Paulson Plan II

Federal Socialist Banking Positions?

What is going on now?

Although the rescue plan is likely to be effective in opening up the crucial credit markets it will take time to implement and deliver results.  It is taking the government weeks to award contracts to companies that will perform each of the plan’s functions and to ensure that the plan is most efficiently and effectively executed. 

Although taking a bit of time to get it correct is understandable, delay does nothing to address the overall credit market freeze, to get banks trading with each other, or to help the lack of general confidence in the financial system.  The truth is, even if the plan was in effect today it would still have taken time to see its positive impacts.

Unfortunately, US banks were out of time.  The frozen credit markets, sinking equity markets and lack of cash liquidity around the world were going to sink dozens of banks.  Going into the market close, last Friday (10-11-08), many professionals weren’t even sure if world renown investment banks Morgan Stanley and Goldman Sachs were going to be able to open for business the following Monday.  Still struggling from the fallout of the Lehman Brothers failure and fund redemptions by the billions, the system could not absorb additional financial strain and failure. 

In unprecedented fashion, the Federal Reserve of the United States begrudgingly took on an equity ownership position in many of the largest US financial banking institutions.  Basically, the US government has nationalized many of the largest most influential US domestic banks.  This move has received much scrutiny and appeal because it is socialist in nature, in the center of what is supposed to be a country based on democracy and capitalism. Unfortunately, the Federal Reserve had no choice and needed to adopt the “Marshall Plan” that was already being implemented around Europe.   As said by Secretary of Treasury Hank Paulson, “This is something that we would have preferred not to do, but it needs to be done to add strength to the system and the global credit markets.” 

Infusing capital into the balance sheets of the US banks has an immediate impact on the ability of companies to operate their businesses.  Available cash and credit will keep them afloat and functioning because the US Federal Reserve becomes both the lender and creditor of choice on both sides of the transaction.  This enables the Federal Reserve to back short term trading and lending between banks which will help un-freeze the credit markets and help operations of both Wall and Main street firms.  At this point, the Federal Reserve has basically reinforced every gap in the suffering banking system and has made substantial progress in creating liquid in the credit markets and overall operations of the US financial system.  Positive results have already been seen, credit liquidity has improved, and further efficiencies and operations will continue over time.  This undesired, socialist series of actions is proving effective and has all but eliminated the possibility of a 1930’s style repeat depression.

What is the Rescue Plan?

Without getting stuck on the intimate details of what was proposed in the initial plan by Treasury Secretary Paulson, that was eventually voted down earlier this week, the proposed plan is best described as one which is aimed at addressing the present critical weakness in the core credit  system of America.  

According to the statistics presented at the US Senate hearings, the good news is that 95% of the US mortgage market is what is called “money-good.”  This means that 95% of the mortgages held in the marketplace are being paid on-time, in full, every month.  The issue is really with about 5% of the mortgage market made of those that are no longer paying, are late paying, are foreclosing, have foreclosed, or are preparing to do so.

In effect, the plan proposed by Treasury Secretary Paulson was basically to create a US federally backed US primary residential distressed real estate fund.  The goal of the plan is to have the US government purchase the distressed assets (i.e. mortgages) from the private and public companies that want to sell them at a discount to what they were worth.   Purchases would be made over time and would likely amount to about $50 Billion per month in the beginning with a cap at about $700 Billion, although it is doubtful that all of this money would be used.

The government would hold the assets and once the market recovered a bit would be able to sell them at a profit much like a distressed asset hedge fund or leveraged buy-out firm (LBO).  Proceeds of the operation would go to the taxpayers whose money is being invested to create the fund.  Of course there are many terms and conditions to the ideology of the plan that are being forced into bill by both democrats and republicans.  Regardless, the mission and object of the plan is the same.

Is the Plan a Wall Street Bailout or Main Street Rescue Plan?

