Behind the bale-out

Hopefully, we will come out of all this with our bank balance and house intact.

I have seen so much stuff lately that I am convinced that we are in a no man’s land where people (bankers, for goodness sake) make predictions about the future that they have created through their misdeeds. Who on earth would pay any credence to their predictions, particularly when some of them say that the good times are just around the corner and others say that there are still skeletons in every cupboard?

The problem was and still is that when interest rates were ridiculously low (and they are at that point again in the US), people were sold houses on long term mortgages but with short term interest rates close to zero.

Who the hell wouldn’t buy a house when you could borrow money for nothing?

However, those legal documents called mortgages had provisions in them that at a certain time in the future, the interest rate would go to market. In the meantime, everyone wanted to buy a house, even Gerry who had just been released from prison, had no income and had previously been bankrupt.

Then an amazing thing happened. The price of property went through the roof and Gerry found for the first time in his life that he had an asset, so he borrowed against the asset at close to zero interest.

Then there were millions of these people borrowing money at low interest. Then the dark side of the story starts to creep up on us.

There in the background were guys in pinstripe suits with white shirts and silk ties. They had the Dale Carnegie smile and everyone trusted them. They got hold of these mortgages and put them together in a bundle and pointed out that while the interest rate at the moment was close to zero, “look at the fine print” and you will see that in a couple of years, the interest rate will go to market. Buy these mortgages now for a bit more than they are worth on the present interest rate and you will make a fortune”.

A guy called O’Neal at Merrill Lynch and a guy called, of all names, Charles Prince at Citibank came in like suckers and bought billions of these things. They and a lot of their pinstripe suited mates made unimaginable commissions on the transactions.

Merrill Lynch and Citibank have taken such a hit that Merrill Lynch has now been taken over. A few majors have collapsed.

The fact is that people couldn’t pay the interest rate when it went to market (thanks to the Federal Reserve Bank which was the initial and ultimate culprit because it didn’t pay credence to the damage of zero interest rates on the one hand and unbearable interest rates on the other).

Suddenly, banks were calling on borrowers to pay them interest, otherwise the banks would have to write off losses. Of course, the likes of Gerry couldn’t and so the banks did what banks do, and that is call in the loan and sell the house. That was fine for the first few sales but suddenly, every 10th house in the street was on the market and you couldn’t give houses away.

Then there was another interesting twist to the story. The regulators had insisted in recent times, because of the dishonest behaviour of many CEOs, that all assets had to be brought to account in the books of the various businesses at market values.

What was the market value of mortgages where the property was worth less than the value of the mortgage? No one would touch them and so you couldn’t get a market value with the result that the banks who bought this stuff had to write them off to zero.

That made a big hole in their balance sheet with the result that it was difficult for banks in US to borrow money because people feared that the money would end up in a big hole. So, what to do? Sell the damned properties for anything they could get and get the hell out of the mess.

However, when everyone is selling property, you get the opposite result to when everyone is buying a property. Prices go through the floor. Decent people who had their family homes were then faced with their entire life saving going up in smoke. America was faced with the prospect of domestic wealth disappearing into banking-greed-created ether.

In the meantime, O’Neal, Prince and Co and a lot of lesser pinstripe suited geniuses had walked away, like naughty children who had set fire to the school and didn’t own up, with millions. O’Neal took a cheque of $170 million and Prince $93 million. That doesn’t take into account the commissions that they and all of their cohorts received by setting up this fiasco. They are now sitting pretty on all of their millions.

Along comes a guy called Paulson who is the Treasurer in the US administration. He is an ex banker and took a capital gains free ride on his sale of $500 million worth of shares in Goldman Sachs when he took on the Treasury appointment in the administration. (I bet he looks at the stock price of Goldman Sachs at the moment and counts his blessings.)

Despite that, he can add up and subtract and get pretty close to the right answer when he adds two plus two and takes away five. He does the sums and says “Sh….eet! What the hell are we doing here? If we don’t do something we are @&*%+!!!!).

