Ron Paul on the Wall Street Bailout Plan - Part 2

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Today's Blog: Congressman Ron Paul's insights on the proposed Wall Street bailout

Washington's current approach to today's credit crisis is the same destructive strategy that government tried during the Great Depression: prop up prices at all costs. The Depression went on for over a decade. On the other hand, when liquidation was allowed to occur in the equally devastating downturn of 1921, the economy recovered within less than a year.

F.A. Hayek won the Nobel Prize for showing how central banks' manipulation of interest rates creates the boom-bust cycle with which we are sadly familiar. In 1932, in the depths of the Great Depression, he described the foolish policies being pursued in his day - and which are being proposed, just as destructively, in our own:

Instead of furthering the inevitable liquidation of the maladjustments brought about by the boom during the last three years [late 1920s], all conceivable means have been used to prevent that readjustment from taking place; and one of these means, which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion.To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection - a procedure that can only lead to a much more severe crisis as soon as the credit expansion comes to an end... It is probably to this experiment, together with the attempts to prevent liquidation once the crisis had come, that we owe the exceptional severity and duration of the [1930s] depression.

The only thing we learn from history, I am afraid, is that we do not learn from history.

The very people who have spent the past several years assuring us that the economy is fundamentally sound, and who themselves foolishly cheered the extension of all these novel kinds of mortgages, are the ones who now claim to be the experts who will restore prosperity! Just how spectacularly wrong, how utterly without a clue, does someone have to be before his expert status is called into question?

Oh, and did you notice that the bailout is now being called a "rescue plan"? I guess "bailout" wasn't sitting too well with the American people.

The very people who with somber faces tell us of their deep concern for the spread of democracy around the world are the ones most insistent on forcing a bill through Congress that the American people overwhelmingly oppose (calls to the capitol have been running up to 100 to 1 against the bailout). The very fact that some of you seem to think you're supposed to have a voice in all this actually seems to annoy them.

NEXT: Three Bank Monty - Monday's Global Bank Failures

Daryl Montgomery

Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The Peoples Republic of the U.S. - the AIG Bailout

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

In a socialist state, the government decides what a company is worth, not the market. The Federal Reserve clearly demonstrated this concept by purchasing almost 80% of the insurance giant AIG on Tuesday night, September 16th. The Fed paid over 10 times what the market said its stake in AIG was worth. It is not clear what U.S. laws allow for the nationalization of part of the insurance industry, nor what companies will be bought next now that this precedent has been set.

The final phase of AIG's death spiral began on Monday evening when the major credit agencies downgraded it. This credit downgrade required AIG to post billions of dollars of additional collateral for its mortgage derivative contracts - capital that AIG simple didn't have. The implications were far more serous than the public realized, since AIG is a central player in the CDS (credit default swaps) market and does business with almost every financial institution in the world. If AIG went under it would have been unable to pay off its CDS obligations and its counter parties would have unable to collect on its trades. It was estimated that a large number of hedge funds, and possibly some banks, would have gone under along with AIG.

Over the weekend AIG attempted to borrow $40 billion form the Federal Reserve. The Fed, originally set up to lend just to commercial banks, had no legal authority to lend to insurance companies. And even though it had extended its lending to broker-dealers in March and to mortgage giants Fannie Mae and Freddie Mac in July, it was reluctant to add insurance companies to the list. Then on Tuesday evening, the Fed (with support from the Treasury and President Bush) decided to extend its legal authority way beyond anything ever intended by agreeing to pump $85 billion into AIG. The media described this $85 billion as a 'loan' even though a 79.9% equity stake in AIG was being given in exchange (note to media: this is a stock purchase, not a loan). This is not for already existing AIG stock, but for newly issued AIG stock, so AIG will have to increase its outstanding amount of stock to five times its current level. This is a better deal for stockholders than usual, since they will be left with something, instead of being completely wiped out.

Based on Tuesday's closing price, AIG had a market cap of just over $10 billion dollars. In order to buy 80% of the company (which was worth $8 billion according to the market), the U.S. paid $85 billion or over 10 times the market price. Socialism leads to just such economic absurdities. Unless this is stopped, expect more of this in the future - and the permanently ruined economy that always follows.

NEXT: The Mega Move Up in Gold and Silver

Daryl Montgomery
Organizer, New York Investing
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Subprime Freezes Over

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

In December of 2007, the Bush administration proposed freezing the rates on adjustable subprime mortgages for 5 years. This program was 'voluntary'. Indeed the U.S. government had no legal authority to void valid contractual commercial transactions between parties, one of the most fundamental underpinnings of our economy. Nevertheless, presidential candidates Hillary Clinton and John Edwards both immediately criticized the proposal as not doing enough and advocated an even longer freeze on rates.

While the alleged purpose of this program was to help the 'struggling homeowner', an examination of the details indicated otherwise. Homeowners with fixed-rate mortgages got no relief. Homeowners with non-subprime variable-rate mortgages got no relief. Why were just sub-prime adjustable-rate mortgage holders singled out? The answer is simple, these mortgages were defaulting and would be defaulting at the highest rates. Many of these had been granted at the end of the mortgage boom and were for a substantial percentage of the house price at the time of sale (up to and even exceeding 100%). Mortgages for 100% of equity, especially when housing prices are falling, are the last thing banks want to take back and have to write off on their books. These are guaranteed losses for the bank since the foreclosed house would likely sell for much less than the amount of the mortgage. Any bank that had a large number of this type of defaulted mortgages could become technically insolvent fairly quickly. Mortgage bond holders, many of them big banks and brokers, who had bought bonds containing these loans would also lose out. It is a much better deal for banks to foreclose on mortgages that have been substantially paid down, since they make a big profit on these. These homeowners were the most deserving and required the least assistance, so they should have been the centerpiece of any mortgage relief program - but they weren't. Helping them would mean hurting bank profits.

The proposed freezing of sub-prime mortgage rates also represented the first attempt at price controls on the part of the government. Price controls are an almost universal response to inflation by the authorities and prices for necessities are the most likely to be controlled. While the rise in mortgage payments was preplanned and the exact amounts were known in advance (rarely the case with most inflation,) this was no different from any other attempts to dampen rising prices by freezing them. it was not surprising that this took place first in housing either since it is one of the most basic of necessities. Unfortunately, price controls always have negative consequences. In the case of the mortgage freeze, anyone offering loans in the future would have to demand higher rates to compensate for the possibility that rates might be frozen. Or lenders seeing higher risk in the market would simply not offer loans at all. In both these scenarios future mortgage rates will be higher than they would have been. The government could then solve this problem that it created by offering subsidies (a common second response to increased prices for necessities), most likely through Fannie Mae and Freddie Mac. These government supported enterprises would then wind up dominating the mortgage market so much that it would effectively be completely socialized. By the end of 2007, it looked like this was already taking place.

NEXT: The Fed's (long) Term Auction Facility

Daryl Montgomery
Organizer, New York Investing meetup

For more about us, please see our web site: http://investing.meetup.com/21