Much of the US public thinks that Secretary Paulson’s efforts and proposed plan are an intention to bail out the Wall Street elite and to keep additional firms from suffering the same fate and some before them.  This would be true if the issue was just with Wall Street Firms and had not been proliferated and extended to many Main Street companies in the form of investment, and if there wasn’t a “Pearl Harbor” like seizure of the credit markets.  Because this has become an attack on the system, it is necessary for the last line of defense, the US Federal Government, to intervene and stabilize the financial credit system in the short and longer term.  For without a credit or lending system, there will be no inventory on retail shelves, cars in lots, money for payrolls, or in ATM machines.  The short term credit markets need to work without the fear and lack of transparency that exists today.  The failure of this system is not an option and its preservation is necessary for people everywhere to maintain a reasonable standard of life as many know it in the United States.  Further, in past instances where the government has intervened when the system has been threatened the plan has worked, achieved it objective and run operationally profitable.   

What will be the effect of the plan?

The effect of the plan will be a couple fold.  First, companies with securitized debt investment products on their balance sheets will have the opportunity to sell these products into the US Federal distressed asset fund, albeit for less than they bought them for.  This will provide these companies the opportunity to clean up their balance sheet and shed the “Anaconda” from their operations, putting them in a position to be able to do business and lend money out to those who require it a reasonable rates and requirements.

Second, the Paulson plan will bring stability and a forced bottom to the US primary residential marketplace. Needed liquidity in the credit markets will slow down and possibly halt the streams of US foreclosure requests that are originating daily by the thousands.  Many people will have the renewed opportunity to stay in their homes and satisfy the terms of a re-negotiated mortgage.   Confidence will return to the buy and sell side of the system and pent up demand (i.e. buyers) will have the confidence and the credit available to return to the marketplace and begin buying again.  Buying in the marketplace will reduce the inventory of homes available on the market and will stabilize prices, inventories levels, and will finally get the market to bottom with better prospects on the horizon. 

The third and equally important thing the plan will do it restore confidence and trust to the marketplace and the US credit financial system overall.  Much of what occurs in economic cycles is as based on trend confidence and momentum of the system itself and how people feel about what is going on and the prospects moving forward.  Right now, many are questioning the US credit system and a system and its ability to work.  Banks don’t trust each other and are afraid to lend each other money because they think the guy across from them will be the next to blow up, and everyone is scared to do anything because it feel like  you reaching out to catch a falling knife.  This is destructive because nobody makes money or makes the right decision in a state of panic, and when everyone is in a state of panic and fear, losses and down cycles extend more severely and unnecessarily.    

Implementation of the plan will relieve the fear in the system and will provide the much needed liquidity to the credit markets to get it flowing in an orderly fashion.  There will actually be an operational, systematic credit market once again in the United States.  At the same time peoples trust and confidence in the system will be re-established and banks will be able to lend to each other and to main street firms with confidence once again.  Once things return to “business as usual” the entire mood of the marketplace and business overall will be restored and everyone will be able to take a deep breath because they will feel better about the direction of things that are so critical to the way that they live their lives.  This will make a monumental difference in the length and severity of this crisis and US residential real estate downturn overall.

The Paulson Plan

Bailout or Rescue Plan?

Position Document: Legacy Resort Consulting

We have been getting a lot of calls from many of our clients over the past couple of weeks asking us how we are feeling about things on Wall Street and Main Street and what our general position on the treasury proposed rescue plan.  Some of the most common questions have been So how did we get here?, What is the plan?  What are the eventual effects of the plan?  And Is this really just a Wall Street bailout in disguise? We have spent a lot of time sharing our professional position on these critical topics and decided it best to share our overall position with everyone via our Blog.

It is to be noted that our position on this topic and time period in general is based on the overall theory, principals and spirit of the rescue plan.  It seems that with every passing day another senator or congress person is trying to attach their personal agenda to a continuously modified plan that is not yet finalized and at the time of this document a final version still has not been released to us for review or for “house” vote. 

So…How Did We Get Here? 

A Brief Synopsis:

By: Legacy Resort Consulting

Do you have a couple of days??...In all seriousness…although we are not economists or Wall Street professionals, we are often in touch with both and follow market trends and situations very closely as they directly affect our lives and the lives of our clients. 

