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9 Points about Paulson's Plan

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Oct 1, 2008 7:15 pm

I got this in a spam email from, I usually wouldn’t post these, but I thought it had some nice points that you may want to share with your clients.


1. Don’t confuse the stock market with the credit market. Yes,
the stock market lost 780 points Monday and regained 485 Tuesday. But
that doesn’t mean the crisis is over. That doesn’t mean the credit
markets are safe.

The stock market is about owning equities. Credit markets are about
owing debt. People can live large but owe it all to the bank. So can

Think of the economy as a human body. The stock market is the body’s
temperature, while the credit market is the body’s circulatory system.

Rising and falling temperatures indicate problems in the body, but
they aren’t the cause of the problem, and they can usually be managed
with two aspirin.

Credit, on the other hand, circulates throughout the system, fueling
businesses, industries, and consumers—all the organs that keep the
economy alive. Shut off that blood—even choke it back a bit—and vital
organs start to shut down. One organ failure leads to another until the
whole system enters a death spiral. That’s what happened in the
depression of 1929.

2. The credit markets are frozen.
The lifeblood of the capital system—the credit markets—is on the verge
of totally seizing up, because banks don’t trust each other’s solvency.
This solvency and trust issue has the potential to throw the economy
into a coma.

Symptoms are already beginning to appear:

Bank of America refused loans to McDonald’s franchisees, and United
Airlines is “doing everything short of roaming through its cabins
looking for loose change,” said BusinessWeek.

California State University campuses, the largest four-year
higher-education system in the country, warn they won’t be able to
accommodate rising enrollments due to budget concerns, reports the Los
Angeles Times.

A tractor company recently announced it will no longer provide six
months’ credit on equipment parts, said Rochester, New York’s Democrat
and Chronicle.

Credit card companies are offering lower lines of credit, reports the Associated Press.

Approximately 65% of domestic banks have tightened lending standards
over the last three months, the Federal Reserve Board reported in
August. About 80% of banks reported tightening their commercial real
estate loans, and 75% (up 60% from the previous survey) tightened their
lending standards on residential mortgages.

How much more money do you want to lose? The
government’s failure to pass the bailout bill took $1.1 trillion off
the market Monday—not to mention the trillion lost since the start of

Those kinds of losses come directly out of investors’ accounts—a fact
that will be very apparent when statements arrive in the next couple of
weeks. More losses will be forthcoming as the credit markets convulse.
True, the bailout may also cost investors $1 trillion dollars, but they
won’t have to pony up the cash immediately. In fact, there’s a very
good chance that taxpayers may never feel the hit if assets are sold in
a profitable manner. And some of the best money managers in the world
are lining up to sell those assets—for free!

Systemic problems require systemic solutions. Suppose an arm or leg
loses circulation. Amputation is often necessary, but if you don’t
treat the circulatory issue, the patient could die. The rescues of Bear
Sterns, Fannie Mae and Freddie Mac, and AIG were amputations. But they
didn’t treat the underlying issue. The government needs a broad
strategic approach to cure the bad mortgages. In effect, we need a
treatment that either eradicates the malignant cells (bad mortgages) or
transforms them into benign cells (good assets) that could eventually
benefit the system.

Government intervention is necessary.
In an ideal world where rational economic units transact business in a
transparent and frictionless environment, markets might be able to work
out dislocations on their own. But as noted economist John Maynard
Keynes observed, markets aren’t always self-correcting. Irrational
investors can demonstrate extreme forms of "liquidity preference,"
stampeding into safe investments like three-month Treasury bills. “Once
doubt begins, it spreads rapidly,” he said.

Keynes advocated deficit spending during economic downturns to maintain
employment and mitigate “social misery.” Fed chairman Ben Bernanke, an
expert on the Depression, has estimated that if the credit lockup
continues, three to four million people could lose their jobs in the
next six months.

While the bailout plan may not be perfect, it will create a market
where the illiquid mortgage-backed securities can be valued and traded.
It will set up regulatory oversight on how these toxic assets are
valued and disposed of. It will get money and credit moving again.

And this isn’t the first time the government has intervened to solve
economic problems. During the savings-and-loan crisis of the 1980s, the
government established the Resolution Trust Corporation, which made a
profit of $394 million. President Clinton bailed out the Mexican peso,
which made the American taxpayer $500 million. During the Great
Depression, Congress established the Home Owners Loan Corporation,
whose purpose was to refinance mortgages to prevent disclosure, and it,
too, turned a profit.

Nor does the bailout lead the way to increased socialism. This
legislation is not the biggest government intervention ever. That honor
belongs to Richard Nixon and his imposition of wage and price controls
in 1971. Henry Paulson may privatize unprecedented amounts of debt, but
Nixon commandeered the entire economy, says noted economist Robert

More toxic debt is coming.
People need to be reminded that this is only the beginning of what
could be a very prolonged crisis. Moody’s estimates that
banks made 15 million questionable mortgage loans from 2004 to 2007. It
estimates that 10 million of those will default.

These toxic assets are heading toward lenders’ balance sheets in waves.
The data, according to Clayton Holdings, a reporting service, is grim:

Subprime mortgage delinquencies have increased. The percent of loans
made in 2006 that are now 60 days late reached 40.24% in August, up
5.49% from the previous month. The delinquency rate is 30.82% (up
6.05%) for subprime loans made in 2007.

