse Robin Hood plan, of stealing from the poor and
giving to the rich, is so hard to sell to financially responsible
Americans, Wall Street firms argue Armageddon. If you don’t do what
they say, the U.S. financial system will suffer dire consequences
too terrible to imagine. Since most people are not international
economists, how can the average fellow argue? Well, the system just
doesn’t work as they say.
It happens that a large percentage of the U.S. mortgages were
repackaged and passed on to Chinese, Middle-Eastern, and European
investors. The argument goes, responsible American families must
make up the losses of the Chinese, Arabs and Europeans. If we don’t
make up for the past losses from overextended borrowers, these
foreign investors will no longer lend to the US and we will not be
able to get any more credit card, student, housing or business
loans. This is impossible.
It is impossible because when Arabs send oil to America, we pay them
in dollars. When Chinese send us plastic toys or the Germans send us
a Mercedes, we likewise pay them in dollars. They then have two
choices: they can buy American goods with those dollars, or invest
in American stock and assets. If they go to France with our dollars,
the French will ask for Euros. If dollars are exchanged for Euros
(or Yen), the exchanged dollars will eventually need to come back to
America to buy goods or investment. The flow of dollars is always
Arab oil will continue to flow to the U.S., Chinese plastics will
continue to be shipped, and Nintendo will continue to be sold here.
As a result, these dollars will continue to circle back into the US.
In the long-run, the balance between imports and exports of goods
and services is always balanced by investment. A trade deficit is
balanced by an investment surplus.
To say the countries will not invest in the USA is tantamount to
saying the countries will no longer ship oil, plastics and games to
the U.S. Nobody suggests the supply of goods in the front half of
the investment cycle will vanish, so the return of dollars will
Additionally, and not to be hard-nosed about it, let us recognize
that the foreign country losses are a sunk cost for them. They took
a hit. If they invest with us in the future, they can make fresh
profits. We do not need to make up for past losses in order them to
make future profits. Having lost, they will be cautious. If we pay
them more than they were due because much of the bailout flows to
them, they will still be cautious. We gain nothing and only transfer
hard earned cash from responsible Americans to overreaching
foreigners by entering into a $700 Billion bailout that often ends
up flowing overseas.
What should then be done is — absolutely nothing. The government
should step back. Let the market sort things out. Treasury, the Fed
and the SEC should only supervise the orderly liquidation of the
assets that were squandered and not send another nickel to prop up
If any much smaller monies should be allocated it should only be
sent to firms not involved in the sub-prime losses for the purpose
of facilitating substitute avenues for the duplication of the credit
functions of the old firms. There will be some tough love
disruptions, including a slowing of credit, but these annoyances
will be fraction of the pain of taking $7,000 from every American
If we take the other path, expanding government’s role, we will be
transferring wealth from the frugal homeowner to the wastrel, from
the well-run firm to the failures, and from Americans to foreigners.
We gain nothing from the future foreign investors who will be doubly
cautious, in any case. We also set a bad precedent for jumbo loans
coming due in the next few years, credit cards, student loans and
other dinosaur companies that are or may shift into trouble.
Personally, I would think you would rather keep your $7,000 down
payment and cancel the current program and all future installments.
Chet Billingsley is the President of Mentor Capital, Inc. (Symbol:MNTR)
that invests in hedge funds and smaller companies. MNTR has no debt
and no exposure to the financial, sub-prime or real estate sectors.
Information on the firm may be found at
(Disclosure: Bob Meyer holds Mentor Capital stock.)
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