To dive deep into the details of what has occurred over the past few years to get us to this point could and will be a novel someday.  The following is our opinion and our 10,000 foot overview of how we got hear based on our research, analysis and experience. 

Much of what is presently occurring will be traced directly back to a legendary excesses in the US primary residential real estate market, loose regulations and restrictions on lending practices, and organizations that exercised extremely poor judgment and business sense with respect to unsustainable leverage and risk tolerance in securities developed and secured by the originated mortgages in the forms of CDO’s, SIV’s and other investment tools.  For years, these loose mortgages and the investment vehicles created from them were issued and proliferated around the world during a sustained US market primary residential housing boom.  Folks that were unqualified by many standards for credit were receiving loans without documentation of anything and were in some cases buying houses with little to no down payment.  They would get into adjustable rate mortgages with a short term lead years teaser rates that were affordable in the short term but would go up in time via a mortgage recast.  However, these buyers didn’t care because they would either sell “flip” the home for a profit before the rate increased, or would refinance the loan into a lower fixed rate note using the “guaranteed” equity gained over the next couple years as the new down payment.

This method worked well as long as the US primary residential market was growing consistently year after year which it was.  Home ownership was increasing annually, home owners were making money, securitized debt investors were making money, and everyone was happy….until the wheels fell off the wagon and it all turned.  Everyone seemed shocked to discover that no market or asset class goes up in a straight line forever.

 In the end, all markets are based on the theory of supply and demand and eventually will get out of balance and need to correct.  Corrections are normal part of economic cycles and are expected, but in this case things are different because of the proliferated greed, lack of regulation, and intolerable amounts of invested leverage.  These three things combined with some questionable accounting rules such as the “mark to market” rule and others have created a perfect storm of equity and liquidity evaporation bringing the American credit and lending system to a grinding halt. 

Without liquidity, credit, and a market to trade many of the questionable securitized debt vehicles, several well known and respected banks and investment companies were no longer able to sustain their business operations were literally choked out of business.  Reputable, well known firms Freddie and Fannie Mac received the “Anaconda treatment” as well as well known Wall Street names such as Bear Sterns and Lehman Brothers.  The “Anaconda” spread to get some deposit banks also such as IndyMac, Washington Mutual, and Wachovia which were all forced to close their doors and/or open as a merged company fire sold in the middle of the night to the likes of companies like Citibank and JP Morgan with the assistance of the FDIC and other federal agencies to ensure an orderly and successful failure. 

If this was just a US real estate market correction, or a Wall Street problem we might be ok, shrug our shoulders and say boom and bust is the way of capitalism, and only the strong survive.  Failure of some brings opportunity for others and this is how people get ahead.  But this time it is different and bigger because the noxious securitized debt products were acquired as investments by many pension funds, private companies and other entities that touch Main Street firms and “regular” people.  Further, risk in these noxious debt investment products was insured and re-leveraged by many of the largest insurance firms in the country against failure against a cash reserve of about three cents on the dollar in which over exposure has brought some like AIG literally to their short term operational knees. 

So….this de-leveraging cycle has created an issue where the financial credit system of the United States of America is at risk.  Without liquid credit markets from and between financial institutions, many companies in various industries around the country on Main Street and Every Street will fail, causing wide spread panic, loss of jobs, retirement funds, and fear not seen since the depression in the 1930’s. 

The main issue and cause for grave concern is not so much the fact that pension and retirement funds are losing money across the world it is more about the lack of confidence and transparency on other financial institutions that have led the short term credit markets to freeze up.  This freezing up gravely affects many companies and various levels of government because they rely on short term debt to fund their daily operations.  Without a short term credit system in good working order companies all over the country and globe are not able to get money to run their business operations and will be choked out of existence.

 The last line of defense in the system is the Federal Reserve.  In the instance of system failure and seizure it is their job and duty to step in and do everything possible to avert a financial “Pearl Harbor” and keep the financial system intact and working.  This is why Treasury Secretary Paulson has come to Washington, DC with a “bailout” or “rescue” plan that needs to be recognized and passed into law.