Thursday, October 2, 2008

Making Tough Decision

I almost titled this post "The Bitter Pill" but thought better.

The Senate has voted in favor of a $700 Billion bailout of Fannie Mae/Freddie Mac. Wow. $700 Billion is a lot of money no matter how you view it. What do the taxpayers get in exchange? We get to be in the mortgage investment business corporately (as in we're all in this thing together). We will own $700 Billion worth of mortgages which are secured by about $560 Billion worth of real estate (assuming a 125% of value mortgage).

Once we own those mortgages what will we do with them? The first hope is that we could re-sell them on the open market. That could be a problem. The one's the government will own are the one's no one else wanted in the first place. Will we foreclose on the properties for those mortgages that are non-performing? Hmm -- I have a hard time seeing that happening although it does in small doses already. FHA has been foreclosing on real estate for a long time.

Let's say that we eventually will recover about half of the $700 Billion by either selling the mortgages or the foreclosed properties. That means about $350 Billion will be non-recoverable debt -- that will be made up from taxes. That's what makes this such a bitter pill to swallow.

But, let's look at the other side of this. What happens without a bailout?

First, we have a bankrupt Fannie Mae and Freddie Mac. Their assets are liquidated by the court and the net result to the economy will still be a loss of about $350 Billion. But we also have all of the $5.3 Trillion in mortgages that were guaranteed by Fannie Mae/Freddie Mac whose guarantees are now worthless. Any of the mortgage based securities sold to various financial institutions and individuals that are non-performing are now worth considerably less than their previously guaranteed value.

In the case of securities held by individuals, it is a matter of writing down their value, taking the loss and moving on. In the case of those held by financial institutions there is suddenly a huge problem. When the securities are written down, the financial institutions must then "classify" those assets as non-performing. Those classified assets offset the capital of the financial institution and cause many to drop below the minimum threshold required by the FDIC or other regulatory bodies. It also drops the available funds for lending to borrowers even though they may be well-qualified borrowers. In other words, the credit market dries up and many banks fail.

What happens when the credit market dries up? Business comes to a halt. Grocery stores can no longer stock their shelves. Auto dealers can no longer extend credit because somewhere behind that dealership is a bank or other financial institution underwriting the loan. In fact, many businesses will fail if credit becomes tight. When businesses fail, people lose their jobs. When people lose their jobs in an economy which is contracting due to unavailability of credit, there is little hope of finding a new job. We enter into a Depression.

This financial disaster is NOT a Wall Street problem alone. It is a Main Street problem. It affects the stock market because corporations must have credit to operate. The real problem though is the impact on the credit markets. Without credit, our economy comes to a halt. The taxpayers are going to be hit whether a "fix" is passed or not. The hit will be much harder and much more severe without a fix. No fix means Depression and huge loss of equity in retirement plans and many other assets. A fix means buying time to come up with a longer-term solution.

I applaud those Senators, like John Cornyn, who voted in favor of the fix. They knew that it was not the popular thing on Main Street. But, they also know that it is sometimes necessary to make tough decisions. I mention Senator Cornyn because he is up for reelection this year. His opponent can make political hay of this vote and if he's smart, will do his best to make the Senator appear to favor Wall Street over his constituents. In fact, it's the other way around. By making the tough call, Senator Cornyn is siding with the people of Texas. I pray that he will have opportunity to present legislation that will begin the process of fixing the underlying problems that created the financial meltdown in the first place. We need to send him back to Washington for another term.

1 comment:

Anonymous said...

John Cornyn and Kay Bailey Hutchison both voted FOR the bailout last night.

Today I dropped my support of Sen Cornyn and his re-election to the post of Senator, and I sent the Cornyn campaign and Sen Cornyn himself an email letting them know, it can be read in the thread linked above.

In a very short time I was contaced by Vincent Harris, wanting my phone number, their campaign manager wanted to talk to me, and I told him NO, I could not, and would not support ANY candidate that voted to bailout $700B, a figure that is still low, actual figures are reported closer to $820B, and that I was pulling their logo from TexasFred's, The American Conservative and The Texas Connection, and I did.

Jimmy Kerr of But That's Just My Opinion posted a message in my comments saying he had done the same thing. Jimmy and I are trying to contact and encourage as many Texas bloggers as possible to contact Vincent and let him know that YOU are doing the same thing as well, lets send Cornyn a HUGE, Texas sized message!

Please, if you believe that this is a very important issue, PLEASE contact Vincent and tell him that you're dropping the logo too, and ask to be removed from their blog roll, no LINK is that important, request that your blog be taken OFF of their roll...

Contact Vincent here:
vincent@johncornyn.com
http://www.johncornyn.com


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