The delinquency of Alt-A loans—so-called liar loans, because they
were made with little documentation—is growing worse. For Alt-A loans
made in 2006, the 60-day delinquency rate is 25.26%, up 9.44% from a
month earlier. For Alt-A loans made in 2007, the 60-day delinquency
rate is 22.65%, up 16.43% from a month earlier.

Foreclosures are declining somewhat, but not because there are fewer
of them. Banks are slowing the process down because of falling housing
prices—which means they are carrying a lot of inventory on their books.

The ratings services are increasing their loss assumptions. Standard
& Poor’s now estimates 40% losses on Alt-A and negative
amortization loans, up from 35% earlier this year.

Many of the Alt-A loans were made to borrowers with good credit
scores but who were not required to document their income or assets.
Many of the loans were adjustable-rate, interest-only for the first
five to seven years, so their defaults aren’t even being felt yet.

What’s worse is that there are just as many Alt-A loans as subprime
loans. Alt-A loans made up 28% of mortgage-backed securities in
2005—the peak of the lending bubble. Subprime made up 29%, and
prime—loans to credit-worthy borrowers—made up 24%, according to

The key point here is that we need a clearinghouse or program in place
to deal with years of toxic assets. This is not just a 2008 problem,
but one that could last well into the next decade.

We don’t know what stocks are really worth. Companies
are carrying more than $62 trillion in credit default derivatives on
their books (compared with $1 trillion in subprime mortgages). These
financial “weapons of mass destruction” are so convoluted and toxic
that they have toppled such venerable companies as AIG, Bear Sterns,
and Lehman Brothers. Warren Buffett has said it took him four years and
$400 million to unwind the positions in one of his insurance companies.

Why are derivatives so important to get off the books? They are
clogging up balance sheets, which affects earnings and stock prices.
Price-to-earnings ratios are down, but they are still not cheap, says
Rob Arnott, chairman of Research Affiliates, in a recent Pensions &
Investing webcast. As balance sheets are cleaned up, there will be
fewer market shocks, investors will regain their trust in the market,
and equities can resume their upward trend.

Employment will stay steady. A thriving credit market
means employment stays strong. Businesses keep selling and consumers
keep buying. “Without the bailout, the unemployment rate could hit as
high as 12%,” said Brad DeLong, a professor of economics at the
University of California at Berkeley. “A successful bailout could help
keep the unemployment rate stay below 8% for the next year.”

America’s superpower status is at stake. It’s
imperative to show the rest of the world that the U.S. can act swiftly
and responsibly in the face of a crisis. We must be sure that
international creditors such as China and other nations continue to be
confident in the security of the U.S. economy. Foreigners finance the
American economy, and if they stopped buying Treasuries, or started
selling their reserves, the dollar would fall and interest rates would
rise, squeezing the economy further. “If we were an emerging market,
the exchange rate would be down 70% and interest rates would be up at
25%—that’s what a crisis looks like,” says Kenneth Rogoff, an economics
professor at Harvard University.

Perception may be even more important to military might than having a
great army or the latest technology. Max Boot, a senior fellow at the
Council on Foreign Relations, wrote in a recent editorial in the Los
Angeles Times:

“A visiting Israeli Cabinet minister made an
interesting point at a conference in Washington over the weekend. The
current financial crisis, he said, is undermining the perception of
American power when it comes to dealing with problems such as the
Iranian nuclear program, Russian adventurism, or the growing threat
from Hamas and Hezbollah. Various actors around the world look at the
U.S. and see a crippled giant. That reduces incentives to make
concessions to Washington.”

Is it merely coincidence that North Korea picked now to reactivate
their nuclear plants? Or that Russia is selling arms and nuclear
technology to Venezuela? Unfortunately, democratic dithering can look
very messy to outsiders, and the lack of decisive action can undermine
America’s standing as a military and economic superpower.
Oct 1, 2008 7:48 pm

Ice …the Looming Financial Crisis has panicked not only Wall Street but Main Street. If I hear one more reference to Main Street ( the reporters have obviously not seen the deserted and boarded up Main Streets ) in many cities I am going to upchuck on Cramer and Suzie

Oct 1, 2008 8:07 pm

I am making up a list for my clients and co-workers and if I hear any of the phrases they will be promptly taken out My personal version of the" No Spin Zone ".

Oct 2, 2008 1:14 am

Dedicated ta muh ma friend…Mr Billy Joel in the hood

Seen the lights go out Wall Street
I saw the Empire State laid low
And life went on beyond the Palisades
They all bought Cadillacs
And cashed out long ago

They held a concert out in Brooklyn
To watch the mortgage-backed securities blow
They turned our power down
And drove us underground
But we went right on with the scheme

I’ve seen the lights go out on Wall Street
I saw the ruins at my feet
You know we almost didn’t notice it
We’d seen it all the time on Wall Street

They burned the Stock Exchange down in Manhattan
Like in that Spanish civil war
The flames were everywhere
But no one really cared
It always burned down there before

I’ve seen the lights go out on Wall Street
I saw the mighty skyline fall
The boats were waiting at the battery
The union went
on strike
They never sailed at all

They sent a carrier out from Norfolk
And picked the Yankees up for free
They said that Queens could stay
And blew the Bronx away
And sank Manhattan out at sea

You know those lights were bright on Wall Street
That was so many years ago
Before we all lived here in Florida
Before the Mafia took over Mexico
There are not many who remember
They say a handful still survive
To tell the world about
The way the credits dried up
And keep the memory alive