Informed Speculation

…and I’m not wanting to take on any more.  It’s bad enough that the government is running huge deficits again under George W. Bush, a Republican president (and one whom I mostly admire), but now the taxpayer is being asked to shoulder the burden of bad decisions made by multi-millionaire executives and billionaire hedge-fund operators.  Enough!

Sure, the Dow Jones rose over 400 points today on news that the government is prepared to take even more bad debt off of the market.  Why wouldn’t investors cheer a decision that takes away the pain of their bad investment decisons? When I say cheer, I mean literally:

Traders erupted into cheers on the floor of the New York Stock Exchange as the Dow Jones Industrial Average jumped 617 points from its low of the day after Senator Charles Schumer proposed a new agency to pump capital into financial companies.

“A new agency to pump capital into financial companies”…it sounds so innocuous, doesn’t it?  But what can that possibly mean?  Companies raise capital by selling assets, bonds, or shares…so who’s going to buy these assets?  Why, you – the taxpayer, that’s who.

We are nationalizing huge chunks of the financial industry, and though legislators such as Chuck Schumer are assuring us that the government will get paid back first, there’s no guarantee the government will get a single red cent for the taxpayers’ involuntary ‘investments’.   In fact, there is every reason to believe the losses will be staggering, into the hundreds of billions.  These assets are beyond distressed – they are practically worthless:

At least three things need to happen to bring the deleveraging process to an end, and they’re hard to do at once. Financial institutions and others need to fess up to their mistakes by selling or writing down the value of distressed assets they bought with borrowed money. They need to pay off debt. Finally, they need to rebuild their capital cushions, which have been eroded by losses on those distressed assets.

But many of the distressed assets are hard to value and there are few if any buyers.

…In normal times, capital-starved companies usually can raise money on their own. In the current crisis, a number of big Wall Street firms, including Citigroup Inc., have turned to sovereign-wealth funds, the government-controlled pools of money.

But both on Wall Street and in Washington, there is increasing expectation that U.S. taxpayers will either take the bad assets off the hands of financial institutions so they can raise capital, or put taxpayer capital into the companies, as the Treasury has agreed to do with mortgage giants Fannie Mae and Freddie Mac.

One proposal was raised by Barney Frank, the Massachusetts Democrat who is chairman of the House Financial Services Committee. Rep. Frank is looking at whether to create an analog to the Resolution Trust Corp., which took assets from failed banks and thrifts and found buyers over several years.

“When you have a big loss in the marketplace, there are only three people that can take the loss — the bondholders, the shareholders and the government,” said William Seidman, who led the RTC from 1989 to 1991. “That’s the dance we’re seeing right now. Are we going to shove this loss into the hands of the taxpayers?”

The answer appears to be an emphatic “yes”…

UPDATE 5:22 p.m.: I find this assertion by Barney Frank to be less than reassuring:

“We need someone big enough, strong enough, stable enough to buy them and see some more value in them,” Frank said. And this approach appears to have gained strength not just because of the deteriorating markets but the possibility that the long term risk to the government may be less at the current prices.

“We hope to structure this so a lot of it would get repaid,” Frank said. “I think you have undervalued assets out there…but the costs of not doing anything are enormous.”

Rubbish…if the assets are undervalued, there are plenty of entities who have the cash to take them on.  The market is signaling that the assets are OVERVALUED with the sell-off we are seeing.  Bad debt must be purged from the balance sheets, and it will be very, very painful.  The problem is that the assets are probably properly valued, at next to nothing…

UPDATE 8:06 p.m.: Look at that Barney Frank quote above again: “We hope to structure this so a lot of it would get repaid”.

Translation: We know up front that most of this is going straight down the tubes, but we’re crossing our fingers that we might get 30 cents back on the dollar…

UPDATE 10:49 p.m.: An update on The Great Government Bailout, Part 87, to be announced this weekend, from the Washington Post:

While it is unclear what form such an entity would take if, it could be costly for taxpayers, said [Bill Stone, chief investment strategist for PNC Wealth Management]. “That is why you need intense pain for people to be willing to do it. You are still putting significant taxpayer money at risk,” he said.

While the reports of the move helped spur a late-day surge, “it is not clear at this time if it will be sufficient to calm the markets,” said Joseph Brusuelas, chief U.S. economist at California-based Merk Investments. “One would think that what is needed is coordinated global action by central banks and Ministers of Finance to address the evolving breakdown of the global financial architecture.”

“Significant taxpayer money at risk”…”not clear at this time if it will be sufficient to calm the markets”…getting nervous yet?  Just wait:

The credit ratings agency Standard & Poor’s this week said financial institutions face “another large wave of write-downs in the second half of 2008″ in the value of securities backed by mortgages. S&P predicted that write-downs on subprime-mortgage investments would reach $378 billion, and that the total could be “well over $500 billion” if securities backed by other types of impaired mortgages are included. The forecast was far worse than in March, when S&P said subprime totals could reach $285 billion. 

How much of that $500 billion should be eaten by taxpayers, and how much by investors in the relevant companies?  My own answer is zero, and all, respectively, but I fear the obverse is now the official government goal…