Why Not Help Main Street?

I can understand why politicians have shown opposition to the current administrations bail-out plan. Simply put, it was insane. They asked for up to $700 billion of taxpayers’ dollars with really no thoughtful explanation of how the money was going to be used or who was going to make sure it was used wisely. That said, some sort of plan is critically necessary if for no other reason than the President said that without it, our financial system would likely fail. The basic reasoning put forth for this plan was that the financial system was clogged up, and the government needed to do something immediately to clear out the pipes to get the money flow moving again. Although the reasoning is sound, the suggested action was not.

What the administration should have done is announced a thoughtful plan of significant magnitude was in the works, outlined the key objectives and possible tactics, pulled in the best bi-partisan thinkers on the topic for substantial and meaningful dialogue, then worked with Congress to get it passed. The confidence that something meaningful would come of it, combined with the uncertainty as to what exactly that was going to be, I think would have been enough to settle the markets for a while. Instead the ridiculous plan and the alarmist remarks and posture has caused impossible to quantify damage to the reputation of the United States overall, and the financial markets in particular. Enough said. What now?

Now they still have to come up with a plan to declog the system of bad loans, but I would like to suggest why pairing that plan with a main street bail out is a really bad idea. First of all they are really two separate issues. If the primary concern right now is to reduce the risk and hopefully prevent the financial markets from experiencing a systematic failure, then that implies a set of actions which equitably support those institutions and processes on which the system depends. A lot of this has already been done. First they took over Fannie Mae and Freddie Mac, the largest owner and guarantor of mortgage backed securities. My hope is that they are putting together a good team to manage them, but since that is ‘old news’ we have not heard anything yet. They also bought AIG, the country’s largest insurance company, and are in the process of thoughtfully dissecting their balance sheet and associated risks. By guaranteeing money market funds they stopped the flee of assets out of them, and by turning the largest investment banks overnight in to bank holding companies, they stopped the money exodus there. Further by expediting the sale of WAMU to JPMorgan, they saved the FDIC. Other such moves are likely and have nothing to do with the ‘bailout’ per se.

This bailout fund could thus be exactly that, a bailout fund. The government should hire the smartest, independent, fixed income and specifically mortgage asset minds they can find and give them a chunk of money to manage with oversight. I could name three people right now that would be right for the job. Just like private players are scrambling to put teams together, raise money, and start buying, so should the government.

This is now a significant human capital challenge and not just a financial capital challenge. Can and will the US government find the best people to help manage the assets that now sit on the US Governments Balance Sheet? Key hires would certainly go a long way to regain my confidence.

So now that we have that problem of a Wall Street problem solved, on the Main Street Issue. I understand and empathize that Americans are suffering great financial hardship. I do not want to see families forced out of their homes because they cannot afford to pay the mortgage. I further understand that the costs associated with foreclosures are likely higher then reducing many people’s outstanding loan balances. Some people are in that situation because they have faced spirally health care costs, others because of lost jobs in the construction industry, others because they took out a mortgage the terms of which they did not understand. The reasons are in the millions and each is unique. According to today’s Wall Street Journal 4 million households are behind on their mortgage payments and facing foreclosure, with an additional 2 million possible this year. The problem is that for every American in that situation, there is many more who found a way to pay their bills. For some they went without many things their neighbors had to avoid debt, others took second jobs in the evenings, some borrowed from family members, still more bought lesser of a house or took out a mortgage with a higher upfront mortgage payment. Again there are millions of reasons why these people are not in financial ruin and each is unique.

Let me complicate this all another step. The majority of all these loans are securitized which means that they are not held by the issuing entity but rather have been packaged and sold to the public markets. What happens in the event the borrower defaults is outlined in the bonds offering memorandum. Primarily institutional investors buy (and sell) these securities knowing, and relying upon, the bond paying off according to those terms. The price at all times should be a function of the buyers and sellers assumptions of the likeliness of payment or lack thereof, of the underlying cash flows. The government altering the terms of the loans somewhat arbitrarily has unknown consequences on the financial system and the players there in that have bought and sold and written derivative transactions on those underlying cash flows. Once again we are talking about the integrity of the financial system here. The Government and all associated regulatory authorities allowed this level of complexity and yes, craziness, in to the system, and know they must, must, thoughtfully not arbitrarily work to undo it.

So there it is, the moral question, who do you help and who do you not? Is it fair for the government to suggest substantial and blanket relief for the homeowners in delinquency situations while offering nothing to those who might have handled the exact same life circumstance with more financial prudence? Is it fair that they change the terms under which financial participants, those same participants that collectively hold trillions of government debt, buy and sell mortgage backed securities? Talk about moral hazard? Again my heart goes out to people in economic hardship, but the message the government would be sending to everyone in this country by some sort of blanket Main Street bailout is just plain ‘Un-American,”

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