Paulson could see all of these decent Americans and quite a few Gerrys absolutely going down the gurgler. Now, being an ex banker, that probably didn’t bother him all that much, but he is smart enough to realise that if that happens, everyone else goes down with them; the American economy would go into tail spin because no one would have the assets to borrow, let alone spend anything (except guys like O’Neal and Prince who were savvy enough to put their money under their pillows).

Houses would be sold for nothing, people would be out in the streets waiting on food lines and the great US economy that drives the world would be in tatters, not to mention what would happen to you and me.

So, Paulson comes up with a brilliant idea. Uncle Sam can borrow $1 trillion (don’t even try to think of how much that is because it is incomprehensible other than to indicate the extent of the rapacity of the guys who caused the mess) and give it to the banks (who have stuffed up and paid the O’Neal’s of this world squillions so that the banks can dress up their balance sheets), the tax payer can wait until houses are worth something and the owners have a job and can make repayments and everyone will live happily ever after.

Then the plot gets really sticky and demonstrates why you should never trust bankers or politicians with your money. Paulson has to get the representatives of the people to agree to this phenomenal undertaking. The politicians want to look good in the eyes of the public who know that the bankers have screwed them and have walked away with billions and left Gerry and Co in the lurch.

So, the politicians say to Paulson “to hell with your scheme, you are just loading on to the tax payer the cost of salvaging your mates on Wall St who have walked away with billions”. Paulson says “I am afraid that is true but if you can look at what happens if we do nothing. Our friends on Wall St who made squillions in this fiasco, will still have their money, and in the meantime the ordinary Gerry in the street, the taxpayer et al will lose everything and the US economy will go down the spout. Give me a better idea”.

The politicians then smell a rat and think they are being set up by this smart banker from Wall St and so they parade on the stage making all sorts of wonderful comments like “we aren’t going to get the taxpayer to pay the bill of these crook bankers”.

The public love it but are unaware of the fact that a time bomb is ticking away. Paulson says that if nothing is done, then a meltdown is inevitable. The politicians secretly know this to be true but publically are trying to score political points.

In the meantime, Paulson has done his balance sheet. On the face of it, Treasury borrows $1 trillion of debt from banks that have no market value because you can’t sell them for love nor money. Suddenly, the banks get something for what they had previously brought to account as valueless, so their balance sheet is improved and their ability to borrow is enhanced.

Then Uncle Sam stops the foreclosures that have been continually reducing the price of property as well as the balance sheets of banks. There are fewer houses on the market and the value of property stops falling. In fact, after a while it gradually starts going up again. Then, all these debts that Uncle Sam has purchased are worth more than they paid for them with the result that the taxpayer actually comes out on top.

But politicians can’t add up and bankers find it hard to subtract, with the result that no one is prepared to take the risk on Paulson’s bale-out package and no one can come up with an alternative. We are on the brink.

My guess is that the politicians will throw in the towel and say to Paulson “it is on your head and God forgive you if this doesn’t work”. Paulson will say, ‘It won’t work unless everyone, including the politicians, pay more than lip service to the scheme”.

In the end, some half baked compromise will come along and America will limp by until some bankers and politicians finally find the formula to completely wreck the world economy. My hope is that Congress will go with the Paulson fix and stay with it. If that happens, we will walk out of this nightmare with our bank balance and home intact.

It would be nice to catch the crooks who made this mess, but if we let emotions enter into the process of addressing the problem (and it would appear that Paulson hasn’t succumbed to that terrible affliction) then nothing will be done and everything that shouldn’t happen will. It is out of our hands and in the hands of the United States Congress which ostensibly represents the people. Let us hope that they act in the best interests of those they represent.

To be continued.

Louis Coutts left law and became a successful entrepreneur. His blog examines the mistakes, follies and strokes of genius that create bigger, better businesses. Click here to find out more.

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