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.